Mixed up markets

When most people think of "the market," they think of the stock market.  But, there are other markets that are equally or more important to pay attention to.

For example, bond and currency markets are bigger than stock markets.  Commodity markets are important, too, but most people ignore them.

Why are other markets important, you may ask?  Because they frequently bring warnings of contradictory premises held by different participants in each specific market.

In a normal state of affairs, currencies and gold should move in opposite directions.  That's what's happening right now, especially with gold flying high and the U.S. dollar crashing.  All good there.

Normally, commodities move opposite the dollar.  Commodities have been soaring and the U.S. dollar is tanking, so everything looks as it should there, too.

Next, we come to bonds.  Bonds and commodities normally move opposite each other, and here we run into our first contradiction.  Commodities are soaring and bonds are climbing, too.  The first indicates inflation and fast economic growth and the second indicates deflation and slow or declining economic growth.  Both markets can't be right.

Furthermore, commodities and stocks usually move opposite each other, which is just another way of saying bonds and stocks tend to move together.  Climbing commodities indicates inflation and high interest rates (lower bond prices) which both tend to be bad for stocks.

Don't get me wrong, I'm not saying these relationships exist at all times and all places.  But, when I see markets seeming to indicate different opinions, I take notice.  It means markets are mixed up and one will turn out to be right and the other wrong.

Things are pretty mixed up right now.  The dollar is sinking, commodities are climbing, as are stocks and bonds. 

The dollar is sinking because the Fed is going to print money to try to further revive our flagging U.S. economy.  That means a lower U.S. dollar, higher inflation, and rising commodities and gold.  So far, so good.

But, a lower dollar, higher inflation and rising commodities is inconsistent with high bond and stock prices.  High inflation is bad for bonds and stocks.  That contradiction must be resolved.

To further muddy the waters, rising bond prices usually correspond with higher stock prices, but not super high bond prices.  Super high bond prices means very low bond yields, which tends to indicate low growth, deflation and economic stagnation.  And, that's usually NOT a recipe for higher stock prices.  As illustration, Japan's bond prices have gone up for 20 years while its stock market has lost 75% of its value. 

Bonds are indicating slow or negative growth and stocks are rallying, and that doesn't make sense.  Bond markets are right more often that stock markets, so the on-going stock rally might be in danger. 

High gold and commodity prices and a falling U.S. dollar should mean lower bond prices and high bond yields (a.k.a. inflation).  Once again, this contradiction must be resolved.

Over time, all markets will sync back up again.  Either bonds and stocks will tank and the dollar will continue to fall; or, commodities and gold will tank, the dollar will rally, and stocks and bonds will continue to rise.  It may take time, but markets will re-achieve consistentency.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Competitive Devaluation

The issue I fear most from an economic, political and geo-political standpoint is the huge debt overhang of the largest developed economies of the world: U.S., Europe, U.K. and Japan.

Solving this nightmare is not just an issue for the developed world, either, because it also greatly impacts the developing world (especially Brazil, Russia, China and India).

In order for the developed economies to pay off their debt, they must either grow their way out of debt or print money to inflate away the debt they owe. 

Growth would be the best and most honorable way to solve the problem, but growth in developed economies is inhibited by high debt loads (which lead to slower growth) and huge social programs (Medicare, Medicaid, Social Security and their equivalents in the other developed economies).

I'm sorry to admit it, but democracies have never successfully voted away social programs, and I don't think they will this time, either.

That leaves inflation.

But, inflation is a nasty solution to debt problems. 

From an economic standpoint inflation is tough to put back in the bottle once you let it out.  If you think the Federal Reserve or any other central bank has a dial they can turn to 3%, 5%, or any other specific level of inflation, I'm sorry to let you know that smurfs aren't real, either.

Inflation crimps a whole economy as everyone--from employees to employers, from government bureaucrats to private companies--becomes bogged down in trying to figure out wages, salaries, costs, prices, tax rates, etc.  No high inflation economy runs smoothly and efficiently.

The political and geo-political stage started to ripple this week as the U.S. Congress is trying to pressure China into revaluing their currency and Brazil's Finance Minister remarked that an "international currency war" is taking place as governments manipulate their currencies to improve their export effectiveness.  Japan recently announced they will be active in currency markets to prevent the price of the yen from rising too much and becoming uncompetitive in global markets.  These trends will result in the beggar thy neighbor problem I highlighted in a previous blog.

This competitive devaluation process is a race to the bottom and has an ugly history.  In the past it's led to world war and economic collapse.  I wish I could say these were idle fears, but they are not.

The U.S. economy currently has low inflation, and that looks set to last until the private market works down its bad debt problem (which I think will happen over the next 3 - 5 years).  Some believe the U.S. economy will experience the low inflation, deflation and low interest rates of Japan over the last 20 years.  In that environment, cash and bonds will do very well.

Never say never, but I doubt we'll experience what Japan did.  In that case, inflation is the more likely threat, and that's not a good scenario for owning a lot of bonds or cash.

The competitive devaluation that's occurring does not need to continue, so my fears may be unjustified.  Even if they are justified, the end-game is unlikely to play out soon, but over the next decade.  Hope is not a strategy, so I'm hoping for the best while preparing for the worst.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Stock picking is dead; long live stock picking!

As human beings, we have a tendency to look backward instead of forward. 

Psychologists have illustrated this tendency with experiments demonstrating hindsight bias and recency bias.  Nowhere does this seem more evident than with respect to economics and, particularly, the stock market.

As support, see the Wall Street Journal's article today: 'Macro' Forces in Market Confound Stock Pickers. 

The article's point is that stock pickers, with a few exceptions, have not shined brightly in their performance over the last couple of years as macro-economic "forces" have over-whelmed stock picking ability.

Fair point, but only if we drive best by looking through the rear-view mirror instead of the windshield.

It's true, gold, U.S. Treasuries and cash did best over the last two years.  It's true, too, that bonds and cash have beat stocks, as a whole, over the last 12 years. 

But, that's history, not the future.  As Warren Buffett put it, if the past were the best guide to the future investments, librarians would be the billionaires.  They are not.

I couldn't help but chuckle at the title of the article, too.  Confound.  CONFOUND!  The word means overthrow, defeat, ruin according to my Oxford English Dictionary. 

Not a reference to short term under-performance; not a temporary set-back that may reverse; not in contradiction to all financial history; but, confound! 

Isn't this from the same popular press that said Warren Buffett was washed up in 1999 because he didn't "get" the Internet?  Aren't these the same folks that fawned over the housing boom and how home prices could never go down?  Check, and check.

And, now, they've pronounced stock picking is ineffective, done, washed up.  To me, that sounds like an excellent reason to bet that stock picking is about to come back in a major way.

Remember, the popular press called for the Death of Equities in 1979, just 3 years before the greatest, 20-year bull market in history. 

It may not happen tomorrow, or even the day after, but a headline like that leads me to believe that stock picking is about to experience a renaissance.

Stock picking is dead.  Long live stock picking!

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Manic-Depressive Mr. Market

Benjamin Graham, Warren Buffett's mentor, had a wonderful parable for thinking about the stock market.  He called it the parable of Mr. Market:

"Imagine that in some private business you own a small share that cost you $1,000.  One of your partners, named Mr. Market, is very obliging indeed.  Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis.  Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them.  Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly."

"You may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low.  But the rest of the time you will be wiser to form your own ideas of the value of your holdings..." (Graham, The Intelligent Investor, 1973)

The market has been particularly manic-depressive lately, and this has reminded me of the parable of Mr. Market.

One day, the market seems to foresee another recession on the horizon--the market sinks as investor sentiment tanks.  Another day, the market foresees an economic boom on the horizon--the market leaps and investor sentiment soars.

Is the data really that self-contradictory, or is the market just that short-sighted.  I believe the latter.

Much economic data, like unemployment claims, housing market numbers and income growth, indicate an economic slowdown.  Not a recession, mind you, just a slowdown.

Other economic data, like railroad traffic, commodity prices and industrial capacity utilization, indicate an economic expansion.  Not a boom, per se, but an expansion.

Mr. Market, in his manic-depressive way, takes these data points as signs of a collapse or boom.  As a result, market commentators have referred to the stock market's reaction as risk-on/risk-off.  It's either one or the other, and nothing in between.

What is the reality?  Not too surprisingly, given the data and my build-up, something in between.  The slowdown could turn into a recession, but hasn't, yet.  The expansion could turn into a boom, but it isn't at present.

Mr. Market should be more sober-minded and focus on the long term instead of the short term.  There is neither reason to dive for cover nor party like its 1999 (can you tell I'm about to turn 40?).

Given the data and a long term view, it is best to be cautiously optimistic.  The market is mildly over-valued, but nothing like it was in 2000 or 2007.  In fact, long term returns look promising, especially when compared to bonds or speculations like gold. 

Mr. Market needs to take a chill-pill, relax and take a deep breath.  Lucky for sober-minded investors, he probably won't, and this will provide ample opportunities to exploit Mr. Market's manic-depressive tendencies.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Price paid = returns reaped

Investing has to be one of the worst fields for excess noise.

Currently, most people are focused on the short term versus the long term, inflation versus deflation, macro-economy versus micro-economy, developed versus emerging markets, bonds versus stocks, fiscal versus monetary policy, stimulus versus cost-cutting, etc. 

The list goes on and on. 

But, almost all of that is noise.  As far as your investing and financial future are concerned, what matters is the price you pay today.

In the short or long run, whatever you invest in will be at some price in the future and will have yielded some interim cash payments.  If you pay too much for it now, you'll get a poor return.  If you pay a cheap price, you'll reap a good return.  That's it.

All the factors I highlighted above may influence that outcome, but it's mostly noise, because what you pay for an investment now will determine your return in the future much more than the rest.

This is a simple concept to grasp, but hard to execute.  It's easy to get distracted by the noise.  I get distracted every day by it--sometime several times a day!

Let's take the stock market as an example.  With the S&P 500 at around $1110, you'll get a 6%-like return over the next 5 years.  If you paid the $1023 it was selling for in early July, you could expect at 8%-like return over 5 years.  If you paid the $1217 it traded at in late April, you could expect a 4%-like return over 5 years.

The price you pay now determines your return later.

Emerging markets are growing faster than developed markets.  But, emerging market prices reflect that fact, so the price you pay now determines your return.

Apple is growing like a weed.  But, Apple's price reflects that growth, so the price you pay now will determine your future return.

If you pay too much now, you won't get your desired return.  If you pay a cheap price now, you're return will be satisfactory.

Ignore the noise.  Ignore the crowd.  Focus on price paid relative to value received.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Is Deflation Really That Bad?

People in the financial world don't have nightmares about werewolves or falling off a cliff, they wake up in a cold sweat crying out one bone-chilling word: "Deflation!"

Ordinary (or should I say normal?) people don't suffer from this affliction.  In fact, I'd dare say most people don't even think of the word deflation, much less dream about it.

However, to those in the financial world, whether investors, economists, accountants, or central bankers, the word deflation conjures up visions of the Great Depression and Japan's Lost Decade (it's been 2 decades, actually, but it's always referred to as 1 for some reason).

Is deflation really that bad?  It all depends on what you mean by the term.  For some odd reason, the term refers to two very different things.

One refers to the end of a credit expansion that ends in debt defaults, bank failures, and tremendous and long-lasting economic collapses.  That's the nightmare one.

The other thing deflation refers to is when money supply doesn't keep up with economic growth.  In my opinion, this one isn't bad at all. 

Can you imagine what life would look like if the cost of goods went down by 3% a year instead of up 3% a year?  Would you really have nightmares if the cost of computers, cars, TV's, food, clothing, etc. went down each year?  I don't think so--everyone loves a sale!

And yet, this is why people get so confused, because deflation refers to two entirely different things.  Can you imagine going to the grocery store and seeing hamburgers labeled "Rat Poison"?  You know hamburgers aren't poisonous, but the label would definitely throw you off.  The same is true with the word "deflation."  It refers to something yummy like a hamburger, and at the same time something terrible like rat poison.  No wonder people fear deflation.

Historically, deflation (the good kind) got a bad name in late 1800's United States.  After the Civil War, the U.S. experienced years of declining prices as the government worked to get its finances back in order and U.S. currency back on the gold standard.

It was great as long as you hadn't borrowed lots of money.  This was a boom time for railroads and manufacturing industry like Carnegie Steel.  If you owned stock in James J. Hill's railroad, the Great Northern, you received 8% dividends that bought more and more stuff each year, plus you benefited from the railroad's growth! 

The cost of things were going down because the U.S. economy was becoming more productive.  It was great unless you owed debt.  Debtholders hate deflation because it means they must pay back loans with dollars worth more each year.

This was especially painful for marginally profitable farmers.  Industrialization had made farming more productive, which meant marginal farmers couldn't break even.  They borrowed to try to keep up with productive farmers, but this just created new problems.  You can't pay back loans or farm profitably if the value of the corn you produce is going down faster than the debt you owe. 

So it is with every technological advance.  I'm sure caveman Ug was put out of the hunting business by caveman Thug who invented a new, more effective spear.  Such is the way of the world.

This industrial/technological/economic shift led to the populist movement and William Jennings Bryant's "cross of gold."  But, none of that helped the poor farmers who needed to find economical work.  Eventually, they went to work in factories and a new boom occurred.

But, the legacy of deflation as a bad thing lived on.  The very vocal minority of unprofitable farmers (and especially their political demagogues) made enough of a ruckus that deflation has a bad name to this day.

Next time you wake up in a cold sweat dreading deflation (not very likely, huh?), just reflect on which type you dreamed about--the hamburger, or the rat poison?

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Pushing on a string?

If you've ever water-skied, you know you must keep slack out of the line to stay on your feet.  If the line loosens, you have little time to take out the slack or you'll be swimming.

The Federal Reserve, too, must keep the line tight.  Otherwise, it finds itself pushing on a string.  And, as any water skier knows, pushing on the string is of little use.

Why is the Fed pushing on a string?  Because it--like a boy with a hammer--has only one tool at it's disposal: creating money out of thin air.

When the economy slackens, the Fed reduces interest rates (by printing or threatening to print money).  This is supposed to encourage borrowers to borrow, thus increasing economic activity.  As long as borrowers think they will get higher returns on the money they borrow than the interest rate they owe, they'll borrow. 

But, a problem occurs if borrowers either can't or don't think they can get good enough returns on the money they borrow.  When that happens, the Fed can lower rates and print money all they want and the economy won't improve.  That's when the Fed finds itself pushing on a string.

There are serious questions about the U.S. economy being at this point.  Very smart people are concerned the Fed can't get the economy going again, and they have powerful historic examples like the Great Depression and Japan to support their thesis.

During the Great Depression, the U.S. experienced a huge drop in economic activity, high and sustained unemployment, and significant deflation. Shrinking money supply was one of the things blamed, and so most economists have taken that as the solution to a similarly deflationary scenario like now.

Japan has been in a 20 year on-again/off-again recession.  Over this time, its stock market is down 75% and its economy hasn't grown.  Its central bank, like the Federal Reserve, has tried lowering interest rates and quantitative easing (a euphemism for printing money).  These solutions have kept unemployment from spiking, but have done nothing to improve economic growth and have left the Japanese government with a huge load of debt.

I think these two examples are important in understanding our present situation, but most analysts and commentators miss the point.  I do think the Fed is pushing on a string, but not for the reason that most suggest.

Borrowers will only borrow if they think they can get good returns on capital.  Such lending will only be effective if positive returns on capital are earned.  For the economy to grow and standards of living to improve, you need positive returns on capital. 

The issue is not employment, nor printing money, nor interest rates, nor fiscal stimulus.  The issue is positive returns on capital.  Without that, there is no growth, only decline.

The U.S. government tried all sorts of things during the Great Depression to improve employment and get the economy going (both Hoover and Roosevelt).  The result: the worst economic decade in U.S. history.  The U.S. economy finally started growing again during World War II.  Was that because killing people and destroying property is growth?  NO!!!  It's because the government boondoggles finally ended and individuals were able to get positive returns on capital.

Japan will not improve until positive returns on capital becomes its focus.  As long as employment and consumer demand are the focus, Japan will not grow.  Only when the Japanese economy refocuses on generating positive returns on capital will it grow again.

The same is true here in the U.S.  Printing money, lowering interest rates, giving loans to negative return on capital projects, and creating boondoggle employment will not create growth. 

The Fed is pushing on a string, but that's because it doesn't understand where growth comes from.  It doesn't come from creating money or lending, it comes from positive returns on capital, and there's nothing the Fed can do to bring that about. 

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Contrarianism

My daughter, like her mama and daddy, is a tad bit independent. 

Being terribly independent myself, I have little problem with that.  But, it can be a bit difficult at times, especially as a parent trying to get a three-year-old to brush her teeth or get dressed in the morning.

One of her teachers, Ms. Karen, was very delicate in communicating this predilection to us.  She used the sandwich approach, saying that Vivian was 1) self-directed, 2) independent to the point of being difficult, and 3) more likely to be a leader than a follower.  Mama and daddy were quite proud despite the obvious and nerve-fraying meat of the sandwich.

Like most parents, we tend to amuse ourselves with our child's tendencies.  So, to prove Vivian's independence to others, we simply ask her if she is a contrarian.  Naturally, she proudly states that she is NOT a contrarian (missing the irony of the statement).  Mama and daddy are quite amused, even if at her expense.

The investing world, too, is filled with it's own Vivians--contrarian to a fault.  They don't see themselves that way, of course.  In fact, they credit their contrarian approach for their investing success.

Don't get me wrong, I think a contrarian approach makes a lot of sense, but not as a principle to action.  It makes sense to look at what everyone else is selling; the contrarian trash pile is an excellent place to look for bargains.  But, everything thrown away is not of value, and doing the opposite of everyone is not by itself the best approach to picking investments.

I was reminded of this when I saw how many big, smart, and vastly more-successful-than-me investors had invested in British Petroleum (BP) during the second quarter.

Did they invest in BP simply because everyone was selling?  This makes some sense because it's obvious that many sellers were irrational, simply selling to get it off their books no matter at what price.  As a trading strategy, I suppose I follow that reasoning.

If you had followed BP for years, understood its value, and then bought when the price tanked, I can understand that, too.  That shows an appreciation for the nature of the investment, the risks involved, and the price to value relationship.

But, to buy it as a long term investment simply because others are selling makes little sense.  As Warren Buffett put it, if you aren't willing to own an investment for 10 years, why would you want to own it for 10 minutes? 

I didn't buy BP because I thought it was a terrible company before the Horizon rig blew up in the Gulf of Mexico.  It had been carefully cultivating its green image and spouting "beyond petroleum" blather while racking up lousy returns and the worst environmental record in big oil (just for reference, the most profitable company, Exxon, has one of the best). 

Not only did I judge BP poorly, I also thought its long term risks were almost incalculable.  Few thought Three Mile Island would halt one of the cleanest, most efficient energy sources in America, but it did.  Knowing how irrational people were about that, why would I think a huge oil spill in the Gulf would be different?

Contrarians buy what others are selling without necessarily  understanding their purchase.  The strategy works like a charm...until it doesn't.  That's why a lot of contrarians tout their records as proof.  But, investing has a huge element of luck as well as skill, so both short and long records can be deceiving. 

Exhibit 1 is Bill Miller's record at Legg Mason Value.  He beat the market every year for 15 years, then got crushed from 2006 to 2008 (down -56% vs. the market's -23%).  I'm certain he did more research than a pure contrarian, but he also owned Bear Stearns, Countrywide Credit, Fannie Mae and a host of other companies with terrible business models.  After all, he had made a fortune and his reputation buying lousy banks in the early 1990's that were bailed out by the government.  Not surprisingly, he was cursing the government for not bailing out his investments in 2008.

A contrarian approach works as a good starting point, but it's not the whole enchilada.  You need to do a lot more research and be very honest with yourself (if you don't really know, you'd better walk away). 

Excellent long term investment results are as much about not stepping on landmines as buying good investments.  A pure contrarian approach will eventually find landmines and lead to a blow-up.

Now, if I could only convince Vivian that contrarianism isn't its own end...

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Unemployment puzzle

Unemployment in the U.S. has stayed at a stubbornly high 9.5%.  This has puzzled many economists, politicians, commentators and individuals.

In almost all post-WWII recessions, employment has recovered more quickly toward normal levels.  But not this time.  In fact, unemployment hasn't stayed this stubbornly high since the Great Depression.

I think I understand why, and, if I'm right, it means unemployment will stay high for quite some time.  I believe there are two causes: interest rate policy and the unemployment safety net.

When the government sets interest rates, they will of necessity always be above or below where free-market rates would settle in the natural supply and demand for funds.  Just like any government price control, it will always and everywhere lead to either surplus or shortage. 

When rates are set too high, new investments won't be made where demand would otherwise exist, leading to mis-allocation of capital and an economic slowdown.  When rates are set too low, new investments will be made where demand would otherwise not exist, once again mis-allocating capital, but with a boom and bust cycle ensuing.

Because the majority prefers lower interest rates and we live in a democracy, too low interest rates are most often what we experience.  That leads to an escalating over-investment and crash cycle.

Remember the dot-com boom?  Prior to that episode, the Federal Reserve had dropped interest rates to fight the Asian contagion, Russian default and Long Term Capital Management debacle of 1997-1998.  In 1999, rates were maintained at artificially low levels to deal with the phantom Y2K problem.  The result: a dramatic over-investment in technology, media and telecom that resulted in a tremendous mis-allocation of capital and employees.  To this day, fiber-optic cable that was deployed 10 years ago still hasn't been fully utilized.  To this day, people who were employed in technology, media and telecom during the boom are transitioning into other fields.

To fight the dot-com wipe-out, the Fed again resorted to extra-low rates.  These low rates encouraged people to speculate again, but this time in the housing and credit markets.  The result, again, was a huge mis-allocation of capital.  Many more homes were built than people could afford.  Many more loans were made because home ownership was seen as an inherent good.  Many more cars were built and auto loans were made because rates were so low.  The result was a tremendous mis-allocation of dollars and people to the housing, financial and auto markets than otherwise would have existed.

Now, of course, many of those who had been employed in housing, finance and the auto field are unemployed.  The mis-allocation of capital to those fields has led millions to be trained to do something for which the market had no need. 

And, this is where the unemployment safety net comes in.  When those employed in technology, median and telecom lost their jobs, they had to find new ones.  Because they weren't offered unemployment benefits for 99 months, they went and found new jobs.  Many of those jobs, ironically, were in the housing, finance and automotive fields that were being artificially spurred by too-low interest rates!

I'm not blaming unemployment insurance as a political statement.  I'm pointing to facts.

Rogoff and Reinhart's work (This Time Is Different) shows how employment recovers much more quickly in emerging economies without unemployment benefits.  Whether a recession or banking crisis hits, emerging economies recover employment more quickly. 

Anecdotically, I've heard several stories of people who could get full- or part-time work, but elect not to because they'd be paid less to work than not to work!  It's not a political statement to say that many people prefer to be paid not to work than to work. 

Combine huge mis-allocations of capital due to interest policy with a huge unemployment safety net, and you have a recipe for sustained, high unemployment.  (As another example: see Europe.)

Or, consider the Great Depression.  Interest rates were held artificially low after World War I to allow France and Britain to less onerously pay back war debts.  The result was first a huge real estate boom and bust in the mid 1920's and then the stock market boom and bust in the late 1920's and early 1930's. 

Just like recently, artificially low interest rates led millions into fields that had no fundamental end demand (at that time, most of it was related to farming and banking).  When the inevitable bust came, millions were laid off from those fields and provided unemployment benefits. 

Interest rate policy leads to mis-allocations of capital and large groups being unemployed.  Unemployment safety nets then encourage those unemployed not to look for new work.  It's a recipe for high and sustained unemployment every time.

If I'm right, we'll have high and sustained unemployment until capital is correctly allocated (not likely with--once again--artificially low interest rates) and/or the unemployment safety net is removed, neither of which seem likely in the short or intermediate term. 

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Beggar thy neighbor

I was surprised this week to read several reports that Europe announced improving production and business confidence, particularly out of Germany.  Several European companies announced better than expected earnings, too. 

After all, weren't financial commentators the world over (including yours truly) prattling on a couple of months ago that Europe was coming apart at the seams?

And then I remembered the phrase "beggar thy neighbor."  It refers to the political policy of devaluing one's currency and/or erecting trade barriers to boost one country's economy at the expense of other economies. 

It's called beggar thy neighbor because it only works as long as your neighboring countries don't react (hence the begging).  If they erect their own trade barriers or devalue their currency, then the game is up and everyone ends up worse off.  Like most boondoggles, it only seems to work as long as you focus on the surface and not the aggregate.

Because I have a sarcastic sense of humor, I couldn't help but be amused by all the Germans who were coldly saying, a few short months ago, that the Club Med countries should be dumped from the euro currency and even the European Union.  Now that the Club Meds have caused the euro to drop, Germany seems to be making out like a bandit. 

The main reason is that Germany is mostly an export economy (like China and Japan).  In fact, China overtook Germany only last year as the world's largest exporter.  Germany's economy would grind to a halt if it weren't selling to others.  Not surprisingly, the euro dropping benefited them most.

But, it won't last too long.  Even now, U.S., Japanese and Chinese politicians are most likely forming policies that will lead to our own devalued currencies or new trade barriers that will eliminate the euro advantage.  The effort will succeed in kicking Europe--particularly German--in the shins, but it won't make anyone better off.

In the long run, people adjust to currency changes.  Over time, a burger in Asia, Europe and America will cost about the same in real value.  Buyers and sellers adjust the prices they are willing to pay and receive until things are back to the way they were.  Currency depreciations don't work for long, and trade barriers just reduce everyone's standard of living. 

Beggar thy neighbor doesn't work, unless of course your goal is to get elected in the short run.  It may be the only thing less productive than re-arranging deck chairs on the Titanic.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Ponzi finance, government style!

My wife is beginning to dread it when I talk about the economy (perhaps I'm being over-generous in saying "beginning"...).  This past week, I even dragged my dear sister down into the muck.  Now, poor reader, it's your turn.

Government finances are looking more and more scary to me.  I was reminded of this recently when recalling much of what I read about housing finance in 2003-2005 (yes, I was that early...and no, I didn't make any money betting against it...).

In particular, I remembered the intellectual framework of one Hyman Minsky, a great economist most people have never heard about.  His "Financial Instability Hypothesis" was frequently quoted with respect to subprime home loans.

In general, he said there are three types of lending, one following the other.  As lenders proceed from one financial crisis to the next, they walk farther and farther out on the risk limb until they fall off.  Then, they start all over again.  Silly, isn't it?

The first type of lending he called "hedge finance."  This is lending where the bank expects to be repaid both interest and principal.  Seems infinitely prudent, huh?  It is.  But, when it works well for some time, financiers move out the risk limb.

Next comes what Minsky called "speculative finance."  This is where the lender expects to be paid interest, but not all the principal.  Does that sound imprudent to you?  It may, but it's quite common.  If you've ever paid 20% interest on a loan or credit card, you've participated in speculative finance.  Banks charge that high interest rate because they don't expect you (or someone else offered the same loan) to fully repay the principal.  The high interest rate allows them to still make money even without full principal payment.  This is very profitable business in good times, which leads lenders farther out the limb.

The final phase is called "Ponzi finance."  This is where the lender expects neither full interest nor principal payment.  It only works as long as asset prices are rising, as was the case with the housing market, or as long as a "greater fool" can be found to buy the loan from the lender, also the case with housing.  This is the phase that ends in tears.

Which, brings me back to government debt.  A long time ago, the developed economies of the world went from hedge financing to speculative financing.  They did this when they decided never to repay their debts, but simply to roll them over (which means using a new loan to pay off the old one) each time they come due.

Because governments don't die like people do, they can--in theory--keep rolling their debts over forever.  In practice, every government dies and every single one has defaulted at some point.  If they haven't, yet, it's only a matter of time.  If you don't believe me, see the excellent work of Niall Ferguson, and Carmen Reinhart and Kenneth Rogoff.

Just like home loans progressed from speculative to Ponzi finance, I believe government debt is walking out the same limb, too.  This struck me most profoundly this week because of two data points.

The first was when I read that U.S. mutual fund investors were putting 6 times as much money into bond funds as they were putting into stock funds.  At the same time, any poll you read will tell you that the very same investors openly acknowledge that U.S. debt levels are a major problem and that they are skeptical the debt can be repaid.  If people are investing in debt they think is bad, they are not expecting principal and interest--they are expecting a greater fool to buy their bonds at a higher price!  That, my friends, is Ponzi finance.

The second data point comes from very smart, professional investors who support the deflation premise.  Most such investors openly acknowledge that U.S. debt problems are almost insurmountable, but that they are investing in U.S. debt because they believe deflation will happen and that they can make money as U.S. debt prices rise (in deflationary times, people seek the same safe havens, like U.S. debt, thus driving up the price).  Such investors aren't saying they expect to hold that debt long term--they doubt that interest and principal will be repaid!  They are overtly expecting to offload such "investments" on other dumb investors.  Ponzi finance!

Like the housing market, this is likely to end in tears.  The problem is getting the timing right (as it was with the housing market).  With so many buying government debt they openly acknowledge is dodgy--at best--everyone will be looking for greater fools to sell to at the same time, and the race to the exits is likely to be ugly.

Although my wife hates to hear me say it, it's getting scary out there.  We can still pull back from the precipice, but time is running out.  Our elected officials may suddenly become prudent (not in any democracy I know of).  We may experience a growth boom that saves the day--until the next crisis.  But, at some point over the next 5 to 10 years, we are going to live through the transition from Ponzi finance back to hedge finance, and that's just plain scary. 

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Short term pain, long term happiness

With my daughter turning three in August, I know we'll soon have a conversation or two about honesty. 

It's a complicated subject, so I expect this conversation to occur off and on over the next...say...75 years (I plan to live to 115).

Most people think honesty is about lying or not lying, and therefore not very complicated.  I disagree.  I think honesty is about facing the facts.  If you frame honesty in such a way, you can live a moral life, and achieve and sustain happiness (which is what I think morality is all about).

You can lie and be moral.  For example, if I'm served liver and Brussels sprout casserole I can tactifully lie by thanking the server.  I'm not denying the fact that I hate liver and Brussels sprouts, but the thanks is polite.  That white lie is not incompatible with honesty.

If the Nazis come to my door and ask where I'm hiding the Jews, I can't say, "first door on the left," and be moral.  Once again, the lie does not deny the facts, it simply acknowledges that I have no moral obligation to be truthful with monsters (actually, being truthful will definitely bring unhappiness).

It's my stand that you have to be honest, to face the facts, in order to be happy.  But, happiness is not equal to instant gratification.  Sometimes, being honest with oneself or others is short term painful.

For example, think about making a mistake on the job and telling your boss.  Your boss is unlikely to be happy, but you have to face the the facts and let your boss know because she has the right to know.  If your boss is any good, she will reward that honesty over time even if she isn't happy with the mistake.

In fact, I would go so far as to say that many (most?) moral things, like honesty, are short term painful in order to reach long term happiness.

I exercise 5 days a week.  I work out hard enough that it's mildly painful.  But, the rewards pay for the effort.

I work hard to find investments.  I spent hours, day, months doing research on each investment idea.  This is rarely a fully pleasant experience.  And yet, I know it will work in the long run.  That's why I do it.

Buying investments that will do better than average almost always includes short term pain.  The reason why it will do better than average is because something is wrong.  Most people will think you're nuts for investing there--that's why it's cheap!

Over the long run, too, buying such short term pain provides long term happiness.

Do you think my three year old will understand why honesty or investing can bring short term pain and long term happiness?  No, me neither. 

But, over time she will, and then she'll be long term happy, too.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Why I don't work in a big city

A question I regularly get from clients, prospects, family and friends is: "if you're so good at what you do, why don't you work in a big city like New York, Boston, Chicago or San Francisco like all other investment managers worth their salt?"

It's a great question, and highlights what most people think: a) people who are good at what they do need to go to the biggest stage to do it, b) those who don't go to that stage probably aren't as good as they say.

Fair point.  No truly great baseball player plays pick-up games on weekends.  No virtuoso pianist only plays in her basement. 

Investing, however, is different.  With investing, all you have to do to compete against the best is buy or sell securities directly.  Each time you buy, you may be buying from the best; when you sell, you may be selling to the best.  You never know who is on other side of your trade, but the best are all participating in the same markets.

So, it's not necessary to go do New York, London or Hong Kong to compete with the best.  All you have to do is decide to buy securities directly.  I do. 

The reason why I'm not in a big city can be summed up in one word: independence.

To be a great baseball player, you have to compete against the best.  To become a virtuoso pianist, you have to play against the best.  Direct competition makes each individual better.

Investing, however, requires independence.  Groupthink is the source of poor performance.  So are marketing departments. 

If you're pressured to sell products because you work on commission, you're not independent and unlikely to beat the market.  If you're boss is pressuring you to post good quarterly results to increase assets under management, you'll lack the independence required to out-perform.

If you're surrounded by people who represent the market, it's very hard to resist being affected by their thinking.  If you meet and talk daily with people who disagree with you and think you should follow the herd, you're almost certain to be worn down and comply. 

Or, as Benjamin Graham, Warren Buffett's mentor, put it in the Intelligent Investor, "To enjoy a reasonable chance of continued better than average results, the investor must follow policies which are (1) inherently sound and promising, and (2) are not popular in Wall Street."

Sound and promising means long term oriented.  Marketing departments hate that because short term results are what sell. Not popular on Wall Street means contrarian.  But, that's difficult when you're amidst the Wall Street herd day in and day out.

I believe I have and will beat the market over the long term because I've kept my independence.  Being in Colorado Springs and without a marketing department breathing down my neck is an asset, not a liability. 

Keep in mind that Warren Buffett spent his first 10 years operating out of the sun room in his Omaha home.  He, too, saw the benefit of independence.  Perhaps he was on to something.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Raging debate.

The investing world has divided itself into two camps: those fearing inflation and those fearing deflation. A debate is raging about what we'll face going forward and the appropriate way to invest under each scenario.

This debate is not between dummies. I'm not referring to the talking heads on TV or the perma-bulls of Wall Street who perpetually advise buying stocks NOW! Nor am a talking about the perma-bears and gold bugs that advise canned food and fall-out shelters.

I'm talking about the smart investors who saw the 2000 tech bubble and the 2008 housing bubble popping years in advance. They made money when almost everyone else lost it.

They were in complete agreement back in 2000 and 2008, but now they aren't. Now, they hold diametrically opposed views about the economy and where to invest.

If we face deflation, you should hold cash and buy high quality fixed income instruments. If we face inflation, you should buy commodities and stocks that will thrive in a rising price environment.

They are in total disagreement about which one we face and are ripping each other to shreds in articles and interviews. I've never seen such strong disagreement between the smartest in the field.

The outcome really matters. If you invest in cash and bonds and inflation occurs, you'll get killed; if you invest in commodities and stocks and deflation occurs, you'll get killed. This is no mere academic debate. This will impact the lives of millions of investors.

Like many, I don't know how this story ends. It's my opinion we'll experience deflation until bad debt is squeezed from the system and then inflation from there. The problem is getting the timing right of when we go from deflation to inflation (and correctly guessing ahead of the herd when the crowd will recognize that shift).

And, to further confuse things, the outcome depends more on the decisions of government officials than economic analysis. If they print lots of money, we'll get inflation. If they don't, we'll have deflation. We're in an uncomfortable position.

I don't think it's possible to get the timing right, so I'm not trying. Instead, I want to own instruments that can do well in either inflation or deflation. For me, that's investing in businesses with pricing power and competitive advantages that can cut costs in deflation or raise prices in inflation.

I prefer businesses with cash on hand and that pay a meaningful dividend. That's the same as owning cash and a fixed income instrument, but it has the benefit of adapting to inflationary conditions in ways that cash and bonds can't.

I'm also favoring strong management teams that own a significant chunk of the business and are focused on building shareholder wealth. A smart management team can adapt and exploit a changing environment in ways that cash, fixed income, canned goods and commodities can't.

In other words, I'm looking for the best of both worlds. I don't want to guess whether we'll experience inflation or deflation or when one or the other will kick in. Instead, I'm investing for either environment.

Such investments are likely to feel short term pain if either strong inflation or deflation occurs. But, in the long run they will survive and grow in ways the other alternatives can't.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Rolling over?

The S&P 500 is down 16.2% since April 23. Commentators all over are trying to peer into their crystal balls to figure out if the market is tanking, or just taking a breather before resuming its climb.

Data point in both directions.

The Chinese stock market is down much more than U.S. markets, but state manipulation makes that data point suspect.

Railroad figures continue to look good. They haven't recovered summer 2008 highs, but they've been steadily heading in that direction.

Commodity prices have pulled back but haven't broken down to levels that would suggest all hope is lost. Copper is below $3, but has paused around that level. Oil prices are over $70, just where Saudi Arabia wants it (suggesting demand is still strong). U.S. natural gas prices have been climbing since late February and are hitting new highs. Asian steel prices have declined since March, but have leveled off above prices of last summer. Dry bulk shipping prices have tanked, but that could be as much due to on-coming supply of ships as lower demand.

The Economic Cycle Research Institute's (ECRI) Weekly Leading Index has declined to the point of many past recessions, but hasn't crossed the threshold or time period to make recession certain.

Weekly unemployment claims are below 500,000, but not below the significant 400,000 level that frequently signals the sustained end of recessions.

What's an investor to do in such situations?

First, remain calm. No one predicts recessions with precision, except in hindsight.

Second, stick to your discipline. If some of your investments look cheap, buy more. If others look expensive, sell some or all. Don't try to time the market, evaluate prices relative to potential returns and buy when returns look good. You won't catch the bottom, but no one but the lucky do anyway.

Third, plan to react to up or down side. It's handy to have a plan instead of reacting emotionally. Feelings are an investor's worst enemy. Decide what you'd do if prices took off (probably selling) and what you'd do if prices decline (probably buying), and then have the courage of your conviction when the time comes. Don't change your plans based on how you feel, but on what you rationally think.

Investing is a game where cooler minds prevail. Don't get emotional and don't abandon your soberly made plans. In the long run, the next few months will probably look like an unmemorable blip on the computer screen. Invest wisely and you won't care.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Renminbi redux.

The Chinese finally decided to let their currency, the renminbi (or yuan), "float" against the U.S. dollar. (For background, please see my prior post: Renminbi revaluation). I put the word float in quotes because it will be highly controlled and not a float in the free market sense.

Political leaders the world over, but especially in the U.S., have been pushing for this revaluation for some time. I doubt it will generate the outcome such leaders hope for. My expectation is higher interest rates and commodity prices in the long run that will eventually make our problems here and abroad worse instead of better.

An interesting question to ask, then, is: why did the Chinese finally do what everyone wanted them to do?

The most obvious answer, and the one that will satisfy most political leaders, is that China bowed to U.S. or international pressure. I doubt that's the case. Right now the rest of the world depends on China as much as or more so than the other way around.

Another suggestion, mostly from political thinkers, is that China is assuming its position on the world stage and having an independent currency is part of that. Although more feasible than caving to pressure, I think this argument misses the mark, too. I believe China desires a prominent position in the world, but I don't think it would sacrifice a piece of its low cost edge in order to get it.

No, I think the real reason behind revaluation is inflation in China.

In fighting financial problems over the last decade, the U.S. Federal Reserve has printed a lot of dollars. That printing has led to higher prices, especially for food and the key inputs to production (copper, iron ore, oil, etc.).

This impacts first world countries much less than third world countries. The first world spends somewhere around 20% of their income on such things as food. The third world, including China, however, spends much closer to 60%.

When the price of an apple doubles and it's less than 20% of your income, you complain a bit, but it doesn't cause a significant problem.

When the price of food doubles and it's 60% of your income, you riot in the streets.

That's the situation I think China is facing. They'd like to keep their currency on par with the dollar to maintain their low cost competitive advantage (with significant margin to spare), but not at the expense of having inflation cripple its poorest people.

I believe China's goal is to grow to first world standards of living without causing a revolution. That's a very delicate goal to achieve, especially with centralized planning and in the short time period they want to achieve it.

They won't get there if their economy slows too much, or if they have high inflation.

I don't think China is caving to pressure from the west or seeking the prestige of an independent currency. I believe they are walking a tight rope, and inflationary threats were making them lean way too far in one direction.

Revaluation, for them, is a practical economic matter, not purely a political one.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Look east, young man...

In trying to read the economic Tarot cards, most are focused on the U.S. and Europe.

At first glance, this is quite understandable. The European economy is the largest in the world, followed closely by the U.S. But, that's not where the action is.

Indeed, the world economy increasingly turns on the axis of #3: China.

If you want to know where things are going, look east.

I say this for two reasons: 1) markets have been increasingly led by action in China, and 2) fundamental economic reality is being driven most by China.

When the economies and stock markets of the world turned positive in 2008 and 2009, it happened first in China.

All other markets are reacting to what happens in China, too. When China hints they may let the renmimbi appreciate, markets shout "how high?" When China hints its trying to subdue real estate speculation, markets shutter the world over.

The simple fact of the matter is markets are reacting increasingly to news from China.

You may think of markets as being speculatively fueled, but a look at underlying economic reality provides a basis for these flighty reactions.

China is the world's third largest economy, passing Japan within the last two years.

The Chinese economy is--by far--the fastest growing large economy.

China became the world's largest export economy, passing the former #1, Germany, just last year.

Demand from China is driving the markets for the most basic inputs to production. Watch the price of shipping, iron ore, copper, steel, oil, or almost anything else, and you'll most likely find news from China caused prices to jump or dive.

China has become the manufacturer to the world. You can't consume what hasn't been produced, so China is holding the economic cards, now. If you don't believe it, watch Chinese workers striking Honda or demanding hiring wages from purchasers like Apple and Hewlett Packard. This wasn't happening a year ago because China didn't hold the cards. They do right now.

Finally, China's economy is the only large economy whose government isn't in a fiscal straight jacket. The U.S., Europe and Japan are all hand-cuffed by borrowing and spending too much. China's government is almost certainly making uneconomic investments, but they have the ability to invest whereas the other large economies' governments are out of ammunition (or soon will be).

If you want to know where things are going economically, look east.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Tipping Point?

The next crisis we face may be much worse than the housing crisis. It's what I've talked about in the space before: sovereign subprime or too much government debt.

This may seem like a problem facing far-off Greece or Hungary, but it's bigger and more problematic in the developed economies. Here, I'm talking about the big economies we typically associate with stability: Japan, Germany, France, Britain and the United States.

The issue is that such developed economies have borrowed too much money, like subprime borrowers, to live high on the hog today. This borrowing is going and has gone to generous social programs, defense, and, most insidiously, growing interest payments.

When the burden of paying debt, both interest and principal payments, get too high relative to incoming money (taxes) or an economy's size (GDP), you get to a tipping point where there's no where to go but down.

This problem is exacerbated by two additional issues: who did you borrow from and when do you owe them principal.

If you borrow from your own citizens, you're in a better situation than when you borrow from foreigners, especially when those foreigners aren't your best friend (hello, China).

If you borrow the money short instead of long term, you face the same problem as paying off a credit card versus a home loan--no credit card will give you wiggle room while you get your financial house in order.

Japan and Britain borrowed mostly from their own citizens. The U.S. borrowed mostly from Japan and China. Japan and Britain predominantly borrowed long term, the U.S. borrowed short term and must roll over most of its debt over the next several years.

The U.S. has an advantage over Japan, Britain, France and Germany, though: our economy grows faster and so does our population (both organically and from immigration). This gives us some wiggle room they don't have.

Back to the tipping point issue. When interest payments get too high relative to economic production or tax revenues, those who lent you money want a higher interest rate. Guess what a higher interest rate does to those interest payments? Yep, higher and higher.

You can see why there's a tipping point--once you reach a certain threshold, people start to doubt you can pay and want higher interest payments (or won't lend you money), which creates a vicious cycle.

The developed economies of the world are entering that vicious cycle over the coming years. We stand on a knife's edge and can chose, now, to stay on the good side or go to the dark side. And, we don't have much time to chose.

If you tip to the dark side, what do you have to do? Theoretically, you can grow your way out of trouble, lower your interest payments, get bailed out by someone else, cut spending and jack up taxes, print money (inflation) to pay back loans, or default (also known as restructuring, repudiation, rescheduling, etc.).

The U.S. has been growing its way out of trouble for over 200 years. Unfortunately, when government spending grows to a certain percentage of the economy, your growth rate slows dramatically. We're reaching that point, so we need to allow a lot of immigration, cut government spending, and reduce taxes to increase growth. I'm guessing the chance of any of those three happening is as great as finding a snowball near the sun's core.

Is there any way we could lower the interest rate on our debt? You'll have to ask Japan and China on that one, but don't count on it.

Is it possible that any country in the world is capable of bailing out the U.S.? Please see snowball reference above.

Can we cut our spending and raise additional taxes? We could, but in a populist environment like we're in, that will probably work as well as it has in Greece (please see riot footage as reference).

Can we inflate? This is the most likely outcome, and it won't be a lot of fun for those who lent us money or for those on a fixed income here in the U.S.--and, by the way, that's a lot of people!

Can we default? Like inflation, we can do it, but it won't be pretty and will likely be a disaster for many.

Standing on the knife's edge and looking at those six options, I would chose to knuckle down now, so we don't have to go down the path of the six. I'm not optimistic that will happen in a democracy, so I'm planning on inflation.

So should you.

(I think we'll still experience slight inflation/deflation over the next couple of years, but the turning point is hard to predict because our lenders will get to chose the timing).

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Judging expertise--the right way!

I was simply dumbfounded.

I was having breakfast with a good friend, recently, when she explained the good qualities of her financial advisor. Specifically, she referred to her advisor's a) ever-present volunteer activities in the community and b) diligent hobby fly-fishing on every possible occasion.

First, let me highlight that my friend is no dummy. She's one of those people that is fiercely dedicated to her job, an expert in all the important areas of her work, and possesses a mind-numbing amount of information about her interests. This is one smart cookie.

Second, I have nothing against volunteer activities or fly-fishing, or long walks on the beach for that matter.

Third, I'm not an unbiased observer. I am, after all, an investment advisor myself.

With all that, why on earth would you judge your financial advisor based on their presence in the community or their various hobbies!

When I look for a doctor, I don't care if she sings in a barbershop quartet, or if she likes to play bridge. All I care is if she is an expert in her medical specialty. I want to know she reads the latest journals and works diligently to improve her results over time.

When a fireman comes to pull my unconscious body from my burning house, I don't care if he enjoys flower-arranging or Internet chat rooms, I just care if he can carry me down a flight of stairs and then put out the fire with minimum property damage. I want to know that he can squat 300 pounds and studies fire damage to figure out how best to put them out in the future.

And, when I look for an expert in investments, I don't give a hoot if they volunteer and fly-fish, all I care is that they are expert at what they do.

Personally, I want that doctor, fireman and financial advisor to be a neurotic, obsessive/compulsive individual so dedicated to their field that they seldom have time for much else.

So why was my friend so excited that her financial advisor was always volunteering and trying to fly-fish? I don't get it.

Doesn't she realized that when her advisor is doing something other than being an expert in their field, she's the one losing. Doesn't she realize that every hour volunteering or fly-fishing is another hour when the advisor's competition is finding ways to get better returns, better plan for her future, or broaden their knowledge?

There's a right and a wrong way to judge expertise. You don't judge it based on ancillary interests or good intentions in the community. You judge it based on best practices, proper education, diligent improvement, and long run results.

And one more thing while I'm on my rant: when your advisor regularly calls you to suggest you make changes to your portfolio, and he's compensated based on commissions, he's not calling to help, he's generating sales so he has more time to fly-fish while your portfolio is floundering.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.