Barack Obama - Enemy of Business?

The same people who were clamouring for financial reform during the height of the crisis now appear to be taking a "if it's not broken don’t fix it" approach. Having seen their stocks go up since the lows of 2008, fear of change has taken hold. How can we be considering financial reform when talk of it makes markets drop? Don't the markets "know everything?"

Many conservatives have branded financial reform or regulation as "socialist" or "communist," making the ridiculous conclusion that since the highly-regulated communist structure didn't work, a complete lack of regulation must be best. Such short-term and narrow minded thinking is bad for the nation. Financial reform is necessary - and has been a long time coming:
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"If we bail out this one (Penn Square Bank)...then the markets will know that, no matter what risks they take, the government will bail them out. Eventually, its going to lead down the road to nationalization of the banking system."

William Isaac, FDIC chairman, 1982
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"If this sounds like a warning, it is."

Gerald Corrigan, President of the Federal Reserve Bank of New York, telling bankers that the over-the-counter (OTC) market seemed to be expanding without adequate controls, 1992
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"Improved 'transparency' - a favorite remedy of politicians, commentators and financial regulators for averting future train wrecks – won't cure the problems that derivatives pose. I know of no reporting mechanism that would come close to describing and measuring the risks in a huge and complex portfolio of derivatives."

Warren Buffet, Berkshire Hathaway 2008 Annual Report
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"A key question: Should we opt for even more pain now to gain a better future? For instance, should we create new controls to stamp out much sin and folly and thus dampen future booms? The answer is yes. Sensible reform cannot avoid causing significant pain, which is worth enduring to gain extra safety and more exemplary conduct."

Charles T. Munger, 2009, in the Washington Post
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"A clear lesson of this crisis is that any strategy that relies on market discipline to compensate for weak regulation and then leaves it to the government to clean up the mess is a strategy for disaster."

Timothy Geithner, Secretary of the Treasury, 2010 in the Washington Post
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"It is simply unacceptable to walk away from this recession without fixing the system's basic flaws that helped to create it."

Timothy Geithner, Secretary of the Treasury, 2010, in the Washington Post
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"A clear lesson from the events of the past few years--and a recommendation in the report with which we strongly agree--is that the government must not be forced to choose between the unattractive alternatives of bailing out a systemically important firm or having it fail in a disorderly and disruptive manner. The government instead must have the tools to resolve a failing firm in a manner that preserves market discipline--by ensuring that shareholders and creditors incur losses and that culpable managers are replaced--while at the same time cushioning the broader financial system from the possibly destabilizing effects of the firm's collapse… The financial reform legislation in both the House and the Senate would provide for such a resolution regime."

Ben Bernanke, Chairman of the Federal Reserve, 2010, Fed Speech
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In my estimation, one of the reasons people hate Obama is because he is forward thinking and logical, and therefore does things that voters hate (a rare combination in politics). In doing what's necessary, he successfully manages to piss off every possible segment of his support base. He makes poor people get health insurance coverage, even if they don't want it. He institutes financial reform at a time when the market is recovering and when each word from his mouth causes the market to drop. His logic, rather than his strict adherence to political philosophy, makes him "difficult" and "impossible to predict." Personally, I like the fact that Obama ignores popular opinion and just gets things done. No doubt he will be a one-term president.

Enemy of Business: no.
Enemy of dangerous, unregulated, pre-1929 style business: yes.
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"Issues are never simple. One thing I'm proud of is that very rarely will you hear me simplify the issues."
Barack Obama

Reflexivity and the Decline in Home Sales

Recent headlines confidently announced that the 33% reduction in U.S. new home sales for May 2010 was due to the expiration of the new-home buyer’s tax credit at the end of April.

In other words, we are supposed to believe that home sales were robust due to an $8000 tax credit, and now that this credit is over the housing market is bust. Nonsense.

In fact, the reversal in new home sales was primarily caused by an equally large decline in psychological wealth that occurred at the beginning of May - which had nothing to do with tax credits.

Rapid declines in consumer spending are caused by rapid declines in asset values, such as stocks or real estate. While there is much talk about how a drop in stock prices can “predict” an economic downturn, there is little notice that a drop in stock prices, rather than predicting a downturn, may actually be the cause of one.

When people see their net worth decline, they compensate by saving. That is, they decrease their spending and increase their margin of safety, further exacerbating the symptoms of the decline.



The “flash crash” of May 6th 2010 punched the confidence out of retail investors, psychologically forcing them to transfer billions of dollars out of equity investments. So, while April saw inflows to equity mutual funds of $13.89 billion, May saw outflows of $29.94 billion (www.ici.org). Negative headlines caused retail investors to run for the hills - and they haven’t stopped running. These days, the market fluctuates wildly from the trades of hedge funds and volume traders, while those working with retail clients (such as Financial Planners and Brokers) sit at their desks, bored.

Stocks are reasonably priced, with little room for a disastrous collapse like the one from the peak. Home prices are low. Interest rates are low. Despite problems in Europe and Asia, the U.S. economy has all the logical conditions which make it ready to rise from the ashes. However, retail investors and consumers are anything but logical.

Until the chat-room anger and gloom subsides, both stock and housing markets will linger - and the buying opportunities for rational long-term investors will be sublime.
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“…the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be moderate for a time.”
The Federal Reserve, Press Release, June 23 2010

“Housing cannot lift the United States from its new state of Marxist depression, you bunch of morons. The American Dream is just that. Rest in Peace, USA.”
Anonymous comment on a financial news website, June 24 2010
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See also: Reverse Attribution

A Barrel of Reality

BP, formerly British Petroleum, has been making headlines for weeks with its outrageous 35,000+ barrel per day ocean-based spill. With President Obama calling for revenge (at least publicly), and congressmen berating BP executives while vainly attempting to maneuver them into admitting guilt, some say that the offshore oil market is finished. Others add that the rise of alternative energy vehicles is now assured. Still others say that BP is a great buy. This article is a dose of reality all around.

I am a big fan of alternative energy. Wind and solar power have come of age, and can successfully compete with traditional sources like coal and hydroelectric power for electricity generation. Alternative energy vehicles, however, are simply not at the same level.

Despite all the hype about alternative energy vehicles, how many recharging stations do you actually see on your way home from work? How many people do you know who run electric vehicles for personal use (not just for corporate image)? Major alternatives to electric, such as fuel-cell cars, have been “in the works” and “soon affordable” since I visited Ballard Power’s (BLDP) office 11 years ago.

Although fuel cell and electric vehicles hold great promise, they simply aren't ready. No one wants to wait 20 minutes to "refuel" their car. No one wants a low-cost commuter vehicle that goes 35 miles per hour. Nor does anyone want to pay a year’s salary for a car that goes the same speed as their existing car.

Like personal computers, alternative energy vehicles will truly take off once cost and functionality reach reasonable levels, and once the infrastructure to maintain them is in place. Until then, oil and its producers maintain a bright future.

As for BP, should you buy or sell? Although BP looks tempting at these levels, I should remind everyone that the inglorious well is still leaking thousands of barrels per day. Until it’s actually capped, my money is going into more reliable opportunities; like, for example, this disaster's beneficiaries, Chevron (CVX) and ConocoPhillips (COP).
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“Already those who have seen this new model are acclaiming it the finest car of any type yet produced for city and suburban use. You, too, will be delighted with it.”
Advertisement for the Detroit Electric Car Company, 1920.

Choosing the Right Broker

INVESTOR PSYCHOLOGY

Investment books typically say that you can choose the right broker by checking their background, pedigree, past performance and investing style: the best brokers will have a track record of success.

Such advice seldom works. It assumes that making money is the client’s primary reason for choosing a broker. It also assumes that the investor actually wants to make money, which is not necessarily the case.

Investing is more about psychology than anything else. Therefore, choosing the right broker is mostly about psychology as well.

The descriptions here are written tongue-in-cheek, but describe real investors and real brokers. Recognizing which one of these reflects you most gives you a powerful advantage.


TYPES OF BROKERS

The Punching Bag – The punching bag broker is essentially a displacement target, whose main purpose is to serve as an outlet for frustration. For instance, a Japanese businessman who is surrounded by superiors may get scolded regularly, yet has no one with which to do the same. The broker, in this instance, would serve as the person against whom the powerless individual could vent his frustrations. Those looking for a punching bag broker should pick either a meek broker who is used to it, or a strong broker who won’t care. A punching bag broker can be an important source of stress relief through Freudian displacement (taking out your aggression against a socially acceptable target), and can lead to greater success in other areas of life, such as work and marriage.

The Thrill Provider – The thrill seeking client does not wish to invest in index funds or other practical investment vehicles, but rather wishes to be part of the exciting world of mergers and acquisitions, penny stocks and new issues. It is not so important whether the stocks go up or down, so long as risk and danger is omnipresent. A broker that specializes in thrill providing is usually a frequent trader, and will cost the client more in trading commissions and taxes. Selecting a thrill seeking broker is an excellent alternative to more harmful options like gambling, drugs, or marital infidelity.

The Loser – The hypochondriac investor should seek a broker with a mediocre record. This way, a client can tell his friends how much money he lost, how horrible it is etc. and get as much attention and sympathy (“injustice collecting”) as required. The loser broker is also good for those who are afraid that success will bring undue pressure to their lives, and so who just avoid being successful altogether. Note that those who use a loser broker are not investing to win, but rather are investing to intentionally fail; therefore, it is important to choose a broker who is not particularly successful. A moneymaking broker will not meet the required psychological needs.

The Arm Candy – Arm candy refers to a broker at one of the world’s top investment firms, whose membership requires a high initial investment amount or referral by an existing member. The purpose of the arm candy broker is primarily snob appeal. For example, a client can say, “My broker at Goldman Sachs told me…” and know that dropping the name “Goldman Sachs” implies a certain elite status and cache that a local boutique would not. Investment returns are not as important as having the account itself.

The Team Player – The team player relationship – perhaps the most healthy of all client-broker relationships - is when client and broker work together to create winning strategies. Good calls are held, and bad calls are dropped before they become overly bad. The client calls the broker just often enough to maintain a regular presence, but not often enough to annoy. With a team player broker, one will actually be working with a broker in a partnership, and so investing prowess and a match of styles is important. Team player relationships tend to break down into co-dependency.

The Discount (Online) Broker – Discount brokerages give no investment advice at all, so winning or losing is completely due to individual investment decisions (assuming the investor does not ask friends, lovers etc., in which case that person becomes the substitute broker). Those who use discount brokers love the intellectual challenge of investing, and tend to believe that they are superior to most other investors. During the early and middle stages of market cycles this idea of superiority may have a grain of truth to it, but is definitely not true during bull markets, when uneducated investors open accounts in droves. Discount brokerage users also tend to believe that their strategies are “secret,” even when they are buying small amounts of stock in large corporations that trade millions of shares a day. Since they are working alone, discount brokerage users must be keenly aware of their own psychological shortcomings (hint: if you make a mistake once, it is a mistake. If you make the same mistake several times, it is not a mistake).

The broker descriptions above are, of course, not exhaustive, and several types may be blended together. Nevertheless, knowing your own motivations – and making sure these motivations are healthy – is useful knowledge. By eliminating those motivations that are most unhealthy, investment success can be improved exponentially.
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"He is a masochist who wants to lose."
Sigmund Freud, in regard to compulsive gamblers

This Volatile Market: Buy or Sell?

The markets are in turmoil from weak jobs reports, gushing oil, protests, currency values, regulations and more. Prices wave and drop; the VIX fluctuates. Mr. Market has a panic attack on Monday, celebrates on Tuesday, and then flips out again on Wednesday. And it’s been going on for weeks. Glorious chaos.

In such times of gloom and uncertainty, should one invest in stocks, or stay as far away as possible?

The answer depends on your timeline and your stomach. How much do you worry about money? If your stocks were to drop 30% from today, would you be distraught? Would you feel regret, or anger? Would you lose sleep? If so, buy a GIC and forget that the markets exist: they are not for you.

In the last week of May, outflows from long-term U.S. mutual funds reached almost 17 billion dollars. This means that retail investors (your parents, your friends, your coworkers) were fleeing the market in droves (and still are). They told their friends they were selling because they are clairvoyant and “knew” the market would drop, but really it was because they were scared. So they sold, and their selling indeed made the market drop.

Most people start out with every intention of being a long-term investor - “I’m going to keep these until I retire.” Then they watch the news, until finally they break out in a cold sweat, panic and sell. Retail investor capitulation (i.e. “giving up”) is a valuable buying signal.

In volatile markets such as this, with countries around the world at very different stages of crash and recovery, it’s important to keep your margin account well margined or your cash account in cash, in order to take advantage of opportunities as they arise. There is nothing worse than to see the market fall and not be in a position to take advantage of it.

Will U.S. stocks go lower from here? Maybe, since financial news reporters don’t look lugubrious yet. But, maybe not. No one actually knows what will happen in the markets next week or next month, and the sooner you accept this fact the better.

What is known is that by all reliable methods of valuation (P/E ratios, price-to-book values, ROE to bond rates etc.) many U.S. stocks are both healthy and cheap. Seek them out. Within 5-7 years, today’s stock prices will look laughably low.

“Five to seven years!” you might be thinking. “I’m not waiting that long!” If so, your disposition is probably that of a trader, not an investor. Investing requires the patience and fortitude to wait until the next period of euphoria to sell, and that could realistically be years away. I don’t mind waiting several years to triple my money (or more). How about you?
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“The markets are always wrong. At some points in time they are more wrong than others.”

George Soros, The Alchemy of Finance (in response to the notion that “the markets are always right.”)

The World Housing Bubble - Part II

Just in case you thought it was over...

Back in March, The Frost Report noted that during the economic crisis of 2006 and beyond, countries around the world drastically lowered interest rates to spur economic growth. Like the Frankenstein monster, the good intentions of these low interest rates have morphed into a hideous mess: a multinational, worldwide housing bubble.

Some economies have already moved from the "we don't have a bubble" stage to the "bubble is beginning to burst" stage, while others are still recovering from the first one. In case you missed the original article or it has faded from memory (see: World Housing Bubble), here is another selection of this year’s headlines to remind you that the problem is far from over.

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THE UK

House price rises ‘unsustainable’ as lending falls
The Times, June 2nd 2010

"Vicky Redwood, Capital Economics’ senior UK economist, said that the data 'continues to suggest that the recent rise in house prices is unsustainable'."

http://business.timesonline.co.uk/tol/business/industry_sectors/construction_and_property/article7142355


CHINA

May property sales plunge in Beijing, Shanghai, Shenzhen
Xinhua, June 2nd 2010

"Beijing, property signings slumped nearly 70 percent to 3,357 in May from April, the Shanghai Securities News reported, citing data from the city’s housing regulator. In Shanghai, transactions may have dropped about 70 percent to 2,550 signings, the paper reported, and in Shenzhen, sales fell 62 percent."

http://news.xinhuanet.com/english2010/business/2010-06/02/c_13328894.htm


AUSTRALIA

Interest rate rises subdue housing bubble
The Australian, June 1st 2010

"The Reserve Bank of Australia's rate rises have pricked the boom in housing prices and have also sent lending to businesses skidding into reverse."

http://www.theaustralian.com.au/business/property/interest-rate-rises-subdue-housing-bubble/story-e6frg9gx-1225873746105


KAZAKHSTAN

National Bank Chairman: Kazakhstan Focuses on Economic Recovery
Ministry of Foreign Affairs, May 4rth 2010

"Kazakhstan was one of the first countries to experience the global economic meltdown of credit. As a result, it was one of the first to respond with a comprehensive program to deal with problem sectors, such as banking, financial services and property development — the industries that created an economic ‘‘bubble’’ whose collapse the country is still recovering from."

http://portal.mfa.kz/portal/page/portal/mfa/en/content/news/ASTANA%20CALLING/2010-05-04


KENYA

As Nairobi Property Prices Rise, Home Buyers Suffer Low Returns
AllAfrica, Feb 22nd 2010

"Many people who have taken mortgages to buy rental properties are finding it increasingly difficult to service the loans since rents accrued are not sufficient to cover the monthly mortgage repayments.
At the heart of the problem is the fact that rents in many parts of Nairobi suburbs are facing a property price bubble."

http://allafrica.com/stories/201002221638.html


ISRAEL

Legal Ground: The end of easy mortgages?
The Jerusalem Post, May 28th 2010

"It was predictable that the Bank of Israel would move to cool the residential mortgage market. We have seen what anarchy of easy mortgages could do to a massive established economy like that of the US. Even more so, the collapse of a bank in a small economy such as Israel could be a disaster."

http://www.jpost.com/Business/Commentary/Article.aspx?id=176747


CANADA

House prices to drop: TD
The Globe and Mail, May 5th 2010

"House prices will fall in 2011, TD Bank said Wednesday as it revised its outlook for the Canadian real estate sector."

http://www.theglobeandmail.com/report-on-business/house-prices-to-drop-td/article1557540


TAIWAN

Taipei Real Estate Risks Grow After Record Rally
Bloomberg, May 20th 2010

"Investors should sell Taipei property now, taking advantage of a 21-month rally in prices before the government acts to make real estate more affordable, according to the Taiwan Real Estate Research Center and the island’s largest real-estate brokerage."

http://www.bloomberg.com/apps/news?pid=20601206&sid=a0cIUQ74Wfy0
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After today’s “hot economies” become tomorrow’s “busted economies” and real estate prices return to normal, the world map of economic health will need to be redrawn. Those with developed infrastructure and the ability to raise taxes will fare better, while emerging markets will likely be hardest hit.

If you have a margin account and/or trade international stocks, it would be wise to raise some cash (if you haven't already), to take advantage of bargains as they come available in the next 18 months.

Despite ongoing domestic problems, it is my belief that in a few years the United States - whose massive deleveraging has preceded and superseded all others - will look enviously safe and stable.

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"...in an environment in which the financial sector is prone to excess and the supervisory structure does not respond sufficiently, the interaction of low interest rates and financial vulnerabilities can clearly be dangerous."

Donald Kohn, Federal Reserve Board, 2010

What's Wrong with It?

"What’s wrong with it?” is a question that first-time investors (and some seasoned ones) have a tendency to ask when a stock goes down.

The full question is, “I just bought the stock last week, and now it’s going down! What’s wrong with it?” The actual problem may be the company, it may be the market, or (most likely) may be the question itself.

When a stock drops, the first thing to consider is what the general market is doing. If the market is rising and your stock is dropping, it is likely that something is indeed wrong with the company, especially if the selling continues for more than a few days. On the other hand, if the whole market is dropping and yours is dropping along with it, there is nothing necessarily wrong with the stock you purchased. But, a decision is necessary. And you have to ask yourself a couple of questions before making that decision.

Question One: Has the company changed?

There should be some good reasons why you initially bought the stock. Hopefully, most of these reasons are related to the company behind it. If you bought a stock only because the chart looked good, you’ll likely lose money. If you bought the stock because the company has steady earnings, low debt, great return on equity, reasonable P/E ratio etc., and the chart looked good, you should be just fine. If the reasons you bought the company still apply, strongly consider keeping the stock.

Question Two: What is the state of the economy?

There’s an expression in investing: “Don’t try to catch a falling knife.” If the market begins falling from a peak, and you have reason to believe that the entire market will continue falling for an extended period of time, you should seriously consider selling the stock and buying it back later. No matter how good your stock is, if the entire market is falling, yours will likely fall with it. On the other hand, if you are not 100% sure (I repeat: 100% sure) that the market will be significantly lower a month from now than it is today, keep the stock.

Question Three: What is the state of the industry?

Have their been any rule changes or significant developments that have impaired the moneymaking potential of the business? Have their been any adverse political developments? If there have been changes, find out about them and assess their impact yourself – do not rely on others to do so for you. Emotions tend to run high in such situations, and emotions have no place in investing.

The fact is, stocks of good companies drop all the time. Just because a stock price drops does not necessarily mean that the stock is “bad.” In fact, if the price has dropped significantly, and the company still has all the great qualities that made you buy it in the first place, consider buying more. Many a fortune has been made by purchasing under-priced assets and having the patience to wait.

“What’s wrong with it?” is often just a way of saying; “I’m overwhelmed with the human fear of losing money, and have no confidence in my original decision.” If this applies to you, take a deep breath and re-read this article with your stock in mind. Then make a decision.

If you still feel overwhelmed, sell your stocks and get out of the market, forever. Not everyone was meant to own stocks. To make money in the market, you have to not care about money.
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“I think that if any reader of these chapters is convinced – really convinced – he cannot master the market, a great deal has been accomplished, because the great majority will fail in the market, & it’s worth dollars and cents to them to know it.”

Gerald Loeb, The Battle for Investment Survival

Abouuuuut….Face!

The CREA Gets Real




Just seven days ago, I wrote an article stating that the Canadian Real Estate Association should be ashamed of themselves for their cheery and completely unrealistic assessment of the Canadian housing market (see: CREA to the Rescue).

Today, in a stunning about-face, the CREA "updated" its forecast, admitting that by 2011 a "demand-driven downturn" will push Canadian home prices lower. They even added that the threat of rising interest rates and new taxes caused buyers to jump into the market sooner than they may have otherwise (something I wrote about in April, in Spending 'til it Hurts).

It’s unclear what prompted the CREA to come clean. I’d like to think it was my blog, but more likely they simply realized that a small dose of reality now prevents egg-on-your-face later.

Of course, the CREA is still being idealistic (read "deceptive"). Amongst other nonsense, they insist that Canada’s "conservative lending practices" and mythical "prudent borrowing" will prevent a large price correction; that the two most overpriced markets (Ontario and B.C.) will inexplicably plateau next year after a small drop; and, of course that the current market shows a good balance between supply and demand. But, at least they aren’t encouraging a new wave of oblivious buyers. The CREA has, with its latest press release, gained back a shred of dignity.

I have to give credit where credit is due: the CREA did the right thing. More of the same would be nice.

For the CREA's full press release, see Housing Forecast Revised.
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"Home sales are coming down from the mountain peak, but they will level out at a high plateau -- a plateau that is higher than previous peaks in the housing cycle.”

David Lereah, Chief Economist, National Association of Realtors, USA 2006