Saturday, August 28, 2010

Wall Street Consensus Is Often Wrong

There is one sucessful way to not only make money but to avoid losing money in the financial markets. That is to avoid the 'certainties' determined by the Wall Street consensus and to consider investing into areas disliked by the Wall Street consensus.

Look back a decade ago...The United States' government was running a budget surplus, no Western country could ever imagine facing default and the only BRICs anyone had heard of were the ones used to build houses.

At the time, Wall Street was telling everyone there were two surefire investments which were the road to riches for the average American. The two surefire investments were technology stocks and housing. Subsequently, both the Nasdaq bubble and the US housing bubble burst in spectacular fashion. It was the bursting of the housing bubble which has brought the American economy to its knees.

And at the same time, Wall Street told everyone to avoid other areas such as those "dangerous" emerging markets like China. And gold? It was a relic and only a nut case would invest in gold. After all, it was at a two-decade low of $279 an ounce.

That advice really worked out well - not! While the Dow Jones average has gone nowhere, the Nasdaq was sliced in half, and housing prices collapsed, gold prices have steadily climbed in the past decade to its current level above $1200 an ounce.

Meanwhile, China experienced near double-digit economic growth nearly every year in the past decade. And other emerging markets like Brazil and India have also done remarkably well.

In fact, the emerging markets have done so well that they are countries that are sitting on huge amounts of surpluses and are not at the risk of default as are many Western nations.

So what are the "geniuses" on Wall Street saying today?

The consensus is that gold is a "bubble" and sure to collapse. The geniuses are also saying that China and other emerging markets are also bubbles sure to collapse at any time.

Keep in mind, these are the same people that somehow did not see the almost-impossible-to-miss bubbles that were the Nasdaq and the US housing markets.

And what does Wall Street like? Why, of course, they love US Treasuries. The consensus is urging everyone to get into Treasuries for "safety" reasons. That is laughable!

US Treasuries are the biggest bubble I have seen in my 30 years in the investment industry. It is merely a "momentum" trade that everyone on Wall Street is piling into.

During the Nasdaq bubble, people would "invest" into companies with no realistic business plan, no revenues and no hopes of ever making money. Or if a company had earnings, investors would pay 100 times earnings.

Today in the Treasuries bubble, investors are once again paying sky-high prices for tiny streams of income. For example, in the case of the 10-year inflation adjusted notes (TIPS), investors are now paying more than 100 times the expected annual return.

In addition, the amount of money pouring into bond funds from individual investors is similar to the money flows that went into technology mutual funds at the height of the tech mania. And the chart comparing the performance of the Nasdaq in the bubble years to the recent performance of the US Treasury market is also scarily similar.

Bottom line - it will end very badly some day for investors who buy Treasuries, with the bonds losing 50 per cent or more of their value.

What should investors do? Get out of bonds and look at areas that are out of favor on Wall Street such as gold, other commodities and emerging markets.

Saturday, August 21, 2010

A Tale of Two Economies

Charles Dickens 'A Tale of Two Cities' begins with "It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness."

Apparently Dickens was an economist. His quote describes perfectly the global economy and the current juxtaposition between the German and American economies.

The contrast between the two economies can be seen in the recent important economic news, which the mainstream American press pretty much ignored.

That news was the performance of the German economy and its vigorous rebound from the recession of last year. Germany's economy grew by 2.2% in the second quarter of 2010. That stands in stark contrast to the American economy which looks to be slipping back again.

The German economy's 2nd quarter growth translates to a 9.1% annual growth rate! This is emerging markets type of economic growth, which we normally see in countries like China and India. In addition, Germany's unemployment rate is now at the lowest level it has been in years - a 7.6% rate.

How did Germany accomplish this?

One key factor is that Germany is still an industrial powerhouse. Its industrial sector makes up about one-quarter of its total economy.

And it's not an just export story...German imports are also surging. German imports in June surged to a record 100 billion euros thanks to confident consumers.

Germany's industrial sector sold all sorts of manufactured goods to fast growing emerging economies such as China.

And speaking of China.....

In the United States, there is constant griping about China and how they don't compete fairly or buy American products,etc.

In Germany, policymakers are "worried" that German companies are selling too much to China and becoming dependent on Chinese demand.

Siemens is an example of a large German industrial company. It recently reported that its order backlog is the highest ever in its entire 163 year history! And much of that is thanks to China and other emerging markets.

Another factor in Germany's strong economic performance is that it was wise to ignore American economic "advice".

German leaders ignored American government leaders like Tim Geithner and American economists who all urged Germany to not work so darn hard, go on a spending spree and pile up debt like America in order to stimulate its economy.

However, instead Germany focused on the basics. It encouraged work and productivity and focused on making products that other nations around the world actually need and want. It did not focus it efforts on leisure activities or creating the latest 'cool' tech gadget.

The contrast between the two economic philosophies could not be sharper and neither are the economic results.

'The age of wisdom and the age of foolishness' indeed.

Saturday, August 14, 2010

The Federal Reserve Strikes Again

A recent headline on the cover of Barron's said it all: "Why the Fed will soon print $2 trillion".

This past week the Federal Reserve, headed by Ben Bernanke, said it would continue to keep interest rates near zero and that it would continue to buy billions of dollars worth of Uncle Sam's debt.

Its decision has two obvious effects. First, the Federal Reserve continues to screw savers with those near-zero interest rates.

Second, the Fed's purchases of US Treasuries continues to distort the Treasury market. Their actions keeps rates artifically low, creating a dangerous bubble in the Treasury market. This bubble has sucked many unwary investors into bond funds and will blow up eventually. When the Treasury bubble bursts, it will cause huge losses for investors who thought they were playing it "safe".

Why is the Federal Reserve doing this? Because the so-called recovery in the US is a flop. Trillions of dollars of "stimulus" have produced nothing.....

Unemployment is not getting better. Consumers aren't shopping. Banks aren't lending. And the list goes on.....

Both the Federal Reserve and the US government continue to blindly follow Keynesian economics, named for famed economist John Maynard Keynes.

But it is a perverted form of Keynesian economies...Keynes is probably turning over in his grave.

The government only follows half of Keynes' advice - to stimulate the economy during downturns in the economy.

It conveniently forgot the other part - any stimulus money was to come from money that had been SAVED during good economic times.

Keynes' theory is much like the Bible story concerning a dream the Egyptian pharaoh had about seven lean years which would follow seven good years, that was interpreted by Joseph.

Apparently the US government didn't have a Joseph and forgot to save anything during the good years.

The Swedish Solution

And much like the BP oil crisis where the US government arrogantly refused any sort of help from overseas, the Federal Reserve refuses to implement a solution given to them by the Swedish central bank to jumpstart lending.

The United States has a big problem with its banks reluctance to lend to anyone. Here is why.....

When the financial crisis hit, in an effort to "save" the banks, the Federal Reserve began paying banks interest on any money deposited with the Federal Reserve. The Fed did not do this before the crisis hit.

So the banks' logic is "why take a risk and lend the money out, when we make money just by letting it sit there 100% risk-free at the Fed?"

Sweden had a similar problem with their banks not long ago. Their solution?

Negative interest rates.

In plain English, if Swedish banks left money deposited at the Swedish central bank, they would have to pay the central bank interest on the money!

Needless to say, Swedish banks soon took their money out of the Swedish central bank and began making loans in an effort to make a profit.

But the Federal Reserve, with its only concern seeming to be Wall Street and the banks, has refused to do this. At the least, it could go back to its old policy and quit paying interest to the banks.

But do not expect a change in the Fed's or the government's policies until the train (US economy) completely jumps off the track.

Saturday, August 7, 2010

No Ratings Agencies Reform

The ongoing global financial crisis has prompted great changes in almost every industry. Credit rating agencies, one of the main culprits of the crisis, somehow seems to have escaped unscathed. Until now.....

When it came to rating a bond, there were only three companies which did this and all of them are US-based. The three firms are Standard & Poor's, Moody's and Fitch.

But that has now changed. There is a new player in town. It is China's Dagong International Credit Rating Company.

This makes sense. China, the largest sovereign debt holder in the world, with nearly $2.5 trillion would like to have a bigger say as to the risk and reward Beijing deems appropriate for its investment money.

It has already created quite of stir by lowering the debt rating of the United States down from AAA. It lowered its rating to AA with a negative outlook.

That may just be politics but what Dagong said about its competitors is pertinent and rings true.

It accused its American rivals of becoming politicized. It said the three rating agencies were "too close to the clients" [Wall Street] and highly ideological - "the United States will always be a AAA rating" - and thus have lost their objectivity in rating bonds.

As if to confirm the Chinese criticism, the Wall Street Journal recently reported that the three big US credit rating firms have made an urgent request of their new clients.

That request? "Do not use our names on bond issues!"

Why? Because the new financial reform law made them liable for their ratings effective immediately.

So, instead of defending and standing behind their work, the three companies basically told the world "China is right. Do NOT trust us!"

The big three credit rating firms have been highly criticized in the aftermath of the global financial crisis and rightly so.

The firms rated any piece of junk issued by Wall Street as AAA, as long as they were highly compensated by Wall Street.

This inherent conflict of interest was NOT addressed by the new financial reform law, so even the Europeans are joining the Chinese and soon will be setting up their own credit rating agency.

The rating agencies can be put into the too big to fail and too stupid to survive category. These firms' incompetence, or is it complicity, is truly outstanding.

In any true financial reform legislation, their government-supported monopoly should have ended and the firms should have been shut down or at the least completely revamped to make them truly independent.

It looks like the corrupt monopoly is ending anyways though, thanks to the Chinese and the Europeans.