Bennie Put!

Oh but they're weird and they're wonderful
Oh Bennie she's really keen
She's got electric boots a mohair suit
You know I read it in a magazine
B-B-B-Bennie and the Jets

Elton John - Bennie and the Jets **with lyrics**

Last week the Federal Reserve could not have been clearer in its Open Market Committee Statement that it wants more inflation. "Measures of underlying inflation are currently at levels somewhat below those the committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability," the statement said. By saying that the inflation rate is too low the Fed is signaling that it wants more inflation to hopefully reduce unemployment. Is it any wonder that gold has moved above $1,300 per ounce and the dollar continues to fall.

Back in the day when Alan Greenspan was in charge, we had what was known as the Greenspan Put; whenever the economy or the markets got into trouble Greenspan rode to the rescue by cutting rates. This Greenspan Put led to asset inflation; real estate, bonds, equities, and commodities. It ended badly.

Fast forward to today and we have the Bennie Put. Unfortunately for Ben he doesn't have the luxury of cutting rates since they are already at zero. No, instead his only real alternative is quantitative easing (QE2), printing money to buy treasuries, mortgages, or other assets. The value of that newly printed money goes down, and new bubbles are created.

There is an old saying in the investment business, "Don't fight the tape, and don't fight the Fed." The "tape" is simply an assets price trend, or momentum, and the Fed controls the $$. 

There's often a tendency in our business to over-think things, this is clearly not one of those times. The Fed has given the "all's clear" signal for risk assets, and the markets are responding. So far this month the S&P 500 is up nearly 9%, and gold is up about 5%. On the other hand, long-term treasuries have lost about 1%. 

I'm not saying that we should throw caution to the wind, I'm just saying that in a diversified portfolio a bit more risk exposure should be fine, after all we have the Bennie Put watching our backs.

But Bennie makes them ageless
We shall survive, let us take ourselves along
Where we fight our parents out in the streets
To find who's right and who's wrong

Now I'm not the only investor who feels this way, hedge fund manager David Tepper also believes in the Bernanke Put. For those not familiar with David Tepper, he is a Pittsburgh native who went to Pitt and CMU, and then went on to amass fortune (recently #62 on Forbes wealthiest list with $4.2 billion) and fame as the head of Appaloosa Management. Last year his hedge fund made a tidy profit of about $7 billion. In 2003 he gave CMU $55 million for the new David A. Tepper School of Business. Listen to his interview on CNBC:

Hedge Fund Titan David Tepper - CNBC.com

War Has Been Declared:

Not conventional warfare, but currency warfare. Brazil's finance minister, Guido Mantega, recently stated, "We're in the midst of an international currency war, a general weakening of currency. Devaluing currencies artificially is a global strategy and this threatens us because it takes away our competitiveness." This is also known as competitive currency devaluation. Countries resort to currency devaluation to make their exports more affordable and their imports more expensive, therefore hopefully stimulating their economy at the expense of their trading partners. This is often attempted during periods of global economic stress, and generally does not end well (see Great Depression). Since all nations have "FIAT" currencies, a currency can only devalue "relative" to other currencies, (or relative to some hard asset like gold). Unlike most wars the winner of the currency devaluation war is usually not much of a winner.

The main culprits in this war are the United States with it's stated policy to devalue the dollar via Quantitative Easing, and the Chinese who have pegged the Yuan to the dollar. Countries like Japan and Brazil have seen their currencies strengthen versus the dollar and at least in Japans case are actively intervening in the currency markets. The Euro has also strengthened versus the dollar.

Investment Implications:

If you're in a conventional war, and you have the misfortune of being located in the losing country, you want to try and get as many of your assets outside of your country as soon as possible; usually starting with loved ones. In a currency war the same analogy holds true. You want to get as many of your assets denominated in currencies that will appreciate relative to your losing currency. If the US is successful in "winning" this currency war (winning as defined by devaluing their currency the most! ), then as US citizens/investors need to think about allocating assets to other currencies. We use gold first and foremost as the ultimate currency hedge, but we also have allocations to international equities (particularly emerging markets), international fixed income, international real estate, and Chinese Yuan. 

Oh! what a tangled web we weave when first we practice to deceive! -- Sir Walter Scott 1808 

This famous quote instantly came to mind when I read in today's WSJ about the Feds manipulation of the TIPS market (HEARD ON THE STREET: Fed Tips Inflation Expectations - WSJ.com ). 

TIPS (Treasury Inflation Protected Securities) are Treasury securities designed to reflect investors inflation expectations out five to ten years. We buy them as inflation hedges with the full realization that they are based on the governments own calculation of CPI. They are not perfect inflation hedges, but they are better than nothing. Now we find out that since the Fed is purchasing Treasury securities, the spread between treasuries and TIPS is distorted. Not to worry, the Fed also stepped in to buy $550 million in TIPS to hopefully keep the spread at what they feel the free markets would price it at. WOW, what is the real market interest rate and what is the real market inflation expectations??? Don't worry, I'm sure they'll get it right.

Scary Sign Of What's To Come: 

Her Majesties Revenue & Customs (the UK's IRS) has proposed that all employers simply send employee paychecks to the government, after which the government would deduct what it deems as the appropriate tax and then pay the employees the net amount via a bank transfer. This is being sold as a massive productivity improvement since employers would no longer be responsible for deducting taxes from employees pay checks. Everyone will eventually get their democratically assigned allotment when the bureaucrats get done with their calculations. And if you have any questions with your deductions you won't have to bother your boss, you'll just call your friendly, always helpful, HM Revenue & Customs representative. I'm sure there's more than a few people in Washington salivating over this plan!

Ah! Paree!

Last week my lovely wife and I went to Paris to celebrate our 25th wedding anniversary. Why Paris? Well, other than the obvious fact that it is easily one of the worlds most beautiful and romantic cities, it is also the only non-stop international flight out of Pittsburgh (how's that for romance). After a rather cramped but pleasant 8 hour flight, we were greeted with a $100, two hour taxi ride into the city. Other than that the trip couldn't have been nicer. We stayed at the Hotel LA Tremoille just off the Champs-Elysees, and everyone we met couldn't have been more helpful or nicer. We were able to dine at several of the bistros visited by Anthony Bordain in the 100th episode of "No Reservations" ( Paris - Anthony Bourdain: No Reservations Travel Guide - Travel ... ) and ate and drank our way to a happy place. 

I found the automatic 15% gratuity on every tab an interesting socialistic expression, "We're French and all of our service is equally good." I was also amused at the VAT (Value Added Tax) that was attached to each tab, not that it was there, but in how it was implemented. Certain items, such as frog legs and escargot, had a lower VAT than other items. Just the governments way to reward some at the expense of others.

None of these are complaints, just amusing observations; we loved Paris and can't wait to take the girls there for some real food.

Be careful out there, and keep the light's on,

Chris Wiles

www.rockhavencapital.com

For prior Rockhaven Views visit:

www.rockhavencapmgmt.blogspot.com

This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management.  The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

    

 

Rock On Gold Dust Woman

"So rock on, ancient queen
Follow those who pale in your shadows
They say rulers,
They make bad lovers
You'd better put your kingdom up for sale
Well you'd better sell it, sell it "

"Gold Dust Woman" by Stevie Nicks

With gold hitting a new high in dollar terms of $1,275, I thought it was an appropriate time to trot out an old article (circa 1967) written by none other that Alan Greenspan, former Chairman of the Federal Reserve. The reason this article came to mind was John Paulson's (the multi-billion dollar hedge fund manager) recent letter to investors reminding them that Alan Greenspan now works for them, and that Greenspan's currency views are a major reason why Paulson's $30 billion hedge funds have over 25% devoted to gold. An excerpt of the letter:

"Lastly, and perhaps most importantly, from a monetary policy perspective in developing an ability to forecast the timing and future price of gold we believe we have an unparalleled team. Former Federal Reserve Chairman Alan Greenspan has been extremely helpful to us in understanding the relationship between the monetary base, the money supply, inflation and gold prices."

One of our cardinal rules here at Rockhaven is to be in harmony with the markets, and a big part of that is to observe where money is heading and get in front of it. All of our client accounts have had at least 10% invested in gold. Numerous people talk about gold being in a bubble, they point to the TV ads, and the gold exchanges at the Mall, but the truth is very few people actually invest in gold. How much gold do you own as a percentage of your net worth? How much do you think the big bank trust departments have invested in gold (zero to not much)? Everything you own is valued in fiat currencies, mostly US dollars, is that diversification? If the biggest risk we face as investors is the rapid devaluation of the US dollar, isn't gold a way to hedge that risk?

I've always found Greenspan to be an interesting character, for a money geek. An accomplished saxophonist, he dropped out of Juilliard to join a jazz band, but soon grew tired of starving and went back to school to study economics. In the 1950's he became good friends with Ayn Rand, who stood next to him in 1974 when President Ford swore him in as Chair of the Council of Economic Advisors. He dated Barbara Walters in the late 1970's, and in 1984, at the age of 58, he began dating 38 year old journalist Andrea Mitchell. They were married in 1997 by Supreme Court Justice Ruth Bader Ginsburg. 

It appears that since leaving the highly politicized world of the Fed, Greenspan has reverted to his old libertarian beliefs. Here are a couple of his quotes from a recent investment conference in New York:

"What is fascinating is the extent to which gold still holds reign over the financial system as the ultimate source of payment." And "Rising prices of precious metals and other commodities are an indication of a very early stage of an endeavor to move away from paper currencies." 

Here is a copy of his 1967 article:

GOLD AND ECONOMIC FREEDOM

An almost hysterical antagonism toward the gold standard is one issue which unites statists of all persuasions. They seem to sense-perhaps more clearly and subtly than many consistent defenders of laissez-faire -- that gold and economic freedom are inseparable, that the gold standard is an instrument of laissez-faire and that each implies and requires the other.

In order to understand the source of their antagonism, it is necessary first to understand the specific role of gold in a free society.

Money is the common denominator of all economic transactions. It is that commodity which serves as a medium of exchange, is universally acceptable to all participants in an exchange economy as payment for their goods or services, and can, therefore, be used as a standard of market value and as a store of value, i.e., as a means of saving.

The existence of such a commodity is a precondition of a division of labor economy. If men did not have some commodity of objective value which was generally acceptable as money, they would have to resort to primitive barter or be forced to live on self-sufficient farms and forgo the inestimable advantages of specialization. If men had no means to store value, i.e., to save, neither long-range planning nor exchange would be possible.

What medium of exchange will be acceptable to all participants in an economy is not determined arbitrarily. First, the medium of exchange should be durable. In a primitive society of meager wealth, wheat might be sufficiently durable to serve as a medium, since all exchanges would occur only during and immediately after the harvest, leaving no value-surplus to store. But where store-of-value considerations are important, as they are in richer, more civilized societies, the medium of exchange must be a durable commodity, usually a metal. A metal is generally chosen because it is homogeneous and divisible: every unit is the same as every other and it can be blended or formed in any quantity. Precious jewels, for example, are neither homogeneous nor divisible. More important, the commodity chosen as a medium must be a luxury. Human desires for luxuries are unlimited and, therefore, luxury goods are always in demand and will always be acceptable. Wheat is a luxury in underfed civilizations, but not in a prosperous society. Cigarettes ordinarily would not serve as money, but they did in post-World War II Europe where they were considered a luxury. The term "luxury good" implies scarcity and high unit value. Having a high unit value, such a good is easily portable; for instance, an ounce of gold is worth a half-ton of pig iron.

In the early stages of a developing money economy, several media of exchange might be used, since a wide variety of commodities would fulfill the foregoing conditions. However, one of the commodities will gradually displace all others, by being more widely acceptable. Preferences on what to hold as a store of value, will shift to the most widely acceptable commodity, which, in turn, will make it still more acceptable. The shift is progressive until that commodity becomes the sole medium of exchange. The use of a single medium is highly advantageous for the same reasons that a money economy is superior to a barter economy: it makes exchanges possible on an incalculably wider scale.

Whether the single medium is gold, silver, seashells, cattle, or tobacco is optional, depending on the context and development of a given economy. In fact, all have been employed, at various times, as media of exchange. Even in the present century, two major commodities, gold and silver, have been used as international media of exchange, with gold becoming the predominant one. Gold, having both artistic and functional uses and being relatively scarce, has significant advantages over all other media of exchange. Since the beginning of World War I, it has been virtually the sole international standard of exchange. If all goods and services were to be paid for in gold, large payments would be difficult to execute and this would tend to limit the extent of a society's divisions of labor and specialization. Thus a logical extension of the creation of a medium of exchange is the development of a banking system and credit instruments (bank notes and deposits) which act as a substitute for, but are convertible into, gold.

A free banking system based on gold is able to extend credit and thus to create bank notes (currency) and deposits, according to the production requirements of the economy. Individual owners of gold are induced, by payments of interest, to deposit their gold in a bank (against which they can draw checks). But since it is rarely the case that all depositors want to withdraw all their gold at the same time, the banker need keep only a fraction of his total deposits in gold as reserves. This enables the banker to loan out more than the amount of his gold deposits (which means that he holds claims to gold rather than gold as security of his deposits). But the amount of loans which he can afford to make is not arbitrary: he has to gauge it in relation to his reserves and to the status of his investments.

When banks loan money to finance productive and profitable endeavors, the loans are paid off rapidly and bank credit continues to be generally available. But when the business ventures financed by bank credit are less profitable and slow to pay off, bankers soon find that their loans outstanding are excessive relative to their gold reserves, and they begin to curtail new lending, usually by charging higher interest rates. This tends to restrict the financing of new ventures and requires the existing borrowers to improve their profitability before they can obtain credit for further expansion. Thus, under the gold standard, a free banking system stands as the protector of an economy's stability and balanced growth.

When gold is accepted as the medium of exchange by most or all nations, an unhampered free international gold standard serves to foster a world-wide division of labor and the broadest international trade. Even though the units of exchange (the dollar, the pound, the franc, etc.) differ from country to country, when all are defined in terms of gold the economies of the different countries act as one -- so long as there are no restraints on trade or on the movement of capital. Credit, interest rates, and prices tend to follow similar patterns in all countries. For example, if banks in one country extend credit too liberally, interest rates in that country will tend to fall, inducing depositors to shift their gold to higher-interest paying banks in other countries. This will immediately cause a shortage of bank reserves in the "easy money" country, inducing tighter credit standards and a return to competitively higher interest rates again.

A fully free banking system and fully consistent gold standard have not as yet been achieved. But prior to World War I, the banking system in the United States (and in most of the world) was based on gold and even though governments intervened occasionally, banking was more free than controlled. Periodically, as a result of overly rapid credit expansion, banks became loaned up to the limit of their gold reserves, interest rates rose sharply, new credit was cut off, and the economy went into a sharp, but short-lived recession. (Compared with the depressions of 1920 and 1932, the pre-World War I business declines were mild indeed.) It was limited gold reserves that stopped the unbalanced expansions of business activity, before they could develop into the post-World War I type of disaster. The readjustment periods were short and the economies quickly reestablished a sound basis to resume expansion.

But the process of cure was misdiagnosed as the disease: if shortage of bank reserves was causing a business decline-argued economic interventionists -- why not find a way of supplying increased reserves to the banks so they never need be short! If banks can continue to loan money indefinitely -- it was claimed -- there need never be any slumps in business. And so the Federal Reserve System was organized in 1913. It consisted of twelve regional Federal Reserve banks nominally owned by private bankers, but in fact government sponsored, controlled, and supported. Credit extended by these banks is in practice (though not legally) backed by the taxing power of the federal government. Technically, we remained on the gold standard; individuals were still free to own gold, and gold continued to be used as bank reserves. But now, in addition to gold, credit extended by the Federal Reserve banks ("paper reserves") could serve as legal tender to pay depositors.

When business in the United States underwent a mild contraction in 1927, the Federal Reserve created more paper reserves in the hope of forestalling any possible bank reserve shortage. More disastrous, however, was the Federal Reserve's attempt to assist Great Britain who had been losing gold to us because the Bank of England refused to allow interest rates to rise when market forces dictated (it was politically unpalatable). The reasoning of the authorities involved was as follows: if the Federal Reserve pumped excessive paper reserves into American banks, interest rates in the United States would fall to a level comparable with those in Great Britain; this would act to stop Britain's gold loss and avoid the political embarrassment of having to raise interest rates.

The "Fed" succeeded; it stopped the gold loss, but it nearly destroyed the economies of the world in the process. The excess credit which the Fed pumped into the economy spilled over into the stock market -- triggering a fantastic speculative boom. Belatedly, Federal Reserve officials attempted to sop up the excess reserves and finally succeeded in braking the boom. But it was too late: by 1929 the speculative imbalances had become so overwhelming that the attempt precipitated a sharp retrenching and a consequent demoralizing of business confidence. As a result, the American economy collapsed. Great Britain fared even worse, and rather than absorb the full consequences of her previous folly, she abandoned the gold standard completely in 1931, tearing asunder what remained of the fabric of confidence and inducing a world-wide series of bank failures. The world economies plunged into the Great Depression of the 1930's.

With a logic reminiscent of a generation earlier, statists argued that the gold standard was largely to blame for the credit debacle which led to the Great Depression. If the gold standard had not existed, they argued, Britain's abandonment of gold payments in 1931 would not have caused the failure of banks all over the world. (The irony was that since 1913, we had been, not on a gold standard, but on what may be termed "a mixed gold standard"; yet it is gold that took the blame.) But the opposition to the gold standard in any form -- from a growing number of welfare-state advocates -- was prompted by a much subtler insight: the realization that the gold standard is incompatible with chronic deficit spending (the hallmark of the welfare state). Stripped of its academic jargon, the welfare state is nothing more than a mechanism by which governments confiscate the wealth of the productive members of a society to support a wide variety of welfare schemes. A substantial part of the confiscation is effected by taxation. But the welfare statists were quick to recognize that if they wished to retain political power, the amount of taxation had to be limited and they had to resort to programs of massive deficit spending, i.e., they had to borrow money, by issuing government bonds, to finance welfare expenditures on a large scale.

Under a gold standard, the amount of credit that an economy can support is determined by the economy's tangible assets, since every credit instrument is ultimately a claim on some tangible asset. But government bonds are not backed by tangible wealth, only by the government's promise to pay out of future tax revenues, and cannot easily be absorbed by the financial markets. A large volume of new government bonds can be sold to the public only at progressively higher interest rates. Thus, government deficit spending under a gold standard is severely limited. The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit. They have created paper reserves in the form of government bonds which -- through a complex series of steps -- the banks accept in place of tangible assets and treat as if they were an actual deposit, i.e., as the equivalent of what was formerly a deposit of gold. The holder of a government bond or of a bank deposit created by paper reserves believes that he has a valid claim on a real asset. But the fact is that there are now more claims outstanding than real assets. The law of supply and demand is not to be conned. As the supply of money (of claims) increases relative to the supply of tangible assets in the economy, prices must eventually rise. Thus the earnings saved by the productive members of the society lose value in terms of goods. When the economy's books are finally balanced, one finds that this loss in value represents the goods purchased by the government for welfare or other purposes with the money proceeds of the government bonds financed by bank credit expansion.

In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.

This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard.

--Alan Greenspan

1967

"Did she make you cry
Make you break down
Shatter your illusions of love
Is it over now--do you know how
Pick up the pieces and go home."

 It's The Spending Stupid:

I'm not sure the folks in DC fully understand the angst of the American public, but I think it can be summed up nicely as "It's the spending, stupid."

The WSJ just reported that the percentage of American households receiving some form of government benefits (wealth transfers) has risen from 29.6% in 1983 to 44.4% in 2008 ... nearly half the population! In the meantime the percentage of American households not paying federal income taxes has also grown to 45% in 2010, from 39% in 2005! So we have nearly half the people getting checks from the government, and an increasingly smaller portion of the population paying for it. Even the mathematically challenged in DC should be able to realize that these trends can't continue much longer. The math doesn't work.

Be careful out there, and keep the light's on,

Chris Wiles

www.rockhavencapital.com

For prior Rockhaven Views visit:

www.rockhavencapmgmt.blogspot.com

This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management.  The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

    

There's A Monster Living Under My Bed

Hey now, all you sinners
Put your lights on, put your lights on
Hey now, all you children
Leave your lights on, you better leave your lights on

Because there's a monster living under my bed
Whispering in my ear
There's an angel, with a hand on my head
She say's I've got nothing to fear 

"Put Your Lights On" by Santana 

Santana, Everlast - Put Your Lights On

I worry about monsters. My job is to worry. I even worry about things that I have no control over. Some say I should chill (chillax, my daughters say ) , but its just not in my nature.

I believe that as investment managers we should worry about everything, things that we can control and things that we can't control, even those that we can't imagine.

We need to "Put Our Light's On" and keep them on, for only by shedding light on potential monsters can we hope to protect ourselves.

The monster whispering in my ear of late is very scary. So scary that both Dennis Blair, Head of US Intelligence, and Admiral Mullen, Chairman of the Joint Chiefs of Staff, agree that it is the biggest single threat to our national security.

What is this monster that strikes fear in the hearts of our military? Is it Iran, the Taliban, North Korea, or Hezbollah? No, this monster is our National Debt. I know what you are saying, "How can something as soft and fuzzy as a debt monster scare the leaders of the worlds most powerful military?" Well, as Admiral Mullen says, "our national debt has grown to such a level that by 2013 the annual interest alone will be $600 billion, which is more than Pentagon spending." 

While this monster is huge, its size is not really the scary part. No, the scary part is the insidious makeup of this monster, and who controls it.

You see, of the total $8.3 trillion in national debt more than 60% of it ($5.2 trillion) comes due in the next three years. The current weighted average cost of this short-term debt is 1.21%, but with ten year treasuries now yielding 2.77%, we could be faced with an additional interest rate expense of $133 billion annually. While the sheer magnitude of the numbers and the refinancing risk are pretty scary, what really keeps our military leaders awake at night is who controls this monster.

In the United States we have placed our continuing political solvency in the hands of the Federal Reserve, and we have greatly increased their power of late. This in and of itself is not the risk, the risk arises from the fact that the Fed has exposed itself to an incredible degree of vulnerability by telegraphing its positions and asset support mechanisms. In the cut-throat world of international finance, showing your opponent all of your cards is usually a very quick way to insolvency. What worries our leaders is that if you take down the Fed, you take down the USA! Every Treasury auction brings with it the fear that buyers may not show up. Is it hard to imagine a day when the Chinese or the Russians decide not to participate in our Treasury auctions? It wasn't all that long ago that we bankrupted the Russian economy by outspending them in the Cold War. Now of course naysayers (angels) are quick to point out that since the Chinese and Russians own huge amounts of our dollar denominated paper they would never consciously seek to bring down the US via a failed auction. That our economies are so intertwined, that a depression in the US would cause them as much or more pain at home. "There's an angel, with a hand on my head, she say's I've got nothing to fear." 

Now that's all well and good, but forgive me if I agree with our military leaders in not totally trusting everyone; especially those who have developed missiles and lasers to attack satellites, and are constantly launching cyber attacks on our internet infrastructure. The risk is very real, we are strung-out debt junkies, reliant on the kindness of our foreign pushers to keep stringing us along. Not the strongest position for a nation to be in.

As US based investors, how do we protect our wealth from this risk? Not easily. First, as US citizens we can try to elect politicians that understand the nature of this threat, and who have the nerve to take the harsh steps necessary to wean us off the debt drug.

Second, we need to think globally with our portfolios. Owning stocks, bonds, and real estate outside of the US. Owning gold, and even foreign currencies like the Chinese Yuan.

Diversification and tactical asset allocation can help, but they only mitigate the potential damage. No, the only cure is to banish the debt monster, and remove the threat forever. "Leave your lights on, you better leave your lights on."

Speaking of Debt Monsters and Debt Junkies

The attached is a great article by Michael Lewis for Vanity Fair titled "Beware Of Greeks Bearing Bonds", enjoy: 

Vanity Fair

A Meal To Die For

I love America, and our willingness to flaunt conventional wisdom in order to embrace our personal freedoms.

A great example of Americans embracing their personal freedom is Bill Geist's visit to the Heart Attack Grill, truly enjoyable: 

A Meal To Die For

Be careful out there, and keep the light's on,

Chris Wiles

www.rockhavencapital.com

For prior Rockhaven Views visit:

www.rockhavencapmgmt.blogspot.com

This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management.  The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

    

Bye-Bye Miss American Pie

A long, long time ago...
I can still remember
How that music used to make me smile.
And I knew if I had my chance
That I could make those people dance
And, maybe, they’d be happy for a while.

American Pie by Don McLean

Don McLean- American Pie (with Lyrics)

For most of my 25 year career as a professional money manager I practiced various forms of fundamental analysis. You know, picking stocks based on "fundamentals," such as; sales growth, earnings growth, balance sheet strength, management quality, and valuation. Variations of this fundamental approach to stock picking has served many managers very well over the last seventy years, but in the last decade it was often lacking, "Now for 10 years we've been on our own". There were always periods where fundamentals didn't work, generally when one sector or another was experiencing a bubble (think, nifty fifty in the '60's, energy in the '70's, or technology in the '90's), but since the early 2000's something has clearly changed. 

Over the years I've had many frustrating conversations with my peers trying to figure out why being a fundamental analyst was failing us. We never had a precise answer, but we did have some theories. One was the advent of sector funds and sector ETF's. With the advent of sector funds we noticed a marked increase in the correlation amongst stocks in that sector. When Pepsi moved up or down, Coke was most likely moving in tandem. The correlation among stocks in specific sectors grew closer and closer to 1.00. It often didn't matter if the fundamentals or valuations were better at Pepsi or Coke, they both moved in tandem. 

Now clearly there were outliers. There are always company specific events that may separate one company from another (i.e. BP with the rig explosion, or on the positive side Apple with the iEverything), but these are becoming rarer and rarer to find.

What this means for fundamental portfolio managers is that the opportunities to add value (or Alpha in quant speak) are becoming fewer and fewer. This fact can be readily observed by looking at the performance convergence among active managers. "I can't remember if I cried..."

Another area of concern was the massive increase in trading being done by Quant shops, or High-frequency Trading (HFT) operations. Ten years ago we were aware that trading based on computer algorithms accounted for nearly 50% of daily trading volume in US markets. Since then the technology has accelerated to the point where HFT platforms have ramped up speeds from trades per second, to trades per millisecond, to trades per microsecond (that's one-millionth of a second). These trades now account for more than 80% of daily total trading volume. "Oh, and while the King was looking down, the Jester stole his thorny crown." One CEO of a High-frequency trading firm stated that their longest duration holding period for a stock was eleven seconds, and he considered that rare and unacceptably long. These trades have absolutely nothing to do with corporate fundamentals. Go back to May 6, how can Procter & Gamble be trading at $62 one minute and $39 the next? It wasn't fundamentals. Attached is an excellent article from International Economy magazine by Harald Malmgren and Mark Stys on HFT and "The Marginalizing of the Individual Investor." http://www.international-economy.com/TIE_Su10_MalmgrenStys.pdf

This divergence between fundamentals and reality is one of the main reasons I set up Rockhaven Capital Management the way I did, "singin' bye-bye Miss American Pie". At Rockhaven our goal is to preserve and grow our assets, it's not to try and find an undervalued stock and hope that someday it may trade to our perceived fair value (the deck is stacked against you if that's your game). Our job is to allocate assets broadly around the globe and be in harmony with what is working. The most important part of the job is the protection part, constantly monitoring risks and managing them. 

I believe that High-frequency Trading is a risk, potentially a very large risk, that is undermining what markets were traditionally designed to do...allow companies to raise capital and allow investors to participate in a companies potential growth, the proverbial "American Pie". Hopefully the exchanges and regulators will be able to mitigate this risk, but we as investors must remain constantly vigilant, or "this will be the day that I die." 

Investment Considerations:

After a tough August (S&P 500 down 4.50%) we've seen a very strong bounce in the first couple of days of September (S&P 500 up 5%+). Trends, momentum, and seasonality all point to lower equity prices, but maybe the short-term bearish sentiment had run a bit too far. The economic numbers out this week were not rosy, but they were better than the dire expectations. The real wildcard for September and October is how aggressive the Fed will be with Quantitative Easing II (QEII), and more importantly what may come out of a very panicked White House prior to the elections. With the administration facing third and very long, with the clock rapidly ticking towards November, it would not be surprising to see a hail Mary proposal to extend the Bush tax cuts, or implement some type of payroll tax relief. 

Even though we are firmly in a secular bear market, there can be some very strong cyclical bounces, especially of the government engineered type. 

Where do we stand?

US Equities -- Neutral, but very close to moving into Bearish territory

Int'l Equities -- Neutral for EAFE and Bullish for emerging markets

US REITs -- Bullish 

Int'l REITs -- Neutral, and moving towards Bullish

Gold -- Bullish 

Commodities -- Neutral, but moving towards Bullish

US Fixed Income -- Bullish, record highs and overbought

Int'l Fixed Income -- Bullish, and emerging market debt Bullish

Cash Equivalents -- At 16.5%. 

A Fair Tax Plan:

Wayne Angell, former Governor of the Federal Reserve Board, in conjunction with several dozen economists have put together a very compelling plan to get this country on the right track. They call it a Fair Tax Plan, and all it does is eliminate all personal taxes, corporate taxes, and the IRS, and replaces them with a national sales tax (also known as a consumption tax). 

It may be wishful thinking, but its at least nice to see something like this proposed by some very respected thinkers. 

An Open Letter to the President, the Congress, and the American people

The Student Loan Scheme:

For those of you with college students heading back to school please take a look at this excellent graphic from Jess Bachman. 

Student loans have now taken over the number two spot in Americas debt bubble (behind mortgages but ahead of credit cards).

Client work: The Student Loan Scheme: Gateway Drug to Debt Slavery

Be careful out there,

Chris Wiles

www.rockhavencapital.com

For prior Rockhaven Views visit:

www.rockhavencapmgmt.blogspot.com

This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management.  The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.