Turkey Economics

Thanksgiving Day, my favorite holiday; food, drink, family, and football, just doesn't get better than that. One of my new favorite Thanksgiving stories comes from Nassim Nicholas Taleb, author of two great books (Fooled By Randomness and Black Swan). In "Black Swan" Taleb tells the story of the Thanksgiving Turkey to explain the existence and occurrence of high-impact, hard-to-predict, and rare events that are beyond the realm of normal expectations. Enjoy: 

The turkey spends the majority of its life enjoying daily feedings from a caring farmer. Weeks go by, and its the same thing, day in, day out, for the Turkey. The thinking turkey may even surmise that the farmer has a vested interest in keeping the turkey alive. For the turkey, it is a symbiotic relationship. “The farmer feeds me and keeps me happy, and I keep the farmer happy,” says the turkey. “The farmer needs me, otherwise, why would he be taking care of me.”

And this goes on for years. Every day confirms to the turkey and the turkey’s economics department, and the turkey’s risk management department, and the turkey’s analytical department, that the butcher loves turkeys, and every day brings more confidence to the statement. So it’s fed for a 1,000 days…  

Then, one day, out of the blue, the farmer shows up with a knife, grabs the turkey, and slices its throat.

This is a black swan event — for the turkey. By definition, it is a high-impact, hard-to-predict, and rare event for the turkey who not only never saw it coming, but never even contemplated the possibility that it could occur.

For the farmer, on the other hand, this was not a black swan event. The farmer knew all along why he was feeding the turkey, and what the end result would be.

The very nature of black swan events make them almost impossible to predict. The point of this parable is to put forth the idea that sometimes we are the Thanksgiving turkey and understanding this may make it easier to begin to, at the very least, contemplate the possibility of far-from-equilibrium events.

This year, when you enjoy that drumstick or Turkey breast, give thanks to the latest victim of the black swan for being non-contemplative, otherwise, he may have jumped ship long ago and you’d be eating a chicken instead.

And Now Taleb's Ten Principles:

1. What is fragile should break early while it is still small. Nothing should ever become too big to fail. Evolution in economic life helps those with the maximum amount of hidden risks – and hence the most fragile – become the biggest.

2. No socialisation of losses and privatisation of gains. Whatever may need to be bailed out should be nationalised; whatever does not need a bail-out should be free, small and risk- bearing. We have managed to combine the worst of capitalism and socialism. In France in the 1980s, the socialists took over the banks. In the US in the 2000s, the banks took over the government. This is surreal.

3. People who were driving a school bus blindfolded (and crashed it) should never be given a new bus. The economics establishment (universities, regulators, central bankers, government officials, various organisations staffed with economists) lost its legitimacy with the failure of the system. It is irresponsible and foolish to put our trust in the ability of such experts to get us out of this mess. Instead, find the smart people whose hands are clean.

4. Do not let someone making an “incentive” bonus manage a nuclear plant – or your financial risks. Odds are he would cut every corner on safety to show “profits” while claiming to be “conservative”. Bonuses do not accommodate the hidden risks of blow-ups. It is the asymmetry of the bonus system that got us here. No incentives without disincentives: capitalism is about rewards and punishments, not just rewards.

5. Counter-balance complexity with simplicity. Complexity from globalisation and highly networked economic life needs to be countered by simplicity in financial products. The complex economy is already a form of leverage: the leverage of efficiency. Such systems survive thanks to slack and redundancy; adding debt produces wild and dangerous gyrations and leaves no room for error. Capitalism cannot avoid fads and bubbles: equity bubbles (as in 2000) have proved to be mild; debt bubbles are vicious.

6. Do not give children sticks of dynamite, even if they come with a warning . Complex derivatives need to be banned because nobody understands them and few are rational enough to know it. Citizens must be protected from themselves, from bankers selling them “hedging” products, and from gullible regulators who listen to economic theorists.

7. Only Ponzi schemes should depend on confidence. Governments should never need to “restore confidence”. Cascading rumours are a product of complex systems. Governments cannot stop the rumours. Simply, we need to be in a position to shrug off rumours, be robust in the face of them.

8. Do not give an addict more drugs if he has withdrawal pains. Using leverage to cure the problems of too much leverage is not homeopathy, it is denial. The debt crisis is not a temporary problem, it is a structural one. We need rehab.

9. Citizens should not depend on financial assets or fallible “expert” advice for their retirement. Economic life should be definancialised. We should learn not to use markets as storehouses of value: they do not harbour the certainties that normal citizens require. Citizens should experience anxiety about their own businesses (which they control), not their investments (which they do not control).

10. Make an omelette with the broken eggs. Finally, this crisis cannot be fixed with makeshift repairs, no more than a boat with a rotten hull can be fixed with ad-hoc patches. We need to rebuild the hull with new (stronger) materials; we will have to remake the system before it does so itself. Let us move voluntarily into Capitalism 2.0 by helping what needs to be broken break on its own, converting debt into equity, marginalising the economics and business school establishments, shutting down the “Nobel” in economics, banning leveraged buyouts, putting bankers where they belong, clawing back the bonuses of those who got us here, and teaching people to navigate a world with fewer certainties.

Then we will see an economic life closer to our biological environment: smaller companies, richer ecology, no leverage. A world in which entrepreneurs, not bankers, take the risks and companies are born and die every day without making the news.
In other words, a place more resistant to black swans.

Happy Thanksgiving!

Be careful out there, and keep the lights on,

Chris Wiles, CFA

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.

A Letter To My Daughters

A Letter To My Daughters  

Dear Lauren & Rachel,

As you guys get a bit older I thought it would be a good time to start putting some thoughts together on a very important subject...money. (I'll let your Mom handle the letter on boys!)

You see, there is an old saying, "A fool and his money are soon parted." My job, as a dad, is to make sure that you are not the fool.

There is another saying made famous in a great movie, "Wall Street" (we'll have to watch it soon), "A fool and his money are lucky enough to have gotten together in the first place." Unfortunately this saying is practiced by far too many so called financial "professionals".

Money can be a very emotional and complicated subject ... it doesn't have to be. Hopefully with some simple rules, and some education, we can start you down that road of enlightenment (the opposite of fool).

- Money (also known as investment capital) is a perishable commodity if not handled carefully. Be serious. Pay attention to your own financial affairs, don't count on anyone else to have your best interests at heart. I know this may sound harsh, but if you count only on yourself you'll rarely be disappointed by others, and you may even be positively surprised on occasion.

- Another word for money is capital. There are two types of capital, financial (money) and intellectual (education). It is important to remember that capital will always flow to where it is welcome, and stay where it is well treated. Think of this whenever you are investing or looking for work. Is the investment or potential employer attracting capital? And why? Investing is a lot like working, you want to work for a place that attracts the best and brightest. You want to invest in the company or country that is going to treat your capital the most favorably.

- Think of your Net Worth (assets minus liabilities), not your paycheck. Divide your assets into three baskets. 1) Your education and career, how you make money. This is where most of your focus should be. 2) Your savings, your liquid assets, they should cover at least six months of your living expenses. Protect and preserve them. 3) Your long-term investments. This is your diversified investment portfolio. It is higher risk, and more speculative, so be prepared for volatility.

- Be frugal/cheap. If you can't afford it don't buy it. Watch this video clip  Saturday Night Live: Don't Buy Stuff  . Save as much as you can. Especially in employer sponsored savings plans, like 401-K's. However, invest minimally in your employers stock. You are already reliant on your employer for your income, if something were to go wrong and the company no longer exists, than you would lose your job and your savings.  Don't over do the frugality, life is way too short to worry about every dollar. Focus on getting the big things right; education, house, car, investments. But allow yourself to enjoy life's simple pleasures; dinner with friends, travel, etc.

- Credit cards should only be used as a cash substitute and paid off every month. This is very important. Do not fall into the credit card debt spiral.

- Be ethical in all of your endeavors, even if the world may not be. So much of finance is based on trust, you have to hold yourself and everyone that handles your money to the highest possible ethical standards.

- KISS. Not the kind you're thinking, the other KISS, as in Keep It Simple Stupid. Investing doesn't have to be complicated. In fact, the harder an investment is to understand the more strenuously you should avoid it. Complexity is a wonderful way for the financial industry to hide fees, expenses, and risk. 

- Understand the Financial Services Industry. While they serve a purpose in helping people save and financing homes, etc, that is not their primary objective. Their primary objective is to make money for themselves and their shareholders (especially at the larger institutions). They do this by gathering assets and skimming a little from every investment or transaction. There is nothing wrong with this, it is how they make money. You need to realize that you will be paying for everything, you just want to make sure you don't overpay. See "Fool" quote above. 

- Insurance is not an investment, it is an expense. Until you have a family, life insurance is a waste of money. Even with a family don't over do it. Health insurance and property insurance are pure expenses, necessary evils. You want to carry the largest deductibles as possible, thereby lowering your monthly expenses.

- There is no free lunch (unless of course your Dad is buying, and even then you'll probably have to endure my lame preaching). What this means is that for every investment return you expect, there is a risk associated. Risk and return go hand-in-hand. There is no such thing as risk free. The higher the expected return, the more risk you are taking. Even if you don't invest you take the risk of your money losing value, because of inflation. Again, there is no free lunch.

- Don't put all your eggs in one basket. Diversify. When you think of diversifying, think about diversifying your risks, not your returns. The big risks are economic (think globally), inflation/deflation (choose assets that do well in either environment), and currency (currencies can lose value rapidly, diversify globally, and use hard assets like gold or collectibles).

- Never borrow money to invest. Leverage cuts both ways, and while leverage may enhance your returns it also magnifies your losses.

- You cannot eat relative performance. It doesn't matter how you performed against some benchmark like the S&P 500, what matters is how you performed against your own objectives. You need to think of absolute performance not relative. You probably won't be very happy if the S&P 500 is down 30% and you are only down 25%.

- What type of return should you expect? Unfortunately, this is not a pretty number. You need to think of real returns, not nominal returns. Real returns are what you get to eat, after inflation, taxes, and fees. If stocks have returned about 9% annually on a nominal basis the real return is closer to 2% (9% - 3% inflation - 2.5% taxes - 1.5% fees = 2%). Historically you've done really well to earn a real return of 2% -3%.

- Since we are talking about real returns, it should be obvious that there are two areas where you can quickly increase your returns. First, lower the tax bite by maxing out your IRA's and 401-K's. I know it's only tax deferred, but the long-term tax-deferred compounding adds up. Second, watch your fees. There is no way to invest for free, believe me I've tried, but you can lower the bite the investment industry takes. If you invest on your own, using index funds or ETF's, you can get your fees and trading costs down to the 0.25% range. If you hire someone to help you the best you could hope for is about 1% - 1.25% in fees and expenses. Remember to add all the fees in. If you use an investment advisor find out exactly how they are getting paid, also add in all the investment management fees in any mutual fund or ETF, and add in trading costs. Unfortunately way too many people end up paying 2% or more every year.

- Speaking of investment advisors, if for some reason I am no longer able to act as your advisor (you know, senile), then you may need to hire one. First try and do it on your own for as long as you can, but I realize that you have a life and following global financial markets may not be at the top of your list of fun things to do in your spare time. OK, if you have to hire an advisor, what should you look for? Since there are ten's-of-thousands of so called investment advisors out there the first thing to do is narrow down the universe. The easiest way to do that is to focus on CFA's (Chartered Financial Analysts) only. Why CFA's and none of the other alphabet soup designations? Well, because your Dad's a CFA and he's biased. Seriously though, the CFA designation is by far the hardest most grueling designation to earn. It shows a level of commitment to the profession that no other designation can match. It requires a candidate to pass three successive exams given over three years (less than 10% of those who sit for Level I pass in three years), and requires four years of "acceptable professional work experience". The level of ethical studies in the CFA program is also unmatched. Just because an advisor is a CFA doesn't mean they are great, you'll still need to review their track record, talk to existing clients, and see if there is a good emotional fit. Emotional fit is very important. You need an advisor who can talk to you and explain to you why he has lost you money. Yes, there will be times when no matter how good your advisor, they will lose you money, it is in those dark days that he will need to be able to explain his strategy and why it didn't work. This isn't a marriage. Give them a few years, but if it isn't working out don't hesitate in leaving.

- Spend your interest, never your principal. If at all possible, take out less than comes in, in the form of dividends and interest. If you never have to tap into your principal your portfolio should continue to grow.

- Don't be afraid to take losses, they happen. Admit to your mistake and move on.

- Act. Be decisive and make decisions. We live in the information age, but no amount of information can remove all uncertainty. Have confidence in your moves, but be willing to change course if the information changes. 

- Prepare for the worst, while enjoying the good times. Expect the unexpected. Even though the world may say that it won't/can't happen prepare for it. You should never be surprised by an economic calamity, they can and will happen. The key to survival is being prepared and willing to act. For every loser there is a winner, find out who the winner is and join them.

- No one can predict the future. The investment industry is full of prognosticators, but none of them know what will happen in the future, they are just opinions. The collective intelligence of the market is much greater than that of any individual. You should strive to be in harmony with the market, don't fight it. If a segment of the market is bullish than you should be bullish, if a segment is bearish than you should be bearish. Don't try and force your opinions or beliefs onto the market. "Those who have knowledge, don't predict. Those who predict, don't have knowledge." - Lao Tzu

- "Read, every day, something no one else is reading. Think, every day, something no one else is thinking. Do, every day, something no one else would be silly enough to do. It is bad for the mind to be always part of unanimity."  - Christopher Morley 

Well, I know that there's a lot of information here, but hopefully over the next several years we'll be able to work through some of these in real time. My goal is to get you girls to a point where you won't have to worry about money, you'll understand it for what it is...a means to an end.

Love always,

Dad

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.

Quantitative Easing Explained

I just watched this very educational video and it made me smile for 10 minutes, no better way to spend a Friday afternoon.

Enjoy:

Quantitative Easing Explained

Chris Wiles, CFA

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.

Delusional Sunset

You sound so innocent, all full of good intent
Swear you know best
But you expect me to jump up on board with you
And ride off into your delusional sunset


Who cares if you disagree?
You are not me
Who made you king of anything?
So you dare tell me who to be?
Who died and made you king of anything?


Sara Bareilles - King Of Anything

You don't need the people to elect you, and you can devalue our currency without one iota of input from Congress or the President, are you King? Clearly Ben Bernanke believes he is king. He has the unelected power to print money at will and devalue the governments massive debt, and our assets, as he sees fit -- "Who died and made you king of anything?" While he tries to sooth us with his good intentions; I'm just trying to make people feel better (aka Wealth Effect) so they will spend more money, and then that will make corporations start hiring again. I just don't buy it. You "swear you know best, but you expect me to jump up on board with you and ride off into your delusional sunset." Sorry King Ben, but that's one trip that I'll skip. 

And it appears that I'm not alone. Since the Fed actually began it's QE2 process we have seen wicked declines in just about everything that ramped up prior to the actual event. A simple case of "Buy the rumor, sell the news?" There were wrenching declines in everything that raced up the most; including precious metals (gold down 6%, silver down 13%), copper (-10%), cotton (-19%), and commodity currencies. The broader markets also saw some fairly strong declines. What may be a bit surprising (and frustrating to King Ben) is that interest rates have actually edged higher, especially at the long end of the curve. In fact, this is the only time that I can find that you, Joe Citizen, can get a 30 year mortgage for 4.17%, while Uncle Sam has to pay 4.25% to borrow at 30 years! That's right, Mr Bond Market is saying that you are a better credit than Uncle Sam. Of course that's not the case since Uncle Sam can tax you to death to make his interest payments, but it is a pretty good example of just how delusional/fake/phony our markets have become.

Not all of this turmoil can be laid at King Ben's feet, he's had plenty of help. The Presidents humbling experience at the G20. The continuing Euro saga; with the imminent Irish bailout, and ongoing problems with Greece, Portugal, and Spain. Rising interest rates in China, where they are actually trying to slow inflation. Yes, the world is a risky place, but can you afford to leave your assets invested in cash earning a negative return after inflation and taxes? On the one hand you have the guaranteed negative return on cash, and on the other hand you have the very volatile (though potentially positive) return on risk assets ... tough choice.

For now we are still choosing risk assets and continue to be very nearly fully invested. The one asset that is nearest to turning neutral and heading to bearish territory is US Treasuries.

GOLD: STILL A RODNEY DANGERFIELD ASSET

The following is a note I got from an old friend Jason Trennert. Jason used to work at ISI, but left a few years ago to start his own firm Strategas Research Partners LLC. I thought you might enjoy it.

“It just can’t be right,” said the 30-something hedge fund manager through a towel after a grueling 45 minutes on the squash courts of the New York Athletic Club.

“I mean, G. Gordon Liddy is trying to sell it to me on Fox News. My orthodontist owns gold -- he wears gold, for crying out loud. It just can’t be right,” he said, shaking his head, his voice trailing.
The case against gold is well-known and, until relatively recently, time-tested. The yellow metal is never ever really consumed, provides no yield, and carries with it storage costs. The polemic surrounding gold, like the inflation vs. deflation debate, is enough to result in bar fights in some sections of this grand city and it’s hard to find too many investors who are agnostic about it. You either see it as the barbarous relic of the retail crowd or a necessary hedge against the cupidity of politicians the world over. Despite the recent run-up in gold, it is, by our lights, too early to fade. There are now, unquestionably, elements of froth in the market that should give investors pause. But if there is one fact that is missed among investment sophisticates, it’s that investing in gold is still considered a hopeless backwater at most large mutual fund companies in this country. It is for this reason, that we believe that it is not yet over-owned.

I find a certain irony in the fact that I have two friends in the investment business who, after enjoying great success and fortune managing other peoples’ money in the 1980s and 1990s, have been, in their retirement, buying physical gold. They are unknown to each other and are different in many ways save for the fact that they were born in foreign lands – one in Armenia, the other in Cuba. They live in America, not by tradition or family ties, but by choice. Despite the fact that they so obviously believe in the great promise of this country, they have both come to the conclusion that they should hedge their hard-earned fortunes with hard assets. For them, their decision to own gold isn’t the result of some ethereal academic exercise, it is based on life experiences most people born in America couldn’t possibly understand.

While the hard asset story may seem tired and old to some in the investment business, it is just starting to capture the consciousness of many professional and retail investors alike who thought it was overly alarmist to believe the political class might seek to devalue its way out its own profligacy. This isn’t to say that we believe the Fed is intentionally trying to cheapen the dollar. We take the Chairman at his word that he is simply trying to decrease the tail risks associated with deflation. But intentional or not, the net result of further monetary accommodation is the same – weaker purchasing power of the greenback. Ultimately, we believe the crux of the case for gold is that it’s hard to quadruple the size of the Fed’s balance sheet and run budget deficits of nearly 10% of GDP and also stick the landing on inflation. However you might handicap the prospects of either a Reinhart-Rogoff style deflation or efforts to reflate that work too well, gold remains one of the best hedges against the volatility of inflation. In the past century, the asset “worked” in two distinct periods – the deflation of the 1930s and the inflation of the 1970s. Given the uncertainty of global monetary and fiscal policies today, there is probably still room for it to garner the respect it deserves.

THE SELF ESTEEM SOCIETY

Availing myself of the pleasures of commercial airline travel each week and frequently subjected to the sullen ennui of the cashiers at Duane Reade here in Manhattan, I had thought that I was well past the point at which the nerve endings of my dignity could register the slightest offense. That was until we decided to place postings for a variety of entry-level jobs in recent months and we started to receive cover letters from recent college graduates that would have made Donald Trump blush in their pomposity. “The question isn’t whether you should hire me,” started one, “it’s whether I’m going to want to work for you.” Another candidate made it clear that he was “a caged tiger waiting to enter the arena of the world of finance.” Subsequent interviews with candidates whose cover letters were the least obnoxious often didn’t go much better – and regardless of how little ego you may think you have, it’s hard to maintain your composure when a 22-year old kid expresses disgust at the fact that your company doesn’t possess green initiatives greater than recycling.

Of course, we are a small company and only four years old and our offices have a certain Eastern European DMV-vibe. There is no fish tank, no tragically beautiful receptionist. We know we’re not Goldman Sachs but we are, after all, offering these candidates the prospect of gainful employment and a paycheck which, one would presume, might engender some humility among the unemployed. Of course, most of us are idiots when we first leave college, often not nicked-up enough by the slings and arrows of outrageous fortune to understand how hard life is and how little to which others actually think we’re entitled. This all started to make sense to me upon reading a small squib in the paper about how American kids, when compared to their contemporaries in 29 other developed countries, ranked 25th in math, 21st in science, while ranking # 1 in only one category -- confidence. I started to think about my late father, as I often do in the quiet of long transcontinental flights. At his core, he was a sweet man with the heart and soul of a poet. But he was a man of different era in which there were no participation trophies. His code was based on the belief that self esteem had to be earned and he had zero tolerance for phonies or pretense of any kind. When confronted with those who had no appreciation for the great opportunities this country afforded, he could make The Great Santini look like Deepak Chopra. The transformation of a society in which  prior generations prized an equality of opportunity to one that insists on an equality of outcome seems so much more important now, when the country is again faced with the need to make sacrifices to ensure its long-term fiscal viability and to compete with increasingly aggressive economic rivals. It is in this context that we should all be somewhat saddened by the reaction of those on both the right and the left to the recommendations of the President’s Commission on Fiscal Responsibility. Everyone recognizes that, despite our status as a reserve currency, the U.S. cannot sustainably spend far in excess of its means. But when it seems as if we all want the other guy to make the necessary sacrifices we reveal, in the process, our own, although more mature, sense of entitlement. This is, of course, not a uniquely American problem. One doesn’t know whether to laugh or cry at the spectacle of 17-year old French students protesting the fact that their retirement age needs to be extended from 60 to 62 in a country in which the average life expectancy is nearly 81 years old. But without political leadership designed to do the right thing regardless of the electoral consequences, it’s hard not to feel that the correlation between the West’s sense of entitlement and the price of gold will only grow.

By:  Jason DeSena Trennert

Strategas Research Partners LLC

If You're So Smart, Then You Solve The Deficit Problem!

This weekends NY Times had a fun article on balancing our massive budget problem. While it is by no means totally accurate, it is a fun exercise that helps show where the bang for the buck is.

I solved our budget deficit problem with 79% spending cuts and 21% tax increases. Click on the following link to see how you do.

deficit puzzle on The Times’s Web site

So, What Are You?

During election season I got asked this question fairly often, and I assumed they meant Republican, Democrat, or other. Fortunately there is a very short quiz you can take that does a pretty good job in telling you what you are. The Washington Post said it has “gained respect as a valid measure of a person’s political leanings.” The Fraser Institute said it’s “a fast, fun, and accurate assessment of a person’s overall political views."  I took the 10 question quiz, and my results are pretty much where I imagine myself — fiscally conservative, socially progressive. I don’t have a problem with gay marriage, legalized pot, cutting spending, or letting insolvent companies die.

If you want to take the quiz, just go to theadvocates.org/quiz, and it tells you where you stand politically. It seems to go beyond the Democrat, Republican, and Independent spectrum.

Be careful out there, and keep the lights on,

Chris Wiles, CFA

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.

Sunday Bloody Sunday

I can't believe the news today
Oh, I can't close my eyes
And make it go away
How long...
How long must we sing this song?
How long? How long...
'cause tonight...we can be as one
Tonight...

U2 - Bloody Sunday

Watching 52,000 students rioting in London this week over increased tuition made me think, "How long...how long must we sing this song?" Unfortunately, the answer is quite a long time. You see the riots in London weren't over a war, or racial inequality, the riots are happening because the government is trying to shrink. The size of the government relative to its economy can shrink in two ways; one, grow the economy faster than the government (not happening), or two, make broad based cuts to the government. In England's case, one of the cuts is to the college education entitlement. Prime Minister David Cameron's Conservative Party is trying to get their fiscal house in order and raising tuition (actually cutting subsidies) is one of many austerity moves. Cameron is proposing a tuition of $14,500 per year versus current tuition for a British student of about $5,300, prior to the 1990's it was free. The National Union of Students said it would try to recall legislators from the party who vote in favor of the hike. "We will not tolerate the previous generation passing on its debts to the next, nor will we pick up the bill to access a college and university education that was funded for them," said union president Aaron Porter. 

Of course with the average US tuition at about $27,000 they get little sympathy from us. But this isn't about us versus them, this is about what happens when you take away entitlements. 

Thursday the White House commission on deficit reduction laid out a plan to cut our deficit by $3.8 trillion by 2020. Here are some highlights:

-Cut $100 billion in defense spending.

-Raise Social Security age to 69.

-Raise gasoline tax by $0.15.

-Lower corporate tax rate to 26%.

-Repeal alternative minimum tax.

-Kill deductions on mortgages over $500,000.

-Cut federal work force by 10%.

-Cut farm subsidies by $3 billion.

Now we're a long way from any of these recommendations becoming law, but if we are really serious about getting our fiscal house in order, then there will have to be serious cuts that will affect us all. Hopefully there won't be violence in the streets, but I'm pretty sure some affected parties won't go along peacefully.

The other thing to think about is what do austerity measures mean to economic growth? The short answer is less growth near-term, and hopefully more growth in the future. For an example of this you needn't look any further than Ireland or Greece. Their economies are shrinking along with the size of their governments. 

What do you think will happen to our GDP growth rate and unemployment rate, in the short-term, if we cut the federal work force by 10% and cut defense spending by $100 billion? Right, it's the opposite of going up.

An example of this on a micro level is this weeks earnings call by John Chambers of Cisco. Chambers put his company's second-quarter revenue growth at 3% to 5%, significantly below estimates of a 13% increase. During the call, he specifically pointed to a slowdown from the public sector, with weaker government spending from the U.S., Japan and Central Europe. The public sector represents nearly a quarter of Cisco's revenue. Cisco's stock is down 16%, one if it's worst one day declines ever.

Austerity = Slower Earnings/GDP growth and higher unemployment.

But austerity is needed when you are technically bankrupt. We all know this on a personal level. If you are deeply in debt, with minimal or no opportunity to grow your way out, then you simply must make hard cuts to your standard of living. This is what is happening all over the Western World, and will soon be happening here in the good ole US of A, we will all have a lower standard of living. 

On that sour note I'll leave you with a priceless clip from Saturday Night Live. Enjoy!

Saturday Night Live: Don't Buy Stuff 

More on QE2:

Last week I spent a lot of time going over the Fed's QE2 policy, and although I totally disagree with it, I also stated the importance of going along with any Fed induced bubbles so you can at least attempt to keep up with the coming inflation. Today I read this great quote by Billy Shakespeare, a man definitely ahead of his time. An astute businessman, he realized the importance of going with the tide:

"There is a tide in the affairs of men. Which, taken at the flood, leads on to fortune; Omitted, all the voyage of their life Is bound in shallows and in miseries. On such a full sea are we now afloat, And we must take the current when it serves, Or lose our ventures." –JULIUS CAESAR ACT 4, SCENE 3

Another good review of the "Bubble of all Bubbles" is this two-part video clip from Mark Fisher. 

Key highlights: "QE2 can't end right. Worthless paper after endless paper.... What's good for the equity markets is not necessarily good for the economy. The equity markets are not going to create jobs. If you have a paper bag full of money are you going to go out and hire workers and take risk with healthcare and all these other regulatory restrictions? No, you are going to go ahead and buy high yield, you will buy equities, you will buy risk assets. The fallacy in the whole thing is that you are not going to go ahead and create jobs just by pushing up the market by 20%, 15%. In fact, to some degree by pushing up commodity prices to levels that are going to be obscene, which is what is going to happen, you are hurting everybody in mainstream America... If you have all this money coming into the system, and this money stays in the equity and commodity markets, when at some point you take this money out of the system, where is this money going to come out of? Parabolic moves have Parabolic corrections. This is going to end bad. It is not a matter of if, just a matter of when. This is going to be the ultimate bubble, this is going to make 2000 look like a cakewalk. This is going to be the bubble of all bubbles."

Protecting Your Portfolio From QE2  3 hrs ago

Are We in a Commodity Bubble?  2 hrs ago

Shifting Wealth From The Developed World To The Developing World:

I'm old enough to remember when the world was divided into a first, second, and a third world. It has since become known as the "West" and the "Rest", and more recently the "Developed" versus the "Emerging". I'm not sure what we will call it in twenty short years when the world's former "poor" countries account for nearly 70% of global GDP. That's right, by 2030 the current undeveloped countries will see their share of the worlds economic pie grow from 50% to 68%. And I wouldn't be surprised if it happens much faster as the "developed" world undergoes forced austerity.

In a new report, the OECD Development Centre states that Developing countries have enjoyed strong economic performance over the past decade – often growing twice as fast as OECD economies. Updating Angus Maddison’s famous projections, it forecasts a world starkly different from today’s. The worlds’ poor countries will account for nearly 70% of global GDP in 2030. This remarkable turnaround is due to the dynamism of the developing world, in particular India and China. Combined with their large populations, this means that the economic centre of gravity of the global economy is changing rapidly, with all kinds of implications for economic policy in many spheres – macroeconomics, natural resource management, technology, agricultural, and development policy.

The scenarios depicted below (Table 1) include a revision of Maddison’s estimates for Asia, Latin America, and Africa. They also revise downwards the growth estimates for the rich countries in the aftermath of the financial crisis, motivated by recent studies that suggest that long-term growth in high-income countries may be dragged down by the high fiscal burdens resulting from the crisis (e.g. Reinhart and Rogoff 2010). It may also, of course, take a long time to sort out some of the other structural imbalances impacting growth performance in many industrial economies.

Table 1. Shifting wealth and the world in 2030 – New forecasts

Source: Author, based on Maddison (2007:Table 7.1) and updated from data available at the Groningen website (http://www.ggdc.net/maddison/).

This simple growth dynamic explains the need to have a fairly high allocation to emerging markets, both equities and debt. Go where capital is treated best.

What A Competitive Currency Devaluation (aka. Currency War) Looks Like:

http://www.youtube.com/watch?v=lYehqE0rMMQ

Lastly a little humor on traders:

Local Trader

Be careful out there, and keep the lights on,

Chris Wiles, CFA

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.