The lack of humility before nature that's being displayed here, uh... staggers me.
Dr. Ian Malcolm - Jurassic Park
One of my all time favorite movies is Jurassic Park - The believable audacity, the study of complex systems, chaos theory, and the law of unintended consequences, all mixed together with fabulous effects and action. It is really one of the greatest movies of all time.
"Living systems are never in equilibrium. They are inherently unstable. They may seem stable, but they’re not. Everything is moving and changing. In a sense, everything is on the edge of collapse."
— Michael Crichton (Jurassic Park)
— Michael Crichton (Jurassic Park)
What brings me back to this subject are the events taking place in the Middle East. Who could have imagined that one frustrated Tunisian street vendor igniting himself would have touched off the overthrows of both the Tunisian government and the Egyptian government. Thats the amazing part of living systems, you just don't know what will happen. The other interesting part of living systems is man's (and woman's) hubris when it comes to trying to forecast what will happen next. Many of us, especially those who've spent most of their adult lives in academia, believe that since we are smart we should be able to see into the future. Unfortunately, it just ain't so. So when you hear the talking heads on TV telling you that the downfall of Mubarak is positive, or negative, remember that they don't know. All they are offering is an opinion, nothing more.
While we're on the subject of hubris, I keep coming back to Fed Chairman Bernanke's outrageous statement on 60 Minutes back on December 5, that he is 100% confident in his ability to keep inflation in check. Wow, 100%. I don't know about you, but the older I get the more certain I am that I'm not 100% certain of anything. Bernanke testified to Congress this week that inflation in the US remains "quite low". He blamed higher prices on food and commodities on fast growing emerging markets, not the Fed's trillion dollar printing press. There may be riots around the globe, but it certainly has nothing to do with the world's reserve currency (the US dollar), being devalued. How do we know there is no inflation? Because the man who failed to see the biggest housing bubble of all time, is 100% certain that he has it all under control.
"The purpose of life is to stay alive. Watch any animal in nature--all it tries to do is stay alive. It doesn't care about beliefs or philosophy. Whenever any animal's behavior puts it out of touch with the realities of its existence, it becomes exinct."
— Michael Crichton (Congo)
— Michael Crichton (Congo)
If the purpose of life is to stay alive, then the purpose of investing is to keep your portfolio alive. Survival should be your investment objective. To protect and grow that nest egg in the face of the many forces trying to kill it. Forces such as; inflation, deflation, currency devaluation, sovereign defaults, and corporate defaults, to name a few of the big ones. This is our challenge, and it is the principal objective here at Rockhaven.
Step one in protecting any portfolio is diversification, and not just "asset" diversification but "risk" diversification. When constructing a portfolio you need to first look at the specific risk presenting itself and determine what securities might protect you. Let's take inflation as our first potential risk. I know that the Bernanke says its not a risk we should worry our little heads over, but humor me.
In inflationary times the asset most at risk is any longer-term fixed income instruments. The 3% interest you receive on that bond is worth less and less in an inflationary world, therefore limit your exposure to long-term bonds. Equities generally do well during the initial stages of inflation as they become relatively more attractive than bonds, and hopefully the companies will have pricing power to keep up with inflation. TIPS (Treasury Inflation Protected Securities) should do well in an inflationary period. I say "should" because they are priced off of the CPI numbers that the government calculates, clearly the government has a strong incentive to make sure that the "official" CPI numbers are low. Real estate tends to do better during inflationary times, as long as wage inflation comes with commodity inflation. Not sure this will happen with 17% real unemployment. The inflating commodities themselves are a good hedge. As is gold, that other currency.
After you've thought about inflation risk you now need to head over to deflation risk. I hear you, "Why do we need to protect against deflation when inflation is the risk?" Who said inflation is "the" risk, it is just one of many unknown risks. Managing money is not about forecasting, it is about surviving. Your portfolio does not care about your beliefs or philosophy, it only cares about survival.
Well, this is the task at hand, portfolio survival. If you need a hand with your risk diversification give me a buzz.
Where we stand today:
1) Cheap Money = Speculation -
Since late last year the massive liquidity of QE2 has kept a firm bid under this market. Losses have been modest to minuscule, and selling pressure well contained. Merger & Acquisition activity has also picked up. Even dips are an excuse to buy. The S&P 500 is now up over 100% since its March 2009 lows, which compares rather favorably to the 107% average of the 18 prior cyclical bull markets since 1932.
The bears are bloody but unbowed, they know a correction is imminent. The bulls have heard the bears lament for nearly two years, but still the markets power higher; easy money is a bulls best friend. The bears have been early and wrong, but eventually the grizzlies will be fed. The trillion dollar question is "when?"
US Equities --
Bullish, stocks are showing no signs of weakening yet.
Int'l Equities --
Bullish, both emerging markets, and developed markets, but the emerging markets are showing signs of weakening due to inflation fighting rate hikes.
US REITs --
Bullish, but showing some signs of tiredness.
Int'l REITs --
Bullish, but nearing neutral.
Gold -- Bullish, but moving towards neutral with recent sell-off.
Commodities --
Bullish, but overbought.
US Fixed Income -- Bearish, minimal weight in US fixed income but neutral in TIPS.
Int'l Fixed Income -- Neutral, after a recent rally.
Cash Equivalents & Currencies -- Currently at 13%, divided between US, China, Australia, and Brazil.
The government assisted rally in equity markets and commodities may continue, but I wouldn't be at all surprised to see a noticeable pullback over the next several weeks that may knock us down to neutral exposures in those markets.
Some great comments to Congress from President of the Dallas Fed Richard Fisher:
“But here is the essential fact I want to emphasize and have you think about today: The Fed could not monetize the debt if the debt were not being created by Congress in the first place.The Fed does not create government debt; Congress does. Deficits and the unfunded liabilities of Medicare and Social Security are not created by the Federal Reserve; they are the legacy of Congress. The Fed does not earmark taxpayer money for pet projects in local communities that taxpayers themselves would never countenance; only the Congress does that. The Congress and administration play the dominant role in creating the regulatory environment that incentivizes or discourages job creation.
We shall see if the new Congress will prove worthy of the power the American people have “loaned” them, and, together with the president, actually draw the spirits of fiscal reform and sanity from the “vasty deep” to at long last implement meaningful fiscal and regulatory policy that incentivizes private-sector job creation here at home while arresting the hemorrhaging of our Treasury. If they do, then more Americans will find work and be better off, better paid and freer to make their own decisions about the economy.
If they don’t, then woe to our children, their children and the American Dream."
You can read the whole speech at the Dallas Fed website
Be careful out there, and keep the light's on,
Chris Wiles, CFA
412-260-7917
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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.
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