Some Are Still Saluting Free Market

Andrew Sullivan today passes along Charles Krauthammer's response to Paul Krugman's thinking. He may have a point, but haven't we seen "free-market control" just about drive us into the ditch? I think I understand that a pure, survival-of-the-fittest free-market is theoretically wonderful to some people. But how much more evidence do we need that such a pure system carries huge risks when carried out by impure human beings?

Will Economic Reform Happen?

Paul Krugman worries that our fixation on the fix of our economic system may crush any possibility of long-term change.

The Economy is Very Grim

The broad stock market is now down 50% for the year. Very little good news is coming from the financial world. Things look very bleak indeed. Some encouragement comes from how much bad news there is. Most predictions about the economy and financial markets at any moment turn out to be wrong. But one phenomenon has repeated itself through history, When virtually all the experts are convinced that things are terrible, they begin to get better. So, listen to the experts!

Paul Krugman says that the transition between presidencies may carry big risks.

The Sage of Omaha Speaks

In the many years I've been reading about Warren Buffett, and reading his Berkshire Hathaway shareholder letter (always very entertaining), I've never heard him say what he says in today's New York Times.

A lot of attention has been paid to Buffett over the last few months, especially since he is an advisor to Barack Obama.  He is amusing, self-effacing and, incredibly, manages consistently to both talk and act rationally about investing.

His column is really worth a read.

They may not do well in the next several months, but looking ahead two or three years, investors may see some of the best opportunities of their lives

The title is a quote from an interesting article in Barron's.  Number one rule of investing: If you're losing sleep over your investments, something's not right.  This is quite literally an excellent rule.  The idea is to take just enough risk to make you a teeny bit uneasy from time to time.  But you shouldn't be losing sleep, even at times like this.

If you are that fearful or obsessed about your paper losses over the last month, you need to do something.  Maybe it's simply to cal your financial advisor.  Maybe it's to change your allocation.  It's okay to do whatever you need to sleep better.

Remember that, just like at any time, any decision you make now will carry consequences and risks, so be sure to have as clear a picture as you can of what those are.  Also be clear with yourself that your account balance is what you see in front of you--it isn't what it was a month or a year ago.

Stocks may go much lower, or they may bounce around for months.  Or, they may go higher.  No one knows.  Try to be rational, and take the severe doom-and-gloomers with a grain of salt.  Virtually all of them are long-time gloom-and-doomers and, like the proverbial broken clock that is right twice a day, they have now, finally, been right.  This doesn't mean they are correct in what they predict now.

The Barron's piece provides some perspective.  For the supremely rational, there are some interesting opportunities.

Should I Move Everything to Cash?

Excellent piece yesterday in the NY Times considering the temptation that all of us feel to simply sell all investments and put the money in  a mattress or something.  It might feel good, but it's probably a bad idea.  Read it here.

We Now Worship Debt

Let's Talk Oil and Grain

Video: Is Credit Crisis Over?

The Tax Rebate is in the Mail

Quote of the day:
“[The reality show] ‘The Hills’ isn’t aiming to stimulate or inspire; I think people watch it mostly to figure out why they’re watching it.”
--Nancy Franklin, The New Yorker, April 21

Well, well, well. This week most of us will be getting a cash gift from our government. Isn’t that special?

I’m not about to send ours back, but this is a bit of a lame idea. This tax rebate is based on the premise that we need encouragement to spend money. I don’t know about you, but I have no problem spending money, thank you very much.

I suspect that most Americans also have no such problem. For those who do, or who are congenitally parsimonious, what makes anyone think a sudden cash infusion is going to change them? I don’t get it.

Yes, I know, “economists” say we are strapped, and have no money to spend. After in-depth analysis and discussion, they have concluded that If we just had some money, we would spend it.

We can certainly hope the equation is this easy. But I suspect most of us have gotten past the stage of getting 50 cents from Mom and buying a candy bar with it.

We’ll see.

Oil Highest, Dollar Lowest

Quote of the day:
“ There is scarcely anything in the world that some man cannot make a little worse, and sell a little more cheaply. The person who buys on price alone is this man's lawful prey.”
--John Ruskin

I woke up this morning to news that oil is at $119, an all-time high, and that the dollar is at .62 euros, an all-time low.

It sounds like a broken record. Yet what makes this news is the relentlessness of these moves. Oil has been at or around all-time highs for the last four months. The dollar has been at or around all-time lows for more than a year.

There is no sign that either direction will change any time soon. The current surge in the oil price is partly due to a disruption in the supply coming from Nigeria. This is a short-term effect, which means that oil’s price will likely back off a bit after a while.

But the key words in that sentence are “a bit.” As always, there will be choppiness in oil prices. One day the price will be down a few dollars, the next week it will be up a few dollars. Or vice-versa.

But it is untenable to suggest that oil prices are “going back down.” Yes, in the short term, they probably will. The long-term trend, however, is inexorably higher. And eventually MUCH higher, as China’s and India’s economic development continues to accelerate.

Indeed, we are headed for an oil crisis in the coming years. There will come a point when world oil production cannot possibly keep up with both current needs and the needs of millions of new drivers and hundreds of new industrial companies. We don’t know when this crisis will happen, but it will happen.

The dollar will keep sinking as long as the primary direction of interest rates is down. A very weak currency is part of the price we pay to give ourselves cheap credit to buy what we want, and to help prevent businesses from having to scale back.

Everything has a price. Everything has a consequence.

Another Primary Day

Quote of the day:
“ The reason lightning doesn't strike twice in the same place is that the same place isn't there the second time.”
--Willie Tyler

Well, at long, long last, today is the Pennsylvania primary. Watching the news these last few weeks, it sometimes seems as if nothing else is going on nationally.

The voting patterns will be interesting to watch. It’s possible for Barack Obama to pretty much have the nomination sewed up. Most likely, though, we’ll continue to see continuing mini-dramas until election day in November. That’s 6 1/2 months from now. Oh, boy.

I really hope some entertaining things happen, because the issues are getting a little tiresome.

That sounds ridiculous, but I mean it. All three of the candidates have developed positions on just about everything meaningful. Sometimes their proposals are detailed and very insightful. And very necessary.

The tiresomeness comes from incessant repetition, and from efforts to be very certain and increasingly precise in forecasts and calculations. Any level of precision in knowing how much something will cost, or what the effects of any proposal might be, is impossible for any candidate.

Doing this is very difficult for those whose job it is to manage the government. Hearing someone running for President say emphatically that either tax cuts or any program is going to be paid for through cutting “waste” (or “pork-barrel spending”) or some other manipulation of the budget is a stretch at best.

Yet all three candidates are doing this, because it’s what they think we want to hear. Maybe some of us do.

What is very, very clear is that the Iraq war costs something like $200 million a day. And interest on the national debt costs us about $650 million a day. We are much deeper in debt than we were seven years ago.

I’ve heard just one of the candidates talk about this.

But is this trend going to change?

Why Are Stocks Stronger Now?

Quote of the day:
“The best lack all conviction, while the worst are full of passionate intensity.”
--William Butler Yeats

The stock market goes down, the stock market goes up. It’s hard to make sense of it. Many people just give up and don’t worry about it. Others give up and do worry about it.

In reality, there is a bit of logic to the movement of the market.

I guess the clearest part of things is why stocks were down early this year. More and more bad economic news was coming out each day.

But why are they stronger now? There has been no letup in the stream of negative news. Two reasons.

One is the release last week of bad unemployment numbers. This is usually interpreted as an indication we’re much closer to the end of a recession than the beginning. Investors are always trying to see what will be happening in six to nine months. In this case, they looked out and saw the probability of a stronger economy then than now.

The other reason is much more basic, and usually ignored in financial reporting. It’s the Al Pacino/Godfather 3 effect. The money goes out, and it has to come back in.

Realizing this has really helped me over the years. When the stock market goes down--and especially when it goes down sharply--I ask myself where that money is going. Is it permanently going into another kind of investment? In most instances, no.

Instead, the money is put into treasury securities--like this time--or other short-term low-risk low-return investments. In other words, the money is “parked,” waiting to come back in. It may take a few days, a few months, even a year or two, but the money will come back.

Where does the money wind up? It always winds up where investors think they will get the highest return. It doesn’t stay parked.

A lot of money came out of the market and into short-term treasuries over the last three months. Does it makes sense to think that investors are going to be perfectly satisfied watching that money earn 2% or less? Not for long.

A Not-Investment Idea

Quote of the day:
““The Maasai of Kenya, soccer moms of Scarsdale, the Amish, the Inughuit of Greenland, European businessmen—all report that they are happy.”
--Sue Halpern in the April 3 New York Review

Now that I’ve gotten myself all worked up about what to invest in, I thought it was time to mention something not to. Or at least to be cautious about.

Gold. There is probably no investment whose cause is taken up by so many hucksters in so many varieties of garb. An excellent recommendation against gold is the scintillatingly obnoxious commercial with classical music and a woman intoning its other-worldly virtues in an oh-so-seriously-sophisticated British accent. If you haven’t seen this commercial consider yourself very lucky. It’s worse than head-on, apply directly to the forehead. Vomit city.

Precious metals and their associated stocks are perfectly valid investments. The problem is getting into them because of fear, or because you think they are “safe,” which is what that commercial is about. They are no more or less “safe” than any other investment.

With the economy having some trouble right now, a lot of folks have moved into gold, and the price has gone up significantly over the last several months. If you want to find a good time to buy gold this is not it. The price is high.

The same is true for most commodities and natural resources--including oil. The price on all these things may go higher--probably will, eventually. But a much better (less risky) time to buy is when prices are depressed--such as when the stock market is booming.

Two Investment Ideas

Quote of the day:
“When I see people destroying their privacy — what they think, what they feel — by beaming it out to millions of viewers, I think it cheapens them as individuals.”
--Richard Widmark, on why he never appeared on talk shows.

Times of economic turmoil always present investment opportunities. A good indicator of such an opportunity is one that elicits the following response from your friends: “What are you, nuts?”

Many of us like to consider ourselves apart from “the crowd.” We say to ourselves that we are following our own unique, enlightened path. But contrarian thinking is very hard.

Investors behind the truly “smart” money are invariably contrarian thinkers. They buy when most are interested in selling, and thus they buy cheap. Smart money is patient and quiet. If and when we learn where their money is going, it’s already gone there.

The best-known contrarian is Warren Buffett, whose investments have become so large that it’s hard for him to stay quiet. It’s always news when he makes a move.

I don’t know what Warren Buffet is investing in right now, but there are two clear areas of opportunity: municipal bonds and residential real estate.

Real estate may be more obvious to the average person. There is virtual unanimity that the bottom of the market is still to come.

While everyone is standing around waiting for the bottom of the market, there are opportunities to buy properties at least 20% below their prices two years ago. Over the next two to three years, I have no idea where prices may go. But it is clear that there are some very good values appearing.

This is even more true in the municipal bond market. Because there is no tax on interest paid by these bonds, they usually pay significantly less than equivalent treasury securities.

But due to the turmoil in the credit markets--and specifically concern about the health of bond insurers--investors have been shunning municipal bonds for the rock-solid safety of treasuries. This concern has been way overdone, and top-quality munis now are yielding more than treasuries--and the yield is tax free.

Prices on municipal bonds are very low right now, and I bet there is some serious smart money taking a hard look at them.

Inflation and Recession

Quote of the day:
“General Motors is preparing to shift half of its $3 billion budget to online advertising over the next three years.”
--Advertising Age

A major focus of economic coverage on the news over the last few weeks has been are we in a recession or not, and has inflation jumped?

What is rather ridiculous about endlessly waiting for official tipping points is that they come late if they come at all, because no official wants to be accused of being negative about the economy. Also, while reporters are spending all their time quizzing economists they don’t simply look for themselves.

Have you been grocery shopping lately? Duh. Have you bought gas lately? Double duh. Have you applied for credit recently? Duh, duh, duh.

The price of wheat and other grains have gone way up, causing price jumps or product shrinkage, and causing a squeeze on restaurant owners. The price of oil is near its all-time high, so the prices of the myriad of petroleum-based products are marching upward. And all who use transportation are affected.

Yes, I know that gas and food are not included in the official CPI. But we use more of these things than anything else. This is inflation that whacks us every day.

Housing prices have declined significantly over the last two years, crimping the plans of those counting on short-term equity growth. Financial institutions are facing fast-growing loan losses, and those who took the most risk are in trouble.

Credit has become difficult to get, especially for smaller businesses. This slows business growth.

Thus it’s clear that inflation and recession are both with us.

Interesting thing, though. The parking lots at Fashion Valley and Mission Center are full. There are waits to get into bustling restaurants. And this morning JP Morgan makes a more-generous offer to buy Bear Stearns.

Maybe things aren’t that bad.

Extent of Financial Crisis

Click here for video: Ramifications of Fed bailout of Bear Stearns.

This Time It's Not Different

Quote of the day:
“What has been is what will be, and what has been done is what will be done; there is nothing new under the sun.”
--Ecclesiastes 1:9

I want to spend another moment considering Alfred North Whitehead’s quote from yesterday.

To paraphrase a cliche, when you live long enough, you see almost everything. Actually, it goes further than that. If you live long enough, you see many things repeat themselves over and over.

This applies especially to bad decisions resulting from delusional thinking, be it mild, moderate or severe. The delusions are more important than just about anything, and we will not let them go. Thus the same bad decisions, over and over and over again.

We all carry around delusions of some sort, often relating to our self-image. Some get us into trouble, but most are benign, the worst consequence being foisting ridiculous arguments and opinions on the people around us.

Two areas that seem especially susceptible to delusional thinking are money and politics. These can be personal and relate to our daily lives, or they can be part of group-think and relate to larger issues.

Two cliches apply:

“The definition of insanity is repeating the same actions over and over, expecting a different result.”
--Source unknown

“Those who don’t understand history are condemned to repeat it.”
--Benjamin Disraeli

Unfortunately, the cliche we often live by, even passionately swear by is:

“This time it’s different.”

Whatever the case, I gotta tell you, it is almost certain that this time it’s not different. Sorry.

I used to think it was charming to say “there’s nothing new under the sun.” But there is much more to it than charm. Maybe even a profound truth.

A Down Economy

Quote of the day:
“Na-na-na-na-na-na
na-na-na-na-na-na-
na-na-na-na-na-na-
na-na-na-na-na.”
--Wilson Pickett

It looks like retail sales at the end of the year were not as good as expected, though data will continue to trickle in for a while.

The Fed is saying it is ready to take some significant action to lower interest rates.

There are continuing reports that home sales and prices are both down.

It’s pretty clear that we’re in a bit of an economic slowing. If it worsens, some people will need some help, but most of us will be ok.

A lot of what is being measured is not actual decline but slowing growth. Where there is decline, the setback is not to the stone age. Rather, we are seeing numbers that were common a few months ago.

Real estate is an exception, at least here in San Diego. Prices are where they were about 3 years ago.

Still, most of us will be ok. That includes homeowners who bought a place to live at any time, including at the price peak.

Even if a homeowner who bought at the peak finds himself having to move, he should be just fine. Any loss in the value of his home should be matched by the lower price of his new home.

Real-estate investors who bought for the long term also will be ok.

The only folks at risk are speculators who expected continuous upward price movement and who therefore bought with the intention of selling in a few months or years. If they can’t live in their investments and don’t have the resources to wait a long time, they’re likely in trouble.

Speculators expect great reward and take great risk to go after it. We are seeing the downside of that risk right now, as we saw it in 2000 with day traders.

We don’t hear much about day traders anymore. Many of them were wiped out in 2000. Just as many amateur house flippers are being wiped out right now.

The Stock Market: What Goes Out Comes Back In

Quote of the day:
“I do not see any real signs of recession, despite all the news headlines, which I believe many journalists are overplaying in order to attract attention. The Cold War is over. Global warming is becoming a bore--at least to this jaded writer. Journalism, which thrives on bad news, needs a new scare. Why not economic collapse?”
--Jerry Flint, January 3 Forbes

The economy and stock prices have been in the news since the start of the year. There are growing worries of recession, and special concern that consumer spending seems to be slowing.

We may or may not have a recession. We may or may not be in a recession. I don’t know. There are too many variables, and too many of them are only fuzzily known.

I try to stick with what I know. And I try to keep things simple.

When the stock market is weak, I ask myself a question: “Where did the money go?” When investors sold stocks, where did they put the money?

Most of the time it goes into money-market funds or T-Bills. Is the money going to stay there? No. At least not for any length of time.

So where will the money go? If bond yields (interest rates) look good, some or all the money will move into the bond market. This is what happened in 2000 and 2001 when the tech bubble burst. 30-year triple A bonds (highest quality) were yielding almost 8% then.

A lot of that money is still in the bond market, which showed a healthy return for the next few years.

Even though interest rates are declining again, bonds are already at 5%. To deliver the kind of return we saw at the start of the decade, the yield would need to decline to 2.5%. Unless the world is ending, I don’t know who in his right mind would invest in a 2.5% 30-year bond.

I don’t see the bond market delivering much of a long-term return from here. So the money is not going there.

Where else might it go? Some might go into real estate, if institutional or individual investors have the flexibility to invest money there. Most institutions do not have this flexibility. And I think individuals are all too aware of how illiquid real estate is.

The only realistic choice right now is the stock market. The money will come back. Just like Al Pacino said in “Godfather 3” about trying to escape the mafia. They try to take the money out, but it has to go back in.

In the declines and choppiness of the stock market, we’re also seeing the actions of speculators trying to time their sales and purchases. That money is not going permanently somewhere else.

So if the long-term money nor the short-term money is permanently moving out of stocks, will the market head permanently south?

Just asking.