The holidays are upon us!  I’ll keep it brief this week and let you all quickly get back to what really matters.  Thanksgiving is one of my favorite holidays of the year and this year our whole family is very excited to try, for the first time, deep fried turkey.  Assuming we don’t burn down the house, I will report back on whether the rumors of it being tastier than oven-baked turkey are true.

Deep fried turkey is exciting, but we’ve got a lot of other awesome stuff for the weeks between here and Christmas.  I’m not sure how I’m going to squeeze it all in but I will try.  Here are a few things to look forward to:

• Another look at real estate
• Some dividend stock strategies
• A recap of our 10 Predictions for 2010 (I can’t wait for this one!)
• 11 Predictions for 2011

I’ve also got another great newsletter from Kelsey on investment strategies for the socially conscious investor.  I think you’ll enjoy that one.

Giving thanks

You all have honored me with your attention over the last year by spending your Thursday mornings at our place.  There is no more valuable commodity in the entire world than another person’s time.  For the time and respect you have given me I am humbled beyond belief.

Respect is a two way street.  Since our raggedy beginnings I have endeavored to keep a respect for your time and respect for your intelligence at the forefront of my thoughts.  Contrary to popular belief, I really have no idea what I’m doing with this thing.  But that principle of mutual respect is my guide, my sherpa through the rocky frontier of Newsletterland.  Something tells me that if I treat you intelligently, share generously, and tell the truth, all sorts of wonderful things are possible.

Who knows where we’ll go from here.  That’s a really neat feeling!  And I owe it entirely to you.

Thank you, everybody.

We open with a brief thought:

Last week, a home buyer with means and a good credit score could borrow money more cheaply than the U.S. Government.

Think about that for minute.

What does that mean?  I’m really not sure.  What does you think it means?  It’s an apples/oranges comparison but it’s intriguing and we haven’t seen anything like it before.  If you are one of those rare individuals with a clean credit history and plenty of cash to put down, you can borrow money cheaper than the United States Government for the next 30 years!

Sometime in the next few weeks I want to take another look at real estate.  In the last year we have done two in-depth newsletters on the housing market.  They’re available here and here and the latter recounts the sordid tale of how I got my first mortgage, a story that will no-doubt sound disturbingly similar to all of the other mortgage legends that circulate at various cocktail parties.  Both of those newsletters were among our most popular and well-received issues, and I guess we’re about due for an update.

So stay tuned for that.  I think it’ll be interesting.

In the meantime, there are more pressing matters to discuss…

Ireland

I mentioned Ireland last week when relatively few people were talking about it.  I like to watch bond markets and the reason I watch bond markets is because they let you know when things are juuust about to get dicey.  This week the entire world is talking about Ireland and reporters are stationed 24/7 outside the Irish Parliament in Dublin.

It’s seems a little scary today but the lesson we all should have learned from Greece is that before you know it, the market will move on and forget about this.  That is, until they have to roll over another big stack of bonds next year.

The fascinating thing about Ireland is that they’ve been doing it “right” pretty much from the start.  That is to say, when they first ran into trouble the reaction was not bailouts but austerity across the board.  They actually made a serious effort to get out of their jam and slashed spending in draconian fashion!  No surprise, it was painful.  Unemployment tripled, GDP fizzled, and their stock market deflated.  But the Irish government did this to demonstrate to the world that they were committed to resolving their own problems by themselves and in a responsible manner.  Even Jean Claude Trichet, Europe’s version of Ben Bernanke, applauded them earlier in the year when Club Med was melting down.  He said, “Greece has a role model and that role model is Ireland.”  Even with all the bailout talk this week Ireland appears to be fighting it tooth and nail.  Clearly, these guys don’t want a bailout but it appears that the rest of Europe will get its way.

I’m not Irish and I’ve never been to Ireland, but somebody tell me, is this an Irish thing to do?  To hold fast and take it on the chin?  To grit one’s teeth and muscle through it?  While many European countries have welcomed a bailout or even felt entitled to one, I wonder if the Irish feel a sense of shame about help being forced upon them.

Fiscal austerity hawks are getting a lot of blowback over Ireland right now.  The criticism is that it didn’t prevent a bond meltdown and that it hurt the economy.  Well…duh! That’s what austerity does!  Of course higher taxes and spending cuts will amount to a slower economy.  Issuing a final judgment on this matter at this point is totally ridiculous.  The reason Ireland tried to go the route that they did is because they thought it would get them back to the land of health & prosperity quicker than the Bailout Expressway.  It will be years before we have even a glimpse at the answer.

The question is whether quickly taking the tough medicine and enduring the gut-wrenching pain that follows will be preferable than allowing the disease to fester.  Japan is the best example that we have for never-ending bailouts and stimulus.  Two decades later Japan’s economy still sucks, their banking system is still on shaky footing, and their level of government debt is still so stratospherically insane that it’s impossible for most people to believe.  I don’t know of any examples in history where non-stop bailouts and stimulus solved an economic problem of this magnitude.  But if you know of any, send me a message at Feedback@TheDraconian.com.

You might wonder why we’re talking about a teensy economy on the other side of the world.  The reason why we’re talking about it is that their problems are exactly the same as ours.  The United States also has a gigantic mismatch between revenue and expenses.  California on its own is worse than any European nation by basically any metric.

If Ireland can’t get their act together without spooking the markets and eviscerating their economy, how on earth is the United States going to do it?!  As I said, this is tough medicine.

I seem to say it every week, but the path we have chosen in this country was to exchange short term, acute pain for prolonged malaise.  I’ve always said that a trade off of that type isn’t really an economic matter.  It’s a matter of cultural philosophy.

Might WE turn Irish?

This is one of the coolest things I’ve come across in the last couple weeks.  It’s an interactive feature over at the New York Times that gives you a chance to solve our budget problems from the comfort of your home.  I was able to do it with about 70% of the savings coming from spending cuts and about 30% of the savings from tax increases.  Were I serving my country in Washington D.C. I’m sure my budget decisions would get me promptly sacked and shipped back to the desert.

This nifty little application was inspired by the bipartisan commission that Obama assembled to try and figure out how to reduce the country’s deficit.  In my opinion, this commission lived up to its mandate and co-chairs Erskine Bowles (D) and Alan Simpson (R) served up a rare helping of political honesty.  Here are just a few of their suggestions on how to clean up our fiscal mess:

• Increase the age to qualify for Social Security to 69 by 2075 and index it to a lower rate of inflation.
• Reduce Social Security benefits for the middle class and especially high-earners.
• Raise the Social Security contribution ceiling.
• Flatten out the tax code to three simple brackets (8%, 14%, and 23%) and one corporate rate while eliminating all credits and deductions including, yes, your beloved mortgage interest deduction.  YAY FLAT TAX.
• Raise the federal gas tax by 15 cents per gallon.
• Eliminate all earmarks.
• Freeze government worker wages through 2014 and eliminate 200,000 government jobs by 2020.
• Increase Medicaid co-pays and accelerate cuts to Medicare Advantage.
• Big time tort reform for the healthcare industry to bring down medical malpractice costs.
• Bye-bye, NASA.  Bye-bye, NPR.  Bye-bye, lots of other little government programs.
• Slash a bunch of defense spending on high-tech projects and reduce military forces abroad by one-third.

As you can see, nobody is spared.  Simpson himself said, “we have harpooned every whale in the ocean and some of the minnows.”  Yet even with all that the Bowles-Simpson plan still doesn’t balance the budget until 2037.  We’re going to be mopping up the mess we’ve made for basically the rest of my life.

Me?  I love this plan.  I don’t love it because I’m a masochist and want to see economic pain inflicted on myself and everybody else.  I love it because it’s honest and it zeroes in on the things that are broken.  Nancy Pelosi calls it “simply unacceptable.”  But she made a bunch of false promises to her constituents to get herself elected and I didn’t.  That’s probably why we differ here.

If you want to read the fiscal commission’s entire report, you can grab it here.  To my knowledge, Wisconsin congressman Paul Ryan is the only other high-profile individual with an actual plan on how to heal our woes.  In many ways, his plan is even more aggressive and it seeks to balance the budget even sooner.  It’s long and it isn’t just talking points.  You can download the whole thing from his website.  It’s worth taking a look at.

I know that none of this is possible in the current political environment, but I bring this up because this is the conversation we all need to have.  When you get home from work today, talk to your spouse about what kind of sacrifices you are prepared to make to prevent the slow decay of your country.  I know that a disproportionate number of you on this newsletter are high-earners.  You guys are lucky enough to not have to rely on Social Security for your retirement and you’re lucky enough to be able to afford a nice health insurance plan.  Are you willing to ultimately give more of your salary back in taxes?  And for the rest of you who have more difficulty making it from month-to-month, are you prepared to give up some of the entitlements that you’ve been promised?  Are you prepared to push back the date of your retirement even further?

This is an adult conversation and it extends far beyond the childish Democrat and Republican talking points that are driven solely by emotion.  There aren’t a lot of adults in charge right now and the responsibility for that rests on our shoulders.

Solving our problems is quite easy, much easier than you might think.  I’ve been harping on this for the last year or so: it’s an era of sacrifice.  If we really want to clean up our fiscal house then everybody needs to buck up.  Right now nobody in the country is willing to do this.  Everybody wants to see their neighbor sacrifice, but nobody wants to make sacrifices themselves.  There’s a reason I spend so much time talking about touchy-feely stuff like culture and philosophy and this is why.  The real source of our problems is cultural.  Fiscal profligacy is simply one of the ways in which they’ve manifested.

Last weekend I was up at Tahoe sitting by the fireplace drinking my tea and watching Meet the Press with the dog.  Alan Greenspan was on.  I know that nobody listens to Alan Greenspan anymore but I still do.  I’ll listen to anybody who for years had the ear of the entire planet and then went before the entire planet and admitted that for all of those years he was wrong.  That takes guts and a rational, objective outlook on life.  Anyway, he said that all these budget measures are going to happen.  It’s inevitable as it’s the only way to clear the market.  The question, however, is whether these measures will come before a bond market crisis, or after.

I doubt we see a full-on bond crisis in the coming decade.  But I think we get one or two scares.  Fear is the great motivator, after all, and maybe we get scared into action.  Or maybe not.  Maybe we do become Japan.  Maybe this is the Zombie Bank Apocalypse.  There are so many paths that lie ahead and it’s anybody’s guess which way it’ll go.

If you can get above the fear and uncertainty, it’s actually kind of an exciting time to be alive.  We are an integral part of the history that our unborn grandchildren will be studying a hundred years from now.

What kind of history do we want them to be reading about?

Let’s bring it home

This is an investing newsletter after all.  So let’s bring the conversation back to your portfolio.

I spend a lot of time on here talking about “structural challenges” and “economic headwinds” and what I’m really talking about are things like the Bowles-Simpson plan.  Total fiscal reform is just one of the many issues swirling beyond the horizon.  Permanently higher unemployment is another.  So is a decade of stagnation for the real estate market.

Look: none of these things are good for the economy.  We can’t say a lot about the stock market with great certainty but we do know that over the long-run, the stock market is based entirely on economic fundamentals.  A share of stock is nothing more than a discounted claim on a stream of future cash flows.

The long-term economic fundamentals and the future cash flows aren’t anything to get excited about.  The next decade simply will not look like the 1980′s or the 1990′s.  Sadly, those are the decades that many investors are still living in.

This is not to say that the years ahead will be devoid of rallies and mini-bull markets.  There will be plenty of these.  If you are a professional, you will have ample opportunity to take advantage of these cycles on a tactical basis.  And if you are a professional, you know that’s really difficult to do.  If you are the investor at home and you don’t know how to deal with range-bound markets, you need to renew your subscription to The Draconian and find a good financial advisor.

There are a million ways to play the coming decade tactically, but only a handful of really good strategies.  In my opinion, the strategy that offers the best bang for the buck is a defensive one centered around preserving capital now for outstanding opportunities later.  Jeremy Grantham — who is a far better writer, smarter strategist, and bigger investor than I — is a champion of this strategy and you can listen to him talk about it in an interview he just gave with CNBC.  It isn’t just about holding a bunch of cash and waiting for assets to fall into your lap, it’s about establishing a core of defensive positions while the environment for risk taking improves.  Things like high quality stocks and exposure to natural resources and base metals, stuff that’s integral to the foundation of any economy.

As for the tactics of today, we’re in the middle of a pullback right now that everybody has known was coming.  I know a lot of folks out there were waiting for a market pullback and the catch is that it took a little longer than everyone was expecting.

Then Fed is going to be throwing $75 billion a month at the markets and that’s force I’m not inclined to fight.  It could be a nice six months for the stock market, but I’m not sure I want to own much after that.

Especially if these Irish trends of austerity and fiscal responsibility pick up steam.

The last week has been interesting.  We’ll jump straight into it.

Two things are at the top of my radar screen.  The first is what’s happening in Ireland.  There’s no other way to put it: Irish bonds are spiraling out of control.  Go have a look for yourself.  Every day seems to be a new high in yield.  This is the market’s way of saying that holders of Ireland’s bonds are likely in for a haircut.  But I think the more interesting (and important) issue is the reminder that the mess in Europe is far from over.  The Euro has rallied something fierce in the last few months as have the rest of the risk markets, and it’s done it against a situation in Europe that is actually deteriorating.

We were early in pointing out the European dangers near the beginning of the year and it’s likely we’re early again.  It may or may not have global consequences and contagion effects — Ireland isn’t very big — but it still warrants watching.

The other thing I’ve had my eye on is Crude Oil.  It’s quietly sneaking back up towards $90 per barrel.  At first it had pretty much everything to do with Dollar weakness, but the Dollar has bounced a little bit in the last week and Crude continues to climb.  What’s going on here?

According to a recent CFTC report, the number of net long positions in crude oil held by hedge funds is at an all time record.  Hedge funds don’t have the best reputation in the financial industry but just about everybody in finance agrees (if begrudgingly) that the hedge fund space is where the best talent and intellect lives.  They are the professionals that take money from the amateurs.

Crude oil is an interesting thing to watch.  Because it’s a relatively inelastic good it has an interesting relationship with the economy and stock market.  At low and tolerable levels, crude oil tends to correlate with stocks and the economy.  There’s a good reason for that.  When people are feeling good and the market is rising they use more energy.  But when oil prices rise beyond a certain point, it starts to have a negative effect on consumer psyche.  They’re forced to spend a greater portion of their income on energy and cut back in other areas which has a detrimental effect on the economy.  The relationship is sort of parabolic.

The slippery thing is that this relationship is difficult to quantify and this knock-on threshold changes over time as prices inflate and consumers adjust to new market equilibria.  Since 2006 the point to watch has been around $85/barrel.  Below that level the daily correlation between crude oil and the Dow is about 0.36 — not super meaningful but it is modest positive correlation.  Above that $85 threshold is where it gets interesting.  The correlation collapses to almost zero.  Again, not tremendously meaningful but it’s clear that something breaks down when crude oil gets expensive, or a related, hidden exogenous factor comes into play.

As an anecdote, consider the 2001 recession where oil prices shot from $13 to over $30 in the two years prior.  Energy prices played a role in that recession.  Or the 1970′s where fluctuating oil prices wreaked all sorts of havoc on the economy.  And by the opposite token, consider the striking rebound in energy prices exactly alongside the economic recovery of 2009.  People started to feel OK about filling up their SUVs again.

Anyway, we’re at the point now where it’s time to start paying closer attention to crude.  We’re about to cross the threshold where the tight correlation that we’ve seen for the last two years may start to break down.  And there’s a cultural milepost as well; make note of how often people complain about high gas prices.  For the last year or two nobody has been complaining too badly.  Keep your ears open.

The energy sector is one of my favorite areas of the market and has been for quite some time.  I see it benefiting in so many different scenarios, everything from depletion of natural resources to inflationary panics to the powerful intrinsic demand for the goods they produce.

Don’t worry be happy!

The market has broken out to new highs for the year.  It charged through resistance and into new high ground for the year.  About a month ago on Twitter (@TheDraconian) I tweeted about the Golden Cross, which is when the 50 day moving average crosses above the 200 day moving average.  If the phrase “moving average” made your eyes glaze over, don’t panic.  It’s just another way of saying that medium trend is good and even stronger than the long-term trend.  This one is an incredibly bullish indicator, and at the time I mentioned its fantastic track record.  It’s 8 for its last 8 since 1990 and the average gain following a Golden Cross is 24%.

Since that day, the market has only gained a couple percent so there could be some life left in this trade.

For what it’s worth a rally of 24% would take the market back to pre-recession levels.  Would that represent another bubble in equity prices?  You betcha.  QE2: mission accomplished!  The Fed is doing everything it can to re-inflate any bubbles it can and if we’ve learned one lesson in the last 15 years it’s that nobody should get in the way of a good bubble, intentionally manufactured or not.

The last two times we got the Golden Cross were in June 2009 and June 2006, both excellent times to buy the market and hang on for a little ride.  In 2006 you had about 18 months to get out.  Odds are, if you bought in mid-2006 you probably didn’t get out at the top in the following summer, but I would have hoped you’d pulled the plug by December 2007.  That’s when we got the opposite of the Golden Cross — when the 50 day moving average drops under the 200 day moving average.  That signal also has a name, the “Death Cross”.

Or as it’s known colloquially in our office: THE DEATH CROSS!!!

You might think technical analysis is silly but it offers some really great power tools that investors can use.  Obviously, you can’t build a house with just a gas-powered circulating saw, so don’t trade on a single indicator alone.  Use it in conjunction with the other tools in your box.

Right now, I like the setup.  The bull trend is back on.  The short term economic data is undeniably improving — it even seems to be looking up a little bit for small businesses according to the NFIB.  When it comes to recession forecasting few do it better than Lakshman Achuthan and the Economic Cycle Research Institute.  He recently said that a double dip recession is totally off the table and I believe him.  He’s a lot smarter than me and my general policy is to at least listen when smart people have something to say.  Everybody knows that growth for the next year is going to be slow, but it is going to be positive. And everybody knows the economy won’t be creating enough jobs to dig us out of the unemployment hole, but it will be creating some.

We’re no longer drowning but neither are we back at ramming speed.  We’re treading water.  That’s no so bad.

On top of that, we’ve got the Fed buying about $600 billion worth of stuff over the next eight months.  That’s a powerful force to fight.

Look, the long-term fundamentals of the U.S. are terrible.  We’re basically Japan with better demographics and the world’s reserve currency.  That doesn’t mean the market can’t move higher and it doesn’t mean that market is going to go straight down every year.

Heck, even Japan has enjoyed its own set of rallies in the last few decades and there isn’t a stock market and economy in the world more reviled than theirs.  Take a peek into our future:

There are plenty of little cyclical bull markets in that chart with gains of 30-100% that lasted for a year or more.  The U.S. is going to see its share of these in the coming decade.  We’re in one right now, and depending on what you use as your starting point there’s either a little life left or quite a bit of life left.  The endpoint, I fear, will be just the same but that shouldn’t stop people from having a little fun along the way.

And it’s going to be volatile.  The VIX (volatility index) has been squished back under 20.  The last time it was that low was right before the European debt crisis this spring and the time before that was August 2008, the eve of Lehman’s death.  I mention this not to say that we’re about to have another shakeup, but rather that the risk out there in the markets is to the downside.  Pretty much all the good stuff has been priced in and the bad stuff resides at the bottom of currently-unknown booby traps.

For you sailors out there, it’s like cruising through the Caribbean solely by dead reckoning.  The skies are clear and the water is smooth as far as the eye can see.  Is there a hurricane brewing east of Barbados?  I have no idea.  Our boat doesn’t have GPS and a radar weather map.

But we have Captain Ben at the helm, so everybody may as well get up on deck, grab a pina colada, and enjoy the sunshine!

Just be sure and wear a life preserver.

Don’t be a Goofus

When I was a kid my parents bought me Highlights Magazine.  I have no idea if it’s still around but back then it was pretty awesome.  One of the things I remember about it was a feature that they did every issue called “Goofus and Gallant”.  It was an educational cartoon to teach kids basic social skills.  Kids were supposed to emulate Gallant who always embodied the right kind of qualities and made the responsible choices.  He was the good guy and Goofus was the bad boy.  Goofus was the one who was rude and irresponsible and had the psychological makeup that parents didn’t want to see their kids adopt.  Goofus was the cautionary tale for young Highlights devotees like me.

Anyway, it got me thinking about another project I’ve been working on in which I’ve been developing a compendium of sorts about the basic principles that all the great investors adhere to.  I thought it might be nice to also include a bit about what not to do it led me to build a composite profile of the chronically unsuccessful investor.

I’m not a psychologist, but I’ve worked with enough people in this industry to learn a few things about general investor behavior.  This includes both the professional traders and the scores of investors at home who would consider themselves “average”.  From all this and my basic understanding of some psychological principles, we can draw some broad conclusions about the psychological makeup of the poor investor.  The Financial Goofus, so to speak.

By and large, the Financial Goofus is somebody who doesn’t understand the fundamental and technical aspects of the market and makes decisions based on emotion and herd behavior.  It doesn’t take a lot of education, but people that haven’t studied the basics of investing invariably wipe out at some point.  These emotional individuals move with the herd to mask their poor knowledge of the basics of finance.  The unsuccessful investor doesn’t take continual education very seriously.

Education is a relatively simple thing to fix — The Draconian is a great place to start!  But the more troublesome psychological factors are buried much deeper.   The Financial Goofus tends to suffer from a lot of anxiety in most areas of his life and he doesn’t have the proper mechanisms in place to cope with all his daily stress, much less the additional stresses of investing.  These high-strung individuals tend to have a generally negative outlook on life, expecting the worst out of all of their endeavors, and they always –always – blame others when things go wrong.  They don’t always make bad decisions but when they do, they never take responsibility for it.

Keep in mind that a lot of investors with this kind of negative mindset do experience success or at the very least, don’t lose in as disastrous a fashion as one might expect.  Luck plays a huge role when it comes to investing and sometimes the Financial Goofus will make an investment that starts paying off right away.  The irony is that these guys have a knack for taking a bit too much credit for their wins.  It’s their broker’s fault when their investments go down but when things go up, they take all the credit as a client.  I’ve known a bunch of financial advisors who lament having to deal with investors that fit this profile and most of them would admit that dealing with these Goofuses is the toughest part of their jobs.

One of the key elements in the psychological profile of the Financial Goofus is a total lack of patience.  These investors want to see results immediately and want their investments to perform now.  All investors want to see their investments perform immediately but the Goofus, the chronically unsuccessful investor, gets angry when they don’t perform and makes the wrong decision at the wrong time.  It isn’t just their investments that they have no patience for, it is most things in life.  They can be frustrating employees to work with and as spouses their impatience often causes domestic unrest.  Impatience doesn’t always translate to poor results but when paired with some of the other psychological characteristics of the Goofus it acts as a disastrous modifier.

There’s a chance that profile might be you.  Take an honest inventory of your personality.

If that is you, don’t panic.  It’s not the end of the world.  When it comes to investing make peace with this fact and instead seek out professional help.  The professional help that I’m speaking of here is that of a trusted financial advisor, someone who can make good decisions on your behalf or at the very least encourage you not to make self-destructive decisions.  But if you want to seek out professional psychological help, that’s fine too.

Odds are you probably know some people with that kind of makeup.  In fact, I’m almost certain you do.  Individuals like that are quite common.  And I’ll bet dollars or donuts that these folks don’t fall into the bucket of what you would call “generally successful individuals.”  These are not the leaders at your company, they’re not the kind of folks at the center of your social networks, and they’re not the kind of people that make for successful investors.

Apparently they never read Highlights Magazine!

It’s finally over!

No more attack ads and junk mailings and late night calls from the Whatever Party national convention.

I couldn’t be happier.  In this sense, all of us have won.

We didn’t learn much.  We knew the Republicans would take the House and we knew it’d be close in the Senate.  Here in Nevada, we knew that Angle led in the polls but we knew that meant nothing.  When we woke up this morning to see that Harry Reid won, half of us were angry and half of us were glad, but none of us were surprised.

The market reacted accordingly.  Wednesday morning it opened unchanged and didn’t do much the rest of the day.

This is why you can listen to the market.  It tells you things about the future.

Because of the extreme political imbalance, the last two years have necessitated a specific strategy for each party.  With a supermajority, the Democrats had a brief window where they could accomplish pretty much anything that they wanted.  And they did.  Wouldn’t you if you were driving the bus?  They rammed through clunky legislation on two of the most important issues we face in this country: healthcare and financial reform.

Behind the eight ball, the Republicans had no choice.  Like a spoiled kid who doesn’t get his way, they all went and pouted in the corner and “just said no.”  They had no incentive to contribute anything meaningful to the debate, to offer any real solutions of their own, so they didn’t.  Why would you reach across the aisle if only to have your hand slapped?  So their dominant strategy was to refrain from the discussion, point fingers, and wait for the inevitable blowback.  And their strategy worked brilliantly.

Ideally, this is not the way that government should work.  There shouldn’t be one party that represents only half the nation that gets its way all of the time.  And the other party should actually do something and make a substantive contribution to the debate rather than call people names from the corner.

But I’m an idealist.  And when it comes to politics I have always been and always will be a bit naive.  I am not your man when it comes to running for office.

This isn’t a political newsletter, but every once in a while we talk politics because politics affects business and the markets.  It’s a delicate subject — along with religion and sex, it’s one of the things my wife tells me not to talk about at cocktail parties.  But for the most part I haven’t ever had too much difficulty with those kinds of discussions.  I enjoy listening to why people feel certain ways and am somewhat adept at visualizing things from multiple perspectives.  I actively shun dogmatic thought and long ago I came to terms with the fact that most of the world couldn’t possibly care less about what I think.

As you can imagine, that could create something of an existential crisis for someone actively engaged in writing a public newsletter.  Nobody cares about my personal beliefs, therefore I have to give you guys something so you come back next week and the week after.  My goal every issue is to deliver something that is:

1. Informative
2. Useful
3. Entertaining

I don’t always succeed but our traffic goes up every month and every week new people sign up to get The Draconian by e-mail and I hope it’s because we’re delivering at least a little bit on that promise.

Either that, or it’s all the bribes I’ve been handing out!

OK, what do these elections mean for the markets?

The big question right now is what this Republican victory will mean for the markets for the next two years.  We’ll spend a couple weeks exploring that topic.

We know a few things right off the bat.  We know we’re going to have political gridlock, and if you look back through history you’ll notice that for the most part, political gridlock is good for the markets.  Though Dan Greenhaus of Miller Tabak has a really neat and concise argument against that view view right here.  Either way, the one thing that the market hates most of all is uncertainty, and the good news about gridlock is that it investors know what to expect.  Everybody knows that nothing major is going to happen and that the status quo will live a little longer.

Rumblings have already begun about possibly repealing the big healthcare bill.  I have no idea if that will happen or not, but if I was an insurance company, I might be getting a little nervous.  That bill was a pretty sweet deal for them.  In theory, any Republican revision of this bill will include a bit more privatization and market competition (bad for Big Insurance) but with these guys you never know.  Again: uncertainty.

That’s yesterday’s chart of some of the biggest health insurance companies vs. the rest of the market.  Once John Boehner opened his mouth, Wellpoint, Cigna, Humana, and UNH all sold off relative to the S&P.  Watch these kinds of stocks as we move towards any potential action on healthcare.  The market will let you know what’ll happen in advance.

The other big question is the fate of the tax cuts.  Everybody knows that most or all of them will be extended for a little while, but the question remains what will happen to them beyond that.  That will have economic consequences.  Nobody debates the fact that lower taxes are better for the economy, but the government is really hurting on the revenue side right now, especially in proportion to its spending.  That equilibrium simply cannot sustain itself forever.  Tough choices with respect to taxes lie ahead.

The last issue that the market will be watching is jobs.  And this is the big one.  There will not be any significant, sustained advance in the stock market until the unemployment rate has a reason to start going down.  The public sector is tapped out right now and private businesses aren’t going to hire until they start feeling more confident about the future.  You can see the problem here.

The U.S. economy doesn’t grow if people don’t spend money.  And people don’t spend money if they don’t have a job or are worried about losing their job.  The strategy so far has been to hand out as much sugar-packed proposals to stimulate everyone to spend, but on that front, our country’s free candy bucket is just about empty.  The political will for more stimulus has dried up and even if it hadn’t and hardcore Keynesians like Paul Krugman got their way, we’re at the point where the marginal benefit of any stimulus program probably isn’t worth the cost.  Krugman’s a lot smarter than I am and has one more Nobel Prize than I do, so who knows.

In any case, the recent election all but guarantees no further action on that front.  For better or worse, the economy is now on its own.

I still think the economic fundamentals of the U.S. are terrible, as bad as they have been since the Depression.  That’s not gloom and doom; it’s fact.  The data is ugly.  Over the long run, fundamentals are the only thing that matter and this is why I feel a certain degree of confidence that the next decade will be a tough one for investors.

Don’t get me wrong — there will be opportunities, but it’s going to take a lot of work.  Professionals will have an edge and the days of passively investing a portion of our 401(k) in the market and hoping for double digit returns are looong gone.  For the next 5-10 years the markets are going to go up and down and when it’s all said and done investors will wonder if any marginal gains they experienced were worth the heartburn.  Many will give up entirely, and at that point, which I have tentatively circled on my calendar as 2017 +/- a couple years, will be when investors should be buying with both hands.  The irony, of course, is that few will be in a position to do so.

This leads me back to the general strategy for the next few years.  The name of the game is capital preservation.  Over the long, long run investors will be best served if they can stay alive and tread water during this difficult time so they have the resources to deploy when it’s time for America to rock and roll again.

Between now and the next boom, here are a few things you can do.

Some timeless strategies for times certain or uncertain

My favorite strategies are ones that remove volatility from the markets.  These can be difficult because they require discipline — low volatility strategies are boring and investors have to fight the urge to chase the shiny objects with sexy recent past performance.  But in my own experience, slowly compounding one’s way to wealth is the most reliable way to go.  It’s hard work and it takes patience, so I understand why many seek other routes.

In the last year or so, we have talked about a lot of different strategies.  We’ll continue to explore these areas and some possible new frontiers as we move through the fall and winter.  Most of this stuff falls into the category of timeless, but these areas become particularly more attractive when everything else in the world looks grim:

1. High quality corporate bonds (avoid junk!)
2. Near-term Treasury Bonds
3. Inflation protected Treasury Bonds
4. Gold
5. High quality stocks that trade at low valuations, with minimal debt loads, and good dividend yields
6. Alternative investments like hedge funds
7. Look abroad for aggressive growth, places like Brazil, China, Korea, and Turkey

There are actually quite a lot of things you can do when you think about it.  But what’s crazy is that most of the items on that list aren’t very popular right now.

Gold obviously is, but our lifelong stance on gold is that investors should always have 5-10% of their portfolio in gold at any time.  Why?  Because it’s different.

Emerging markets are also very popular because investors are becoming increasingly desperate for growth in this depressingly-low growth environment.  And that’s really the reason why the rest of this isn’t very popular.  The majority of those things don’t carry high yields or return expectations and there are a lot of investors out there that are starving for yield and are reaching farther out the yield and risk curves than might be prudent.

Remember that I’m just a guy.  I don’t know what the future is going to look like and I don’t know what investments are going to do well.  There are a lot of gurus and professionals in this industry who claim that they do know.  They feel like they can speak about the future with such confidence that it demands your attention, and usually, your dollar.

That’s part of the reason why we do this thing for free.  Selling people your vision of future is no different than fortune telling.  This what sets us apart from the gypsies.

You might agree with our vision, you might not.  That’s what makes this business interesting!  Who cares if you think the strategies we’ve outlined are terrible.  In fact, I encourage you to seek out investments that work for you.  This newsletter was one of our most popular and well-received publications to date.  Every investor needs to embark on a journey of self-discovery to figure out the right kind of investments, the ones that can help you build a portfolio tailored to your personality.  It’ll help you make better decisions and you’ll sleep better at night.

While on your journey of self-discovery you might find that the two of us have similar values and tastes, and because of that, you might find yourself also responding to the types of investments we talk about on here.

Or not!  In that case, we hope we are at the very least informative and entertaining.

World Champs

And finally, perhaps most importantly in this tremendous week of news, congratulations to the 2010 San Francisco Giants!

My dad was a big Giants fan and some of my earliest memories are of watching games on the couch with him and the rare trip to Candlestick.  The Giants of the 1980′s were a lot of fun.  There was many a summer afternoon when my brother and I would go out in the yard and pretend we were Will Clark or Robby Thompson with the bases full of ghost runners.  A hit past the end of the driveway was a double and anything that landed beyond the pine tree was a home run.  It was exciting to imagine that lineup, all those powerful bats on our front lawn.

The older I got and the more I learned about the game, the more I found myself attracted to a different type of team.  I became less interested in a star-studded lineup of sluggers and drawn instead to a dominant rotation, homegrown young talent, crafty defense, inexpensive veterans, and an unwillingness to neglect the most under-appreciated of all baseball roles, the middle reliever.  The 2010 Giants embodied exactly that, and while it’s exciting when your favorite team wins the World Series, it’s a truly sublime experience when it’s a team that feels built just for you, the kind of club you would have built yourself if you had any clue how to do it.

Thanks, Coach Bochy.  We couldn’t have done it without you.  You made a lot of gutsy moves down the stretch with this club and we trusted you every step of the way.  Giants fans were missing a World Series title for a long time, but what we’ve been missing even more is the knowledge that we have a solid core of guys that will be great for the years to come.  That’s what’s really cool, that optimism about the future.

I wish we could say the same about our team in Washington D.C.