We’ve got a couple of big announcements this week, so let’s run through those and then we’ll close with a quick market recap and, yes, another movie review.
First, I’m excited to announce that Alex Lawrence of The Entrepreneurs Blog and Funding Universe fame has featured one of our articles as a guest post!
Alex is kind of a superstar on Twitter where he has over 45,000 followers. Thats, like, a lot, especially if your name isn’t Ashton Kutcher. I can see why, though. Alex tweets all sorts of interesting things about growing a small business and sharing resources for start-ups. If you’re on Twitter check him out.
Our article is called Lessons from the Crisis. I wrote it a while back for Alex. He gave me freedom to talk about whatever I wanted with only one caveat: that it be honest. So I gave him an honest look at what was happening inside our business during a unique moment of financial history. Our readers really responded to it and many wrote in with comments. I think it touched a nerve. Our readership and site traffic has grown almost tenfold since I originally wrote that so there might be a couple of you on this newsletter who haven’t seen it yet.
Click here to read it.
Secondly, I’m excited to announce another new feature here at The Draconian…
“Ask a Hedge Fund Manager”
It’s a little known fact about the cottage “industry” of newsletter writing, but the main reason why people read these things is to have their own beliefs validated by an authority. People like it when they hear professionals agree with them. For the publishers it’s about telling a consistent story and attracting readers who want to be told the same story over and over again.
It’s very soothing, I suppose. And it gives us something safe and familiar to cling to in this scary world. I think that desire goes all the way back to the cradle. My daughter is only one year old but she already comes to me with the same books over and over again. She never, ever gets tired of reading Hop on Pop. And it never, ever fails to make her smile.
As you might have surmised, we’re a little different because our story is constantly changing in response to the markets. Markets are very dynamic things and if you want to play in them you have to be flexible. Yet, rare is the newsletter that takes such an open-minded, non-denominational stance. Rare is the newsletter that is unafraid to challenge fundamental conventions and also change tack when the facts reveal that they’re wrong. Rarer still is the curious and intelligent reader who’s looking for that sort of thing.
I’m kind of amazed that we’ve manage to round up so many of those readers in one place. Unlike the perma-bulls who watch Cramer and subscribe to Louis Navellier’s newsletter, or the gold bugs that read Richard Russell and the folks at The Daily Reckoning, or the perma-bears that follow Rosenberg & Roubini, our newsletter lacks what I would describe as dogmatically dedicated followers. Our readers read all of those newsletters… and also Rolling Stone or Us Weekly.
That being said, even an audience as uniquely diverse as ours have specific issues that are closer to the hearts than others. They also have questions. And my guess is that a lot of you share the same ones.
So ask them!
In our ongoing “Ask a Hedge Fund Manager” feature I invite you to write in with your questions. Here’s your chance to ask a real live hedge fund manager — team of fund managers, actually — with your questions about the markets.
We’ll start off doing this once a month or every other month. I’ll always announce it one week and then publish the responses in the following week. Everything we discuss will be subject to the same disclaimer the rest of this newsletter adheres to. (Basically: all of this stuff is our own opinion and you should always, always, always consult your financial advisor before making any investment decisions.)
Feel free to ask us more specific questions about the stuff we always talk about like Greece, or inflation, or exactly why the stock market is an insanely dodgy risk/reward proposition. Ask us questions about some of the things we don’t always talk about like why Turkey is an interesting place for investors to look or about the nuances of certain trading strategies and tactics. Need a recommendation for a good movie, book, or beer? The Draconian is your man. I promise to do my best to keep it relevant and entertaining.
The one thing you can’t ask about is specific stocks. There are some rules about that which require a few extra lines in our disclaimer, but there’s a much better venue for that discussion. Follow us over at SeekingAlpha to join in on that conversation.
Everything else is fair game.
Send those emails to Feedback@TheDraconian.com. They go straight to my desk.
I hope this idea catches on. I think it will.
I’m really excited about it.
Market Recap & WHOAH IT’S ANOTHER TECH BUBBLE!
The days before a holiday weekend are usually pretty quiet. There’s actually been a bit of action an excitement this week. We had a fairly hefty selloff on Monday and then stabilized as the week went on.
Since last month the market has made a series of progressively lower highs and lower lows. In the world of technical analysis, this is a bad sign.
It’s a sign that a market is rolling over. We’re back under the 50 day moving average so be careful and keep your eye on the crucial support level of 1300.
The stat of the week came from Credit Suisse’s Doug Cliggott. He thinks the market is in for a rude awakening come the end of QE2. The Fed has been buying $20 billion of bonds per week since August. According to Doug that’s equal to the total amount of mutual fund purchases in the last three years.
Yikes.
I know there are some people in this industry who are expecting a smooth transition from all this Fed buying to private sector buying, but I haven’t seen any good data to support that argument. I mean, that’s not to say it couldn’t happen; it can. I could be totally wrong and the retail and institutional market might be totally satisfied with a 10-year yield a whisker above 3%.
But I doubt it. I think investors would rather have a super high quality company with a strong balance sheet, compelling valuation, and superior dividend yield. Something like Intel, Johnson & Johnson, AT&T, Kraft, GE, or P&G. I don’t personally own any those and am not making any specific recommendations here — I just think that investments like those would be quite a bit more attractive for most investors. High quality has been out of fashion for a couple years now and I think it could come back in vogue like it always does during volatile periods.
And don’t forget, if you own a lot of Treasuries and rates go up, you can lose a lot of money. Now is the time to bring your duration way in. Bonds have had a nice little rally here, too, so hopefully you’ll be taking profits.
If you’ve been sleeping lately or spending too much time on the golf course, I’d suggest that you wake up for just a brief moment and check on two things:
- Make sure you’ve got the appropriate defenses in place to deal with some market volatility this summer.
- Check the tech headlines. We’re back in Bubble City!
I didn’t think I’d get to see another tech bubble in my lifetime, but lo and behold, another one is officially upon us!
LinkedIn — who had no need whatsoever to raise additional capital — sold about 8% of their shares in an IPO on last Thursday. The IPO priced at $45, the top end of the expected range, and then promptly shot north of $100/share once it started live trading. LinkedIn is now a $9 billion company. That’s a bigger company than international favorite of moms everywhere, J.M. Smucker’s. Smucker’s has over fifteen times the sales revenue, too. I guess the market believes that someday more people will subscribe to LinkedIn than those who enjoy tasty blackberry jam.
Yandex, a company I’d never heard of before Tuesday, went public this week. They too released only a very small number of shares, 16% of the company. It priced in the low $20s and as soon as it hit the market skyrocketed into the high $30s. It’s now an $11 billion company. Apparently they are Russia’s largest search engine. Or, as Yandex shareholders and cheerleaders describe it, “The Russian Google.” I have news for these people. I don’t care that Yandex has a 64% market share in Russia. In terms of raw technological power, capacity for growth and innovation, and economies of scale, they aren’t remotely close to Google. Google has a 22% market share in Russia and I think there is only one way each of these companies can go.
Zynga, the annoying and annoyingly profitable company behind Farmville and other online games, should be filing to go public in a matter of days. In the private market they’ve already been assigned a higher valuation than Electronic Arts despite generating only half the revenue. When they go public Zynga could become the largest video game company in the world.
I’ve seen some tweets from official and unofficial sources that Twitter may be ready to “shock the world” and go public themselves.
A couple months ago I was on a conference call with some managers of one of the largest and most famous hedge funds in the world. They said the private equity markets were as strong as they’d seen them in a long time. The PE guys are really hoppin’.
I’ve heard other rumors that pretty much every internet or social networking company is scrambling as fast as they can to go public rightNOW!
They other day I saw Bloomberg reported that 230 companies have filed for IPO this year.
Suddenly, Groupon doesn’t look so stupid at turning their noses up at that $6 billion offer. How much longer before they hit the open market? The scuttle is a valuation north of $15 billion.
Two major things disturb me about all of this.
First, these companies are selling only a very small percentage in the open market. The supply of shares is artificially small relative to the demand. I don’t think this is an accident, either. The owners and underwriters (investment banks) sprinkle a handful of shares into a feeding-frenzy market and sit back while the market assigns the company an insane valuation. The dumb public buys this stuff up and turns a couple of lucky individuals into overnight billionaires. And all the real money is made before the public has a chance to get a piece.
It’s exactly the sort of thing I’d expect here in this environment where those at the tippy-top keep ascending higher while the middle class is stuck in the mud, muttering unintelligibly about how they’re getting screwed once again.
The second thing that disturbs me is that the market for these fresh IPOs is completely unbalanced. The float is small. There’s no options market for these companies yet. And it’s impossible to borrow shares anywhere to sell them short. Investors can only choose to own shares of a company like LinkedIn or choose not to own them. There isn’t any way for short sellers to keep the market honest.
My gut tells me this mini-bubble will be short lived. Though it may end in a whimper instead of a bang. The fact of the matter is that I’m just not properly wired to understand things like this. It’s frustrating. It makes me feel like an uncool dinosaur. What’s a hardcore value guy supposed to do? I just hope none of the eventual wreckage leaks into the rest of the economy. Let the internet hipsters have their fun and let the IB and venture capital guys get another Ferrari.
OK. Rant over.
You guys can go back to sleep now.
Here’s a quick movie review I wrote for IMDB about HBO’s latest movie, Too Big to Fail. Check it out when you get a chance. Watch it right now if you’ve got the totally-awesome HBO GO app.
Too Big to Fail
I’m not kidding.
This is the scariest movie I’ve ever seen. But that’s just me.
As some who works deep in the world of finance and lost sleep with the rest of Wall Street during that dark and disturbing week, it’s possible that I’m a little too close to this story. It hits home. Thankfully, Too Big to Fail opens up a window so that the rest of world can look in from the safety of their living room.
Forget monsters, serial killers, and the nouveau low-budget movement of “two guys in a room with a camera and a ghost.”
This is real. This happened. This could happen again.
You’ll be terrified to see just how close to the brink we came, how close we were to one of the biggest economic disasters in human history. And you’ll be shocked to learn about the types of personalities in which the rest of the planet has invested so much power and authority. Troubling, yes. But it’s an important piece of history as well.
In terms of production HBO knocked this one out of the park. That’s to be expected, I suppose, when you sign one of the great working American directors in Curtis Hanson and use one of the most highly respected chronicles of the financial crisis as your source material. Andrew Ross Sorkin even has a cameo and gets credit as a consulting producer to make sure they got the facts straight.
So it’s no wonder such a brilliant, top shelf cast fell in line. HBO must have had their pick of the litter. The names in this movie are not only eerie facsimiles of their real life counterparts, but these are the actors that can really act.
The ever-dependable William Hurt is admirable in the lead, bring a little humanity to Treasury Secretary Hank Paulson, but it’s the supporting performances that deserve special praise. Billy Crudup boils with intensity as an anxious, f-bomb dropping Tim Geithner, and Paul Giamatti perfectly captures the essence of Ben Bernanke, that quietly authoritative voice that the biggest egos in the world always shut up and listen to. Viewers at home will get a kick out of Ed Asner as Warren Buffett and, as is always the case with Buffett, his folksy charm serves as a bridge into to the arcane world of high finance. And former Lehman Brothers CEO Dick Fuld is appropriately vilified thanks to James Woods, not for being a greedy fraudster, but for being a sadly out-of-touch executive unable to adjust to a world that changed overnight. Despite Fuld’s arrogance and bluster, Woods invests him with a subtle sense of dignity.
Too Big to Fail achieves a rare feat for talky dramas: it sustains acute tension for ninety full minutes, never slowing down and never climaxing prematurely.
Even if you’re not a financial insider or policy wonk you’ll be on the edge of your seat from start to finish.
Just don’t watch it late at night.
- Check out our guest post over at The Entrepreneurs Blog. It’s the story of what our business went through during the crisis.
- There’s a new tech bubble underway! Don’t blink or you’ll miss it. In the meantime, get your portfolio ready to handle some volatility if it’s not currently prepared for it. All of this tech stuff is a fun sideshow. Keep your eye on the QE2 ball and what’s going on over in Europe.
- If you subscribe to HBO, queue up Too Big to Fail. It’s pure dynamite, one of the scariest movies I’ve ever seen.
What happened to all the inflation hawks?
They were getting pretty loud there for a while but now they’ve really quieted down.
Here’s the thing: inflation is starting to heat up a little bit. But just a little bit. It’s not time to panic. Remember, I promised you all long ago that I will let you know as soon as it’s time to panic about The Inflation and today I want to explicitly renew that promise. I will let you know when it’s officially time to panic about The Inflation.
The fact of the matter is that most people already have their minds made up about inflation. They’ve sorted themselves into two camps. They either see the all the QE “money printing”, the rising food & energy prices, and the excitement in gold and are totally convinced — in a dogmatic sense — that inflation is upon us. Or, they’re an economist. Neither camp cares much for the other. It is the classic battle between real people and intellectual elites.
I’m not going to change any minds in this debate. The best I can do is help the ivory tower economists understand that the middle class gets fussy when gas rises over $4/gallon and help the mainstream understand that systemic inflation, the kind of inflation that warrants getting nervous about, is a much more complicated calculation than how much you are paying to fill up your tank.
Despite that it still remains that a lot of people out there are worried that we’ll get a repeat of the 1970′s.
The 1970′s were a scary time.
For a lot of reasons.
Personally, I’m thankful for the 1970′s.
Yes, that was the decade produced yours truly. But it also gave us some of the best and darkest films in American history. Consider: The Godfather, Chinatown, One Flew Over The Cuckoo’s Nest, Apocalypse Now, Taxi Driver, Alien, The Exorcist, Annie Hall, Network, Dog Day Afternoon, The Last Picture Show, All The President’s Men, and A Clockwork Orange. Oh, and Monty Python!
If you fancy yourself a cinephile like myself, that list probably will make you say, “damn!” It’s a good list. But every single one of those movies is disturbing or twisted in one sense or another. I think that really says something about where we were as a society during those years.
Highly-praised, critical darlings aside, the biggest grossing movie of that decade was an allegory about the cold war, global political tensions, and the spread of communism. The second biggest grossing movie was about a shark. That one messed up our psychology in a more tangible way: we literally were afraid to go in the water. Amidst all of this darkness, 1976′s Rocky stands out as a phenomenally unique achievement.
You might wonder why I pay attention to movies and popular culture and I do it because it helps me understand our collective psychology. And collective psychology is one of the big factors that drive investment trends. Economics is simply another branch of the science of human behavior. There’s money to be made here if you know how to link one thing to another.
Anyway, while that decade produced some interesting bits of culture and some hideous fashion, it also created a brand new economic mindset. Up until that point, the big economic fear had always been deflation, a psychological relic from the dark days of Great Depression. But the 70′s changed that. It introduced a completely new kind of pain. The new economic bogeyman was called “Inflation”.
And since then, that’s been our primary economic worry. (Though if you Austrians/Anti-Keynesians want to tell me that our society has become irrationally afraid of the business cycle then I’ll listen.)
Even with the brief deflationary panic of the financial crisis, the fear today still centers on inflation. That’s fine, but when you look at the actual, broad-based data, significant inflation is nowhere to be found. That’s why I call it “The Inflation Chupacabra”. I’m not saying that it couldn’t exist. I was a fan of the X-files too and I want to believe in the supernatural.
Systemic inflation is one of those things like the Chupacabra (or UFOs). It’s a scary story we tell ourselves at night or when we turn on CNBC. A lot of freaked out farmers claim to have seen one, but so far no one has come forward with legitimate proof. Maybe someday someone will. I keep an open mind.
In the meantime, the best we’ve got is a menu of imperfect indicators.
A couple of months ago I started following the Billion Prices Project at MIT. It’s pretty cool. These guys are trying to track inflation in real-time by compiling daily data from a wide range online retailers. Here’s their latest chart which runs through April 24th.
At first glance that image might look a little scary. You’re probably saying, “that’s inflation!!!” Step back from the ledge. Allow me to explain:
- The graph doesn’t include May and May will show a very sharp reversal. Commodities are down big in May with a lot of speculative money sliding to the sidelines.
- Even at the April peak, we’ve only inflated about 2.8% over the last 20 months, well below the historical average.
- Since the days of the financial crisis the Federal Reserve and the U.S. Congress have used every tool at their disposal to kindle some positive inflation. They are trying as hard as they can to make those red and blue lines go up. That tailwind won’t always be there.
In addition to the Billion Prices Project, which is backward-looking like the CPI, there are forward-looking measures of inflation. The TIPS/Treasury spread is still forecasting inflation in the 2-3% range for the next decade. That’s perfectly normal. The Cleveland Fed also keeps some great charts and data on different ways to measure inflation and nothing there is flashing any warning signs yet either.
So for right now, don’t worry. I promise I’ll let you know when it’s time to panic about inflation.
Besides, there’s something else that you should be panicked about instead…
Greece. Remember them?
People in the markets have short memories so you may not recall that last summer was a rather volatile one. Greece sparked some real fear in the credit markets and U.S. stocks dropped 17% in response.
But then Jean-Claude Trichet and the European Central Bank rode to the rescue and bailed Greece out to the tune of about $150 billion. That bailout was worth about half of their total GDP. There’s a chance that the phrase “half of GDP” made you say whatever as your eyes glazed over. Let me put that into perspective for you:
For the U.S., an event of that magnitude would have amounted to — are you sitting down? — a seven trillion dollar bailout.
Imagine what the U.S. would have had to have done to require a bailout of that magnitude. Think about it. What kind of shenanigans would be required to put our country in a hole $7 trillion deeper than it currently is?
TARP was one tenth of the size.
Now you have an idea about what’s been going on in Greece. Now you understand the extent to which their government was abusing the privileges and super-low interest rates one receives from being in the same economic union as Germany. And now you how how much trouble their economy is in. The bailout numbers are big and scary in an absolute sense. But in a relative sense it’s almost impossible to fathom.
Oh yeah, bailouts aren’t free, by the way.
All of this Greek bailout debt is going to have to get renewed next spring.
If the U.S. economy was on the hook for an additional seven trillion dollars of debt, do you think we could honestly pay it back through legitimate means? Do you think there’d be any chance of crawling out from under that without defaulting? What makes you think the Greek economy will?
Now you see why Greece is going to either:
- Get kicked out of the Eurozone, go back to the drachma, and devalue their currency by like 50-70% screwing their bondholders, or
- “Restructure” their debt and impose a 50-70% haircut, screwing their bondholders.
Greek officials would have you believe there is an option #3 which is basically, “yeah we’re gonna raise our taxes and cut our spending and everybody just be cool y’all will get paid back.”
But in the real world there is no #3. Don’t take it from me, listen to the markets. The yield on 2-year Greek bonds is 25%. That’s the market’s way of telling you that Greek officials are full of it.
We’re all in agreement here… but
It’s funny. Everybody agrees about Greece. Everybody’s read the Reinhart & Rogoff book and everybody believes that Greece is pretty much toast. Nobody out there really buys the line from the Greek officials that all this debt will be legitimately paid back. Heck, I doubt the Greek officials spouting that nonsense truly believe it.
But nobody is really talking about how this will affect the market.
The key phrase in that list of options above is “screwing the bondholders.” Those guys are going to get crushed in a default. And who holds Greek debt? Well, a lot of it is held by various European governments and entities like the IMF. But a lot of it is held by European banks.
There exists the possibility of not just one but two nasty cascading effects.
First: if some of this stinky sovereign debt goes bad, then maybe a big European bank has trouble rolling over some of its own paper. Maybe other banks change their minds about lending that guy any money. Maybe banks in general get skittish about loaning each other money. Maybe some of the entities that have insured this dodgy debt come under pressure. Maybe everybody gets panicked about all the money they’ve loaned those insurance guys. It could get ugly.
And second: if Greece defaults in some way, then what will Ireland do? Why should they shackle their economy for the next twenty years when Greece didn’t have to? What will Portugal do? I know how it works. I had a brother when I was growing up. Any time I saw him getting away with something I’d try and do the same exact thing. The Greek problem is bigger than Greece.
Who knows who owns what and what the exact fallout will look like. But listen, in financials crises none of that stuff matters. Everybody goes to the mattresses without thinking.
I know this is a little bit like shouting fire in a crowded theater, but I’m getting really worried by the parallels between Greece and the subprime crisis.
In the financial community, concerns about Greece are starting to get out of control. You wouldn’t guess it from the headlines, which are all about Dominique Strauss-Kahn or Microsoft buying Skype or when that darn Facebook IPO will be so we can finally all get a piece of it. Tuesday on Bloomberg there was a headline about the Yankees losing streak extending to six games.
This is all noise and just beneath all of this noise, everybody is talking about Greece.
Somewhere another countdown clock is ticking.
The Psychology of Inevitable Default
To bring this back to culture & psychology, the attitude in the early days of the subprime crisis was, “ohh, it’s this little section of the market and even if all of this debt which we know is bad does actually go bad then it won’t have that big an impact on the entire system.” This is exactly the same mindset today about Greece and their bailed-out brothers-in-shame, Ireland and Portugal.
Everybody knows the debt is bad but nobody’s concerned about how that inevitability will impact the market. The psychology is really weird. Everybody is simultaneously freaked out and totally lackadaisical. Perhaps this explains some of the volatile, mania/depression that we’ve started to see lately in the market. Everything is hunky dory until one day the world is ending. And then the next day we feel fine. Maybe this is the only way to cope with the knowledge of inevitable pain. We just keep kicking that can and kicking that can and hoping that we’ll figure out how to deal with it some day.
We kicked the can for a while with the subprime crisis. There were lots of signposts on that road too. A couple of major hedge funds blew up. Major banks quietly started writing down stinky paper. One day Bear Stearns’ heart stopped beating but then financial doctors brought the patient back to life and immediately arranged a marriage with JP Morgan. Jamie Dimon became a superstar.
The ultimate problem with Europe right now is the same as the last crisis. It’s a bunch of debt that everybody knows will turn sour and a complete lack of understanding of the second- and third-order effects of the actual souring.
I’m not trying to get all Nouriel Roubini on you here and try and forecast another crisis. I don’t think we’ll see anything like 2008 again for a long while. That’s not to say we’re in the clear and it’s not to say that the market won’t go down. I’m just saying that a financial crisis like that is a once in a lifetime event. (Thank goodness, right?)
But we can absolutely have a mini-crisis like we did last summer. We can absolutely have a couple of months where things look pretty grim and the market pulls back by 20% or so. 20% is a big drawdown. Is your portfolio prepared to handle that?
I was wrong. Wrong, wrong, wrong.
One of our biggest predictions for 2011 was that the dominant economic story would be stress at the municipal level. I never bought into Meredith Whitney’s forecast of widespread default; my concern was that this would be an insidious economic issue. Tightening up state budgets mean state workers get their pensions cut or benefits scaled back, public works projects get cut, and many contracted employees lose their jobs outright. I thought all this harsh middle class sacrifice would create some serious uproar.
Unfortunately, I totally failed to consider the regional nature of the problem. People in New Jersey are pissed. People in Madison are pissed. People in that broke little town in California where their city officials were getting paid hundreds of thousands of dollars for doing nothing are pissed. Just about everybody whose paycheck is in some way dependent on a revenue stream from the state, county, or city is pissed.
These people are getting stuck with real cuts. They have less money to spend. Some of these stories made the evening news, but failed to gain the kind of traction to turn it into a real item of national interest. When it comes down to it the folks in California don’t care about the folks on the Eastern Seaboard. The general nature of their woe is the same, but the details are different.
Anyway, I still think this is an important story and it will move the economic needle. But it will do it under the radar. If we get a recession or an economic stagnation in 2012 perhaps this takes the blame. Perhaps that’s when angry Wisconsonites join together with angry New Jerseyites and the story gets cohesive. But nobody will ever be able to look past the specific details of their own situation and so this will likely remain an item of purely academic attention.
The big story of 2011 is going to be Greece (and Ireland, Portugal). It’s happening right now under the surface and I think the story gets a whole lot bigger as we move through summer and towards the fall. That’s when it could boil to the top.
Exciting news
The other day while brushing my teeth I had a really exciting idea for this newsletter. I plan to roll it out next week. I almost can’t wait and considered launching it right away. But today I’m already bumping up against my self-imposed word limit.
It’ll be a new feature here on the site. I think you guys will really enjoy it. It’s one more thing that most investment newsletters don’t do that most readers want.
- Inflation is heating up a little bit but it’s not time to panic. Don’t worry. We’ll let you know when it’s OK to panic.
- Most of the rising prices in the market are due to all this volatility in the commodities space. I know it’s no consolation as you pay $90 to fill up your SUV with gas, but this kind of thing really is temporary.
- In order for broad based inflation to grab hold, other prices aside from food and energy need to start going up. Most of those “other prices” are wages and housing. Think those are going up? So while there is definitely risk of broad based inflation, I have a hard time believing it really catches hold. Deflation is still a risk, especially if commodities fall apart.
- Greece is becoming an increasingly big concern in the financial community. Everybody knows they won’t make good on their debt but none of the major markets are pricing in the effects of Greece actually defaulting.
Wow — thanks for all the compliments on last week’s newsletter! I know it wasn’t really about investing, but I’m glad that it touched a nerve and resonated with so many readers.
I made up for the lack of market nitty-gritty this week in an article that I did for Seeking Alpha. For legal reasons, I can’t repost that article here on this site. But it’s easy enough to just click here to get it.
In that article I asked the question, “should long-term investors buy or sell this market?” I think I answered the question too, by investigating whether the market is cheap or expensive at these current levels. I looked at a lot of historical data and drew some really neat charts. Seeking Alpha even featured it on their front page and so far it has been one of the most popular articles of the week on their whole site!
But you can be the judge: check it out.
Commodities getting volatile
Volatility made a dramatic comeback in the last week, especially in the commodities markets. Most of you will remember that this was exactly the kind of thing we were nervous about a couple of weeks ago when we discussed some of the things that might happen here as QE2 winds to an end. Commodities getting killed was one of them.
The Reuters/Jefferies CRB index was eviscerated, dropping nearly 10% in a manner of days. The good news is that it bounced off of technical support. The bad news is that commodity prices are still high and there is still a boatload of speculative money in this space right now. If you aren’t prepared for a bumpy ride then it’s time to hurry up and get prepared.
A couple of weeks ago I wrote, “crude oil could be under $100 before you know it.” Honestly, I didn’t think it’d be last Thursday so let’s not get too excited about calling it correctly. Still, it goes to show how much this market can move in either direction when so many of the participants are speculators. Today Nymex crude is at $96.
Gasoline futures dropped $0.25/gallon last Thursday and dropped another $0.25 yesterday but I didn’t hear much celebration. Perhaps because actual gas prices have a strange knack for going up faster than they go down. Hmm. Real folks won’t get any relief until the trend in gasoline futures starts to reverse. And notice how I used the word “until” and not “unless”. I do believe this trend will turn around at some point before this fall. Perhaps it already has.
Dr. Copper — a commodity that a lot of smart investors look to as a forward-looking indicator of industrial demand and growth — has been rolling over in a slower, more disturbing manner:
That could be indication of a little slowdown on the horizon or trouble in China. Copper is an industrial metal and that’s why people look to copper prices to gauge the health of the global industrial economy. Keep your eyes peeled.
The BIG commodity story, however, is silver. Check out this chart:
OUCH!
That, my friends, is what eventually happens to bubble charts. They are fun to ride for a while but they don’t go forever and it’s impossible to guess when they’ll stop.
Here’s a longer term chart that shows that parabolic bubble move in better detail. Though it doesn’t adjust for inflation and isn’t log scale and that’s my preferred way of getting a true read on historical chart trends.
This week we are all laughing, but last week people were actually paying $47.52/oz to buy silver. They were paying that because they thought it was going to $55/oz. Or $100/oz. Nevermind the fact that this commodity was range bound for a long, long time and most of human history before that.
In this industry there is a misconception that gets me a little frustrated. It’s this notion that “silver is a poor man’s gold.” Silver is not gold nor is it even a poor man’s gold. Yes, it is precious metal but silver doesn’t have the history that gold has and it doesn’t have the je ne sais quoi that makes gold gold. That distinction may sound silly and arbitrary, but it isn’t. The magical luster that gold has — that power it has always wielded over us — is why gold is a fundamentally different commodity than silver.
Central banks don’t hold reserves of silver bars the way they do gold. Silver is mostly used for industrial purposes and silverware. Silver has little more intrinsic value as a currency than a bushel of corn or pile of lumber.
The scariest thing about this whole story is the Chicago Mercantile Exchange’s report that one of the reasons why the drop was so large and so fast was due to people trying to get out of the silver ETF (SLV). In fact on a couple of occasions in the last few weeks, trading volume in SLV has surpassed trading volume in the SPY (the super-gigantic S&P 500 ETF).
Throughout the year I’ve written here and there about the predictions we made in January. I make predictions because they are fun and because for whatever reason, people really like to read them. Contrary to what others in the industry might have you believe I can’t actually predict the future.
Anyway, it wasn’t really a prediction, but one of the things I wanted to get on the record about is that these exchange traded funds are moving the markets in strange ways. Most ETFs are OK, but some of these commodity ETFs concern me. I’m not entirely sure how and to what extent the existence of a commodity ETF like SLV is affecting the underlying commodity. I doubt anybody can answer that question with great certainty.
But when silver drops over 30% — it’s worst week in thirty years — I wonder if something new and extraordinary is behind the move. ETFs didn’t exist in 1975 which was the last time silver got slaughtered this badly in a single week. I didn’t exist in 1975 either, but I do know that there’s a new set of rules nowadays. I think these new investment vehicles make it even easier for bubbles to form and pop. This kind of financial innovation facilitates the flow of capital. For better or worse.
Either way, the one thing you can say about these things — here in the modern era of the bubble and the burst — they are truly products for their time.
Speculation continues
It’s a desperate market right now and investors are really struggling to make money in this environment of negative real interest rates. I’ll quote the always-awesome Barry Ritholtz on one of the 10 things to be concerned about right now:
Hot money seems to be rotating from speculation to speculation rather than inflows accumulating longer term holdings.
This makes me nervous in a more general sense. Despite all the bluster about money printing and inflation, I’m not sure there’s anything really special about commodities right now. Silver was just another speculation that hot money chased into and eventually panicked out of. It didn’t matter that it was silver. All that mattered was that it was something traded on an exchange that was rising in value.
If this seems like a bizarre, perverse way to invest, then welcome to the world of hot money. Investors are dying to make money these days. And I’ve noticed them get increasingly more desperate to do so in the last year.
One of the things that I hear from a lot of financial advisors nowadays is that their clients are coming to them and saying, “look, I need to make money. Can you help me?” These are the same people who in 2008 were saying, “please, make the losses stop. I don’t care, just sell everything.”
If you need to make money and aren’t prepared to lose half of it in an equity bear market or a third of it in one week like what happened in silver, then it’s probably best to look elsewhere.
The Traps We Set
There is no trap so deadly as the trap you set for yourself
- Raymond Chandler, The Long Goodbye
One of the coolest characters in all of film and literature is Philip Marlowe. He’s the original American private dick, the hard-boiled template on which just about every fictional detective of the 20th century is based. He smokes, drinks, lives alone, wears sharp suits, and isn’t afraid to say anything to anybody or hit a man if he’s talking out of line. He’s also intelligent and well-read, ferociously loyal to his clients, and champion of the damsel in distress though perennial victim of the femme fatale. He was immortalized on screen by greats such as Humphrey Bogart, Robert Mitchum, and Elliott Gould, and inspired everything from Jake Gittes to Magnum PI.
One of the things that makes Marlowe so exciting to watch is that he understands basic human psychology. He understands the flaws of himself and those that turn to him for help. And it’s the reason why he’s so damn good at his job.
Yes, investing is about numbers and dollars and ratios and charts. These are the things they teach you in school when you check the “Economics” box as your major.
But investing is also about human behavior. Psychology is the kind of thing that data-wonks give short shrift to and it’s part of the reason why someone with such a comprehensive knowledge of market fundamentals can be such a lousy investor. Jim Cramer is the textbook example. There is no debating the brilliance of his mind and his knowledge of stocks is as broad as anybody in the world. But his actual track record as an investor is terrible.
Why?
The problem is that most investors set themselves up to fail. Humans just aren’t properly wired to be good investors. They’re too emotional.
In some sense they are aware of this, yet they set that trap for themselves anyway. And it’s a deadly one. They make investment decisions that are destined to damage them down the road.
James Altucher wrote about this a couple weeks ago in his blog. I totally agree. Investors should really think twice before buying stocks. Take it from an industry insider and manager of hedge funds: we have tools and knowledge that you guys don’t. Sometimes the guy at home with a Schwab account gets lucky, but over the long run it’s the professionals that typically win. Sorry about that. We just spend more time (and money) working on it.
This is why I council everyone, especially those who don’t have the time or desire to really work at it, to engage the services of a registered financial professional. I do think it’s possible for the investor at home to do OK. But the solution requires changing the rules of the game. He has to play the game on his terms not the market’s. And that requires a deep knowledge of self. He has to truly understand how risk works and the types of emotions he feels while responding to it. He has to be comfortable being honest with himself. He has to know, for sure, whether he is or is not a greedy bastard.
Basically, he has to be Philip Marlowe.
I’ve found that those individuals who go through that process of self-discovery — those that can be honest with themselves and truly understand their weaknesses and flaws — wind up making different types of investment decisions. And generally speaking, these decisions help them get better results over the long run. But it’s different for everybody.
To Cramer’s credit, he figured out how to reap the benefits of his knowledge of self. He’s a master showman and entertainer and this is why shut down his hedge fund for a career on television. It’s tough to run a good fund when you’re bipolar — impossible, actually, as Todd Harrison wrote about in his memoirs of trading beside Cramer. But TV is a different story. Cramer’s swingy personality thrives in front of a camera and it’s made him much more money than managing money ever would.
Philip Marlowe wasn’t interested in money. But he’d probably approve of Cramer and see right through the facade the rest of us watch on TV.
What to do about it
Those of you who have been following along here for a while know that this is one of our ongoing projects.
This week, try the following exercise:
Think back to 2008. Remember 2008? The financial world was falling apart and threatening to take the rest of planet down with it.
That was Hank Paulson got up and begged Congress to pass TARP. Remember TARP? Ahhh… good times.
How were you feeling in 2008?
How was your investment portfolio positioned in 2008?
If you were nervous, why were you nervous? What exactly were you afraid of? Losing all your money? Your bank getting shut down? Being forced to work instead of retire? Losing your job? The answer will be slightly different for each one of you.
Now that you’ve summoned all of those wonderfully awful emotions, think about what would have prevented those feelings in the first place. Maybe it was not having so much money invested in the market? Or maybe it was not owning a house that you reeeally stretched to buy? Maybe it was not having too much debt? Again, it’ll be different for each of you.
Take that experience and those actual feelings and merge it with the things you could have done to prevent it. There’s a lesson there. Learn it.
If you were losing sleep in 2008 because you were trading penny stocks on margin, then don’t trade penny stocks on margin anymore. If you were panicked because you had 90% of your money in equities, then bring that number way down. Even if the environment is good. The other lesson you should have learned in the last decade is that these nasty environments can be on you before you know it.
There’s a chance that perhaps you were really excited and feeling groovy in 2008. If that’s the case, rock on. So long as you haven’t lost your head in the last year or two, keep right on doing what you’re doing.
Pat yourself on the back if it’s still working for you today.
It was my second day of work.
I graduated from UCLA that June and received an offer to be a commodities broker.
My first day at my first real job was Monday September 10th, 2001. I had a few hours of the old ways and then it all turned upside down on my second day.
I didn’t know it as it was all happening — none of us really did; we were all in shock — but that one day would shape the trajectory of the rest of my life. It would steer the actions of my country and it would set the tone for the financial industry I was falling in love with.
It was the dawn of uncertainty.
Like everybody else in the world, 9/11 is permanently seared into the flank of my psyche. I first heard of the attack on the radio on my drive in to work. They weren’t even sure it was an attack at that point. My mom called. We each said we were OK. Ground zero was 3,000 miles away, but still. The news was on at the office and we all stared at the tiny screen, dumb and insignificant bags of flesh in a heartless galaxy of indifference. The markets weren’t open yet and wouldn’t for days. The Boss came out and asked all of the senior brokers into the conference room. The rest of us felt safe. They were putting together a plan. We would all be OK. They were putting together a plan.
When he came out, I can still hear The Boss saying, “…if you need to take a day, go ahead and take a day.”
And I can still see the reaction. Every female broker walked to their car and drove home. Every male broker stayed, huddled around that television set. For ten years I’ve been trying to figure out what that meant. I don’t know. I never will. It probably doesn’t mean anything.
I don’t remember if I slept that night.
Kept calm…
The initial shock didn’t last forever and once it wore off we all got back to the one thing we knew how to do: work.
I had a lot of calls to make. Cold calls. That’s what you do when you’re a junior broker. You don’t have clients and you have to get clients from somewhere and back then the most efficient way to do it was pick up the phone.
I could make more calls than anybody in the office. We’d get a call sheet every week that showed how many calls each broker made and his average time on the phone and my name was always at the top. I was in the office before most of the senior brokers and I would practice my pitches on the drive home. I knew every trick in the book to get past a secretary.
None of that mattered because I was learning my first post-9/11 lesson: I was a lousy salesman and couldn’t develop a lead or close a deal for the life of me. For better or worse, a fat commission was not motivation enough. That was another good lesson in self-discovery.
Man, that was a hard life. It was a scary time. Markets were crashing. We were in recession. Airports were scrambling to implement new policies and procedures to keep us all safe in the air (and on the ground). Nobody wanted to invest. Everybody just wanted to lock their doors and watch CNN. I got told “no” five hundred times a day for six months.
I was 21 years old. All I’d known in my life was success. One of the best GPAs at my high school. A letter jacket plastered with geeky stuff like Academic Olympics, chess club, and perfect attendance. Graduation from one of the top universities in the country. Ahead of schedule, no less, with a hyper-competitive major and demanding minor.
Kids like me had been told all of our lives that we would go on and accomplish great things and win all the games and make lots of money and naturally, we all assumed that this would start right away. I don’t think I was really equipped to deal with failure. After an entire youth of success I was failing miserably. Sure, I was failing because of the lousy environment. But I was also failing because of my own shortcomings. I lacked many things, and fortunately one of them was a capacity for self-delusion. I couldn’t lie to myself and the responsibility stung.
So I made peace with it.
…and carried on.
In retrospect, it was probably the best experience I could have had. If you have faith in some sort of Divine it’s the kind of event you would ascribe deep meaning to. It all happened for a reason; I am sure of that. In an incredibly short span of time I learned volumes about myself, the working world, everyday people, life, money, peace, and the financial industry. In retrospect, it was a pretty good trade for all of that failure. I’d make that deal again in a heartbeat. Failure wasn’t so bad after all.
Thank goodness for that lesson too, because all I’ve really done in the last decade is fail. I failed as a commodities broker. I failed as a corporate drone, unable to fit my spiky-shaped peg in their tidy square box. I failed to live up to the potential I promised in my youth. I fail daily as a husband and father. I tried playing online Scrabble once. I’m half decent at Scrabble and know how to work all the obscure 2-letter words. But, wow. Talk about epic fail.
So what.
I could probably blame Osama bin Laden for all of this. My life was filled with nothing but success until his stupid minions crashed a plane into New York City and upended the world and re-wrote American psychology in a single stroke. But what good would blame do?
I wouldn’t give up this last decade for anything. As a naive kid with an inflated sense of self worth, the one thing in the world I needed most was a reality check. Back then I was afraid to fail. I thought the world would stop loving me and deny me the approval I so desperately craved. Today I couldn’t possibly care any less about those things.
Today my philosophy on life can be summarized by this tidy list. One of our investors sent me that. I wish I had that list ten years ago and didn’t have to go through the hassle of figuring all that stuff out for myself. That’s what a decade of failure taught me. I learned things the hard way but I learned them well.
Had my life taken a different path between college and here, had I been handed a cushy, high-paying job with a big bank or made sufficient bucks at a tech startup and spent my nights hanging out with well-dressed, attractive people like these, I’d probably take myself a little more seriously. I’m not sure I’d be able to get up here in front of thousands of people and embarrass myself on a weekly basis. Writing a public newsletter is not for the thin of skin nor for those sensitive to failure and judgment.
A lot of my cohorts at UCLA went the cushy route. A lot. Some went to Wall Street and brought that broken psychology of entitlement with them. It took them 8 years but in 2008 they were finally taught their lesson. Given what I’ve seen in this industry since then, I’m not entirely sure the lesson stuck. Oh well.
I’m thankful for my failures. Without them, you and I would never be friends. I might judge my colleagues by the kind of car they drive or the brand of refrigerator in their kitchen instead of the quality of work they produce. I’d probably be too good to eat Tuna Helper. I’m not ashamed to admit it, I like Tuna Helper. Tuna Helper makes me feel good for two reasons: it’s full of butter and it didn’t cost me very much.
What’s wrong with that?
The Dragon & The Garden
As I reflect on my life now and my life back then, that memory of all the senior brokers going into the conference room hangs with me. On that fateful day I was just a kid. I would be protected by the guardians all around me. The guys in the office were going to make everything OK.
Should something like 9/11 happen again — and deep down, who among us isn’t expecting something — then I will be the guardian. My daughter will look to me for safety and reassurance. So will my clients. So will some of you readers.
I can handle that. This is what I have to show for all of my failure. It isn’t tangible but it’s the most valuable thing I own.
My guess is that all of you readers feel this way too. We have this in common, you and I, especially those of you who matured as professionals in the last decade. In fact, maybe this is denominator that our incredibly-diverse readership shares. In one way or another: we are the people that others look to when it gets dark outside.
We are the guardians.
Contrary to popular belief, our origin of “The Draconian” is actually mythological. Zeus’s wife Hera had a spectacular orchard full of golden apples and the two set a band of blissful nymphs to watch over it. But the nymphs were weak and sometimes they ate the golden fruit for themselves. So Hera summoned Ladon, a fierce and ugly dragon with a hundred heads. The dragon never slept and kept a constant vigil over the garden. He did the thankless work and kept the garden safe.
Surviving a post 9/11 world
This has been the dawn of uncertainty. The age of the black swan.
This is the era where everything is just fine. Until one day it’s not.
We go to work on Monday. We laugh with our coworkers. We call our clients and adjust our spreadsheets. We eat a sandwich for lunch and talk about fantasy baseball. We go home and kiss our wives and daughters and sleep soundly on soft mattresses. Sometimes we dream.
We come into the office on Tuesday and our country is under attack. A Flash Crash drowns the market in a sea of blood. Gas prices are a dime higher than they were last week. Enron is revealed to have been a fraud. The dot-com stock your 401(k) bought no longer has value. Your home is the worst investment you ever made. Lehman Brothers fails and credit markets around the world collectively seize in an instant, locking businesses who rely on that sort of thing, which is pretty much everybody, out in a cold, deflationary winter.
Suddenly, you’ve been laid off.
Volatility and surprise have always been themes of our country and the markets. But, I would argue, not like this. Not like this last decade.
It is a bipolar, boom-bust world. Forget investing to make money — how does one simply not go insane in a decade like this?
It’s a really difficult psychology to deal with, this latent fear that at any moment the rug will get tugged out from under you. We tell ourselves lies every day to shield ourselves from these stark truths. We pray that the bubble we know is bunk will last just one more day. And then one more.
The guy that started all of this is now dead. Bookended by his ascension and decline is one of the most dramatic decades in American history.
Are we in the clear from here?
God, I hope so.
But I know better. This is the unfortunate lesson of having lived as a man through the last decade. I know that it’s OK to hope and I know that there are times when it’s the only the we can do. But I learned my lesson. I know how the age of uncertainty works and will not be fooled.
Our job is to keep the garden safe. You and me. It is thankless, round-the-clock work. We are wrong every day and every day we are tempted. Then one Tuesday morning we are unfortunately correct and the garden comes under attack and the nymphs look to us for strength, feeling, for a fleeting moment, glad that we are there before forgetting all about us as blissful creatures often do.
There will be volatility and there will be failure. But we don’t take it personally. We learn and grow stronger. We cannot allow the garden to be destroyed and we are the ones who understand the cost of protecting it.
The rest of the world dances. Let them.
This brings us joy.
- If you felt too much pain or lost sleep in the dot-com bust, real estate crash, or financial crisis, make sure your investment portfolio is now structured in such a way to ride through additional volatility. There is more of it ahead.
- Learn from your failures.
- Go home and hug your family. Tell your friends you love them. They are the reason why you do what you do.
- Thanks for reading. I promise we’ll get to more investment nitty-gritty next week.
