The Coming Collapse

Given the path we are on (high levels of debt, unsustainable deficits and the promise of massive unfunded future liabilities), it is not a matter of if, but when, the current structures and institutions that comprise the existing international monetary system (actually that is bit of a misnomer because there is no actual system, but a loose assortment of institutions, rules and accepted norms) collapse under the weight of their own imbalances and corruptions.

2008 was a shot across the bow, but it doesn't look as though we are paying heed to the warning. As such, in the absence of courageous change and honest leadership, we are still on a path to reckoning. You can pay the piper now, or pay the piper later (with interest). That is the choice when you stretch beyond the laws of economics.

But let me be clear. It is not likely to be a collapse in a catastrophic sense. Rather it is likely to be over a long period, punctuated by short periods of crisis, and with the consequent dismantling of whatever structure, institution or norm is ailing us at that particular point in time.

We will awake at some point in the future, and in looking back, will see that all the institutions, structures, rules, and norms that guided us, have been replaced by a new set of rules, structures, and institutions.

A phrase that really irks me

It irks me when people refer to hedge funds as a catch-all.

There is the hedge fund as a distinct legal entity in some offshore haven - a really bad investment vehicle for investors in my opinion (high fees, lock-ins, side pockets, minimal transparency, and limited regulation...need I say more).

There are also hedge fund-type investment strategies - these usually differ from the traditional mutual fund-type strategies by incorporating such other investing elements as leverage, shorting, futures, options, other derivatives, alternative assets, greater theme orientation (event driven, global macro, etc.), etc..

There is also the euphemistic use of the phrase hedge fund to describe the actors behind the markets machinations. In the absence of anymore Long Term Capital Managements, it is most likely that the "hedge funds" implied by this use are probably large bank prop desks.

As with most industries, power is concentrated, with 80% of the assets residing in 10% of the hedge funds (industry has roughly $2 trillion in assets, spread among 5000 odd hedge funds).

Roger Hodgson & Supertramp

Came across a blog the other day talking about songs that make life worth living and the guy there referenced a couple of Dan Fogelberg songs and a bunch of Supertramp songs.

Now I love Supertramp and grew up listening to my brother listening to Supertramp (as he made tapes from Casey Kasem and the American Top 40 off the radio), but I have a hard time hearing lyrics and it is usually the sounds and choruses that I identify with. When I went back and revisited some of those songs, I was taken aback by their spiritual depth and philosophical speculations (from some so young), and it also provided greater perspective on their other songs. And so I looked up Supertramp on Wikipedia and that led me to Roger Hodgson and a desire to find out more about the guy behind many of the songs and the music.

A good time of personal introspection.

P.S. The songs mentioned were lessor known signatures: Fools Overture, Even in the Quietest Moments and Lord, Is it Mine (look 'em up on YouTube). I pretty much like most of Supertramps stuff and think Crime of the Century is one of the greatest albums ever (but I need to get Breakfast in America).

The Key to 2010

Q. Will we go up by more than 10%, or down by more than 10% from current levels in 2010? Ans. Yes.

The key to having a really good 2010 will be picking which comes first. I'm pretty sure both will happen, but if you get the call right it can make for a much more enjoyable year. Despite my skeptical bias on the longer term outlook, it seems to me that the odds are stacked toward an upward move of 10% first.

Reasons supporting that contention: growing confidence in the economic recovery; increasing signs of an economic recovery; current market trends and momentum are supportive; investors coming out of their bunkers; cash at 0%; big money is positive; still large amount of skepticism and risk aversion (sentiment is supportive); continuation of the carry trade; the optimism of entering a new year and a new decade; ongoing relief that catastrophe has been averted; the scramble to get back in; the confirmation bias; recent market consolidation sets us up for the next move higher.

Factors mitigating that contention: market needs a break after a 65% bounce; the psyche is fragile; signs of reversal in the trend; investors pulling in their wings and putting money in the bank after a good 2009; focus moving to fiscal/monetary exits and outstanding systemic risk factors; growing risk aversion; a crowded reflation/carry trade; increasing doubt in the sustainability of the recovery.

I Want to Repent of My Sins

I want to repent of my sins, but I am not sure it will change who I am.

The main sin I want to repent of, is the sin of tardiness. Or, more specifically, the sin of being too slow in changing my opinion. I have this nasty tendency of being way too slow in adopting a new outlook. It means that I am late to the party, and therefore miss a decent portion of the fun. It also often means, that I am so slow in changing my opinion/outlook, that I am actually ahead of the consensus. As such this tendency plays havoc with my convictions, but it also plays into my contrarian nature.

The biggest issue I deal with when considering a change in opinion/outlook is the fear of regret due to anchoring. Regret that I'll change my outlook just as the consensus comes around to my position.

All of which is to say, that I am currently doing my next year review and am seeing a lot of things pointing to a more constructive environment than where I am presently at.

This is serious

The stunning rise of gold over the past 8 years is serious. It is signaling an end to the existing monetary and economic order. Now that might be quite some time away, but it's rise reflects concern over the value of paper currencies.

I have completely missed this run-up. I am a market child of the 90s. By the time I entered the industry, gold had already been falling for 10 years and had another ten years to fall. My first boss was a persecuted goldbug from Switzerland. He had sailed to New Zealand on a yacht and decided to stay and play in the newly deregulated financial markets (nothing like cowboy markets to attract punters). I took a look at gold at the time and dismissed it for the same reason Warren Buffett dismisses it (as a quaint historical artifact with limited intrinsic, and economic value). To add insult to injury, the case for gold was often being touted by "the end is nigh" folks on the fringe. Their arguments were reasonable, but in order for their predictions to come to pass, massive social and economic upheaval must occur. A collapse of the fiat monetary system couldn't happen! Could it? The longer gold underperformed, the further it fell from favor. Alas, if only I had listened to those prophets from the wilderness (aka the Austrians) and taken a little gold on board (just for insurance sake).

But, as with most things in the markets. There is nothing new under the sun. What comes around, goes around, and it is presently the time for gold to shine.

Hopefully I've learned a lesson here. But I wouldn 't count on it (can you say hard headed). I still don't buy the economic argument for gold, and don't see why gold, as compared to many other goods, is "the chosen" store of value. But what I think doesn't matter. It is what the market thinks, that matters. And gold is definitely the asset du jour.

Complacency and Comfort

My sense is that there is a growing feeling of complacency and comfort among market participants with the market's level and rise.

The previous pushback associated with the market's historic rise (both speed and magnitude), has increasingly been lulled to sleep by a certain familiarity and increasing comfort with present levels.

This is dangerous for the simple reason that when you put your guard down, you are more susceptible to a negative surprise. But it is also paradoxical because the more you have your guard up, the greater the chance the market goes higher - climbing the wall of worry is all about drawing the skeptical in from the sidelines.

The Cash Dilemma

What do you do as an investor if you have cash sitting in the bank gathering dust, the markets are running, and you see inflation in the outlook?

What do you do if you are a corporate with cash burning a hole in the balance sheet, shareholders demanding a return on investment, and you see inflation in the outlook?

You deploy your cash.

ZIRP forces cash from the sidelines into the market, almost irrespective of the fundamental outlook.

Investors are scarred and highly skeptical of the markets, and are not surprisingly reluctant to leave those sidelines. But many have no option. That cash is slowly but surely getting squeezed back into the markets.

What happens if/when that cash is redeployed and the market fesses up to reality? A potential disaster waiting to happen.

Tiger! Tiger! Tiger!

Quite apart from the media frenzy over the car crash, salacious revelations, and gross invasions of privacy (sadly, a grotesque reflection of our modern culture).

What were you thinking!

Eliot Spitzer (and every other high powered guy messing around with flouzies) comes to mind.

What are these guys thinking? I'm not sure I want to go there.

It isn't the first time, and it sure won't be the last. I don't really think anyone is surprised. Just disappointed. There are plenty of high powered folks who have led lives of honesty, integrity and fidelity. That does not mean they are perfect, only that their weaknesses and indiscretions are "normal."

Dead Man Walking

Globalization v 1.0.

Disaster exhibit no. 1: Japan

Cause: selfishness

I don't think we're at the point of no return (even in Japan), but the "writing is on the wall" for the developed nations of the world. They have lived beyond their means for too long, have made too many promises they are unlikely to deliver on, and are currently bailing as fast as they can to avert the piper. Unsustainable debt levels, unrealistic standard of living expectations, too many unfunded future promises, the need for massive infrastructure investment (water, power, transportation, alternative energy, carbon reduction), a failure of political leadership, the changing balance of global wealth, rising taxes/interest rates, and the demon of demographics are all leading us closer to a point of no return. The developed nations of the world are on notice. Now if they and the current system go down, then the developing nations will also suffer correspondingly (but because they are coming off much lower bases, their recovery will be faster and greater).

The ultimate result will be a reordering of global and domestic institutions (legal structures, governance structures, political structures, financial structures, economic structures, security structures, labor structures). China will experience a very severe recession (it is a 10 year bubble waiting to burst), but will arise stronger. India takes advantage to play catch-up.

Time frame: anywhere between 5-30 years.

P.S. Life will go on. People will work and play, love and enjoy life. New technologies will enhance our lives. For most, we will only cursorily be effected by these monumental shifts. I would also add that this doesn't necessarily imply terrible markets over the whole period. Just as always, there are likely to be periods of significantly positive returns and periods of negative returns in equity markets. The trick will be correctly understanding, interpreting, and navigating the winds of change.

An important article on deflation and hyperinflation

Here is a link to an article I found very useful in describing the relationship between deflation and hyperinflation.

The article is titled, How Deflation Creates Hyperinflation and is by Eric deCarbonnel.

What I found most interesting was the description of how hyperinflation takes hold, and how the accelerating velocity of money signals not animal spirits, but increasingly fearful spirits. We could do with a little increase in the velocity of money right now to unclog the system. But, be careful what you wish for. I doubt that we will undergo hyperinflation here (hyperinflation is generally only associated with failed states), but the possibility of heightened inflation (10%-15%) is not out of the question. Much depends upon the strength, the courage and the independence of the Fed, and its commitment to fight inflation. On the basis described in the article, I would say that Japan is a potential candidate for hyperinflation at some point in the future (although the demon of demographic deflation will serve as a counterweight...much will depend upon whether all those seniors retain their faith in the existing order).

Note: Somewhat strangely I think it could be argued that the American penchant for cynicism toward big government makes it a greater candidate culturally for hyperinflation compared to the more conforming Japanese culture. Only time will tell.

2010 - A Year of Reckoning

2010 figures to be a year of reckoning.

It was the best of times and the worst of times in 2009, but 2010 will be a time of transition, a time of honesty, a reality check. A time where the rubber meets the road. Gains will not be so easy. Cracks in the system are likely to be tested. Risk increases as expectations increase.

Govt's will try and pass the economy back to the private sector, while central banks will try and extract themselves from the market, all the while hoping they don't upset the applecart, or have their bluff called.

Fear and trembling dominated 1Q09, while hope and relief characterized the last half of 2009. Unmitigated reality awaits the market in 2010.

Partying like it's 1999

The market is a little like a drunk heading out and having one last hurrah, before giving it up for good.

Partying like its 1999...except it is 2009 and 2010, the year of reckoning, awaits.