Vigilant Investor

Stephen Roach has another fine piece challenging the accepted wisdom of market experts with regard to the infinite resilience of the U.S. market to handle virtually anything. Roach has commented on excessive complacency among his peers previously. Now he questions if we can expect a clean handoff from U.S. consumer driven activity to one where U.S. businesses step up to the plate with their built up stores of savings, with the result that the economy will continue marching on.

Well, we’ve long questioned if you can call what our economy is doing as “marching on”. After all, U.S consumers have kept the economy just above water since 2001 by taking massive amounts of new debts. As they tighten their pocket books eventually, the hope is that businesses will in turn take over. But why would they? For what reason in an environment with ever increasing capacity, and for a consumer that has spent itself into oblivion?

Your guess is as good as mine, but I’d not be expecting an investment environment like 1990 all over again.

“A speculator puts down a deposit of a few thousand dollars on a house that won’t be built for several months. By the time the house is finished, the market has boosted the value far more than the contract price. So he sells it without ever stepping inside.The question — as the real-estate market cools — is whether it still works like this.”

That’s a clip from an Orlando Sentinel article on one of the hottest flippers markets in Florida, “If Baldwin Park values plummet, we’re all in trouble”.

The analogies are many — from musical chairs, where folks get stuck empty handed when the music stops, to just a good old fashioned Ponzi scheme. Whatever the case, their is a rule of common sense that tells you that when things defy gravity for too long, and too boldly, eventually they must return to earth. Some things just don’t add up.

Where real estate goes, so could go the economy — and probably your portfolios. Learn it and know it.

It is simply amazing that collectivism is so alive and well at the U.N. Central planning will always appeal to busy body types, and it will always waste tremendous resources, while always claiming that, with just a little more money, it’d finally be fixed for good.

UN unveils plan to release untapped wealth of…$7 trillion (and solve the world’s problems at a stroke)

You need to plan around how this type of wild thinking affects the geo-political and global-macro elements, which in turn, can turn your investments into something you never expected.

Consumption Based Policies Drives Savings to Depression-era Lows

Mainstream thought on economics — from Wall Street, to the Fed, and to Washington D.C. — seems to hold the belief that consumption is the best thing for the economy. From that, some even believe that government deficits are good for savings — suggesting that without government, nobody would save (if you can imagine?!?).

Robert Murphy at the Mises site takes that line of thinking to task by pointing out the clear folly of such arguments, but it appears as if that line of solid reasoning has fallen on deaf ears for far, far to long. Of course, we’ve long been pointing out that absent savings, you can’t expect to have recovery.

For what its worth, at least some folks are taking note at the AP. Martin Crutsinger has documented that the U.S. savings rate is the lowest its been since The Great Depression.

That can’t be good. But not if you believe pop-economists. They keep saying, the more we spend, the better it is for the economy.

Ok. There’s not much we can do about that. But there is stuff you could be doing with your portfolio to counter the possible ill side-effects so such obviously flawed thinking. And that starts by learning as much as you can about what the herd is missing.

• Crude Oil Rises on Concern Iran Standoff May Disrupt Supplies
• Silver sets 19-year peak, gold near highs
• Platinum all-time high
• Bankers see volatile markets as Bernanke joins Fed
• China isn’t moving yuan fast enough for the U.S.
• Pension Bombs Go Boom in Bonds; Treasuries Next?
• Survey Shows Doubt on Economy
• Growth pace weakest in three years
• Small Companies Note Pricing Pressures
• Economists predict sliding dollar

This a.m. i came across these two articles within minutes of stting down with a cup of coffee:

• Stocks Soar on Strong Earnings Reports
• Economy slows to drag in final quarter of 2005

Investors certainly are more than willing to shrug off bad news and latch onto good news these days. In the past it was almost as if all news was good news. Who is right? The Gold and Silver bugs, or the return to the bull stock market types? Usually its not both at the same time.

Meanwhile, the complacency of those in the investment industry is most alarming.

Common sense would tell you that you can’t not save and become rich. But that’s just what most so called “economics experts” are telling us is the best thing for the country when they force policies on the economy that push consumption and debt to unprecedented levels. We’ve argued for years that this only reason we averted a deeper recession in 2001, and a long term damaging and unsustainable policy.

If you don’t believe it from us, CNNMoney has affirmed that we have the title as the World’s Worst Savers.

There is a point where one must wonder, when will foreigners decide lending to a country with such a reckless mentality is not such a good idea?

It isn’t that they can’t see the solution, it is that they can’t see the problem.
– G.K. Chesterton

We think that this applies to most of the investment industry, most investors, and most economists and pundits. For a list of the problems, check out our Global Economic Storm Clouds: The Definitive List.

“I’d be a bum on the street with a tin cup if the markets were always efficient.”

– Warren Buffet

At the crux of popular modern investment methodology is modern portfolio theory, which is rooted firmly in the belief that markets are generally too efficient to bother with any sort of investment or allocation timing.

Who do you believe: A bunch of Ph.D.s with a theory, or the Oracle of Omaha, one of the world’s richest and most proven investment minds?

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Government debt may seem like a good idea for the taxpayer who lends money to the government. But does the taxpayer not understand that his own taxes are used to both pay him his bond interest and eventually return his principle? After all, the government has no revenue of its own other than what it takes from the private sector through taxes. As such, a government bond investor is simply getting his interest and his principal taken from his right pocket, and returned to his left!

To put this in perspective — if I borrowed $20 from you and then paid you back by opening your wallet, taking out $20, and handing it back to you.. you’d either think I was joking, or you’d punch me in the nose. For that matter, you’d not feel so good if you bought a bond from, say, Wal-Mart, and in turn, Wal-Mart paid you back interest and principle by raiding your bank account. Imagine the outrage! Imagine the politicians lining up in protest!

But for some reason, if politicians do this very same thing to taxpayers, those taxpayers wave the flag, feel patriotic, and talk about what a great nation they have.

Granted, all things being equal, you will be taxed anyway. But that still does not change the reality of the cash-flow behind the “investment”, or the fact that by lending to government, you are enabling governments to continue spending more and more and continue the ruse at an ever larger scale.

For a short and sweet explanation of why government debt is very bad for the U.S. economy as well as the average taxpayer, read Robert Murphy’s Government Debt Has No Upside, posted up by our friends at Mises.org. The article is a winner, and it also explains who the real winners are when it comes to our massive government debt.

U.S. Automakers are facing the reality the rest of the U.S. — especially when it comes to government — has yet to fully acknowledge: Fat and bloated business models don’t work. G.M. we’ve argued has long been the bellwether in this respect, but Ford is not far behind — they’re expected to announced 25,000 job cuts and the closing of 10 U.S. plants.

You can read about Ford’s predicament in an appropriately named article, “‘Black Monday’ looms over Ford’s future.

At least Ford is ultimately forced by the market face the reality of economic gravity. Unlike the Government, it can’t simply raise taxes to cover shortfalls, or for that matter, paper it over with an endless supply of fresh debt either sold into the open market, or financed by printing fresh money out of thin air via the supposedly independent Federal Reserve. Instead, for Ford to survive, it has not choice but to fix its broken model. (Although, with history in mind, there is always the possibility of a Chrysler-like government bailout…)

But readers should not ignore the fact that Ford’s business model (and for that matter, GM’s as well) is only half the equation making it difficult for it to survive. Were Ford and GM the perfect example of efficiency, they’d still be hand-cuffed by the ever more stifling taxes, regulations and other assorted legislated barriers to efficiency enacted over the last 100 years by the U.S. Congress, leaving the United States with only the leanest vestiges of an unobstructed and efficient free market. Although, with their vast resources, Ford and GM are still better off than smaller manufacturers that can’t afford to pay for the swarms of tax, regulatory and trade specialists our Congress requires for the privilege of doing such business in the U.S.

With that in mind, the U.S. form of economy is not - contrary to popular misperception - a free market. At best it is a parasitic capitalist economy, where the economy each year is micro-managed more and more by tax laws and a myriad of special interest regulation, each benefiting some connected groups at the expense of others, and especially favoring the mega businesses that have the critical mass to afford what small businesses can’t: experts to navigate the artificially created complexity.

Because of that, the best anyone should hope for with all the turmoil in the U.S. auto industry is a new GM and Ford more in the image of Wal-Mart. And, when it comes to that model of doing business, don’t forget that it is merely a reaction (and natural progression to efficiency) based on the environment created by the extensive meddling coming out of Congress. The Wal-Mart model is, in the end, still being true to the one and only point of being in business: the win-win proposition of providing something of value to a consumer at the best price possible, resulting in profits to its owners. Never mind what you hear otherwise from collectivists like Paul Krugman.

On that last subject, read our recent post “Maryland’s Punitive Wal-Mart Law Ignores Real Problems“. It knocks down a few popular myths about the Wal-Mart model, and lays the blame for the negatives associated with Wal-Mart squarely at the feet of the near-incompetent architects of our current business environment.

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• Oil Price, Nearing $70, May Rise on Iran, Survey Says
• Currency market wary of Iran
• World economy vulnerable to jittery markets
• Home Equity Extraction Still Hot In Q3, Fueling Shopping Spree
• Lacker says Fed not done yet on raising rates
• U.S. Stocks Drop for Week as Earnings Disappoint
• Ford Motor May Eliminate 25,000 Jobs to Stem Losses
• Dow plunges 213
• Higher Oil Prices Send Shares Tumbling

We’ve talked about what’s going on with Gold for years now, and having been “commenting on it” since it was down at $317 several years ago.

Yesterday it was trading at $558, having zoomed up to just under $540 near the 2005 year end, only to give back to under $500, and then back up again to where it is today — trading at about $555.

So what gives? Is this just the same old relic that most conventional investment advisors tell you has no part in your portfolio? Well, to answer the finer details of that, we encourage you to review our past commentary on the metal of the Gods. And when you are done with that, give a read to Bill Fleckenstein’s recent comments about it in his “Contrarian Chronicles’

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“So far, so good, for an unbalanced world — the sky has yet to fall. And the longer a lopsided global economy continues to chug along with impunity, the more the broad consensus of opinion becomes convinced that this is a sustainable outcome. This increasingly complacent mindset may be about to meet its toughest challenge: A likely turn in the liquidity cycle appears to be on a collision course with ever-widening global imbalances. This could well be a lethal combination that triggers the long-awaited capitulation of the American consumer — heretofore the mainstay of a US-centric world.” – Stephen Roach

Well, that’s a dandy way to start off the latest view from Morgan Stanley’s Chief Global Strategist…

Roach has long been one of the few sober voices among Wall Street opinions in the last few years; he’s been willing to not reflexively dismiss concerns about the U.S. economy. In fact, he’s gone long out of his way to make sure investors are avoiding some pretty big blindspots, just like we do here at Vigilant Investor. Here, we agree that a complacency of massive proportions permeates the investment industry, from top down, on the subject of what we are noting as critical, core structural problems with the U.S. economy. Roach entitles his piece “The Irony of Complacency.”

Complacency about what, you ask?

What core structural problems do we speak of?

Lately we’ve referred folks to our Economic Storm Clouds definitive list. But before you click on that link, we encourage you to read Roach’s very timely dispatch in its entirety, which concludes that the great capitulation to massive global imbalances may be closer than the complacent masses can ever imagine.

Indeed, in the face of it all, folks obsess about the latest comments of Osama Bin Laden, when in reality a very large thread to ou economic stability is right under our own noses.

What on earth is going on with the Tokyo Exchange?

Well, simple enough: it couldn’t handle all the volume. At the core of it was a tech glitch that prevented orders from being matched –amid a dropping market (losing 6% in two days).

Now, how would you feel if you decided it was time to get out of your stock positions ahead of the heard before everyone else panicked, but you couldn’t?

That’s long been a dire warning of extreme bears who see a massive market crash as a realistic possibility. They say that the kind of unbalanced volume you’d experience in a massive sell-off would grind the system to a halt, especially since so much of our markets volume today are bracketed by “programmed trades”, where an arbitrary trigger is hit by the markets and trades are ordered automatically. Massive volumes of sells are programmed to kick in at certain drop points. The more the market drops, the more sells that are ordered, round and round. Bear critics point out that once critical mass is hit, the system becomes very vulnerable.

Well, for years those bears have been marginalized as “kooks” by a mainstream that argues, “in this day and age it can’t happen here”…

Well, they’re still right, but something similar just happened in the world’s second largest stock exchange. And, this was no massive crash where the volume grew to levels those bears thought would be required to sink the system. They were far less.

I can’t say we know exactly what to make of this, but let it suffice to say, its one more item to keep in mind when designing a smart thinking, absolute return focused portfolio.