Vigilant Investor

In today’s New York Times, Ben Stein writes an article pointing out that Goldman Sachs has sold $ billions in Collateralized Mortgage Obligations (C.M.O.’s) — including during a period where current Treasury Secretary Hank Paulson led the firm. In his piece, Mr. Stein also mentions that while Goldman was selling C.M.O.’s – it was also shorting them through index sales.

We don’t agree with Mr. Stein’s belief that the Fed will be able to save the lending day with injections of liquidity – because (among other reasons) we believe the resulting inflation will be painful and destructive. Also, after raising the “Spock Eyebrow” over the nexus between Treasury and one major investment bank – perhaps he should cast the same discerning gaze towards the Fed and it’s true loyalties.

That said, his article certainly poses quite interesting and intelligent questions — which should make any rational person think long and hard. An interesting read, indeed!

Our long–term readers know we have continually cautioned about serious economic consequences to come. Not because we’re “doom and gloomers” – but because we feel the best way to take advantage of the truth – is to first acknowledge it. Our opinion has been that when these truths gain increasing acceptance – the full brunt of their effect will soon to be felt. While those in the mainstream conventional camp have long been in denial over unpleasant, troublesome, displeasing economic facts (i.e. the truth) – things are beginning to change.

In today’s New York Times, Bob Herbert writes an “on the money” op-ed titled, “Recession? What Recession?” In it he describes increasingly looming economic eventualities we have long warned about – and he does not sound optimistic – at all.

We feel the consequences of unhealthy, dysfunctional economic policies will, for the uninformed – and those in stubborn denial – have sadly devastating effects. One being their savings & purchasing power inflated into oblivion. However, for those who acknowledge the truth – and act appropriately — this is a time of incredible opportunity.

The window is closing. The boat is pulling away. There is still time. Are you prepared?

You know, we’re continually amazed as we witness an extremely interesting phenomena. Really amazed. Turn on any evening financial television show and you’ll hear the pundits demagogue on how Treasury Secretary Paulson must defend the Dollar. Bemused, we ask –“with what?” Today, Mr. Paulson accused the Chinese of unfair competition for not letting their currency appreciate. He also intimated that letting the Yuan strengthen would help stave off protectionist sentiment in the U.S.

The Chinese must be shaking in their boots! A debt addicted, debt laden, cheap foreign import dependent U.S. — much of who’s debt is financed by and cheap goods imported from the very same Chinese, effectively threatens said Chinese with protectionism if they don’t let their currency strengthen further. What?!

Common sense tells any rational person that the Chinese hold all the cards – are playing them well – and evidently intend to continue doing so. The Chinese have sat back silently and watched us bleed money (which we’ve had to borrow) — in Iraq. Just yesterday, they announced they will likely follow supermodel Gisele Bundchen – and begin to divest themselves of the rapidly depreciating Dollars they are awash in. Will they buy Gold? Silver? Agriculture? Oil? Corporations? We think all of the above – and more. China dumping Dollars is bad for the U.S. Soon the world will follow – and a nation addicted to debt will have to raise interest rates to continue to borrow. The last thing any person, business, or country severely in debt wants is the cost of their debt service rising.

And if the Yuan does strengthen dramatically, the cost of Chinese imports will rise correspondingly. What do you think that will do to the price of goods at Wal-Mart, Target, et al? How will paycheck-to-paycheck mainstream America handle that? We think not well.

An ancient Chinese curse states, “May you live in interesting times.” Well this is going to be interesting.

Protect yourself accordingly.

NASA chief, Michael Griffin, raised the hackles of the Global Warming Industrial Complex recently during an NPR interview by declaring pointedly, “I have no doubt that global — that a trend of global warming exists… I am not sure that it is fair to say that is a problem we must wrestle with.” Continued Griffin, “I guess I would ask which human beings, where and when, are to be accorded the privilege of deciding that this particular climate that we have right here today, right now, is the best climate for all other human beings. I think that’s a rather arrogant position for people to take.”

Well, now he’s back peddling some — very much under pressure from politicians looking to lead the parade to the pocket books of their largest donors, or as in the case of the global one-worlders — to lead the world’s economies to the control of the U.N. or some other global society of Utopian planning. Naturally, the hyper-green environmental crowd is up in arms as well.

At the time, of his initial comments, critics rushed to condemn Griffin as “totally clueless”, as a “deep anti-global warming ideologue,” and that his comments showed “arrogance and ignorance” given the presumption that millions will be harmed by global warming. We are reminded of Carl Sagan’s advice on using the “scientific baloney detector”, where one of the surest signs of baloney is “reducto ad hominum” arguments. Even the Bush administration distanced itself, desperate as it is to appear friendly on some popular (even if badly misunderstood) issue with its recent G-8 overtures. All we can encourage is for readers to beware of possible distortions and intimidations from the self-promoting Groupthinkniks looking to squelch debate, or the politically desperate — as aware as the bandwagon types are of the potential for influence from Big Energy interests.

Of course, regular readers of V.I. familiar with our Global Warming Series know that Griffin is hardly alone, and that there is a ideological rush to legislate on this issue, much at the expense of genuine debate given there is only an asserted predominance of opinion on the subject rather than a real one.

Griffin now admits he made a mistake by making his personal opinions public (gee: crime of crimes?!?), but not as a capitulation on the issue. Says Griffin, “unfortunately, this is an issue which has become far more political than technical, and it would have been well for me to have stayed out of it.”

Sadly, that’s just the kind of effect the demagoguing / rush to legislation crowd wants.

“We are now taught to believe that legerdemain tricks upon paper can produce as solid wealth as hard labor in the earth. It is vain for common sense to urge that nothing can produce but nothing; that it is an idle dream to believe in a philosopher’s stone which is to turn everything into gold, and to redeem man from the original sentence of his Maker, ‘in the sweat of his brow shall he eat his bread.”
–Thomas Jefferson

We recently described the current phenomena of the U.S. consumer ramping up borrowing from the lender of last resort – the credit card companies. Last week, MasterCard announced profits jumping 70% for the first quarter. Now the reason seems apparent. On May 7, the Fed released their latest Consumer Credit statistics. Total Consumer Credit in March rose $13.5 Billion – a significant increase from February’s $5.6 Billion rise. Effectively, in one month, Total Consumer Credit rose from an annual rate of 2.8% to 6.7%. What’s far more alarming is the increase in Revolving Consumer Credit, which jumped from an annual pace of 2.9% in February – to 9.2% in March.

This week we also learn that economists are forecasting slower consumer spending. Based on the above statistics alone – that’s quite a logical statement – and something we’ve been warning about as inevitable, for a long time. Not surprisingly, we learn today that Toyota is forecasting it’s slowest growth in a decade largely due to weakening American demand.

The consumer is getting tapped out.

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“Everything moves in cycles, so twice a century the ocean lets us know just how small we really are. A storm comes out of Antarctica, tearing up the Pacific, and it sends a huge swell north 2,000 miles. And when it hits Bells Beach it’ll turn into the biggest surf this planet has ever seen, and I will be there.”

–Bodhi (Patrick Swayze) in Point Break

Yeah, Bodhi dude — you were there, just a little too long.

Checking the latest economic headlines, we see news such as sales of previously owned homes in the U.S. retreating to the lowest levels since 2003; consumer confidence dropping; the U.S. economy expanding at the slowest pace in 4 years; the Dollar plummeting to an all-time low against the Euro; sub-prime bondholders potentially losing $75 billion; homebuilder confidence dropping as profits slide; first quarter foreclosures doubling from one year prior; a weaker economy as inflation picks up, etc., etc.

And therefore, quite logically – stocks continue to rise, with the Dow closing above 13,000 for the first time ever!

An objective observer would have to ask, “Are the financial markets going nuts?!” The rational answer would seem to be “yes” – and we’d be the first to tell you that markets cannot continue to go through the roof forever in the face of lousy economic news. However, there is a logical reason for all of this. You have to keep reminding yourself of one thing — that you are witnessing the powerful pricing effect of record levels of liquidity on everything, including the current financial markets. It’s nothing new. The stock bubble of the 1990’s, and the subsequent real estate bubble over the past several years were beneficiaries of the same massively expanding money supply. During the current market run-up, equities continue to surf the same liquidity wave. And right now, nobody is complaining

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“Praecesserat per multos dies tremor terrae, minus formidolosus quia Campaniae solitus. (For several days before, the earth had been shaken, but this fact did not cause fear because this was a feature commonly observed in Campania).”

— Pliny the Younger — describing events preceding the cataclysmic eruption of Mt. Vesuvius in 79 A.D. which utterly destroyed the cities (and inhabitants) of Pompeii and Herculaneum.

Today, the metropolitan area of the Bay of Naples is packed full of millions of people (all presumably who can read) in the shadow of the still active Vesuvius. In the meantime, experts clearly state that current evacuation plans would fall woefully short when the volcano has another major eruption. This is particularly disturbing since recent discoveries show Vesuvius had an eruption (the Avellino Catastrophe) 4000 years ago, which was far more violent than that which destroyed Pompeii. The Avellino eruption destroyed a swath of territory including the area which encompasses present day Naples. It made the entire region uninhabitable for centuries.

Evidence also indicates that Vesuvius erupts violently every 2000 years or so. This includes Avellino 4000 years ago. Pompeii — 2000 years after that. 2000 years later – well, that’s now. Actually, statistical tests indicate a 50% chance that Vesuvius will have a major eruption this year – with the probability increasing every year after that.

History is rife with examples of serious (and obvious) warning signs of catastrophic events being ignored – the tremors before Pompeii’s destruction being one of the best known. We ask ourselves – what is it about human nature that causes individuals to dismiss advance warnings, which could prevent experiencing so much anguish? Why do animals listen to their basic instincts – yet “advanced” human beings often override their own (almost always regrettably so)? Why does it seem, the more “intelligent” a being is – the greater it’s ability to go into denial about impending events?

While the reasons for this phenomenon may be complex – we’ll call it the “Pompeii Principle.” It has many parallels, and can most certainly be applied to financial markets and the economy today. Like magma as it builds greater pressure over time while it moves closer to the earth’s surface – the excesses and imbalances in today’s economy and financial markets grow increasingly, grossly distorted. Record U.S. trade & budget deficits; record household & consumer debt; record/massive growth of money supply; plummeting savings; and the housing bubble all factor into the mix. Today, total credit market debt now exceeds 300% of U.S. GDP – a level only rivaled (but not surpassed) by that at the start of the Great Depression. (That’s an eye-popper)!

All rationalized away by the mainstream.

If an event like the Great Depression represents an economic Avellino, or Pompeii – would it not be wise to pay attention to the mounting pressure building beneath our very feet today? We think so. Wise also to not ignore the recent tremors caused by sub-prime lending and housing, along with the 416-point drop in the Dow on February 27th.

If things continue down the same path, something’s gotta blow – and as in Pompeii, it won’t pay to dilly-dally in the Forum.

Occasionally we depart from the finance theme of Vigilant Investor when we find something that meaningfully encourages vigilance on other levels.

Today’s departure: the national sport of ridiculing those who are arguably suffering serious problems.

With the recent crash and burn of Anna Nicole Smith, and today’s confirmation that Britney Spears has entered rehab - yes, her regrettable behavior was the meltdown many of us suspected - perhaps society ought to look in the mirror a touch and question just why so many of us delight so much in ridiculing others when common sense tells us they are desperate and/or falling apart. Why must we be so voyeuristic to demand every detail about others when it is very likely that, with such ripping scrutiny and paparazzi documentation of every second of our lives, we’d be crushed, ourselves? What does it say about the void of compassion an lack of empathy among so many media consumers who make such “sport” a hundred million dollar industry? How thin is the veneer between our culture and that of the Roman Coliseum and bread and circus?

Here’s a link to the sobering and very prescient comments made by CBS’s Late Late Show host, Craig Ferguson, on Monday night. Kudos to Craig for saying what so many observers think.

Please hear Craig out, and then pass it along as if Britney and Anna Nicole are your daughters or sisters.

We are alternative media. You may as well understand the revolution that is taking place — change is why we’re here, so here’s an excellent piece that explains Web 2.0 (the revolution) in under 5 minutes. If you are an entrepreneur like many of our readers, you’d do well to understand it yourself.

Kudos to the effective ad guys over at IdeaMill for keying us in.

Also, don’t forget to be leery of those who think the internet media is too unrestrained to be allowed for opinion, political or otherwise. Watch out for restrictions to political speech. As Plato asks in the Republic, “Quis custodiet ipsos custodes?”: “Who shall watch the watchers/ protect us against the protectors? Web 2.0 is the answer and the future of freedom and liberty. Don’t let the regulators ruin it.

“To suppose that the value of a common stock is determined purely by a corporation’s earnings discounted by the relevant interest rates and adjusted for the marginal tax rate is to forget that people have burned witches, gone to war on a whim, risen to the defense of Josef Stalin, and believed Orson Wells when he told them over the radio that the Martians had landed.”

– James Grant

If you’ve been thinking lately that the markets seem a touch less volatile re: the breadth of the ordinary ups and downs, you’d be on the mark. In fact, the indexes appear to be treading in or near record territory regarding consecutive days and weeks that have passed without substantial downside corrections. Very few market periods have gone so long without investors getting a firm slap to reality through a reasonably severe correction.

Says Frank Barbera of the situation:”…this is the most over-extended stock market, and probably one of the most over-owned and uncorrected stock markets history has ever delivered. For those of you who like Presidential Cycles and are feeling lucky (and I wish you good luck in 2007), something tells me that against this type of stacked deck, you’re gonna need it. Seldom, if ever, has risk premium been this low, and perceived risk, this obfuscated. History says 2007 should favor a Return of the Bear.”

“Woah!!?? Now hold on a minute!”, you say?? What about 1999 and 2000?

Continues Frank, “In the past 100 years, we have now gone the longest period of time - thru today, a total of 959 trading days in which the DJIA has not seen a pull back of at least 10%. That has never happened before with this current streak easily dwarfing the prior long dated runs on 839 days in 3/30/1994, 806 days ending on 10/13/87, and 772 days ending on 6/09/53.”

I wish I could tell you this last quote was the extent of the situation. Actually, this only scratches the surface. We encourage you to read the entire Barbara piece before the link vanishes, which will be soon. So hop on it!

While consensus experts are getting surprised left and right by this week’s very weak numbers, we at Vigilant Investor were not, in the least.

Yesterday it was announced that in October the economy grew faster than forecast, at a 2.2%, but still at the slowest pace for the year. This was revised adjustment from the Commerce Department, who was expecting 1.6%, but upped the number based on increasing inventories. The slew of information for the week has been hardly glowing. U.S. New home sales fell 3.2%, their largest ever contraction. Meanwhile, durable goods orders declined by an abysmal 8.3%, the most since July 2000. This is leading many analysts to suggest that Fed rate cuts are all the more likely, especially if those numbers don’t improve soon. Adding insult to injury, the Chicago Purchasing Managers’ Index (PMI), a leading gauge of businesses activity, surprised consensus analysts dropping to 49.9 from 53.5 in October. Below 50 signals a recession. Some predict layoffs are in the future if the PMI slumps further.

Meanwhile, retailer sales in November were growing slower than expected as analysts dropped their forecast with Wal-Mart as the retailer for Middle-America again lowered its expectations and announced its worst monthly performance in 10 years.

The dollar showed continued weakness, slumping further — a long term trend we should all expect to continue, especially when measured against hard assets vs. other currencies that are often printed out of thin air to maintain trade parity against the U.S. dollar.

Proof is in hard asset prices, with Oil rising above $63 in today’s trading, while gold marched to a 12 week high trading above $650, up over $40 for November alone, and over 30% for the year.

Mainstream finance folks will continue to view us as Cassandra’s. We think the proof is in what is unfolding. Will this be the final unwinding of the Credit bubble, or will policy makers engineer another round of liquidity stimulation to ward off the inevitable for one more cycle? We don’t know, but act as if all is just fine at your own risk.

Remain Vigilant!

“History does not repeat itself, but it sure does rhyme a lot.”

– Mark Twain

As the election results are finalized, and we see the Republicans lose both the House and Senate – we muse about what is to come. As to the tenure of Donald Rumsfeld as Secretary of Defense – the musing is over. Rummie is out.

We are constantly amazed at how supposedly “intelligent” and “highly educated” people can make such bad decisions when it comes to matters like war. They are either lacking in judgment, in fact not so smart, or hubris has gotten the better of them. Then again, how smart can you be to let cockiness cloud your judgment? As a wise man once told me – “Only not so swift people get overconfident – because they are not smart enough to realize something can go wrong.”

So Donald Rumsfeld has joined the pantheon of myopic mis-calculators, which includes (among others) former “Whiz Kid” Robert McNamara – one of the architects of our ill-fated foray into Viet Nam. Like Rumsfeld, McNamara had all the educational pedigree you could ask for – and lacked all the foresight you could ever want. We wonder how the Rumsfelds and McNamaras of the world keep missing the point.

It’s not like history isn’t rife with examples of superior armies getting bogged down, confronted, and ruined by unexpected consequences. The Persians in Greece, English in Ireland, French in Spain, English in America — all come to mind.

History shows that initial military victory is also difficult for an invading army to follow up. In 216 B.C. — Hannibal and his Carthaginians inflicted perhaps the most devastating single defeat in military history upon the Romans at the Battle of Cannae. In little more than one day, his army captured or killed 70,000 of the original Roman force of 87,000, which opposed him. Yet Hannibal never achieved complete victory. He and his army traipsed around the Italian countryside for years – ultimately losing the war on the peninsula in large part due to the Roman strategy of attrition. It was the beginning of the end for Carthage.

Leaders have chosen to ignore History’s blatant, repetitive warnings. In 1708, Charles the XII of Sweden marched his feared army into Peter the Great’s Russia with an assault on Moscow. He was confronted by a Russian scorched earth strategy (which included Russian withdrawal and the destroying of anything which might be of use to the invading army) – along with “one of the coldest winters on record.” Charles suffered total and unrecoverable defeat – which marked the end of the Swedish Empire.

In 1812, Napoleon marched his unbeatable army into Russia – with an assault on Moscow. He was confronted by a Russian scorched earth strategy – along with “one of the coldest winters on record.” Napoleon suffered the loss of most of his army – and all of his Empire.

By now, the average Joe would sense a pattern here. (Note to self: Don’t invade Russia – especially in winter)! However, in 1941, Adolf Hitler (ignoring the well established precedent of successful military tacticians meeting their doom by invading Russia) — invaded Russia. He was confronted by (you guessed it), a scorched earth strategy – along with “one of the coldest winters on record.” The German army bogged down outside Moscow – and was ultimately destroyed. Like others before him – defeat in Russia cost Hitler his entire short-lived Reich, or empire.

Mark Twain certainly hit the nail on the head.

We at Vigilant Investor are not cocky. We know History rhymes – and we take it’s valuable lessons seriously. Which is why we raise the “Spock Eyebrow” when certain “learned” economists tell us record levels of debt, along with an exploding money supply do not matter – and that we can borrow and spend our way into prosperity.

Ten American Panics and Crashes before the Great Depression tell us otherwise.

But that is the subject of another post!

“…If the “Beta” or return from various asset classes is correlated to the growth rate of nominal GDP, then what we have to look forward to is a rather anemic “Beta” in future years. In turn, if because of that increasing realization, investors have responded by compressing risk spreads and therefore potential Alpha, then what’s looming over the immediate horizon is an Alpha/Beta anemia that can’t come close to meeting investor expectations or for that matter come close to immunizing this nation’s collective liabilities.”

That’s Bill Gross of PIMCO in his latest Investment Outlook, where he also published this chart:

We’ve long said that our post 2000 economic environment will translate into sub par investment returns among the conventional asset classes, especially when measured not against each other but by hard assets and the only form of money that has outlasted all central banks ( which eventually collapse-at taxpayer and citizen’s expense), all nations, and every empire — colonial or otherwise. (For those of you asleep at the wheel up to this point, that currency is gold.) Gross’ chart would seem to confirm that we’re in for sub-par returns among stocks and bonds.

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“Facts are stubborn things; and whatever may be our wishes, our inclinations, or the dictates of our passions, they cannot alter the state of facts and evidence.” –John Adams

We view history as the study of human nature – and have observed that one of the most intriguing qualities of people is that most ignore & even ridicule the truth if it threatens their belief system. History provides us with countless examples of this phenomenon – and interestingly, so does the behavior of many Americans today.

Americans – including a large number of economists — stare down a gun barrel of truly harrowing economic facts, and act as if they do not even exist. Record deficits; a declining dollar; a debt level relative to GDP substantially greater than — and only rivaled by — that immediately preceding the Great Depression; a bursting real estate bubble; a negative savings rate; and for the first time in 90 years the US is paying more to foreign creditors than it receives from investments abroad. Yes, these facts are stubborn. And as we watch the recent price swings of Gold (and the other honest form of money – Silver) — we can’t help but notice a few things.

As Gold dropped to the $571 an ounce range yesterday – commentary to the tune that since prices of oil and other commodities has been “contained” — the support for the Gold rally is over.

Really? We guess it depends on what your definition of a rally is. If you are a trader – and make your moves day-to-day, or week-to-week – perhaps. We choose to look at the bigger picture to provide much needed – and proper — perspective.

In October of 2001, Gold traded in the $280 an ounce range. In October of 2005, it traded at around $460.  Yesterday — $571.  That’s a 104% return over 5 years — and a 24% return over the past 365 days. It’s also important to note that Gold is nowhere near its inflation adjusted high. Gold peaked at around $850 in 1980.  Adjusted for inflation (2006 dollars) – it would have to trade in the $2200 range to peak again. In light of the ominous economic facts mentioned above — the yellow metal may be downright cheap. 

With all its potential — and all during its meteoric five-year run — Gold has been largely assailed, discounted, and derided by mainstream financial pundits. We wonder why. Then we re-read the quote above by Adams. Facts sure are stubborn things – and we have no problem acknowledging them, or putting aside our “inclinations, or the dictates of our passions.”

It seems like a whole lot of folks do.