Trading and Investing

In 1999, at the height of the tech boom, two books were published that highlight the investor mentality of that time period. Jim Glassman and Kevin Hassett’s “Dow 36,000″ and Charles Kadlec’s “Dow 100,000″ both predicted that the stock market surge of the late 1990s would continue for a decade or more.
Now that the Dow has finally reached its (non-inflation-adjusted) 1999 peak again, Bloomberg news interviewed Glassman and Kadlec about the topic:
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=atovhd65yQxc

Key quotes from Glassman and Kadlec:

“Glassman, 59, defends “Dow 36,000’s” original premise as well. The prediction — that the Dow would triple by 2005 — is still valid, he says, although he’s pushed the deadline out to 2021.”

” “I’m more confident today than I was five years ago that we’re in the early days of prosperity and the Dow will reach 100,000 by the mid-2020s,” said Kadlec”

The authors certainly look a bit silly to have to push their stock market predictions out to the mid-2020’s, but I think their views highlight a fundamental difference between stock market optimists and pessimists right now. The big question that needs to be answered is the following: Are we going through an Information Revolution that will increase productivity in similar ways as the Industrial Revolution did in the 1800s?

People view the technology boom and crash of the 90s in one of two ways. Either it was a stock market that got wildly out of control with visions of growth that just could not be fulfilled, or it was the beginning of an Internet revolution that just got ahead of itself.

I tend to believe the former because I don’t think that information technology has fundamentally changed the way the world will produce things. Certainly ideas are spreading now at a rate we have never seen before, but are these ideas translating into economic production?

The basic things that humans need to survive: food, housing, safety, health care, etc., have not moved into a more productive era by information technology. You can’t farm or build a house or produce a car that much more efficiently just because you have the Internet.

In order to believe that the Information Age will propel the US stock market to new highs, you have to be convinced that GDP will start increasing at rates never seen before. But when the latest GDP numbers released this week show 1.6% annual growth (caused by the housing slowdown), it’s a tough sell. Historical GDP growth has been in the 3% range for most of the 1900s.

If we start to see GDP numbers in the 4-6% range for an extended period of time then maybe I will be convinced. But until then, I don’t think we’re positioned for Dow 36,000.

– defo

…Continued, 10.29.06
The Economist published an article this week related to the productivity slowdown in America that is worth checking out:
http://www.economist.com/business/displaystory.cfm?story_id=8079134

One of my favorite financial columnists is Peter Schiff, President of Euro Pacific Capital, a broker dealer that specializes in foreign markets and securities (www.europac.net). On all of the financial news shows, he is known as Dr. Doom.

They call him Dr. Doom because of his doomsday outlook on the U.S. Dollar the U.S. economy. He is currently predicting a housing crash, a collapse of the dollar, and rising energy prices over the next 5-10 years. While I may not be quite as doomsday-ish as the master of Doom himself, I’m resonate with many of his views.

He writes a weekly commentary that is worth checking out:

http://www.europac.net/archives.asp?year=2006&qtr=3

http://www.europac.net/archives.asp?year=2006&qtr=2

Some of the best ones are: The Reality of Stagflation, The Paradox of Housing, and Higher Interest Rates Still Won’t Help the Dollar.

Do I think the dollar is overvalued? Yes. Do I think there will be a housing crash? Yes, if you count a 10-30% decline in housing prices a crash.

It’s a scary time to be an investor right now. Protecting your assets from a potential crash is one of the most important things you can do.  Even if the crash never happens, I’d rather be wrong and miss out on some asset growth than risk my life savings in cash or U.S. equities.

Everybody is waiting to see what the Fed policy will be over the next 3-12 months.  Here are my thoughts.

The Fed is playing a waiting game right now.  Inflation is still a real threat but growth is slowing down.  The last reading on year-to-year Core CPI is 2.9%, which is above the Fed’s publicly announced target of 1-2%.  If inflation stays above 2% long term, the Fed will almost certainly raise rates.

Right now, the Fed is waiting to see whether a slowdown in growth, fueled by the housing sector, will be enough to cool inflation.  If the growth slowdown stalls inflation, the Fed will continue to pause or to cut rates.

So there is a two-dimensional vector that the Fed is watching:
1. High growth, high inflation - Raise rates
2. Low growth, low inflation - Lower rates
3. High growth, low inflation - Hold or lower rates
4. Low growth, high inflation - Economy screwed, but Fed must raise rates

The Fed is hoping for outcome 3, but 1 or 2 would be okay.  Wall street is hoping for 3 and is pricing this into the Dow.  I think Outcome 3 is extremely unlikely.  Outcome 4 is what people should be worried about, in which case the economy stalls at the same time as the Fed having no option but to raise rates.  This will likely send housing and the U.S. economy on a downward spiral.

I would assign probabilities of the four outcomes as follows:
Outcome 1: 35%
Outcome 2: 25%
Outcome 3: 10%
Outcome 4: 30%

This matters to real estate because it is impacted both by economic growth and interest rates:

Outcome 1: Good for real estate owners.  Bubble does not pop.  The question is how long can this last because Fed will have to raise rates.
Outcome 2: Medium outlook for real estate owners.  Rates stay low and hold up prices but real estate falls a bit.  This is the soft landing scenario.
Outcome 3: Best scenario for real estate owners.  Rates stay low and growth keeps housing afloat.
Outcome 4: Worst case for real estate owners.  Economy tanks at the same time the Fed is forced to raise rates and sends prices even lower.

Prospective real estate investors care about the part of economic growth that is *orthogonal* to rates.  If rates go up, we have worse financing but prices drop.  If rates go down, we have better financing but prices stay higher.  So the impact of rates should matter much more if you currently own property.  It does, however, affect future selling potential, in which case I would rather buy with high rates and low prices.

A gold investment will pay off huge in Outcome 4, which will be the exact outcome that will create an incredible buying opportunity in real estate.  Hence my bias towards gold.  Nobody else will have money because they lost it in real estate or the stock market, so l will be one of the few buyers.

Real estate investment opportunities will be best in 4, worst in 3, and medium in 1 and 2.  Investors and the Fed will just have to wait and see.

defo

Gold bugs have been pumping up gold as an investment for years.  Anti-gold bugs claim we are in a gold bubble right now.  Who is right?

I have a positive overall outlook for gold in the next 2-5 years for several reasons:

[] Gold has never fully recovered from it’s peak of $850 an ounce in 1980.  This was a real gold bubble and in fact one of the larger financial bubbles historically.  In inflation adjusted terms, that price today is equivalent to around $2,200 an ounce.   Gold has a long way to go to reach another peak like that since it is currently trading at $600 an ounce.

[] Why should the price of gold go up in the long run?  Gold doesn’t *produce* anything.  It’s not a company that has a product and can grow over time.  The answer is that gold has had fundamental value as a means of storing value for centuries.  While governments can print as much paper money as they want, the supply of gold is fundamentally limited.  So  gold is a real means of storing wealth.

[] Gold went through a 20 year bear market from 1980-2000 while the U.S. economy surged.  This has created a generation of investors who do not even have gold on the radar.  I bet if you asked people at a party, 9 out of 10 would have no idea that gold was even on the move.  They’d probably be surprised to learn that just five years ago gold was trading at $250 an ounce.

[] In the event of a dollar collapse or devaluation, both US and foreign investors will likely have a flight to hard assets.  Gold is one of the easiest ways to preserve wealth against a devaluation of paper money.  If you have not read “The Dollar Crisis” by Richard Duncan, put it on your To Read list.  The basic thesis of the book is that the current global monetary situation is unsustainable and that the dollar is headed for severe devaluation.  More on this in future entries…

[] There are now trillions of dollars in hedge fund money just waiting for the next big investment vehicle.  If the Dow does not continue to grow, where will they invest next?  Their ability to make huge swings with the push of a button give gold the ability to skyrocket in a financial crisis.

[] Finally, gold is a basic hedge against financial crises.  It should probably be a part of any diversified portfolio.  But if you’re worried about the US equities market and housing market like I am, a larger investment in gold may make more sense.

More on this topic in the future.

- defo

The Dow Jones Industrial Average broke 12,000 today to hit an all time high. The markets are rallying strong, with the Dow posting almost an 11% gain in the last 3 months. The question for investors is whether or not this trend will continue.

The Capital Asset Pricing Model (CAPM) is one of the fundamental models of modern financial theory. The basic idea is that an asset’s correlation to the overall market is one factor in determining it’s expected rate of return. For example, you might think that housing construction companies perform pro-cyclically while bankruptcy law firms perform countercyclically. Since countercyclical assets are desirable from a risk perspective, pro-cyclical assets must have a higher rate of return to justify their riskiness (for more information on CAPM, see http://en.wikipedia.org/wiki/Capital_asset_pricing_model).

But the other advantage to holding countercyclical assets besides their risk profile is that they allow you to invest after a crash in the procyclical assets. If housing and U.S. equities tank simultaneously, it will create one of the best buying opportunities in 50 years. But who will have any money to take advantage of it? Only those people who held countercyclical assets.

So if you are like me and you believe that domestic equities are overvalued, you want to hold assets that will allow you to take advantage of a possible decline. So what do you hold? A healthy combination of cash, hard assets (gold?), and dividend producing stocks will put you in a perfect position to buy when nobody else can. And you’ll make a killing.

Sergey Brin and Larry Page have created one of the most influential companies in the last ten years.  Their capacity to change the world with their ideas is incredible.  But what impresses me most about them is the motivation behind their creation.

If you haven’t already, consider reading Google’s IPO letter to its investors: http://investor.google.com/ipo_letter.html .  It is very inspiring.

I have posted some of my favorite quotes below:

“Google is not a conventional company. We do not intend to become one. Throughout Google’s evolution as a privately held company, we have managed Google differently. We have also emphasized an atmosphere of creativity and challenge, which has helped us provide unbiased, accurate and free access to information for those who rely on us around the world.”

“Don’t be evil. We believe strongly that in the long term, we will be better served—as shareholders and in all other ways—by a company that does good things for the world even if we forgo some short term gains. This is an important aspect of our culture and is broadly shared within the company.”

“We encourage our employees, in addition to their regular projects, to spend 20% of their time working on what they think will most benefit Google. This empowers them to be more creative and innovative. Many of our significant advances have happened in this manner. For example, AdSense for content and Google News were both prototyped in “20% time.” Most risky projects fizzle, often teaching us something. Others succeed and become attractive businesses.”

Sergey and Larry have created something special and useful for the world.  I hope there are more people out there trying to follow in their footsteps.

I suppose I should use my first post to describe some of my motivations and goals moving forward with this forum. My vision is for this site to become a collection of ideas related to a variety of topics, ranging from trading and investing to entrepreneurship to macroeconomics to general discussions about life.

Recently, I have been thinking a lot about some of the fundamental values that I would like to hold throughout my life and professional career. Some of them are as follows:

[] I want to become an expert in building and creating. I know many people with good ideas that don’t have the means or the knowledge to move forward with them. Think of the potential gain for the world if we can learn how to transform ideas into tangible creations.

[] I want to create a steady stream of income so that I can wake up every day and work on whatever I want. This is not a means to be lazy, but rather a means to be free to think and create.

[] I want bring people together to produce projects that are net positive for the world. This means meeting and joining up with other motivated people with similar goals and ideas.

The question then is the following. What can we be doing now in order to make this a reality? Many of the posts on this forum will be directed towards answering this question.

For now, one thing that we can be doing is sharing thoughts and ideas towards this end.