Survival

For the past 10 years, investors have lost money. The chart below indicates the net annual nominal yield (including dividends) with monthly compounding for 10 years. For the 10 years ended in December 2008 and 2009, the yield was a negative -1.58%, and -.89% respectively.

Factoring in the inflation rate (as measured by the Consumer Price Index) it was even worse, with a negative yield for the 10 years Ended December 2008 and 2009 of -4.09% and -3.45%. So much for the buy and hold theory.

The Table below shows various percent changes for the 10 years ended 12/31/08 and 12/31/09 and the related nominal annual yields compounded monthly. The Gross National Product grew at 4.64% and 4.29% respectively. The Inflation rate as measured by the Consumer Price Index was 2.53% and 2.57%. Commodity investments provided a 1.83% and 5.25% yield. Gold (the best of the best) yielded 10.48% and 13.85%. New homes (based on price only, assuming no carrying costs) yielded 4.10% and 2.97% while the US dollar collapsed, declining 16.76% and 27.50% for the 10 years.

Even high quality stocks such as Cisco Systems, Coca-Cola, Microsoft, General Electric and Bank of America provided negative yields for 10 years. It is highly unusual for any ten year period to provide negative yields in common stocks. What’s going on?

The Federal Reserve policy of low interest rates and easy money has fueled the “era of the bubbles.” The creation of retirement plans many years ago created a new demand for stocks. Mutual funds started popping up that were more than willing to handle Employee Retirement Plans. Then for an encore, Exchange Traded Funds (ETF’s) were created to give investors access to any type of investment desired. Today there are quotes from Mutual Funds, and ETF’s that fill 3 pages of the daily newpapers. Today the average investor can invest in Brazilian Reals, Platinum, Gold, Natural Gas and Oil – all through Mutual Funds or ETF’s. It’s no wonder that America does not produce anything any more. The United States has become a service economy.

There are too many Mutual Funds, and ETF’s, all competing for investor dollars. Their only business is to own stocks, bonds, and real estate, regardless of whether such investment medium is reasonably priced. In fact I submit the continuous buying has created bloated stock values.

The current high priced stock market is just another bubble. The bubble is fueled by low interest rates, complacency, and easy money. The stock market wins by default because there are no other alternatives. Where do you put your money? Real Estate, Commodities, Gold, Debt instruments? In my opinion the stock market is overvalued and will decline materially from current levels.





Dr. John Hussman (hussmanfunds.com) referring to the current stock market notes that “Most of what we are seeing now is a tendency to make marginal new highs, back off slightly, and then recover that ground enough to register another marginal new high. As I’ve noted frequently, when market conditions are characterized by unfavorable valuations, overbought conditions, over bullish sentiment, and upward yield pressures, the market’s tendency is exactly that – to make continued marginal new highs for some period of time, followed by abrupt and often steep losses virtually out of nowhere.”



Personal Consumption as a percent of GDP is about 68% to 70%. For the Economy to improve, you need the Consumer to spend money. If he’s unemployed and his asset base has been depleted, it’s impossible for that to happen. As a result GDP drops. As GDP drops, so does the stock market. Over the next few years, GDP will not grow at the levels of the past. Pimco (an investment manager) has termed this slower GDP growth as the “new norm”.

The consumer is in the process of de-leveraging and saving, not spending. This process of de-leveraging is deflationary. Our politicians and leaders have printed money and added substantially to Public Debt which is inflationary. For inflation to really get going, the consumer must spend money. While we wait for the consumer to get out of debt and save his money we get deflation.

So, in the short run, we get deflation (a correction of the price level which is not positive for most investments). As the Economy improves and the unemployment rate starts to drop, the money supply (which has been expanded exponentially) turns over faster (economists call this turnover of money “Velocity”.) As velocity goes up we get inflation.



US Public Debt is estimated to be over 100% of GDP by 2010/2011. This assumes that GDP will grow by 5% in 2011 and almost 6% in 2012. In my opinion, these assumptions are overly optimistic. The size of US Public Debt as a percent of GDP will probably be over 100% by 2011. The creditworthiness of the USA and its Reserve Currency status is at risk. The US Dollar is a currency that other countries can use as a reserve (saving). China, Brazil, Russia, India, and most other countries use the US Dollar as a reserve. This means, that US Dollars are hoarded, not sold. Should the US lose their Reserve status, dollars would be sold, US Dollar denominated Bonds would be sold, and interest rates would go through the roof, which would make it substantially harder for the US to finance their nonsense, and could well have the US Bonds rated “junk”. Needless, to say, the Stock Market would crash.

The US Economy is undergoing a major correction of excesses that have been building since the late 80’s. There are major cross-currents in today’s World Economy: Deflation/Inflation; credit standing of the USA and other developed countries; Public Debt etc. The US Dollar in a deflation, make sense, as long as it is still considered the “Reserve Currency”. Stocks will not do well in a deflation or inflation. Some Bonds will due well in a deflation (US Bonds) and Commodities and Real Estate should do well in an inflationary environment.

In the interim, stay liquid, get out of debt, and hold some Gold. The theme is survival!

Game Theory 101

Many moon’s ago, the Mathematics Department of various Universities, came up with the notion of “Game Theory”. The theory dealt with games from Business to Monopoly. The results of those studies were profound. The basic principals of the theory centered on the concept of “fair games”. That is, a game is “fair” when the player has a 50% chance of winning, and a 50% chance of losing. Thus, “fair” produces no winners or losers.

In investing, the propositions of Game Theory are:

(1) Never play fair games (other than for amusement). Find games that have a higher probability of success than failure.

(2) Never play games unless you understand the rules. The rules must be articulated in an understandable way. The rules cannot change during the game. Do over’s etc cannot be allowed.

(3) Make sure you know the players in the game, and their skill level. Your skill set should be as good, or better, than the other players in the game.

(4) You must understand the game. Life is short – If you don’t understand the game, find another one. If there are no games you understand, become a spectator.

In the current crisis, most players in the game are under 50 years old, and have never seen a “game” this tough. Folks under 50 did not play the bear markets of 1969-1970, 1973-1974, and 1976-1978. In business school they probably did not even study the Depression of the 30’s. Currently, there is no game you can play (other than Gold), that gives you a fair chance of success. Stocks, Real Estate, Commodities, Foreign Currencies, Bonds – they all suck! Why?

(1) BECAUSE THERE ARE NO RULES, AND THE RULES CHANGE DAILY.

(2) Who are the players? You, me, the Federal, State, and Local Governments, Banks, Other World Sovereignties, Finance Companies, Special Interest Groups, the Unemployed, etc. In short - everyone on this planet.

(3) The Game today is totally incomprehensible. Do-overs are now allowed. Without understanding the game or rules, you must sit on the sidelines and allow the other players to fail.

There is a major war going on between Deflation, and Inflation. We all know that there is a credit collapse. The market value of assets is under siege. Liabilities against those assets in many cases exceed the asset value. The collapse of asset values and credit is clearly deflationary. Wait – here come our favorite rule changers, the US Federal Government. The Fed’s always gets us with taxation and inflation.

Our Governments boondoggle (TARP, Stimulus Plan, etc) is presumably going to “get our Economy back on its feet”. As of this writing I have seen nothing that will materially stimulate the Economy. In fact it appears that most of the money has been thrown at Banks and Auto Companies that are Bankrupt and social programs that provide no stimulus. Our beloved leaders, (President Obama, Nancy Pelosi, Barney Frank and Harry Reed) are running amok. The package totals $819 Billion, and may run up to $900 Billion.

There is: $345 Million for the Agriculture Department computers; $650 Million for TV converter boxes; $15 Billion for college scholarships; $1 Billion to deal with the Census problems; $88 Million to help move the public Health Service into a new building next year; $2.1 Billion to pay off a looming shortfall in public housing accounts; $870 Million to combat the flu; $400 Million to slow the spread of HIV and other sexually transmitted diseases such as chlamydia; $380 Million for a rainy day fund for the Women, Infants and Children (WIC) program that delivers healthful food to the poor (this group got $1 Billion last fall), $87 Billion to bail out the States providing Medicaid, Bee Keepers Insurance, and Medicare funds for Illegal Aliens.

Also everyone that has an Income Tax ID card (which includes those that do not have a Social Security Card) will receive a tax rebate of $500 if single, and $1,000 if married. People that do not pay taxes get the tax credit too. Remember the last Tax Rebate program didn’t work because people saved or paid bills with the windfall.

There is more nonsense in this package, but you get the idea. Upon being questioned on the bill, Rep David Obey, D-Wisconsin, one of the chief authors of the house package and chairman of its appropriations committee said, “If the house is burning, you’re not going to worry about which hose you grab, so long as you get water on the fire.” Is he crazy? The printing presses are going wild. As Richard Russell the guardian of the Dow Theory (www.dowtheoryletters.com) said (tongue firmly in cheek), “buy Paper Stocks.”

The forces of Deflation have been strong. Yet Gold and TIPS (Inflation indexed US Bonds) are rising, suggesting that: (1) There is an Inflation expectation over deflation, or (2) There is a major fear that the Worlds paper currency will become worthless or (3) both of the above. The Worlds currency today is referred to as fiat currency or fiat money. By definition fiat money is currency or money whose usefulness results not from any intrinsic value or guarantee that it can be converted into gold or another currency, but instead from a government’s order (fiat) that it must be accepted as a means of payment. For example the US $100 Bill is only worth $100 because our government says it is. Obviously there is no intrinsic value of the bill except maybe the value of the paper (5 cents?)

The game is now very complex. Stocks in my opinion are not cheap but overvalued considering where we are in the economy. A SP 500 Index to be cheap would be 600 or less (currently at 850). US Government Bonds are not cheap (a 10 year yield of 2.842%, is not my idea of a risk justified return). Income producing Real Estate is not cheap, due to vacancy rates rising and a substantial oversupply of rental space. Housing isn’t cheap, since you can’t buy a house today and rent it out at a profit. All other investment alternatives are in a state of uncertainty, because of the absence of rules.

In my opinion to make money over the next three years, the proper investment game to play will be decided on the direction of the price level, and the “real” value of the Dollar and other World paper (fiat money) currencies. If the “people” ever figure out that the current mass flooding of paper money causes inflation, and that our currency is really worthless, we will have the largest Economic and Political crisis ever faced in modern times. Below are some of the charts I use to follow the Deflation/Inflation, worthless US dollar sentiment. Below are three charts that indicate the ratio of Gold Prices divided by: the Ten Year US Treasury Bond Price; the Inflation Indexed US 10 Year T-Bond (TIP); and the US Dollar Index. Also there is one chart indicating the ratio of TIP to the 10 Year T-Bond Price.




Note that the TIP is also rising against the 10 Year T-Bond. Like all market data (that reflects investor sentiment), this could all change tomorrow morning. What’s interesting about the TIP to Bond chart is that it shows the initial Deflationary sentiment (dropping ratio). Currently however the TIP shows strength, and with it confirms the other Inflationary sentiments. My opinion is the stimulus package will stimulate very little except Inflation. It seems likely we will continue our credit and asset collapse followed by high rates of Inflation.







It is prudent to be very risk adverse today. Invest in Federally insured Cash Instruments, and some Gold. If you have a Mortgage that has an interest rate of more than 3.673%, make extra principal payments. Stay liquid, and out of debt. This economy and the Federal Solutions thereon will not have a happy ending.