Thursday, May 27, 2010

NY Times Opinion|Einhorn: Easy Money, Hard Truths

From David Einhorn in the NY Times Opinion Today:

"Before this recession it appeared that absent action, the government’s long-term commitments would become a problem in a few decades. I believe the government response to the recession has created budgetary stress sufficient to bring about the crisis much sooner. Our generation — not our grandchildren’s — will have to deal with the consequences.

EASY money has negative consequences in addition to the risk of inflation and devaluing the dollar. It can also feed asset bubbles. In recent years, we have gone from one bubble and bailout to the next. Each bailout has rewarded those who acted imprudently. This has encouraged additional risky behavior, feeding the creation of new, larger bubbles.

The Fed bailed out the equity markets after the crash of 1987, which fed a boom ending with the Mexican crisis and bailout. That Treasury-financed bailout started a bubble in emerging market debt, which ended with the Asian currency crisis and Russian default. The resulting organized rescue of Long-Term Capital Management’s counterparties spurred the Internet bubble. After that popped, the rescue led to the housing and credit bubble. The deflationary aspects of that bubble popping created a bubble in sovereign debt, despite the fiscal strains created by the bailouts. The Greek crisis may be the first sign of the sovereign debt bubble bursting."

Scott Dauenhauer CFP, MSFP, AIF

US money supply plunges at 1930s pace as Obama eyes fresh stimulus

Chart of U.S. Money Supply Growth

The M3 figures - which include broad range of bank accounts and are tracked by British and European monetarists for warning signals about the direction of the US economy a year or so in advance - began shrinking last summer. The pace has since quickened.

The stock of money fell from $14.2 trillion to $13.9 trillion in the three months to April, amounting to an annual rate of contraction of 9.6pc. The assets of insitutional money market funds fell at a 37pc rate, the sharpest drop ever.

The US authorities have an entirely different explanation for the failure of stimulus measures to gain full traction. They are opting instead for yet further doses of Keynesian spending, despite warnings from the IMF that the gross public debt of the US will reach 97pc of GDP next year and 110pc by 2015.

Larry Summers, President Barack Obama’s top economic adviser, has asked Congress to "grit its teeth" and approve a fresh fiscal boost of $200bn to keep growth on track. "We are nearly 8m jobs short of normal employment. For millions of Americans the economic emergency grinds on," he said.

David Rosenberg from Gluskin Sheff said the White House appears to have reversed course just weeks after Mr Obama vowed to rein in a budget deficit of $1.5 trillion (9.4pc of GDP) this year and set up a commission to target cuts. "You truly cannot make this stuff up. The US governnment is freaked out about the prospect of a double-dip," he said.

As I've stated before, Deflation is a real possibility at this point and this is a major indicator. Get ready for more money printing and more "stimulus" packages (there is already a new state bailout bill pending, of course it is called something else).

Scott Dauenhauer CFP, MSFP, AIF

Wednesday, May 26, 2010

Simon Johnson: The Financial Reform Sham

Former economist for the IMF and author of 13 Bankers (or should we say Banksters) Simon Johnson writes:

By now you have probably realized – correctly – that “financial reform” has turned into a victory lap for Wall Street.

When they saved the big banks, with massive unconditional support (both explicit and implicit) over a year ago, top administration officials promised they would be back later to fix the underlying problems. This they – and Congress – manifestly have failed to do.

Our banking structure remains unchanged, the rules will be tweaked at the margins, and the incentive and belief system that lies behind reckless risk-taking has only become more dangerous. (The back story, if you can still stomach it, is in 13 Bankers).

If you think this is scary, read on:

No doubt the administration feels good about what it has “achieved” on financial reform. The public aura of mutual congratulation will last for about three weeks.

At one point in early 1998, Larry Summers called Brooksley Born – the last person who really tried to rein in the dangers posed by derivatives (and it was a much lower level of danger then compared with now). Summers reportedly said, “I have thirteen bankers in my office, and they say if you go forward with this you will cause the worst financial crisis since World War II.”

We now seem to have come full circle to exactly the same people saying exactly the same things – no doubt top people in the administration are now calling Senator Lincoln and impressing upon her a version of the same point made by Summers to Born.

The 13 bankers have won, completely. Here we go again.

We are setting ourselves up for something that is entirely without precedent.....unless you consider history.

Scott Dauenhauer CFP, MSFP, AIF

Tuesday, May 25, 2010

Zweig: Legendary Investor Is More Worried Than Ever

Sorry to do this to you, this is another Wall Street Journal article by Jason Zweig.

Zweig got the chance to interview the legend you've probably never heard about, Seth Klarman, it was one of the most important interviews you will ever read. You can click the link above to read the article (hopefully its not behind the subscription log-in) or you can read the entire interview below:

Notes from Seth Klarman's discussion at the CFA Institute's Annual Conference

You will not read more important words of financial wisdom.

Scott Dauenhauer CFP, MSFP, AIF

It's The Valuations, Stupid

Not sure you'll be able to view this article because its on the Wall Street Journal website, but its a good read - basically says that the markets are volatile because they are overvalued using historical measures.

Scott Dauenhauer

Thursday, May 13, 2010

California Dreamin'

Many investors have been asking me about their California Municipal Bonds, before I go any further please note this post does not represent any type of investment advice.

So what should you do with your Cal Muni's. California is in the tank, another $20 billion budget deficit and no possible way to fill it without major tax increases (which failed to work last time) or significant cuts to what many consider vital services. So what should California do? The likely answer is one that might sound counterintuitive. They should spend more and become hopelessly deadlocked in the budget battle. Why? One word - Greece.

The Obama administration and the Federal Reserve played a big part in helping the EU/IMF bailout Greece and set up a fund to bailout other bankrupt EU nations - in fact the US will pitch in more than $50 billion. If Obama and the Fed think Greece is systemic, I'm willing to bet they aren't going to let California (the worlds 8th largest economy) fail. Everybody knows this; we have institutionalized Too Big Too Fail and California is the poster child for profligate spending and bad behavior....i.e., they make the perfect bailout candidate. Of course the government will be loath to bailout just California (as the EU was loath to bailout just Greece) when New York and many other states have issues as well - so look for another stimulus/state bailout bill. This will be another short-term cure that will transfer more debt onto the Fed's balance sheet, but who cares, whats another few billion or trillion dollars?

Will some California muni bonds default, possibly, but I'm willing to bet that like Greece, they will all be made whole in the short term. My main concern however is the duration, I'd keep my duration short (though longs are paying nice returns right now).

Can I be positive of a bailout - no. Is it likely given the current circumstances - yes. Be mindful though that this bailout will cause irreparable harm to the country.

Scott Dauenhauer CFP, MSFP, AIF

Monday, May 10, 2010

Future Energy: New Bacteria To Transforms Sewage Plants?

Frequent readers of this blog will notice a recurring theme when it comes to energy - the future will look much different than the past (though the near future will not). I believe that breakthroughs in bio, nano and just regular old "tech" will transform how we use energy and as I come across ideas and breakthroughs I like to post them (even if they sound far fetched).

The latest is a new bug...err, bacteria that turns sewage plants from consumers of energy to producers of energy - its actually quite remarkable. Click the link above to read more about it.

Scott Dauenhauer CFP, MSFP, AIF

The Question Isn't The Drop, It's The Pop - Fat Finger Fed

Everyone is talking about the 1,000 point drop last Thursday - how could it have happened? How do we prevent another one? All the while ignoring that the drop wasn't an out of the ordinary event (unless you believe markets are efficient in the short term....they are not) - it was, as I alluded to the day it happened, the evaporation of liquidity (buyers). These dislocations happen. The question for me is not why the market dropped - there were plenty of reasons that could have been given (of which none of them as glorious and ridiculous as the Fat Finger). The question is who created the "pop"? Who was behind the insanely quick turnaround? My hunch is that in fact there was a Fat Finger and its name is the Fed.

Call me a conspiracy theorist, but the speed that liquidity returned to the market after the free fall panic was unlikely to occur without a catalyst and I believe that catalyst was in fact the Fat Finger Fed who jumped into provide liquidity. Is it no irony that the day the market dropped 1,000 points and then suddenly rose 700 was the day that the Fed Audit amendment died?

Perhaps its all coincidence. What last week hopefully did was show investors that the markets are still risky and volatile (on both sides).

Scott Dauenhauer CFP, MSFP, AIF

The Trillion Dollar European Bailout

I'm not finishing researching the details, but the markets have reacted positively thus far to a massive bailout of just about everyone in the Eurozone.

As I've stated many, many times - never underestimate the power of the central bank in the short term.

While this might relieve short term pain it will only increase the long term pain. This will not solve Europe's problems, only extend them. In fact it could set off a raise to devalue as the only likely scenario of funding $1 trillion of bailout funds is through money printing.

The markets have reacted positively now, but the fact that 3 months ago everything was great in Europe and now they need a Trillion dollar bailout fund should be a wake up call that risk exists and should not be ignored.

Regardless, I don't know where this market will take us now, down would not surprise me, nor would up....probably why I'm not a good speculator!

I'll keep you updated as I digest this package and attempt to understand its implications.

Scott Dauenhauer CFP, MSFP, AIF

Sunday, May 09, 2010

Quarterly Commentary: What Can't Happen, Won't

The following was mailed to my clients about three weeks ago:

There is a saying, though for the life of me I can't figure out who said it, "What Can't Happen, Won't." Though perhaps understated it communicates a powerful truth. Let's take for example straw, it cannot be turned into gold. No matter how hard we try, you cannot spin straw into gold (trees on the other hand are another story once they are turned into pulp, then into paper and eventually money issued by a can buy gold with it....thus, trees can be turned into gold, at least temporarily). What is my point?

First, let me point out a few facts (via

National Debt $12.86 Trillion
Projected National Deficits through 2020 $7 Trillion
Present Value of Social Security Liabilities $14 Trillion
Present Value of Medicare and Medicaid Liabilities $94 Trillion

Added together these liabilities of the United States represent a total of over $120 trillion or nearly $400,000 per citizen.

The Peter G. Peterson Foundation has a different estimate. According to the foundation, only about $62 Trillion or only $200,000 per citizen....only. The difference between the two is likely the use of different time frames.

Keep in mind this excludes other off-balance sheet items like the guarantees that will need to be financed from losses at the FHA, Fannie Mae, Freddie Mac and the Federal Home Loan Banks. Nor does it include state and local debt or the deficit many state and local pension plans face. Don't forget the costs of the new health care reform just passed into law, despite the rhetoric and regardless of your support or opposition, it will eventually add to the deficit and national debt.

Bottom Line: The United States cannot continue on its present course, nor can most of the western (and eastern for that matter) countries. We have created a financial structure that we cannot pay for.

We can argue all day long about whether we should be providing the promised benefits, but at the end of the day the facts are we cannot pay for these benefits, at least not as currently structured. The amount of growth that would need to take place to fund all the promised benefits has never happened in history and there is no reasonable belief it can happen in the future, even in the great nation of America. The fact is we can't grow our way out of this problem. We also can't inflate our way out of this problem.

The national debt is projected to approach and probably pass $20 Trillion by 2020. While this is a massive number and history has clearly shown it to be very dangerous, if this was all we had to deal with I am confident we could dig ourselves out of the hole, though not without real pain. Even if we couldn't we could go back to the age old ploy of inflating the currency so that our debts become worth less to those who hold them. Since the Federal Reserve came into being in 1913 we have done just that, inflating our currency so that a $1 today is worth the equivalent of 5 cents in 1913 dollars, a 95% devaluation. This would be devastating to people receiving a pension with no inflation benefits (in fact it used to be considered treason). This is not to say we won't try to inflate our way out, but our other liabilities (entitlement programs) are in real dollars, meaning the less our dollar is worth, the more our liabilities increase (in direct relation). Thus, inflating simply won't work.

If we can't grow our way out of the problem and we can't inflate our way out of the problem, what can we do? I don't have the answers anymore, I wish I did. Simply becoming more fiscally responsible is not enough. Without massive entitlement reform there is not an answer.

Remember, in order to finance our deficits (and rolling over of current debt) we must sell bonds (or bills). There are only three entities that can buy these bonds - foreigners, citizens (and their agents) and the Federal Reserve (though technically not directly). At what point will foreigners and citizens demand a higher rate than they are receiving now? Is there a point at which the world (or our citizens) would stop buying our bonds?
It is entirely possible and as each year passes with our fiscal condition deteriorating the probabilities increase. This would leave only the Federal Reserve to buy our debt, effectively monetizing (printing money to finance our deficits) our debt. This eventually leads to hyperinflation and a collapse.

I don't say all this to scare everyone, only to point out what we already know to be true, "What Can't Happen, Won't" - I'm beginning to think I heard this phrase from John Mauldin. If we can't pay back our bonds or the interest on our bonds and if we can't pay our entitlement costs - we won't. This doesn't mean we will immediately default, it just means we will eventually default (I consider the Federal Reserve monetizing the debt to be a default if they are the only buyer). The scenario's that play out will almost certainly be different than any of us predict, but the end game will be the same - not enough money to pay our liabilities.

When this will happen is anybody's guess. Some believe the end is very near, like next month, others believe it could take years, even decades due to the position of the United States as the world’s reserve currency. I do not know the timing, nor the trigger, I only know that if we can't pay our debts, at some point we won't.

This forecast of sorts shouldn't be taken as a prediction of impending doom, though I would never discount that possibility either.

We all experienced 2008 and while most have tried to forget, our 20% unemployment rate is a good (actually bad) reminder that our problems still continue. If the probability of a financial collapse occurring was just 5%, would it not be worth your time to prepare for such a collapse - especially if the cost was negligible?

The stock market has been booming lately and it may continue, I don't know. What I do know is that using the Shiller valuation measure PE10 (if you really want to know more about this measure call me and we’ll talk) is overvalued on a historical basis (see chart above).

We learned that bubbles allow stocks to become overvalued and that this condition can last for many, many years, but eventually the valuations revert. The Federal Reserve's Zero Interest Rate Policy is having the desired effects - waning risk aversion. This risk aversion has pushed stock prices up with no relation to the underlying economy and has removed the margin of safety that existed a little over a year ago. Who would have predicted that a volcano eruption in Iceland could have a such a huge impact on the world? It wasn't something that could be predicted, but what could be predicted is that something unexpected would occur (Goldman Sachs lawsuit filed by the SEC) and that could have a serious affect on overvalued stocks.

It is for these reasons that I continue to be defensive in your portfolios in general. I understand the frustration that occurs when the stock market is up 1% and your risky assets don't follow. But the days when the market is down 2% and your risky assets aren’t down nearly as much (which is what I am happy to report is occurring) this feeling trumps the other. Our goal is to take risks when it appears those risks will be aptly rewarded. This doesn't mean we won't lose money or experience fluctuation, but hopefully we will lose less and experience less fluctuation.

Many of you have been asking me about Gold and Silver lately and would I advise you buy it? The answer is somewhat ambiguous. I'm not convinced we will experience inflation (though I can testify that I am experiencing it) as deflationary forces appear to be settling in. Thus Gold and Silver in the short term could fall a lot. My answer to you is that you must be prepared for substantial losses if you buy Gold and Silver (at least in the short term). Gold could easily go to $2,500 per ounce, it could also just as easily fall to $600 per ounce. I'm not positive it won't hit both at some point. So if you buy it you should do the following:

• Prepare for a wild ride

• Own it physically (not via an ETF or mining stocks)

• Hold it in your safekeeping, not a bank safe deposit box (it has been illegal to own gold in the past)

• Silver is easier to trade than gold because it costs less

• Don't go overboard, but having a small percentage of your net worth in gold or silver shouldn't hurt you long term

Please don't take this as recommendation to buy Gold and/or Silver, only a suggestion that if you do, the above is how you should do so.

I do want to encourage you about the long term. I am writing this quarterly commentary on my brand new iPad (Apple). I love the iPad. The iPad is ushering in a new era in connectivity and computing and represents something entirely new. Decades from now we will look back at this little device as the start of a computing revolution. I also believe the world is on the brink of a technology and bio-technology revolution - the likes of which will change our world forever. Our world will look very different 30 years from now than it does today (not exactly a prescient observation) and while we face enormous struggles and uncertainties the ingenuity of free people will continue. The irony is that while our financial picture looks bleak, the potential for scientific leaps forward is huge. Perhaps these future leaps will allow us to dig out of the hole we dug ourselves into, but then again that wouldn't be a very good lesson to learn.

P.S. Just read Thomas Donlan's recent Barron's article in which he found the original of my commentary title - Herbert Stein. Stein’s Law states "If something can't go on forever, it will stop."

Scott Dauenhauer CFP, MSFP, AIF

Friday, May 07, 2010

When Will Helicopter Ben Spin Again? Deflation Looms.

Bloomberg has an article out talking about the possibility of deflation and how Bernanke will deal with it. The article notes:

The Fed’s preferred inflation gauge -- the core personal consumption expenditures price index, which strips out food and energy -- rose at an annual rate of 0.6 percent in the first quarter, the slowest pace since records began in 1959, according to an April 30 Commerce Department report.

Bentonville, Arkansas-based Wal-Mart Stores Inc. cut prices on more than 10,000 items after sales at U.S. stores opened at least a year fell 1.6 percent in the quarter ended Jan. 31, the world’s largest retailer said April 9, adding it plans more reductions.

Home Depot Inc., the largest U.S. home-improvement retailer, lowered prices in March on flowers, fertilizers, lawn equipment and outdoor furniture to help meet its goal of increasing annual sales for the first time in five years.

“We are looking to continue to drive our traffic in the stores,” Craig Menear, executive vice president of merchandising for the Atlanta-based company, said in a March 17 telephone interview. “Things are still difficult out there for customers.”

So what does this mean for policy? Continued low rates and bubble blowing.

The Bloomberg articles goes on to say:

Money supply also points to declining inflation. The broadest measure compiled by the Fed, known as M2, expanded at a 1.5 percent annual rate in March, down from a 9.2 percent rate a year earlier.

“Central banks ignore money at their own peril,” said Gabriel Stein, a director at Lombard Street Research in London. “One of the key signals of threatening deflation is if money supply grows very slowly or in fact contracts.”

Even so, there are signs of life in the economy. The U.S. expanded at a 3.2 percent annual rate in the first quarter following a 5.6 percent pace in the fourth quarter of 2009, the strongest back-to-back performance since the second half of 2003. Employers added 290,000 workers to their payrolls in April, the fourth consecutive gain and the largest since March 2006, according to the Labor Department.

“We’re seeing very soft price pressures right now, but the fact that the economy is expanding at an above-trend pace means we’re going to see price pressures eventually start to turn up as recovery becomes expansion,” said Carl Riccadonna, senior U.S. economist at Deutsche Bank Securities Inc. in New York. He predicts the Fed will begin raising rates in August.

Be very careful out there folks, risk is still alive and lurking.

Scott Dauenhauer CFP, MSFP, AIF
Meridian Wealth Management

Thursday, May 06, 2010

Dow Plunges, Then Regains - What Happened?

The market at one point today dropped below 10,000 on the Dow and was off by about 1,000 point - however it closed off only about 350.....only. The story of the day will not be that the market was off 3% (which is real news), but that the huge drop was just a glitch, or was it.

Right now there are news reports that this was a glitch, an error. Others think a 1987 style programmed trading event occurred. But what if neither is true? Forgive me for sounding like a conspiracy theorist, but what if the plunge happened because things are bad and people began panicking.

Either this was an error or someone stepped into buy to prevent a massive sell off - could it be the rumored Plunge Protection Team? Did the Federal Reserve stop the route by purchasing S & P contracts? If so, nobody wants us to know.

Dow is off about 6.5% from its high.

Scott Dauenhauer CFP, MSFP, AIF

Tuesday, May 04, 2010

Hedge Funds: Very Short 10 Year Treasuries

Societe Generale is out with a report that hedge funds are net short against 10 and 30 year treasuries, in fact, net very short, as the graphic below displays.

Why is this important?

Two reasons:

1. If the Hedgies are right then their bet would pay off (and big time) if interest rates rise, thus the hedge funds are forecasting inflation or rising interest rates (or both).
2. If the Hedgies are wrong look for another wave of systemic financial crisis caused by massive leveraged losses. There is quite a bit of evidence (unless of course you buy food or gasoline) that we are in a deflationary,not inflationary environment currently. If true, interest rates on these bonds could go down - which would potentially cause massive losses on the hedge fund bets.

The question is - what banks are exposed to these hedge funds and are any of these hedge funds so large that they could cause systemic risk if the trade goes bad?

Scott Dauenhauer CFP, MSFP, AIF