Jun

5

Whenever knocking a hat off I feel, and want to tear the weekly paper to pieces, and lash out at all the nabobs,  I don't take me to Nantucket but read "The Surprise" by O'Brian. There I find a passage about how the hands like to pretend that the ship is about to go under with the non-mariner dignitaries, and how the water is going to sink it, if not the waves or the backlash. It makes me think about the reasons for all the negativism. Is it the insiders trying to scare the daylights out of the public like the mariners? Yes. What difference does it make if the economy is down 1/2% this quarter and goes up 4% a year the next several years? Or what difference does it make that there was a housing recession the worst in 25 years. Or that the financial institutions had much water on their balance sheets. Such has happened before in the last 100 years, and is it bullish or bearish when all this negativism is about. One needs a Jack Aubrey with his natural ebullience to see the sweet sailing ahead on the blue waters that beckon.

Tim Melvin replies:

It makes all the difference in the world for any of us who wish to bet on US stocks… unless we are capitalized to withstand a 20% or more drawdown in stock prices. it especially matter if you are using any leverage at all (and yes I counted it. The average peak to valley drawdown in stock prices in a recession is on the order of 30+%. we have not even come close to the 1000 SPY levels that would be normal. The last time we had stagflation, the market fell over 60% peak to valley) There will indeed be blue skies ahead someday… the question is when? The combination of a falling economy, falling real estate and higher food and energy prices is crushing the consumer. If consumers do not buy luxury items, go out to eat, to the movies or even replace wardrobes, household items and even wardrobes, the companies that make these items, the retailers that sell them, and the companies that supply raw materials have lower profits. They cant borrow to make it through bad times and the water on bank balance sheets has tightened credit.

Loathe as I am to ever be opposite to one of the men I most admire, I think that most stocks are a poor bet right now. yes we will cure cancer, technology will advance and the long term future will be bright indeed. But not right now and reality is still not priced in the stock market. The dollar gets it, and bonds are starting to. The storm must pass before the sailor can safely leave the harbor. One caught in the storm must batten down and hope to ride it out as safely as possible. many , if not most, of those who ignored the warnings of wind and tide may well perish. Not even Aubrey would sail into the typhoon unless he it was a matter of the greatest urgency. As investors and traders we have one supreme luxury. We do not have to leave the harbor, and can profit by betting on the typhoon once in a great while, or simply sail a different sea.

Vic illustrates:

Here is a passage from The Surprise: "The envoy, Stanhope, had been told that water was coming in through the sides, and a seaman had told him that this was the gravest sign of all. One of the young gentlemen added that being pooped was more likely than actual foundering, or breaking in two, though neither possibility was to be overlooked. " Stephen said "The water coming in was inconvenient and even disconcerting but it was a usual phenomenon in such circumstances, particularly in aged vessels: It was what the mariners termed "the working of the ship." And be cautioned against too literal a belief in the words of the sailors: "They take an obscure delight in practicing upon us landlubbers". Once relieved of the sensation of imminent death, Mr. Stanhope…. ". Yes, the delight the brokers take in downgrading one another, and spreading rumours of runs, and trying to run the nakeds up again as they did the last two Springs, is not too innocent, but calculated to gain increased emoluments from the government and their future colleagues at the Board, and increase their share of the prizes as the landlubbers abandon ship.

Russ Humbert writes:

Perhaps it is no coincidence that Lehman, Merrill and Morgan Stanley, having received a review from the rating agencies that downgraded but still maintained their excellent ship worthiness, that the shorts would be emboldened. After getting so much wrong on the mortgage backed front any affirmation from them is similar to an endorsement from Bush's foreign intelligence chief on Iran. And perhaps it is no coincidence that Merrill, was the first to come out stating the shorts are full of hot air on Lehman's because they see they are next in line.

It will be interesting to watch for confirmation that Ben's revival meeting with all the investment banks included thinly veiled threats to those Investment Bankers who don't support their competitive brothers and reminders that  any piling on by them would be remembered for a long time. Was there a reminder that Bear Stearns did not help LTCM in 1998? Will Ben rally the troops? Will he speak in code? And how will the other brethren react? And will the SEC this time understand that their turf is in jeopardy and launch a full assault on the rumormongers, as they did on the  hyperbole of the dot com analyst? It has been my experience that a regulator fearing a turf grab is a dangerous animal backed into his own den with the hunter thinking he is cornered. And finally, could it be that the switch in NY governors will be the wind turning against those who believe their job is to protect us from big business without regard to method because size is equal to guilty?

The President of the Old Speculators Club, Mr. Tierney, issues a warning:

"Seems to me the greatest opportunities to make money going forward over the next 18 months to 24 months is to Short Gold, Short Oil, Dollar Cost into Equities as always, Long Dollar" - A reader of this web site

An interesting observation. In that it's been almost exactly 7 years since I announced the dumping my entire portfolio except for a couple of resource stocks, some retrospection is in order.

A recent post lauded the performance of IBM, hitting a multi-year high of ~$125. More recently, AXP was commended for its performance around $45. Those were among the equities I cast overboard, IBM @ $115.04 and AXP @ $39.43. As of today I would have been up 11.47% with Big Blue and 18.67% with AmEx - not exactly stunning performances over seven years (especially if one were to calculate the effects of inflation).

On the issue of shorting gold it has been an idea promoted by various List members at various times over that same time span - they have been incorrect. The concept of overpriced oil harkens back to the build-up to the second invasion of Iraq, when it was posited that the price would go back below $35; similar pullback predictions have been scattered over the past five years - once again, incorrectly.

The long dollar argument was made most forcefully by Yale Hirsch and his imported and highly regarded currency-expert henchwoman. That dates back about three years or so and, again, was incorrect.

Now the drunk who insists on looking under the street light for his lost keys because it's easier to see, may, once in a millenium, find them there. That's just luck. However, how do we judge the many sighted Street "names" who, over an extended period of time, have groped in the dark but come up empty?

More important, to whom do you listen for guidance in perilous times: the babbling and infrequently lucky drunk or to the sober and calculating historical record? The answer is obvious. Unfortunately, as has been documented and repeated innumerable times, the Market Mistress does not do the obvious.

Nor does she (nor anyone else so far) prepare meals of crow.

J. T. Holley asks:

Do you really think that we are in perilous times?

Jack Tierney replies:

Yes, I do. But in fairness, that's my nature. While many look on the markets with unflagging optimism (Vic and Laurel , L.V. Gave , Dimson et al. ), I tend to believe we have lived at a truly extraordinary time in an extraordinary country. So extraordinary, in fact, that not only those with the courage and capital, but also those who've stood and waited at the right place, have seen modest sums grow exponentially.

I am one of the latter, caught up by events and carried with the wave. Others, through risk-taking and foresight, have done substantially better, and deservedly so. However, the last 60-70 years doesn't, in my opinion, establish an immutable pattern. Historically, our past century is an anomaly. There has always existed a self-selected minority which achieved wealth through courage and daring.

But these last two (or three) generations have been unique in that wealth has "trickled down." Enough so, unfortunately, that it has become politically correct to view abundance, if not affluence, as a birthright - and one which can legislated for those who have missed out.

In itself, though, that's not enough to make me skeptical. My profit sharing account took some real whacks in '73-'75 and again in '79. I was fortunate enough to be in cash in '87, but got a minor haircut again in '91. I can live with oil crises, the slow motion crack-up of steel, autos, and aircraft. Technology, however it is defined at different times and different places, always ends up with more losers than winners.

But when major problems come out of the banking/finance sector, it's time to squeeze the pennies. Forget for the moment about those who have overspent and under saved. Instead, consider those financial institutions which have peddled gobs of their mortgage paper to pension funds, both public and private. By Greenspan's description, these are among those most able to undertake risk. In fact, they are not.

Much like myself, the memberships are made up of ordinary individuals who expect a modest sum to be available when they retire. If nothing is there, there exists no fallback positions. Already there are rumors of deficiency notices circulating… some involving major unions, others major metropolises. Jefferson County in Alabama is on the hook for over $3 billion in auction rate securities because JPMorgan and others sold them on interest rate swaps as a way to cut down on expenses.

In short, from the time of John Law, banking foul ups have had a much more severe effect on an unsuspecting public than any other business blunder. When bankers get it wrong, almost everybody gets hurt. So, yes, I'm concerned.
 

Stefan Jovanovich dissents:

I don't think the facts of American history support John's pessimism or his assumption that the years since the Great Depression have been uniquely profitable. The increase in wealth in the British colonies of North America from the end of King Phillip's War to the start of the Revolution was far greater per-capita than anything we have seen in the last 90 years; that is why there was an immigration boom that dwarfed anything the country has experienced since then. The period from the end of the Civil War to the passage of Smoot Hawley was equally spectacular as far as individual wealth in the North, Middle and Far West (but not the South) are concerned; and, once again, people literally flocked to the United States. Both periods depended on changes in technology that were - at least from the point of view of their effects on the rest of the world - far more dramatic than anything we have seen in our lifetimes. The improvement and broad use of Jethro Tull's seed drill was an agricultural revolution that equaled the effects of artificial fertilizer in our time, and the mating of steam power with Jacquard's loom turned India from a textile exporter to importer (with help, it must be admitted, from Britain's discriminatory trade rules).

John is right that, initially, "technology …. always ends up with more losers than winners" in the sense that machines replace people. But without that displacement no increases in wealth are possible. Socialism's real curse is that it kills all invention and change; in the name of fairness and equality Lavoisier's head is always the first to go.

The genuinely new and different improvement of our time has not been in wealth but in health. What the world has never seen before are the mortality statistics. Even with the devastations of the two World Wars and the results of Marxist national self-improvements in Europe, Asia and Africa, the change in the ability of people to be born safely, survive childhood and live long enough to suffer the diseases of old age and indulgence over the last hundred years has been breathtaking.

I wish I could share the assumption that the "public" - that anonymous sociological beast - has been duped by the evil bankers. Perhaps that has been true elsewhere in the country. But, from the point of view of California, the people who have borrowed money to buy dirt and houses and condos have been a great deal less unsuspecting than the folks who bought the securities that allowed the pyramid party to keep going. The borrowers knew they were signing for far more money than they could pay back out just the way anyone who could read knew during the Internet bubble that very few people were actually making any money from the brave new virtual world. In both cases the buyers thought it didn't matter; and, for a great deal longer than we supposedly rational business people considered possible, they were right.

My real quarrel is not with John's assumptions but with the premise that seems almost universal - namely, that bankers are still the source of enterprise capital that they were even a generation ago. Nothing that I know from direct experience or from studying the numbers for profitable non-financial public companies bears that out. We own common stock in 147 companies that do business in everything from shoes to lasers, and not one of them has relied on commercial borrowing or public financing as a significant source of cash since 2000. Of the over 100 independent business people I know here in California, the only ones people who have been able to rely on commercial credit from banks have been the folks dealing in real estate. Everyone else has been told no. Even SBA loans became dependent on the entrepreneur's having real estate that could be pledged as security.

Ironically, now that residential real estate out here is finally getting cheap enough to compete with rental prices and people with jobs and savings want to buy houses, the same bankers who issued ARM liar loans are largely unwilling to issue straight mortgages when the numbers pencil out. Having watched the Sandlers convert everyone to their cultist belief in appraisal values as the standard for credit-worthiness, most California lenders are now refusing loans because of their fears of what REO sales will do to future housing prices. The prospective buyers, who are offering to put real money down, are willing to take the risks; but the bankers still think they know the market better than people willing to put up most of their savings because they can buy a house for what it now costs them to rent an apartment.

The old bankers are always getting it wrong. That is why we end up having to find new ones.
 


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