*LEVERAGE
*Note: this involves all credit, not just credit cards
Remember the story of the three little piggies? I Wonder what the Big Bad Wolf would have thought if he had seen a house like this?
This picture may look like an exaggeration but it really isn't...
I have been meaning to write this blog for over a month now. On Vfrtxn's member's forum site I said that I would write about how I felt about the economy based on the views of people like George Soros, Warren Buffett, and other very intelligent people who know exactly how serious this situation has the potential to be. Well here it is. If your eyes aren't already open they should be...
Before I get started let me just remind everyone that one of the oldest, biggest, foundations of this country (Bears) just went bankrupt. In all the years of economic weakness and strength, of market fluctuations and credit cycles, of times as prosperous as the post-WWII years and as disastrous as the Great Depression, this has never happened. Other financial institutions are also very weak and it is very possible that more bankruptcies could ensue. The Federal Reserve under Ben Bernanke has lowered interest rates from 5.25% to 2.25% since August and are using tactics not seen since the Depression. I am not saying this to scare people or because I enjoy strutting around like a nihilist (I am really annoyed by people who find pleasure or even more frightening meaning from foretelling apocalypse). I am writing this for the same reason that I told one of my best friends to at least read about what was going on and think about protecting his mutual fund positions. For many the seriousness and granularity of the real risk out there has not sunk in. It's no ones fault. It's human nature. But I'm shaking you now and telling you to avidly seek an understanding of what the heck is going on.
That's the key word here: RISK. Not inevitable aftereffect. The outcome of this situation may not be a cataclysmic scenario by any means although some sort of economic slowing is guaranteed. Alongside the backdrop of global developments, technological improvements, and government intervention the downturn may be a bit difficult but not devastating and may serve as a source of strength long-term. That is the rosiest endpoint. However, if the scenario does play out anywhere near the worst case possibility it could create a very rough road for who knows how long. So... why take on this risk right now of having heavy positions or even any positions long stocks? (There are some exceptions but they are just that.) There are so many unknowns and so much leverage that if the bottom cards fail in earnest the whole house could come down. THIS IS WHY THE CLASSIC PARADIGM OF: JUST HOLD A BASKET OF STOCKS FOR THE LONG TERM AND THEY WILL GO UP OVER TIME is so dangerous here.
Financial stocks typically have lower P/E ratios even in good times than that of other stocks. Why? Because money can evaporate like the morning dew. Especially when leverage, greed, and loose regulatory standards are involved. Of course, as we have already seen, more than just financial stocks are in trouble here especially when the earnings and economy slow.
So on the other hand why not just pull out all money and short the markets and wait for the collapse? Well this sounds better than Buy and Hold to me but the subtlety of this situation requires one to tread much more lightly in my opinion. In fact the true winners may be the ones that barely leave a footprint. This topic is for a future post.
Enough of my viewpoints for the moment... I want to post some insightful articles that I have accumulated over the past months and let everyone else make up their own minds.
Here is an incisive viewpoint from George Soros. Considering that he has returned 29% on average for longer than anyone in the history of the business I tend to listen to him. This also shows the opinion of Alan Greenspan, of Jim Rogers (who co-founded the successful fund with Soros), and of Warren Buffett.
http://business.timesonline.co.uk/tol/business/economics/article2819069.eceAs a side not it is interesting that Buffett who believed the credit crisis would not hurt the overall economy changed his mind a few months later.
http://www.reuters.com/article/ousiv/idUSWEN425620080303
Here is a link directly from the mouth of Jim Rogers. This one freaks me out a bit...
http://moneynews.newsmax.com/money/archives/st/2008/2/25/114655.cfmNow let's leave the US for a moment. Sometimes you have to change your latitude so to speak and see things from a fresh perspective to see things with perspicuity. This article, very interestingly, was written in 2005 in China and was a warning to China to protect themselves against the impending collapse in the dollar and the credit crisis that was going to ensue and affect the whole world. This is an extremely interesting article. It's title: "It's time to take seriously a US-lead global recession". It's scary how much of it has already come true...
http://www.globalresearch.ca/index.php?context=viewArticle&code=LAU20051019&articleId=1110This article comes from Glenn Beck of CNN Headline News. I think this article very accurately puts the finger on how the everyday investor and American should be looking at the situation. It does not predict but shows exactly why everyone should be asking questions.
http://www.cnn.com/2008/US/02/28/beck.commentary/index.htmlHere it is from the mouth of Countrywide's Mozilo himself... you know if he's saying there's a problem it's worth reading ...
http://www.worldproutassembly.org/archives/2007/08/countrywide_ceo.htmlThe guy who posts below, Satyajit (pronounced Sajeet) Das, is an Indian born Australian, an electrical engineer, who has written several books on Derivative and has been a consultant for risk management for various hedge funds.
Read the following if you want to get a better understanding of what lies underneath the hood in this credit situation. It takes some time if you are not at all familiar but it is well worth it if you have money in the markets.
This first article doesn't get into the nuts and bolts but is a good primer of the problem and a bit about Das...
http://www.thestreet.com/s/the-credit-crisis-could-be-just-beginning/newsanalysis/investing/10380613.html?puc=_tscanaThis is the best article in terms of understanding how, at least on a basic level, these CDSs, SIVs, CDOs, etc. work is here. Really really good to know. I really recommend that everyone not familiar with this, including the fact, for example, that many banks had to buy equity traunches and thus didn't spread risk at all... except to their shareholders, take a look.
These article provide excellent additional reading as well.
http://www.prudentbear.com/index.php?option=com_content&view=article&id=4748&Itemid=58http://www.wilmott.com/blogs/satyajitdas/index.cfm/Credit-Crunch-2007
It was my own research, sparked in part by V.'s insights, that has caused me to trim my long positions, including my mutual funds, to almost zero and hold cash and at times go short. I have played short-term long trades as well but as I mentioned on earlier posts I am only currently long a reduced position in CMED.
So I guess the point of this post follows the old GI Joe line: "Now you know. And knowing is half the battle". Everyone needs to do what they think is right for themselves. Just be informed. That is what is so important here. The potential risks certainly merit it.
I did not discuss my thoughts on the newly proposed regulation of the investment banking ind. I hope to do that on a future post as it has the potential to be highly significant for a number of reasons imo. Also I hope to elaborate some more a little bit on treading lightly going short when the time allows.
Best,
Jon
Note: This blog is for informational purposes only. It does not give investment advice.
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