From Whence We Came and Where We Go. 2006 In Review & 2007 The Look Ahead: Does The Financial Bubble Get Bigger?

Happy New Year to everyone! I hope 2007 will be a memorable year for all. So, let's take a few moments and look back at 2006 and what 2007 may have in store.

2006 was again the year of the consumer, small caps, emerging markets and commodities. Funds and investors focused on these sectors were outperformers once again. Towards mid-year we started to see a measurable shift. Many commodities corrected large amounts and some actually cratered. That was expected. We'll likely see other commodities pick up the slack going forward. This does not mean we are having a twenty year bull market in copper or other commodities. It does mean we'll likely see violent swings in commodities for quite some time. Maybe even another five to ten years. But, higher highs and higher lows, the definition of a bull market, is not what we'll see out of commodities over the next decade. We've talked about that ad nauseum though.

2006 was also a year where we have been told that Asia and emerging markets have finally matured. That they have reached a level of development and sophistication where they can be trusted as a source of investment diversification. Many believe they will carry the load if the U.S. has an economic slow down. I believe there is a stronger argument to be made that there is a lack of demand for capital in the U.S. which has found its way into emerging and international markets (for many reasons) thus creating instabilities on a global scale. This situation has been exacerbated by a relative loss in value of dollar denominated assets. Or, put another way, if you are in natural resource rich Australia, Saudi Arabia, Russia or Canada, as an example, the tremendous run up in dollar denominated commodities has fueled extremely distorted and unsustainable commodity-related profits. Economic miracle or economic mirage? My thesis for this cycle's investment returns is gaining momentum as Thailand markets imploded late in the year caused by government attempts to control the destabilizing instantaneous flow of funds from "western" investors. ie, Mostly U.S. and British hedge funds. I wouldn't be surprised to see more of this in the months ahead. Especially given the parabolic moves in Russian and Chinese equities this past month. Remember, most emerging markets are like the wild west. There is little understanding of safety and risk, lack of sophisticated market controls, weak leadership, nepotism and all of the other risks I've written about. If you like emerging markets, do so for the right reasons. Do so because hot money is plowing new fields of temporary wealth with an eye towards getting out before the mess is created.

It also seems as though 2006 was the year of vacillation. Many money managers have jumped back and forth on their investment ideas and market expectations. I'm not sure how they successfully invest with so many changes of opinion. I suppose they either underperform the markets as the majority of money managers do or they are saying one thing and doing another. Of course, why would underperformance not be expected? The reason most money managers underperform are because they lack discipline. What is vacillation? A lack of discipline. The world's greatest investors are anything but lacking in discipline. Why? Because they are confident in their approach and methodology. In other words, they know what works at what time and they play to win.

I believe the most important macro topic we've discussed this past year is the "topping" or peaking of the financial industry. I can't recall the exact title of the post. I believe it was "The Finance Industry Is Peaking" and was posted in August or September. We simply have a disproportionate amount of people, capital and resources flooding into the entire financial industry food chain be it hedge funds, funds of hedge funds, investment banking, private equity, real estate agents, accountants, private trading desks, commodities, mortgages, consumer credit or the other massive dislocations. You must remember, in long wave cycles, it is the finance industry that is the last to peak. If this isn't peaking, I don't know what is. Every spare dollar, yen, euro, peso, yuan and nearly every other currency are piled into nonproductive use. As I stated before, we will eventually see excess capital destruction. I view this as an absolutely essential requirement to create a new long cycle bull market in American business and thus American equities. Unfortunately, the process is going to be painful. Ultimately, we'll see a reversion and redeployment of productive assets and intellectual capital into constructive wealth creators such as technology, green initiatives, biotechnology, health care, lean manufacturing and other productive investments.

So, what will 2007 hold? I've said it a few times and I'll say it again. Markets are extremely overvalued to overvalued. Does that mean the markets are going to fall off of a cliff the first week in January? No. Wall Street is terribly bullish about 2007. In addition there seems to be a general consensus that sentiment is too bearish and that is going to fuel a massive 20-30% rally in the S&P. I simply don't pay that much attention to sentiment. It's rather ridiculous to me. Everyone jumps on the bandwagon when the Nasdaq goes down 10% saying sentiment is awful and we are due a rally. Well, that works until it doesn't work. Tis better to measure what the markets are doing instead of what people are saying. Did sentiment help in 2000-2003 when the Nasdaq went down 80-odd percent? Certain sectors of the S&P could go down 75% to be fairly valued with other secular bear markets. Some 30%. Does that mean I am calling for a 75% correction in the S&P? Only if we are at the end of the world. But, the complacency is palpable. Anyone calling for a 10-15% correction is being laughed out of town right now. I believe we are going to see a very nasty correction starting in 2007. Originally, I wrote that I expected to see a bottom in October of 2007. That might be a bit premature but then it's also based on esoterics that only a handful of people even attempt to harness. (As I've said before, I do not invest based on estoric cycles analysis.) All I will say is forecasting the turning points of the markets is not a science. It is an art. Forecasting times of high risk is a science. We are in a time of incredibly high risk and most Wall Street professionals look like the proverbial deer in the headlights. Last time we saw that same look was in 2001 when Wall Street professionals were as bullish as they are for 2007. Take note. When Wall Street has achieved prajna, it's time to worry. Emerging markets? Brazil or India may have a low valuation comparative to the U.S. but then again, they deserve a low valuation. They have not proven their ability to create continued reform, wealth and economic prosperity over long periods of time. Their financial infrastructures are unsophisticated and their capital markets are typically a ruse. In other words, don't buy the ridiculous statements that such and such international market only has a PE of 10 so it's undervalued. That's Wall Street prattle. If the long term PE has been 10 or less, there's a reason for it. They aren't called emerging markets for nothing. Most have been emerging for the last one hundred years and many will still be emerging one hundred years from now.

Alot of people believe small caps, energy and a few other sectors are still outperforming. That is simply not true. There are multiple methods to measure outperformance and from my methods, there are no major sectors outperforming mega caps. In other words, mega caps as a class are leading all sectors. So, how does one interpret this? Well, I interpret that data point as a run for safety as I mentioned a few months ago. My long term models are unbelievably bearish on all equities and if I were a buy & hold investor, as most mutual funds, retirement funds and the sort are, I'd be running, not walking, to mega caps. That is exactly what they are doing.

Some final comments about 2007. Now, I'm not going to share any proprietary work but I will share a comment which I am quite confident will come to pass. I've said it half a dozen times but I like repeating myself. It sounds better the more I say it. Those expecting to ride "defensive" sectors through any severe correction, when one happens, will see tremendous capital destruction. Those who are investing in higher dividend paying stocks for the same reasons are likely due the same outcome. There is only one segment of equities which I consider to be value priced in comparison to all other sectors. It isn't defensive. And, while it is cheap comparatively, it's still overvalued.

My view of equities was that most investments would print May of 2006 as the high. I thought 1400 was possible on the S&P but didn't expect broader markets, technology or small caps to follow suit. That position still holds for most nearly all sectors and styles. We are basically at the same level or lower than May in nearly all equity sectors and styles. The lone dissenters are the mega cap averages which sit a handful of percentage points above the May high. We are due a correction at some point here. Some data points I follow have fallen off of a cliff in December but I discount light holiday season activity so we just have to see. Whether any future corrections turn out to print the October breakout in the S&P as a false breakout and an opportunity to short or whether it's a buying opportunity is the big question. Regardless of what happens, the upside is limited in my opinion. In other words, no Dow 30,000 any time soon.

As you can tell, I am not optimistic about the near term future of equities. The higher we go the bigger the ultimate mess is my concern. Nor am I optimistic about the global economy. Anyone who is not hedged, positioned defensively or in mega caps is playing with fire. When they get burnt is the only question. One of my favorite quotes was made famous by Hyman Minsky: "Periods of stability create instability.". In other words, it is human nature to be generally self destructive when exposed to long term prosperity. To expect anything different from the inflated asset prices we see in so many investments is to disregard human nature. That said, in all likelihood we are going to get the buying opportunity of a life time in equities at some point. You'll know that point. It is when you've vowed never to invest in equities again.

Capitalism, Communist Style. The Big Red Machine And The End State

Good day comrades. Another interesting article today from the ministry of propaganda. Sounds implausible? Well, your friendly communist government does indeed have such a post. And, that means China has one. The article really isn't from the ministry of propaganda but since all Chinese communications are cleansed before being released, draw your own conclusions.

I posted a link to a story some time ago where China was overproducing over a million cars annually. Exactly what happened in the former Soviet state. I don't know what happens with those excess cars but the article said they were slated for export. Export to where? Maybe they are simply broken down and recycled to create more new cars to be broken down. And so on and so on. That would be a very industrious process worthy of employment for fellow comrades. In any event, it appears the Chinese government has realized they have an automotive capacity glut growing to unmanageable proportions. Remember, this article is cleansed so the situation is likely worse than reported. 20 million units of production and expected demand for 9 million units?

In addition to gluts in basic materials, steel, chemicals, real estate and just about everything else the communists have centrally planned, we now have a glut in auto production capacity. Now that significant malinvestment exists in every "planned" sector of the economy, where do the communists "plan" to create their next mess? The continual creation of over investment is a situation the communists cannot win in the end.

What will be the ultimate unintended consequences for this centrally planned economy? Does anyone remember Perestroika? Is history repeating itself and is China following in the footsteps of the Soviet Union's collapse? Eric Hoffer postulated that a broken or beaten people or society proved little resistance to total control. (China before the current economic reforms.) But, once a people or society had a glimpse of what is possible, society ultimately becomes unmanageable if opportunity is taken from them. In other words, in a bit of irony the Chinese communists had unknowingly created their own demise once they opened the door to economic reform. I am quite confident we will get to the point of communist collapse before the Chinese government reforms domestic controls. Why? China has more people working for the communist party than the total population of Britain. It would be a very unusual act of altruism for a corrupt, inefficient, self-serving bureaucracy to work themselves out of power for the benefit of the masses. In other words, those reforms will not come without strife.

There must be a trigger for such events. I expect that trigger to ultimately be China's ever expanding trade imbalances with Europe and the U.S. I'm not sure what circumstances will arise surrounding these imbalances but I am quite confident exchange rate reform will not even begin to solve them. Such an approach might work for a smaller economy or a smaller imbalance but China is simply too large and, therefore, the imbalances too great. Europe has already started imposing trade regulations. Expect the U.S. to follow in some form with the humiliating failure of the high level U.S. trade delegation to China. We don't need to see a total curtailment of trade. A reduction in Chinese export growth would stifle job creation and create unrest in the Chinese economy. If unemployment claims in the U.S. start to rise significantly, we will likely see the beginning of the end for communism in China in the forms of U.S. protectionism and reduced consumer demand for Chinese produced goods. I expect this to happen before 2012. My next prediction? Come back in 2012.

Update: It never ceases to amaze me that people have called for an improvement to the U.S. current account deficit for the last thirty years. I say this as I see a guest on Bloomberg making such an argument. On what, may I ask, do people base such ridiculousness? The only way that is going to happen is recession. The current account deficit is based on a combination of two primary facts. One, the U.S. doesn't produce enough of what the world and American consumers want. Two, and most importantly, in order for global demand to outstrip our consumption and reverse the current account deficit, global economies must reform domestic agendas to stimulate demand for American goods and services. Neither is going to happen in the foreseeable future. Do they think some miraculous shift is going to take place? Do these people get paid for this?

Richmond Federal Reserve Survey

Hoping everyone is enjoying some time off with family and friends or a reduced work week. As I mentioned before the holidays, this week would be a light posting week.

Today the Richmond Fed released data which validated my suspicions of a weak holiday season.

• Seasonally adjusted manufacturing index decreased to -6 from November’s reading of 7
• Shipments lost ten points to -4
• New orders fell fourteen points to -8
• The jobs index moved down fifteen points to -5
• The capacity utilization index turned negative, losing twelve points to finish at -11
• Orders backlogs indicator shed five points to -16
• Vendor delivery times edged down three points to -1
• Raw materials inventories was somewhat higher, gaining six points to 20.
• Finished goods inventories index trimmed three points to 12.

Happy Holidays

2006 has been an interesting year in this big old world. For those of you have visited this blog, I'm hoping that it was entertaining, informative or both. While I try to keep it to business, I enjoy honing my sardonic writing skills as much as anything. In the end, blogging and business are a mere distraction from life's important moments so I tend not to take it too seriously.

If you've learned anything or even simply enjoyed this blog, I would ask you to consider giving something special to charity this year. Most people who read this blog have the financial wherewithal to help out in some form and I'm sure most do. This holiday season hundreds of millions of mothers and their children will go to bed with no roof over their head or no food in their stomach. While this topic is discomforting for many, sometimes discomfort is what we need to move ourselves to action.

As we all reflect upon this past year, I hope all us will use this opportunity to rededicate ourselves to being a better person. This world needs everyone to do so. In the end all that matters is compassion and kindness. Not just to those who love us but to everyone. Kindness is a contagion. It creates more kindness. Take this opportunity to be kind to someone you haven't made amends with or to a stranger in need. Life is too short and there will come a day when it will be too late for all of us.

There are a few links on the lower left side of my site of children's charities who generally rank quite high in external audits. Or maybe you have a favorite. If you are not fortunate enough to to help out in some way, I truly hope your fortunes change in 2007. I'll probably have a light or nonexistent posting schedule until after the new year at which time I'll resume my rantings.

Wishing everyone peace and serenity.

Sincerely,

Ranting "Me"

Thinking In Absolutes, Restricted Variable Analysis, The Federal Reserve And The Dollar

Being that I enjoy a good debate, I was recently posting on another blog. When I posted that the current liquidity cycle was coming to an end along with a few dollar notations another poster chimed in and said he was going to give me an economic tutorial. His tutorial was, “When capital is fleeing uncertainty as in Asia, a declining dollar makes U.S. markets look like a safe haven”. He must have done some Googling because he came back a few hours later and recanted. His new post was “I didn’t mean it made the declining dollar appear as a safe haven. What I meant was a declining dollar makes U.S. assets look like a safe haven.”

I guess my question is, “What is the dollar?” Uh, it’s a U.S. asset. So, is the U.S. dollar excluded from that comment of U.S. assets? I’d like to sell you a few rubles before the Russian currency crisis if you think a declining currency either represents a safe haven or that assets in a declining currency represent a safe haven. Maybe if that currency theoretically went to zero as an extreme statement of decline, you’d really enjoy holding assets denominated in said currency. You could always sell those assets and exchange them for another currency. Let’s see. Theoretically, how many units of a currency valued at zero do you need to buy a currency not at zero? (Hint: You don’t need to Albert Einstein to get the right answer.)

My point is that there is a lot of misunderstanding out there about the dollar. And a lot of misunderstanding about the forex markets and what drives them. Given many have declared an end to the dollar and, by inference, all things U.S., I thought now would be a good time to talk a little bit about a very complex topic. It’s quite convenient that the wrong way crowd over at The Economist has the incredible shrinking dollar on their cover. Their dollars calls are the poster child for idiocy. They are always wrong!

This post includes remarks on Fed policy as I said I would post a few weeks ago. One cannot have a currency discussion without central bank policy. If you are going to read this, it’s going to take you a few minutes because it’s a long post. If you are interested in economics, the dollar or the Federal Reserve, I'd hope you will take the time to read on. The objective of this post is not necessarily to answer all of the questions concerning the dollar. I don't know the answers. But, it should dispel quite a few myths and hopefully be somewhat educational.

First off as I've stated, I'm expecting a repricing of risk in most asset classes. That does not mean I am not long term bullish on the U.S., Europe or Japan. Developing markets? Well, that depends. I'm certainly not bullish on developing economies without painful political and economic reforms they've had decades and/or centuries to undertake but haven't. Some modicum of reform has been achieved but nothing compared to what needs to happen for most. Without reform, their domestic investments and consumption will suffer at the first whiff of a serious economic slow down. That might have been the impetus for the Thai Baht fiasco. We’ll soon see if their economy was softening with their rising currency. I'm actually more inclined to be bullish on Japan than any other large Asian economy because Prime Minister Abe is very reform minded unlike politicians in Korea and China. In addition, much of the heavy lifting has already been accomplished in Japan decades ago. That said, Japan is disproportionately reliant on a very muscular export engine. Historically domestic consumption has not been able to offset that export engine when America experiences a significant slow down.

I surely don't profess to know what all of the ramifications are of a global slow down but that's why my definition of long term investing is-until my models say step aside, hedge, become defensive or whatever. If that's a year, then that's my definition of long term. If it's ten years, then that's my definition of long term. I do know my money will remain in dollar denominated assets. I'm most comfortable with this statement because it is the safest place in an unsafe world. If I were British or Japanese or German or French, I'd feel quite confident with my investments being in Pounds, Yen or Euros as well.

Remember, recessions or worse are part of capitalism. Recessions have always been here and they are not going away with current policy, economic tools or methods of thinking. Nor are they exclusive to the U.S. There is no economic certainty, but should we cheat this cycle and not experience a recession, it would be a first in modern times (post 1925) given the circumstances. In other words, with me the question is more a matter of “if” not “when” we will experience a repricing of risk and a recession of some sorts. If we do cheat the business cycle, there will be no one happier than me. I don't particularly enjoy bad news or loss. What does economic weakness mean for company profits? Well, if they drop a comparable percentage as took place in 2001's very minor recession (Remember, the 2000-2003 sell off had little to do with an extremely mild recession. It was all about repricing asset risk.), we will see the S&P with valuations similar to the most extended indices in 1929. The Russell 2000 PE could end up in the stratosphere comparable to the Nasdaq in 2000. How many times can I say this market is not cheap? Obviously one more time as witnessed by my incessant rantings. I won't belabor the point but the bubble we are experiencing is far more disconcerting than the narrowly focused bubble in 2000. This one is global and includes commodities, commodity laden stock exchanges, the broader small caps in the U.S., global real estate, private equity, debt and credit as potential asset classes. Now the markets are chugging along without a concern today but given the risk and historical precedence, I'm not ready to jump on the bull bandwagon. Especially given some of the data points in my recent postings. Currently the markets are consuming massive amounts of risk and the rewards are not commensurate from what I am measuring.

There are many journalists, media and bloggers telling us the Fed is pumping money into the system, that the U.S. is going to have a dollar crisis, a credit crisis, a debt crisis and even cede economic leadership to China. The reality? Most of these people don't know a whole helluva lot more than the neighborhood bartender. (Maybe that's being too harsh on bartenders.) Yet, what is ironic is that many are paid quite handsomely to know what they are talking about. If they are supposed to be paid for not knowing, they are performing quite well. Let's break some of these fallacies down.

First, let's take a look at debt. Debt by itself is hard to quantify. There will be a day when the cumulative debt in the U.S is over one quadrillion dollars or whatever we are using as currency. What does that mean? Well, that depends. As long as my assets grow faster than my liabilities or as long as I can service that debt, am I to panic? No. In fact, the public debt of many nations, including Japan and Europe, is greater in percentage terms (burden) than the U.S. But, there is some concern because the U.S. economy is not as vibrant as it appears. Even the Fed has recently stated that underemployment is a problem. In other words, the labor participation rate is down significantly post 2000. I recently read on statistic from a very reliable money manager which had the labor participation rate of American men under the age of forty something to be around 83%. A little different than the unemployment numbers of 5%. If there is ever to be a concern, it is likely at a stage when the consumer is due a recession from a cyclical perspective, labor participation rates are down and wages are generally stagnant. I could cite a concern with debt every single year and many have for forty years. Is America richer than it was in 2000? Of course it is in nearly every measure. Does it have more debt? Yes in nearly every measure. Are we living in a Utopian society? Not hardly. Maybe we'll see much of the wealth created since 2000 disappear. Not just in the U.S. but everywhere. I've pointed out in prior posts that the finance industry is almost surely peaking and we are going to have a bout of wealth destruction. Ultimately assets, people and investment will be reallocated to productive use in comparison to an overabundance of all three pushing around money. That means a re-industrialization and reallocation to growth industries such as biotechnology, capital equipment, general technology, alternative energy research, etc. We’ve seen this act before and we’ll see it again.

So, what does history tell us about times of massive debt? Democratic societies realize problems reach a level of concern and remedial consensus is reached. Or put another way, quit driving through the rear view mirror. Trends never last forever. If debt is peaking on a percentage basis and America once again becomes a nation of savers, who will suffer disproportionately? The rest of the world. Specifically economies closely aligned with the American consumer. Who is most reliant on the American consumer? China. Who is the least reliant? Europe. What have I said repeatedly? The only place I would personally invest my money today is European or U.S. mega caps.

Additionally, I'm not a big fan of personal savings rates measurements. It's an incomplete method of calculating wealth. Are Americans spending too much? Likely. Is it going to last forever? Of course not. Will there be pain associated with that change? Possibly. Is any western economy much different? Well, since I see the British and Australian press talking about their negative savings rates and cracking jokes about their healthy spending practices, it's likely the same most everywhere in the western world. That is to be expected after experiencing tremendous wealth expansion over the last three decades. People forget about rainy days when it is generally sunny for decades. The method of calculating savings rates is less than adequate for today's society. It does not capture a huge bulk of savings by Americans. Yet, the same calculation might capture the bulk of savings in China. Why? Because people in China don't trust anything other than cash so they disproportionately bury their investments in their mattresses rather than invest in new business, financial instruments, investment, etc. There was a time when Americans felt the same way. Ever see someone who lived through the Great Depression who wasn't a saver? My grandparents wouldn't invest in anything other than CDs. They didn't even have a checking account until they were over seventy. So, what will it take to make western societies save again? Likely some type of serious economic or financial shock that reinforces the fact that good times never last forever. When will that happen? Maybe soon or maybe not so soon. Some of that answer may depend on how accurate the data is. We all know there are lies, damn lies and statistics.

Now, what about foreign ownership of American debt or American assets? I even hear many of the people I respect worried about this. This is such a non issue for me. First off, if the foreign world wants to buy our national debt, let them. Fiat currency depreciation over time means that we can borrow today and pay foreign investors their investment back with a depreciated asset. In other words, tis better to have foreign capital financing our debt than my money. The long term real returns for them will likely be negative. Good for the U.S. and good for me. On the broader topic, is America not a melting pot for all nations and peoples? So, why is investing in U.S. assets any different than buying triple A rated bonds in GE? Do we complain about foreign investors owning GE debt? Seriously. Who cares? The peoples, nations and companies of the world want safety and they want to invest where they are most assured of getting it. Or maybe they just want to recycle dollars from the current account deficit. Whatever the answer is, today safety and the best returns are achieved by investing in the U.S. and Europe. (Risk adjusted returns.) Americans should wish for foreign investment. Just not at the expense of hollowing out national industry. In other words, I don't want to live in a society like China where foreign investment comprises most of the exports. Should companies decide to move assets out of China, what national industries are going to pick up the slack? More importantly, how does China convince labor arbitraging exporters not to pick up shop and move elsewhere when it is economically beneficial? By depressing wages? By some other unattractive method?

I'm leading up to the dollar with all of this. The dollar is everybody's whipping boy. I see these ridiculous articles such as the one in Der Spiegel and there's almost an air of exuberance that Goliath is ready for a fall. Even if it is a generally benevolent Goliath. Der Speigel’s article is an embarrassment. Very short on facts and very long on emotion. Or, as we used to say in Texas, "Big hat, no cattle". Every statement made in the article could be applied to the dollar over the last forty years. It is also an argument which I could apply to nearly every country's currency. Simply take out the U.S. and put in your country of choice with one difference: the dollar is the world's reserve currency. A little bit of schadenfreude in nearly every dollar bear's representation of the dollar.

So, now everyone has become a forex expert. I know enough to know those squawking about the dollar generally don't have any idea as to what the variables are moving the dollar. Look, being the world's reserve currency is a tough job with alot of demands not placed on other currencies. If the world was denominated in Yuan, we'd likely see gold at $3,000 an ounce and oil at $250 a barrel because of China's monetary policy. Some may argue that is because China has effectively outsourced monetary policy to the U.S. I say that's a little bit of bunk as well. As for the Euro, I remember when people laughed at the Euro because it immediately plummeted when introduced. Now it is up over 50% against the dollar. Yet, the money supply growth in the Euro region is just as high as it is in the U.S. So, actually, I could argue their central bankers have an inferior policy to that of the U.S. Why? 55% of global trade is in dollars. All commodities are priced in dollars. Oil is traded in dollars. With commodity prices being significantly higher than they were six years ago, it takes 6x as many dollars to buy the same amount of oil today than it did less than a decade ago. Ditto for other dollar denominated commodities. What are all of the commodity producing nations doing with all of the dollars they are collecting due to higher prices? Couple that with a dozen countries that use the dollar as their currency. Then we've got global central bankers buying and selling dollars in the currency markets. Some on a massive scale to affect their currencies. We've got normal credit creation and economic growth in the U.S. on top of that. Then we have instantaneous movement of capital around the global financial markets. Then we have complex financial leveraging and derivatives. Then we have excess cash sitting in short term instruments because people and companies are not investing. So, we have alot of dollars floating out there for reasons other than central banking policy and alot of stresses on the dollar not experienced by the Euro or any other nonreserve currency. I could type a book the size of War And Peace on all of the dynamics regarding the value of the dollar. But first I’d have to know them all. The dollar isn't necessarily going to weaken because of Fed policy. Nor is it necessarily going to weaken because of fiscal policy. Nor is it necessarily going to weaken because the American economy is slowing down. Nor is it necessarily even going to weaken period.

It's all very complicated and anyone who quotes M3 as proof the Fed is in some sinister plot to secretly pump money into the economy and ultimately destroy the U.S. is simply showing their lack of sophistication on the topic. (I'm being really generous with that statement.) What they are effectively saying is the Fed is pumping money into the system so that people and companies will turn around and park it in short term cash accounts. Because that’s what is happening. If I know that, I can assure you the Fed knows that. As I've said in prior posts, there is a lack of demand for capital. That is why mergers are off the charts. Why private equity is able to do deals that make no sense. That is why corporate cash is at astronomical levels. That is why stock buy backs are off the charts. That is partly why commodities exploded in price. That is why emerging markets are booming with American and European investment. That lack of demand is adding to money supply growth as an overabundance of dollars is parked in cash and cash equivalents. That contributes to dollar weakness. That is why I've stated those expecting a ramp up in massive capex spending are going to be trapped in the likes of IBM, Microsoft, Oracle, GE and others major capital equipment players. If companies aren't spending now, is throwing more money at them two hundred basis points lower going to convince them to spend? We are experiencing a liquidity trap, dollar glut, savings glut or whatever you want to call it. It’s all part of the same dynamic and all caused by the same systemic problem: lack of demand for capital.

It was reported a few weeks ago the head E.U. central banker intimated there might be something lacking with a policy that does not take into account money supply. This was after Bernanke said half of all dollars in circulation aren't even in the U.S., therefore he doesn't monitor money supply growth that closely. Well, how might Trichet handle all of the complex issues of the dollar? Oh, I forgot. He doesn't have to worry about most of them because the Euro is not the world’s reserve currency. The U.S. effectively restricts money supply growth through the same method the E.U. uses. In the end, the E.U. hasn't done any better job managing their money supply with a lot less complicated situation than Bernanke has.

The point I’m making is any concern about the dollar is driven more because of the concept of reserve currency issues and economic malaise and not because the U.S. central bankers are inept. The concept that the world's central bankers, sans the U.S., are somehow running a much more sound policy is maddeningly ridiculous. Anyone attempting to say the Fed has a death wish for the U.S. or is attempting to destroy the U.S. with massive debasing of the most important U.S. asset, the dollar, is attempting to bamboozle you on a topic they know little about. Don’t be fooled by fools. Or as Benjamin Franklin said, "Of learned fools, I have seen ten times ten.".

The reality is currencies are an extremely complex topic. Especially when it comes to being the reserve currency. It's easy to work out the obvious issues in your head-Fed cuts rates and the dollar drops because there is more dollars available. Simple supply and demand. But, that is applicable to any currency. So, will the dollar drop comparatively against another currency if central bankers on both sides are cutting rates? And what about the other ten thousand variables? How do they affect that statement? Do you have a supercomputer, a slew of economists, a few dozen mathematicians, a thousand programmers and a billion dollars? I’ll give you a higher probability of what the dollar is going to do. Most currency traders don't understand the issues. That isn’t so surprising. If you work for the Bank of Korea, all you know is buy dollars to weaken your currency. You don’t care about any of the other dynamics affecting the dollar, the other fifty currencies trading against the dollar, the American economy, global derivatives or what China is doing. It’s too complicated for a salesman so nary a person on Wall Street knows what they are talking about. At least the ones trotted out for public consumption. Most dollar prognosticators are linear thinkers trying to solve a nonlinear problem. The issues are very esoteric and the inter workings are hugely complex. Thinking about the dollar is like playing chess. If you want to know what the dollar is going to do next, I'd search out Garry Kasparov and have him punch it into that massive nonlinear machine in his head.

Let's say the global economies slow very significantly. Commodities will likely take a serious hit. Emerging markets will take a hit. Asian economies will ltake a hit. Government traders across many exchange markets will try to keep the dollar within certain price bands. That means enormous dollar buying by foreign central bankers. Emerging market risk will multiply. Rapid wealth creation and monetary growth in emerging markets will likely mean situations may develop that they have no experience handling. Therefore, their currencies could weaken significantly. Less dollars will be required to buy commodities and less commodities will be in demand. Central bankers everywhere will modify their policies. What if the carry trade is broken? If complex methods of borrowing yen or other currencies and buying dollar denominated bonds is broken, what will happen? Will interest rates rise in the U.S. as leveraged demand for Treasuries is unwound? That could cause a spike upward in the value of the dollar. And on and on and on. All of those issues affect the dollar supply & demand characteristics. How will the dollar react? Maybe it will rise as a safe haven comparatively. Why would I want to own Argentinean denominated assets? Korean? Indian? Assets denominated in those currencies would have a much higher risk profile than dollar denominated assets including gold. Will there be a rush for dollars? Will central bankers turn there dollars in for gold? Why would they do that when such an act would strengthen their currencies and kill exports? Does anyone really know what will happen or why? I’m going on the record and stating that the easily discernable variables do not point to a dollar collapse. In addition, I surely wouldn't want to be short the dollar right now with it being on the cover of The Economist and written about as being nearly worthless by the New York Times.

Now, I have waffled back and forth on the dollar a few times. Mostly on whether the Fed should devalue the dollar as they did in the 1980s. Something that may actually be in the works today for all I know. There is something wrong with how international trade has developed. It hasn't always been that trade was based on floating rate exchanges. Nor has the dollar always been the world's preferred currency of trade. We've seen change in trade mechanics and currencies which last a handful of decades then something happens or something is changed. We are on our third or so iteration in the last eighty years. There is something intuitively wrong with the current implementation of currency exchange rates, trade and the imbalances it is creating. In the future, trade may not be conducted the same way it is today. That wouldn’t be such a surprise as change has happened before. Maybe we have one currency. Maybe we have a partial gold standard of nine or ten cents on the dollar and similar backing by other currencies to help mitigate imbalances. My point is exchange rate rejiggering is not going to fix the imbalances we now see. Hank Paulson and Ben Bernanke can make all of the visits to China they want. Floating rates will not solve the China dilemma both the U.S. and E.U are dealing with. It is likely going to require a different solution at some point. What will instigate change? Maybe it's war. Maybe it's a dollar crisis. Maybe it's trade sanctions. Maybe it's something else. But, I can assure you, it will change at some point be it violently or otherwise. Be it expected or unexpected. Be it tomorrow or ten years from now.

I like to use this simple story told time and again with the “America is going to hell in a hand basket” crowd--Two men find themselves in an exotic locale and hear the roaring of a lion. Whereupon one of them starts to do warm-up exercises. "Have you gone mad?" says the other. "You think you can run faster than a lion?". "I don't have to run faster than the lion," says the first man, "I just have to run faster than you."

So, as ugly as it seems, the U.S. style of government, capital markets and economics don't need to be perfect. God knows they aren't. They simply need to be better than most anything else. As long as the world doesn't go to into deep depression, the U.S. economy will remain the most resilient in the world. And, America’s wealth will continue on an upward trend for a long time. Frankly, most of the world's politics and economic policies are a mess at best. That is why thinking in absolutes or refusing to take all data into account produces nothing more than GIGO queuing theory. Garbage In--->Garbage Out.

Let's end it here. Most bloggers, journalists and media have a very strong opinion on most topics. Present company included. That doesn't make any of them right. Present company excluded. :) The insanity focused on the demise of everything U.S. is deafening. Those people are clueless. Maybe if they whine long enough, they'll get a few things right. Recession? Yes. Worse? Maybe. Comparative destruction of the U.S.? Absurd.

In closing, I can share two facts with you. First, dollar volatility is at a half a decade low so there may be a significant move at some point in the next year or so. Second, every trader this side of Jupiter is crowded into the Euro/dollar trade as a dollar bear and that tells me that just as The Economist magazine puts "dirty dollar" on it's cover, the dollar will likely strengthen, at least for now. Free your mind and question everything. Always seek the truth. As it pertains to the dollar, regardless of what happens, it likely has little to do with Federal Reserve policy or what is being written in the press and more to do with the massive globalization stresses placed on a fiat reserve currency regardless of whether that would be a dollar, a euro, a yen, a yuan, a loonie or a baht.

Sam Zell's Holiday Wish

I've said that the dollar post is next but I keep running up on other interesting topics. The dollar post will still be this week but this is too compelling to pass up.

As many of you know, Sam Zell, the billionaire real estate titan, sold his real estate trust to the Blackstone Group for $36+ billion recently. Some may say Mr. Zell is the brightest mind in real estate. It's hard to argue with his success. So, is he selling too early as BusinessWeek asks or has he sold private equity a bubble? Since private equity is likely a bubble, Zell may have been selling a bubble to a bubble. What does that make his sale? Bubble squared? Now, I'd opine that commercial real estate is not as extended as residential real estate but I'd still say pretty risky for Blackstone and their investors.

I'm not sure who's behind this web site but it's being passed around. I'm confident it's Zell's voice in a holiday message set to a an amusing take on bubbles. Well, as amusing as this can be. Zell is basically saying the investment world is in for a rough ride for many years. Nothing new. I'm not sure if his premise is complete but his conclusion is interesting. Nearly every savvy financial mind has been saying the same thing.

Zell states that "in the interim the world growth with benefit from a lower cost of capital." Read: Asset DEFLATION and accompanying low rates. He goes on to say "Reducing the relative expectation on equity". Read: Below normal investment returns. He closes by saying "It's with an optimistic perspective" I share this extremely messy situation.

I'd say he ought to be optimistic. He just cashed out a very illiquid asset at it's likely bubble peak. This is an amazingly frank assessment by a very savvy business executive. Enjoy Sam's holiday message here until someone yanks it.

Here's What The Stragee-gerists Don't Tell You About Emerging Markets

Just a quick post I couldn't resist. Thailand's stock exchange crashed a few days ago. Well, I guess it wasn't a crash if you don't consider an equivalent one day loss on the Dow of nearly 2000 points a crash. The problem? Thailand's government tried to institute controls to keep its currency from appreciating. (They later recanted and said they were just kidding.) Remember, most emerging markets need and want a weak currency to support export growth. That way they keep their citizens from becoming restless and keep attempted coups to a minimum. You see, that way they don't need to worry about domestic reform. Not that Thailand needs any domestic reforms. I guess that Thailand coup de' etat earlier this year was just another day at the office. Pete said, "Hey John, what's new today?". John replies, "Oh, nothing. The government fell by force and we have a new leader." To which Pete replies, "Where do you want to go for lunch?".

At this phase of the expansionary cycle, it wouldn't be unusual to see more messy situations develop. Wanna buy a Baht? Not really. Wouldn't you rather own dollars? "Argh!", says the dollar bear.

Now, all of this brings up an interesting side bar discussion. From what I read, Thailand's entire stock exchange appears to have a market capitalization similar to Google's. I've mentioned before that Google's market cap is higher than many country's GDP. So, let's ponder deep thoughts with Jack Handy. If you were sitting on $150 billion in cash, would you rather own Google or would you rather own every public company in the world's 21st ranked economy of $600 billion? Well, that's really difficult, isn't it. People who say Google is fairly valued don't live on the same sanity plane I do. Maybe in the roaring 90's it was fairly valued until it would be no longer fairly valued in 2000. But today? Let me drain my savings and put it all in Google. Puuuhhleeeaasse!

The NYSE Composite And Long Cycles

Click on the chart for a larger view.



Ok, today I post a treat. It's not exactly secret but it's a chart that very, very, very few people have likely seen. Did I say very? I've never seen this chart any where else and likely there are only a handful of Andrews' Media Lines users across the globe who have ever seen this chart. That's because he did his work nearly a century ago and the use of his work is somewhat of a lost art. Consider it your Festivus treat.

The NYSE Index has always been considered the institutional index. It's where the smart money has historically done business. Above is a chart of the NYSE Index starting with the bull market of 1982 till today. Overlaid on the chart are Andrews' Median Lines.

Andrews' Median Lines are drawn by selecting three points on a chart. Not by drawing the lines themselves. In other words, there is no cheating. You start with a significant high or low, then pick a significant high and low at a later point in time. In other words, A, B and C points. From there, the charts are drawn from the three points.

I'm not going to go into details on how to use median lines but this is an after the fact use. Not the primary intent for their use. We start by selecting the low in 1982 (A) which is considered the start of the greatest bull market in history through 2000. We then select the price peak in 2000 (B) which was the end of the bull market. Finally, we select the price low in the post 2000 bear market (C). I've got software which then automatically draws the median lines but if you were to draw them manually like Andrews did eighty odd years ago, here's how you would do it: Connect lines B and C. Determine the midpoint of that line and draw a line from A through the midpoint. Then draw lines parallel to the that line from points B and C for the upper and lower median lines. There you have it.

This chart is really using median lines as linear regression lines. Therefore, we can draw some conclusions. Sure seems odd how we bounced off of support and resistance time and again. The crash in 1987? The May 2006 peak? The 1998 LTCM scare? Coincidence? Well, if that's coincidence, I'd like to have gone back in history and invested with coincidence. What conclusion would I draw from the October 2006 price shove north of the upper median line? Anyone calling a new bull market from here is buying at historically extreme price levels. In other words, they very likely wrong. Did I say very?

Dollar post later this week.

Time To Have Your Favorite Commodities Hedge Fund Make You A Copper Bracelet

I'm written time and again that industrial metals are in the biggest bubble in the last one hundred years. I remember reading some time ago the cost of mining a pound of copper was something ridiculous like 1-2 cents. Maybe with petrol prices so high, it's 3 cents. With copper well over $3 and at one time $4, it's time to have your favorite metals hedge fund make you a copper bracelet with any delivery they may have taken on expiry of their futures contracts.

Isn't it interesting that so many money professionals have been out convincing retirement fund managers that commodities are non correlated to stocks and provide a superior return over the last thirty years? By the way, that is an extremely dubious statement unless you are a very aggressive market timing commodity trader who is taking tremendous risk. Now, retirement funds are left holding the bag, adding to their under performance and unfunded liabilities should prices collapse. Now, copper hasn't fallen off of the cliff yet so hopefully retirement funds will do something they shouldn't be doing, which is aggressively trading, and beat a path to the exit.

Interesting quote from an old geezer in an article at Bloomberg today. "The cost of taking copper out of the ground is so low, I don't know how we can justify these prices,'' said Warren Gelman, 73, president of distributor Kataman Metals Inc. in St Louis. "$4 overwhelmed me. $3 copper is way overpriced.''

So, does one believe a 73 year old president of a metals company who has lived through decades of market dynamics or a 35 year old Wall Street representatitive who tells you it's different this time?

What's a fair price for copper? How about less than $1? That sounds fair to me. That's the long term average. Never, ever believe it's different this time. Copper's price came awfully close to the low end of silver's price range this cycle. That either means we are seeing a collapse of our economic system because of monetary issues or we are in a bubble. It's copper not diamonds. The long term availability of copper is coming out of our ears.

Was Witching Week Putting A Bid Under Equities?

Markets sometimes move in mysterious ways. Shorter term gyrations lasting months can have less to do with fundamentals and more to do with market mechanics. I've written before about this recent rally and what the likely causes were. Some people choose to label it as a rally by some secretive Plunge Protection Team, some as a manipulative rally, some say it is fueled by Fed liquidity injections. I tend to believe what is most obvious is that people who are calling a rally conspiratorial were likely positioned for the market to go down and didn't get their wish. It's easier to explain away your faulty market calls if you blame some unknown forces. Having clients sitting on the sidelines while the indices are screaming higher is surely a very unpleasant situation. So, what does one do? Blame it on conspiracy. I guess a little of "the devil made me do it" from the Church of What's Happening Now! Unfortunately, Flip Wilson was a hell of a lot more funny.

What money managers, caught on the wrong side of the trade, should have said was that risks did not warrant an aggressive market stance. Ben Graham, Warren Buffett, David Dreman, Julian Robertson, Richard Russell and John Templeton would all likely feel extremely uneasy being long and hard right now. In fact, I know a few of these names are sitting with inordinate amounts of cash because there is nothing to buy. That includes Warren Buffett who is sitting on a monster mound of cash and has commented that there is little value out there. These are the people who will (or did) win the investment race over the long haul. And so will you if you learn to think like them. Part of that philosophy is not chasing nor feeling some great desire to be in the markets all of the time. There are simply times when one needs to stay true to their discipline knowing they will ultimately be rewarded with better opportunities. That compares to the frantic "return chasers" who are gambling in the market today.

Historically, it's not that difficult to find a rally into weakening fundamentals. For that, all you need to do is look at the second half of 1998 and 1999. In addition, the data has not been so bad that every major market participant would run for the door. ie, The soft landing crowd still has an argument although it is a weakening argument.

I've shared my disdain for all of the conspiratorial theories as to why the markets have rallied and chalk much of this rally to short covering with a dash of defensive movement, money moving out of real estate, merger mania and money moving out of commodities. The dump in May was telegraphed quite clearly. The particular day it started was a mystery but not the months leading up to the sell off. Once the ashes had cleared in August, there was a dearth of sellers. So, the market basically did nothing for quite some time until participants got their bearings. As we all waited for the next move, there was a selling vacuum and the big money had all they needed to see. Everyone was short or in cash and someone was going to have some fun jamming all of those short positions. Most of us know when shorts have to cover, that act over covering is actually called a "buy to cover" for those who are neophytes. When the pain is too great, the shorts cover, buy their stocks back and actually fuel the buying momentum upwards. It's not rocket science. It also explains the almost step-like approach to the rally. The same action was common intraday where many daily moves were finished in an hour with the rest of the day basically treading water. That was likely cash/futures arbitrageurs as a relatively easy explanation for that type of intraday activity. Buy the futures premarket and the cash market rams higher immediately at the open. Ultimately when there are no more shorts, the market easily slides higher with no resistance above. That is, until there are no more buyers. Then, what is left below? An area of no support because normal action of backing and filling never occurred. Look at the Major Market or OEX and you'll see what I mean. There is no support below until you get to the May top. To me, that potentially means any sell off could be brisk and steep until we drop back to the May highs.

To the uninitiated the market action appears as though Wall Street is speaking and the global fundamentals are fantastic. Maybe they are but there's too much fundamental data to the contrary so I tend to believe this is a temporary phenomenon. That said, we just have to wait and see. Wall Street's insanity can be long lasting. The market was wildly overvalued in 1998 but that didn't keep the machine from grinding higher for another eighteen months. Why would this bubble be anything other than irrational like the last one?

I don't expect the averages to implode on Monday but underlying strength in the markets is weakening. On the chart below is the NDX with two plots against it. These plots are the normalized buying pressure of two groups of Nasdaq equities. The blue-green line is the cumulative buying pressure of a set of underlying Nasdaq stocks I would classify as value oriented. The red-gold line is the cumulative buying pressure of a set of underlying Nasdaq stocks I would classify as speculative. In other words, the buying pressure for each individual stock is normalized and added to a total for the set of equities included in the calculation. Buying pressure is my definition of an algorithm, whose primary input is volume, which I have developed. They are not oscillators hence theoretically, they should remain in the direction of the trend for as long as it lasts. Of course, markets never trend forever without some type of pause to refresh. So, maybe we are just pausing here. But, it's rather abnormal to see the data points turn negative without the averages showing any weakness. It will be interesting to see if there was a bid put under the markets that might be gone now that we are out of witching week.

Beware The Angry Bear

It seems every where I turn, all I hear is the soft landing story. One of the most well respected Wall Street money managers had a commentary a few months ago which starting something like this: "Never in all of my years of investing has the case for a new bull market been so strong.". My response to that is never have I heard someone so delusional. Get back on your medication.

I saw a comment today on another blog where a thoughtful poster was concerned about the economy and was questioning his expectation of a hard landing. Maybe we won't have a hard landing. Well, ok, we will. Sorry to ruin Festivus.

Beware. The bear is lurking. You may not see him but he is out there. I appreciate market commentary but the reality is I don't write about much of anything I can't validate with facts. I have opinions but I use data to support it. The data might ultimately be wrong or I may be misinterpreting the data but I quickly became bored with opinion as soon as I was old enough to have my own.

Below is a graphic from January of 2002 till today. It's pretty easy to recognize the beginning of the economic expansion in March of 2003. It's also hard not to notice it's falling off of a cliff today. (You may click on the graphic for a larger view. It is wider than your screen if you do so. So, you'll have to scroll side to side for a full view.)

Last post this week. I'm taking a few days off. Next week we look at Fed policy and the dollar. Happy holidays!

Sincerely,

The Bear

Retail Sales "Surge"?

The AP has a story out this morning stating retail sales surge by 1%. Well, given this is the season most retailers generate 30-50% of their profits, I don't think they would classify this as a surge. Be that as it may, Best Buy reported major appliance sales were down significantly and the auto industry has already reported their sales are down, yet both of these numbers are up in the ESTIMATED data reported this morning. Is a downward revision in the cards? A couple of data points I track are pointing to a weak Christmas.

The King And I. Roger's Fable

Or, more aptly put, Roger and Me. Ah, the good old days. The days when GM executives were at the height of their arrogance. While GM complains of cheap imports even today, we are reminded of what GM is capable of when the company puts its mind to it. Former CEO Roger Smith, quite possibly the worst CEO in the history of America, championed efforts such as this in GM's drive to unequaled customer service, superior product quality and international design excellence. Roger was rewarded with a multi-million dollar retirement package while the rank and file at GM endured hundreds of thousands of job cuts due to his unequaled leadership. Roger spent enough money on robots running into each other in an attempt to "out modernize" Toyota than he could have paid to buy all of Toyota. For that we got the product highlighted above on Autoblog today. Oh, great King, how we miss your divine leadership and wisdom.

Compare that to today or here. Has GM finally turned the corner? Not yet. The product mix is still not what consumers want. But, they are making exponential gains in product design, especially interior design. They are also recognizing failures and quickly planning replacements or redesigns.

Banks, Hedge Funds, Brokerages, Derivatives And The SEC

As I've written time and again, consumer protections in the financial system are one of the most important set of laws any society must have. Full faith in a country's financial system needs to be a given under the worst of circumstances. There are many imbalances which have never been stressed before in global financial markets. At the same time, with complex new strategies and the co-mingling of consumer savings with these new strategies is worrisome. I would say the world financial system is near a point of heightened risk. Where we go from here is anyone's guess. Maybe no storm will develop. Maybe any storm will be contained. Maybe we could all experience a major hiccup. While there are many who are predicting the demise of all things U.S., I would argue the U.S. is in a much better position to absorb a trillion odd dollar mess than China is with a 2-3 trillion dollar+ mess with their absolutely horrendous, Tokyo II, Godzilla eats China, banking and overbuilding mess in the making. As I've said incessantly, China's potential for a banking and/or deflationary crisis makes Japan's deflationary pop look like dinner with the Cleavers.

I believe these risks exist in nearly every country. This is surely the most unusual situation since the 1970s and more likely only superseded by those decades before the 1970s. Why? Because modern day economics are not prepared to handle global synchronized growth. What do I mean by that? The boom & bust cycle created by central bankers injecting and retracting liquidity simultaneously and on a global scale only exacerbates imbalances and creates higher odds the ultimate mess is significantly larger. Significantly..........global. So why tout TV raves of global growth potential, the ultimate outcome concerns me. Why does this situation exist? Here I go again. Because global leaders don't want to tackle the painful issue of reforming their economies and political institutions to stimulate domestic demand. Hence, everyone relies on America to consume all of their output. So, when America sneezes, the world catches a cold. The end result is a synchronized central banking effort of lowering and raising rates in concert with the state of the American economy. Some economists and investment professionals will tell you global economies will not be affected by a U.S. slowdown but how many times does it have to happen to realize IT IS NEVER DIFFERENT THIS TIME. Yes, I sound like a broken record but with China's exports being 35% of their GDP and up to 75% of those exports from foreign national corporations doing business in China, it doesn't take a rocket scientist to see the shit is going to hit the fan some day. (As is with concern over the Russian banking system per a prior post. I'm sure the list goes on and on.)

Back from my rant to the topic of this post. The global real estate situation has the potential to create a severe recession globally. That alone could create a crisis but what concerns me the most are global financial systems. Credit derivatives, mortgage backed securities, speculative risk, unstable loan practices, credit expansion and lack of demand for capital have created a situation that could turn into a perfect storm at some point. Now, my opinion is that there is no sense in worrying about what may happen. Such a thesis would have everyone worrying their lives away. But one should be aware of potential risks and incorporate those risks into their strategy. To have Warren Buffet state much of this situation is a "ticking time bomb" which has never been stressed or the EU's concern about a financial meltdown caused by credit derivatives and hedge funds should be duly noted.

While no one can predict the future, the global imbalances concern me enough that I have moved all of my paper assets to financial institutions with little to no exposure to such concerns. If the government is going to repeal Glass Steagall and take a laissez faire approach to regulation of those who hold my savings, then I'm going to become my own regulator. I'd rather have my investments where I can take advantage of any situation rather than be part of the situation. People in 1929 never expected a run on the banks and while I think that is extremely remote, almost paranoid to think it could happen again, it took me a total of two hours to do and it cost me nothing. So my minor bout with paranoia is taken care of. Or, as I like to say, "A bad plan is better than no plan". That reminds me, "Only The Paranoid Survive" is an excellent book written by a brilliant CEO and even more brilliant strateee-gerist who was quite good at strateee-gery.

Gary Aguirre, an SEC attorney, made headlines this past summer with some very serious accusations re the state of the U.S. financial system. I thought it was very timely to dig up his letter and post it. Obviously, I don't know Mr. Aguirre but he appears to be a very able and quite articulate attorney. Is there any substance to his claims? His letter is relatively long but a very easy read. I highly recommend reading it. Regardless of whether Mr. Aguirre is correct, he brings up many concerns and parallels between history and today's environment that remind us why corporations should never be trusted to do the right thing when it comes to our savings. ie, Regulation of the financial industry isn't simply attempts to impose bureaucratic will, stifle innovation and kill job creation as said CEOs and business leaders might have you believe. I am well aware of history and man's endless ability to create unbalanced situations.

Note: Does anyone know how to upload and attach a nonpicture file to Blogger Basic? If so, I'd appreciate your comments.

Automobile Fuel Efficiency Or Lack Thereof

It's no secret the automotive industry isn't known for its innovation. While I highlight the American auto manufacturers as being generally unresponsive and delivering terrible products over the last half century, there's plenty of finger pointing when it comes to energy efficiency innovation. Getting significant gains out of the standard four stroke internal combustion engine is a slow and arduous process. Even if auto makers were able to achieve theoretical efficiencies, and they never will, we aren't looking at engines capable of hundreds of miles per gallon in a family sedan. In fact, we probably aren't looking at more than 40-50mpg in a gasoline powered family sedan. But, GM has spent more money on research & development since the 1970s than it took to develop whole new ranges of technology and put a man on the moon in the 1960s. Yet, for this we get a 2007 subcompact, the Aveo, which appears to get worse gas mileage than a 1975 or 1985 Chevette. Below is a headline news story from 1975 showing what appears to be the combined EPA mileage for a 1975 Chevette being 33mpg. Below that is a 1985 (The oldest model year I could find) Chevette with statistics pulled from a U.S. government page showing combined mileage of 31mpg with a manual transmission. And, below that is the 2007 Chevy Aveo subcompact with mileage numbers worse than a 30 year old GM car.

Is this what a shareholder of GM gets for its research dollars? A smaller car with less efficiency than a thirty year old car. Imagine if IBM or HP delivered a computer with less capability than thirty years ago. Now, I realize the comparison is not fair. But, what is fair is that GM and other auto makers have not really made any significant innovations as it pertains to environmental or fuel efficiency issues. They would tell me that it is because the market hasn't demanded it. I would tell them that it is their responsibility to create new markets. To tap into latent or unknown demand. To create demand around a relevant marketing message. So, did people not care about the environment for the last thirty years? Oh, that's right. Those people were radical liberals. An image reinforced by the automobile industry and its politician buddies.

So, does anyone have a 1975 Chevette? I'm concerned about the environment and the impact of high fuel prices on my wallet. I'd like to buy one. It's the best gas mileage of any car in the GM global portfolio of products. And, that is pathetic.

CBS Evening News for Monday, Sep 22, 1975
Headline: EPA Tests / Gas Mileage
Abstract: (Studio) Environmental Protection Agency tests on gas mileage show American car to be 1 of top gas sources.
REPORTER: Walter Cronkite
Environmental Protection Agency films shown. Tests report 12.8% average m.p.g. increases in 1976 cars from 1975 cars. Cars tested on dynamometer. Mileage winners are: Datsun B-210 at-33 m.p.g.; Chevette (98 cubic inch) at 33 m.p.g.;

1985 Chevrolet Chevette
	Chevette
EPA Fuel Economy
Fuel Type	Regular Gasoline
MPG (city)	28
MPG (highway)	36
MPG (combined)	31

2007 Chevrolet Aveo
	Aveo
EPA Fuel Economy
Fuel Type	Regular Gasoline
MPG (city)	27
MPG (highway)	37
MPG (combined)	30