What to do going forward (part 2)

While I will agree with you on the metals play, you jumped in a bit early (not a sin), as hedge funds are unloading everything to raise cash--stocks, bonds, commodities, their first-born, etc.You're down 10%, but again, not a sin.

What I do object to is your recommendation of speculative mining stocks. Some of these junior mining companies could run out of cash unless the coming boom occurs soon, which it may or may not. An investor would lose all or much of their investment (cash-poor mining stocks sometimes agree to be acquired, albeit it at a low price). It would suck to make the right call on the direction of metals, and but lose money because the mining company ran out of cash. So yes, on mining companies with cash, no on the speculative plays.

I do like your call on coins and some of the larger gold and silver mining companies--as long as they earn a profit and are well-capitalized (have lots of cash).

As for peak oil, that call proved to be disastrous--or really early, as there has been demand destruction due to a worldwide slowdown. An alternative energy play is natural gas MLP's, which are currently yielding double-digits (all-time highs). Their prices have been battered, but I like the bigger ones who are paying out dividends to unitholders, as they must from positive cash flows. I don't mind waiting for a turnaround if I can earn 20% on my money--most of it tax-deferred. Crude oil is sensitive to the worldwide economy. Natural gas is less sensitive to the transportation and manufacturing industries. However, people need to heat their homes, and cook their food. And more fleet vehicles are being converted to natural gas, as it burns cleaner. But like I said, earning 10-20% is better than earning 1%. When energy prices do recover, these MLP's will appreciate as well.

What to do going forward (part 1)

There's nothing confusing about this: Dave and I just made a ton of money today. Trust me, it's just the beginning. I'm not even referring to the stock market. As I said earlier, the buyers and sellers will continue to fight each other on where the exact bottom will be. Stocks will trade inside a range, albeit it a wide range, due to high volatility. Meanwhile, contrarians like he and I will be adding to our positions geared towards inflation and financial meltdown. Savvy investors will eventually see it, then CNBC viewers, and by the time the mainstream audience catches on, gold will be testing their all-time highs.

When you print money like toilet paper, something has to give. Don't just look at the $USD/gold relationship. Look at the price of gold from a foreign currency perspective. From their standpoint, the price of gold is at an all-time high already, because the $USD is temporarily gaining strength due to the flight to quality, as sovereign funds, hedge funds, mutual funds, and private equity firms face redemptions from investors selling. More banks and financial institutions will go under as a result. Companies will go bankrupt, due to lack of liquidity and lack of access to credit. If people insist on owning shares, the only ones I would trust are Wal-Mart, McDonald's, Coca-Cola, Berkshire Hathaway, Altria, ExxonMobil. Focus on dividends, cash flow, cash position, and ability to borrow. Microsoft will be able to tap into the corporate bond market at 2%....which is better than what the US government will be able to borrow at. Think about what I just said: Microsoft will be more credit-worthy than the US government.

In light of all these federal government bailouts, and solvency issues with banks, financial institutions, insurance companies, autos, airlines, etc. has anybody even thought of whether the government itself will be solvent? They continue to print money at a rate of $1 trillion extra a quarter. That devaluates the local currency. Once people wake up to this inflationary scenario (where the US Treasury will have to borrow at 8% or above), one where the $USD deteriorates, gold and silver will skyrocket. Right now, the markets are focused on deflation. That will change--it's only a matter of time. And when you have disinvestment AND inflation, you get stagflation like we experienced in the 70's, only this time, the overshoot will be even more severe.

What happened?

The stock market, and pretty much every other assets are plummeting due to hedge fund, mutual fund, and private equity firm redemptions. Investors are bailing out, so these funds have to sell assets--any good assets to raise cash. They can't sell the bad assets because no one wants them. So they are unloading good assets at low prices--that's why value players are salivating, but they keep getting burned because assets at cheap prices are getting hammered and getting even cheaper. This tug of war between bottom fishers and forced asset sellers is what's causing the high volatility. Overall, tho, the sellers are winning, as they are panic selling in droves, swamping any brave buyers. Eventually, these buyers lose out (at least in the short term), as even the savviest value buyers are seeing their entry points as being too early and too high, despite metrics that suggest they are good buys. Ultimately, over the long-term, these value buyers will be proven correct, but for now, guys like Buffett and Soros have seen their positions drop by more than 10-20%, despite buying assets that have already dropped more than 50% already.

For example, if a solid company's share price has already dropped 80%, it may seem cheap. It may be, but that doesn't preclude it from dropping another 50%. Let's say a stock is at $100 last year during its peak. It is now at $20. A Buffett buys at that price, thinking he's getting it at a bargain. He may be right (based on projected earnings growth, or more correctly, discounted cash flow), but that doesn't mean the stock won't drop to 10 before bottoming out, say next year. Ultimately, if the stock is worth $50 a share, Buffett may ultimately win out (he usually does), but only if he has a long-term view. While he may be annoyed, and since he's got plenty of cash, he can wait it out.

Realize that the fixed-income market dwarfs the equities (stock market)--that's why the subprime mortgage debt bomb obligerated everything around its wake. I wrote a quick email to some folks recently:

"That's not entirely correct. Derivatives allowed investment banks to transfer that risk to shareholders and get it off their books. When default rates on sub prime mortgages reached inevitably high rates, the credit default swaps (CDS) blew up, as they insured the sketchy collaterized debt obligations (CDO).

These CDS's are basically contracts which insured these mortgages against default--in this case, highly-risky subprime mortgages to marginal borrowers. The problem was that insurers like AIG didn't charge enough premium to insure these mortgages, as everybody assumed California real estate prices would always go up, and that few borrowers would actually default. With home prices/income ratios above 10, this assumption was unsustainable. And because these derivatives were highly-leveraged ($1 could control $40 or $100 due to Wall Steet's repackaging of said debt), if those assumptions turned sour just a little bit, whatever little equity put up as collateral disappeared. And once the selling of assets to unwind from those positions began, the vicious spiral just fed upon itself, as everybody had to de-leverage from their overly leveraged positions. It became a Category 5 game of hot potato, and the investors (hedge funds, pensions, institutional money) got burned, while chasing the high yields during good times.

Wall St. did a great job of selling this "AAA" paper as non-risky, when they were extremely speculative. The ratings agencies were unknowing perpetrators of this shell game. Wall St. repackaged these @#@% loans, and the ratings agencies gave it their blessing as low-risk, investment-grade securities. What compounded the problem is that some of this paper was created without even any mortgages to back them.

Derivatives by definition use leverage. It can be useful for hedging strategies, but hedge funds didn't use them as hedges--they used them as levers to squeeze out more returns. When the bets turned against them, they had to sell assets to raise cash as investors headed for the exits. This de-levering is causing markets to tumble.

I could go on ad nauseum, but I think you get the picture. I don't worry about what happened--I was able to avoid most of the roadkill, as I was out of the market in June. I am concerned about what's going to happen next, and I'm afraid the worst is ahead of us. We are going to see a carnage unseen since the Great Depression, as the unwinding of positions is not over yet--not even close. Thankfully, I've got a strategy in place for me and my clients which will enable us to not only survive this crisis, but also profit handsomely from it.

Without going into details, it does involve certain currency plays, financial institutions here and abroad, and various asset plays, including equities (surprisingly). More shoes will drop, and there will be bigger shocks and bank failures, some unfathomable only a few months ago. I predicted GM would be insolvent as far back as two years ago when people thought I was crazy (all documented in my blog). Last month, CNBC splashed it on their headlines, and now CNN has it on theirs.

I can send you a link to my blog, as well as what to Google. I will not do the research for you, but I will point you in the right direction. I will tell you the strategies will not be mainstream or conventional, but then again, conventional hasn't worked, has it?

I will give you this thought in case you think I am ringing alarm bells unnecessarily. Everybody is bitching and moaning about a $700 billion bail out (which is less than $1 trillion). Recall I mentioned CDS's as basically insurance--only they were labeled by Wall St. as "swaps" in order to avoid regulation (insurance contracts are heavily regulated, and you can't pile leverage on them). They were creating these insurance contracts with no regulation, and hence, no reserves to cover them. Guess how many swaps were written, and how big the derivatives market is? Some are predicting over $500 trillion! (A definitive number is difficult to calculate since these products were so complex, were sold so many times, and generally not transparent). In other words, there's no bailout that will mitigate this deleveraging. The current band aid will only prolong the process, but the perfect storm will come down upon us--soon."

As an edit: we've lost $10 trillion in equities market capitalization (net worth) in the last two months. That figure will seem minuscule when these derivatives blow up in our faces, and when Paulson et. al will no longer be able to hide it from the public. Read his past comments over the past year and a half. You will see he has hoodwinked us all along.

The next shoe to drop...

We've seen the subprime mortgage crisis spill over to the whole residential mortgage industry, causing property values to plummet in many regions. Collateral debt obligations and credit default swaps turned sour have caused a further erosion of asset values and balance sheets across the globe. This has caused a run on several investment and commercial banks, most notably Lehman Brothers and Washington Mutual, respectively. This cascaded over to the stock market, leading to breath-taking declines across all sectors, including industries in hard assets, like oil, natural gas, gold, and the other minerals and commodities. While the Fed dropped its funds rate to 1.0%, and the Treasury turns on the money spigot, we anticipate future inflation. However, due to massive investor redemptions at hedge funds and now mutual funds in an effort to raise cash, individuals and institutions alike are scrambling to de-lever their precarious financial conditions. Deflation--not inflation, is the current concern. The R word (recession) is not a question of if, but how deep and for how long.

So the worst is over and the unknowns are out on the table, right? Wrong. Just as many teaser residential loans have been re-setting, causing a barrage of foreclosures, the commercial real estate market, which has held up relatively well up to this point, is now in real danger of falling off the precipice as well. As companies announce massive layoffs, and as consumers hunker down to save for a rainy day, companies have lowered earnings projections (hence, shares of equities have plummeted). These conditions will be disastrous for commercial real estate values, which are ultra-sensitive to economic conditions. Expect more bankruptcies, vacancies, and foreclosures in the commercial real estate space.

I wrote this letter before the day after...

I wrote this after Obama was declared the winner in the Presidential race:

Obama will perpetuate the welfare state, as people seek handouts instead of being productive members of society.

I agree with all you said about Obama--he's charming, articulate, intelligent, and perhaps even well-meaning. Jimmy Carter was the brightest President we've ever had. Look what happened when he was in charge. Granted, he had a speech impediment, but Obama's ideas are actually more dangerous.

My advice right now is to put your money in tax-free vehicles, whether muni bonds or properly structured, maximum-funded life insurance, or the Mississippi Go Zone. For Growth, buy Wal-Mart and McDonald's, as the strong will get stronger. Natural gas pipelines master limited partnerships are down 80% from their peak, yet reporting recording earnings. And meanwhile, they're giving 20% dividends annually while we wait for a rebound. 200-300% returns won't surprise (between the quarterly dividend and share appreciation), and it's not some speculative high tech play--it's an investment in a gas pipeline company--people will still need to heat their homes and cook, even if they turn the thermostat down. Plus, more municipalities are converting their fleet vehicles to natural gas, as they burn cleaner. T. Boone Pickens made a fortune in oil, then natural gas, and now alternative energy. Bet WITH him, not AGAINST him. Two gas plays I've bought have ex-dividend dates of Nov. 10, so it's too late to buy (it takes 3 business days to settle positions)--there are others, or I will wait another 3 months for the next window.

Kinder Morgan is the safest play, but their dividend is only 6% at today's prices--still solid. My buys have higher yields (20% and 14% dividends, respectively). Since it's an MLP , all its cash flow and earnings go directly to unitholders (me). These MLP's should double within a year, but even if they are flatlining, I still earn the dividend. Disclaimer: this is not a recommendation for any single commpany--these are shares I purchased myself or am considering purchasing.

If you wanna be lazy, just put it in an orange account earning 3%, but realize the big, bad wolf of inflation is just around the corner. The Treasury is printing all kinds of dollars, trying to save this sinking ship, and it's going to make our currency worthless, much like the 70's, when gold, oil, gas, and every other commodity skyrocketed. It's not a matter of if, it's a matter of when. The market will finally wake up to it, and you're going to see a mass exodus OUT of the stock market and real estate markets, and one INTO hard assets.

Meanwhile, watch a lot of TV, read a lot of books, work out, surf the internet, because doing anything else will be expensive.

Yesterday's rant:

Well the markets certainly confirmed my suspicions that Obama is not the answer, even if the average person wanted a "change", as the Dow Jones dropped almost 500 points yesterday. Usually, a change in regime brings hope, a renewal of faith, and optimism, which people are holding on to. But the real money is saying "I don't think so". They're saying growth will be negative or non-existent for years, our future looks grim, and so do our children's and grandchildren's, as we sock them with future taxes on money we spent that we didn't have.

I was wrong--GM lost $6.9 BILLION last quarter--much worse than even the most pessimistic projections. Their collapse is inevitable, as even a bailout by the governement won't help--neither will a merger with Ford or Chrysler.

Hell, at this pace, the US government will be out of business this next decade. At which point, the gun enthusiast with 50 guns will seem prescient instead of crazy.

The Obama un-rally....

As predicted, the market tanked as the Presidential race is over, with Obama being the victor, but the US economy being the loser (this is not an endorsement for McCain). The market is basically showing no confidence that Obama will succeed in stewarding our economy out of this financial crisis. The markets are living down to their negative bias of the President-elect who has repeatedly stated he wants to tax our way out of this slump. History shows it has never worked, and it won't work again. Based on rhetoric, the Obama regime will look more like the Carter years than the Clinton terms--only Obama is inheriting a much worse economy than the other Democratic Presidents.

Economic models explained by...cows

I stole this from another blogger from my alumni site, Paula Lorenz (who knows where she read it):

The 2008 update

SOCIALISM
You have 2 cows.
You give one to your neighbour.

COMMUNISM
You have 2 cows.
The State takes both and gives you some milk.

FASCISM
You have 2 cows.
The State takes both and sells you some milk.

NAZISM
You have 2 cows.
The State takes both and shoots you.

BUREAUCRATISM
You have 2 cows.
The State takes both, shoots one, milks the other, and then
throws the milk away...

TRADITIONAL CAPITALISM
You have two cows.
You sell one and buy a bull.
Your herd multiplies, and the economy grows.
You sell them and retire on the income.

SURREALISM
You have two giraffes.
The government requires you to take harmonica lessons

AN AMERICAN CORPORATION
You have two cows.
You sell one, and force the other to produce the milk of four cows.
Later, you hire a consultant to analyse why the cow has dropped dead.

VENTURE CAPITALISM
You have two cows.
You sell three of them to your publicly listed company, using letters of credit opened by your brother-in-law at the bank, then execute a debt/equity swap with an associated general offer so that you get all four cows back, with a tax exemption for five cows.
The milk rights of the six cows are transferred via an intermediary to a Cayman Island
Company secretly owned by the majority shareholder who sells the rights to all seven cows back to your listed company. The annual report says the company owns eight cows, with an option on one more. You sell one cow to buy a new president of the United States ,leaving you with nine cows. No balance sheet provided with the release. The public then buys your bull.

A FRENCH CORPORATION
You have two cows.
You go on strike, organize a riot, and block the roads, because you want three cows.

A JAPANESE CORPORATION
You have two cows.
You redesign them so they are one-tenth the size of an ordinary cow and produce twenty times the milk. You then create a clever cow cartoon image called 'Cowkimon' and market it worldwide.

A GERMAN CORPORATION
You have two cows.
You re-engineer them so they live for 100 years, eat once a month, and milk themselves.

AN ITALIAN CORPORATION
You have two cows, but you don't know where they are.
You decide to have lunch.

A RUSSIAN CORPORATION
You have two cows.
You count them and learn you have five cows.
You count them again and learn you have 42 cows.
You count them again and learn you have 2 cows.
You stop counting cows and open another bottle of vodka.

A SWISS CORPORATION
You have 5000 cows. None of them belong to you.
You charge the owners for storing them.

A CHINESE CORPORATION
You have two cows.
You have 300 people milking them.
You claim that you have full employment, and high bovine productivity.
You arrest the newsman who reported the real situation.

AN INDIAN CORPORATION
You have two cows.
You worship them.

A BRITISH CORPORATION
You have two cows.
Both are mad.

AN IRAQI CORPORATION
Everyone thinks you have lots of cows.
You tell them that you have none.
No-one believes you, so they bomb you and invade your country.
You still have no cows, but at least now you are part of Democracy....

AN AUSTRALIAN CORPORATION
You have two cows.
Business seems pretty good.
You close the office and go for a few beers to celebrate.

A NEW ZEALAND CORPORATION
You have two cows.
The one on the left looks very attractive.

And the bonus, recently added:

A VEGETARIAN CORPORATION
Your cows are really soy plants.
You claim the milk they produce tastes just as good but uses less energy to produce, and no one buys it. (No animals were harmed in writing this comment)

The other side of calls and puts...

Most speculators buy calls and puts, looking to earn exponential returns if they guess right on the movement of shares. Reading charts and using technical analysis, as well as exercising discipline and pricing models are pre-requisites in order to succeed. A great sense of timing--and luck help.

I normally don't like to do it, but selling covered calls is actually a conservative strategy to increase income and overall returns, so I've been known to utilize that strategy occasionally.

And I've never entertained selling puts--until now. Due to high volatility (as measured by the volatility index) and extreme uncertainty in the markets, options premiums have been astronomical. Hence, I sold a few puts on INTC, collecting the premiums, and lowering my entry point on Intel shares, should they dip below my strike price. If they don't hit, I still keep the premiums. Not a bad way to make money by doing nothing and standing pat.

And if the world were to end tomorrow, people will still go on-line, so Intel will be one of the strong brands that will be left standing. They have dominant market share, a strong cash position, no debt, and high margins. I like them at the present price, but I like 'em even more if the price falls further.

Bargain basement

Any bargain hunters who have ever been to Boston know of two names: Filene's Basement, and the No-Name restaurant. The former gets you designer rags for pennies on the dollar, especially factoring in the age of the apparel, as time erodes its price. The latter is a no-nonsense Maine lobster house, where prices are half of the more famous Legal Seafood chain and local favorite SkipJack's. There is no ambiance, but you get the true local flavor of what Boston is famous for: lobstah and chowdah. With both time-honored institutions, you get value, something you couldn't get from the nearby mutual fund industry--at least, not until now.

With the implosion of the stock market, due to hedge fund and mutual fund redemptions, it's time to nibble at this double-bottom (October 10 was a secular bottom, in my opinion). I picked up a couple natural gas plays, one a pipeline outfitter for both domestic oil and natural gas. With oil demand destruction driving crude prices lower, natural gas prices have fallen in tandem, as the markets brace for a long, crushing recession (some are predicting an outright depression).

But while oil is an indicator of economic activity, with the transportation and manufacturing industries being major consumers, natural gas is not as interconnected to the overall economy. Sure, we'll turn our thermostats lower this winter in the hopes of reducing our energy bill, but natural gas is more tied to consumer use than industrial use. My thesis is that natural gas use will decline, but not by 80%, as recent market prices suggest. We'll still use natural gas, and public transportation fleet vehicles are converting over to natural gas in increasing numbers, since they burn cleaner. Besides, if T. Boone Pickens is on that side of the bet, I want to be next to him.

But here is the kicker: the owners of these natural gas pipelines are like toll-booths--they just collect revenue for being gatekeepers--no drilling, no speculation, no unknowns. And with some share prices down over 80%, there is deep value, as some are kicking off 20% dividends! These are better than junk bond-like returns, yet these are solid, stable companies, with little debt. Even if I have to wait for a rebound, I don't mind collecting 20% on my money. And these aren't speculative startup plays with hockey stick growth trajectories. On the contrary, these are boring energy plays, with dividends over triple what they normally are.

Perhaps I'm older now, and I still get excited over discovering the next early-stage growth company, but for my serious cash, I really, really like dividend plays. Not earnings--dividends. Despite stricter accounting rules, earnings are still malleable (and manipulated quarter to quarter). Cash flow and dividends to shareholders are transparent. Companies either pay them, or they don't. And they are either increasing the dividend pay outs, or they aren't. Natural gas master limited partnerships (consult your tax advisor on the differences between common shares and MLP's, especially regarding qualified retirement plans) are not only paying out juicy dividends, but their revenue and earnings growth are accelerating.

Of course, all bets are off if the world were to come to an end, as some are predicting, but if you aren't one of those expecting Armageddon, you may want to consider natural gas pipelines. This will be one of the most painful recoveries, as we still have more de-leveraging ahead of us, but if your long-term horizon is beyond a nanosecond, these MLP's look awfully enticing. Consult your investment advisor, and proceed with caution.

Meanwhile, enjoy your lobstah and chowdah, and sleep better knowing you're pocketing 20% dividends at these levels.

Why Obama will win...

Obama is more media-friendly, specifically internet-savvy. He owns the youth vote (I've read up to 92% of young voters in urban centers), and one could argue he's younger and resonates with the youth better than McCain. I would drill down deeper and say he had better technical advisors, leveraging the internet to his benefit, while McCain ran a more traditional campaign. McCain is out of touch with America and especially the youth.

As a proponent of technology, I may be overstating its role in this election, but I could also make a very compelling argument that the US defeated the USSR in the cold war because of our smart investments in technology. Due to our capitalist system, we were able to launch smarter, more powerful weapons of destruction. How? The transistor, the precursor to today's high-intellectual content of semiconductors. Russia had a huge lead on us in Physics (they were first to launch humans into space, for instance), but our country fostered an environment conducive to innovation, as we allowed Moore's Law to produce smaller, faster, and most importantly, cheaper processing power. Hence, our bombs and missiles were more precise. We not only outspent the Russians, we were more precise in our investments. They had to inevitably declare "Uncle"--we tapped them out.

While they were playing around with glass tubes, Intel was busy producing CPU's cheap enough and powerful enough to house more processing power in one chip than in a whole Univac machine back in the day.

Much like the former Soviet Union, McCain never had a chance. The problem is whether we learn from our "win", because Russia and the rest of the eastern Europe certainly has learned from their "loss".

We need to keep developing the next great mousetraps, whether it's in nanotechnology, a cancer cure, genetic bio-indicators of disease, sustainable technology ("greening" our ecosystem), etc. We not only have to make things smaller, faster, and cheaper, but we also need to make them consume less power.

Who stands to benefit from this? Buy Intel. They've created a moat around their business, continually road-killing potential competitors. Their huge market capitalization makes them an unlikely 25% gainer per anum, but it's a play on America's future.

The market may tank more short- and mid-term, but when the dust is settled, Intel will be standing. No one else can power your laptop like Intel can. Of course, please consult your investment advisor, as any investment has risk. This is not a solicitation to purchase stock. This is just what I've done personally, as I hope to live another 40 years. As a non-real estate professional, certain areas seem pretty cheap long-term also. Not sure where the bottom is, but I would hope we're close to it. Although, hope is no strategy.

I'm out of MS for a tidy profit

Morgan Stanley shares were actually up over 80% at the end of the trading day yesterday, and were up big again today, as a certain Japanese bank thinks they're worth $25. I got the cue, hit my target, and sold for a 100% gain in less than a week. I am normally not a trader, but this one was too sweet to pass up.

I'll stick with my INTC position and scour for companies with dominant market share, plenty of cash, and a solid balance sheet. The market still has a lot of pain to endure over the next couple years, but there are bargains out there if you are looking for long-term value.

Good huntin'.

I guess I didn't screw up after all....

Morgan Stanley shares are up 50% today, so I'm treading water again. In hindsight, MS and INTC are cheap at these levels, so I'm glad I bought. I still like water stocks long-term.

I don't like the trading mentality I've been taking on recently, but at these levels and with the high volatility, it's hard not to do some bargain hunting.

If you must...

If you must gamble (and yes, investing in stocks is a gamble, and something I don't recommend to clients since most are unfit investors) my next call is buying water stocks. Living without oil will be a struggle, but we will survive future oil crises. But living without water will lead to death. Not only do we need it to hydrate ourselves, but we also need water for our crops, and almost every product we consume. For instance, It takes thousands of gallons of water just to make one pair of jeans. It obviously takes a lot more water to manufacture autos, semiconductors, toasters, etc. I'm not at liberty to recommend specific stocks (for legal and other reasons), but you can do your own research on that. Just tread carefully, and only invest if you can afford to lose some or all of your investment. Hence, for most people whose net worth is under $5 million, I do recommend applying Missed Fortune strategies developed by Doug Andrew. It's a safe, conservative strategy to provide liquidity, safety of principle, and earn a competitive, tax-advantaged rate of return.

I screwed up...

I violated my rule of not trying to catch a falling knife, and nibbled at shares of Morgan Stanley--I'm down 25% in ONE day, and was actually down even further intraday. Of course, MS is already down over 90%, so at least I avoided the majority of the decline.

I also nibbled on INTC, and am down 10%--still manageable, as this will be a long-term play--INTC has plenty of cash, market share, and a competitive advantage in their manufacturing processes, which gives them pricing power. Hence, they are killing their only remaining viable competitor, AMD, which announced they are pursuing the fabless model. Going fabless frees up cash (a state of the art fab costs up to $4 billion these days), enables agility in fast-moving markets, but you lose control over your manufacturing process, and your variable costs can spiral out of control, especially during allocation (tight supply).

INTC will test their 52-week highs within a year. I really should have stuck to what I know--semiconductors, vs. credit default swaps (I'm not sure anyone understands how to value cds's--which is exactly why we're in the mess we're in).

Lesson learned.

GM on the ropes

I've stated for months that General Motors will be insolvent within 18 months (now 12 months--see previous blogs), and now CNBC is splashing it all over the headlines today. Shorting it was the call. It may go down further, but if this trade was put in a while back, it's time to cover and take profits. I may miss out on further gains, but there's no need to be greedy.

The larger issue is the cascading of financial crises from one sector to another, and to the general economy overall. The capitulation is coming (despite several false proclamations already), and we want to see a definitive bottom forming before jumping back in. I will confess that I nibbled at quality yesterday on long-term plays, but it is still too early to catch the falling knife. Warren Buffett stepped up big with Goldman Sachs and GE, and in hindsight, could have bought better (and lower). Even the best of the best can be early. But let's face it--even he admits he is a lousy market timer--he is a long-term value buyer, being a Benjamin Graham disciple. His participation means we're closer to a bottom than a top, but the market and the economy still need to unwind some more before I feel confident we indeed have reached bottom. My rule (and one I don't always follow, to my detriment), is to sell early (to avoid the bulk of the carnage), and buy late (even if it means I don't catch the exact bottom). Specifically, I want to see confirmation, and right now, we're not anywhere near close to that.

As usual, I am not dispensing advice and please consult your investment advisor, but the call here is to play some more golf--you'll save money for now.

Unfortunately for some, I feel vindicated...

This is not a case of schadenfreude, as I don't relish in this, but I've had many naysayers, including friends and family, who did not agree with my recommendations of home equity planning, and the implementation of index-based annuities and index-based maximum-funded universal life contracts. Unfortunately, it's been "I told you so."

Fortunately, I helped a few other family members and friends escape the majority of the carnage, as the IUL's have a mininum floor guarantee of 1%. The best part is that when the market recovers, they'll be able to participate in the majority of run up as well--tax-free. But avoiding the carnage is huge, and they sleep at nite. Even better is that due to the resetting of the new starting point, the next year going forward should actually give them tremendous upside. So they are thriving even in this perfect storm of plummeting asset values, whether stocks or real estate.

AIG and Other Insurance Companies in this Bailout

I agree with Porter Stansberry's take on AIG's near-collapse, and its financial ramifications worldwide. Here is my take, with my own edits:

There's 3 things I learned that we need to understand before we figure out what we have to do going forward:

1) Without the government's actions, the collapse of AIG could have caused every major bank in the world to fail.

2) Without the credit default swap market, there's no way banks can report the true value of their assets - they'd all be in default. That's why the government will enact laws that require the suspension of mark-to-market accounting. Essentially, banks will be allowed to pretend they have far higher-quality loans than they actually do. AIG can't cover for them anymore. Our "recovery" plan includes false accounting.

3) Without the huge fraud perpetrated by AIG, the mortgage bubble could have never grown as large as it did. Yes, other factors contributed, like the role of Fannie and Freddie in particular. But the key to enabling the huge global growth in credit during the last decade can be tied directly to AIG's sale of credit default swaps without collateral. This went on for a decade, exacerbating the problem.

I agree with allocating at least 10% of assets toward gold. But a flight to quality means not only gold, but also to well-capitalized market share leaders who are being undeservedly punished. I have my targets, but every individual needs to find their own comfort level.

Bailout or Re-liquefication?

Well, it looks like Wachovia did fold like a deck of cards, altho technically, they didn't fall into insolvency. Tell their shareholders that, as they got "acquired" for $1 a share by Citigroup; they might as well be bankrupt, according to shareholders. The silver lining is that financial behemoths like Citigroup, JP Morgan, and Bank of America are grabbing market share, and should survivie and perhaps thrive going forward. Keep your money in these big money centers--Wells Fargo has managed to keep their high credit rating as well. Among investment bankers, Goldman Sachs is the gold standard, and could be an acquisition target itself. I wouldn't touch anything else among financial stocks.

Bailout or re-liquefication? It's the latter--we need liquidity to resuscitate the economy, much like a dehydrated patient needs liquids, even if it's done intravenously. Congress doesn't get it, and I'm afraid many of our citizens don't either. Anyone looking to get a loan will too, when the bank turns them down--or if the bank itself collapses.

This financial crisis was caused by risk mis-managment, poor due diligence, sloppy underwriting, and lack of oversight--not de-regulation. Go after the culprits, and certainly don't pay executives golden parachutes--but inject some liquidity. This world economy needs capital, for it to flow again. The alternative is a return to the stone age.

Speaking of draught, the last time I passed by the San Luis Reservoir between the 101 and I-5, it looked like a backyard pond--the water levels were almost depleted. With oil prices up ten-fold, with stock markets and real estate values plummeting, are we going to have a water crisis also?

Who's next?

Is Wachovia at risk? I gave my opinion on GM earlier. Is Ford a bailout candidate? What criteria is being used to determine whether a bailout is warranted? Taxpayers are already strapped. Can they afford a bigger tax hit? I like the concept of taxpayer-funded bailouts enabling taxpayers to enjoy any upside via warrants, but even if that best-case scenario plays out 5 years from now, will the funds actually trickle down to the taxpayers? Or will the government continue to be poor stewards of said funds?

Washington Mutual...what's next?

I posted this last week on WaMu:

Well, another shoe just dropped--the biggest bank failure ever. Washington Mutual was just seized over night, so good luck to any depositors with over $100,000 in their accounts. I'm going to guess there are many Californians, Floridians, New Yorkers, and Washingtonians who lost millions.

Hate to be the bearer of bad news, but this is getting ridiculous. I saw this coming a couple years ago, and adjusted accordingly, but my friends thought I was a doom and gloomer, when in hindsight, I wasn't gloomy enough.

So what's next? More bank failures, I assure you. Berkshire Hathaway's Warren Buffett (only the wealthiest man in the world), just mandated that one of their portfolio companies stop insuring any assets above the FDIC limit of $100,000. That should tell you something--get any amount over that limit out of there--now! Bank deposits, money markets, etc. are NOT the safe haven you thought they were. Check the capital reserves of your bank (banks are required to have reserve requirements to cover bad loans) to measure how healthy they are. I predict hundreds, if not thousands of banks will fail going forward. Heck, the biggest ones are failing before our eyes--expect this to cascade to other major money centers, as well as smaller regional banks. The Federal bailout programs may save some, but if they let big commercial banks like WaMu go under, and big investment banks like Lehman fail, should we have confidence that the local bank around the corner will be saved?

I hate to be an alarmist, but I can't in my conscious NOT give my opinions. As always, seek professional investment and tax advice from your investment advisor and tax advisor. But please, do your own research as well, because they are human and not infallible.

Looking further out, I predict General Motors will be insolvent within 18 months. Shareholders will be slaughtered. Their manufacturing costs are too high relative to their nimble competitors, and their obligations to fund the pension fund and healthcare will drive them to bankruptcy. Instead of building hybrids in the face of $5 a gallon gas, they continued to build gas-guzzling SUVs.

In between banks failing and American industry icons going under, everything else is Jim Dandy. :-) The economy will recover, but it's going to be a long time before things get better. I'm thinking we bottom out in 2010, which means we've got a few more years of pain.

Keep a cool head, stay the course, and tell your loved ones how much they mean to you.

China

Even the most optimistic have conceded that the Chinese will be the next superpower within a decade. It's inevitable. But they will have huge growing pains as well (witness the recent precipitous decline in the Chinese equity market), much like America did when we became a superpower. Look at their human rights and how they deal with social injustice and civil unrest, as well as their deliberate flogging of environmental issues (although America has no right to point fingers, given our track record of polluting). I just don't want America to be the next UK--a financial center with little else. The UK experienced a huge brain drain to the US because of our manufacturing and economic might. There could be a mass exodus of smarts out of the US this time--actually there already is.

My opinion of Sarbanes Oxley is that it has driven entrepreneurial spirit under or overseas. Instead of developing next-generation technology, entrepreneurs have become bean counters and lawyers, dealing with compliance instead of focusing on their core competence. London is now underwriting more IPO's than New York. Legislators rant about the evils of the outsourcing of jobs overseas--yet they misguidedly enact laws which encourage it. We don't need more regulation--we need enforcement of existing laws on fraud.

I've been engaged with venture capitalists and serial entrepreneurs focusing on China, the next great frontier for not just making Nike shoes, but also highly intellectual property-intensive semiconductor technologies. I used to be a vendor selling enabling tools to these semiconductor companies (I now manage money), and I was lucky enough to participate in the tech boom in silicon valley in the late 90's. These people are replicating that business model in China. Some VC's ONLY invest in Chinese startups--serial entrepreneurs (Chinese natives) who had success in the States, and aim to replicate it in their return to China. They are creating another silicon valley in China--lots of them. The brain drain is already occurring.

For instance, those from San Diego are well aware of Qualcomm, the developer of the 3G wireless standard. They double dip because they make money on the semiconductor hardware as well as through royalties from their intellectual property (3G technology). Broadcom (socal) and Marvell (norcal) are also semiconductor icons which have had very successful IPO exits in the last decade. They are industry leaders in networking and storage, as they developed the silicon content enabling many technologies. The intellectual property in these leading edge technologies resides in the silicon, much like Intel's Pentium controls your computer.

Hence, the Chinese are getting tired of paying royalties on technologies and standards US companies developed. The domestic Chinese market is big enough to support development of their own standards--they're basically saying "screw the US--we can do it better and more pervasively--and we're tired of paying you royalties". And while there are challenges--this stuff ain't easy--they will get there.

And don't pooh pooh these efforts. Some of you recall the last big downturn in the economy, the housing markets, and the thing called the S & L crisis--during the early 90's. We had the riots, the closing of naval bases, debilitating earthquakes, the defense industry downturn, etc. as well. You could have bought a home on a 1/2 acre lot in Beverly Hills (north of Wilshire) for half a million, and a 12 unit apartment building in Long Beach for $350,000 via foreclosures.

Sounds awfully similar, doesn't it? Low-end homes have tanked first this time, and it's just a matter of time before higher-end markets take a dump, too.

But here's the silver lining: do you also remember when the internet was spawned (no, Al Gore did not invent the internet)? It happened many years ago, then known as DARPA, part of the Defense department communications network. Companies like Netscape and Yahoo rolled out the internet to the masses during these dark economic times, thereby enriching thousands of shareholders and employees. They went public in the teeth of that recession--I would argue they helped end the recession and catalyzed the start of the great tech boom.

I can assure you innovation in labs is still occurring today, what techies geeks affectionately coin "disruptive technology". These soothsayers can see around corners and will develop the next "new thing". My concern is that the next wave of value and wealth creation in the US will be dampened because much of this technological innovation is occurring overseas. The wealth generated by these startups won't be as widely distributed in the States. In other words, we need more Google's and fewer pets.com's. Long-term, I shouldn't be so cynical, because it is not a zero sum game. We should encourage innovation abroad as well as domestically. But my fear is that the US will not be playing at the adult table--and relegated to the kiddie table.

I've been a doom and gloomer for 2 years, and people thought I was heretical. Well, the manure did really hit the fan, and it turned out I understated the magnitude of this crisis. We'll climb out of it, and I have a feeling I'll be fine by staying close to the next wave of faster bandwidth, Moore's Law, and bio-entrepreneurship, but I'm afraid the deep end of the pool is going to be more treacherous this time. More people will lose their homes and jobs, and more realtors and loan officers will be waiters and waitresses. It's disheartening, but we are paying penance for our excesses.

Until our schools seed more engineers, scientists, and computer scientists, we will lose more high-intellectual, high-paying jobs overseas. It's got nothing to do with outsourcing--capital flows where it gets more bang for its buck. It's got everything to do with upgrading our skill sets, because the market will determine where the next good jobs will be.

Bailout or No Bailout?

I'm from the school of let 'em die. If you and I make poor investment decisions, we have to suffer the consequences. These executives applied far too much leverage, took on way too much risk, and after plundering their firms, they get golden parachutes. Where's the accountability factor?

I'm all for the founders of Google earnings billions because they have created a lot of value for consumers, business, shareholders, and employees. But when executives run their firms to the ground, they should not profit from said disasters, whether their firms get bailed out or not. A meritocracy rewards those who add value, not those who detract from it.

As much as I hate that the taxpayers bear the brunt of rescuing an AIG, I reluctantly agree they should probably be bailed out, because if they implode, the cascading illiquidity would essentially freeze up markets worldwide, as the sovereign funds, hedge funds, pension funds, mutual funds, private equity firms, and every financial institution would suffer a loss of confidence in the US financial markets, which would bring about a dark age analogous to the Great Depression. No one wins in that scenario, save the few bottom fishers with cash and balls to step up and play in the deep end of the pool.

But make no mistake: the intended recipients of these bail outs are the big institutions--not necessarily the common man, altho we all are in the same boat.

Having said that, there is a downside to this massive injection of liquidty--re-inflation. Interest rates should be favorable short-term, but when oil approaches $150 a barrel, when gold flirts with $1500/oz, the Fed will have no choice but to raise rates. Again, the lesser of two evils, but still an evil...Eventually, the economic shocks worldwide and the domestic slowdown will eventually dampen demand and cost of living increases, but until then, gold seems more stable than the US Dollar.

You know the world is turned upside down when there is more concern about the USD than the Brazilian currency, Russia has a flat tax, and the US has the 2nd highest tax brackets in the western world. Our leaders have forgotten what has made this country (and California) great.

The massive bailout and how it affects us...

Berkshire just injected $5 Billion into Goldman Sachs, while the Fed and Treasury announces a $700 Billion bailout. Despite the market turmoil, I'm going to guess this signals we're closer to a bottom than a cataclysmic meltdown in equities and real estate. We'll still have to endure a couple more years of pain before the economy and the housing market recovers. I think we'll have a couple more big legs down and more bank failures, but bottom fishers should eventually do well by investing in companies with strong balance sheets. Having said that, Christmas will be subdued this year.

The big risk is that more financial institutions become victimized by the cascading insolvency, as many are linked due to naked derivatives. which encourages high-risk speculation without accountability, which got us into this mess in the first place. Leverage works both ways--it's great for maximizing returns in a healthy economy, but it's lethal when markets are unwinding. Right now, we are experiencing a de-leveraging process not seen since the Great Depression. If more big banks start going under, buy more ammo--it's going to get uglier.

Hopefully, the worst is behind us, but I'm not jumping in just yet--I need more proof this tanker is going to turn around. The thought of buying into a fire-sale is enticing, but I'm not going to try to catch a falling knife--it can cut you. I want to see more blood in the streets, and the whites of people's eyes before I dive into the deep end of the pool. For now, I'm happy to be wading in the kiddie pool.

Good luck people--it's going to be a wild ride. This downturn will be a doozie--the worst in our generation, but eventually we will recover, I assure you.

Hunker down, work the extra overtime, use generic instead of designer labels, and ride this sucker out. Don't wait for the other shoe to drop--even if you are currently employed, be prepared for impending layoffs. Work you network, stay in touch with your influencers, and plan for the worst, while hoping for the best. Save for a rainy day, because this is that rainy day. And remember: equity is not cash. Cash is cash. Stay liquid.

Lehman and Merill Lynch this morning....

I wrote this in response to a concerned client:

XXXXX, on the contrary. These firms (investment banks, commercial banks, and insurance companies) invested in mortgage-backed securities, thinking they were safe. Little did they know it was just another asset bubble bursting.

Life insurance companies are more conservative by nature, investing premium payments in short- and long-term bonds, and in the case of indexed products, are linked to stock indexes like the S & P 500. With your contracts, if the S & P tanks, you are still guaranteed a 1% floor--which isn't much, but it's better than losing 15% or more, which is what your current stock portfolio is doing. They are able to guarantee the 1% due to options trading, much like they cap you at 15%.

Expect a big loss in the stock market this morning, as this is really, really bad news, but not something I didn't warn you all about several months and years ago. I predicted the real estate bubble, and it's coming to fruition as well. While the more expensive neighborhoods of the bay area are holding up, expect high-end prices to start declining. Manhattanites continue to brag their real estate market has held up, but do you really think that will continue, now that hundreds of billions of dollars are vanishing? Not only are Wall Street bonuses going to disappear at the end of this year, but many investment bankers will be lucky to have jobs. Having a consortium of banks to band together to raise money to prevent the next disaster is akin to gathering 10 cancer victims into a leaky boat--a few will get tossed over the side. First Bear Stearns, Countrywide, now Lehman and Merrill Lynch. Don't forget insolvent Freddie Mac and Fannie Mae, who only hold trillions of dollars of mortgages (70% of all US mortgages). Check out their share prices--they've lost over 90% of their market cap, which makes the tech bubble look like Disneyland.

Expect more big losses and layoffs--it is going to be a bloodbath--the biggest since the Great Depression. Insurance companies were the only ones standing in the aftermath of the Depression, as thousands of banks failed. They set premiums based on actuarial data, not based on speculative lending practices. Banks use 10:1 leverage, which works great in a growing economy, but is terrible in a downturn, as bad loans mount. Expect Washington Mutual to fold, too--unless they get bailed out. It amazes me that people still think banks are safe, despite pervasive evidence to the contrary. How many more banks have to fail before people get it? In any case, insurance companies are forbidden by law to implement that type of leverage.

The VC market has dried up as well--last quarter was the first time ever that there were no IPOs. The liquidity crisis is spreading up and down the food chain--couples with high FICO scores and sizeable assets are having trouble getting financing. Cash is more important than ever, so curb your spending and hoard it. Don't mess around this time, this ride is going to be hell.

In summary, this is EXACTLY what should be doing in a severe downturn, where every asset you turn to is dropping like a Thai thunderstorm downpour. The next 2 (or more years) will be very difficult, and when the last bulls finally turn bearish, basically giving up all hope and expecting the world to end. hopefully we will reach a bottom. Real estate agents and stock brokers have been preaching to me their respective markets will turn around for the last two years, and given their polyannish outlook, I know this hellstorm is going to last longer. They're like Colonel Klink in Hogan's Heroes--whatever they say will happen, do the exact opposite.

If you had to pin me down, the meltdown recovers in 2010, which means you can expect a climactic abyss in stock markets late 2009. THAT will be the time to nibble at good companies who got thrown out with the baby wash--the companies themselves are solid, but the financial hurricane took them down unfairly Pick the winners of each struggling group: Goldman Sachs will be a screaming buy in a couple years, but don't try to catch a falling knife--it'lll cut you. Wait till they bottom and bounce off the bottom a couple times. It's better to be late when bottom-fishing (buying), and it's better to be early when selling.

Of course, I could be wrong and too optimistic on the recovery time, at which point, all bets are off. Just to give you an idea of how bad it is, Warren Buffett of Berkshire Hathaway just sent a directive to one of his portfolio companies, a reinsurer who guarantees funds above the FDIC limit of $100,000 for banks. They lost a mint in guaranteeing losses when IndyMac went under recently, so the reinsurer just notified thousands of banks they are no longer guaranteeing accounts above $100,000! Do you think wealthy depositors are going to react to that?

As an aside, the formerly venerable Lehman firm was the preemiment fixed-income (bond) banker who got themselves in trouble with junk offerings years ago. Buffett actually stepped in and helped bail them out at the time. Obviously, he's not bailing them out this time. These subprime mortgages are the latest cyanide, only this time the Kool-Aid is a lot more toxic. You thought I was a doom and gloomer earlier, and it turns out I understated the magnitude. And unfortunately, it's going to get even worse.

Good news, bad news...

The good news is that oil and fuel prices have backed down, as I predicted recently. Further good news indicates Americans are driving less, reducing our carbon emissions. The bad news is that the reduced tax revenue from fuel sales has left the federal and state governments even more cash-strapped.

Another gem I saw on the news is that our superhero Governor has mandated all non-emergency response state employees will now earn the minimum Federal wage of $6.55 an hour. That paycheck should really help pay the variable mortgage about to reset--not.

The US is a mess, and a recent trip by a friend to Australia illuminates the growing gap, as the land Down Under is experiencing a bull market in natural resources, fueled by booming economies in China and India. Australia is clean, modern, and their citizens are in good spirits, buoyed by a tourism boom as well. Kinda reminds me of us in the late 90's.

Meanwhile, China and India are aggressively securing energy and natural resources, acquiring equity stakes in suppliers, setting the stage for the US to be forced to buy at spot prices.

The Fed has to continue printing dollars in order to sustain an unsustainable balance of economic growth and fiscal responsibility. A money manager quipped that he senses the public believes we're in the late innings of this recovery, which is true--but not when you consider it's a 7-game World Series, not a one-game wonder. In other words, we should continue to have record foreclosures and bankruptcies for a couple more years before we turn this tanker around. The good news is that equity prices should rebound a year before the actual bottom, as the stock market is a forward discounting mechanism.