MY WEEKEND READING “MORSELS”
- Chase is marketing a CMBS structured offering with a bottom traunch that has no credit rating and will be sold to hedge funds or swallowed themselves.
- CDO spreads show our fear levels, with Citi being at 327 bps, Goldman Sachs at 260, and JP Morgan at 138.
- Last week the Australian dollar rose vs. the US dollar 3.1%, the Canadian dollar 2.8%, the New Zealand dollar 2.75% and the Swiss franc 1.3%.
- The Barron’s Confidence Index (mentioned last week as an unusually bullish indicator) dropped some of the way back to its prior level.
- The Wall Street Journal suggested this is a time to use leverage.
All of the above elements are indicating that we are in a more normal or even a “new normal” period.
For my clients, family and the institutional investment committees that I serve, I try to focus on long term needs. Additional inputs that contribute to my long-term thinking are:
INPUTS FOR THE LONGER-TERM
- The state of Colorado after using a future investment returns assumption of 8.5% has recognized that if they lower their assumption to a somewhat more reasonable 7%, they will run out of money to pay pensions in 30 years.
- Jason Zweig in his always important but often controversial column in the Weekend edition of the WSJ (click here to read) compares the current difficulty of the DJIA to sustain a reading over 10,000 over the last ten years to the sixteen year period it took the index to sustainably rise over the 1000 level.
- Last year for the first time in perhaps thirty years, investors bought more gold than the jewelry trade. I have read that one gold ETF owns more gold in one London vault than all but a few central banks. Diamonds are also in significant demand. A high end Jeweler told me that he is having difficulty in obtaining serious diamonds caused in part by De Beers' control of the market. I also learned that in the US the retail price per carat is about $200, and in China over $1000.
- There is a new study that that suggests after a 10 year bull market in commodities, a 20 year bear market follows. (This makes sense to me in that higher prices bring into productions new mines and a major rise in capital expenditures, which we are seeing now.)
I maintain all of the above items are tactically important and are descriptive of the present moods. I would daresay that a consensus has been formed that the current markets do not offer any major opportunities to meet long term needs through investment gains.
BETTING ON NON-FAVORITES
My training at handicapping thoroughbred race horses holds that favorites, by definition consensus chosen, may win about a third of the time. When they do, the rewards are not enough to pay for the other losing tickets and their imbedded fees and taxes. The only to win money on balance is to selectively pick non-favorites. Almost by definition this process works on a different set of conditions occurring than those that have bet on the favorites.
THREE TENETS THAT LEAD TO CHANGE
I believe that future conditions which could start at any time will be viewed differently than those of today. As usual in these tautologies my beliefs are based on three growing forces. The first is innovation and technology. My Caltech bias may be showing, but long before joining their board I was a reasonably good electronics analyst. The second force is demographics as the growth both in numbers and drive for higher standards of living will raise the aggregate level of demand and to some degree where the supply will originate. (For the most part the countries in the northern hemisphere are facing a demographic time bomb of having too few workers to pay for those who are retired. The US is on the cusp of such dilemma. Our way out is to encourage the right sort of immigration and education.) The third force is very difficult: discipline. I have little faith in so-called reform measures imposed by governments without getting their own houses in order. I do believe that many people including business people, investors and loan officers have recognized some of their prior enthusiasm has led to bad decisions. Similarly, some of the losing teams in the World Cup will go home with an understanding that good intentions are not enough without the proper training and on-field discipline.
FOR INVESTMENT COMMITTEES:
The question before the formal and informal investment committees is how to structure for this expected change in conditions. Recently, I have advocated for a significant non-profit that the endowment be divided into three unequal parts. The first is to fund the current year’s needs as well as the next years’. (In other words, if the investment world collapses you have at least two years to live.) The second and the largest piece is to invest to meet the identified needs; which could be new facilities or sending Johnny to college. The third piece is to invest the needs beyond the identified horizon. We all have experience in our lives, both challenges and opportunities, that we did not expect. With the correct mind-set and a little bit of capital, these challenges can be opportunities. I will be the first to admit this three element strategy is easier to manage through the use of mutual funds or specifically designed separate accounts, than by choosing individual securities.
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