Sunday, September 23, 2012

Investment Lessons of the Week

Previously I have written about the eventual trap of arrogance. Most politicians, and many investors will not admit to making critical mistakes. I try to be different. The only thing I promise each of our accounts is that I might make mistakes that hopefully I correct before there is too much pain. My main defense against arrogance is that I try to learn something new every single day. I have suggested this pattern to my children and grandchildren. The power of the new idea, new view, and new approach is that it forces one to relate the new with the old - and that becomes a challenge to many of our beliefs. Just this week, I have knowingly been exposed to at least five new elements to my thinking. All of these have a global context.

Logistics lead, but need to be interpreted

Last week I commented in my blog about what I learned from our visit to Mount Vernon. First, that steamship volume was increasing and that I saw many trucks from logistics companies going south on the Interstate Highway. This week a friend of mine noted that in September, the Baltic Dry Index moved from 662 to 778. What was even more encouraging is that the spot rate for the largest-sized vehicles carrying dry cargo (for example, iron ore) skyrocketed from around 2000 to 7600 this week. I believe the surge noted in iron ore shipments is due to the announced efforts to build many subway systems throughout Chinese cities. (As someone who for most of my life lived in and around New York City, the idea of relieving the roads of the clogging, expensive, and pollution generating car traffic seems to be a great idea.) To me the materially-increased infrastructure investment in China is a very practical stimulus that will use imported iron ore to make steel in local Chinese mills, a very intelligent way to address its economic slowdown.

A careful searcher for truth will almost always find some contradictory evidence. One of the oldest of all technical (market) indicators is the belief that the Dow Jones Industrial Average cannot make and hold new high levels if the Dow Jones Transportation  Average (which used to be composed of just railroads) does not confirm by making its own new high. The belief is that if the two indexes diverge they will have to find a bottom before there can be a successful sustained new high. This week the Norfolk Southern Corp. lowered its expectation for the current year’s earnings. The Dow Jones Transports declined on this news. The decline’s impact on the industrials needs to be put into perspective. The railroad is one of the largest shippers of coal in the country. Just as governments can attempt to make companies grow; e.g., solar and wind power, it can force lower sales of others. The Obama administration, along with much lower natural gas prices, is making coal an unattractive fuel for our electric utilities. Fuel for the electric utilities is not being delivered by train, but by pipelines, barges and other vehicles. Thus, as of this week I believe that we are seeing some resurgence in industrial activity, which the stock market is already discounting.

Cash to stock is becoming an easier switch

Last week I attended two investment focused meetings. In the first a large regional bank gathered some of its best potential and actual investment clients to a private lunch to hear my views on investing. They would not have taken time from their busy day if they were not already investing in equities or considering it. In our conversations they recognized that long-term they needed to be significantly exposed to the world of stocks, perhaps through funds. Everyone at the lunch could recite, in detail, their concerns about the stock market, but they still came and stayed for two hours.  One evening last week I was at a post-meeting dinner for a board on which I sit. At one point during the long dinner, a very successful second generation Wall Streeter leaned over to me to tell me he had not bought a common stock for his own account for over two years and now he was ready to buy. I suggested that he call a mutual friend of ours with whom he had successful business dealings, to help him reenter the market. He noted on his pocket pad to call our friend in the morning. These two instances suggest to me that the historic pattern of people coming into the stock market as it goes up is holding. While some of the easy money has already been made in the low volume markets, there will be opportunities at higher prices.

‘Tis the season to be “Vixed”

Many commentators have spent much time noting that there appears to be a low level of fear expressed in the options on the S&P 500 as captured in a traded index with the symbol of VIX, (CBOE Market Volatility Index). If one reads Randy Forsyth’s article in Barron’s Friday September 21, we should be prepared for problematic markets. I have lived through the October “crashes” in 1978, 1979, 1987, and 1989 but not the big one of 1929. What I had not compiled were the other autumn events that were dangerous to one’s capital base. As today’s global stock markets are reacting to government manipulated fixed income markets, recognition of the following Autumn occurrences is important:

1.    September 24th 1869: the US government sold gold  to break the “corner” that was attempted by Jay Gould and Jim Fisk.

2.    September 20, 1873: the New York Stock Exchange closed due to a panic.

3.    September 21, 1931: Great Britain’s suspension of the pound’s link to gold.

4.    September 21, 1985: the so-called Plaza Accord broke the ascent of the US dollar. (Too bad to bring that wonderful grand hotel into another round of government manipulation.)

5.    September 16, 1992: The withdrawal of Sterling from the European Exchange Rate Mechanism and reportedly a huge winning bet by George Soros.

6.    September 23, 1998: the culmination of the Asian currency crisis which began in July 1997.

7.    September 11th, 2001: the attack on the World Trade Center in NYC.

8.    September 15th 2008: the collapse of Lehman Brothers followed the next day by the near collapse of AIG.(These were much more significant in the global fixed-income markets than in the stock markets.)

Long-term fears and where you hold your investments

Ray Dalio, the founder and co-CIO of Bridgewater Associates in an interview with CNBC  had some dark thoughts. His fear is that after a ten to fifteen year managed depression (austerity without growth), that the social tensions between various economic and ethnic classes in southern Europe may produce an appeal to some strongman/woman to take over and solve the problem; e.g. the appeal that brought Hitler to power. Much closer to home, a savvy investor shared her concerns with me. She is worried that in the US (and by some extent in other Western countries and Japan) that the medical and related costs of keeping the elderly will be too much for the younger tax paying generations to tolerate. A financial class war is what she is predicting.

I asked this smart, experienced lady how she was preparing for this with her portfolio today. In general she had foreign investments for 30-40% of her portfolio. But the bulk of the rest was in multinational companies. She uses Coca Cola as an example, which gets most of its earnings from outside the US. I am not sure that her strategy will deliver against her fears or those of Mr. Dalio.

For many years I have complained to various fund managers that displayed their portfolios on the basis of the statements they receive from their custodians. The custodians list securities on the basis as to where the entity is legally domiciled. From an analytical standpoint, I am interested where the company is making most of its operating profit. That is the country or region which will have, in general, the biggest impact on sales and operating earnings. For regulatory reasons I will probably won’t win this argument with published reports but with careful analysis I can probably guess the key sites of operating earnings power which should help in determining the strategic value of the investment. However, the concerns expressed by the lady and Mr. Dalio raise another issue.

If our current fears turn us into a refugee mentality, it is not where an entity makes its money that is important, but where are the assets and where can they be traded in a period of distress. If these fears become somewhat more widespread, we may see wealthy US investors move to vehicles that are beyond the problem areas.

Which comes first: weak currency or weak military will?

A study of history suggests that a weak military will eventually invite others to seize our assets and possibly our lives. Often the decline in military willingness to aggressively defend its homeland comes from a policy of weak currency management as it attempts to take market share away from trade counterparties by having lower prices than they do. For a generation we have seen that many Europeans will not support a strong military; e.g. in the Balkans, and we also see that the value of their currencies decline. While much has been written about Quantitative Easing Infinity,  in terms of US stimulation, on a longer-term basis the decline in the value of our currency is in effect a weak dollar policy. Combining our planned Asian withdrawals and defense expenditure cutbacks, a weak dollar policy is going to invite more trouble. As much as we don’t like to be negative, maybe we need to pay more attention to our worriers.

The bottom line: be careful and stage your money into equity vehicles with some concern as to where your assets are being housed.

What Do You Think?

In London

I will be conducting interviews and investment manager meetings in London during the week of October 8 - 12.  If you would like to meet to discuss investments, client strategies or one of my blog topics, please email me at .

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