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Science/Tech See other Science/Tech Articles Title: 4 Recommendations to Defend Against a Financial Armageddon 4 Recommendations to Defend Against a Financial Armageddon posted on: March 17, 2008 * Font Size: * Print * Email Another week of all-time record high commodity prices and a fresh record low US dollar has had the expected result in US equity markets: the stocks of the commodity producers and export manufacturing sectors have led the way to a week over week gain in the broad indexes, but traders are focused on the macro picture and remain nervous. Capital markets are operating in a stagflationary environment, similar to the 1970’s. The combined impact of slowing or receding economies and rising costs is that equity prices, which are based on inflation-adjusted corporate revenue, cash flow and earnings growth, are under pressure. Should inflation worsen, interest rates will rise, with further damage to economic growth and corporate earnings and net cash flow. The problem has been caused by the massive increase in debt, on the one hand, without a counter-balance increase in economically-based sustainable asset prices. Phony asset prices, which had been used to support the debt bubble, were discovered as banks tried to rein in credit that had been expanding at rates that were out of control. In the typical credit contraction cycle, the parties that suffer most are business corporations and real estate developers that are over-leveraged, which did not happen in this cycle. This time, it was the banks and brokers that were over-leveraged on the basis of these phony assets they carried on their books. A proper write-down of those assets to economic reality means that many of the financial institutions have capital reserves below the ratios permitted by regulators. In fact, there are concerns that should all banks write off these dubious assets, the result would be insolvency, which is to say a complete elimination of equity, and worse. So, the big picture is looking bleak, and it is not one that can be fixed overnight or even in a month or a quarter. This problem will probably take a few years to resolve. As the credit contraction cycle works itself through the economy, cash and unencumbered assets will continue to be king. Periodically, there are injections of liquidity by central bankers and by sovereign wealth funds, but these are mostly based on new debt, which is like pouring fuel onto the fire, stealing from the children and grandchildren of the future, and the elderly and others who are presently or soon to be in need of social assistance, all done with the intent that vested interests among bankers can be protected today. At the heart of today’s economic and capital market woes is the unnecessary Iraq War. Nobel laureate economist Joseph Stiglitz and his associate sum up the issues in their book, The Three Trillion Dollar War. Others are saying this war will cost five trillion. The architects of this war attempted to pay for it, not in the normal course with an increase in taxes, but by a lowering of taxes and a huge push to base economic growth, and revenue from taxation from real estate construction, largely fueled by speculators and others who did not have the savings or incomes to afford it, and so who turned to easy credit that was made available by bankers who securitized these dubious loans. As long as there was a conspiracy among bankers to price these real estate assets on fiction, backed by so-called insurance programs that work only as long as the credit ring remains intact, the beneficiaries of a strong US dollar, and low interest rates, such as the bankers, telcos and regulated utilities were able to lead equity market indexes higher. But as the real estate market peaked and headed south, and higher inflation set in, the US dollar started to plunge. Capital markets remained stable only as long as bankers could continue to sell their fiction-based assets, and the available excess capital went into bonds. That process started to come to a conclusion in June 2007, and the big capital pools started to switch from equities to the most risk-free bonds, the US Treasuries. Now, even that safety valve has come to the end as the yields have collapsed on short-dated US Treasuries to the point where in just four weeks, the yield on 2-year T-Notes has plunged from 1.90% to 1.48% and on the 3-month T-Bills from 2.17% to 1.06%. The excessive negativity moniker among bloggers doesn't hold water. The fact is that traders are simply prepared to earn little to nothing if their capital base is preserved at this point, and the T-Bill rate proves just how negative is the market reality. These yields are massively under the inflation rate, so wealth is rapidly being destroyed. As soon as the commodity price bubble bursts (and it will since record high oil and precious metal prices are economically unsustainable and will crack, just like real estate prices cracked in the summer of 2005), a huge deflationary wave will engulf the world. Writing his syndicated column Global Issues Sunday, David Crane points to the red flags waving when the International Monetary Fund warns that governments need to “think the unthinkable.” He opines, “Indeed, we could be headed for the worst financial crisis since the 1929 stock market crash and the Great Depression of the 1930’s.” Negative I might be, but not nearly that much so. Where I see the credit crunch has hit home the most – the banks and telcos – traders have been selling to raise cash. In fact over the past six and twelve months the price performance in these sectors is the worst across the broad market: down over 3, 6 and 12 months -18.7%, -29.2%, and -31.3% for Financials (XLF) and -24.6%, -32.0%, and -26.6% for Telcos (IYZ), respectively. How can anybody be positive with such a disaster? A week ago I asked rhetorically, “As a trader you have to ask yourself if conditions are likely to change in the next three to six months to where Mom & Pop start getting ahead financially, start spending again, and start saving and buying equities. You want to ask how the Telcos (and other financial income sources) are going to pay out high returns on capital without it being a return of capital. In addition, you want to know how the Banks can recapitalize their balance sheets without traders somewhere in the world taking on huge debt. Debt inspired by greed, after all, is the cause of the problems today.” I am asked every day what my recommendation would be to defend against a financial Armageddon, and I will sum it up here: (1) Go temporarily to a combination of cash, in the form of US Dollars held with the most secure financial institutions (preferably a Swiss bank outside UBS (UBS) and Credit Suisse (CS), which are international investment banks), and 3-month T-Bills, regardless of how low the yield is. (The minimum account size for private banking with Swiss banks is about $250,000 for those who are interested.) In the meantime, maintain small loans at various financial institutions -- if the interest rate is low -- because your continued payment of the principal and interest will put you into the most valued client category when the global financial crisis is ended and banks are seeking to issue new loans. (2) Then wait for the crack in the precious metals market, which will come as most of these record high commodity prices are futures contracts based, which will fall apart when the credit ring snaps and counter-parties are unable to pay off. I’m now looking at $780-$800 gold, possibly lower, for example, in the months ahead. Yes, gold prices may go higher than Friday’s high of $1009 for $GOLD because the market is adrenalin driven at the moment, but if you are not a day-trader with your finger on the buy/sell button, it’s best you stay away. (3) When precious metal prices, after the peak, spike down on the extreme sell-off days that I see upcoming, use that low price to buy physical bullion bars and coins for safekeeping, preferably in a private Swiss bank. For those who want the least exposure to the current financial crisis, I would not hesitate to put 90% of the cash into a variety of precious metals bullion holdings in safekeeping because even during the Depression era of the 1930’s, physical gold was the best performing asset class. (4) After the global bankers appear to be resolving their crisis, and real estate prices and equity market prices have sunk to ultra long-term lows, which may take six months to two or three years to unfold, I would begin a program of selectively selling the precious metals and buying real property with rock-solid mortgages, probably in Emerging Markets, plus the stocks of Cara 100 companies that managed to survive the difficult economic period ahead. With that in mind, I would start to narrow the Cara Global 100 down to one in each sector, like: Exxon (XOM), Goldcorp (GG), ABB (ABB), Toyota (TM), Diageo (DEO), Glaxosmithkline (GSK), ICICI Bank (IBN), Google (GOOG), Nokia (NOK) and EXC, as examples. That list would give a global balance of very strong companies, and I would probably weight the holdings on average with the S&P Global 1200 sector weightings at the point of entry. These are tough times. It will pay to keep cool. The publishing world today – both hardcopy and electronic – has stooped to a new low of vacillating from “cut and paste” to the shouting of idiots who managed to get themselves a piece of the entertainment media. There is very little rigorous analysis being done today. It’s mostly synthesis (i.e., storytelling) by people who really don’t know from nothing. The trouble is that transparency in the global financial system isn’t what those in control crack it up to be, and now that those persons are in deep financial trouble themselves, the public is being left even further in the dark. As I wrote this week, the global liquidity crisis was brought on by bankers and the public ought to protect themselves by pulling their capital out of the market, which would send the system into crisis, forcing these bankers to sort out their various conflicts of interest and return us a legitimate capital market that is not controlled by debt market dependent financial services companies.
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#1. To: tom007 (#0)
I don't think so.
A society grows rich by producing things…and saving money.
I'd love to see it happen.
We had a lot of very sophisticated investors in Bear Stearns that are today counting thousands instead of millions.
A multi-billionaire Brit, lost $1 billion. http://blogs.wsj.com/wealth/2008...water/?mod=googlenews_wsj 'Individuals should not take responsibility for their own defense. That’s what the police are for. ... If I oppose individuals defending themselves, I have to support police defending them. I have to support a police state.”' Alan Dershowitz
Her should have had some of our resident experts advising him on his investments.
Lots of PPT throwing everything they got at the market.
A society grows rich by producing things…and saving money.
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