Friday, May 28, 2010

The Fed and the May 6 'Flash Crash' – By Mark Spitznagel

Thanks to Matt for passing this along. Starting tomorrow, I'll be on vacation without Internet access until the end of next week, so the blog will be quiet until then.

Alan Greenspan Article from 1966: Gold and Economic Freedom

Interesting – in light of everything that has happened since it was written – article by Alan Greenspan from over 40 years ago. Thanks to Jason for passing it along.

Under a gold standard, the amount of credit that an economy can support is determined by the economy's tangible assets, since every credit instrument is ultimately a claim on some tangible asset. But government bonds are not backed by tangible wealth, only by the government's promise to pay out of future tax revenues, and cannot easily be absorbed by the financial markets. A large volume of new government bonds can be sold to the public only at progressively higher interest rates. Thus, government deficit spending under a gold standard is severely limited. The abandonment of the gold standard made it possible for the welfare statists to use the banking system as a means to an unlimited expansion of credit. They have created paper reserves in the form of government bonds which-through a complex series of steps-the banks accept in place of tangible assets and treat as if they were an actual deposit, i.e., as the equivalent of what was formerly a deposit of gold. The holder of a government bond or of a bank deposit created by paper reserves believes that he has a valid claim on a real asset. But the fact is that there are now more claims outstanding than real assets. The law of supply and demand is not to be conned. As the supply of money (of claims) increases relative to the supply of tangible assets in the economy, prices must eventually rise. Thus the earnings saved by the productive members of the society lose value in terms of goods. When the economy's books are finally balanced, one finds that this loss in value represents the goods purchased by the government for welfare or other purposes with the money proceeds of the government bonds financed by bank credit expansion.

In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.

This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard.

Thursday, May 27, 2010

Matthieu Ricard - The Art of Meditation

Steve Eisman's Ira Sohn Conference Presentation and Speech

Via Market Folly:


Easy Money, Hard Truths – By David Einhorn

Are you worried that we are passing our debt on to future generations? Well, you need not worry.

Before this recession it appeared that absent action, the government’s long-term commitments would become a problem in a few decades. I believe the government response to the recession has created budgetary stress sufficient to bring about the crisis much sooner. Our generation — not our grandchildren’s — will have to deal with the consequences.


While one can debate where we are in the recovery, one thing is clear — the worst of the last crisis has passed. Nominal G.D.P. growth is running in the mid-single digits. The emergency has passed and yet the Fed continues with an emergency zero-interest rate policy. Perhaps easy money is still appropriate — but a zero-rate policy creates enormous distortions in incentives and increases the likelihood of a significant crisis later. It was not lost on the market that during this month’s sell-off, with rates around zero, there is no room for further cuts should the economy roll over.

EASY money has negative consequences in addition to the risk of inflation and devaluing the dollar. It can also feed asset bubbles. In recent years, we have gone from one bubble and bailout to the next. Each bailout has rewarded those who acted imprudently. This has encouraged additional risky behavior, feeding the creation of new, larger bubbles.

The Fed bailed out the equity markets after the crash of 1987, which fed a boom ending with the Mexican crisis and bailout. That Treasury-financed bailout started a bubble in emerging market debt, which ended with the Asian currency crisis and Russian default. The resulting organized rescue of Long-Term Capital Management’s counterparties spurred the Internet bubble. After that popped, the rescue led to the housing and credit bubble. The deflationary aspects of that bubble popping created a bubble in sovereign debt, despite the fiscal strains created by the bailouts. The Greek crisis may be the first sign of the sovereign debt bubble bursting.

Though we don’t know what’s going to happen next, the good news for our grandchildren is that we will have to face our own debts. If we realize that our own future is at risk, we might be more serious about changing course. If we don’t, Mr. Geithner and others might regret having never said never about America’s rating.


Related link: David Einhorn's Ira Sohn Presentation

Wednesday, May 26, 2010

Benjamin Graham 1963 Lecture: Securities in an Insecure World

Found via the Reflections and My Investing Notebook blogs. The description, via Jason Zweig:

Here is the original typewritten text of a speech Benjamin Graham gave in San Francisco one week before John F. Kennedy was assassinated. In this brilliant presentation, Graham explores how an investor should go about determining whether the market is overvalued, how to tell what asset allocation is right for you, and how to pick stocks wisely. This speech is a rare opportunity to see the workings of Graham's mind in the raw.


I Want to Break Free, or, Strategic Asset Allocation ≠ Static Asset Allocation - By James Montier

Link to Montier's latest paper (via the GMO website):

Art De Vany on EconTalk

I've been meaning to listen to this for a while, and finally got around to it. Nassim Taleb originally got me interested in Art De Vany and also Gary Taubes. I think they both are good thinkers who, like Taleb, have successfully questioned and tested ‘conventional wisdom.’

Link to: De Vany on Steroids, Baseball, and Evolutionary Fitness


For those interested in other diet and health interviews, here are some links to a few done by Jimmy Moore, who I think is a great interviewer:

Art De Vany

Taubes 1

Taubes 2

Taubes 3

Doug McGuff

Kurt Harris

Mark Sisson 1

Mark Sisson 2

Related previous posts:

Health Benefits of a Low-Carbohydrate, High-Saturated-Fat Diet - by Donald W. Miller, Jr., MD

The Scientist and the Stairmaster: Why most of us believe that exercise makes us thinner—and why we're wrong. - By Gary Taubes

Related paper: “Why I Do All This Walking, or How Systems Become Fragile” By Nassim Taleb

Bill Gross – June 2010 Investment Outlook: Three Will Get You Two (or) Two Will Get You Three

Several months ago I rhetorically asked whether it was possible to get out of debt crisis by increasing debt. Yes – was the answer, but it was a qualified yes. Given that initial conditions were favorable – relative low debt as a % of GDP, with the ability to produce low/negative short-term policy rates and constructively direct fiscal deficit spending towards growth positive investments – a country could escape a debt deflation by creating more debt. But those countries are few – the U.S. among perhaps a handful that have that privilege, and investors, including PIMCO, have strong doubts about U.S. fiscal deficits leading to strong future growth rates.

So the developing predicament is becoming more obvious to Shakespeare’s “lenders and borrowers be.” Fiscal tightening and budget conservatism may have come too late for Greece and its global lookalikes. Continued deficit spending may be an exorbitant privilege extended to only a few. Caught in the middle are many developed countries that likely face New Normal growth rates and a continued bumpy journey toward that destination.

Investors must respect this rather tortuous journey in the months and years ahead for what it is: A deleveraging process based upon too much debt and too little growth to service it. No longer will “two get you three” in the investment world. Not 1,000%, but for 4-6% annualized returns for a diversified portfolio of stocks and bonds is the likely outcome. And be careful – sometimes “three gets you two.”

Tuesday, May 25, 2010

Monday, May 24, 2010

Hussman Weekly Market Comment: Don't Mess with Aunt Minnie

Over the years, I've noted that certain subsets of market conditions - occurring together - are associated with very specific outcomes, such as oncoming recessions, abrupt market weakness, strength in precious metals, and so forth. Such indicator subsets, or Aunt Minnies, are essentially "signatures" that often have very specific implications. In medicine, an Aunt Minnie is a particular set of symptoms that is “pathognomonic” (distinctly characteristic) of a specific disease, even if each of the individual symptoms might be fairly common. Last week, we observed an Aunt Minnie featuring a collapse in market internals that has historically been associated with sharply negative market implications.

Of the 3257 issues traded on the NYSE last week, 2955 declined and just 275 advanced. The S&P 500 has now abruptly erased nearly 8 months of progress. Moreover, we observed a "leadership reversal" with new 52-week lows flipping above the number of new 52-week highs. Our broader measures of market action deteriorated to a negative position as well. Historically, we can identify 19 instances in the past 50 years where the weekly data featured broadly negative internals, coupled with at least 3-to-1 negative breadth, and a leadership reversal. On average, the S&P 500 lost another 7% within the next 12 weeks (based on weekly closing data), widening to an average loss of nearly 20% within the next 12 months - often substantially more when the Aunt Minnie occurred with rich valuations and elevated bullish sentiment.

The most recent instance was November 9, 2007, which was followed by a market loss of more than 50%, but the instances also include September 22, 2000, prior to a nearly two-year bear market decline; July 14, 1998 prior to the "Asian-crisis" mini-crash; July 27, 1990, at the beginning of the pre-Gulf War plunge; October 9, 1987, just prior to that market crash; July 2, 1981 at the beginning of the 1981-82 bear market and again in May 21, 1982, following a strong rally during that bear market, leading into a steep decline to the final lows; November 9, 1973 (just after a swift rally during the 1973-74 bear market, and leading into the main portion of that loss); and November 21, 1969, at the beginning of the 1969-70 bear market.

Given my aversion to market "forecasts," I hesitate to interpret this record as a hard prediction of what will occur in this particular instance. This is particularly true because in a handful of instances (2/9/68, 9/12/75, 10/20/78 and 4/30/04), the outcomes were fairly benign. Still, the average outcome has been awful. For that reason, the combination of unfavorable valuations and collapsing market internals is a sharp warning to examine risk exposures carefully here.

I haven't used the word "warning" for some time, and I certainly don't want to be alarmist. If your asset allocation is reasonable and you are following a well-defined discipline, do nothing. There is wisdom in ignoring the views of others and staying the course, provided that your investment strategy is in fact based on a well-defined discipline. That said, I disdain when analysts advise "staying the course" when the subtext is to disregard risk.

Friday, May 21, 2010

David Cameron in conversation with Nassim Taleb

From August 2009.

Craig Venter unveils "synthetic life"


"This paper reminds me of a saying that is well-known to pure mathematicians: "Every big discovery starts with a bad proof'". This is true in mathematics. The first proof in a new subject is bad, because the discoverer is a first-rate mathematician, struggling to overcome one obstacle after another and not caring about elegance. Afterwards, second-rate mathematicians tidy up the details and find good proofs.

I think the same saying holds good in science if you replace "proof'" by "experiment". This experiment, putting together a living bacterium from synthetic components, is clumsy, tedious, unoriginal. From the point of view of aesthetic and intellectual elegance, it is a bad experiment. But it is nevertheless a big discovery. It opens the way to the new world of synthetic biology. It proves that sequencing and synthesizing DNA give us all the tools we need to create new forms of life. After this, the tools will be improved and simplified, and synthesis of new creatures will become quicker and cheaper. Nobody can predict the new discoveries and surprises that the new technology will bring. I feel sure of only one conclusion. The ability to design and create new forms of life marks a turning-point in the history of our species and our planet." -Freeman Dyson (via

"If I understand this well, to the creationists, this should be an insult to God; but, further, to the evolutionist, this is certainly an insult to evolution. And to the risk manager/probabilist, like myself & my peers, this is an insult to human Prudence, the beginning of the mother-of-all exposure to Black Swans. Let me explain.

Evolution (in complex systems) proceeds by undirected, convex bricolage or tinkering, inherently robust, i.e., with the achievement of potential stochastic gains thanks to continuous and repetitive small, near-harmless mistakes. What men have done with top-down, command-and-control science has been exactly the reverse: concave interventions, i.e., the achievement of small certain gains through exposure to massive stochastic mistakes (coming from the natural incompleteness in our understanding of systems). Our record in understanding risks in complex systems (biology, economics, climate) has been pitiful, typically much after onset of events, and there is nothing to convince me that we have gotten better at risk management. In this particular case, because of the scalability of the errors, you are exposed to the wildest possible form of informational uncertainty (even more than markets), producing tail risks of unheard proportions.

I have an immense respect for Craig Venter, whom I consider one of the smartest men who ever breathed, but, giving fallible humans such powers is similar to giving a small child a bunch of explosives." -Nassim Taleb (via

Big Fat Lies

Here's the video mentioned in the article from the last post. It is a clip from the documentary film Fat Head.

Health Benefits of a Low-Carbohydrate, High-Saturated-Fat Diet - by Donald W. Miller, Jr., MD

The 60-year reign of the low-fat, high-carbohydrate diet will end. This will happen when the health-destroying effects of excess carbohydrates in the diet become more widely recognized and the health benefits of saturated fats are better appreciated.

“Life imitates art,” Oscar Wilde said, “far more than art imitates life.” In Woody Allen’s film Sleeper, saturated fats are health foods. Miles Monroe, part owner of the Happy Carrot Health Food Restaurant in Greenwich Village, is cryogenically frozen in 1973 after a botched peptic ulcer operation (done at the now closed St. Vincent’s Hospital there). Scientists wake him up 200 years later and have this exchange. Dr. Aragon: “Has he asked for anything special?” Dr. Melik: “Yes. This morning for breakfast he requested something called wheat germ, organic honey, and tiger’s milk.” Dr. Aragon: “Oh yes. Those were the charmed substances that some years ago were felt to contain life-preserving properties.” Dr. Melik: “You mean there was no deep fat? No steak or cream pies or hot fudge?” Dr. Aragon: “Those were thought to be unhealthy, precisely the opposite of what we now know to be true.” Dr. Melik: “Incredible!”

There is good reason to believe that this will prove to be the case in life as well. Saturated fats play many important biologic roles. They are an integral component of cell membranes, which are 50 percent saturated fat. Lung surfactant is composed entirely, when available, of one particular saturated fat, 16-carbon palmitic acid. Properly made with this fat, it prevents asthma and other breathing disorders. For nourishment, heart muscle cells prefer saturated long-chain palmitic and 18-carbon stearic acid over carbohydrates. Saturated fats are required for bone to assimilate calcium effectively. They help the liver clear out fat and provide protection from the adverse effects of alcohol and medications like acetaminophen. Medium-chain saturated fats in butter and coconut oil, 12-carbon lauric acid and 14-carbon myristic acid, play an important role in the immune system. They stabilize proteins that enable white blood cells to more effectively recognize and destroy invading viruses, bacteria, and fungi, and also fight tumors. Saturated fatty acids function as signaling messengers for hormone production, including insulin. And saturated fats signal satiety. Not surprisingly, given all these biological functions, saturated fats make up 54 percent of the fat in mother’s breast milk (monounsaturated fats are 39 percent; and polyunsaturated fats, a tiny 3 percent).

Evidence against fat wilts upon close scrutiny. In his Six Country Study, Ancel Keys ignored data available from 16 other countries that did not fall in line with his graph. The results would have been a clutter of dots all over the place if he had included all 22 countries. In Norway and Holland, people eat a lot of fat but have relatively few deaths from heart disease; and in Chile, where people don’t eat much fat they have a high incidence of fatal heart attacks. In an entertaining 2½ minutes, “Big Fat Lies” on YouTube (available HERE) exposes the fraudulent science supporting this widely cited study. Saturated fat may raise cholesterol somewhat, but primarily HDL cholesterol. The ongoing Framingham Heart Study has come to show that fat and cholesterol are, if anything, healthy. A 30-year follow-up reported that for each 1% mg/dl drop in cholesterol there was an 11 percent increase in all-cause mortality (JAMA 1987;257:2176–80). In another report, one director of the Framingham Study states, “We found that the people who ate the most cholesterol, ate the most saturated fat, ate the most calories, weighed the least and were the most physically active” (Arch Int Med 1992;152:1271–2).

An epidemic of obesity has accompanied the adoption of a low-fat diet. In 1900 only 1 in 150 people were obese, 0.7 percent of the population. By 1950, 9.7 percent of Americans were obese. Now two-thirds of Americans are either overweight (33 percent) or obese (32 percent). The average American weighs 30 pounds more today than he or she did 100 years ago. In 1900 people ate more animal fat and were not exposed to high amounts of carbohydrates in sugar-rich sodas and fruit juices, and to a whole panoply of processed foods sweetened with high-fructose corn syrup.

In the body, dietary carbohydrates, sugars and starch, are converted to glucose, which indirectly directs the pancreas to release insulin into the blood. Insulin not only transports glucose into the cells, it stores glucose as glycogen in the liver and muscles. It is also the primary fat-building enzyme, converting glucose to fat. When the liver and muscles are filled with glycogen, insulin turns excess glucose into body fat. Carbohydrates are the primary cause of weight gain, not fats.

Indoctrinated in low-fat dogma by nutrition authorities, government agencies, and the American Heart Association, I used to advise my heart surgery patients to restrict the amount of saturated fat in their diet and not have more than one egg a week. (My Cousin Sally had eggs and bacon for breakfast most days of her life and lived in good estate to the age of 103, which I then attributed to her having very good genes.) Following the USDA food pyramid, I did not voice any concerns about how many carbohydrates they consumed, from starch in bread, pasta, rice, and potatoes and sugar in fruit, pastry, fruit juices, and soda.

Not now. Now I caution them to watch their carbohydrate intake and advise that they follow a diet like the one Christian Allan, Ph.D. and Wolfgang Lutz, M.D. recommend in the Life Without Bread: How a Low-Carbohydrate Diet Can Save Your Life (2000). Their diet limits carbohydrate intake to 72 grams a day, which is equivalent to 6 slices of bread (somewhat more than the Atkins diet). I urge them to eliminate soft drinks from their diet, including diet sodas, which contain health-damaging aspartame, and drink filtered water instead; to avoid baked goods and condiments that contain high-fructose corn syrup; to stay away from the excitotoxin monosodium glutamate (MSG) used in some restaurants and to enhance the flavor of processed foods; and to scrupulously avoid trans fats, which cause cancer, trigger type-2 diabetes, interfere with immune function, and cause heart disease. But they can eat as many eggs as they please.

For optimum health and weight maintenance, the ideal caloric ratios for the three macronutrients are carbohydrates, 10–15 percent; protein, 15–25 percent; and fat, 60–70 percent of calories. Among the different kinds of fats, saturated fats and monounsaturated fats (olive oil) are good; polyunsaturated fats, except for omega-3 and (a small amount of) omega-6 essential fatty acids, are bad, especially industrially processed vegetable oils; and trans fats are terrible. Saturated animal fat is best obtained from grass-fed beef and pastured chickens, along with nitrate-free, additive-free bacon and sausage; and seafood from wild (not farm-raised) fish.


Related previous post: The Scientist and the Stairmaster: Why most of us believe that exercise makes us thinner—and why we're wrong. - By Gary Taubes

Related link: Fats and Oils

The ‘Security Analysis' of diet and health: Good Calories, Bad Calories: Fats, Carbs, and the Controversial Science of Diet and Health

Good sources of saturated fat are pure butter and coconut oil.

A diet I believe is very healthy: PāNu

Albert Edwards: Europe Is On The Edge Of A Deflationary Precipice That Will, Paradoxically, Usher In 20-30% Inflation

Via Zero Hedge:

Amid all the recent euro-related turbulence, the markets have not focused enough attention on the rapidly vanishing core CPI inflation rates in the US and eurozone. With both moving below 1%, we are now only one cyclical mishap from joining Japan in outright deflation. Given our view that this cyclical recovery will end surprisingly early, slipping into the deflationary mire will trigger further, more extreme rounds of Central Bank monetisation, inevitably driving us towards our ultimate destination – 1970’s style 20-30% inflation will surely return.

Of all the inflation data released this week, the one that caught the markets’ attention was the UK’s dramatically higher than expected 3.7% yoy rise for April. Even the core measure of CPI managed to creep up above the 3% mark. Meanwhile the old RPI, to which most state benefits are indexed, rose a heady 5.3% - the highest pace since July 1991. While many commentators proceeded to berate the Bank of England for consistently underforecasting inflation in recent years, many also saw the first signs of the quantitatively eased pigeons coming home to roost.

But I would argue that in a year or so, we will see the UK’s relatively high inflation rate as a godsend. For elsewhere, it went almost unnoticed this week that core CPI inflation rates in the US and eurozone continue to slip-slide their way down towards zero (see chart below). Although this is seen as buoying bond prices at the margin, it is a pernicious development that investors will focus on when this cycle starts to fail. Regular readers will know that I believe that in a post-bubble world, recession follows recession with surprising rapidity. We are now only one cyclical failure away from Japanese-style outright deflation in the US and the eurozone at a time when de-leveraging still has years to run (falling prices bring the risk of a classic debt deflation trap). Impending cyclical failure and a deflation scare will trigger new lows in equities as the valuation bear market finally plays itself out with the S&P falling below 500. We therefore maintain our long-standing target of sub-2% US 10y bond yields - and that is the point when QE will really begin to get serious.

Niall Ferguson - Fiscal Crises and Imperial Collapses

Thanks to Jason for passing this along (via Investing in a Life of Value).


Thursday, May 20, 2010

The Eclectica Fund: Manager Commentary, May 2010

Via Market Folly:

Hugh Hendry just released the May market commentary from his Eclectica hedge fund. We haven't checked in on Hendry since his March update when we saw he liked Annaly Capital Management (NLY), but his time around we get much more in-depth macro commentary. Hendry has compiled eleven pages worth of insight complete with charts, pictures of Chairman Mao, and even lyrics from the band Gorillaz. The main takeaway from his commentary though is that he sees hyperinflation in store as sovereign entities will need to pay off their overwhelming debts via 'worthless fiat currency.' However, for this to occur, he argues that first we need to see a large deflationary event.

Curiously enough, Nassim Taleb mentioned this sort of scenario at an investment panel where Hendry was a speaker as well. Taleb presented the idea that if you were creating a portfolio today you should allocate a tiny portion to insurance against hyperinflation. If the scenario doesn't unfold, your cheap insurance expires worthless. However, if it does occur, your investment returns an exponential amount. We just yesterday detailed how legendary fund manager Seth Klarman is worried about inflation and has bought insurance to hedge this risk.

Turning back to Hendry's recent commentary, he writes that, "it is now commonly accepted that the magnitude of the financial problems confronting the world economy are so great that in all likelihood we will be confronted by a hyperinflation allowing sovereign debts to be paid off in worthless fiat currency. Just like the Bolsheviks in 1918 and 1919, the machine-gun of the Comissariat of Finance will pour fire into the rear of the bourgeois system. We do not dispute this outcome."

Wednesday, May 19, 2010

GR-NEAM Reflections: 05/01/2010 - That Which Goes Around

Thanks to Matt for passing this along.

Greece may be the canary in the coal mine, as Thailand was in the Asian financial crisis of 1997. The conclusion may be ironic - that the eurozone contributes to a bubble elsewhere, this time in Asia.

Baupost's Klarman sees poor outlook for stocks

Update (Sept. 2010): A great transcript came out in the September/October Financial Analysts Journal: HERE


Star hedge fund manager Seth Klarman sees few bargains in the current environment and predicted on Tuesday that the stock market could suffer another lost decade without any gains.

"Given the recent run-up, I'd be worried that we'll have another 10 years of zero returns," Klarman, who rarely speaks in public, said at the CFA Institute's annual conference in Boston.

Current market conditions remind Klarman of a Hostess Twinkie snack cake because "everything is being manipulated by the government" and appears "artificial."

"I'm more worried about the world broadly than I've ever been in my whole career," Klarman said.

Klarman has 30 percent of assets at his $22 billion Baupost Group in cash, he said. He started the firm in 1982 with $27 million and has averaged 20 percent annual gains ever since. In 2007, amid the depths of the credit crash, Baupost had its best year, gaining 52 percent.

Inflation is a risk that Klarman said he is particularly concerned with given the government's high rate of borrowing to bail out the financial system. Baupost has purchased far out-of-the-money puts on bonds to hedge the risk, he said.

The puts, which Klarman said he viewed as "cheap insurance," will expire worthless even if long-term interest rates rise to 6 or 7 percent. But if rates rise to 10 percent, Baupost would make large gains, and if rates exceed 20 percent the firm could make 50 or 100 times its outlay.


Some more great notes were posted HERE.

Article where Klarman clears up some of his comments: HERE.

Paul Volcker on Fox Business

Video: Volcker: Dodd Bill Can Deal With 'Too Big to Fail'


Tuesday, May 18, 2010

Malcolm Gladwell's Keynote Address at the Options Industry Conference

Found via Simoleon Sense.


Videos: Carmen Reinhart, co-author, of This Time is Different

Via Simoleon Sense:

Videos: Carmen Reinhart, co-author, of This Time is Different


Book: This Time Is Different: Eight Centuries of Financial Folly

Jeremy Grantham Guarantees Gold will Crash - By Robert Huebscher

Jeremy Grantham, the investor celebrated for his ability to spot and exploit bubbles in asset classes, guaranteed yesterday that the current bull market in gold will end. His proof? He bought some – for his own account – at the end of last week.

His tongue-in-cheek comment was part of a discussion about relative value in various segments of the market. Indeed, Grantham is bullish on two asset classes – which I’ll address in a moment – but gold is not among them.

Grantham, the Chairman of the Boston-based investment firm Grantham Mayo Van Otterloo (GMO), spoke at the CFA Institute annual conference in Boston, where he delivered the keynote address.

He predicted a real (inflation-adjusted) return of 0.3% for the S&P 500 (shown above as large-cap US equities). That, of course, follows a decade of negative returns.

Small-cap stocks offer the worst prospective returns, -1.8% inflation-adjusted.

But US high-quality stocks still offer attractive opportunities, with a forecasted inflation-adjusted return of 5.8%. He defined those as stocks with low debt and consistent returns, typically highly rated by S&P. They include the “usual suspects,” he said, such as Johnson & Johnson, Microsoft and Coca Cola. He said there is “no chance” this asset class is not undervalued.

Opportunities in emerging markets and timber

The two asset classes Grantham singled out as truly attractive were emerging markets and timber, which boast projected inflation-adjusted returns of, respectively, 4.7% and 6.0% annually.

Emerging markets are entering a bubble, according to Grantham, who called them his “favorite” asset class. He likened the opportunity in emerging markets to bubbles in the Japanese and NASDAQ markets, when PE ratios went to three-times that of markets in the rest of the world.

Commodities are Grantham’s other candidate for entering a bubble, but he said that emerging markets are “much easier to play.” Within commodities, timber is the only asset he said he could accurately analyze, and he projects for it 6.0% inflation-adjusted returns.

Grantham said timber is one of the safest asset classes outside of TIPS, and he prefers it to sovereign debt, which is exposed to inflation risk (which Grantham called a big risk worldwide). Timber has proven to be an enormous holder of value, he said, and even worked on an inflation-adjusted basis in the 1930s and 1970s. In the crash of 2008, it lost nothing. “It is a nice contra-cyclical asset class,” he said.

At the other extreme is fixed income, which Grantham called “horrible.” “It is not capitalism,” he said. “It is an administered rate.”

The negative inflation-adjusted yields in the short-term bond market are artificial and, if it were not for Fed intervention, he said they would rise 100 to 200 basis points. Those low rates are “just a way of stuffing the pockets of banks and hedge funds,” he said, because of their ability to invest with a near-zero cost-of-capital.

Grantham suggested that shorting fixed income would be a wise investment, although he said it would be difficult to do.


For a rebuttal to Grantham, go HERE.

Monday, May 17, 2010

Hussman Weekly Market Comment: Two Choices: Restructure Debts or Debase Currencies

In the end, as I've argued repeatedly over the years, monetary policy is only as good as fiscal policy. A central bank does not have wealth of its own. It is a zero-sum entity that can only enrich those from whom it purchases debt by debasing the relative wealth of people who hold the existing stock of currency. If a government insists on running deficits, engaging in wasteful spending, and dissipating public resources to bail out private bondholders, it has to find somebody willing to buy its debt. If it does not, the central bank buys it, and dilutes the currency by doing so. The situation is particularly insidious when the central bank buys low-quality debt, because there is no taxing authority behind it to provide a basis for confidence in the currency.

The Euro-area has a special problem in this regard, because the bailouts represent clear country-to-country transfers of wealth, and risk creating inflation for all the members of the European Community in order to defend the deficit spending of countries that simply do not have enough flexibility to cut those deficits. Greece in particular is likely to experience so much loss of output that it will most likely lose on the revenue side much of what it cuts on the spending side. For that reason, the deficits are likely to come down much slower than expected. Germany, with its particularly strong aversion to inflation, is unlikely to accept the costs for long.

It is difficult to project the timing and events by which all of this will be resolved, but I increasingly suspect that the (relatively) stronger Euro-area countries will reject the prospect of providing continuing subsidies and accepting growing inflation risk as the cost of keeping deficit-prone member countries under the euro umbrella. In short, I don't expect that Greece or Portugal (Spain is more uncertain) will ultimately remain part of the euro.

At the point that Greek and Portugese debt has to be restructured (which seems inevitable given the negative revenue effects of austerity measures), departure from the euro will give these countries a better ability to depreciate their currencies to a level that re-aligns internal wages and prices with competitive levels. This will be a less disruptive solution than having to force - as austerity measures do - a massive internal deflation through wage reductions and spending cuts. The unpleasant alternative is to hold the line on wages and prices within Greece, Portugal and other high-deficit countries, and suffer inflation throughout the entire Euro-area as those debts are monetized. The only other alternative, which does not seem at all likely, is that other Euro-area countries will accept ongoing country-to-country transfers in order to finance the deficits of their neighbors.

Without a central taxing authority, the goal of a common European currency can only survive if the participating countries obey a rule that strictly controls the deficits of individual countries. Without that, the whole system is compromised. It should not be difficult to recognize that the confidence in any currency is tied to the confidence in the assets which stand behind it, and associated confidence in the restraint of fiscal and monetary authorities. The bureaucrats in both the U.S. and European central banks have chosen to betray that trust. It's fascinating that they seem genuinely surprised when their generosity with other people's wealth (and their assurance of greater betrayal) is met with contempt. While I expect that the euro will survive by the coordination of its stronger members, it risks being debased by the unwillingness to accept debt restructuring sooner rather than later.

Cognitive Biases - A Visual Study Guide by the Royal Society of Account Planning

Found via The Big Picture.


Nassim Taleb's Aphorisms


Bill Gates: Giving Back: Finding the Best Way to Make a Difference

Found via Miguel at Simoleon Sense.

Saturday, May 15, 2010

Howard Marks Memo: Warning Flags

For about a year, I’ve been sharing my realization that there are two main risks in the investment world: the risk of losing money and the risk of missing opportunity. You can completely avoid one or the other, or you can compromise between the two, but you can’t eliminate both. One of the prominent features of investor psychology is that few people are able to (a) always balance the two risks or (b) emphasize the right one at the right time. Rather, at the extremes they usually obsess about the wrong one . . . and in so doing make the other the one deserving attention.

During bull markets, when asset prices are elevated, there’s great risk of losing money. And in bear markets, when everything’s at rock bottom, the real risk consists of missing opportunity. Everyone knows these things. But bull markets develop for the simple reason that most people are buying – ignoring the risk of loss in order to keep from missing opportunity – just when elevated prices imply losses later. Likewise, markets reach their lows because most people are selling, trying to avoid further losses and ignoring the bargains that are everywhere.

The Never-Ending Cycle

Why do people buy when they should sell, and sell when they should buy? The answer’s simple: emotion takes over. Price increases excite investors and encourage them to buy, and price declines scare them into selling.

When the economy and markets boom, people tend to assume more of the same is in the offing. They find little to worry about, other than the possibility that others will make more money than they will. Fear of loss recedes, and fear of opportunity costs takes over. Thus risk aversion evaporates and risk tolerance rises.

Risk aversion is absolutely essential in order for markets to function properly. When sufficient risk aversion is present, people shrink from riskier investments and prefer safer ones. Thus riskier investments have to appear to offer higher returns in order to attract capital. That’s as it should be.

But when people get excited about the prospect of easy money – even if from assets or investment strategies that have become far too popular, turning into overpriced manias – they frequently drop their risk aversion and adopt risk tolerance instead. Thus they swarm into the investment du jour without concern for its elevated price and risk. This behavior should constitute an important warning flag for prudent investors.

In the same way that expanded risk tolerance accompanies appreciated asset prices and contributes to the risk of loss, so does risk aversion tend to rise in times of depressed prices, increasing the risk of missed opportunity. When people refuse to buy assets regardless of their low prices, they miss out on the best, lowest-risk returns of the cycle.


The issue of Greece and its debt has been on investors’ radar screens for months, but few people seem to have understood its ramifications and the risks it presented to the markets. Then, in recent weeks, things began to be discussed daily in the media – such as Greece’s profligacy and the risks involved in admitting it to the European Union; Europe’s lack of an established mechanism for dealing with a problem of this nature; and its reliance on Germany to contribute voluntarily to a solution – that in hindsight it seems should have been obvious. This tells us a few important things about investing:

· Investors generally overestimate their ability to see the future, and the worst of them act as if they know exactly what lies ahead.

· It’s important to worry about what’s coming next. The fact that we don’t know what it is shouldn’t permit us to think there’s nothing to worry about.

· Low asset prices allow us to invest aggressively, without much consideration given to worrisome fundamentals and the possibility of negative surprises. But as prices rise, so should our degree of concern over these things.

The bottom line is this: the fact that we don’t know where trouble will come from shouldn’t allow us to feel comfortable in times when prices are full. The higher prices are relative to intrinsic value, the more we should allow for the unknown.

The recovery of 2009 in the face of significant fundamental uncertainty meant that the markets were reincorporating optimism and thus vulnerable to surprise and disappointment. This in itself should be sufficient to induce caution.