Long-Term Investing Perspective: Five Charts

These five charts suggest a long-term investing perspective.

Every picture tells a story, and so does every chart. Some readers press on to the next blog as soon as they see a chart here, while others patiently wade through the wordy ravings in hopes that the next entry will bring the refreshing clarity of some charts.

I earnestly recommend that even the chart-phobic glance at these five charts.There is a big story told here in these representations of data.

As I note below in the HUGE GIANT BIG FAT DISCLAIMER, I do not offer investment advice here, as I am not qualified to do so, nor do I wish to. This blog is the freely offered random ravings of an amateur observer, and nothing more.

In the service of transparency, I try to disclose my own positions and will try to disclose recent trades, both good and bad. The idea here is to only reveal positions which have been exited so you will not be tempted to copy my highly risky and anachronistic trading.

Here are all my recent trades:

1. QID calls, bought 3/8/11, sold 3/14/11, + 45%

2. SSO calls, bought 3/16/11, sold 3/17/11, +26%

3. GLD calls, bought 3/16/11, sold 3/17/11, +40%

4. SSO calls, bought 3/16/11, sold 3/17/11, +23%

Total return for the week: +112.7%

It's awfully tempting to "disclose" only winning trades and somehow forget to list the losing trades, but that is really not helpful to readers. These are all my trades of the past week.

I have of course made hundreds of losing trades over the years (a very expensive education, heh). Please note the positions taken here were very small, and were highly speculative, i.e. held for a day in most cases or for 5 days at the outside. I will not be retiring on the gains; these trades were made mostly as an intellectual/emotional challenge and to test my trading ideas in the real world.

Also note that these are bets (yes, bets, not "investments") on both the long and short side, all within the same week. As I noted earlier in the week, volatile trading is a speculator's ideal scenario, and low-volatility melt-ups are the least profitable environments. I have basically avoided trading for the past few months as I did not see any low-risk opportunities. As insane as it sounds, I considered all these high-risk option trades to be very low-risk bets, and I was acutely aware that I could be dead-wrong and thus was ready to exit the moment the trade was revealed as faulty.

My next four trades could all be losers. That's OK, as long as I exit stage left immediately.

I currently own some calls on the QID, i.e. a bet that the NASDAQ 100 will decline. If I'm wrong then I will exit that bet and suck the loss. I suspect the market might rally, and perhaps rally big in the coming weeks, but perhaps not just yet.

Two last disclosures: I have learned a great deal from readers who are much better traders than I am: for example, Steve R. and Harun I. I am grateful to those readers who have shared their expertise and strategies with me, and my goal here is to attempt to pass on some of the sensibilities I have gained.

My Weekly Musings for subscribers and contributors is home to my furthest-out speculations and "notebook" of nascent/gestating ideas.

OK, enough disclosure. Let's look at five charts which tell a longer term story.

Consumers have taken on a lot of debt and barely begun to pay it down.

Their primary store of wealth, their home, has plummeted in value.

The number of jobs in the formal economy is declining, a fact masked by the wholesale manipulation of data i.e. removing millions of citizens from the labor pool so the unemployment rate is artifically reduced for propaganda purposes.

The Fed has goosed the stock market by destroying the U.S. dollar. The dollar may be reaching a level of support which the Fed cannot break. This is not a win-win strategy--if the Fed succeeds in destroying the dollar, the consequences will be dire for the American people.

The Fed and the political "leadership" have blown gigantic asset bubbles as a way of masking the imbalances and rot at the heart of the U.S. economy and machinery of governance. Unprecedented central bank and Central State intervention has blown yet another bubble in stocks, but can the Fed goose the S&P 500 up to a triple top above 1,500?

It seems likely that time is running out for the Fed's game plan. Three years of monumental manipulation and intervention has not healed the economy or the market, it has only bought time via "extend and pretend." Since nothing has been actually repaired or addressed, then reality will intrude at some point. Given the ill health of the real economy and its total dependence on Central State borrowing and intervention, I doubt the Fed's QE shuck-and-jive can push the SPX to a triple top.

But who knows, maybe they'll manage this one last blow-off top. Longer term, however, it may well be time to exit equities as a "buy and hold" investment for a decade or so.

I have been setting up a new PC and a bunch of other tech stuff, so please bear with delayed email responses. Your understanding is greatly appreciated.


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Volatility and the "Permanent Bull Market"

The "permanent Bull market" engineered by the constant intervention of banking and political authorities has a problem: the duration of each cycle is getting shorter.

As we all know, the central banks of the world have decided that in lieu of actual prosperity, they will provide the illusion of prosperity via a "permanent Bull market" in stocks.

I have discredited this "wealth effect" many times, as have others. Since the vast majority of equity and financial assets are held by the top 10% of households in the U.S., then the "wealth effect" only benefits this narrow band of households. Very little trickles down as the newly enriched account for about 40% of all consumer spending--but luxury shopping creates mostly low-paying jobs: clerks in jewelry stores, busboys in fancy restaurants, etc.

So far, so good, as far as the Federal Reserve and the politicos in Washington are concerned; since Wall Street is skimming billions again and big campaign contributors all come from that top 10% slice of the economy, then their pals and supporters are benefitting immensely from the facsimile "prosperity" of a propped-up "permanent Bull market."

But something is going wrong with the interventionists' delight: each new run of the "permenent Bull market" is shorter than the last one. Consider this chart of the S&P 500:

Although it is not shown, you will recall that the first leg of the "permanent Bull market" (PBM) lasted from about March 2003 (final sputtering end of the dot-com bubble) until about July 2008, when the market finally fell below the critical support offered by the 200-week moving average. That run lasted about five years.

The next "permanent Bull market" began in March 2009 after the central banks and politicos intervened on an unprecedented scale in the second half of 2008. That run ended in May 2010 when the Eurozone's debt problems broke through the EU's thick crust of denial and obfuscation. So that leg lasted a mere five quarters.

More intervention and a new layer of denial and obfuscation "solved" that crisis (which seems to reappear with alarming regularity) and the next leg of the "permanent Bull market" was launched by the Fed's QE2 $600 billion quantitative easing program--yet another unprecedented intervention in an economy which was supposedly one year into "recovery."

This most recent return of the "permanent Bull market" lasted less than seven months--from September 2010 to mid-March 2011.

The dynamic is clear, isn't it? Each new leg of the "permanent Bull market" requires a heavier dose of unprecedented intervention, denial, "stimulus" and obfuscation than the last one, yet the resulting Bull market is significantly shorter in duration than the previous run.

If this pattern holds--and exactly what evidence supports the claim that the next "permanent Bull market" will last longer than the previous one?--then we can anticipate that the next Bull market will last considerably less than seven months, and the one after than even less, until the forces of intervention and manipulation encounter a solid wall of granite.

At that point, massive intervention won't spark yet another "permanent Bull market": it will spark a collapse of equities as participants realize that the last iteration of the "permanent Bull market" lasted less than a month, and the next one might not last a week.

I have been setting up a new PC and a bunch of other tech stuff, so please bear with delayed email responses. Your understanding is greatly appreciated.


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Anatomy of a Trade

Why I bought calls on a 2X ETF of the S&P 500 in the last hour of trading yesterday.

Investors see little benefit from volatility, while traders thrive on volatility. For the buy and hold investor (in, say, Joe's Beanery) who bought stock in Joe's because he liked the food and the place was always busy, then volatility brings bad things: his stops (if he followed all the investor gurus' advice and set stops) get triggered and blow off his position, and he's left with the discomfitting dilemma of either buying back in after the stock has popped back up or wait for another dip.

If the investor is really long-term, then when Joe's gets dumped along with all other equities, then he sees the dip as a buying opportunity. This works in a Bull market but not in a Bear market. The long-term investor is basically counting on a permanent Bull market. That works until it doesn't.

The boring melt-up that delights buy-and-hold investors bores traders to deathbecause it's hard to make a killing in a low-volatility melt-up or meltdown. So this week's trading is Heaven-sent for traders. Even a two-bit player like myself has been able to make a few bucks on the long and short side.

I am both an investor and a trader. As an investor, I'm buying small U.S. oil companies with leases in the U.S. I don't really care if they go up or down, it's a long-term play on $300/barrel oil. If they get trashed, fine, I'll add to my positions. (I suggested this idea in my Weekly Musings--not as investment advice but as an investment idea.)

Speaking of which, please note this is NOT investment advice--it is only the freely offered weird and colorful ramblings of an amateur observer. Please read the HUGE GIANT BIG FAT DISCLAIMER below for the very good reason that trying to duplicate the trading strategy presented here could wipe you out.

Nuff said, right? DO NOT make investment decisions based on the colorful ramblings of an amateur.

Yes, I am about to describe an extremely high-risk trade which nonetheless strikes me as a very low-risk trade. Only an idiot trade options on a leveraged ETF--unless said idiot is relatively confident in trading options, i.e. only trades what he can afford to lose and/or as a hedge against another position on the other side of the trade.

Basically, I made a bet that the market is poised to make a nice little rebound right here. If I am wrong, then I will be spectacularly wrong, and if I'm right, then it may well be a profitable little gamble. I am posting it tonight, before the market opens, so I can't second-guess my positions.

I sent a Tweet about mid-day which asked if Da Boyz (Wall Street) would suck up these huge imbalances in their trading positions (long and short) come Friday options expiration. In general, they don't like sucking up huge losses, and for that reason alone I expect a rally (bogus, engineered, real, take your pick) tomorrow that lasts into Friday so Da Boyz can exit their options positions without sucking too much wind.

The market has fallen to major support. The Dow Jones Industrials have slumped to the 11,600 area, a level of support/resistance going back to the 2000 dot-com peak and the 2007-2008 head and shoulders. A bounce would be technically typical here.

Then there's the Bollinger bands--price has punched right through the lower band, an extreme that is typically resolved by a short-term bounce.

Lastly, there's the pervasive expectation of complete disaster regarding the Fukushima nuclear reactors. If you read/watch the mainstream media and the blogosphere, then you might conclude that it's only a matter of seeing just how awful and horrendous the criticality will be.

In other words, the market has discounted the possibility of any good news on the reactor front. I have a bit more faith in the resilience and work ethic of the Japanese, however, and therefore I anticipate some good news shortly: one of the reactors will cool off, some measure will finally provide some positive results, etc.

At that point, the market could explode in a relief rally, and I will be poised to gain from that reversal of guaranteed disaster to glimmers of hope because I bought calls when the market was plumbing the depths of dispair.

I have no idea what will happen on March 17, and neither does anyone else. But I do know one thing, which is violent swings of hope and despair and high volatility are a trader's best friends--if the trader is on the right side of each swing.

In other words, I may have my head handed to me on a platter. I am well aware of this possibility and sized the bet accordingly.

I have been setting up a new PC and a bunch of other tech stuff, so please bear with delayed email responses. Your understanding is greatly appreciated.


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Perspectives on Japan and the Global Economy

Regaining perspective is difficult in the moments after crisis.

Even as we share the sense of tragic loss caused by the earthquake and tsunami in Japan, we who are far away need some sort of perspective on the calamity and its after-effects. For the 126 million residents outside the northeast zones of destruction, life goes on: young people will graduate from college soon, others are getting their drivers license, and despite the souffle of hysteria whipped up from conflicting/minimal data, most people in Japan are not taking any radical responses.

According to my friends in Kanto and Kansai, they're getting info from the Web and TV just like we are.

Even with the horrendous loss of life and property, Japan remains a wealthy, well-organized society and the third largest economy in the world. But while it is just behind China in terms of total GDP, it has only 1/10th the population and thus enjoys a per capita income 10 times that of its neighbor on the Asian mainland.

What is remarkable but rarely noted is how little damage has been caused by the many large (6.0 and above) aftershocks which have struck areas hundreds of kilometers away from Sendai. Nagano and even Shikoku have experienced major aftershock earthquakes which in themselves are significant seismic events.

In less seismically hardened places, 6.0 quakes do quite a bit of damage. That these big aftershocks have caused so little destruction is evidence that Japan's infrastructure has been hardened, especially since the Kobe quake revealed vulnerabilities.

The economic after-effects are difficult to assess. Correspondent Jim S. submitted this report, Japan quake strains supply chain from chips to ships which describes the disruption to shipping, surface transport and manufacturing which will last at least a few weeks and possibly a few months.

The more enduring consequences will probably be less measurable but more important. A people's faith and trust in their government is tested by national calamity, and Japan's people will come away from this crisis with either a renewed faith in their government and its leaders' ability to handle difficult challenges, or they will (as Americans did after the Hurricane Katrina calamity) suffer a loss of faith in their government's core competency.

The consequences to the global economy will probably be hard to quantify even as they trigger other cascading effects. Shortages and disruptions will fade soon enough in most cases, but longer-lasting effects may ripple for months or even years, especially in the nuclear power industry and in the subtler disruptions to global trade and finance.

For example, the world's stock markets have soared on the winds of rapidly rising profits. In the U.S., corporate profits have regained an unprecedented pinnacle. Disruptions resulting from Japan's quake could pinch margins, and thus act as a critical grain of sand on the pile of rising input prices that are already pressuring global profit margins. That nudge could trigger a sharp decline in global equities more lasting than the one which punished stocks yesterday.

Japan's already precarious domestic finances might also reach a Stick-Slip moment as the costs of the quake act as a tipping point in interlocking markets. A Critical Moment for Japan's Economy.

Japan's central bank might stop buying Euroland and U.S. bonds, for example, removing key props from those markets, and the costs of borrowing in Japan may rise as some hidden threshold is breached by the sudden demand for trillions of yen for reconstruction and additional "stimulus."

None of these long-term consequences are as yet visible, but we can anticipate the possibility that the initial disruptions will be resolved relatively quickly even as the effects of those disruptions ripple out, tipping precarious systems into imbalances with no easy resolution.


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Sorry, Fed and People's Bank of China: You Can't Have It Both Ways

My thoughts are with those trying to contain the nuclear reactor crisis in Japan, and with their families, who are justifiably worried about the health consequences their loved ones risk as they work long hours in hazardous and difficult conditions.

You can't have it both ways, but that isn't stopping the Fed and the PBOC from continuing their doomed policies.

The Federal Reserve and the People's Bank of China are each trying to have it both ways: they want rapid growth in money supply, lending and the economy but no troublesome jumps in the price of essentials. Yet the rapid expansion of money supply and credit feeds volatile price increases and politically disruptive income inequality.

While the world watches and hopes the reactor containment structures in Japan hold, whatever the aftermath of this deepening nuclear crisis, we will be living in a world defined by the financial policies of the Federal Reserve and the People's Bank of China.

Frequent contributor Harun I. neatly summarized the problem with Fed Chairman Ben Bernanke's explanation for why the Fed's policies had nothing to do with skyrocketing global commodity prices:

What I find troubling about Bernanke these days is his overt dissembling. Before congress he says that the recovery, not money printing is causing a rather destabilizing spike in commodity prices. Looking for evidence in nominal price charts, there is none to be found. What he is trying to make us believe that from 1982 to 1998 (the great equity bull market) there was not enough demand to drive crude oil prices where they are today. Hmm.

At any rate he can not have it both ways. He cannot claim that he needs to print money to spur "acceptable inflation" (which effectively raises prices) while claiming that money printing has nothing to do with rises prices.

Thank you, Harun.

The Fed is being disingenuous in claiming it is blameless for global inflation: the Fed's zero-interest rate policy and quantitative easing are both unleashing "hot money" that is seeking higher returns anywhere they can be found in the global economy.

In a larger sense, the Fed is attempting to repeal the business cycle. In the normal course of capitalism, low rates and easy credit lead to increased borrowing, which leads to rising consumption and investment in production to feed that increased consumption.

This leads to higher profits, which feed more investment and debt.

At some point, the cycle hits a brick wall: borrowers can't afford to pay more interest, so debt stops rising, and consumption and demand slump as borrowing levels off. In the rush to mint profits, production capacity exceeds demand, and as a result prices and profits both fall.

As the boom progressed, investors sought out riskier, more marginal investments. As new debt and demand fall, then these riskier investments lose money and are either shuttered or sold for a loss.

As profits decline, workers are laid off and commercial borrowers find their income streams aren't sufficient to meet their obligations. The credit cycle turns from expansion to contraction, as marginal borrowers go bankrupt and insolvent businesses and loans are liquidated or written down.

This purging of bad debt, speculative excess and misallocated resources sets the foundation for another cycle of renewed growth.

But the Fed has attempted to repeal the credit cycle. Rather than allow credit to fall sharply and interest rates to rise as bad debt is purged from the financial system, the Fed has pursued a policy of making credit even cheaper in the hopes that financial-sector borrowers will be able to borrow more since rates are near-zero.

But since consumers and enterprises are still burdened with mountains of existing debt, few are willing or qualified to borrow more. As I recently wrote here, consumer debt in the U.S. has declined a paltry 2.7% in the Great Recession.

The Fed's quantitative easing ends up flowing not to households or productive enterprises but to the “too big to fail” banks and Wall Street firms, which then seek higher returns in assets such as stocks and commodities.

The Fed's intention was to push money into productive enterprises, but instead it has fed pools of speculative money chasing high returns in global commodities. This is helping to fuel inflation in food and other commodities, not just in the U.S. but globally.

Now the Fed has backed itself into a corner: if it keeps interest rates low and continues pouring hundreds of billions of dollars into “hot money” hands, then it will adding to the destabilizing consequences of rising commodity inflation. If it stops its quantitative easing stimulus to help cool global inflation, it threatens to derail the stock market run-up. Without QE2 to hold down rates, interest rates will rise, pushing marginal borrowers out of the market and increasing borrowing costs for everyone from new home buyers to those buying new vehicles.

By attempting to repeal the business cycle and refusing to allow a necessary credit cleansing (writing off of bad debt) and repricing of risk, the Fed has created an inescapable double-bind for itself: either continue to pursue easy-money policies and help destabilize the global economy with rising commodity inflation, or allow interest rates to rise and destabilize speculative markets and marginal borrowers.

China is also trying to have it both ways. China's leadership is on the horns of a dilemma: if it continues pumping up rapid growth, it will inevitably feed inflation, while if it raises interest rates and curbs lending to limit inflation, that policy will restrain overall growth.

Though profits and gross domestic product (GDP) have been surging over the past decade as China's productivity improved, these gains have not trickled down to the workers' paychecks. According to the National Development and Reform Commission, incomes only kept pace with profits and GDP in three of China's 27 provinces.

In other words, the "rapid growth" is flowing only to the top tranch of China's households, while food and energy inflation's impact is felt mostly by lower-income wage earners. In effect, China's economy and political structure is creating a nation of Haves and Have-Nots. (Sound familiar? Just substitute "America" for "China" and the statement is equally true.)

Victor Shih, an Associate Professor of Political Science at Northwestern University, sees the government's tight control over yields on savings accounts and lending rates as a primary cause of rising inequality: as inflation accelerates, China's savers are losing money, as the return on savings is lower than the rate of inflation. Negative returns on savings act as a stealth tax on China's households and a subsidy to the government-owned banks.

The banks then turn around and loan money to politically connected real estate developers and government-owned enterprises at interest rates that are near zero in inflation-adjusted terms. "The Chinese financial system channels wealth from ordinary households to a small handful of connected insiders and state-owned firms," writes Shih.

Insiders and top managers take home substantial income in cash that goes unreported in regular channels—so-called "grey income." This is another source of wealth inequality: average workers don't receive these large cash payments, which are considered commissions and bonuses in China.

A Credit Suisse survey of urban households in China found $1.5 trillion in grey income unreported in the official household income numbers. About 60 percent of this grey income flowed to the top 10 % of households. According to Shih, while income of normal households rose 8%, the top 10% of households saw their income leap by 25%

The net result of these structural imbalances, in Shih's view, is a China that is "increasingly splitting into a small upper class that spends freely on luxury goods, and a remaining population whose earnings and savings are eroded by inflation and state confiscation."

So both the Fed and the PBOC are creating two equally destructive and pernicious financial forces: runaway commodity prices fueled by asset bubbles and heavily goosed speculation, and rapidly increasing wealth/income inequality as the gains from speculative excess flow to the top while the price increases and low yield on savings stripmines purchasing power from those least able to afford it.

You can't have it both ways, and that's something neither the Fed nor the PBOC is willing to admit--yet.


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