My long time readers are familiar with Jeremy Grantham of GMO as I quote him a lot. He is one of the more brilliant and talented value managers (and I should mention very successful on behalf of his clients). He writes a quarterly letter which I regard as a must read. I have excerpted parts of his recent letter, where the chief investment strategist really takes the current financial system follies to task. Typical of his great writing and thinking is the quote from this week's Outside the Box selection:
"I can imagine the company representatives on the Titanic II design committee repeatedly pointing out that the Titanic I tragedy was a black swan event: utterly unpredictable and completely, emphatically, not caused by any failures of the ship's construction, of the company's policy, or of the captain's competence. "No one could have seen this coming," would have been their constant refrain. Their response would have been to spend their time pushing for more and improved lifeboats. In itself this is a good idea, and that is the trap: by working to mitigate the pain of the next catastrophe, we allow ourselves to downplay the real causes of the disaster and thereby invite another one. And so it is today with our efforts to redesign the financial system in order to reduce the number and severity of future crises."
You can get the full letter at www.gmo.com (You will have to register).
Your glad to be back home at least for a week,
This week I came across two items that I think are worthy of being in Outside the Box, so I am going to give you both. The first is an essay by good friend Paul McCulley, Managing Director of PIMCO, called "Saving Capitalist Banking from Itself." The second is a recent speech by Paul Volker, former Fed Chairman and a (hopefully very) influential member of President Obama's economic advisory team. This speech is a must read. Taken together they provide a cautionary tale of what the world of banking will need to look like when we get to the end of the process. This OTB is a little longer than most, but I think it is important reading. If you don't know where we are headed, it is hard to imagine the journey.
Milton Friedman famously predicted that the euro would not last past their first economic crisis. This week we look at commentary by Niels Jensen that explores the news from Euroland. Can the euro survive? He explores a number of options which are most definitely not on the radar screen for most investors. It is good to get a perspective from those outside of our own back yard. Note that when he says "our country" he is referring to Great Britain.
Niels is the Managing Partner of Absolute Return Partners based in London (which is my European partner). I work closely with Niels for years and have found him to be one of the more savvy observers of the markets I know. You can see more of his work at www.arpllp.com and contact them at firstname.lastname@example.org. The numbered footnotes are at the end of the letter.
Yesterday I sent you an Outside the Box from Paul McCulley who supports the government and Fed activity (in general) in the current economic crisis. Today we look at an opposing view from Bennet Sedacca of Atlantic Advisors. He asks some very interesting questions like:
- Shouldn't the consumer, after decades of over-consumption, be allowed to digest the over-indebtedness and save, rather than be encouraged to take risk?
- Shouldn't companies, no matter what of view, if run poorly, be allowed to fail or forced to restructure?
- Should taxpayer money be used to make up for the mishaps at financial institutions or should we allow them to wallow in their own mistakes?
I think you will find this a very thought-provoking Outside the Box.
This week I am really delighted to be able to give you a condensed version of Gary Shilling's latest INSIGHT newsletter for your Outside the Box. Each month I really look forward to getting Gary's latest thoughts on the economy and investing. Last year in his forecast issue he suggested 13 investment ideas, all of which were profitable by the end of the year. It is not unusual for Gary to give us over 75 charts and tables in his monthly letters along with his commentary, which makes his thinking unusually clear and accessible.
Gary was among the first to point out the problems with the subprime market and predict the housing and credit crises. You can learn more about his letter at http://www.agaryshilling.com. If you want to subscribe, you can call 888-346-7444. Tell them that you read about it in Outside the Box and you will get not only his 2009 forecast issue but an extra issue with his 2010 forecast (of course, that one will not come out for a year. Gary is good but not that good!)
I trust you are enjoying the holidays. And enjoy this week's Outside the Box.
Exhale for a moment, forget your losses for the time being, and try to appreciate the fact that you're living through the single most important development in global finance since Bretton Woods. This is a "tell the grandkids about it" moment, when governments all around the world have essentially decided in unison that it's time to rewrite the rules, the very framework, in which financial transactions take place. Stock trading, interbank lending, commercial paper, the very concept of private sector ownership are all up in the air right now.
The only thing I can tell you with certainty is that if you try to evaluate your investments using the same metrics you've always relied on - P/E ratios, market share, interest rates, etc. - you're going to be as successful as a football-turned-baseball coach evaluating a pitcher by the number of touchdowns he throws. The rules are changing, gentle reader, changing at least for awhile from market-driven inputs to government-driven inputs. If you try to apply what you know from the "old game" without understanding that you're playing a "new game," the rules might not make sense.
I'm sending you today a piece from my friend George Friedman on how his company Stratfor looks at economics. More precisely, this piece explains how they look at Political Economy. And from here on out, it's political economy that's going to be driving markets. If the old rule was "Never fight the Fed." It's now, "Never fight the Fed. And the Treasury. And the ECB. And the Bank of England. And the Bank of Japan...." You get my point.
George has very kindly arranged for a special offer on a Stratfor Membership for my readers. I strongly encourage you to click here to take advantage of this offer. Now more than ever, you need the kinds of insights that you can't get from traditional finance sources. You need a wider lens, and there's no one better than George and his team at Stratfor at this kind of analysis. I know you'll find them as valuable as I do.
Your Taking-It-All-In Analyst,
The credit crisis is global. Interestingly, some of the more creative and straight forward solutions are coming from England. This week in Outside the Box I am presenting you with a very well written (even entertaining) letter from Bedlam Asset Management from London www.bedlamplc.com on their view of the crisis. It is always instructive to look at your problems from the point of view of another party, and even more some when they give you some thoughtful and cogent analysis.
I have to admit, seeing green on my screen feels good, but we are in a recession that is global and is likely to get worse. What we need to do now is assess what our response will be. First, we need to avoid the pitfalls and then look around for the opportunities which will be presented us. I think this week's Outside the Box will help you think through your personal situation.
Do government bailouts in times of banking crises work? Philippa Dunne & Doug Henwood of The Liscio Report highlight a major study of 42 fairly recent banking crises around the world. Result? Some types of government intervention works and some don't. One characteristic that is needed though is speed. Dithering, a la Japan, is a recipe for disaster. This is a brief summary of the report (to which they provide a link) and their conclusions as to the basic outlines of what the US should do. Given that Europe is already in the throws of its own bank crisis, and the rest of the world could experience problems, this should be useful reading. They also provide graphs of banking crises and comparisons with developed countries and the resulting market experience.
One major point? This is like the old Fram oil filter commercial line "Pay me now or pay me later." As this study points out, the tax payers and citizens of the US (and the world) are going to pay for this crisis in one way or another. Either a major recession (with high and persistent unemployment), reduced incomes and tax collections or a collective efforts to stabilize the banking system. The costs of inaction are much higher. It is not a matter of cost or no cost. We are going to have to pay in one form or another.
We cannot avoid the costs given where we are today. The time to avoid cost was years ago reigning in Freddie and Fannie and proper oversight of the mortgage industry. We (Congress) missed that opportunity. (Sadly, we are going to re-elect the very leadership to both parties largely responsible for the neglect. There is plenty of blame to go around. No amount of partisan finger pointing by Speaker Pelosi shifts that blame.) However, we can choose the form of the cost will be paid in. Personally, I prefer collective efforts to 10% or more unemployment and the risk of an extended recession and its costs. I know this is not pure free market theory, and sticks in the craw of many of my readers, but when many of my neighbors and friends will be unemployed and businesses are suffering theory will not make a very good meal. Congress must act now. This report is a good reminder of what has worked in the past.
My thanks to Philippa and Doug for allowing me to send this as a Special Outside the Box. You can see their work and blog at http://www.theliscioreport.com.
The purpose of Outside the Box is to present views which cause us to think through our basic assumptions. This week our old friend Michael Lewitt of Hegemony Capital Management gives us a view as to why the bailout bill going down may not be as bad as I think it might. There is much we agree on, however. And part of our agreement is that a deeper recession is in our future. Let me be clear. Muddle Through is now at risk.
I have talked with my publisher, and for the next few weeks of The continuing Crisis, we are going to send more than one OTB per week, and I may also add some short commentary. These are extraordinary times, and I know a lot of you (as I can tell from phone and emails) are worried and are interested in analysis that is not biased with either a perma-bull or perma-bear stance. I will call it as I see it, as always, and forward you material from my best sources.
That being said, we will get through this, one way or another. Sanity and clarity will return, as it always does after times of crisis. I wish you the best in your situation.
The weekend has brought us events that can only be described in large, over-the-top terms. The Fed agreeing to take equity on its balance sheet? How bad can things really be? Clearly much worse than most people thought last Friday. Moral Hazard has been re-introduced as Lehman is allowed to go down. I will admit to being surprised. I thought Paulson and Bernanke would put it in the too big too fail category. I think they did the right thing by refusing taxpayer money for a bailout, but it is clearly going to roil the credit markets for weeks and months. It will be interesting to see how long it lasts.
I am in La Jolla today, working with my partners at Altegris, and looking over their shoulders while they monitor the performance of some of our managers. Interesting times. But I have had the time to read two short but very interesting commentaries on the current crisis. I will have more to say on Friday, but for now let's read old friends (to Outside the Box readers) Michael Lewitt of Hegemony Capital Management (www.hcmmarketletter.com) and Barry Ritholtz of Fusion IQ (www.fusioniqrank.com).
As I send this, credit default swaps spreads are simply blowing out. I have been writing about how we would see significant problems in the CDS markets for almost two years. This is something that you could see coming yet nothing was done. I know we are now in crisis, but let's hope that the authorities learn some lessons and put in place some sensible regulations of the CDS market soon. And for the love of Pete (insert your favorite expletive here) put these (more expletives) things on a regulated exchange.
And I agree with Michael below. This is not a time to try and catch a falling knife. That time will come, but not yet. And remember things will get better and we will get through this. As I just said to Barry, "We do live in interesting times."
Last Friday's letter was about the fact that it is not just Freddie and Fannie. There are other problems. The Weekend Edition and today's Wall Street Journal are filled with stories about the problems with Freddie and Fannie. The assumption in so many quarters is that they will soon need government assistance. The only questions seem to be when and in what form? Can this wait until a new president is in place? Congress is leaving town soon. Can it wait until the lame duck session?
As I have been writing for well over a year, the credit crisis is going to be deeper and take longer to correct than the main stream media and economists think. Losses at banks are going to be much larger, and they are going to bleed for a long time. That means we are going to see more banks failing.
Bennet Sedacca, who I quoted in last week's letter, sent out a new letter this morning, providing a list of stocks he thinks may also be in trouble, his "Dead Men Walking" list. He also notes several banks that will be the beneficiaries of the crisis as they gobble up weak competitors.
Caveat: I am not a stock guy, and can't comment on any of the specifics of what Bennet writes about, but I thought it is important for my readers to understand that this crisis is not going to be over when Freddie and Fannie are nationalized. There are still some whales out there left which are coming to the surface. Warning: this is not pleasant reading.
Bennet is the president of Atlantic Advisors in Winter Park, Florida.