Thoughts from the Frontline

This week we look at the "The Triumph of Irrational Expectations over Long Run Experience." It is a cautionary tale, but enjoyable in the telling, and one that investors almost invariably ignore to their own chagrin. Also, at the end of this letter, I tell you how to get a free coy of Andy Kessler's book, "How We got Here." This is a book you want to read and then give to your kids. This past weekend, I along with my partners at Altegris Investments sponsored a conference for accredited investors. In addition to a number of investment managers, attendees heard from Richard Russell, Paul McCulley, Rob Arnott, Andy Kessler and Mark Finn, as well as yours truly. We recorded the main sessions, and in some future letter, I will tell you how you can get a copy of their speeches for your listening pleasure.

This is the text of a speech given at the Accelerating Change 2004 conference at Stanford University. The conference organizers asked me to look out over the next 3-4 decades and offer my thoughts as to what the future may look like. A somewhat daunting task, and one guaranteed to failure, as the future always seems to surprise, I nevertheless tried to peer into that dark glass. La plus ca change, la plus c'est la meme choses. The more things change, the more things stay the same. What of the future? Can we really stand here in 2004 and have some idea of what will transpire in the next 2-3 decades? Looking at which things will not change will give us some clues as to what will change, and some ideas as to the future in which most of us will assuredly live.

This week we look at how politics and geopolitical events can affect our investments. We look at a decade-long forecast from one of my favorite information services: Stratfor.com. I change my view on the euro, talk about a possible Chinese recession and look at uncomfortable analogies between 1900 and today. There's a lot of ground to cover so we will jump right in. I have had the relative value of currencies on my mind every day for the past two weeks. I have been in London, where the pound sterling is at a staggeringly high level, almost two dollars to the pound. Prices in London have always been high, even when the dollar was at its peak. Now they border on the absurd, at least to someone used to the economical confines of Texas. Admittedly I was in a high rent district (Mayfair), but a simple round-trip subway ride was $8. From my viewpoint, it seemed that the price of everything was almost double and sometimes triple what it is for me locally in Texas. There are no cheap drunks in London. Expensive drunks, maybe, but no cheap ones (and no decent steaks).

Writing on the train to Yorkshire from London, I am surrounded by a gorgeous English countryside on a beautiful spring day. Life has its moments. I like the trains in Europe. Quite a civilized way to travel. Yet every time I pull out my wallet, I am reminded of reality. The ebb and flow of the dollar has made this a most expensive country for someone from the states. Nearly everything is the same price, just in pounds instead of dollars. And a pound that is worth more than two of my pitiful dollars, at that. It has given me cause to think about cycles, because some day in the future, the English will be complaining about how expensive it is in the states. Maybe not for a long time, but all things ebb and flow, currencies included, but especially the stock market.

How can we go from oil priced in the low teens only a few years ago to oil now holding steady in the mid-50s? This week we have seen a projected price spike of $105 from Goldman Sachs. Can you say $4 a gallon gasoline, boys and girls? $100 to fill up the tank of your SUV? This week we look at the price of oil and why $100 oil is the solution and not the problem. Since I'm writing this on April 1, I was tempted to start out the letter as an April Fools joke. My topic would have been why the Dow is going to 36,000, but then I realized that James Glassman and Kevin Hassett wrote about that over five years ago in their book "Dow 36,000." So I guess we'll stick with $100 oil.

It seems like every week I get a letter from a reader asking questions along the following line: "How can I make a lot of money so I can retire early and/or live the lifestyle I want to live when I do retire?" Most of them are phrased far more eloquently and with accompanying questions and comments, but the bottom line is, "How can I get rich?" I'm especially touched by the very sincere letters from young people who ask this most basic of questions about accumulating wealth. They are not looking for get-rich-quick schemes but for some guidance as to how to organize their lives. I've never really been able to answer these letters with anything close to an adequate response. In today's letter I'm going to draft a response that we can use for all such future letters. I trust you will find it interesting as we wax a little philosophical about how to build wealth.

This week we finish with our series on the US trade deficit. When will we see a real problem? What are the likely results from a balancing of global trade? Where are the investment opportunities, and where are the pitfalls? It should make for an interesting conclusion and hopefully an interesting letter. Let's start this letter by noting that this week is the anniversary of the all- time high of the NASDAQ. Five years ago this week the NASDAQ topped at 5,048. It eventually dropped to around 1100 before "recovering" to today's close at 2,041. I remember writing in the fall of 1998 that the NASDAQ was overpriced. Eventually, time has shown that view to be correct. But in 1999, I looked like I didn't have a clue. And I confess at the time, I didn't have a clue. I couldn't figure out what was making the market go up. To me it was clearly a bubble. As a value investor, I couldn't bring myself to participate, other than through money managers who were market timers.

We have been looking at the US trade deficit and the global trade imbalance for the past two weeks. It is currently an unsustainable trend, and thus will stop at some point. The questions are when and how? We will conclude this series today, looking at several ways the trade deficit could come back into line. First, a very quick review. For those who remember, you can skip to the next heading. (And for those who would like to read the previous letters, you can go to www.2000wave.com and look in the archives.) The first Bretton Woods system came about when representatives of most of the world's leading nations met at Bretton Woods, New Hampshire, in 1944 to create a new international monetary system.

This week we continue to look at the imbalance in global trade and the US trade deficit. What are the ramifications for the dollar? I am going to weave together several different lines of thoughts from analysts all over the world and see if we can see a pattern emerge. While I give a brief synopsis of last week's letter below, for those interested you can read the full letter at http://www.2000wave.com. As I wrote last week, the first Bretton Woods system came about when representatives of most of the world's leading nations met at Bretton Woods, New Hampshire, in 1944 to create a new international monetary system.

"Another G-7 meeting has come and gone. And what has been accomplished? Next to nothing, in my view. The club of the world's wealthiest nations has punted on the big issues facing the global economy - namely, unprecedented current-account imbalances, currency misalignments, mounting trade tensions, and the liquidity- prone biases of central banks. The G-7's latest communique is emblematic of the increasingly vacuous rhetoric of globalization. This is a perilous course of inaction for a global economy beset with record imbalances." (Stephen Roach, Chief Economist, Morgan Stanley) In his talks to Congress this week, Chairman Greenspan dropped in these words, which did not make the highlight reels, but nonetheless should be listened to: "People experiencing long periods of relative stability are prone to excess. We must thus remain vigilant against complacency."

Last week we talked briefly about some of the problems surrounding Social Security, and especially the possibility that the deficit problems may be worse than we thought because of the trend towards (on average) living longer. But a large part of the current debate misses what I think should be the real point, and that point is the focus of this week's letter. Everyone assumes that if they work hard and save they will be able to retire. While a sad number of people do not plan for retirement, those who do make assumptions about what type of retirement they will be able to afford with their savings, pensions and Social Security based upon historical performance of the markets.

Social Security in the US (and the equivalent in Europe and Japan), as well as some pension plans, might be in far worse shape than you think. And the reason may be very good news for you, and almost certainly will be for your kids. Potentially very good indeed. Today we take a look at one potential pitfall in the future of Social Security that no politician is talking about. I had told myself that with so many people writing about Social Security that I should just go on to another topic. That changed this morning. While dropping off my 16 year old son at school, he turns off his brand new MP3 player (shock!) and turns to me and asks, "So what do you think of this Social Security thing? I mean, like private accounts and all? Isn't there some kind of risk in that?"