Thoughts from the Frontline

This week we are going to look at one aspect of the future of investing. A few weeks ago, I was with good friend Doug Fabian in LA. I spent a session or two on his weekend radio show and then we went out to dinner. Not surprisingly, we began to compare notes on investing. While I generally spend my time focused on the hedge fund world, Doug is a true expert on mutual funds. I wrote in my book that I think the day will come when hedge funds will be available to the public and as an industry will be as large as or larger than mutual funds. Doug, however, looks at a different end of the investing spectrum. He thinks the world of mutual funds will shrink for entirely different reasons. I found his thinking quite interesting and asked him to do an article so I could share it with you while I am out on vacation. I will be back next week, but I am glad to be able to share these thoughts from Doug.

There are always a few dark clouds that determined bears can find, even in the best of times, albeit they may be no bigger than a man's hand. Most of the time, they dissipate into the wind, leaving nothing but ulcers for the worry warts in their place. It's just no fun listening to Jeremiahs in the summer (or at any other time, for that matter). But sometimes, these clouds grow, and like Elijah running to Jezreel for cover, investors might be wise to do the same. This week we survey the economic horizon to see if there are signs of a recessionary cloud coming this way, and if so, what should we do? We look at what the color pink says about the markets and muse upon the nature of recessions.

This week we look at China with a few thoughts that are not part of the conventional wisdom, and throw in a comment or two on global money growth, employment problems in the third quarter, and a comment on the presidential race. Last Sunday morning,I was sitting in my living room talking with the host of a radio show called the Smart Investor in Phoenix, and he asked if I had seen the Sunday New York Times, as they had recommended Bull's Eye Investing as "serious summer reading." After lunch, I went to the local Barnes and Noble, bought a NY Times and sure enough, there in the Business Section, was a picture of my book and a very kind review.

Today we take a final look at the housing market. Are we in a bubble or is it merely a period of overheated prices which will cool off? Is it the right time to buy (or sell) a home? If there is a bubble, how would we spot it? A little full disclosure. Thinking about the housing markets for the past few weeks has been somewhat more than an academic exercise. I sold my last home a little more than four years ago, for family reasons unrelated to valuations or markets (time to downsize). I decided to lease for a time. My thought was to wait until a recession created a drop in values in the type of homes I wanted, and accompanied with low rates, would buy that perfect home. We would get the deal of the century. I persuaded my wife to go along with such an idea.

This week we once again look at the US housing market. We explore what may be the prime contributor to spiraling home prices. (I bet this once catches 95% of you by surprise, but in hindsight, you will all nod and think to yourself that is what you suspected all along, just as I did.) We look at the relationship between income and housing prices, and even find a new ratio to suggest when it is a good time to buy homes. It will make for interesting reading. But before we delve too deep into the data, indulge me for a [very] brief commercial. I was happy to learn a few weeks ago that my book, Bull's Eye Investing, remained for the second month on the New York Times Business Best Sellers List, moving up to #9. The new rankings for June will be out soon, and I hope we keep the momentum. One reader, A Keith Murphy from New Jersey, recently wrote on Amazon.com:

This week we continue our look into the factors involved in housing prices. Specifically, we are going to look at the affect of Adjustable Rate Mortgages (ARMs) on values. Do they pose a risk for the economy at large as rates rise? Some see them as a major crisis in the making, while others see no harm. Plus, we look at just how important housing is to the US economy. It should make for interesting reading. But before we begin, let me briefly answer a few questions I have been getting of late, as we have a large number of new readers. Basically, the questions run: Why do you write this letter? Why is it free? How do you get access to so much information and what do you really do for a living?

As I have written about and documented on many occasions, the economic health of the US consumer is hinged upon the housing market and housing values more than any other single factor. Since the entire economy, not to mention the world economy, is heavily leveraged to a healthy US consumer, the question of whether or not there is a bubble in the housing market is of paramount importance. Today, we begin a series on housing. I have found the research to be fascinating and often surprising and contradictory. I trust you will find it useful, and it is almost guaranteed to be debated, as I will depart from the Conventional Wisdom of both housing bull and bears. But first, I want to address the recent dramatic rise and now slowing of the growth in the money supply as measured by M-2 and M-3. Many commentators breathlessly see alternatively either doom or a new bull market based upon these monetary measures, or the sinister hand of the Federal Reserve manipulating the markets.

As have many of my countrymen, I have been moved today by the funeral ceremonies of President Ronald Reagan. In what may be the most moving eulogy of my lifetime, Margaret Thatcher summed up a life and a time that so changed the world. At the end of this brief essay, I give you the full text of her affecting tribute. We will return to our usual beat of finance next week, but this week I offer a few personal thoughts on the passing of "The Gipper."

Will rising rates cause the hedge fund world to blow up and bring down the economies of the world? What about the huge recent rise in the money supply? Are the large employment numbers for real? Is inflation coming back? Will the economy continue to grow? All good questions upon which we will muse. (Yes, I know I was supposed to write about the housing bubble, but my associates keep bringing in important new research which must be read. Unfortunately, they are all quite long and written by PhD economists, which is to say, dense and complex. I will get to it, I promise.)

In what is the shortest e-letter I have written in years, for which many of you will be grateful, this week we once again delve into Fed policy. Should they raise rates in June? The even tougher question is "Will they?" Plus we look at a very disturbing report that Chinese firms are unable to secure letters of credit for sizeable amounts of soybeans that are already in port. What is going on? Is it a bureaucratic snafu or a sign of real problems? But first, I must acknowledge my real (and embarrassing) proof-reading difficulty last week. I meant to write: "... not my normal gentil self..." trying to be cute and show my limited French vocabulary, rather than the correct English word of genteel. Somehow, (spell-check?) it came out gentile in the copy. I was not meaning to imply anything about the various dispositions of any ethnicities and hope I did not offend anyone.

This week we explore the problems with generalizations and assumptions. We will use as the launching point a rather poor piece of sensationalistic journalism from an otherwise excellent magazine. We look at the problems, costs of and the drive for the regulation of hedge funds. And I offer what may be a controversial opinion or two. This is not my usual genteel style, as I take the gloves off. Let me note upfront that this issue is going to deal with hedge funds. Long time readers know that this is my economic backyard where I make the main part of my living. Normally, I do not discuss this specialized part of the economic scene in this letter, except in oblique references. I try to use this weekly space for general education and thoughts on the markets and investing.

I returned very early this morning from the Las Vegas Money Show, where all flights to Dallas were cancelled last night due to the odd tornado or two in the area. I went back to the hotel, had a dinner with friends, went to the room and began to research the hot questions on the minds of many of the 10,000 attendees at the conference: Where is the market going and are we in the beginnings of a bear market? Downloading a ton of recent research into my computer, I took the time in the airport and on the plane to try and give you an updated answer to what I wrote on February 6 in this space: "As I wrote last month, the markets could continue to move sideways to up, but I think we could see this year as a classic "Sell in May and go away" year. I would have fairy close stops on any trading accounts." (Thoughts from the Frontline, Feb. 6)