Thoughts from the Frontline

Why do we continue to make the same classic investing mistakes, generation after generation, throughout the world, in all times and in every culture? It is as if history has no meaning for each new age, yet it is there for all to read. We explore this and more in today's letter. But first, let me offer a few observations about the current mutual fund scandals. I find it interesting that the funds which are the target of investigations still have 90% of their assets. To illustrate this point, I will first offer an insight about hedge funds. In the hedge fund world in which I mostly reside, if a manager leaves the fund, the tendency is to shoot first (redeem) and ask questions later. If there is a rumor of a problem, head for the exits. It is exactly opposite of stock trading strategy. In the hedge fund world, you sell on the rumor and buy on the news. It doesn't make any difference to the managers of the fund of hedge funds who have about 1/3 or so of all hedge fund assets. "Kill them all and let God sort them out," is the attitude. Since it takes several months (end of the quarter) to actually redeem from these funds, the knee-jerk reaction is to send in your redemption notice and then ask questions later.

Today's letter may be one of the more controversial, or at least debatable, letters I have written in some time. I take a very out of consensus position on interest rates. As promised last week, we deal with the question, "What ever happened to the Muddle Through Economy with the GDP is growing at 7.2%?" Is it time to abandon the concept? I think this week I will leave you a few things to think about, so let's get started. First, let us recall Keynes' bon mot when asked about why he changed a previously stated position, he replied "Sir, the facts have changed, and when the facts change, I change. What do you do sir?"

This week we will look at the very long term trends in demographics. I find this whole topic fascinating and one that is fraught with investment implications, not to mention the basic issues of life with which we will soon be dealing. But first, I want to bring a couple of items to your attention. Last week, I lead off with a few paragraphs from a 1946 article from Life Magazine talking about how we won the war in Europe but were losing the peace. I was not trying to make some comparison between Iraq and Europe after their respective wars. I clearly know the situations were, and are, radically different. The success in Europe in no ways predicates success in Iraq. The point I was trying to make was that the press coverage was similar: focusing on the more emotionally impacting negative aspects of the events rather than the more mundane successes.

Earnings season is upon us, and with each announcement the market seems to surge on new ecstasies or retreat with disillusionment. Each new announcement is cut open, like so many sheep, to see what its entrails will divine to us about the future, as if one more bit of fresh data will give us the clear forward vision we think we so desperately need. Is the bull finally back? Are we climbing a wall of worry, or just on another fool's errand, rising in a bubble toward the inevitable pin? Yet, earnings are up by more than 100% since the end of the last recession. How can we not be optimistic?

Two weeks ago we examined the changes in our lives. Last week we looked at imbalances in the economy. This week the theme that I see in my daily reading is the large number of major contradictions apparent in the markets. There are so many contradictions we will not get to them all, but let's start, as it will make for some interesting and controversial analysis.

Last week we looked at change, and this week we turn our attention to balance, or more precisely, the dangers and opportunities of imbalance. Stock markets, currencies, confidence and government will be our target today for what should be an interesting and thoughtful letter. I have been "saving" this topic for several months, waiting for the arrival of Bill Bonner's new book, Financial Reckoning Day . It has launched at #4 on the Wall Street Journal Best-seller list as well as #8 on the New York Times list. (Jimmy Rogers wrote a great forward.)

"My interest is in the future, because I am going to spend the rest of my life there." -- Charles F. Kettering How well we deal with change is at the heart of the investment enterprise. I make a departure from our normal writing fare to think about the longer term future and some of the changes we will encounter. I speculate about the future of the investment business and what you will be faced with in a few years.

Exactly what are investors thinking? How can I be right about being in something called a secular bear market if stocks just keep going up? Isn't it time for me to throw in the towel, admit I was wrong and declare a new bull has begun? I answer these questions and more as we ponder the meaning of several important, if somewhat obscure, academic studies. We begin with the question posed to me by Butch, an astute businessman and reader, as we watched the Texas Rangers from the balcony office suites in right field at the Ballpark in Arlington. Last Saturday, they looked like World Champions, with six home runs, solid pitching and great fielding. The fact they are in last place and going lower did not diminish our enjoyment of the atypical display in front of us. Alas, one game does not make a trend, nor a season. And as we will see, our home team bias has an analogy which will give you some insights into the direction of the markets.

This week we re-visit Federal Reserve policy, and how their current policy may be setting up a very real problem with interest rates. Is the dollar getting ready to make its next move down? We do live in interesting times. Yesterday I had long telephone conversations with both Jim Bianco and Greg Weldon, talking about Federal Reserve policy, interest rates and the dollar. There was an apparent disagreement on some concepts between them. Last night I did some meditating on those discussions, and decided a summary of them would give us an excellent starting point for this week's letter. Because they may both be right, and that may not be a good thing

This week we deal with tariff proposals and other absurdities, the Chinese and the huge rise in their holdings of US debt by foreign governments, plus one of the more profound pieces on the events in New York, presciently written more than 50 years ago. At the end, I ask my non-US readers a question about investment laws and practices in their country.

Given the wide disparity of views about the economy, it is little wonder that the reaction to Greenspan's latest speech has been all over the board. That is compounded by the fact that bond price expectations are totally disconnected from Fed expectations. Are the bond market critics just a bunch of whiners (give me back my risk free trade!) or is there substance to their major beef? Who's really in charge here? Can the Fed trump the market? Predictably, I answer the latter question with both yes and no. It all depends upon your time perspective, but timing is everything. There's a lot to cover, of course, so we begin.

This week we are going to examine in some detail Alan Greenspan's speech given today in Jackson Hole, Wyoming. I was working on an entirely different letter when this speech hit my inbox. I think it is so important that I am going to start over in the middle of a letter, which I cannot remember ever doing. For better or worse, Alan Greenspan is one of the most important men in the world. His views matter and are taken quite seriously by the market. This is one of Greenspan's more significant speeches (it may come to be seen as his most important) and a departure from his usual opaque (or in Texan: clear as mud) style.