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What keeps me awake at night


Viking
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Barry Ritholtz at the Big Picture provides a link to and article by Andy Xie, who was with Morgan Stanley: english.caijing.com.cn/2009-06-09/110180019.html

 

Andy's conclusion: "The world is setting up for a big crash, again. Since the last bubble burst, governments around the world have not been focusing on reforms. They are trying to pump a new bubble to solve existing problems. Before inflation appears, this strategy works. As inflation expectation rises, its effectiveness is threatened. When inflation appears in 2010, another crash will come.

 

If you are a speculator and confident you can get out before it crashes, this is your market. If you think this market is for real, you are making a mistake and should get out as soon as possible. If you lost money during your last three market entries, stay away from this one – as far as you can."

 

I think Fairfax 'gets it'. I think we will see them play the volatility game. I do not expect them to sell 100% of their positions as the market tops out. However, I will be surprised if they do not book some decent gains when they report Q2 results.

 

Andy's perspective has a much higher probability of playing out than what Mr. Market is currently expecting. I put the percent of another crash happening at 30% (taking the S&P below 6,000). Notwithstanding what we are hearing from Buffett/Watsa, it may still be a little early for 'buy and hold'.

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What do you think of the Van Hoisington argument? I'm oversimplifying, but Hoisington and Hunt cited Irving Fisher's research which demonstrated that excess debt overpowers most economic factors. Until we match debt service to normal income, change in velocity is a non-issue.

 

Most inflationary arguments, including Andy Xie's, focus upon monetization, international competition for commodities, and dollar depreciation. Is there an economic argument for velocity increase in the near future?

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I think Hoisington's argument is weak in two respects.  For every case he has given (US and Japan), the country has had more than enough savings to support the currency internally and each country has had a trade surplus, thus no need for foreign buying to support the currency. 

 

The US now is in a different situation where the strength of the currency is not as dependent upon savings (which would indeed lead deflation) but also upon foreign buyers/holders of the currency (which can lead to a currency decline (in an orderly exit) or a crash (in disorderly exit).  This is what happened to emerging markets in the 90s.  The currency declines will lead to inflation (push) not price inflation leading to a currency decline (pull).  A certain amount of the decline in demand will occur over time as other countries catch up to US on a relative basis.  The real question whether the psychology of the situation will be heightened by an attitude of crazy spending on the part of the US gov't which is not used to being in a currency collapse situation.

 

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I think Fairfax 'gets it'. I think we will see them play the volatility game. I do not expect them to sell 100% of their positions as the market tops out.

 

As for the market topping out... the market is roughly where it was when the year started -- Fairfax was heavily invested in equities at the time, presumably expecting markets to go higher, not lower.

 

 

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Andy Xie's commentary in May warned that the current bear market rally would end in a month or so.

 

  • The bull case is built on three assumptions: (1) the market decline is already deep enough; (2) the global economy is either recovering or about to; and (3) more government stimulus money is coming, should there be more trouble. The bear case rests on: (1) this is a debt crisis, the debt levels are still too high, and the global economy can’t resume growth until debt levels recede to normal; (2) the world economy is still shrinking, though at a slower pace; and (3) government stimulus can’t start another growth cycle as the global economy must restructure itself first.
     
    I am in the bear camp. The bull case is really based on comparing the current recession with other recessions in the past half-century. However, this is a once-a-century recession. The only comparable one was the 1930s Great Depression. For a new growth cycle to begin, two conditions must be met: (1) debt levels, relative to income, in consuming economies (U.S., U.K., Australia, Ireland, Spain, etc.) must return to levels prevailing two decades ago, and (2) the manufacturing export economies (China, Germany, and Japan, etc.) must become significantly less production-oriented.
     
    The debt crisis is far from over. Just look at the U.S. financial sector debt – the source of all problems in this crisis. It has not come down, despite all the talk about deleveraging. It stood at $17.2 trillion at the end of 2008, higher than $15.8 trillion in September 2007, when the crisis began. Even though it can’t borrow from the market like before, it is borrowing from the Fed and the government. How could we say that the crisis is over when the U.S. financial sector’s leverage hasn’t declined?
     

 

http://whereiszemoola.blogspot.com/2009/04/why-this-is-still-bear-market.html

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"Obama has come with a very significant stimulus plan. The Treasury Secretary has a very thoughtful way of handling the banks and yet no one believes it's the bottom.

 

"Today we've some of the biggest actions by the U.S. government in terms of stimulus, interest rates at zero and nobody believes it'll have any impact."

 

 

- Prem Watsa, Feb 2009

 

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Here is the link to a June update from hedge fund, Eclectica Asset Management, that I had never heard of before. I must say their logic makes some sense to me. www.scribd.com/doc/16525584/Eclectica-Fund

 

If we are in a 1 in 50 or 1 in 100 (and I think we are) I do not see how we have seen the worst of the downside yet. This does not mean that the averages will not be higher from current levels in 5 years. Look at past asset deflations (Great Depression in US or lost decades in Japan). These things were ugly, lasted for MANY years and took valuations of all assets much lower than anyone thought possible. I do not see how the worst can be behind us... SO MUCH PAIN IS LIKELY YET TO COME AS WE PAY OUR DUES FOR PAST EXCESSES.

 

Prem also made a comment (AGM?) and asked if the government (20% of economy) could be expected to offset the issues n the non-government (80% of economy). His point, I think, was obviously, NO, this is not possible.

 

I will be watching what FFH does with great interest. Their batting average is tops in the league right now!

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Buffett has stated that we won't have a real estate situation like Japan's because our population is growing and therefore housing demand is growing.  That's pretty much what we said on this board a couple of years ago.  It makes too much sense.  US is growing and Japan is not (to me it is very clear).

 

Prem stated that the US reacts quickly, as opposed to Japan.  It's unclear to me exactly what he means by that, however it sounds like he is not ready to compare the US to Japan. 

 

But look at this answer of Prem's.  Does it sound like he intends to unload at $900 and sit in cash?  It doesn't to me.  It sounds to me like he would rather just buy and hold for the long term.  His actions (not selling at the end of 2008) very obviously point this out.  Otherwise why didn't he sell, and for what reason would he sell now if he didn't then?

 

 

Q How long will it take for fear to disappear?

 

A "The U.S. reacts quickly, as opposed to Japan. But it's a question of pessimism, which means it's not a bad time to buy for the long term. We could have four or five years of difficult times. We really don't know."

 

 

http://www.financialpost.com/story.html?id=1307083

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Guest Broxburnboy

If this situation is indeed similar to the Great Depression, then it will require massive inflows of capital to reboot the growth mode. The US was late to enter WWII, years after the first major combatants were destroying each other's infrastructure. The US was not subject to bombing or invasion with the exception of the attack on Pearl Harbour, which essentially destroyed a backlog of obsolete liabilities (battleships).

 

Massive amounts of capital was moved from the Allied powers to America for safekeeping and also to purchase industrial and agricultural output. Internally taxes were high and there was a push for private savings in the form of Victory Bonds. Personal consumption was rationed. There was full employment.

 

 

 

 

 

 

 

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His point, I think, was obviously, NO, this is not possible.

 

If you take it as a given that the 80% is going down in a hopeless spiral, then no the 20% will not overcome the 80%.

 

Prem does not take it as a given.

 

Here is a quote from him:

 

"The ultimate test is will the 80% start spending and we will not know that for some time."

 

http://www.financialpost.com/story.html?id=1307083

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Andy has another interesting article out. In it, he talks about China's buying of commodities such as iron core, crude oil and copper. Many had described China's buying as inventory stockpiling. Andy Xie has gone one step further by saying that the recent surge in commodities are nothing but speculative inventory!

 

I quote the last few lines..

  • Putting money into speculative investments isn't totally irrational. It's better than expanding capacity which, without export customers, would surely lead to losses. Businesses currently lack incentive to invest. But many boom forecasters wrongly assume that recent asset appreciation, fueled by speculation, signaled an end to economic problems. That's an illusion. The lending surge may have created more problems than it resolved.

 

http://whereiszemoola.blogspot.com/2009/06/andy-xie-calls-it-speculative-inventory.html

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What keeps me awake is hearing, month after month, of double-digit declines in US (and Cdn) steel shipments.

 

There was apparently a methodology change in Sept/08 so year over year stats may not be reliable, although

the compilers of the stats (Metal Service Center Institute) appear to have adjusted for methodology change.

 

The latest figures, for May/09 shipments, show US 49 pct decline and Canada 40 pct decline.

 

Prior month, April/09, was 47 pct decline in US and 31 pct decline in Canada.

 

And so on.  There is demand for steel for capital maintenance - repairs and replacement - but as economy

slows down, even that demand fades as usage-based wear and tear on existing infrastructure declines.

 

Looking at steel, US economic activity is decaying with a 12-month half-life.  I think basically only govt

projects, including infrastructure and military, are holding it up.

 

On the other hand ... stats show auto miles travelled about the same as a year ago, so that suggests a

reasonable continuity of commuting and employment activity.

 

And TSX trading stats are up year over year, so the market is perky.  Maybe a shift from buy and hold,

to trading approaches.  Maybe the automated trading systems are starting to run wild again.

 

But ... the good news, actually can sleep very well - just have to read a book, to nod off promptly.

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Are ALT-A mortgages the next shoe to drop?

 

http://seekingalpha.com/article/144200-alt-a-mortgages-the-new-subprime-meltdown

 

I have to vote with the bears as I think the market will correct and by a significant amount. You can still find good investments (JNJ for example) but be prepared for the price to drop further. Of course, I could be wrong, but I don't think so.....

 

cheers

Zorro

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Seems to us that the various bailouts simply transferred the losses to the global federal governments. The underlying problems haven't gone away, they're just less damaging now because there's less leverage being employed.

 

We see only the NA perspective, but the reality is that China is the 3rd largest economy in the world - & it doesn't need exports to turn itself around. Copper prices have been rising (barometer) & the demand is largely from increased chinese activity. Add to it that both China & India have just redenominated 70B of reserves out of USD & into other currencies (IMF), & the odds of a NA pull-back rise. 

 

Why is it that when a SA country is fiscally irresponsible we see what happens to them as being 'right'; but we cannot possibly imagine the same thing applying to the US, when the US is also doing it. There is no difference.

 

Makes a lot of sense to at least hedge.

 

SD

 

 

 

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Guest Broxburnboy

"The underlying problems haven't gone away, they're just less damaging now because there's less leverage being employed."

 

Actually there is more leverage being employed, as the governments have simply assumed the risk from the private sector and have created more debt from thin air. Too much debt at all levels have caused the problem, but more debt is held to be the solution. It is claimed that at some point in time when the economy is reinflated and starts growing again, the excess liquidity employed will be "mopped up" to forestall inflation.

 

I doubt this is possible, and thats what should keep us awake at night.

 

The good news is that there seems to be a decoupling of national economies from the overlevered, and those who have maintained monetary and fiscal discipline are less affected. Capital seems to be flowing to countries like Brazil, China, the Asian Tigers, and commodity based economies like Australia and Canada (in spite of the current Federal government's policies to out borrow and spend the US).

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