Friday, July 24, 2009

Rude Awakening - The First Shall Be Last...Or At Least A Distant Second, Part II

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Rude Awakening

The Rude Awakening

Vancouver, Canada

Friday, July 24, 2009


* Constructing a "Permanent Portfolio" to weather the storm,

* Those mossy green shoots and why we just don't believe in 'em,

* When GM was and FaceBook wasn't, and plenty more...


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Joel Bowman, reporting from Vancouver, Canada...

We've been wondering about "normal." What is...what isn't...and, most importantly, where are we now?

In yesterday's edition of the Rude Awakening, Eric highlighted the long, slow secular decline of the American economy. During the last few decades, he remarked, the world's biggest economic superpower has become somewhat less super.

In the context of this long-term decline, the American economy is battling the most serious credit crisis since the Great Depression. And this battle is far from over.

"Banks in the U.S. are still not lending," observed Eric Roseman yesterday from the podium of the Agora Financial Investment Symposium. "They are merely sucking in capital to re-build their balance sheets and provision for future losses."

"There are no 'green shoots' of recovery," Roseman insisted. "It's just moss." Roseman is a professional investor who produces excellent investment research for the Sovereign Society. During a captivating forty-five minute presentation, he detailed his thesis that the worst is not over. "I'm looking for major problems in the commercial real estate market…and another wave of writedowns and loan losses.

"I'm expecting several more quarters of economic distress at best, several more years at worst," Roseman wound up. "Stocks are not in a new bull market. Don't be deceived."

Roseman's ominous outlook corroborated some the key observations your California editor highlighted during his presentation here on Tuesday. In today's Rude Awakening, we presents a second sampling of (lightly edited) insights from Eric's speech…

— Mayer's Special Situations Resource Report —

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In 2002, the same royalty "paycheck program" that paid out $50 for every $1 invested… decided to shut the door to new "members."

In 2008, that door is open again… and it just got easier than ever to "make money while you sleep"…

But there's no telling when it could close again…So you'd better collect your own "Chaffee Royalties" right NOW!


The First Shall Be Last…or at Least a Distant Second, Part II
By Eric J. Fry

A lot has changed since 1959, the year I was born. Back then, America was the economic envy of the world…and no other country came close. Today, America remains the world's leading economy. But her lead seems to be slipping somewhat. Investors cannot afford to ignore this unfortunate trend.

The "new normal" for American investors will look very different from the "old normal." In 1954, General Motors became the very fist American company to earn $1 billion. Today, the entire market capitalization of General Motors is LESS than $300 million. Facebook, on the other hand, just sold for $10 billion. What else do you need to know about the strength of the American economy? Can we Facebook our way to long-term economic vitality?

Data points like these should frighten any student of financial history. The good news that Rome wasn't burned down in a day. The bad news is that Rome has been burning for quite a while already.

In September of 2003, Morgan Stanley analyst, Hernando Cortina lamented the deteriorating condition of the U.S. economy. Six years later, his remarks seem even more relevant, if not also a bit quaint:

"My experience as an emerging markets analyst in the 1990s taught me to be on the lookout for signs of financial vulnerability. They include ballooning current-account and fiscal deficits, overvalued currencies, dependence on foreign portfolio flows, optimistic stock market valuations coupled with a murky earnings, questionable corporate governance…These are time-tested warning signs of financial busts around the world.

"Any one of these signals in an emerging market usually raises a red flag, and a market that combines all of them is almost surely best avoided or at least underweighted. I didn't imagine back than that one day these indicators would all be flashing red for the world's biggest and most important market - the US…In our view, investors contemplating the purchase of US dollar-denominated assets would be wise to factor in significant dollar depreciation over the next few years."

In other words, Big Picture economic trends in the U.S. provide little comfort. Small Picture trends provide even less comfort. Over the near term, the U.S. economy continues to face enormous impediments to sustained economic growth.

I don't buy the "green shoots" myth and here's why:

1) The Consumer is willingly de-leveraging.

2) The Consumer is also unwillingly de-leveraging, as the nation's financial intermediaries rapidly withdraw credit.

3) Loan collateral is still falling in value – homes, offices, businesses, plant, equipment and corporate cash flow are all in decline. Unfortunately, a slowing rate of deterioration - like a slowing bout of leprosy - will never put skin on the bones, no matter how long you wait.

4) The economy is deteriorating.

"The de-leveraging that's taking place in the world is continuing on a very massive scale," Igor Lotsvin, a bearish hedge fund manager declared a couple of months ago. "The world is really on a margin call right now and it will not cure itself in the next couple of quarters. There is plenty more pain to come…In order to see the beginning of a recovery, says Lotsvin, we would have to see the beginning of banks' willingness to lend. But that's not happening.

"So think about the American consumers," Lotsvin continued. "They are basically in the situation where their 401(k) got cut in half, where their house is worth 30% less than it was three years ago… and now their only source of liquidity is their credit card. And that's being cut off very rapidly…"

The chart above tracks the quantity of credit that American banks are withdrawing from consumers. This chart does not show the June quarter, which included an additional $500 billion of shuttered credit lines. So altogether, you're looking at something like $1.6 trillion of credit withdrawn from consumers during the last 12 months. That's breathtaking!

So folks, sustained growth in consumer spending is very unlikely to occur any time soon, especially when you consider that 16% of the nation's workers are unemployed. That's the real number because it includes the long-term unemployed.

"But what about the stock market rally?" some of you may be wondering, "Doesn't that signal a recovering economy? And what about the hopeful projections from so many financial experts?"

Ignore them. The economy is not recovering, which means the stock market remains vulnerable to a relapse. In the context of the big rally on Wall Street since March, it is important to remember that this is what stock markets do during big bear markets. It is not unusual for stock markets to produce great big rallies, even in the midst of a wicked, long-term bearish trend. In fact, this is a common phenomenon.

On ten separate occasions during the last twenty years, Japan's Nikkei 225 Index rallied more than 30%. On four of those occasions, the Nikkei soared more than 50%! And yet, the Nikkei still sits 50% percent below where the first of these 10 rallies began, way back in 1990. During each of these bear market rallies, investors invariably believed that the worst was over and that recovery lay just ahead. But that hasn't happened yet.

So now we must ask ourselves, "What do we do? How do we invest in the 'new normal?' How do we invest in the midst of continuing economy distress and uncertainty? How do we invest in the midst of extraordinary and baffling stock market volatility?"

Well the answer I would propose is to construct a "permanent portfolio" – a portfolio that offers a chance of delivering attractive returns over a long timeframe, while also guarding against stomach-churning volatility.

There is a mutual fund called the "Permamanent Portfolio" (PRPFX) that's been around for more than two decades. The fund holds fairly static weightings in U.S. growth stocks, gold and T-bills. For many years, most investors scoffed at this silly fund. But it does not look so silly now. During the last 17 years, the fund's slow, steady and unimaginative portfolio has outdistanced the S&P 500. And the Permanent Portfolio has achieved its returns with much lower volatility than the S&P.

So the Permanent Portfolio's record over nearly two decades illustrates the validity of risk-averse architecture. But I think we can improve somewhat upon this model. I would propose a new permanent portfolio, the components of which would be:

1) Commodities (including gold)

2) Emerging Market stocks

3) Value stocks from around the world

4) Multi-currency liquidity. (CDs and short-term Treasuries, as well as short-term sovereign debt from other countries.)

In the "value stocks" category, I am a big fan of IVA International and FPA Crescent Fund. But obviously, I've presented some very broad categories. You can color within the lines however you like.

If the market keeps soaring, a portfolio like this will lag behind badly. But the opposite is also true. In a falling market, some version of the permanent portfolio I have suggested would perform relatively well. The idea, however, is not to game short-term market moves, but to utilize an investment allocation that has the potential to transport your capital through the tumultuous years that may lie ahead.

Best of luck to you all.

Joel's Note: As we mentioned yesterday, our tech gurus have been busy recording all the presentations and formatting them onto CDs and MP3s. So, if you weren't able to make it up here this year, for whatever reason, you can still avail yourself to all the main speeches, including slides and PowerPoints.

The price jacks up after the conference is over, so getting in early will save you a considerable sum of money. For more info, click here.

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[Rude Endnote: Markets in the U.S. pulled back slightly yesterday after the Dow Jones Industrial Average cracked the 9,000 mark to register a new 8-month high earlier in the week.

Indexes in Europe took the news with barely a shoulder shrug in yesterday's session. France's CAC and Germany's DAX both slipped a tad, down 0.1 and 0.2% respectively. London's FTSE notched up modest gains of just under 0.4%.

Over in Asia, however, things just keep humming along. Japan's Nikkei 225 rose another 1.5% and sits just below the 10,000 mark. Hong Kong's Hang Seng and the Aussie All Ordinaries also rallied, up 0.8 and 0.6% by the day's end.

In the commodity pits, oil still hangs around $67 per barrel and gold around $950 per ounce, give or take a couple of bucks.

We'll be back on the weekend with your usual wrap up.

Until then...


Joel Bowman

The Rude Awakening

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