Posts Tagged ‘Risk’

The Economy: Is It Really Getting Better?


What We See

People are optimistic, The Dow remains above 10,000, inflation fears seem over-estimated, and the financial crisis seems isolated in places like Greece, California, and random long-expected lay-offs.

I just met with a manufacturer of fashion apparel and she was telling us how many designers who were previously afraid to launch their collections are now coming out of the woodwork with some very risky and ultra-modern designs. So we have throngs of risk-taking designers in the already cut-throat industry of fashion design. IS the economy picking up?

What We Get

Sometimes in science, and in economic models we can often assume what something is by what it’s missing. In this case: Fear. Is there caution? Absolutely. But the open-eyed cold-faced pessimism we saw in March of last year seems to have gone into a long winter hibernation. This is the problem. Fashion designers, manufacturers and central bankers are all sharing the same sense of false security.

Here are some reasons why:

  • The VIX (which tracks market volatility, otherwise known as the “Fear Index”) is touching all-time lows. This means people are discounting any chance of risk in the market.
  • Gold and Silver are slowly and quietly creeping up towards their all-time highs, a sign that financial security is again coming under question.
  • Commercial Real Estate, Rising Unemployment, Too Low Interest Rates, Government Irresponsibility, and High Stock Valuations are all playing a major role in the potential for another crisis.

Here are some insights from top banking insider and billionaire, Andy Beal:

When was the last time you prepared for any worst case scenario?

What We Do

One of the best and easiest lessons I ever learned in finance was as follows, bear with me:

Income (money that comes into your pocket) – Expenses (money that leaves your pocket) = Cash Flow (“my money”)

With this in mind there are 3 things you have to do:

1) Stop Spending! Buy used, buy less, buy what you need. This is a timeless and necessary action if you ever want to be happy financially. A used book on Amazon is rarely any different than a new one… but its far cheaper.

2) Get out of debt! There’s no good reason to spend 101% of your income(s). Start paying cash, pay off far more than your minimums, and stop paying someone else 15-30% for everything you buy.

Everyone knows the first two suggestions but few focus on this next one...

3) Make More! Don’t just mope and cry about how you now have money in the bank, but feel broke. Get out there and challenge yourself! Make some more sales calls, do things to get promoted, start your own business (YES in a recession). If you want to have anything significant in life, you’ve got to go get it. Be proactive and MAKE it happen!

No matter what happens, you will always be you, and there will be good times, and not so good times. Your job is to ensure that you and your family are protected and comfortable, both financially and emotionally, no matter what life brings!

The Credit Crisis Visualized


An entertaining and creative explanation of what led us into this debacle.

The Crisis of Credit Visualized – Part I (about 7:30)

The Crisis of Credit Visualized – Part II
(about 3:45)

Glad you enjoyed!

Dow 6440?

If you feel that 7200 is the lowest you’ll ever see the Dow, you may wish to reconsider. I read of an investor who, whenever confronted with an investment idea, used to ask “What can I lose?”. This is very important when investing for profits (yes, today may invest for losses but that’s for another time). You must always consider your downside.

This will be explained by first understanding how the stock market works. Here are a few facts that every investor must know and understand.

Every Stock Represents a Company.
This means that a ticker symbol is something more than the name of a bet on a race horse, rather it stands for a real enterprise, with real value and real earnings. If the intrinsic value of the underlying entity changes, you can guarantee that the share price will follow. Because of this…

What People Will Pay for Earnings is Crucial
While it is important to understand what a business will be worth in the future (the sole territory of the Growth Investor) it becomes integral for understanding what investors will pay for that worth in the future (The objective of the Value Investor). Because of this…

There are Bear Markets and Bull Markets
These are defined as times when the valuations (usually based on earnings, dividends or book value) are either rising (Bull) or falling (Bear). During this time stock prices will consolidate. This means that although valuations may be falling, prices will nevertheless shift far above and then far below their median value. Because of this…

Stocks Never Move in Straight Lines.
There will be gyrations and they are unavoidable. You will have a crash during a rally (1987) and a rally during a crash (1930). This is the market’s way of correlating the hopes of millions of investors and speculators around the globe. Because of this…

P/E Ratios Change
Historically P/E ratios have toggled between 44 and 5 (For example’s sake that gives us a current range of 28,366 and 3,220 for the Dow). Every Secular Bull Market has begun from a ratio below 10 and concluded above 20. Because of this…

The Dow May Soon Find Itself Below 7000
In the event that prices would sell off, a ratio of 10 would give us an estimate of 6440. We must also consider that earnings themselves may rise or fall, but as they say predicting the market is like predicting the weather so we’ll just keep our current earnings figure. (In the event earnings would rise by a figure of 10%, we would still be left with a Dow of 7080). But many will ask…

But I Don’t Own The Dow!
It is said that the Dow reflects 75% of the average issues on all exchanges. As a matter of fact, the Indexes are often known as the safest representations of common stocks. However, in an index itself one stock may rise 50% while the other falls 50%. (This is why you can technically beat the Dow by owning the Dow itself!). This is why you…

Don’t Follow the Market
Investors know never to follow “the market”. A stock may indeed be worth what you bought it for and you’ll make a killing while the market suffers a crash. (In October 1929 one of the shares on the Dow rose while the index as a whole crashed). Assess your margin of safety by whether or not your upside is greater than your downside.

And remember “Buying high to sell higher was never a profitable strategy”

Bill Miller on Bull Markets and Risk

The problem is that real risk and perceived risk are two different things. And that’s where people get into trouble, because they perceive risk to be high when prices are low, and they perceive risk to be low when prices are high. That’s the psychological problem that most people have.

I’m always much happier when stocks are trading at their 52-week lows than I am at 52-week highs. It’s simple: If you have a valuation discipline, then you know that stock prices change more rapidly than business value.

On Risking for Profits

To spread the opportunities and condense your prospective is to diversify your risk. To constrict the possibilities and broaden your potential is to leverage your profit.

Disconnecting the Dots

Risk is selling for too cheap and the Carry Trade is the culprit. These are thoughts that the world most succesful investor seems to agree with but somehow it always gets left off the major highlights of his remarks.

In the market there is a price for everything. For every public company, for every commodity, for every currency. There are even prices for insurance on your portfolio and on the price of risk. The price is usually right. After all they’re scrutinized and evaluated by thousands of analysts and millions of speculators daily.

There are many different types of buyers. Many are there every day, not looking for good value but just something they can sell 10 minutes later at a higher price. Some only show up only once in a while, usually when they hear there’s some sale or issues selling at bargain prices.

Risk Undervalued
But every once in a while, the market as a whole gets it wrong. The 10-minute buyers offer unbelievable bargains for the value-savvy costumers.

In this light, Risk too has a price. You wouldn’t buy hurricane insurance in Kansas, would you? Of course not! But if a hurricane were to show up for all unpractical reasons many home owners would face a major loss of capital. You can afford the risk since your premiums wouldn’t pay off such a far margin of error.

But how about not buying insurance in South Miami because its out of season? That sounds ridiculous. But this seems to be the mistake many investors are making. They are selling risk out of season.

This is demonstrated by the low interest rates seen worldwide. True, they have been rising, but has this essentially performed its duty?

The Carry Trade
Japan has had it tough they had a wonderful economy doing wonderful things, the share market flourished and housing prices boomed. But, then came the inevitable bust that the frenzied public always seem to count as discounted. Japan and everything associated with it tanked.

Just a few years later we have the U.S. and the western world amid such a similar predicament. With the Dow soaring to new highs and a strong economy there wasn’t a dark cloud in the sky.

But then came the moment of transition. But we American’s are so much smarter than the Japanese. After all its been over 70 years since the last depression. So how do we prevent it from happening again? Offer the people what those in the depression lacked most – Cash. The Fed slashed interest rates to a mere 1% and threw cash piles out to the masses.

But it wasn’t just the Federal Reserve who was helping along. Japan at the time was offering a ZIRP or a zero-interest-rate policy. This meant that the government was practically begging for people to take its money, usury aside.

This being the case, even after the Fed began hiking rates investors and companies still found a way to cash in on yesterday’s price of interest. Borrow in Yen. This following later became widely known as the Yen Carry Trade. Yen were purchased on zero interest charges and swapped for higher yielding treasuries such as the U.S., Australian and New Zealand.

Here is what the market is discounting. Eventually, this moat is going to narrow. As a matter of fact this has already begun. Once it begins and the spread becomes less profitable the whole house of cards will collapse no different than the stocks that were selling for 50 times earnings in the past. You can only bet on a phenomenon while its still in motion. Once it stops, and every moving thing that is propelled by nothing more than limited resources does, the game is up.

In an age of knowledge every man and woman, regardless of whether or not they ever stepped into a course on economics has become yen-carry-trading, Chinese-stock-betting maniacs.

A Life Savor for a Dollar
This is what is holding up the U.S. economy. J
apan is supplying it with credit, allowing it to borrow and spend as much as it needs to survive. We then spend this money is low-cost-producing nations such as China and Japan. They in turn reinvest those funds back into U.S. Treasuries benefiting from the interest we will borrow from them to pay them with.

Sounds ridiculous, doesn’t it? But here’s why they continue to do it. If they lose the U.S. they lose their best costumer. As long as he comes in every day and buys half the store, there is no reason to deny him credit.

But Japan is paying out more to keep its best costumer than would be worth to forgo the debt. Real rates in Japan are negative. This means that it far more sensible for people to hold consumer goods which are increasing at the rate of inflation than to hoard cash that compounds at a mere 1/2 percent.

A higher yen as a result of rising inflation fears and higher wages will mean more inflow to economy, raising U.S. rates and consumer prices in the process. This translates as destruction – Hiroshima-style – for the Dollar and the American economy. We will once again face the deflation side of the equation that the Japanese know all too well. The spread between physical goods and its immaterial derivatives will narrow.

You can speculate on a rising Yen, a weaker dollar, a narrower spread for rates on interest and credit, do not however discount what you may not know.

On Finding We Were Wrong

“These derivatives were very complex and suddenly turned against us.”

– Pierantonio Arrighi, Spokesman for Italease

Italease is an Italian bank that was threatened by a massive margin call after interest rate rises in Europe.

“Risk; a reality which reaches further than a perception.” – my1ambition

Postponing the Inevitable

Many investors, myself included, find it hard to believe that we are facing an enormous credit crunch of cataclysmic proportions. But although I’m generally an optimist, logic gets the best of me when I read from Bloomberg I read

“Executives at New York-based S&P, Moody’s and Fitch say they are waiting until foreclosure sales show that the collateral backing the bonds has declined enough to create losses before lowering ratings on some of the $6.65 trillion in outstanding mortgage-backed debt.”

What the hell does that mean? Is that another way of saying “We are not going to actually say that things are bad until people can realize they are bad”. (Sounds like the Cisco-pumpers in the late 90s to me).

I read further and the article states

“Homeowners may be delinquent on mortgage payments for at least three months before foreclosure proceedings begin, and the process can be delayed if a borrower files for bankruptcy or fights eviction. Even when lenders repossess a home, the value of the mortgage isn’t written down until the house is sold.”

Key words: Delinquent, Delayed and phrase “until the house is sold”.

Home Sales
Which raises the question. How have home sales been going? Apparently, not so good. Although housing sales have been picking up – a double edge sword – we do have record inventory and the most gullible group of home owners who still believe that this housing “slump” will be long gone come 2008.

But let me ask you. Which homeowners are the ones really eager to sell, the second-home “investors” or the poor couple with no recorded income, who bought a house because everyone else was? I’m not sure but it would seem that it’s the latter.

I have two reasons. For one, Speculators aren’t that stupid. They are the ones who get out as soon as they realize they’ve been had. They know how to get themselves out of the mess that the investors didn’t get into in the first place. Joe Sixpack on the other hand is the one who gets fried. He is the one who ends up mopping up the mess the speculating public left behind – and at a hefty price.

Secondly, besides for trying to make some money Joe Sixpack also needs a place to sleep. Thus, he is far more reluctant to sell than the well-to-do speculator across the street (all pun intended).

Mortgage Bonds
And when will the bondolders really get had?

“Bondholders see a loss only if the price of a house is lower than the loan used as collateral for debt securities.”

In other words, mortgage bonds are directly related to housing prices. When these houses fall, and along with them the collateral used to buy them, the whole house of cards comes crashing down (all pun intended once more).

“What they don’t understand about the rating process is that we don’t change our ratings on speculation about what’s going to happen.”

In otherwords what we have been telling you for ages – by time Wall Street tells you something you should know, its usually too late. For the record, S&P and Moody’s maintained their investment-grade ranking on Enron Corp until days before the Houston-based energy trader filed for bankruptcy.

Oh and if all this hasn’t freaked you out enough to realize that financial assets are in a rut, “National median home sale price is poised for its first annual drop since the Great Depression” Ouch!

The Butterfly Effect
“So,” the simple investor will ask “what does all this have to do with, say, the stock market?”. Well my curious friend, I would answer, you are obviously not familiar with the dynamics of leverage. As debt strategists at Barclays Capital reported “The worry is that this will be large enough to trigger margin calls which, in turn, will cause other liquidations and so on.”

As they say out in the country: “When one falls they all falls”.

A Derivative Universe

The BIS reports

“Outstanding positions on the derivatives markets are $415,000 billion, roughly seven times world GDP – and up 12 percent over the last six months. They grew 24 percent in the preceding six months”.

If shares sell at multiples of earnings, would it be plausible to say that Risk is selling at 7 times Production?


Quotes of the Day

Risk comes from not knowing what you’re doing.
–Warren Buffett

The Definition of Risk is a reality which reaches further than a perception.
– my1ambition


Thoughts on Silver

As you know we are more bullish on silver than on gold for a number of reasons, including its historical monetary use, its tendency to outperform gold in secular bull markets as well as an apparent short squeeze in the making.

We’ve mentioned many time over that trying to time an investment is like dart throwing. Not that its impossible but how many people do you know who can get the bulls-eye every time. Nevertheless its always exciting attempting to predict the future.

We mentioned that we expect silver to play out the same way it did in the fast-breaks in both May 2004 and May 2006 (also similar the bull market in the 70s). Each experienced a rapid appreciation, followed by a sharp correction and then a rather long consolidation stage.

The reason this is necessary is because in addition to investors and speculators there are, believe it or not, commercial interests – mines, jewelers, coin dealers, etc. – that base much of their business on the stable price of the metals. When the price rises due to the demands of the market it takes months for these institutions to adjust to the new prices.

We thus expect silver to continue its current consolidation stage until September of this year. During this time we expect many of the equity markets to correct as well in something similar to what we saw last May as a global sell off. This will be succeeded by another parabolic rise in the metal unexperienced in over a generation. We believe that prices may reach to $28 an ounce by May 2008 and possibly higher if demand from Central Banks, China and Russia kick in as well. Once again this is not what’s possible but what’s most probable.

Just a thought to ponder in the meantime:

Berkshire Hathaway has a market cap of about $160B and a cash pile of about $46B. That means that Warren Buffett is now suggesting a cash position of about 28%. Risk-savvy?


Quote of the Day

“To avoid moral hazard and let market discipline work, investors must be allowed to bear the consequences of the decisions they make and the risks they accept”. – Federal Reserve Charirman, Ben Bernanke

Hell Yeah! Bring it on! With Bernanke now attempting to hold on current interest rates for as long as possible and continuing to allow hedge funds and the derivative markets to run on, it seems we finally have someone who is willing to give the free-market a chance and let the system fix itself. No guarantees that things won’t get messy though – and I think Ben knows that just as well as we do. Bernanke is giving risk a chance. Anybody ready?

The Game of Risk

Recently, while looking through some analysis on Risk, I found a pyramid identifying the general risk associated with each asset class.There are a few things I found interesting. Firstly, is the fact that the chart may not have any true validity to begin with.

What is Risk?
I define risk as “a reality which reaches further than a perception”. In other words if I like Skydiving and I take courses on the art, learning everything there is to know about it, and following that I sign my life away knowing that at any moment something can and may go awfully wrong, then this is not a true risk. On the other hand if a perfectly sane man walks into what he considers a perfectly strong building, but fails to realize that the floor has no steady support, that my friend is risky.

When is Risk?
Ben Graham in his book The Intelligent Investor makes it quite clear that although stocks carry a much higher overall profit potential they may not always be considered risky, and while bonds and cash may hand over consistent returns they may not always be considered as safe.

It would seem that in the late 1970s, cash and cash equivalents, as well as bonds were the place other than where any investor would rather be. Inflation had been killing the dollar and even with the 30-Year Treasuries selling with a 13% annual return bond investors remained uninterested (pun intended). However, looking back, that opportunity could have made any risk-savvy investor wealthy beyond his dreams. The individual who bought those bonds, maturing in 2012, would be walking out with returns of over 20% including price adjustments – risk-free. He wouldn’t even have to properly time the market as to when to get out as would be necessary with stocks.

Stocks too sold at silly bargains. Disney’s shares were selling for less than its book value. Major corporations were selling at prices only single digits times earnings, with numbers that would make Ben Graham smile.

Today however we see quite the opposite. It seems that most investors opt to wager their life savings (this goes out to all those who configure 401ks into the Negative Savings Rate) with much riskier vehicles such as futures and options. As a matter of fact Americans have come up with even stupider ways to throw out their money, i.e. personal Hedge Funds and leveraged Real Estate bought with ARMs, not to mention rare art collectibles, private equity and emerging markets.

Let us remember that as safe as many investors consider options you still have to know what you are doing. Yes you can gain a lot more than you can lose but let us not forget how much you can lose… everything! So that would make options safer than futures where you can lose more than you put in, but one can also take on more leverage.

Aesop said “After all is said and done, more is said than done”. In the wacky world we live in today I would have to say that it may not always be true. At least in the financial markets. It seems that in an age when speculators now call themselves investors, options are considered ample insurance and bigger returns are all that matter, risk as it is has long been forgotten.

Quote of the Day

I wish to quote a paragraph I recently read in an article written in the Wall Street Journal.

“Goldman Sachs Group Inc. pumped up leverage by the largest degree in recent years. Goldman says it was just trying to catch up to the levels of its competitors after it shifted from a partnership to a public corporation. Its ratio of assets to shareholders’ equity, one common measure of borrowing, climbed to 25.2 to 1 in 2006, from 17.7 to 1 in 2002, according to analyst Brad Hintz of Sanford Bernstein. Goldman says it has a pool of easy-to-sell securities valued at more than $50 billion that it could tap if market conditions require it to raise cash”. (emphasis ours)

Talk about “The Great Unwind”. It seems that the ‘Big Boys’ are ready to bail themselves out at the expense of the individual investor.

The article hosted by GATA can be found here.

Taking Chances


How often have we seen an individual, sometimes a family member or close friend, about to do something either risky or outright stupid, and after fair warning replies “I’ll take my chances”? With these words he assures us and all the spectators that he has weighed in thought all the possibilities of his actions and has chosen for himself a feat by which to challenge himself to.

But when we recall such scenarios what is it that comes to mind? Is it the truthful and just actions that may make us greater and enhance the quality of life for us and those around us, or rather is it those stupid actions with the “just because” attitude that may end up landing us in physical, financial or ethical reckoning?

In psychology it’s explained that people tend to lean towards risk only when they are on the brink of a loss. Walter Linn said “It is surprising what a man can do when he has to, and how little most men will do when they don’t have to”.

In the psychology of investing we find the similar. The “intelligent investor” will aim for small reasonable gains but will mortgage the farm when he feels he may loose and must save himself from further destruction. This is not logical at all but it is what the mind subconsciously resorts to in time of crisis.

Right now when I look around at the manic speculation in the investing field it seems that man has not only reasoned against risk but is taking all his chances. I wonder what people nowadays think of the speculative months preceding the Crash of 1929. Do they really think that there were no Greenberg’s, Roubini’s and Ritholtz’s with a calling back to rational thinking? Do they deceive themselves into believing that there were no Daily Reckonings proclaiming the abrupt end to all the hoopla?

I have no doubt that there were and at the same time I also have no doubt that in the far recesses of the minds there was a surety that all of the hype would one day end. But greed got the best of them and each man continued on bracing himself for the dash towards the door just in case that bearish newsletter he read that morning proves correct.

Call me a bear but with all respect to the regiments we choose to stick to the sidelines cheering on the masses whispering to ourselves… “Be greedy when others are fearful… and fearful when others are greedy”.

One day we’ll be taking chances and wild ones too, loaded with scary stuff like leveraged derivatives and high-risk credit bonds. But that day is not today, not if we’re going to be cheered on for doing so.