The Big Picture

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via Intuit

Frederick Sheehan is the co-author of Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve.

His new book, Panderer for Power: The True Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession, was published by McGraw-Hill in November 2009. He was Director of Asset Allocation Services at John Hancock Financial Services in Boston. In this capacity, he set investment policy and asset allocation for institutional pension plans.

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Leveraged Populists

The recent offering of Facebook stock was the biggest news since a man landed on the Moon. The story was everywhere. Someone said the company is worth $100 billion and that was repeated one-hundred billion times. It is the saturation of noise, more than the supposed price, that should warn investors. This too, shall pass.

Technology stocks such as Facebook are a means for investors to put their money where their hearts lie. At the turn of the millennium the world lost its mind over technology stocks. This eerie atmosphere is too well known to require description. A merger of the time will substitute.

The America Online-Time Warner combination proved the thesis of “convergence.” Stock phrases and Star Wars’ linguistics had inflated AOL stock. (“To you, peering through your spectroscope, mapping the mazes of electromagnetism in its path, the web appears as a global efflorescence….the physical phase of the telescom, the radiant chrysalis from which will spring a new global economy.” – George Gilder, widely hailed technology expert)

Page one of the New York Times Convergence Edition in January 2000 frames the all-telling photograph, captioned: “Steven M. Case, chief executive of America Online, with tie, and Gerald M. Levin, chief executive of Time Warner, without tie, announcing the merger.”

What beckons of course, is the haberdashery insight. “Left” and “right” would have fully explained who dressed down. So why the phrase? (To youngsters: Dressing down was still relatively new on January 5, 2000, so notable.)

It was an underscore. Here we had the Old Economy, and older man, agreeing to be bought out by the New Economy. Gerald M. Levin surrendered to the young man’s conquest of the Old Media. Levin had embraced the New Era, albeit, disrobed, demoted and humiliated before the public like Chuck Connors in Branded. Steven M. Case, an internet idol, wore his tie, a sign of respect for the old, shrunken media mogul who had seen the future in the nick of time. An industry analogy might be a silent movie studio that refused to make talkies in 1930.

In 1927, a third-rate movie studio, Warner Brothers, released the first talking picture: The Jazz Singer. Practically breaking the bank with a $3 million publicity campaign, the studio’s technological escapade swept the nation. We might compare the mass hysteria to the Facebook or AOL-Time Warner silliness. Every studio was soon borrowing and then borrowing some more to catch up with the People’s latest need. That was a period, like our own, when cravings equaled needs. A substantial proportion of the lower classes in Muncie, Indiana (Middletown) mortgaged their houses that they had owned to buy a car. Twenty one of twenty-six families that bought cars (in the lower strata) did not own a bathtub.

That was also a time when borrowing was easy. Lending to a booming, fashionable, and technologically cutting-edge business was fashionable in itself. By that time, movies were the fifth largest industry in the United States, where 90% of the world’s films were made – indicating the tendency of American minds to admire visual (rather than verbal) expression and drift towards fantasy.

After 1929, financing was hard to come by and the highly leveraged studios needed constant infusions of cash. Most went broke. Those who bought and held Warner Brothers Pictures at its $67 peak could sell it for $1 in 1933. Unambiguous needs during the 1920s turned to superfluous cravings a few years later. In The Crash and Its Aftermath, Barrie Wigmore wrote that movie sales dropped [in 1933] “to $546 million from $831 million in 1931….Somehow a myth has developed that Depression crowds anxious for escape sustained the movie business. This is not even remotely true.”

William Fox and Sam Warner retained control, but investors went broke. How they accomplished this feat might be studied by Facebook executives today presuming the Warners of 2012 can identify their revenues.

AOL bought Time-Warner with 45% of its stock: no cash. This gave AOL 55% ownership – and control – of AOL-Time Warner. The stock offered was worth $165 billion. In return, AOL now owned a company that had produced $6 billion of cash the year before. AOL’s cash flow was about one-quarter that amount. Time Warner stock was trading at about 20 times cash flow, fairly high by historical market measurements, but a pittance compared to AOL’s price: cash flow ratio of 110:1.

Levin’s dressed-down marriage with AOL was quite a miscalculation. Even so, it is worth remembering that the company he headed is an example of the past half-century’s leveraged finance, an aggregation of overpriced miscalculations. For the most part, finance has profited: not the companies, not the shareholders, not the customers, nor the employees.

A source of the late 1960s “garbage market” was identified by John Brooks in the Go-Go Years: “Accountants came to think legalistically rather then conscientiously.” This prompted offerings that, today, could make for a raucous feast on the Daily Show. Brooks writes of stocks for every fad: For nursing home fans, there was United Convalescent Homes. The budding fanciers of a greener world could buy Responsive Environments. For those who predicted a boom in spare time, International Leisure filled the bill.

The headline merger of the millennium gained traction during this rumpus. A funeral-parlor chain bought D.C. Comics and Ashley Famous Talent Agency in 1967; the morticians then bought Warner-Seven Arts in 1969; it renamed itself Warner Communications in 1972; Warner Communications bought cable operator American Television & Communications in 1978; Warner Communications and Time Inc. merged in 1989 to form Time Warner; Time Warner acquired Houston Industries in 1995; Time Warner acquired Turner Broadcasting Systems in 1996, this included Ted Turner’s acquisitions and product launches – the Atlanta Hawks (1977), CNN (1982), the MGM library of movies and television shows (1986), Cartoon Network (1992), Castle Rock and New Line Cinema (1993), Turner Classic Movies (1994); Time Warner acquired Times Mirror magazines in 2000; and America On-Line bought Time Warner for $165 billion in 2000 – without one penny changing hands. As noted, payment to Time Warner shareholders was in America On-Line stock.

The day after Facebook monopolized the news, a proposed merger went relatively ignored. Initially priced at $88 billion, Glencore and Xstrata continue to negotiate with each other. The combination would produce, refine, transport, and sell most of the world’s commodities that are harvested in most of the world’s countries and then sold in most of the world’s markets.

As for AOL-Time Warner, it did not take long for Gerald Levin to be shown the door. Time Warner spun off what little was left of AOL in 2009. In January 2000, Steve Case had taken his winnings and bought pineapple plantations in Hawaii.

Existing Home Sales in Jan totaled 4.57mm annualized, below expectations of 4.66mm and Dec was revised lower by 230k to 4.38mm. Taking the two months together and sales were 320k less than initially expected. However, because the number of homes for sale continues to shrink, to the lowest since May ’05, months supply fell to 6.1 from 6.4 to the smallest since April ’06. The median home price fell 2% y/o/y to $154,700, the cheapest since Nov ’01. Distressed sales totaled 35% of the total (22% foreclosures, 13% short sales) vs 32% in Dec and 37% in Jan ’11. Contract cancellations totaled a large 33%, unchanged from Dec but up from 9% in Jan ’11 as mortgage apps get denied and appraisals come in below the agreed upon price. A key for sales and pricing looking out over the next few months will be whether we’ll see a flood of foreclosures now that banks have settled with all the state AG’s, possibly clearing out the backlogs that have been built up when the aftermath of robosigning froze the process in many states.

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Source: Pension Partners LLC

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Although markets have already rallied strongly in 2012, the move is still early if current price ratio trends behave similarly to recent history.  The chart shows the price ratio of the SPDR S&P Dividend Index ETF (SDY) relative to the S&P 500 (SPY).  A rising price ratio means dividend-oriented stocks are outperforming (risk-off), while a downtrend suggests the opposite (risk-on).  Much like a pendulum that swings from fear to hope, investor sentiment goes through cycles in terms of what type of returns are preferred at any moment in time.

Notice the far right of the chart.  When we last put the post up on January 10th, the rally was just getting started, and dividend-oriented sectors such as Utilities (XLU), Healthcare (XLV), and Consumer Staples (XLP) started underperforming in a meaninful way.  The persistance in the downtrend could result in further weakness in dividend stocks and strength in more cyclical/capital appreciation sectors.  The estimated underperformance in SDY relative to SPY should the ratio return back to its support range is a bit under 5% on a spread trade basis.  Either way, the point is that a downtrend in SDY/SPY is the bull investor’s friend, and there is likely much more room to fall in terms of the movement away from income and into growth.  I discussed this idea at length in an interview I did on Bloomberg Radio last week, which can be heard here

The contrarian trade is no longer about markets going up or down, but about the length of time the trend persists.

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Michael A. Gayed, CFA is Chief Investment Strategist at Pension Partners, where he structures portfolios. Prior to this role, Michael served as a Portfolio Manager for a large international investment group, trading long/short investment ideas in an effort to capture excess returns. In 2007, he launched his own long/short hedge fund, using various trading strategies focused on taking advantage of stock market anomalies. Michael earned his B.S. from New York University, and is a CFA Charterholder

This is poetry.

“Congress, 535 commoditized temple monkeys pawing through the ruins of America in search of bribes. The bicameral whorehouse on Capitol Hill works like a vending machine. You put coins in the slot, select your law, and the desired legislation slides out.”
-Fred Reed, May 30, 2009

I added it to the QOTD in the sidebar, but I wanted to pull it out for emphasis . . .

This post was originally published at The Financial Philosopher, by Kent Thune.

“I do nothing but go about persuading you all, old and young alike, not to take thought for your persons or your properties, but and chiefly to care about the greatest improvement of the soul. I tell you that virtue is not given by money, but that from virtue comes money and every other good of man, public as well as private. This is my teaching, and if this is the doctrine which corrupts the youth, I am a mischievous person.” ~ Socrates

Every time I see news coverage of street protests in today’s Greece or of political leaders discussing Greek Austerity, I imagine, if Socrates were living today, if he would be there among the protestors and, if so, what he might say or do. Would he support the protestors? What might he say to the government leaders? Would he approve of Greek Austerity measures?

Luxury is Artificial Poverty

Socrates never recorded any of his thoughts or ideas on paper and all that is known about him comes from the writings of his contemporaries, such as Plato. However, it is clear from these writings that Socrates cared little about money and materiality and he certainly shared no affection with the ruling Aristocrats. Many accounts of Socrates describe him as something of a poor, unattractive hermit wandering the streets of Athens, teaching his philosophies to anyone who would listen. In a time when men labored for a living and spent much of their free time working for the affairs of the city aspiring to political power, Socrates did neither.

In today’s Greece, I believe Socrates would still find himself in the unique position of standing in a corner completely his own–neither with the protestors, nor with the government. While he might sympathize for the struggle of the Greek people against the governing leaders, he would remind the people that money is the corrupting force at the root of all of their troubles and that they would find contentment to let go of their material desires and to end their reliance on government to cure their ills.

Socrates to Greece: Die But Don’t Forget to Pay ‘Debt’

The featured quote at the beginning of this post comes from Plato’s account of the trial of Socrates, where Socrates was accused of “corrupting the youth of Athens” and was given the choice to either denounce his philosophies or die by drinking the poison hemlock. Socrates chose death.

His last words were reportedly spoken to Crito, where Socrates said, “We owe a rooster to Asclepius. Please, don’t forget to pay the debt.” Asclepius was the Greek god for curing illness. Therefore these words are interpreted to mean that death is a cure and a means to freedom.

I would never expect a political body to take the path of a wise philosopher, but Socrates would likely say today that Greece must metaphorically die–to split from the European Union–to be cured of its ills… And, yes, don’t forget to pay your debt to Asclepius…

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Follow Kent Thune on Twitter or subscribe to his blog at The Financial Philosopher.

At least with respect to the Greek bailout news on Monday, European stocks have officially sold on the news as the German DAX in particular is back to Friday’s close and Greek stocks are falling 3%+ to a 3 1/2 week low. The signs of a short term market top are also clear in US markets with the weak action over the past week in transports and lagging performance in the Russell 2000 over the past week. In terms of catalysts of substance, all eyes are on next week’s 2nd LTRO from the ECB with estimates ranging from 200b euros to 1T, a spread that something larger than a truck can drive thru. The Feb euro zone mfr’g and services composite index fell back below 50 at 49.7 from 50.4 and below expectations of 50.5. With respect to the gift the Greeks are getting with a reset lower of the interest rates they will pay on borrowed money, a German official said to Ireland and Portugal not to expect the same treatment. Spain and Italy are also paying a higher borrowing rate now than Greece. In Asia, the flash HSBC mfr’g PMI rose to 49.7 from 48.8, a 4 month high but remains below 50 for a 4th straight month. On the modest bounce in mfr’g, the Shanghai index did rise to the highest since late Nov. The yen has touched 80 vs the US$ for the 1st time since July and the Nikkei continues higher in response. In the US, purchase apps to buy a home fell 2.9% to the lowest since Oct while refi’s fell 4.8% as mortgage rates were little changed. II: Bulls 51.1 v 54.8, Bears 26.6 v 25.8

The 12-month forward estimates are not consistent with the short-term estimates. The first chart below shows that Q4 2011 earnings growth rates are estimated to be near 5.50% (370 actual earnings and 130 estimates are used to calculate this). This is consistent with what FactSet noted above. The second chart below shows Q1 2012 earnings estimates to be near 0%, also consistent with FactSet.

For the 12-month forward estimate (two charts above) to be correct, earning will have to boom starting in Q3. Analysts are predicting that, after a lackluster Q4 2011 and Q1 2012, earnings will indeed boom. This odd forecast had better come true, otherwise the 12-month forward earnings estimates, which are often used in valuation metrics, are not realistic.

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Source:
Bianco Research
Charts Of The Week
February 15, 2012

There was a 21.2% decline in listing inventory from December 2010 to December 2011.

Relying on typical housing market scenarios and reasonable logic, a decline in listing inventory nearly always meant a tightening market was developing – fewer houses coming on line matched against steady demand meant housing prices were more likely to stabilize or rise.

Declining inventory is the variable in the housing equation that usually makes conditions improve. During the mid-decade housing boom, falling inventory was caused by the insatiable demand by buyers – product could not get out to the market fastest enough. Listing inventory was simply “worked off” by (artificially) inflated demand. Listing discounts approached zero, days on market fell to record lows and prices rose rapidly.

Old scenario: Declining Listing Inventory = declining housing prices ease their decline, prices stabilize or prices rise.

However over the last year, listing inventory fell sharply in many markets yet sales were generally anemic or showing nominal increases. In the NAR numbers, non-seasonally adjusted sales were up 1.4% year over year (using NSA since inventory is also NSA) yet inventory was down 21.2%. Inventory was clearly not declining because sales were overpowering the amount of listing inventory that was available.

Then why is inventory declining?

The answer to this question was not considered in the recent prediction of a market bottom.

New scenario: Declining Listing Inventory = fall in seller confidence and the sharp decline in distressed inventory entering the market.

From NAR…

Total housing inventory at the end of December dropped 9.2 percent to 2.38 million existing homes available for sale, which represents a 6.2-month supply2 at the current sales pace, down from a 7.2-month supply in November.

“The inventory supply suggests many markets will see prices stabilize or grow moderately in the near future,” Yun said. – National Association of Realtors

We are seeing unusual declines in many markets I keep tabs on such as:

• Baltimore, MD Down 21.6% YOY
• Washington, DC Metro Down 35.8% YOY
• Las Vegas Down 12.9% YOY
• Broward County, FL Down 35% YOY
• Miami-Dade Down 40% YOY
• ReMax National down 25.7% YOY
• Phoenix (Realtor.com) down 48% YOY
• Boise City, Idaho (Realtor.com) down 41% YOY

Admittedly I am cherry picking some of the cities that are posting huge declines in inventory. However the problem I find in all of these markets, is that sales are only increasing a few percentage points. Not nearly enough to explain the rapid decline.

The drops are being touted as a good sign that housing is getting back on its feet. I’m not so sure.

I think the sharp drop in many US housing markets (and this has been happening for much of 2011) has to do with three key reasons:

• A large swath of foreclosure volume was artificially delayed.
• Seller confidence has waned after the pounding it took last fall.
• Low interest rates extended by the Fed for the next two years have removed any sense of urgency.

Declining foreclosure volume is one of the key reason inventory levels are dropping. The 1/3 decline in foreclosure volume in 2011 has resulted in a sharp drop in foreclosure inventory resulting in a sharp drop in total inventory. Distressed sales have been running at about 30% of total sales nationally for a few years but fell to about 20% in 2011. With a 2 million more homes expected to go into foreclosure over the next 2 years, a year long internal review of procedure after the 2010 “robo-signing” scandal and the 50 State AG settlement with the largest services/banks, distressed inventory is expected to rise sharply over the next several years.

Weak seller confidence is causing property not to be released into the market unless the need to sell is not optional. The 2011 home seller and buyer was bashed with the debt ceiling debate, the S&P downgrade of US debt, 400 point daily swings in the financial markets, the European debt crisis, the AG/Service settlement drama and the political stalemate on housing policy in Washington. What do people do when faced with the unknown? They sit and wait. Buyers had a lot more incentive to act with falling mortgage rates to record levels but mortgage underwriting grew tighter over the year as well.

The extension of the low interest rate policy by the Fed through the end of 2014 has obliterated any sense of urgency by sellers. I am getting a lot of feedback from real estate professionals about this as well as seeing it within my own appraisal practice. There is a lot going on the world right now and the action by the Fed suggested that they weren’t particularly encouraged by the economy. To many this may seem as an incentive for sellers to get going and sell. But many of those sellers have to buy.

The drop in inventory as a phenomenon may or may not pass quickly but one thing is clear – weird changes in market behavior happen for a reason – I don’t see declining inventory as a particular sign of strength in the housing market.

The project is the work of Yanko Tsvetkov, a graphic artist who also goes by the name Alphadesigner. Tsvetkov has lived all over Europe, but back in 2009 when he got the idea to produce maps charting prevailing stereotypes, he was still in his native Bulgari.

Source: Tim Dowling, Guardian

Apple’s recent 5% drop from an intraday high was hailed as a key reversal day for the market leader. But a history of one-day swings shows Apple typically has rebounded a week or month later, MarketWatch columnist Mark Hulbert says. Laura Mandaro reports.

MarketWatch 2/21/2012 6:19:16 PM

I met Joe Fahmy a few years ago at Lindzenpalooza. He has a great way of communicating his trading skills to a novice to intermediate traders based on his 16 years of trading. Fahmy has guided his hedge fund to outperformance over the past 13 quarters. As previously mentioned, I wanted to present something less technical and chart focused;

This is our second attempt at bite size, easy to understand, bullet points for traders. The first post is here.

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1) Loss cutting:  Trading has this amazing historical footnote: If you study the great traders throughout history, they all share the same statement as their number one rule: CUT YOUR LOSSES! Capital preservation “keeps you in the game.” It is especially important once you understand the math: a 25% drawdown requires a 33% gain to get to break even; Down 33% means you need to rally 50% to get back to square one; As we saw in 2008-08, a -50% loss requires a +100% gain to get back to even. In sports “Defense Wins Championships.” The same goes for stock trading. Most traders need to focus more on defense.

Even Warren Buffett understand the traders credo: “The first rule of investing is don’t lose money. The second rule is don’t forget Rule No. 1.

2) Confidence: There is nothing worse than seeing a great opportunity but not having the courage to “pull the trigger” and execute the trade. Freezing up due to fear does NOT happen to great traders. These thoughts don’t even enter their mind because they are confident in their plan. They know wht they will do if the trade goes their way, and perhaps more importantly, they know what to do if it goes against them. Confidence cannot be taught. It comes from making decisions, taking action, and learning from experience.

3) No ego:  Successful traders may have big personalities, but they separate their ego from their trading. They might have serious conviction behind their positions, but when the market proves them wrong, they don’t argue with it. They simply move on and accept it.

Two things I never argue with: the stock market and women. Both of them are smarter than me, and both are always right! (BR: Spoken like a married man)

4) Consistency: The best at anything are the best because they are consistent. Michael Jordan isn’t considered the best basketball player ever because he scored 30 points ONCE in a game. It’s because he averaged 30 points per game over his ENTIRE career.

Traders should not obsess with their day-to-day profit & loss. Rather, they should shoot for consistent positive months, quarters, and years with minimal draw downs. You do not want to be the “boom and bust” trader who does well in a strong market but gives it back during market corrections. These guys are a dime a dozen and typically get blown out of the market at key pivot points (Last cycle, I knew a few who became mortgage brokers — how is that for timing?)

5) Students of the market: Successful traders NEVER get complacent. They are always eager to learn, constantly looking to improve their skills.

One way to improve is through post analysis of your trades. It is important to look at your numbers and make sure your losses are smaller than your gains.

For technical traders, studying your entry points and looking at charts that worked (and didn’t work) is part of the constant learning experience of becoming a confident and consistently profitable trader.

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Fahmy holds seminars for active traders who want to improve their returns.   Readers of the Big Picture who are interested will get a $500 discount on the full day event. Go to TradingBigWinners.com and enter the promotional code: “bigpicture500” for the New York (3/3) seminars. I will be discussing trader psychology and cognitive errors at this seminar.

Created by: Paralegal

Roberta Karmel, Professor at Brooklyn Law School, talks with Bloomberg Law’s Lee Pacchia about her thoughts on how to reform the financial industry. Professor Karmel has recently called for reforms such as breaking up the large American banks and combining the Securities Exchange Commission with the Commodity Futures Trading Commission. Professor Karmel previously served as a Commissioner for the SEC.

Feb. 21 2012 (Bloomberg Law)

My just-got-back-from-Shoals-Bay reading :

• Icelandic Anger Brings Debt Forgiveness in Best Recovery Story (Bloomberg)
• Ben Bernanke: Washington’s Quiet Hero (The Daily Beast)
• Designing Mortgage Bundles to Fail: It wasn’t just GS (WSJ)
•  Massachusetts Home Seizures Threatened in Loan Case: (BusinessWeek) see also Some Doubt a Settlement Will End Mortgage Ills (NYT)
• Don’t sell a dull stock market short (Market Watch)
• Comcast Is Launching a Netflix Competitor (WSJ)
• Yelp, Facebook IPOs to Enrich ‘PayPal Mafia’ (Bloomberg)
• Apple’s iMessage: All Your IMs Are Belong To Us (And Phone Network SMS Revenues, Too) (Fast Company)
• Magic Ink (Worry Dream)
• Full Spectrum Reading List: 7 Great Books by TED 2012 Speakers (Brain Pickings)

What are you reading?

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Investors Shrug at U.S. Small-Cap Surge

Source: WSJ

The 2 yr auction was line with the various metrics but at a yield that is the highest since late October at .31%. It’s still anemic of course but coincides with a recent general rise in rates across the yield curve as the US economy hangs in, implied inflation expectations rise in the TIPS market and European debt issues have been tempered by the Greek deal and the ECB’s LTRO.

Factset – Earnings Insight, February 10, 2012
Estimated Earnings Growth Rate for Q1 2012 Falls to 0% Today.
The blended earnings growth rate for the S&P 500 for Q4 2011 currently stands at 5.5%. If this is the final earnings growth rate for the quarter, it will mark the end of the streak of consecutive quarters of double-digit earnings growth at eight. However, the streak of consecutive quarters of overall earnings growth will extend to nine. Looking ahead to the current quarter, what is the projected earnings growth rate for Q1 2012? Are analysts expecting the streak of consecutive quarters of earnings growth for the S&P 500 to continue? Based on the current estimates, the answer is no. As of today, the estimated earnings growth rate for the S&P 500 dropped to 0.0%. The growth rate has steadily dropped from 8.0% on September 30 to 3.0% on December 30 to 0.0% today. Four sectors are predicted to see earnings growth in Q1 2012, while six sectors are predicted to see earnings decline. It is interesting to note that while earnings expectations for Q1 2012 have declined since the start of the quarter (to 0.0% from 3.0%), the price of the market has continued to rise. Since December 31, the price of the market has increased 7.5% (to 1351.95 from 1257.60).

Comment

The following slides show an update of our series of earnings charts. The story remains that this earnings season is not good. Stocks are simply rallying on the hope of a growing QE world and QE3 specifically. Printed money is a powerful force for risk assets. According to Bloomberg, 370 of the S&P 500 companies have reported earnings for the recently completed quarter. Only 63% beat expectations, one of the lowest “beat rates” of the last decade.
Revenues are doing even worse. As the next chart shows, of the 366 companies that have reported revenues through February 15, only 43% beat expectations. Overall, revenues estimates tend to be lower than earnings estimates as companies do not game revenues as much as earnings.

Click to enlarge:

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Source:
Bianco Research
Charts Of The Week
February 15, 2012

Ben Graham’s Curse on Gold
John Mauldin
February 20, 2012

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This week we have a shorter Outside the Box, from my friend David Galland at Casey Research, with an interesting insight into why gold can be considered as a poor investment by some rather influential investors (like Warren Buffett) while others may see it as the core of a diversified portfolio. As usual when I use someone’s material for an OTB, I include a link at the end, if you want to look deeper. The rather large team at Casey Research specializes in gold, natural resources, and energy-related investments, for those with such an investing bent.

As a quick note, the feedback on this weekend’s letter on taxes has been substantial, and a great deal of it is quite good and worth thinking about. Many bring up real problems with the position I took in my letter, and I may surprise you by agreeing with some of them. My intention right now (barring something happening between now and Friday night) is to take some of the better statements and questions, and answer them. I am not married to any specific plan. I just want to solve the problem and am open to anything that is politically feasible and makes sense, as long as we solve the basic problem of the deficit. I think it will make for a very interesting letter. I do read your feedback, by the way. So if you wanted to respond and wondered if I might actually read it, the answer is yes I do, and this week will answer as many as I can.

And to answer a question I get a lot, I buy a little physical gold every month. I don’t even look at the price. The check is written the same day each month, for the same amount. I take delivery. I hope the price of gold goes down so I can get more gold per dollar. I also hope it ends up being worthless, as that will mean everything else has worked out just fine. But my gold is there just in case my crazy gold bug friends are right and we can’t actually trust the government to find a reasonable solution to our dilemma. And maybe because deep down I really don’t trust the (insert your favorite expletive). Just a little insurance, you understand.

So, until we connect this weekend, have a great week!

Your I am not a gold bug analyst,

John Mauldin, Editor
Outside the Box

JohnMauldin@2000wave.com

Ben Graham’s Curse on Gold

By David Galland, Casey Research

It seems that the mainstream investment community only takes a break from ignoring gold to berate it: one of gold’s most outspoken critics, uber-investor Warren Buffett, did so recently in his latest shareholder letter. The indictments were familiar; gold is an inanimate object “incapable of producing anything,” so any investor holding it instead of stocks is acting out of irrational fear.

How can it be that Buffett, perhaps the most successful (and definitely the most well-known) investor of our time, believes that gold has no place in an intelligently allocated investment portfolio?

Perhaps it has something to do with his mentor, Benjamin Graham.

Graham, author of Security Analysis (1934) and The Intelligent Investor (1949), is correctly respected as one of history’s most knowledgeable investors. Over a career spanning 1915 to 1956, he refined his investment theories, in time becoming known as the father of value investing. Much of modern portfolio theory is based upon Graham’s work.

According to Graham, while no one can tell the future, there are periods when the valuations of stocks and bonds would deviate from fair value by becoming excessively over- or undervalued. To enhance returns and reduce risk, investors should alter their portfolio allocations accordingly. A quick look at a long-term chart supports Graham’s theory clearly shows periods when one asset class offered a better value than the other:

But what of the periods when both stocks and bonds stagnated or fell together? For much of the 1970s and again from 2001 through today, any portfolio allocated solely between stocks and bonds would have at best treaded water and at worst drowned in a sea of stagflation. To earn any real return, an investor would have needed to seek alternatives.

It’s clear from this next chart that gold was exactly that alternative, a powerful counter-trend investment for periods when both stocks and bonds were overvalued. Yet gold is conspicuously absent from Graham’s allocation model.

But this missing asset class is entirely understandable: for most of Graham’s adult life and the most important years of his career, ownership of more than a small amount of gold was outlawed. Banned for private ownership by FDR in 1933, it wasn’t re-legalized until late 1974. Graham passed away in 1976; he thus never lived through a period in which gold was unmistakably a better investment than either stocks or bonds.

All of which makes us wonder: if Graham had lived to witness the two great bull markets in precious metals during the last 40 years, would he have updated his allocation models to include gold?

We can never know.

We can know, however, that given Graham’s outsized influence on investment theory, there is little question that his lack of experience with gold, and therefore its absence from his observations, has had a profound effect on how most investment professionals view the yellow metal. This, in our opinion, goes a long way toward explaining the persistently low esteem in which gold is held by the mainstream investment community. And, as a consequence, its widespread failure to even be considered as an asset class.

A couple of takeaways: first, perhaps now you can stop wondering why your broker, the talking heads in the financial media, and Warren Buffett continue to misunderstand gold as a portfolio holding. More importantly, however, is that in order to have sustained, long-term investment success, one must accept that an intelligent portfolio allocation needs to include not two but three broad categories of investment – stocks, bonds and gold, with the amounts allocated to each guided by relative valuation.

[JFM here: I would suggest additional broad categories of investments depending on your personal situation. Alternative investments like commodity trading funds. Low leveraged income oriented real estate consistent with your ability to handle the ups and down of the rental/leasing market and shorter term carry costs. I for one am not psychology capable of dealing with renters, of whom I am one. I want service and you to pay for major maintenance, and the ability to move at the end of my lease. My choice, not dependent upon your cash needs. But I know of plenty of people who can do that and have amassed considerable portfolios over time. Perhaps your own small business that has the potential to grow. Investments outside of your country of residence. Etc.]

Investors who understand this tenet have an almost unfair advantage over other investors as it allows them to get positioned in gold ahead of the crowd and enjoy the bulk of the ride, while others sit on their hands.

So when you hear commentators ridiculing gold as a barbarous relic, lamenting that they cannot eat it or smugly asserting that it produces nothing, rest contently in knowing that they’re operating with a severe handicap in their own portfolio. Meanwhile, we’ll prosper, armed with the understanding that gold fulfills a very important and specific purpose in a portfolio, namely as real money that protects net worth during periods marked by excessive government debt and currency debasement such as we are currently experiencing.

Given the powerful influence of Ben Graham and his disciples, his curse on gold will not go quietly into the night. But it should.

David Galland is managing director of Casey Research, which provides independent investment analysis on a subscription basis to a global network of over 180,000 self-directed investors and money managers. Recognizing the emerging bull market in gold early on, in the late 1990s, Casey Research formed a metals and mining division that has grown into a leading provider of actionable gold and resource intelligence. For investors looking to become familiar with the asset category, Casey Research offers a monthly newsletter, BIG GOLD (try it risk-free for 90 days), focusing on undervalued opportunities in mid- to large-cap producers, as well as best practices in buying, holding and selling precious metals. Learn now why it’s more important than ever to invest in gold and gold-related equities.

No sooner than the ink is dry on the agreement to provide a 2nd bailout for Greece, the front page of today’s FT is saying that debt and growth estimates in a ‘strictly confidential’ report implies that a 3rd bailout will be needed at some point. We’ll see as Greece is being given more time, again and hopefully they take advantage. Either way, markets care only about the here and now and they got what they had been pricing in for the past few weeks. In terms of the PSI, we are awaiting the participation rate and importantly, the March 20th maturing bond will be included. With respect to containment to Greece, the German FM said today there is ‘no need to think about changing the Portugal program.’ After rallying to the highest level since Aug yesterday, European bank stocks are giving back most of the gain today. The other noteworthy event over the long weekend was the move by the PBOC to cut bank reserve requirements by 50 bps to 20.5% and the Shanghai index rallied for a 3rd day overnight to the highest in 12 weeks. Copper is also rising, getting back what it lost on Friday. In the US, gasoline prices according to AAA rose for the 26th straight day yesterday, up by .03 over the weekend to $3.57 per gallon. Over this time frame, prices are up about .20 which equates to about $28b annualized out of consumer pockets, almost 1/3 of the payroll tax cut.

I HATE this guy!

At least that’s what I thought when I first heard him on Marc Maron’s podcast, when I finally figured out who it was. You know him too, Stoller’s the schnook with the whiny voice, the kind of guy who wants to be your friend who you avoid.

But the intro to Maron’s interview was so fascinating, I came around. You see Stoller was calling after the fact, he felt like he’d screwed up, that he didn’t sell himself, give his bonafides, like his connection to Eddie Murphy, hooking him up with SNL.

And you can listen to the podcast.

But I really recommend reading the book, “My Seinfeld Year”, it’s a Kindle Single.

Stoller’s a loser. He can barely get laid and gave up standup comedy because he couldn’t handle the road or the audience, who didn’t appreciate someone low-key who struggled to work up an hour’s worth of material.

So he became a character actor. Well, that’s a little strong. He started appearing as a delivery man, as a pain in the ass on sitcoms. Just small parts.

And that’s when he ran into Larry David at a party, who wondered why Fred hadn’t pitched him a “Seinfeld” script. He said if Fred put in the effort, he’d read it. He wouldn’t guarantee he’d do it, but he’d read it.

So Fred sat down and wrote a spec script and lo and behold, he got hired as a writer on “Seinfeld”. Where another writer tried to sandbag him and he continually worried he was missing out on his acting career.

And all these years later, Fred’s written a book about the experience. Well, he started it years ago, but he just finished it. He agonized how much to charge for it on Amazon, ninety nine cents or $1.99. Maron gave him a flip answer, but we’re obsessive, it means so much to us, it’s got to be exactly right.

After agonizing, Fred decided on $1.99.

And I recommend you go on Amazon right now and buy it.

It’s great to hear the story of someone who’s not a winner, who’s trying to find his way, as opposed to the self-satisfied schmucks who think they have all the answers. I read those self-help books and say, THAT’S NOT ME!

But reading Stoller’s book, I saw so much of myself in it.

As to the fateful night he ran into Larry David:

“I wasn’t going to go to Steve’s surprise party at first. I wasn’t feeling that social, though I was painfully alone at the time. I do things like that. I’ll moan to myself how isolated I am, go outside, see someone I know and then hide from them. It’s not always because the person is the most annoying. Sometimes with some people I just know what the conversation is going to be and I don’t have the strength to relive it in real life after experiencing it in my head.”

I avoid people constantly. I’ll duck around the corner, I’ll leave early, I just can’t endure you telling me how great things are, how you’re setting the world on fire, as if I’m in Best Buy and you’re selling me a new TV.

When I was single I used to lament being alone all the time. But the thought of enduring the fruitless conversations outside my door was enough to convince me to stay inside.

“Or maybe it was that crazy irrational part of me that feels bad for people when there’s no reason to feel bad for them.”

This is me to a “T”. You think because I say such outrageous things in print I must be a real backstabber in real life, just like you. Whispering behind people’s backs, playing my manipulative game. But that’s patently untrue. I’m just honest in a world where people believe they can’t be. And I’ve been abused by so many that I go out of my way to be nice to those screwed over. I include them, respond to their e-mail, speak to them at affairs, I just don’t want to add to their pain. Then again, are they experiencing any?

“My overall writing experience on ‘Seinfeld’ had left me feeling confused, numb and not very confident.”

Reminds me of playing high school sports. I was on the team but not a member of it. Not one of those high-fiving, towel-snapping, smiling winners. They say it builds character. I would have been better off in my room at home, alone.

And here comes the piece-de-resistance:

“I’m trapped in a weird kind of showbiz sitcom purgatory – I get enough work not to quit, but never enough to feel I can take a deep breath and stop struggling.”

It’s easier if you fail. But if you have a bit of success, you keep going, figuring it’s gonna get easier, your big break is just around the corner.

But Fred Stoller’s break has yet to come.

Until now.

If Fred had brought “My Seinfeld Year” to a traditional publisher, they wouldn’t have taken it. If they were interested at all, they would have told him how to change it, ruining it in the process. But doing it his way, the book resonated.

It’s #65 in the Kindle Store. #1 in Entertainers and Singles.

And that’s utterly amazing, I’m sure Fred’s shocked.

You’ve got to take a chance.

And I’m recommending taking a chance on “My Seinfeld Year”.

Even if you continue to hate Fred, you’ll gain all kinds of insight into the production of “Seinfeld”, stuff I’ve seen nowhere else.

But if anybody else had put forth this information, it just wouldn’t be as interesting.

What ever happened to that guy from fourth grade? You know, who didn’t get straight A’s, who didn’t throw the ball the hardest?

I’m not saying I want to hang out with Fred, I’m fearful of being brought down to his level, caring for a cat alone in an apartment.

But I found more humanity in “My Seinfeld Year” than in any book I’ve read in eons.

The human condition. It’s fascinating and repulsive at the same time.

Take a chance.

“My Seinfeld Year”You don’t need a Kindle to read it, just download a free Kindle app to read it on your Mac or your iPad or your iPhone or PC, Android, Blackberry or Windows phone Free Kindle Reading Apps

Fred Stoller on Marc Maron’s WTF
(Start listening at 9:00 to hear Stoller’s phone call.)

P.S. This is a Kindle SINGLE! Which means it’s short. Budget an hour and a half max. Don’t be too overwhelmed to try.