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The Glide Path Option

John Mauldin — Sat, 07 Nov 2009 04:54:00 GMT

The Present Contains All Possible Futures
The Ugly Unemployment Numbers
Argentinian Disease
The Austrian Solution
The Eastern European Solution
Japanese Disease
The Glide Path Option
Philadelphia, Orlando, and Phoenix

The present contains all possible futures. But not all futures are good ones. Some can be quite cruel. The one we actually get is dictated by the choices we make. For the last few months I have been addressing the choices in front of us, economically speaking. Today I am going to summarize them, and maybe we can look for some signposts that will tell us which path we're headed down. For those who are new readers and who would like a more in-depth analysis, you can go to the archives at www.investorsinsight.com and search for terms I am writing about. And I will start out by briefly touching on today's ugly unemployment numbers, with data you did not get in the mainstream media.

But first, let me welcome the readers of EQUITIES Magazine to this letter. The publisher is sending the letter to you directly. This letter is free, and all you have to do to continue receiving it is type in your email address at www.investorsinsight.com. Likewise, I have arranged for my regular readers to get a free subscription to EQUITIES Magazine, if you would like. You can go to www.equitiesmagazine.com. For those who don't know, I write a brief monthly column for them.

The Ugly Unemployment Numbers

The headlines said unemployment, as measured by the "establishment survey," was down by 190,000; and even though that was slightly worse than forecast, market bulls were cheered by the fact that the number was not as bad as last month's. It is an improvement that we are not falling as fast.

Well, maybe. What I did not see in many of the stories I read was that the number of unemployed actually soared by 558,000, to 15.7 million, as measured by the household survey. The establishment survey polls larger businesses; the household survey actually calls individual households.

Let's look at the real number in the establishment survey. If you don't seasonally adjust the number, the actual change in unemployment for October was 641,000, or about 450,000 more than the seasonally adjusted number. And the Bureau of Labor Statistics added 86,000 jobs that they simply guess were created through the so-called birth-death ratio. Interestingly, the birth-death ratio number is not seasonally adjusted, so it is just added to the unemployment number. http://www.bls.gov/web/cesbd.htm

The total (U-6) employment rate is at a record high of 17.5% (this includes those who are part-time for economic reasons). There are now over 10.5 million people who have lost their jobs since the beginning of the downturn.

My favorite slicer and dicer of data, Greg Weldon (www.weldononline.com), offers up an even more horrific number. As I have noted before, if you have not looked for work in the last four weeks, the BLS does not count you as unemployed. Quoting Greg:

"Moreover, when we combine the monthly change in the number of Unemployed, with the number Not in the Labor Force, we might consider the result to be a proxy for the actual 'change' in the underlying labor market situation ... in which case, October's figure of 817,000 represents the fourth LARGEST yet, behind last month's (September's) second largest figure of 1,021,000 ... for a two-month combined figure of 1.838 million, in newly Unemployed, or no longer 'in' the Labor Force ...

"... the second LARGEST two-month total EVER posted, barely trailing the December-08/January-09 total 1.955 million.

"Bottom line ... basis this measure AND the 'Total Unemployment Rate,' we could conclude that not only is there NO 'improvement' in the labor market, but moreover, that it continues to DETERIORATE, intently."

There are plenty more implications in the data, but let's turn to the topic of the day.

The Present Contains All Possible Futures

Like teenagers, we as a US polity have made a number of bad choices over the past decade. We allowed banks to overleverage and, in the case of AIG (and others), sell what were essentially naked call options of credit default swaps, based on their firm balance sheets, far in excess of their net worth; and that put our entire financial system at risk. We gave mortgages to people who could not pay them, and did so in such large amounts that we again brought down the entire world financial system to the point that only with staggering amounts of taxpayer money was it brought back from the brink of Armageddon. We assumed that home prices were not in a bubble but were a permanent fixture of ever-rising value, and we borrowed against our homes to finance what seemed like the perfect lifestyle. We did not regulate the mortgage markets. We ran large and growing government deficits. We did not save enough. We allowed rating agencies to degrade their ratings to a point where they no longer meant anything. The list is much longer, but you get the idea.

Now, we are faced with a continuing crisis and the aftermath of multiple bubbles bursting. We are left with a massive government deficit and growing public debt, record unemployment, and consumers who are desperately trying to repair their balance sheets.

If present trends are left unchecked, we will need to find $15 trillion in the next ten years, just to pay for US government debt, let alone state, county, and city debt. And perhaps some loans for business will be needed? Where can all this money come from? The answer is that it can't be found. Long before we get to 2019 there will be an upheaval in the market, forcing what could be unpleasant changes.

We are left with no good choices, only bad ones. We have created a situation that is going to cause a lot of pain. It is not a question of pain or no pain, it is just when and how we decide (or are forced) to take it. There are no easy paths, but some bad choices are less bad than others. So, let's review some of the choices we can make. (Again, I am being very general here. You can go to the archives for more specifics. This is a summary letter.)

Argentinian Disease

One way to deal with the deficit is to do what Argentina and other countries have done: simply print the money needed to cover the deficits. Of course, that eventually means hyperinflation and the collapse of the currency and all debt. There are writers who think this is an inevitable outcome. How else, they ask, can we deal with the debt? Where is the political willpower?

One large hedge-fund manager in Brazil humorously remarked that Argentina is a binomial country. When faced with two choices (hence binomial) they always made the bad choice. Could it happen here?

Hyperinflation is not an economic event; it is a political choice. I think last Tuesday's election is a sign that the voter population is beginning to pay attention to the need for something more than talk of change. There is growing discomfort with the size of the deficits. Further, the Fed would have to cooperate in order for there to be hyperinflation, and I think there is only a very slight (as in almost zero) chance of that happening. Could Congress change the rules and take over the Fed? Anything's possible, but I seriously doubt there is any appetite in saner Democratic circles for such a thing to happen.

I think the chances of hyperinflation in the US are quite low. It would be the worst of all possible bad choices.

The Austrian Solution

Here I refer to the Austrian school of economic theory, based on the work of Ludwig von Mises and Friedrich Hayek, et al. There are those in the Austrian camp who argue the need to do away with the Fed, return to the gold standard, allow the banks that are now deemed too big to fail to go ahead and fail, along with any businesses that are also mismanaged (such as GM and Chrysler), and leave the high ground to new and more properly run.

In their model, government spending is slashed to the bone, as are (in most cases) taxes. The advantage is that, in theory, you get all your pain at once and then can begin to recover from what would be a very bad and deep recession. The bad news is that you risk getting 30% unemployment and another depression that could take a very long time to climb out of.

Now, let me say that I have GREATLY simplified their argument. If you want to learn more you can go to www.mises.org. It is an excellent web site for all things Austrian. While I am not Austrian, I have spent a lot of time reading the literature and have certain sympathies for this view.

That being said, this also has almost no chance of being implemented. In Congress, only my friend Ron Paul is its advocate. Most Austrian followers are Libertarian by nature, and that is just not a political reality for the coming decade.

The Eastern European Solution

As it turned out, Niall Ferguson (last week I wrote about his brilliant book, The Ascent of Money) was in Dallas last night, and I was graciously invited to hear him. He gave a great speech and signed books, and then we went to a local bar and proceeded to solve the world's problems over Scotch (Niall) and tequila (me), and went farther into the night than we originally intended. He's a very fun and knowledgeable guy.

As we were talking about possible paths, he brought one to mind that I hadn't thought of. He reminded me of the period after the fall of the Berlin Wall, as the nations of Eastern Europe broke from the former Soviet Union. They started with very weak economies and simply overhauled their entire governments and economies in a rather short period of time, though not in lockstep with one another. Privatization, lowered taxes, etc. were the order of the day.

We here in the US are always talking about the need for reform. We need to reform health care or education or energy. In Eastern Europe they did not reform in the sense that we use the word. In many cases they simply started from scratch and built new systems. They had the advantage that there was general agreement that things did not work the way they had been, so there was more room for change.

Today in the US there are large constituencies that resist change. We only get to tinker around the edges, when real structural change is needed. Sadly, we agreed that here there is not much chance of major change. We can't even get the obvious changes needed in the financial regulatory world.

Sidebar: I am outraged at the paltry proposed financial "reforms." Rahm Emanuel said that no crisis should be allowed to go to waste. The Obama administration is wasting this one. How can we allow banks to be too big to fail? Where is the reinstatement of Glass-Steagall? If we are going to allow large banks to exist, then their leverage must be reduced to the point where their failure would not risk the system and require taxpayer dollars. I don't care if that makes them less profitable. They are making those large profits because they have taxpayers implicitly behind them, and I get no dividend payments from them, the last time I checked. Where is Fannie and Freddie reform (and their breakup)? No mention of an exchange for credit default swaps? (And yes, I know that such an exchange would reduce the number of swaps and the profitability of them. That is the point. They are dangerous if allowed to become too big a market.) This bill reads as if bank lobbyists wrote it. Where is the populist outrage? We have let the fox set up the rules for running the hen house. Shame on us all if we allow this to happen.

Japanese Disease

I have written a lot over the past year about the problems facing Japan. Their population is shrinking, as is their work force. They are running massive fiscal deficits and have done so for almost 20 years. Government debt-to-GDP is now up to 178% and projected to rise to over 200% within a few years. They started their "lost decades" with a savings rate of almost 16%, and are now down to 2% as their aging population spends its savings in retirement. They have had no new job creation for 20 years, and nominal GDP is where it was 17 years ago.

As bad as our problems are here in the US, their bubble was far more massive. Values of commercial property fell 87%! Their stock market is still down 70%. They had twice as much bank leverage to GDP as the US. (Think about how bad off we would be if bank lending was twice as large and had even worse defaults and capital shortfalls!)

And yet, they Muddle Through. Productivity has kept their standard of living reasonable. Up until recently their exports were strong. The trading floors of the world are littered with the bodies of traders who have shorted Japanese government debt in the belief that it simply must implode. While I believe that it eventually will, if they stay on the path they are on, Japan is a very clear demonstration that things that don't make sense can go on longer than we think.

Richard Koo (chief economist of Nomura Securities, in Tokyo) argues passionately that Japan had a balance-sheet recession, and that the only way for Japan to fight it was to run massive deficits. Banks were not lending and businesses were not borrowing, as both groups were trying to repair their balance sheets, which were savaged by the bursting of the bubble. It is said that at one time the value of the land on which the Emperor's Palace sits in Tokyo was worth more than all of California. Clearly this was a bubble that puts our housing bubble to shame.

So, I understand the point that there are differences between Japan and the US . But there are also similarities. We too have had a balance sheet recession, although here it was mostly individuals and financial institutions that have had to retrench and repair their balance sheets.

Japan elected to run large deficits and raise taxes. As I wrote in the October 16^th letter (http://www.investorsinsight.com/blogs/thoughts_from_the_frontline/archive/2009/10/17/muddle-through-r-i-p.aspx), "Savings equal Investments:

GDP (Gross Domestic Product) is defined as Consumption (C) plus Investment (I) plus Government Spending (G) plus [Exports (E) minus Imports (I)] or:

GDP = C + I + G + (E-I)

I don't want to go on at length again, but basically, the literature I quoted suggests that government stimulus and deficits have no long-run positive effect on GDP. In fact, the work done by Christina Romer, Obama's chairman of the Council of Economic Advisors, shows that tax cuts have a three-times-greater positive effect on GDP, and tax increases have the same level of negative effect.

In the equation above, if you increase government spending it will have a positive effect in the short run on GDP, but not in the long run. In essence, the increase in "G" must be made up by savings from consumers and businesses and foreigners.

But "G" does not enhance overall productivity. Government spending may be necessary but it is not especially productive. You increase productivity when private businesses invest and create jobs and products. But if government soaks up the investment capital, there is less for private business.

And that is Japanese disease. You run large deficits, sucking the air out of the room, and you raise taxes, taking the money from productive businesses and reducing the ability of consumers to save. Then you go for 20 years with little or no economic or job growth.

This is the path we currently seem to be on. The Japanese experience says that it could last a lot longer than people think before we hit the wall; because if savings rise in the US, and if banks, instead of lending, put that money on deposit with the Fed, as they are now doing (in order to repair their balance sheets), the US could run large deficits for longer than most observers currently believe.

We will need 15-18 million new jobs in the next five years, just to get back to where we were only a few years ago. Without the creation of whole new industries, that is not going to happen. Nearly 20% of Americans are not paying anywhere close to the amount of taxes they paid a few years ago, and at least ten million are now collecting some kind of unemployment benefits or welfare.

Choosing large deficits does not reduce the amount of pain we will experience, it just seemingly reduces it in the short term and creates the potential for a serious economic upheaval when the bond market finally decides to opt for higher rates. This path is a bad choice, but sadly, in reality it is one we could take.

The Glide Path Option

A glide path is the final path followed by an aircraft as it is landing. We need to establish a glide path to sustainable deficits (could we dream of surpluses?). That is because at some point there will be recognition, either proactively or forced upon us by the bond market, that large deficits are unsustainable in the long term.

If Congress and the president decided to lay out a real (and credible) plan to reduce the deficit over time, say 5-6 years, to where it was less than nominal GDP, the bond market would (I think) behave. Reducing deficits by $150 billion a year through a combination of cuts in growth and spending would get us there in five years.

The problem is that there is real pain associated with this option. Remember that equation above. Absent a growing private sector, if you reduce "G" (government spending) you also reduce GDP in the short run. You have to take some pain today in order to do that. But you avoid worse pain down the road: a bubble of massive federal debt that has to be serviced will be very painful when it blows up, as all bubbles do.

The Glide Path Option means that structural unemployment is going to be higher than we like (which is actually the case with all the options). And the large tax increases that come with this option will by their very nature be a drag on growth (and cause a double-dip recession in 2011). We can debate tax increases all we want, but I sadly think we will soon have a VAT tax. There are no good options. I just hope that we cut corporate taxes enough when we do create a VAT, that it will make our corporations more competitive, which will be a boost for jobs.

That's pretty much it. This is not a problem we can grow ourselves out of in the next few years. We have simply dug ourselves into a huge hole. This is not a normal recession. There is not a "V" ending to this recession. We are going to have deal with the pain. It will be the pain of reduced returns on traditional stock market investments, a lower dollar, low returns on bonds, European-like unemployment, lower corporate profits over the long term, and a very slow-growth environment. But if we choose this path, we will get through it in the fullness of time.

And of course, then we will eventually have to deal with the $70 trillion in our off-balance-sheet liabilities in Medicare and Social Security and pensions. Sigh. But that's for another time.

Philadelphia, Orlando, and Phoenix

I really am more optimistic than this letter makes me seem. But if you ignore reality, then you have no chance to figure out how to make the best of your situation. It is the efforts of hundreds of millions of individuals trying to make their own lot a little better than will get us back to a robust economy.

Monday I fly to Philadelphia and then the next day to Orlando for two speeches, and then the following week a quick trip to Phoenix, then home to start to plan for Thanksgiving. I will be in New York the first weekend of December (the 4^th) for Festivus, a great fundraiser for kids sponsored by Todd Harrison and the team at Minyanville (http://www.rpfoundation.org/), Interestingly, they hold it every year at a "Texas" barbecue joint. Look me up if you are there.

Tiffani has been out the last two days of this week. She is due in seven weeks or less, and her hips are expanding. The pain is too much right now for her to walk up the stairs to the office, so she is working from home. The doctor says this is the one time that her pain is not a sign of something bad. She is being a trooper and not taking any pain meds.

It has been 30 years since I was around a pregnant lady for more than a few hours, and it does bring back some memories. Watching her grow and change has brought back the sense of awe over how our bodies are designed.

Ryan and Tiffani have decided on the name Lively for my first granddaughter, to add to the two new grandsons this year. From zero to three grandkids in just six months! Kind of makes me dizzy.

I really enjoyed my time in South America. Rio is quite beautiful and I want to go back and spend some time.

Have a great week. There will be enough good friends and family that I know I will. And tomorrow night I finally get to go to a Dallas Mavericks game. We may have a real team this year.

Your always optimistic at the beginning of the season analyst,

John Mauldin

Dollar drifts lower....

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In This Issue.

* Dollar drifts lower...
* Looking for silver linings...
* NOK to increase rates...
* Aussie dollar continues to move up...

Dollar drifts lower....

Good day... And good morning to everyone. I wanted to start out this morning's Pfennig by saying my thoughts and prayers go out to all of the families of the fallen soldiers and civilian at the tragedy down at Ft. Hood. It is tough enough when we here about losses of our soldiers overseas in the 'combat zones'; but such a large loss of life right here in the US is deeply saddening.

The dollar moved lower throughout the trading day on Thursday as investors felt more confident with the global recovery and the US stock market climbed back above 10,000. Yesterday's weekly jobs numbers were slightly better than expected, and set the market up for this mornings monthly jobs report which will probably show fewer job losses in October compared to September. But there will still be job losses, not gains; and the 'official' unemployment number will inch closer to double digits. We all know if you count those individuals who are underemployed (part time workers who would like full time jobs) and those that have given up on their job search, the actual unemployment number is more like 16%.

Another number which was encouraging for economists was the large jump in non-farm productivity. US worker productivity spiked up an annualized 9.5% in October as employers found ways to squeeze more work out of existing employees instead of hiring new ones. This jump demonstrates one of the positive aspects of a severe economic slowdown. Contrary to what some reader's of the Pfennig seem to believe, neither Chuck nor I are happy that the US continues to be mired in this economic recession. But business cycles are inevitable, and the more we 'spend to extend' the longer it will take for the recovery to take hold. The jump in productivity is one positive which comes out of an economic downturn. In the good times, companies become fat and happy, with many companies becoming very in-efficient. The severe slowdown causes companies to rethink all of the processes, and worker productivity increases. This need for higher efficiency also encourages innovations to the manufacturing and service sectors.

Another piece of data due out this morning will illustrate another positive aspect of the economic slowdown. US Consumer credit is expected to show another $10 billion drop. The highly leveraged US consumer is continuing to draw in their purse strings, ignoring calls from the administration to resume their old borrow and spend attitudes. While some of this belt tightening has been forced on consumers by the credit crunch, hopefully we will see this adjustment continue. This isn't good news for retailers as we approach the holiday season, but if the global imbalances are to be corrected, US consumers are going to have to continue to increase their savings rate and decrease debt.

So there are a few silver linings to the economic cloud hanging over the US. The United States will eventually emerge from this economic storm with a leaner and meaner manufacturing sector and a much weaker dollar enabling it better compete in the global arena.

Both the ECB and BOE kept rates unchanged, just as Chuck had predicted. Officials at the Bank of England slowed the pace of bond purchases, but still approved the additional purchase of 200 billion pounds. A rebound in factory output, which rose 1.7% (the largest gain in 7 years) combined with a .2% increase in UK producer prices caused the change of direction by the BOE.

ECB President Jean-Claude Trichet signaled the beginning of the end of emergency stimulus measures in Europe. Trichet said next month's offer of 12 month loans would be the last. Data released yesterday was unable to paint a clear picture of the economic recovery in the Euro-area. German factory orders rose for a seventh month in September, as exports helped the recovery. But another report showed European retail sales fell for a 16th month, declining more than economists had predicted.

The Euro rallied a bit after the ECB decision, but Citigroup is predicting an even larger rally. A report by Citigroup stated that the technical trading patterns predict the Euro will climb to $1.5064 short term, and move up to $1.5285 over time. It continues to look like Europe will recover, and the euro will move higher vs. the US$.

The Norwegian krone also moved higher as Norway's central bank Deputy Governor Jan Qvigstad said it is 'most probable' the deposit rate will be moved another quarte point higher by the beginning of 2010. Officials of the Norges Bank are attempting to hold down some of the appreciation of the krone as Norway continues to increase interest rates to combat rising inflation. Norway's oil rich economy was one of the first to emerge from recession, so the central bank is also taking the lead on increasing interest rates. Yield differentials, along with a strong economy should keep the NOK among the world's top performing currencies.

Speaking of the top performers, I was updating the return charts for the currencies yesterday and was amazed at the returns on the Brazilian real and Australian dollars YTD. Brazil is up 31.42%, and the Australian dollar has increased 28.05% during 2009. The Australian dollar continued to strengthen yesterday as the central bank signaled it will continue to increase interest rates in the coming months. "A further gradual lessening of monetary stimulus is likely to be required over time," the Reserve Bank said in Sydney today. A rally in commodity prices, along with increasing interest rates will push the AUD toward parity with the greenback.

Yesterday was Chuck's Friday, as he took today off to spend some time with Alex who was off school. But before heading home, he asked me to include the following in today's Pfennig:

And then there was this... Yesterday, I totally forgot to mention my complete distaste for naming a designated hitter (DH) the MVP of the World Series... He doesn't play the field... And only batted 13 times during the Series... Baseball people like myself, just cringe when the DH is in play... Giving the MVP to a DH goes along with the thought that is prevalent in sports today... To give every kid a trophy... Oh well... Let's move on to other things because it's YOUR Friday!

I am a little late in getting this out, so I am able to tell you the official US Unemployment rate rose into double digits during the month of October, hitting 10.2%. This will probably give some life to the US$, as investors run away from risk and move back into US treasuries for temporary safe haven.

To recap... Silver linings of the current economic storm cloud: increased worker productivity and decreased consumer credit. The ECB and BOE kept rates unchanged. Aussie dollars continue to move closer to $1, and Chuck really doesn't like the DH!

Currencies today 11/5/09: American Style: A$ .9161, kiwi .7247, C$ .9342, euro 1.4881, Sterling 1.6587, Swiss .9848, European Style: rand 7.5482, krone 5.6747, SEK 6.9866, forint 184.70, zloty 2.8567, koruna 17.27, RUB 28.96, yen 90.60, sing 1.3925, HKD 7.75, INR 46.815, China 6.8274, pesos 13.29, BRL 1.719, dollar index 75.71, Oil $79.60, 10-year 3.5%, Silver $17.50, and Gold... $1,093.55

That's it for today... The Blues finally scored a goal at home, but lost to Calgary last night in overtime. The sun is shining again today, and apparently we are supposed to have a rain-free weekend!! The big EverBank sign went up on the new office building next door, we will be moving into our new digs in less than a month. Hope everyone has a Fantastic Friday and a Wonderful Weekend!!

Chris Gaffney, CFA
Vice President
EverBank World Markets
1-800-926-4922
1-314-647-3837

Having the Last Word

Bob Carlson — Thu, 05 Nov 2009 21:49:00 GMT

Most estate plans are missing a key ingredient. Many estate planners don’t recommend it, and it isn't even mentioned in many estate planning discussions. One reason might be that, despite its importance, the document is not legally binding on anyone.

This document can clear up a lot of issues. It can save time and money in processing the estate, answer many questions of loved ones, and prevent the heirs from going to court. The document also can make clear one's final wishes in many areas that are not covered in wills and trusts.

The document often is called a letter of final instructions. That is a bit of a misnomer, because properly done it is more than a letter. It should be several documents contained in a three-ring notebook or other device that makes it easy to update the papers yet keep them together.

The letter of instructions is your last word on a number of issues. It also is a practical guide to handling your estate and managing the property. It can provide advice and guidance. Preparing a letter of instructions also is an excellent way to help do your planning and uncover forgotten information. Let's take a look at the details.

Contacts. Your executor will need to contact your estate planning attorney, accountant or tax preparer, life insurance agent, and any other financial professional who helped you. There also might be investment managers and employers or former employers who are paying benefits. Also include personal contacts: friends, relatives, organizational leaders. Include the name, address, telephone number, and e-mail address of each.

Where to look. Unfortunately, in many cases much of an executor's time is spent looking — for documents, account statements, contact information, personal items, or long-forgotten assets. May you know where everything is (though you probably don't). Make things easy and inexpensive for your executor by leaving behind an inventory of assets that includes where the assets and any documents related to them can be found. If you keep valuables in a safe deposit box or safe, be sure to note this and how the executor can gain entry. Let the executor know where you keep receipts, canceled checks, and any other supporting documents.

How it is divided. Your will, beneficiary designations, trusts and other documents legally determine who gets what. But you can make a plain English explanation of the division in your letter. You might explain why things are divided as they are — especially if you think someone might be surprised, disappointed, or have questions.

If you own a business, be sure to get periodic valuations and asset inventories. The business might own assets your heirs might not be aware of. You should provide separate detailed information about the business, its assets, its operations, and suggested actions to take with it.

You probably have several credit cards and belong to one or more associations, societies, or other groups that offer membership benefits. The benefits might include some kind of life insurance, disability insurance, or medical insurance. Take the time to review your benefits and list them somewhere. Provide full information, such as the brochure received from the provider. Your executor can make claims and boost your estate.

All of these lists can be included as separate statements that are attached to the letter or included in a separate divider in the binder. Also include in the binder copies of recent tax returns for you and your business along with your will and any other estate planning documents. Of course, a copy of your will and any trusts should be included. Recent copies of statements from any financial accounts and employee benefits also should be attached.

In most states, your instructions on funeral arrangements and some other matters are not legally binding even if included in the will. You also don't want to update the will each time a new idea occurs to you. These items can be included in the letter of instructions or notebook. Here are topics to consider:

* Burial, organ donation, and similar preferences. Naturally, if arrangements have been made in advance, these should be explained.

* A suggested obituary or items to include in an obituary.

* Preferences for the funeral, memorial service or other ceremony. You can be as detailed or general as you would like.

* The disposition of special collections or assets, pets, and memorabilia.

* Care for dependents who are incapacitated or for minor children or grandchildren.

Every estate planner with any experience has stories about searches for assets or disputes over seemingly minor matters. You can avoid being part of one of these stories by leaving a letter of instructions.

A letter of instructions has the benefit of being easy to update. You don't need to incur lawyer's fees or have a signature witnessed. Sit down once a year, review it, and determine what needs to be updated. After the revisions, make some copies. Your lawyer and executor each should have a copy, and there should be one in your desk drawer or other place you keep documents.

Preparing a letter of final instructions can provide benefits now. The letter ensures that your financial affairs and documents are organized. It probably will cause you to throw away unneeded items and carefully consider some items that have been put off or neglected. The process will cause you to do things that should have been done some time ago. Make it easy by not trying to do the entire project at once. Break it into manageable pieces and give each the attention it deserves.

When You Don’t Prepare

Without a letter of instructions and good organization, the heirs are forced to engage in the old-fashioned property and document search. Sometimes it is comical. Sometimes things get ugly. Always a lot of time and effort is wasted.

Estate planners tell stories of important documents that never are found and of other documents that are found in the most unlikely places. Cash, jewelry, and other property are found hidden in the backs of closets, in attics, or under floorboards. Sometimes evidence of real estate or stocks is found stuffed where they are discovered only by accident.

When heirs remember seeing property, such as jewelry, or hearing the loved one talk about real estate, suspicions are aroused when the property or documents are not found during the estate settlement process. The results can include accusations, lawsuits, and broken relationships.

Don’t leave your heirs in this position. Prepare a proper letter of instructions and supporting documents. In the process, you probably will re-learn things about the estate you forgot and also realize that some important papers need to be replaced.

Bob Carlson is editor of the monthly newsletter Retirement Watch and the web site www.RetirementWatch.com. He also is author of the books The New Rules of Retirement and Invest Like a Fox…Not Like a Hedgehog.

Rates To Remain Near Zero...

Chuck Butler — Thu, 05 Nov 2009 15:19:00 GMT

..But First, A Word From Our Sponsor..
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* 4 BRIC currencies: Brazilian real, Russian ruble, Indian rupee, Chinese renminbi
* High upside potential
* No market risk to deposited principal
* Low $1,500 minimum deposit

Don't miss this unique opportunity. Deadline to buy the BRIC MarketSafe CD is Dec. 3rd, 2009. Apply today or learn more at http://www.everbank.com/001CertificatesMSBRIC.aspx?referId=11808
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In This Issue..

* Dollar reverses sell-off...
* BOE & ECB meet today...
* New Zealand is not Australia...
* Funny accounting...

And Now... Today's Pfennig!

Rates To Remain Near Zero...

Good day... And a Tub Thumpin' Thursday to you! It's Tub Thumpin' because it's a Thursday and it's not raining! Yay for us! Well... Not only was I wrong, but the Bloomberg Economic Calendar was wrong too... The FOMC was not a 2-day meeting after all! Just one day, so no time to pull out the board games and cards...

I nailed that FOMC statement yesterday... WOW! You might begin to think that I have some inside info on the Fed Heads, the way I've been able to basically call every move they've made since the beginning of this whole meltdown in August of 2007! But that's not important here... The important thing is that the Fed said that "economic growth is not enough to hike rates, and therefore they will keep interest rates at near zero for an "extended period"...

Hmmm... Where have I heard that before? Any way, I thought that by continuing to use the words "extended period" that the dollar would get pummeled... And momentarily, it looked as though it might, as the offset currency to the dollar, the Big Dog, euro, raced to trade above 1.49... But a funny thing happened on the way to the forum, and the invisible hand reached down and reversed this move in a NY Minute! The work of the PPT? Probably... The Plunge Protection Team, probably stepped in to keep the dollar from a free-fall... That's my take on it any way!

Any way... With interest rates remaining at near zero levels here in the U.S. I thought it to be appropriate to pull out this new nickname for Big Ben... "Zimbabwe Ben"... (Thank's Ty!)

The rate hike decision ball gets thrown over to the "pond" to the Bank of England (BOE) and the European Central Bank (ECB) this morning for their versions of: Leave rates at present levels, but try to sound upbeat... I think you'll have the "tale of two Central Banks" here this morning. While both will keep rates unchanged, I think you'll see the BOE opt for more bond purchases in an attempt to shore up Britain's banking system... The ECB will NOT be making any such announcement.

In fact, I believe we'll hear ECB President, Trichet, announce that the ECB is moving closer to withdrawing stimulus from the economy! So, those of you who have the ability to go long euros VS sterling, this would seem to me to be the "trade o' the day"... What do I know, I'm not a short term "cross trader"!

So... With the FOMC finished... And the two European Central Banks on the docket today, somehow the Risk Aversion has crept back into the markets...

I received an email from a reader the other day, asking me why I prefer Australia to New Zealand, as the kiwi had outperformed its kissin cousin across the Tasman from 2002 to 2008.... Well... New Zealand enjoyed a wider yield differential than Australia during that time period, as it posted the highest interest rates in the industrialized world... Now that's saying something right there, and a good reason kiwi outperformed the A$...

But times have changed... And a very timely talk by Reserve Bank of New Zealand Gov. Bollard yesterday, helps explain why A$'s now over kiwi... Here's Gov. Bollard...

"Both countries have survived the crisis well, due to a mix of strong institutions and stimulative policies. However, their immediate prospects are different. Australia has avoided negative growth, and its prospects are driven by strong terms of trade, vast mineral deposits, the Chinese market, and rapid population growth.

New Zealand has had a recession, and the pick-up is slower and more vulnerable - a difference financial markets do not appear to appreciate.

Australia is a lucky country, but we could be a lucky neighbor.

Australia is entering a new minerals boom, investing heavily and encouraged by new finds, re-opening markets, bottlenecks and strong prices. Strong investment and export growth would mean big challenges for Australian policy. This all means an economy that looks less like New Zealand.

However, Australia's potential raised the prospects for New Zealand's manufacturers and services, which have a bigger share of exports than the same sectors in Australia."

OK... Back to me... So... Australia is a "lucky country" but New Zealand could be the "lucky neighbor"... Makes sense to me!

The Brazilian real rally took a walk on the wild side yesterday, gaining 2.5% VS the dollar in one day! But, that's relatively tame for some of the wild moves we've seen in recent times with the real... As long as you are not watching the currency like a hawk, and sweating out each pip move, this is no biggie... Keep your eyes on the horizon...

I find it somewhat humorous that the Brazilian Gov't officials have tried and tried to throw down road blocks for the real, and the investors just keep coming in droves... The 2% tax on Capital inflows did nothing to slow down the real's move VS the dollar, except for the day it was announced... After that, it was Wayne and Garth playing street hockey once more... "Game On!"

OK... I had a few callers and emails yesterday telling me that I was wrong about the Gold sales to the Reserve Bank of India (RBI), saying that it was done in SDR's... I think the confusion exits in the fact that the Gold sale kept getting reported as $6.7 Billion worth of Gold... But to put these questions to rest... Here is a report from the Economic Times of India (leading financial newspaper)
http://economictimes.indiatimes.com/markets/bullion/RBI-buys-200-mt-gold-from-IMF-to-pump-up-reserves-value/articleshow/5194492.cms
The purchase was in SDR 4.8 Billion worth.

Today in the U.S. we'll see the Weekly Initial Jobless Claims data, which will remain above 500,000 per week... And the ICSC Chain Store sales figures, which if consumer spending has gone back to pre Cash for Clunkers levels, would mean these figures would be soft... But I don't think this data gets much playing time with traders, so we'll just carry on...

And then there was this... OK... So... Some people chastised me yesterday for saying that the Gov't can't prove the 650,000 jobs they claim they "saved"... Well... Here's a ditty for you! Did you know that the Gov't is claiming that by giving a person that already has a job, a raise, it constitutes as "saving" that job? Want more funny accounting? Stay tuned, same bat time, same bat channel!

To recap... The FOMC left rates unchanged and said they would remain there for an "extended period of time" this sent the dollar to the woodshed, but reversed on a dime... PPT at work? The BOE and ECB meet this morning to discuss monetary policy. Expect the BOE to announce more bond purchases, and expect the ECB to announce a move to withdraw stimulus.. We learned that New Zealand is not Australia, but lucky to be Australia's neighbor! And try as they might to keep the real from gaining VS the dollar, the Brazilian Gov't's moves have not worked...

Currencies today 11/5/09: American Style: A$ .9085, kiwi .7190, C$ .94, euro 1.4850, Sterling 1.6530, Swiss .9825, European Style: rand 7.6360, krone 5.6975, SEK 7.0540, forint 186.37, zloty 2.8745, koruna 17.55, RUB 29.15, yen 90.32, sing 1.3955, HKD 7.75, INR 47.02, China 6.8276, pesos 13.28, BRL 1.7255, dollar index 75.81, Oil $79.91, 10-year 3.62%, Silver $17.40, and Gold... $1,088.80

That's it for today... Writing from home again, as I have yet, another appointment with a doctor this morning. When you have a blood clot, they monitor the thinness of your blood, and it has to be checked every 3 days... So, I have that going for me! I'm taking tomorrow off, so Chris will have the conn on the Pfennig tomorrow... So, as our little Christine would say... This is my Friday! YAY FOR ME! So with that on my mind... Good luck to my beloved Missouri Tigers as they take on Baylor this weekend, and my little Buddy Alex has his last game on Saturday. Congratulations to the Yankees on their World Series Championship... So... I'm off to see the Wizard... Talk to you again next Monday, and try to have a Tub Thumpin Thursday!

Chuck Butler
President
EverBank World Markets
1-800-926-4922
1-314-647-3837

Another New Record Level For Gold!

Chuck Butler — Wed, 04 Nov 2009 15:19:53 GMT

..But First, A Word From Our Sponsor..
Gain exposure to currencies of emerging BRIC countries-and don't lose a dime on market risk

* 4 BRIC currencies: Brazilian real, Russian ruble, Indian rupee, Chinese renminbi
* High upside potential
* No market risk to deposited principal
* Low $1,500 minimum deposit

Don't miss this unique opportunity. Deadline to buy the BRIC MarketSafe CD is Dec. 3rd, 2009. Apply today or learn more at http://www.everbank.com/001CertificatesMSBRIC.aspx?referId=11808
.

In This Issue..

* Risk players come back out to play...
* Waiting on the Fed's statement...
* Yield differentials come into focus...
* Lisbon Treaty gets signed / ratified...

And Now... Today's Pfennig!

Another New Record Level For Gold!

Good day... And a Wonderful Wednesday to you! Well... Did you see the strong performance that Gold put in yesterday? And it didn't stop yesterday, overnight Gold is up another $7 on top of the +$20 gain it had yesterday... I've got some info on that, we can talk about later...

Oh Shoot Rudy! Let's talk about it right here, right now! It's not every day that Gold not only goes past its previous all-time record high, but obliterates the previous figure! I know you're wanting to take a peek at the price of Gold in the currency round-up portion of the Big Finish, so go ahead, and then come on back... How'd that $1,090 and change price look to you? Pretty sweet, eh? That is as long as you are a Gold holder!

So... What put the tiger in Gold's tank yesterday and overnight? Well, the weaker dollar helped... The thought became clearer that the cartel, I mean the Fed will keep rates on hold this week helped... But the real beef came from the announcement that the Reserve Bank of India was buying the 200 tons of Gold from the IMF... I know, I know, I told you yesterday that I thought it would be a "wash" for the dollar and the Gold price... But that was before I learned that the Reserve Bank of India paid for their $6.7 Billion dollars worth of Gold with... SDR's!

So... Either, the Reserve Bank of India (RBI) didn't want to get rid of their dollar reserves... (yeah, right!) or... The IMF didn't want anything to do with dollars, and preferred receiving SDR's! (for those of new to class, a SDR is a basket of currencies to make one unit called a Special Drawing Right, of which the IMF uses, and has been rumored to be the replacement for the dollar as the reserve currency of the world... The one government, one currency thing)

I'll pin my colors to the mast of the IMF not wanting anything to do with dollars at this point! Been there, done that, bought the T-shirt!

So... The price of Gold is nearing $1,100... I reminded my beautiful bride last night that just 2 months ago I told a group of close friends that they should seriously be considering buying Gold as it had slipped to $940 an ounce... I wonder what they think when they see Gold at nearly $1,100... I'm sure the V-8 head slap is going on all over my neighborhood!

OK... So what's going on with the currencies, as the dollar has had the hammer for 3 consecutive days now... Well... The dollar is back on the slippery slope this morning, as those same thoughts about the cartel, I mean (crying out loud Chuck, why can't you get that thought about the Fed really being a cartel out of your mind!) the Fed, will keep rates unchanged this week, really emphasizing the fact that Australia has raised rates 50 BPS so far, and Norway has raised them 25 BPS... There are places to go where you can get higher yields...

I get a kick out of some people that call the desk here, and say... "I'm looking for a high yield of around 8-10%, with no risk... Do you have that?" Sure, right here in my back pocket! NOT!

The FOMC meeting will be a 2-day meeting, so get the board games out, find the deck of cards, and make sure you have good batteries for the Battleship Game! When the Fed Heads get tired of the board games, and all, they'll announce tomorrow afternoon that they are going to leave rates unchanged, and that while they see improvement in the economy, sans the 3.5% 3rd QTR GDP, it's too soon to remove the accommodating rates... How do I know that? I don't... But, I'll bet a Krispy Kreme to a dollar that what they say is pretty darn close to that!

The key will be to see if the Fed Heads, led by Big Ben Bernanke, leave the words regarding the how long the low rates will remain, "extended period" for if they do... The dollar will immediately be sent to the woodshed once more, without passing Go, and without collecting $200! So... The statement following the rate announcement is the key tomorrow...

So... The euro is 1-cent higher this morning, the Aussie dollar is about 1-cent higher, and so on... Those that bought at yesterday's blue light special prices will be smiling like a Cheshire Cat this morning!

OK... I have to talk about this... For I've received a ton of emails about it...

Quite a few readers have sent me Nouriel Roubini's interview knowing that Mr. Roubini has long been a fave of mine.
Well... Mr. Roubini talked about the "mother of all Carry Trades" being the dollar, of which I told you had become the new funding currency for the Carry Trade a few months ago...

Mr. Roubini also talked about how this was fueling a huge run-up in the prices of risk assets... I've also told you about that, and how... Should the U.S. do the double dip that a huge sell off of stocks would probably occur, and cause an adverse affect on the risk assets of currencies and commodities....

So... All in all... Nothing new... So I was surprised that readers wanted me to comment on this... Well, the caveat here is that Mr. Roubini is calling for a massive sell off of the risk assets when the correction comes... He doesn't specify when this will happen...

I've also said that the risk assets have gone too far too fast, and that a correction is due... So, let's move on from there...

I see where Marc Faber is saying that the correction will net the dollar 10% VS the euro... Again, he doesn't say when this will happen, but that it will...

But again, as diversification people, with our eyes fixed on the horizon that shows that the only way the U.S. Gov't can repay their debts is with cheaper dollars... We just batten down the hatches for this correction, for we know that on the other side of the correction is another massive move upward...

There was something else that I wanted to talk about... And it's something that I'm sure I'll get a few emails about... Good and bad... But here goes... Did you see that Ford announced a nice profit for the last quarter... CAPITALISM ISN'T DEAD! Three cheers for Capitalism! Maybe that's all I'll say about it, for if I went into how I feel that Capitalism is getting beaten like a rented mule, I might start talking about stuff that doesn't need to be discussed here!

So way to go Ford! Didn't take bailout money... And 1 year later books a profit! Whereas GMAC is in need of additional bailout money, and Chrysler is Fiat now... Great use of taxpayer money wasn't it?

Here I go again... Sorry, didn't mean to go on this tangent about this stuff... It's just that I have no idea why this doesn't just tick off any American that reads about this stuff! But not to worry, the Gov't has more plans to spend money they don't have!

Hey! Earlier I talked about Australia's rate increases... Well, the Reserve Bank of Australia (RBA) is running scared these days... Scared that their rhetoric about rate increases is going to push the A$ to parity with the green/peachback... So guess what the RBA members have decided to do? You've got it! They're going to "tone down" their interest rate hike rhetoric... RBA Gov. Stevens said that the 28% gain in the A$ this year VS the U.S. dollar would be a good inflation fighter, and allow him to slow down the rate increases...

Well... Don't get off the A$ love train just because the RBA Gov. Stevens suggests that he could slow down rate increases... The A$ already enjoys more than 300 BPS of yield differential to the U.S. dollar, Japanese yen, Canadian dollar, and Swiss franc!

And the Lisbon Treaty that was hung up in the Czech Republic, has finally been signed by the Czech Republic's President, thus completing the rounds, and putting the Treaty in place. Now, I'm not a big fan of the Treaty, but... It's what the Eurozone needed to remain viable, and so it it's done... This removes the albatross from around the euro's neck, and will shut those people up that keep talking about a collapse of the European Union, and the euro...

Chris Wood is filling in for good friend David Galland this week on David's daily letter called "Casey's Daily Dispatch"... Anyway, Chris Wood had this to say yesterday, which I believe just about sums it all up regarding the Fed and Treasury here in the U.S....

"A group of federal agencies including the FDIC, Federal Reserve, and Office of Thrift Supervision just released new guidelines for how banks deal with troubled commercial real estate loans. And get this:

Under the guidelines, loans to creditworthy borrowers that have been restructured and are current won't be classified as high risk by regulators solely because the collateral backing them has declined to an amount less than the loan balance.

Yes, you read that correctly. Banks won't have to show losses "solely" because the collateral has fallen in value below the loan. Perhaps most incredible is that this move is being applauded by the business community. The next step will be a federal move to facilitate refinancing that same collateral."

Chuck here again... That's pretty amazing, don't you think? First the financial institutions were allowed to drop the "mark-to-market" on their collateral... And now this... And people still question why foreigners are growing very weary of these things, and becoming quite scared regarding their dollar backed holdings? They shouldn't question any longer, eh?

And then there was this...

Remember how excited I was that Ron Paul's bill to audit the Fed was going to discussion? I thought, surely (hey! Who's Shirley?) this would be it... The Fed would finally get audited, and treated like the Corporation they are! But, then Ty Keough sent me this, and my hopes were dashed...

Representative Ron Paul, the Texas Republican who has called for an end to the Federal Reserve, said legislation he introduced to audit monetary policy has been "gutted" while moving toward a possible vote in the Democratic-controlled House.

The bill, with 308 co-sponsors, has been stripped of provisions that would remove Fed exemptions from audits of transactions with foreign central banks, monetary policy deliberations, transactions made under the direction of the Federal Open Market Committee and communications between the Board, the reserve banks and staff, Paul said today.

"There's nothing left, it's been gutted," he said...

OK... To recap... Gold is soaring! Gold has reached a new record all-time high! The dollar has given back some of its gains the past 4 days as traders begin to realize that the Fed is going to keep rates unchanged tomorrow. The Gov't is up to its usual tricks regarding collateral and the bill to audit the Fed.

Currencies today 11/4/09: American Style: A$ .9080, kiwi .7245, C$ .9425, euro 1.4770, sterling 1.6525, Swiss .9770, European Style: rand 7.7365, krone 5.7150, SEK 7.0580, forint 187.60, zloty 2.89, koruna 17.6650, RUB 29.27, yen 90.80, sing 1.3970, HKD 7.75, INR 47.06, China 6.8270, pesos 13.22, BRL 1.7280, dollar index 76.14, Oil $80.02, 10-year 3.48%, Silver $17.43, and Gold... $1,091.70

That's it for today... I hear that my colleague on the Currency Capitalist newsletter that I do for the Sovereign Society, Ashish, is going to fill in for me at the Conference that I'm missing, and give my presentation on the Treasury Bubble... He'll do a great job! We've had 4 consecutive days of sunshine, and you should see the people, they are smiling again! I began making my plans for Spring Training with the family last night... Whenever I do that, I get all geeked up and ready to leave now! But I have 4 months to go! UGH! First we have our move to the new building next door, then Christmas, then New Year's, Orlando Money Show, and then finally March! Oh, and there's a conversion to a new system thrown in there somewhere! It's a moving target so we don't know for sure, but it will be HUGE! OK... Well, as with every day, it's time to go, so I hope you have a Wonderful Wednesday!

Chuck Butler
President
EverBank World Markets
1-800-926-4922
1-314-647-3837

Measuring management effectiveness by decomposing returns

Dave Mossberg — Wed, 04 Nov 2009 05:53:00 GMT

Measuring management effectiveness by decomposing returns – I am a big fan of the Du Pont Identity Method or Decomposition Method and often use it to evaluate investments. Essentially the Du Pont method breaks down Return on Equity into three parts. 1) Net Margin 2) Asset Turnover, and 3) equity multiplier. The formula looks like this.

(NI/Sales) x (Sales/Assets) x (Assets/ Equity) = ROE

or,

(Net Income) x (Asset Turnover) x (Equity Multiplier) = ROE

If you cancel out sales and assets in the formula, you get back to the simple calculation, which is

NI/Equity = ROE

The way I think about this formula is that management has three levers that it can pull to deliver returns.

Lever 1: Net Income - Net Income is the common metric that management teams focus on it. Self explanatory.

Lever 2: Asset Turnover - This is an important metric and more management teams should focus on it. Essentially it gives us how much sales a company can produce with a given amount of assets. Even though a company may have a low net margin, if they can turn their assets several times a year/month, then they can drive good returns. Think of a car dealer....A dealer sells cars on thin margin, let's say it's 5%. After he pays for variable, fixed and borrowing costs, a dealer clears 1%. However, if the average car sits on his lot for less than 30 days, he can make 1% 12 times per year, which can be an attractive return.

Lever 3: Equity Multiplier - This is a measure of how much leverage management is using to drive returns. Getting terms from suppliers (accounts payable) is a good thing. Putting on too much bank debt can add more risk.

A few names profiled in the Digest that may offer high ROE are Dell (Nasdaq: DELL), Western Union (NYSE: WU), GameStop (NYSE: GME), and ABB Ltd. (NYSE: ABB).

If you’d like to see more detail on some of the ideas published in Mossberg’s investor Digest, click here to receive a complimentary issue.

Click here to subscribe.

Dalbar Update: Investors Still Lagging The Market

Gary D. Halbert — Tue, 03 Nov 2009 23:04:00 GMT

IN THIS ISSUE:

Third Quarter GDP Surprises on the Upside
Why Investor Returns Can Trail the Market
The 2009 Dalbar QAIB Study Update
Investor Panic Leads to Poor Decisions
A Chink in Passive Investing’s Armor?
Same Study – Different Conclusions

Introduction

Since late 1994, studies have shown that many investors do not realize the same returns as the mutual funds in which they were investing. The first such study I saw back in the 1990s was one that Martin Zweig commissioned Morningstar to produce. This study analyzed cash flows in and out of stock mutual funds to see how the average investor did. I remember being surprised when I learned that over the period from 1989 through 1994, the average growth mutual fund returned 12.5% but the average investor in those funds actually lost 2.2%.

Soon, the Zweig/Morningstar study was joined by others, the most notable of which was the Quantitative Analysis of Investor Behavior (QAIB) Study conducted by Dalbar, Inc. in 1994. Dalbar confirmed that many investors were not participating in long-term mutual fund returns because of frequent switching among funds.

Until these studies were published, no one worried too much about what kind of returns investors were actually realizing. Everyone just assumed that whatever the large mutual fund firms reported as returns were what investors got. These studies, however, showed that many investors were chasing hot returns in order to get better returns. In other words, they’d jump from one hot fund to the other in hopes of increasing their return. But just the opposite occurred.

To say that these studies had a huge impact on my firm is an understatement, since they were the catalyst for the introduction of our AdvisorLink® Program back in 1995. Fortunately, Dalbar has continued to update its original study each year, and the general trend has remained the same – investors overall are not getting the kind of returns they should because of frequent switching among funds.

This week, I’m going to update you on the latest update of the Dalbar QAIB Study. It’s possible that you might see yourself in these statistics. After that, I’m going to discuss the original conclusion reached in the QAIB Study, and why we chose a different track when developing our AdvisorLink® Program.

First, however, I’m going to briefly discuss the 3Q GDP report that came out last week after my weekly E-Letter had been published. To say the least, the number surprised most analysts by coming in on the high side of economists’ forecasts. I think you’ll find both subjects to be very interesting reading, so let’s get started.

Third Quarter GDP Surprises on the Upside

Last Thursday, the Commerce Department reported that 3Q GDP rose 3.5% (annual rate). This was above pre-report estimates which averaged around 3%. The government noted that the rebound in the 3Q was led by increased consumer spending (think "cash for clunkers"), higher exports and a continued increase in federal spending.

Most analysts concluded that the better than expected 3Q GDP report confirms that the US economy came out of the recession in the July-September quarter. However, the Consumer Confidence Index unexpectedly fell sharply in October, partly due to the continued rise in unemployment, which raises questions about economic growth in the 4Q.

Finally, keep in mind that the 3Q GDP report will be revised two more times in the coming weeks, and it will not surprise me if it is revised downward, what with the unemployment rate on track to top 10% by the end of the year. And for most of us, this economy does not feel like it's growing at the rate of 3.5%.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Why Do Investors’ Returns Trail the Market?

Before going into the most recent update of the Dalbar QAIB study, it is probably worthwhile to provide some background on exactly how investor returns and fund returns can differ. I would bet that many readers just assume that investors always earn returns in line with those of the equity and bond mutual funds they hold, but this is definitely not always the case.

In a nutshell, fund returns represent what someone buying and holding a particular mutual fund would have earned over a specific time period. Returns for the “average investor,” on the other hand, factor in behavioral measures that can (and do) affect the actual returns earned by investors in these funds. Dalbar explains it this way:

“…the [QAIB] study utilizes the net of aggregate mutual fund sales, redemptions and exchanges each month as a measure of investor behavior. These behaviors are then used to simulate the ‘average investor.’ Based on this behavior, the analysis calculates ‘average investor return’ …”

In other words, switching among investments has an effect on the eventual return received, both on a long-term and short-term basis. Dalbar and others have found that investors who tend to hop from one hot mutual fund to another not only fail to enhance their performance over industry benchmarks, but have been shown to actually end up earning a far smaller return because of their periodic switching among funds.

Why do investors hop from fund to fund so much? The reasons vary, but my experience has been that some investors panic when losses occur and get out of the market. Others frequently change their investments to chase the hottest returns. Unfortunately, this hot performance mindset is aided by financial publications that routinely list the top five or 10 or 20 best funds for the previous year. Investors often look at their own return during the year compared with the “hot” funds, and decide to switch and get in on some of that high-powered performance.

Unfortunately, the mass migration of investors to funds with the best previous performance often guarantees that those funds will not repeat as a top performer the next year. The end result is that funds with hot performance one year often lag behind other funds in subsequent years. Thus, those investors who flocked into these funds after their best performance often find that they would have been better off had they stayed in their old funds.

So, do investors learn their lesson and look for funds with consistent long-term performance? The answer for many of them is “no,” and they continue hopping to the next hot fund and hoping for a repeat performance that seldom happens. This is what we like to call becoming a “Dalbar statistic.”

The 2009 QAIB Study Update

The 2009 update of the original QAIB Study measures performance over the 20-year period extending from January 1, 1989 through December 31, 2008. Considering that this period includes both the 2000 – 2002 and 2007 – 2008 bear markets, one might conclude that investors who frequently switch among mutual funds on their own might have had better results than those of the actual mutual funds, but you’d be wrong.

Here’s what the most recent update to the Dalbar QAIB Study found:

Over the 20 years ending December 31, 2008, equity mutual fund investors had average annual returns of only +1.87% while the S&P 500 Index averaged +8. 35% over the same time period.
Fixed income fund investors had average annual returns of +0.77% over the same 20-year period, while the benchmark Barclays Aggregate Bond Index averaged +7.43%.
Note that both the equity and fixed income fund investors’ average returns were less than inflation, which clocked in at 2.89% over this 20-year period of time.
Confirming the “lost decade” concept, Dalbar’s study showed that the S&P 500 Index had negative returns over 10, 5, 3 and 1-year time windows. Fixed income investors, however, fared better with the Barclay’s Aggregate Bond Index averaging positive returns ranging from +4.65% to +5.63% over this period of time. However, neither the average equity fund investor nor average bond fund investor beat the benchmark returns over any of the 1 to 10-year time windows.

Thus, the QAIB Study again shows that investors’ own behavior is detrimental to their long-term investment goals. Following are graphic representations of the study’s findings. The first graph shows the performance of the various benchmarks used in the QAIB Study during various time windows:

The next graph shows the performance of the average equity, fixed income and asset allocation mutual fund investor over the same time windows:

To sum it all up, many mutual fund investors have been their own worst enemies over the last 20 years. The only bright spot, if you can call it that, was a statistic showing that the average asset allocation fund investor fared better than both the S&P 500 Index benchmark and average equity fund investors in 2008, losing “only” 30%. In fact, the average asset allocation investor lost less than the average equity fund investor in most time periods. Obviously, this is a function of having both equity and fixed income mutual funds in the typical asset allocation portfolio.

However, something even more interesting is that asset allocation did not enhance performance over the long haul. Note that the average asset allocation investor had an average annual gain of only 1.67% over 20 years, versus 1.87% for the average equity mutual fund investor.

News Flash – Investors Panic in Down Markets!

Another, rather obvious finding in this year’s QAIB Study update was the fact that “When the going gets tough, investors panic.” In all previous updates of the QAIB Study, Dalbar has pointed out that investors’ emotional behavior can significantly affect their returns. However, their advice has been to simply suppress this emotional behavior and stay in the market.

This advice tends to ring hollow in bear markets like we had in 2000 – 2002 and 2007 – 2009. It’s like being on the Titanic and Dalbar saying “please remain calm and proceed in an orderly fashion to the lifeboats.” Some may heed the call, but the average passenger, like the average investor, is likely going to panic.

Thus, Dalbar has finally realized that investors engage in irrational behavior despite scholarly advice to the contrary. To illustrate this behavior, Dalbar has developed a “Guess Right Ratio” that measures how often the average equity fund investor makes an accurate investment decision based on the market environment. In other words, this ratio measures how often the average investor buys low and sells high. Over the 20-year period covered in the study, Dalbar found that “Market declines caused panic and panic led to bad decisions. And bad decisions combined with declining markets resulted in exacerbated losses.”

What I find disappointing in all of this is why it took Dalbar so long to figure out that investors won’t necessarily heed a call to ignore losses and stay invested during bear markets and major corrections. When I read the first QAIB Study back in 1995, my initial reaction was that investors need professional management because they were not likely to have the discipline to remain invested in losing markets, no matter how many times their broker tells them to “stay the course.” After only 15 years, Dalbar finally sees the light.

A Chink in Passive Investing’s Armor?

Perhaps the most surprising revelation in the 2009 QAIB update compared to all previous years is that traditional passive buy-and-hold strategies are not seen as a solution to the problem. Not only did Dalbar decide against endorsing traditional asset allocation as a solution, they actually came to the realization that such strategies don’t work. Here’s how Dalbar put it in this year’s update:

“This year’s report … also demonstrates that simply adopting a one-size-fits-all asset allocation strategy will not suffice in the new investment paradigm.” [Dalbar QAIB, Page 2] “Portfolio performance during the market meltdown of 2008 is clear evidence that the current methods are ineffective, even independent of investor behavior. Current asset allocation and diversifi-cation strategies are based on uncorrelated asset classes that in 2008 became highly correlated, thus rendering all such strategies moot.” [Dalbar QAIB, Page 11, Emphasis added]

For a while, I thought that Dalbar may have been reading my E-Letters. After all, I have been making similar observations about buy-and-hold strategies for a very long time. However, I soon learned that they are not running plays from my playbook when I began reading their new recommendations to help investors keep from being their own worst enemies.

While space does not permit me to go into detail about each of Dalbar’s recommended solutions to inferior investment returns, I’ll discuss each of them briefly below:

1. Dalbar’s first suggestion to help investors get better returns was to consider using Dollar Cost Averaging (DCA) to ease back into the market. I have written about DCA in the past in the E-Letter, and it is essentially a method of investing where you gradually invest your portfolio in increments over time. This means that you buy into the market at different price levels and are somewhat less susceptible to a major market downturn. In fact, investing during these market downturns can result in buying at bargain prices, which should be good for your portfolio in the long run.

Of course, this only works if you have moved your money to the sidelines or are making periodic contributions to a retirement plan. I think that DCA can be a good idea if you are in a 401(k) or other type of plan where you have only mutual fund options and cannot access actively managed investment strategies. Obviously, this technique is not available for anyone who is already fully invested in the market. For those investors, Dalbar had other alternatives as discussed below.

2. The second strategy that Dalbar suggested was to consider a portfolio management technique known as Purpose-Based Asset Management, or PBAM. This strategy has the benefit of being available to both investors on the sidelines and those already fully invested. That’s the good news. The bad news is that this approach is little more than buy-and-hold “lite.”

According to Dalbar, traditional asset allocation strategies often assume only one level of risk tolerance for the entire portfolio. The main premise behind PBAM is that investors actually have multiple risk tolerances depending upon the particular investment goal. Investors may be more comfortable with higher risk on investments held for longer periods, such as for retirement, than they are for investments held for shorter-term goals.

Thus, investors are encouraged to allocate assets into separate strategic “compartments” based on the ultimate goal for that part of the portfolio, and then design an asset allocation strategy based on the appropriate risk level for each compartment. The hope is that money allocated more conservatively will lose less in down markets than the more aggressive compartments, resulting in less panic on the part of the investor.

In reality, this simply means that instead of having one big asset allocation portfolio, they will have multiple small buy-and-hold portfolios that will be subject to the same limitations as any other passive asset allocation strategy. My personal opinion is that PBAM is simply a marketing gimmick that will result in little difference in overall performance or emotional decision making.

3. A final recommendation from the Dalbar report is to explore the use of leverage within portfolio holdings, both at the portfolio and individual holding level. In essence, Dalbar is acknowledging that leverage, especially in the credit markets, played a big part in the subprime meltdown and resulting credit crisis.

Since this leverage can occur in the private sector, government and international markets, Dalbar suggests that investment experts begin requiring issuers of securities to compute and disclose their true leverage. Once disclosed, Dalbar suggests that leverage should be incorporated into computer models that screen investments as well as asset allocation models.

Same Study, Very Different Conclusions

While the conclusion reached by this most recent update of the QAIB Study pretends to offer a new approach to investing, it’s really just a tweak of traditional buy-and-hold. This really isn’t all that different than the findings in prior years when Dalbar recommended investors follow buy-and-hold strategies and suppress the emotional desire to exit mutual fund investments when (not if) they begin to lose money.

I noted above that the Dalbar and Zweig studies were the catalyst for the development of my firm’s AdvisorLink® Program. Yet, AdvisorLink® is anything but a buy-and-hold investment program, so how did we get from Dalbar’s recommendation to an innovative collection of active management strategies?

It happened this way: I reported the findings of these studies in my monthly client newsletter (remember when publications were actually printed on paper?), but pretty much dismissed its applicability to my audience since most were experienced investors in my managed futures funds. Anyone sophisticated enough to invest in futures funds must be able to handle their own mutual fund investments, right?

Wrong! Imagine my surprise when a very large percentage of my futures funds’ investors responded to my newsletter saying that the Dalbar QAIB Study described their own behavior. They resoundingly supported our research into a way to keep from becoming a “Dalbar statistic.”

We then had to develop a strategy to try to get investors to avoid emotional decisions in down markets. While Dalbar suggested just saying “no” to switching among funds, we knew that investor psychology would dictate moving away from equities when the pain became too great. As a result, we took a different track in addressing investor psychology.

First, we reasoned that investors who are doing everything on their own were becoming confused with all of the conflicting information in the marketplace. We called this “information overload,” and this was just the early days of the Internet. Thus, our first principle was that investors should seek out the help of professional money managers rather than trying to do everything themselves. This helps take some of the emotion out of the equation, since a third party is responsible for investment decisions. This first principle was the genesis of our AdvisorLink® name, since we were linking investors to qualified Investment Advisors.

The next principle we adopted was that all of the strategies in our AdvisorLink® Program had to be actively managed. We saw no benefit in strategies that would stay fully invested in the face of a bear market or major correction. It just makes sense to move to cash or hedge long positions when the markets are going against you. This, too, helped to reduce the emotional impulse to sell during bad markets. We even included more aggressive programs that were able to “short” the market with the potential to actually make money during down markets.

A final principle in the establishment of our AdvisorLink® Program was that it needed to be mutual fund based. While we were aware of active money managers using individual stocks and bonds, many had minimum investments in the hundreds of thousands of dollars, and some required over a million. By concentrating on Advisors who used mutual funds, we were able to bring the advantage of professional money management to our clients at reasonable minimum investment levels.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Conclusions

The Dalbar QAIB Study has been a valuable tool in educating both investors and Advisors about the dangers of emotional trading. While QAIB is instructive in showing weaknesses of the average investor’s actions, it falls short on solutions. I predict that you’ll be hearing more about Purpose-Based Asset Management in the future as this marketing gimmick catches on with brokers who want their asset allocation programs to sound like something other than what they are. Just remember that PBAM is nothing more than buy-and-hold lite.

The purpose of my short history lesson about our AdvisorLink® Program is to give you some insight as to why it is structured the way it is and why we feel it’s important to have active management represented in your portfolio. These strategies not only address the issue of investor panic and emotional trading, but also offer additional strategic diversification over buy-and-hold.

If you would like more information about AdvisorLink® or the various strategies offered within that program, you can learn more by going to our website at www.halbertwealth.com. Or, feel free to give one of our Investment Consultants a call at 800-348-3601. I think you’ll be glad you did.

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES:

How the Economic Crisis Changed Us
http://www.parade.com/news/2009/11/01-how-the-economic-crisis-changed-us.html

Election results today could signal political trends
http://www.nytimes.com/2009/11/04/us/politics/04nagourney.html?_r=2&ref=politics

Republicans to announce alternative healthcare reform
http://online.wsj.com/article/SB125711811707721639.html

Beyond the Sound Bite: An Interview with Michael J. Mauboussin

Vinny Catalano, CFA — Tue, 03 Nov 2009 20:51:00 GMT

In my latest interview with the Chief Investment Strategist for Legg Mason Capital Management, we discussed a bottom-up view of the markets, the sustainability of the US economic recovery, and key segments of his new book: "Think Twice: Harnessing the Power of Counterintuition", including concepts such as decision making danger zones.

The length of the interview is 14 minutes 10 seconds.

(Please visit the site to view this media)

Vinny Catalano, CFA, Global Investment Strategist with Blue Marble Research publishes the "Sectors and Styles Strategy Report" newsletter, which contains the market beating Model Growth Portfolio. To learn about subscribing as well as other benefits, click here.

Just Desserts and Markets Being Silly Again

John Mauldin — Tue, 03 Nov 2009 16:17:00 GMT

My long time readers are familiar with Jeremy Grantham of GMO as I quote him a lot. He is one of the more brilliant and talented value managers (and I should mention very successful on behalf of his clients). He writes a quarterly letter which I regard as a must read. I have excerpted parts of his recent letter, where the chief investment strategist really takes the current financial system follies to task. Typical of his great writing and thinking is the quote from this week's Outside the Box selection:

"I can imagine the company representatives on the Titanic II design committee repeatedly pointing out that the Titanic I tragedy was a black swan event: utterly unpredictable and completely, emphatically, not caused by any failures of the ship's construction, of the company's policy, or of the captain's competence. "No one could have seen this coming," would have been their constant refrain. Their response would have been to spend their time pushing for more and improved lifeboats. In itself this is a good idea, and that is the trap: by working to mitigate the pain of the next catastrophe, we allow ourselves to downplay the real causes of the disaster and thereby invite another one. And so it is today with our efforts to redesign the financial system in order to reduce the number and severity of future crises."

You can get the full letter at www.gmo.com (You will have to register).

Your glad to be back home at least for a week,

John Mauldin, Editor
Outside the Box

Just Desserts and Markets Being Silly Again

by Jeremy Grantham

Just Desserts

I can't tell you how surprised, even embarrassed I was to get the Nobel Prize in chemistry. Yes, I had passed the dreaded chemistry A-level for 18-year-olds back in England in 1958. But did they realize it was my third attempt? And, yes, I will take this honor as encouragement to do some serious thinking on the topic. I will also invest the award to help save the planet. Perhaps that was really the Nobel Committee's sneaky motive, since there are regrettably no green awards yet. Still, all in all, it didn't seem deserved. And then it occurred to me. Isn't that the point these days: that rewards do not at all reflect our just desserts? Let's review some of the more obvious examples.

1. For Missing the Unmissable

Bernanke, the most passionate cheerleader of Greenspan's follies, is picked as his replacement, partly, it seems, for his belief that U.S. house prices would never decline and that at their peak in late 2005 they largely just reflected the unusual strength of the U.S. economy. As well as missing on his very own this 3-sigma (100-year) event in housing, he was completely clueless as to the potential disastrous interactions among lower house prices, new opaque financial instruments, heroically increased mortgages, lower lending standards, and internationally networked distribution. For these accumulated benefits to society, he was reappointed! So, yes, after the fashion of his mentor, he was lavish with help as the bubble burst. And how can we so quickly forget the very painful consequences of the previous lavishing after the 2000 bubble? Rewarding Bernanke is like reappointing the Titanic's captain for facilitating an orderly disembarkation of the sinking ship (let's pretend that happened) while ignoring the fact that he had charged recklessly through dark and dangerous waters.

2. The Other Teflon Men

Larry Summers, with a Financial Times bully pulpit, had done little bullying and blown no warning whistles of impending doom back in 2006 and 2007. And, famously, in earlier years as Treasury Secretary he had encouraged (I hope inadvertently) wild and reckless financial behavior by helping to beat back attempts to regulate some of the new and most dangerous instruments. Timothy Geithner, in turn, sat in the very engine room of the USS Disaster and helped steer her onto the rocks. And there are several others (discussed in the 4Q 2008 Letter). You know who you are. All promoted!

3. Misguided, Sometimes Idiotic Mortgage Borrowers

The more misguided or reckless the borrowers, the more determined the efforts to help them out, it appears, although it must be admitted these efforts had limited effect. In comparison, those who showed restraint and either underhoused themselves or rented received not even a hint of help. Quite the reverse: the money the more prudent potential buyers held back from housing received an artificially low rate. In effect, the prudent are subsidizing the very same banks that insisted on dancing off the cliff into Uncle Sam's arms or, rather, the arms of the taxpayers - many of whom rent.

4. Reckless Homebuilders

Having magnificently overbuilt for several years by any normal relationship to the population, we have decided to encourage even more homebuilding by giving new house buyers $8,000 each. This cash comes partly from the pockets of prudent renters once again. This gift is soon, perhaps, to be extended beyond first-time buyers (for whom everyone with a heart has a slight sympathy) to any buyers, which would be blatant vote-buying by Congress. So what else is new?

5. Over-spenders and Under-savers

To celebrate the overwhelming consensus among economists that U.S. individuals have been dangerously overconsuming for the last 15 years, we have decided to encourage consumption and penalize savers by maintaining the aforementioned artificially low rates, which beg everyone and sundry to borrow even more. The total debt to GDP ratio, which under our heroes Greenspan and Bernanke rose from 1.25x GDP to 3.25x (without even counting our Social Security and Medicare commitments), has continued to climb as growing government debt more than offsets falling consumer debt. Where, one wonders, does this end, and with how much grief?

6. Banks Too Big to Fail

Here we have adopted a particularly simple and comprehensible policy: make them bigger! Indeed, force them to be bigger. And whatever you do, don't have any serious Congressional conversation about breaking them up. (Leave that to a few journalists and commentators. Only pinkos read pink newspapers anyway!) This is not the first time that a cliché has triumphed. This one is: "You can't roll back the clock." (See this quarter's Special Topic: Lesson Not Learned: On Redesigning Our Current Financial System.)

7. Over-bonused Financial Types

Just look at Goldman's recent huge "profits," two-thirds of which went for bonuses. It is now estimated that this year's bonus pool will be plus or minus $23 billion, the largest ever. Less than a year ago, these same guys were on the edge of a run on the bank. They were saved only by "government" - the taxpayers' supposed agents - who decided to interfere with the formerly infallible workings of capitalism. Just as remarkably, it is now reported that remuneration for the entire banking industry may be approaching a new peak. "Well, we got rid of some of those pesky competitors, so now we can really make hay," you can almost hear Goldman and the others say. And as for the industry's concern about the widespread public dismay, even disgust, about excessive remuneration (and, I would add, plundering of the shareholders' rightful profits)? Fuhgeddaboudit! In the thin book of "lessons learned," this one, like most of our other examples, will not appear.

8. Overpaid Large Company CEOs

Even outside the financial system, there are many painfully obvious unjust desserts in the form of top management rewards. And most of the excessive rewards come out of the pockets of our clients and other stockholders, which is particularly galling. When I arrived in the States in 1964, the ratio of CEO pay to the average worker was variously reported to be between 20/1 and 40/1. This seemed perfectly respectable and had held for the previous 30 years. By 2006, this ratio had exploded to between 400/1 and 600/1, which can only be described as obscene. The results certainly don't suggest such high rewards: a) 10-year stock market returns are close to zero in real terms; and b) U.S. GDP growth has finally slipped below its 100-year trend of 3.5%. After deducting the effect of the rampant increase in the financial system, the growth in GDP ex-finance has fallen to 3.1% since 1982 and well below 3% since 2000, all measured to the end of 2007 to avoid the recent crisis. The corporate system, to be frank, seemed to run faster and more efficiently back in the 1960s before CEOs and financial types began to gobble up other people's lunches. I suppose I have done my share of gobbling. But, it still ain't right!

9. Holders of the Stocks of Ridiculously Overleveraged and Wounded Corporations

Yes, I admit this is part envy and part hindsight investment regret. But, really, our financial leaders so overstimulated the risk-taking environment that junky, weak, marginal companies and zombie banks produced a record outperformance (the best since 1933) of junk over the great blue chips. (Ouch!) In a world with less moral hazard, which would be a world of just, although painful desserts, scores of these should-be-dead companies would be. As it is, they live to compete against the companies that actually deserve to be survivors. Excessive bailouts are just not healthy for the long-term well-being of the economy.

10. The Well-managed U.S. Auto Industry

While firms in other industries fail and their workers look for new jobs, the auto industry is rewarded by direct subsidized loans, governmental arm-twisting of creditors forced to settle far below their legal rights, and direct subsidies for their products. All of this for their well-deserved ranking as the most short-sighted industry of the last 20 (40?) years, and one of the worst managed.

11. The World's Most Over-vehicled Country

We chew up a dangerously large amount of Middle Eastern oil (and oil desperately squeezed from Canadian tar sands), which is ruinous for our globalpolitical well-being (and ability to avoid war) and also not so good for an overheating world. So the answer must be to subsidize more car purchases, and when the subsidies run out, you can have all the fun again. Good long-term thinking!

12. Stock Options

This, of course, is the crème de la crème of unjust desserts. Recent practices have basically been a legalized way to abscond with the stockholders' equity. So if the stock price crashes, perhaps with considerable help from management, that's all right - just rewrite the options at the new low prices. There has been no serious attempt to match stock option rewards (or total financial rewards for that matter) to the building of long-term franchise value. Instead, the motto is: grab it now and run! You can fill in your own favorite anecdotes here - there are so many of them!

13. Finally, Just in Case You've Forgotten, We Have My Old Nemesis, Greenspan

Alan Greenspan receives the title of Maestro in the U.S. and is knighted by the Queen for thoroughly demolishing the integrity of the U.S. financial system. He overtly ignored the great threat of bubbles in asset classes and, in fact, encouraged them. He Ayn Rand-ishly facilitated the progressive dismantling of governmental restrictions on financial behavior, he deliberately kept real interest rates at zero for years, etc., etc., etc. You have heard it before. Now, remarkably, in his very old age he has become imbued with the spirit of Hyman Minsky: "Unless somebody can find a way to change human nature, we will have more crises." Now he finally gets it. Too late! In his merely old age, he ignored or abhorred Minsky, and consistently behaved as though markets were efficient and the players were honest and sensible at all times. But for all of the egg on his face, the Maestro continues to consult with the rich and famous, considerably to his financial advantage. In the good old days, he would have been set in the village stocks, and not the kind you buy and sell. And I would have been right there, Alan, with very ripe tomatoes.

The Last Hurrah and Markets Being Silly Again

The idea behind my forecast six months ago was that regardless of the fundamentals, there would be a sharp rally.¹ After a very large decline and a period of somewhat blind panic, it is simply the nature of the beast. Exhibit 1 shows my favorite example of a last hurrah after the first leg of the 1929 crash.

After the sharp decline in the fall of 1929, the S&P 500 rallied 46% from its low in November to the rally high of April 12, 1930. It then, of course, fell by over 80%. But on April 12 it was once again overpriced; it was down only 18% from its peak and was back to the level of June 1929. But what a difference there was in the outlook between June 1929 and April 1930! In June, the economic outlook was a candidate for the brightest in history with effectively no unemployment, 5% productivity, and over 16% year-over-year gain in industrial output. By April 1930, unemployment had doubled and industrial production had dropped from +16% to -9% in 5 months, which may be the world record in economic deterioration. Worse, in 1930 there was no extra liquidity flowing around and absolutely no moral hazard. "Liquidate the labor, liquidate the stocks, liquidate the farmers"² was their version. Yet the market rose 46%.

How could it do this in the face of a world going to hell? My theory is that the market always displayed a belief in a type of primitive market efficiency decades before the academics took it up. It is a belief that if the market once sold much higher, it must mean something. And in the case of 1930, hadn't Irving Fisher, arguably the greatest American economist of the century, said that the 1929 highs were completely justified and that it was the decline that was hysterical pessimism? Hadn't E.L. Smith also explained in his Common Stocks as Long Term Investments (1924) - a startling precursor to Jeremy Siegel's dangerous book Stocks for the Long Run (1994) - that stocks would always beat bonds by divine right? And there is always someone of the "Dow 36,000" persuasion higher prices in previous peaks must surely have meant something, and not merely have been unjustified bubbly bursts of enthusiasm and momentum.

Today there has been so much more varied encouragement for a rally than existed in 1930. The higher prices preceding this crash (that were far above both trend and fair value) had lasted for many years; from 1996 through 2001 and from 2003 through mid-2008. This time, we also saw history's greatest stimulus program, desperate bailouts, and clear promises of years of low rates. As mentioned six months ago, in the third year of the Presidential Cycle, a tiny fraction of the current level of moral hazard and easy money has done its typically great job of driving equity markets and speculation higher. In total, therefore, it should be no surprise to historians that this rally has handsomely beaten 46%, and would probably have done so whether the actual economic recovery was deemed a pleasant surprise or not. Looking at previous "last hurrahs," it should also have been expected that any rally this time would be tilted toward risk-taking and, the more stimulus and moral hazard, the bigger the tilt. I must say, though, that I never expected such an extreme tilt to risk-taking: it's practically a cliff! Never mess with the Fed, I guess. Although, looking at the record, these dramatic short-term resuscitations do seem to breed severe problems down the road. So, probably, we will continue to live in exciting times, which is not all bad in our business.

Lesson Not Learned: On Redesigning Our Current Financial System

I can imagine the company representatives on the Titanic II design committee repeatedly pointing out that the Titanic I tragedy was a black swan event: utterly unpredictable and completely, emphatically, not caused by any failures of the ship's construction, of the company's policy, or of the captain's competence. "No one could have seen this coming," would have been their constant refrain. Their response would have been to spend their time pushing for more and improved lifeboats. In itself this is a good idea, and that is the trap: by working to mitigate the pain of the next catastrophe, we allow ourselves to downplay the real causes of the disaster and thereby invite another one. And so it is today with our efforts to redesign the financial system in order to reduce the number and severity of future crises.

After a crisis, if you don't want to waste time on palliatives, you must begin with an open and frank admission of failure. The Titanic, for example, was just too big and therefore too complicated for the affordable technology of its day. Given White Star Line's unwillingness to spend, she was under-designed. The ship also suffered from agency problems: the passengers bore the risk of unnecessary speed and overconfidence in "too big to sink!" while the captain stood to be rewarded for breaking the speed record. No captain is ever rewarded for merely delivering his passengers alive. Greenspan, nearly 100 years later in his short-lived "irrational exuberance" phase, did not enjoy being metaphysically slapped by the Senate Subcommittee for threatening the then speedy progress of the economy. What is needed in this typical type of agency problem is for the agent on those rare occasions when it really matters, whether a ship's captain or a Fed boss, to stop boot licking and say, "No, this is wrong. It is just too risky. I won't go along."

We have a once-in-a-lifetime opportunity to effect genuine change given that the general public is disgusted with the financial system and none too pleased with Congress. I have no idea why the current administration, which came in on a promise of change, for heaven's sake, is so determined to protect the status quo of the financial system at the expense of already weary taxpayers who are promised only somewhat better lifeboats.

It is obvious to most that there was a more or less complete failure of our private financial system and its public overseers. The regulatory leaders in particular were all far too captured and cozy in their dealings with reckless and greedy financial enterprises. Congress also failed in its role. For example, it did not rise to the occasion to limit the recklessness of Fannie and Freddie. Nor did it encourage the regulation of new financial instruments. Quite the reverse, as exemplified by the sorry tale of CFTC Chairman Brooksley Born's fight to regulate credit default swaps.

But, at least now, Congress seems to realize the problem: the current financial system is too large and complicated for the ordinary people attempting to control it. Even Barney Frank, were he on his death bed, might admit this; and most members of Congress know that they hardly understand the financial system at all. Many of the banks individually are both too big and so complicated that none of their own bosses clearly understand their own complexity and risk taking. The recent boom and the ensuing crisis are a wonderfully scientific experiment with definitive results that we are all trying to ignore. And, except for bankers, who have Congress in an iron grip, we all want and need a profound change. We all want smaller, simpler banks that are not too big to fail. And we can and should arrange it!

Step 1 should be to ban or spin off that part of the trading of the bank's own money that has become an aggressive hedge fund. Proprietary trading by banks has become by degrees over recent years an egregious conflict of interest with their clients. Most if not all banks that prop trade now gather information from their institutional clients and exploit it. In complete contrast, 30 years ago, Goldman Sachs, for example, would never, ever have traded against its clients. How quaint that scrupulousness now seems. Indeed, from, say, 1935 to 1980, any banker who suggested such behavior would have been fired as both unprincipled and a threat to the partners' money. I, for one, saw Goldman in my early days as a surprisingly ethical firm, at worst "long-term greedy." (This steady loss of the old partnership ethic is typically underplayed in descriptions of Goldman.) Today, Goldman represents a potential hedge fund trade as being attractive precisely because they themselves have already chosen to do it. These days, all - or almost all - large banks do proprietary trading that is pure hedge fund in nature. Indeed the largest bank, Citi (owned by us taxpayers), is gearing up to substantially increase its aggressive prop trading as I write. ("No, no, we're not!")

Some insiders have argued that we should not worry about prop trading because they claim it did not play an important part in the recent crisis. I think this is completely wrong for it misses the very big picture. Prop trading can easily introduce an aggressive hedge-fund type mentality into the very hearts of what ideally should be conservative, prudent - even boring - banks. This hedge fund mentality became a dominant organizing principle, particularly with respect to compensation practices. It encouraged personal aspirations over corporate goals and invited bonus-directed behavior at the clients' expense and ultimately, as we have seen, at the taxpayers' expense to rid itself of this problem. All Congress has to overcome is the lobbying power and campaign contributions of the finance industry itself, which I admit is no small feat. In a bank with a hedge fund heart, you can't reasonably expect ethical or non-greedy behavior, and you haven't seen it.

Of course, commercial and investment banks need to invest their own capital. They probably should have the right to do genuine hedging against investments that flow naturally from their banking business. As for the rest, they could easily be required either to limit the leverage used on prop desk trading or to be restricted to investing in government paper and, at the very least, play by the same rules as other hedge funds. What they certainly should insurance, as is now the case.

In the early 1930s, following the famous Pecora hearings, the conflict of interest between the management of other people's money as fiduciary and the business of dealing and underwriting in securities was considered so inimical to the public interest that Congress almost compelled separation of proprietary trading and client trading. Close, but no cigar. Instead, Glass-Steagall made the probably less useful step of separating commercial and investment banking. Unfortunately, they left intact the obvious conflict between the banks' managing their own money and simultaneously that of their clients. We now have a unique opportunity to revisit this matter.

(As we ponder the problem of prop trading, let us consider Goldman's stunning $3 billion second quarter profit. It appeared to be almost all hedge fund trading. Be aware also that this $3 billion is net of about $6 billion reserved for future bonuses. Goldman's CEO had, in fact, the interesting job of deciding how much of this $9 billion profit would be arbitrarily awarded to shareholders. [In this case, one-third. Could be worse!] This means that they extracted every penny of $9 billion from a fragile financial system. "Good for them," you may say, and they indeed are very smart. But surely they should not have been insured against failure by us taxpayers! Remember, they are now also a commercial bank yet very, very little of their $9 billion came from making loans. Three months later their bonus pool for the year is estimated to be a new record at $29 billion. And the whole banking industry is back to a new record for remuneration. How resilient! How remarkable! How basically undesirable for our economy!)

In Step 2, the Justice Department, together with Congressional and other advisors, should be invited to develop a special set of rules for the banking industry that recognizes the moral hazard of "too big to fail." If really too big to fail, banks should be divided by Justice into manageable, smaller pieces that can indeed be allowed to fail. With these two steps and possibly with an intelligent son of Glass-Steagall, the deed would be done! Regulators would have a fighting chance of being able to regulate, unlike their recent woeful past. If an angel appeared, waved his wings and, lo, it was so, almost every single Congressman would sigh with relief.

The separation of commercial banking from investment banking is not as vital as the removal of prop desk complicated enterprises both smaller and simpler, which characteristics I for one believe are probably essential if we are to avoid further disasters. So what is the problem? The argument against all major changes, without at least some of which we will soon surely be back in another crisis, is always the same. "Oh, you can't roll back the clock." But, even repeated twice before every breakfast, it is not persuasive. Why exactly can't you roll back the clock? We did it once before and, although it was very imperfect and probably missed the central point of conflict of interest, it still produced an improved system that was successful enough for 50 years. In general, countries with simpler and less aggressive banks have had much less pain in the recent crisis while we were pawning the Crown Jewels - sorry, the Federal Jewels - to bail out aggressive bankers who were out of their depth in the new complexities.

Step by step, even as the complexity grew, our regulatory leaders enabled systemic risk to grow. They continued to push the boundaries for banks by allowing more leverage, new instruments, and less control. The details are familiar. All this was done in the name of untrammeled, unfettered capitalism, and almost all of it was a bad idea.

"Oh!" say the bankers, "If we become smaller and simpler and more regulated, the world will end and all serious banking will go to London, Switzerland, Bali Hai, or wherever." Well, good for those other places. If that means they will have knee-buckling, economy cracking, taxpayer-impoverishing meltdowns every 15 years and we will be left looking like a boring back water, that sounds fine to me. Remember, just like our investment management branch of the financial system, banking creates nothing of itself. It merely facilitates the functioning of the real world.

Yes, of course every country needs a basic financial system to function effectively with letters of credit, deposits, and check writing facilities, etc. But as you move beyond that it is worth remembering that every valued job created by financial complexity is paid for by the rest of the real economy, and talent is displaced from real production, as symbolized by all of the nuclear physicists on prop trading desks. Viewed from the perspective of the long-term well-being of the whole economy, the drastic expansion of the U.S. financial system as a percentage of total GDP in the last 20 years has been a drain on the health and cost structure of the balance of the real economy. To illustrate this point, in 1965 the financial sector of the economy took up 3% of the GDP pie. The 1960s were probably the high water mark (or one of them) of America's capitalism. They clearly had adequate financial tools. Innovation could obviously have occurred continuously in all aspects of finance, without necessarily moving its share of the economy materially over 3%. Yet by 2007 the share had risen to 7.5% of GDP!

The financial world was reaching into the GDP pie and taking an unnecessary extra 4%. Every year! This extra rent is enough to lower the savings and investment potential of the rest of the economy. And it shows. As mentioned earlier, the growth rate of the GDP had been 3.5% a year for a hundred years. It had proven to be remarkably robust. Even the Great Depression bounced off it, and soon GDP growth was back on the original trend as if the Depression had never occurred. But after 1965, the growth of the non-financial slice, formerly 3.4%, slowed to 3.2%. After 1982 it dropped to 3.1% and after 2000 fell to well under 3%, all measured to the end of 2007, before the recent troubles. These are big declines. It is as if a runner has a growing and already heavy blood sucker on him that is, not surprisingly, slowing him down. In the short term, I realize that job creation in the financial industry looked like a growth driver, as did the surge in financial profits (which we now realize were ludicrously overstated). But in the long term, like a sugar high, this stimulus was temporary and unhealthy.

The financial system was growing because it could. The more complex and confusing new financial instruments became the more "help" ordinary citizens needed from the experts. The agents' interests were totally unaligned with the principle/clients' interests. This makes a mockery of "rational expectations" and the Efficient Market Hypothesis, which assumes (totally unproven, as usual) equivalent and perfect knowledge on both sides of all transactions. At the extreme, this great advantage in knowledge and information held by the financial agents has the agents receiving all the rewards, according to the recent work³ by my former partner, Paul Woolley, and his colleagues at the Woolley Centre for the Study of Capital Market Dysfunctionality. (With a great name like that their job is half done before they start.)

The second problem, right on the heels of the too-big-and complicated issue, is that of inadequate public oversight. Even with existing institutions, we would have avoided most of the recent pain, borne by taxpayers, if we had had better public leadership. Yes, the public bodies had flaws, but the individuals running the shop had far bigger flaws. Greenspan, with arguably the most important job in the world, simply did not believe in interfering with capitalism at all. His regulatory colleagues such as Bernanke and Geithner fell into line without any challenges. And Congress, strongly influenced by the financial industry, or merely misguided, or often both, facilitated the approach that capitalism in general and banking in particular would do just fine if left entirely alone. It was a very expensive error. Does anyone think we would have run off the cliff with even one change - Volcker at the Fed? I, for one, am confident that we would have done far less badly.

Behind this weakness in the recent cast of characters is a systemic (suddenly the trendiest word in the English language) weakness in our method of job selection. How can Greenspan, with his long-established record of failure as a professional economist, have resurfaced as the Fed boss? With no record of success in any important job, he gets one of the world's two most important jobs! Now we have to decide how much more decision-making power to give to the Fed - an institution with a 25-year proven record of failure. How can we separate the logical neatness of institutional design from our recent proven inability to pick effective, principled leaders with strong backbones?

It is a conundrum: too many regulatory agencies and you have too many opportunities for financial interests to shop around for regulatory bargains and to find and exploit the ambiguous seams between them. Too few agencies and we run the risk of my worst nightmare: waking up and finding Alan Greenspan with twice the authority!

At the least we must recognize the improbability of acquiring great leaders and that our financial system must be simple and robust enough to withstand the worst efforts from time to time of poor or even bad leadership. A simpler, more manageable financial system is much more than a luxury. Without it we shall surely fail again. And it looks as if we are bound and determined to bend once again to the will (and the money) of the financial lobby, which is encouraged by the unexpected conservatism of the current administration's "Teflon" men. They seem terrified to make any substantial changes. And the one person with the character to make tough changes - Paul Volker - is window dressing, exactly as I suggested in January. A sad, wasted opportunity!

Summary

Yes, this was a profound failure of our financial system.
The public leadership was inadequate, especially in dealing with unexpected events that often, like the housing bubble breaking, should have been expected.
Of course, we should make a more determined effort to do a more effective job of leadership selection. But excellence in leadership will often be elusive.
Equally obvious, we could make a hundred improvements to the lifeboats. Most would be modest beneficial improvements, but in the long run they would be almost completely irrelevant and, worse, they might kid us into thinking we were doing something useful!
But all of the above points fail to recognize the main problem: the system has become too big and complicated for even much-improved leaders to handle. Why should we be confident that we will find such improved leaders? For, even in an administration directed to "change," Obama and his advisors fell back on the same cast of characters who allowed, even facilitated, the development of the current crisis. Reappointing Bernanke! What a wasted opportunity to get a "son of Volker" type. (Or should that be "grandson of Volker?")
The size of the financial system continues to grow and shows every sign of being out of control. As it grows, it becomes a bigger drain on the rest of the economy and slows it down.
The only long-term hope of avoiding major recurrent crises is to make our financial system simpler, the units small enough that they can be allowed to fail, and, above all, to remove the intrinsically conflicted and dangerously risk-seeking hedge fund heart from the banking system. The rest is window dressing and wishful thinking.
The concept of rational expectations - the belief in the natural efficiency of capitalism - is wrong, and is the root cause of our problems. Hyman Minsky, on the other hand, was right; he argued that the natural outcome of ordinary people interacting is to make occasional financial crises "well nigh inevitable." Crises are desperately hard to avoid. We must give ourselves a chance by making the job of dealing with them much, much easier.
All in all we are likely to have learned little, or rather to act, through lack of character, as if we have learned nothing. In doing so we are probably condemning ourselves to another serious financial crisis in the not too- distant future.

PS: As quite often happens, since I write painfully slowly (even without extra tick-borne delays), a professional slipped in with a great column that gets to the heart of this matter. Please read John Kay in the Financial Times of July 9. It is short and persuasive. "Our banks are beyond the control of mere mortals" - now, that's what I call a title!

Footnotes:

1 Erratum: Last quarter I cast mild aspersions on Finanz und Wirtschaft by suggesting that I had not precisely said that the S&P would scoot rapidly up to 1100; I remembered it more as between 1000 to 1100. Never mess with a Swiss journalist: this one duly pointed out that his tape of April 1 confirmed his accuracy. Either way, here we are, more or less (at 1098 on October 19).

2 Andrew Mellon, Secretary of the Treasury, 1931.

3 Biais, Bruno; Rochet, Jean-Charles; and Woolley, Paul. Rents, Learning and Risk in the Financial Sector and other Innovative Industries. September, 2009. Working Paper Series 2009, The Paul Woolley Centre for the Study of Capital Market Dysfunctionality.

http://www.lse.ac.uk/collections/paulWoolleyCentre/news/RentsLearningAndRisk.htm

RBA Raises Rates Again!

Chuck Butler — Tue, 03 Nov 2009 15:44:43 GMT

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In This Issue..

* Risk Aversion boosts dollar...
* U.S. manufacturing is strong...
* More stimulus? Please say it ain't so Joe!
* Thoughts from the Big Boss!

And Now... Today's Pfennig!

RBA Raises Rates Again!

Good day... And a Terrific Tuesday to you! Well, I'm here! Just when you thought I would be gone for the week, and you would get away from my rants, and get the calm Chris Gaffney, the rug gets pulled out from you! I am so bummed! I was told that I could not travel to Cabo for the Sovereign Society's Offshore Advantage Conference, and I was to remain at home, with my leg up, blah, blah, blah... What a crock!

OK, now that we've got that out of the way... Front and Center this morning, we have a very strong dollar rally going on... It began yesterday mid-morning, when things turned on one thin dime. First, we had the U.S. Manufacturing Index rise in September and the Trading Theme kicked in with the dollar getting sold on the good news for the economy... But then a strange thing happened on the way to the forum. Everyone began to fear what's been going on in Banking... Friday, the 115th bank failed this year, and suddenly, traders, investors, hedge fund dudes, and everyone else, got a case of the flu... Not the "pandemic" H1N1 flu... This is the "chicken flu"... Chicken to continue to takes risks in the face of a banking problems... Well, to think of it, maybe, just maybe, it's not the "chicken flu" but the "prudent flu"!

So... The dollar's losses were reversed by mid-day, and the non-dollar currencies were taken to the woodshed... Shoot Rudy, even a rate hike by the Reserve Bank of Australia (RBA) couldn't reverse the Risk Aversion trading... I'll get back to the rate hike by the RBA in just a minute... But first I need to talk about this shift to Risk Aversion once again... We saw this briefly last week, and it faded into the wind... I hope this shift to Risk Aversion is soon a small item in our rear view mirrors!

Now... The ISM Manufacturing Index rose to 55.7 from the prior month's 52.6 reading. This marks the strongest reading for the index since the April 2006 reading of 56.0. Let me explain something to you, that I've explained before, but this really illustrates what I'm talking about... And that is... This Manufacturing renaissance here in the U.S. comes as a benefit of the weak dollar that's been in place for over 6 months now. It's that simple folks... You want Manufacturing in the U.S. to be robust? Then you need a discounted clearing mechanism... And that is the dollar...

For, the Asians are learning to trade among themselves without the U.S., and the Eurozone already has 80% of their trade among themselves, with out the U.S. that doesn't bode well for U.S. exports unless... Unless there is a discount... And that discount comes in the price they have to pay / convert their currency for the dollars that are needed to buy the export... So... Why shoot the goose that lays the golden eggs?

OK... As I mentioned above... The RBA raised rates 25 BPS (1/4%) last night, as I expected them to, and had told you they would! The A$ got sold though after rallying briefly... Traders go spooked when the RBA Gov said that "it was prudent to lessen gradually" the stimulus to the economy provided by lower borrowing costs... OK... Folks, that's Central Bank parlance for: The interest rate hikes are going to slow down from here on out... So don't expect a rate hike at every subsequent meeting!

Oh come on A$ Traders! The A$ yield differential to the U.S. is now staggering! As it is to Japan, Europe, and Canada! Only New Zealand and Brazil can play on the same team as Australia when it comes to significant yield differentials! But NOOOOOOOOO OOOO! You get spooked! Have you no intestinal fortitude? HEY! The good news is that it gives late comers a chance to buy at cheaper levels, or... Those that already own, a chance to pick up more at a cheaper level! Courtesy of the Chicken Little A$ traders!

Well... I guess I can't blame them too much, with the Risk Aversion campers taking over the campground... Here's another thing that I saw last night that has the Risk Aversion campers spreading like wildfire... A long time reader of the Pfennig and Bloomberg TV personality, Pimm Fox reported last night that: President Barack Obama's advisers are "seriously" considering proposing a second stimulus measure to boost the economy, Commerce Secretary Gary Locke said in an interview. Locke said another stimulus would be "very targeted and specific and we need to be mindful of the deficit as well."

Hmmm... OK... How many times have I said in the past 8 months that the Gov't was going to see the need for more stimulus? The answer? MANY! I've got a question... If the GDP was "so robust" as the Gov't officials claimed it to be, then why are they discussing more stimulus? BECAUSE THE GDP WAS A FRAUD! We all know that... I explained it all to you yesterday! But the announcement that more stimulus is being "seriously considered" is what we used to call as kids as "cheaters proof"!

What does "very targeted and specific" mean? It means the Gov't is going to get deeper and deeper into the private sector... That's what it means!

I have a question for the Gov't... You told us the $787 Billion stimulus package last February was going to keep unemployment from reaching 10%... Guess what? That didn't work! So, what makes you think whatever taxpayer money you spend now is going to work? Oh, and don't give me that barrel of baloney that you've "saved" 650,000 jobs... Saved Jobs CAN NOT BE PROVED! So why not say you saved 1 Million or 2 Million jobs? I mean, what difference does it make... It's not true, and can't be proved!

Whoa, there big boy... You had better stop before the Pfennig gets sent to the White House to shut me down! Yeah, like it hasn't been sent there before now!

OK... Did you hear about the IMF Gold Sale? The IMF sold 200 tons of Gold... Not to worry though, the Reserve Bank of India stepped to the plate and bought the Gold... Gold revisited $1,060 after this announcement, but in reality it should have been a wash, and the price of Gold has backed off a few dollars overnight... But still pretty well bid, given the Risk Aversion going on in the currencies.

And why not? Gold is a store of value... Of wealth... Whey wouldn't it buck the trend?

Speaking of which... The Big Boss, Frank Trotter, and I were talking last week about Gold, and we kicked around this thought of sharing a lesson of money with kids... And he sent me this...

The weather turned around here in about three weeks. Great fall, then 10 days of deluge, now the chill of late fall. And instead of Thanksgiving displays, the march of catalogues imploring us to turn away from savings and save the world through spending have begun to hit the door. In the past few years as our children have become young adults we have started to turn away from the quest for unneeded presents and zombie-like consumption and have started to implement a contribution concept: research and choose a cause that will appeal to the recipient, ensure that the cause is not acting like your average NGO running around in white land cruisers or and staying at five star hotels in the third world, and make a modest contribution. It isn't working perfectly and we certainly backslide enough but it's underway. We may turn it into a gift of a few shares of a good company but enough of this.

Something else that meets the need of a physical gift, but one with a message has been on my mind lately. It isn't easy to start a conversation with a young person, especially quite young about global economics and the transient value of money. In fact it's hard to start a conversation with almost anyone on the topic. So what's a better way to provide a gift box and a message? Readers of "A Pfennig for your Thoughts" will certainly be ahead of me ( the gift of real money of course ) gold coins.

With the gift of a coin, or a set of coins you can tell so many stories or impart values in a variety of ways. Coins are struck around the world providing a geography lesson and of course an insightful and cogent discussion of central bank attention to their country's money supply (well okay, you might want to skip that one). You can tell the story of gold in the history of the world, and if you are brave and the audience attentive, how gold has held its value over the centuries and will probably do so for centuries to come. Bringing things up to date you can cover the astounding fiscal and monetary policy that has become our new national pastime over the current and past administrations (but be sure to take your blood pressure medicine). Tell 'em "you are worth an ounce a year" (or more).

If you are buying for one or two friends or children or grandchildren head down to the local coin store and grab a couple bullion coins. If you have a good size list or have the capacity to do something substantial then give the team here at EverBank a call. In any event lets all be sure to teach our kids, grand-kids and generally people around us about the monetary value of gold.

WOW! That was great Frank! I love it when the Big Boss puts down his thoughts in writing and shares them with the rest of us!

OK... To recap... The dollar is enjoying a strong rally thanks to the Risk Aversion crowd, that is getting spooked about the banks, after the 115th U.S. Bank this year failed... The Reserve Bank of Australia raised rates again by 25 BPS, and the Reserve Bank of India bought 200 tons of Gold that the IMF felt it needed to sell, so a wash if you will. And then Chuck went on a rant about stimulus...

Currencies today 11/3/09: American style: A$ .8935, kiwi .7115, C$ .9235, euro 1.46540, sterling 1.6285, Swiss .9685, European style: rand 7.9210, krone 5.8325, SEK 7.1625, forint 191, zloty 2.94, koruna 18.03, RUB 29.42, yen 90.10, sing 1.4030, HKD 7.75, INR 47.41, China 6.8279, pesos 13.35, BRL 1.7725, Dollar Index 76.73, Oil $77.19, 10-year 3.38% (see the Risk Aversion with the drop in the 10-year yield fall from 3.62% yesterday!) Silver $16.36, and Gold... $1,057.70

That's it for today... A little long today with the Big Boss's thoughts, but well worth them I must say! For all of you that are heading out to Cabo to the Sovereign Society's Conference, specifically to see me, I apologize for not being there! HA! Yeah, like someone was going just to see me! HAHAHAHAHAHA! Seriously though... I feel real bad that I had to remain at home... UGH! OH well, this way I won't miss my little buddy Alex's last game this Saturday, or son Andrew's girlfriend Rachel's birthday on Sunday! Gotta go... I hope your Tuesday is Terrific!

Chuck Butler
President
EverBank World Markets
1-800-926-4922
1-314-647-3837

Weekly Outlook - 11/02/09

Spencer T. Coles — Mon, 02 Nov 2009 15:49:00 GMT

Home Page | Stock Charts | Video Tour | Contact Us | Nov. 2nd, 2009

MARKET OUTLOOK NEWSLETTER

This past week stocks fell mainly due to poor economic reports and worries that Citigroup could file for bankruptcy. The one bit of positive news during the week was better than expected GDP growth for the third quarter. This created a very strong rally on Thursday but quickly gave way to Fridays Consumer Sentiment and Personal Income reports. These both reminded investors of how weak the sector truly is and that it would very likely hinder growth over the next quarter. Since investors tend to be looking forward to what may come the Consumer Sentiment numbers weighed more heavily on the market than the past quarters GDP results sending us into an end of the week sell-off.

In last week's newsletter we forecasted a downward trend for the coming week. Even though our expectations were surpassed as to how far it would drop, the Precision Charts trade signals kept us in check and generated some great trades after a small whipsaw earlier in the week.

SPY (S&P 500 SPDR) 5 Day Chart

1 Week Change -4.0%

Looking back at a study I shared in the October 18th newsletter about nearing the top of an ascending wedge pattern, I have updated the chart while keeping the resistance and support levels exactly the same to discuss again our longer term outlook. As you can clearly see, we have broken out of the wedge well below the support level indicating a strong possibility of a new developing downtrend, or at least a very strong consolidation period.

Looking forward from here there are a couple of technical analysis points to consider. The first is that once the wedge is broken, you will often see a retest of the support level. If this holds true we could see one more rally up to 108.50 before the downtrend really becomes developed. Second, a lower resistance level of 101.50 is not very far below our current price which could limit the continued downturn in the coming week.

Let's adjust our Resistance level to be 108.50 with a support level at 101.50 for the coming week. While I think that the bulk of next week's action will remain between 101.50 and 106, there is a possibility of that 108.50 retest to keep us on our feet.

Upcoming Economic Events

Monday - ISM Manufacturing Index - 10:00 AM

Tuesday - Motor Vehicle Sales

Consumer Confidence- 10:00 AM

Wednesday - ADP Employment Report - 8:30 AM

FOMC Announcement - 2:15 PM

Thursday - Productivity and Costs - 8:30 AM

Jobless Claims - 8:30 AM

Friday - Employment Situation - 8:30 AM

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Disclaimer: The report contained in this newsletter is issued solely for information purposes and should not to be construed as investment advice, an offer to sell or the solicitation of an offer to buy any security. The opinions and analysis included herein are based from sources believed to be reliable and written in good faith, but no representation or warranty, expressed or implied, is made as to their accuracy or completeness. Precision Investing Group LLC and its Members and employees may be registered investment advisors but are not acting or intending to act in such capacities for Precision Investing Group LLC. We are purely a research organization, seeking to provide unbiased information for educational purposes only.

Consumer Spending Drives GDP?

Chuck Butler — Mon, 02 Nov 2009 15:44:08 GMT

..But First, A Word From Our Sponsor..
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* 4 BRIC currencies: Brazilian real, Russian ruble, Indian rupee, Chinese renminbi
* High upside potential
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Don't miss this unique opportunity. Deadline to buy the BRIC MarketSafe CD is Dec. 3rd, 2009. Apply today or learn more at http://www.everbank.com/001CertificatesMSBRIC.aspx?referId=11808
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In This Issue..

* Dollar rebounds after spending fades...
* Chinese Manufacturing rises...
* Eurozone Manufacturing rises...
* Australia as the proxy for global growth...

And Now... Today's Pfennig!

Consumer Spending Drives GDP?

Good day... And a Marvelous Monday to you! And Welcome to November! My least liked month! But that's a story for another time! I hope your Halloween was fun! The rain stopped here, there was a near full moon shining in the sky, and the little kids had a blast! And Hey! The Rams won a football game! WOW!

OK... Well... Friday was a blur to me, as I went to the doctor's office for a test, and then on my way to work, they called my cell and asked me to turn around and go to a lab for more tests... UGH! So, by the time I got to work, Jennifer had set everything up and begun trading for me... Then it was time to go home! So, I'm sitting here this morning, scratching my bald head trying to recall the currency prices on Friday... And Oh yeah! Now I remember! Do you recall the Thursday action after the GDP report showed such strength (whether you believe it or not) and the dollar got sold like pet rocks?

Well the Gov't had made such a big deal out of the fact that a good portion of the GDP report was consumer spending during the quarter... In fact 1.6% of the 3.5% increase was the Cash for Clunkers program! Well... That was a bad thing to do, for on Friday, Personal Spending and Income printed, and the Spending piece had fallen in September... So much for the euphoria of Consumer Spending bringing the economy out of the recession! Oh, and like I said last week, this plays right into my thoughts from long ago, that we would see some growth near the end of this year, but would slip right back into recession, thus a double-dip... So, the first two parts are in the books...

So... The currencies slid VS the dollar on Friday, and haven't really rebounded overnight from what I can see here at home, as I write the Pfennig at my kitchen table! The Aussie dollar (A$) seems to be champing at the bit to move higher VS the U.S. dollar, but just can't get the Big Dog, euro, to get off the porch this morning!

The reason the A$ is champing at the bit to move higher, is the news from China this past weekend that their Manufacturing data from October showed the fastest gain in 18 months! So, in keeping the Manufacturing Index here in the U.S. in mind, the Chinese Manufacturing Index moved to 55.4 in October, from the 55 in September, and the Chinese say that exports were strong... Ok... We have to apply the "believe 1/2 of what the Chinese tell us about their economy... If that's so, then the Manufacturing Index still is above the expansion line of 50... And that's a good thing for the global economies!

I would think that news like this from China would be a springboard for Commodities, and the Commodity Currencies of Australia, Brazil, Norway, New Zealand, and Canada...

Speaking of strong manufacturing... The Eurozone printed a strong Manufacturing Index report this morning too! Manufacturing in Europe expanded for the first time in 17 months, in October, increasing to 50.7 VS 49.3 in September!

The dollar index is beginning to show some weakness as I write this morning... And one would certainly think that news like this from China and the Eurozone, would push the dollar down... But, there's that stinkin' Trading Theme hanging over us like the Sword of Damocles! And with the news this past weekend that CIT Group was going to have to file bankruptcy, if things hold true, it would be good for the dollar... The flight to safety, and all that!

Hey! Doesn't this news about CIT Group tick you off a bit? It does me... And I'll tell you why! CIT Group had received $2.33 Billion of taxpayer money in an attempt to bail them out last year, but they failed any way! Again! Wouldn't it have been far better to just let them fail when they first showed signs of not being able to compete, and survive? I know that in the whole scheme of things $2.33 Billion doesn't sound like that much... Considering the Trillions that have been spend, allocated or guaranteed! But... $2.33 Billion here, and $2.33 Billion there, and pretty soon you're talking about a nice sized pile of cash, that would not have been wasted!

The Business Section of our local paper had an article this past weekend on what I was referring to last week regarding GMAC and Ally Bank... Here's David Nicklaus saying what I wanted to last week... "That clever Ally Bank ad, the one where a boy is denied a toy truck because of a "limited-time offer," omits a fact that would interest most viewers.

You, the taxpayer, are propping up Ally, the bank that's so good at making fun of other banks. And it looks like Ally's parent, GMAC Financial Services, will ask for more money soon."

So... The Gov't is in competition with private sector banks... And they can pay interest rates that are higher than other banks, because... If they lose money, they can just go back to the well and get more bailout money!

This is all just becoming one Big Mess folks... You've got to see what's going on here! It's called Big Gov't... And when you have Big Gov't, you have Big Deficits! The Gov't does not have any money to spend unless they steal it, I mean take it from taxpayers first! And they're spending what they don't have! Tax receipts are falling, and the Gov't's expenditures are rising! That's a bad formula folks...

And one that makes you so aware of the need to be diversified with a portion of your investments out of the dollar!

OK... I've got to stop there, I have to go to the doctor's office this morning, and I don't need my blood pressure boiling!

Hey! I was reading an article on Friday about Australia in which the Australian Treasurer, Wayne Swan, told reporters that he truly believes that the Australian economy is going to outpace most of the world in 2010... This plays well with my thought that I've held for so long, and have told you dear readers about for some time now, and that is... That Australia is the proxy for global growth... And if the "insiders" in Australia think their economy will outpace most of the world, that's a good sign for the global growth! And one that I think traders should be taking notice of!

I think that Brazil has a long way to go to catch up with Australia but, Brazil has made great leaps in the past 5 years, and has really taken the steps to be in the same conversation when talking about Australia... The country is still an Emerging Market though, and with that, you get wild swings in the currency... Just so you know!

I want to get back to the GDP report in the U.S. from last week... Recall that above, I told you that the Gov't made a Big Deal out of the fact that a large portion of the rise in GDP was consumer spending... But you have to ask yourself this question... "how are consumers propping up GDP with spending in the face of over 16% unemployment? Personal Consumption climbed while Personal Income fell in the quarter, as documented in the Pfennig each time they printed... So, the only way that works is if, you don't think, nah, we've had to have learned our lesson, right? Oh well, I'll throw it out there... The only way that works is if the money is borrowed... Credit cards, etc. OH NO! Tell me we're not going down this road again! Ahhh grasshopper, but Christmas is just around the corner... With 16% unemployment going on, this should be a very "plastic" Christmas shopping season!

Ok... The week ahead is chock-full-o-data and events... Like... The FOMC meeting tomorrow, that carries over to Wednesday... You know what I say about those two-day FOMC meetings! Got any Aces? Go Fish!

We'll see our own version of Manufacturing Index the ISM as it prints this morning... We'll also see Pending Home Sales. Tomorrow is the Auto Sales, and Factory Orders. Wednesday we'll get the Treasury Refunding Announcement, and Thursday is weekly initial Jobless Claims, and the stupid Productivity reports, and then Friday is the Jobs Jamboree!

So... We've got a lot to talk about his week... I'm supposed to be leaving for Cabo tomorrow, but I doubt the doctor is going to let me travel, so I'll probably be here all week. So, Chris gets off the hook this week most likely...

To recap... The euphoria that was all over the markets after the GDP report was wiped out by a very weak Consumer Spending report for September. The dollar rebounded on the "bad news for the economy" thus confirming that the "trading theme" is still in place. CIT Group filed for bankruptcy this weekend, thus wasting the $2.33 Billion, that was given to them by the Gov't from taxpayers! And both China and the Eurozone's manufacturing indexes were strong last month, which should be a good thing for the global economies, commodities, and so on...

I'm going to try something different this morning... I still get emails from people that question why I quote currencies in two different ways... Well, there are two pricing conventions in currencies, and so I try to keep currencies in the form they are quoted... But to make things easier... We'll break out the American Style, and the European Style...

Currencies today 11/2/09: American Style: A$ .9045, kiwi .72, C$ .9255, euro 1.4780, sterling 1.6360, Swiss .9790, European Style: rand 7.9175, krone 5.70, SEK 7.0315, forint 186.05, zloty 2.8740, koruna 17.88, RUB 29.20, yen 89.90, sing 1.3990, HKD 7.75, INR 46.97, China 6.8279, pesos 13.22, BRL 1.7635, dollar index 76.15, Oil $78.17, 10-year 3.62%, Silver $16.62, and Gold... $1,054.30

That's it for today... Well.. For once, it was a good football weekend here in St. Louis, as our Rams stopped a 17-game losing streak, and my beloved Missouri Tigers posted a Big 12 win. Little Buddy Alex's team remained undefeated, but tied. Two absolutely glorious sunny, blue sky days here after the what seemed to be 40 days of rain finally ended! November is off to a good start weather wise, but I know all too well what it has in store for us! Well, I'm off to see the Wizard! Speaking of which, my little granddaughter, Delaney Grace was the cutest Dorothy you've ever seen! She came by the office on Friday to show every here just how darn cute she is! OK... Time to go, this time for real... I hope you have a Marvelous Monday, and a good start to the week and month!

Chuck Butler
President
EverBank World Markets
1-800-926-4922
1-314-647-3837

Red Flag

John Nyaradi — Mon, 02 Nov 2009 00:39:00 GMT

To get a Complimentary Special Report from Wall Street Sector Selector, click here:

We go to “Red Flag Flying” status this after last week’s sell off and the technical damage done to the major indexes and sectors. We expect still lower prices ahead. The markets remain overvalued and clearly investor sentiment has dramatically changed over the past few days. As fast as this market has climbed, it’s perfectly plausible to imagine an unwind that could be just as fast and aggressive.

I would rather be “short” than in cash to seek profits in this environment, but the volatility and speed of this reversal has been quite breathtaking and so our cash position has been suitable for the times.

I’m looking forward to more buying opportunities on the long side as this bottoming process and correction completes. Short term, we’ll look for opportunities on the inverse side and in still strong sectors. Our signals caught the start of the March rally very early on and we will watch for a “second chance” to participate in the next leg up when it comes.

In this week’s report we take a close look at what has happened and how the tide has changed and there are lots of charts to look at and so I hope it will make for interesting reading.

I’m writing this at just after 1:00 pm on Sunday in Oregon and CIT has just announced that they will be declaring bankruptcy within a few hours. As we’ve discussed in this report, CIT is a major lender to small businesses and has been in trouble since the summer and this will be the fourth largest bankruptcy in U.S. history and generate a $2.3 Billion loss for the TARP program.

This news will very likely make for a volatile opening and trading day tomorrow.

Not that things haven’t been wild enough the last two weeks on Wall Street with the Dow Jones losing more than 100 points on 4 out of 6 days and putting in a +200 point gain on Thursday followed by a -250 point loss on Friday. The widely followed VIX, the “greed and fear indicator,” surged last week and now is back to mid summer levels.

While still not at the nosebleed levels of early in the year, in the chart below we can see how a degree of panic returned to the market during the last days of October.

Chart courtesy of stockcharts.com

And major technical damage was done on the S&P 500, as well, with the index dropping below its 50 Day Moving Average and breaking through significant support at the 1040-1050 level.

Beyond that, the MACD continued a steeper descent as seen on the bottom panel of this chart.

chart courtesy of www.stockcharts.com

I’m a student of Point and Figure Charting and many sectors and ETFs went to sell signals this week including major sectors like Oil and Gas Exploration (XOP) Homebuilders (XHB) Real Estate (IYR) Russell 2000 (IWM) and many of the formerly high flying emerging markets including Latin America, Brazil and Mexico.

But many major sectors remain on Point and Figure “buy” signals, including China, Financials, Industrials, Materials, Utilities, Consumer, Gold, Silver and Energy.

Among the major indexes, the Dow Jones went to a “sell” signal as did the NASDAQ and Russell 2000. The Russell and NASDAQ also broke their October lows which were significant support and indicative of lower prices ahead.

On the S&P 500, 1020 is the magic number for the October lows which, if broken, could lead to a quick drop to 1000.

It should be noted, however, that the S&P remains on a buy signal, barely, after last week’s rout. And all of the major indexes are still above their blue support lines and 200 Day Moving Averages and so still in technical long term up trends.

Further weakness is seen in that just 30% of all stocks are now above their 50 Day Moving Average, down from 90% just a month ago and Friday alone saw a shocking 42% decline in this percentage. The 50 Day Moving Average is a widely followed indicator for short term strength and often used by technicians as a “sell” signal.

So what does it all mean? Clearly a fast and sharp correction of 5% has taken place in just eight trading days beginning on October 20th. Whether this is just a normal correction or becomes something more remains to be seen, of course, but in today’s world, moves that used to take years now take months and months have been compressed into days.

Just as clearly, the sentiment has changed rather abruptly as Thursday’s ‘better than expected” GDP report triggered a powerful rally but one that didn’t have any legs or follow through on Friday as consumer spending and sentiment remained weak. Major technical support levels have been breached and so in my opinion, we can expect continued turbulence ahead as market participants try to figure out if this year’s euphoric rally has been justified or not.

Many economists put 890-1000 as fair price for the S&P 500, and we’ve been on a quick trip in that direction over the last few days.

The View from 35,000 Feet

The only good news for the week was the 3.5% growth in GDP for the 3rd Quarter reported on Thursday. The markets responded predictably but then reversed again on Friday as everyone wonders if the growth can be sustained without ongoing government support.

Treasury Secretary Geithner said as much on a Sunday talk show when he described his view of the recovery as being “uneven and choppy” and that “this is gonna be a different recovery from the past. A lot of damage was caused by this crisis. It’s just the beginning. This is a very tough economy.”

No kidding, Tim.

Nine more banks failed on Friday, bringing the yearly total to 115, the highest count since 1992 and as we’ve discussed, this is going to continue for as far as the eye can see due to the strapped consumer, the devastated housing market, a precarious commercial real estate market and continued tight credit with the biggest banks reducing lending activity by double digit percentages.

But the biggest danger remains the consumer as spending in September dropped for the first time in five months. As we’ve noted before, the consumer is 70% of the U.S. economy and all you need to do is understand what the consumer is doing to understand what the economy is and is going to do. With continued weak employment, reduced hours and ongoing deleveraging, slow growth is certainly the most likely outcome.

The Week Ahead

It's going to be a huge week ahead for economic reports that will be market movers.

Monday: September Construction Spending, October ISM

Tuesday: September Factory Orders, October Auto Sales,

Wednesday: ADP Employment Report,

Thursday: Weekly Jobless Initial and Continuing Claims

Friday: October Non Farm Payrolls Report, October Unemployment Rate

Last night was the first Halloween in 20 years that I didn’t go trick or treating with at least one of my kids. Our tradition was always to carve pumpkins and then go out together in seek of candy on the dark, autumn streets.

I would always wear the same costume they would, so over the years I’ve been Darth Vader, Phantom of the Opera, a ninja and a pirate among others. But yesterday, my teenager was off with his friends and we couldn’t even find a pumpkin to carve as late afternoon settled over Bend. As we drove home empty handed from the grocery store, my son said, “I’m sorry I grew up, Dad,” and I replied, “I’m sorry, too.”

But life does pass us all by and as he headed out the door dressed as “Edward” from the Twilight series and left the old man behind, I grabbed a single malt scotch and settled in to watch the Yankees game, remembering Halloweens past from his childhood and mine.

Wishing you a great weekend wherever you may be. To get a Complimentary Special Report from Wall Street Sector Selector, click here:

John

Wall Street Sector Selector

All information presented herein is for general information only and deemed to be from reliable sources, but we cannot guarantee its accuracy. Readers are strongly advised to check with their investment counselors before making any investment. There is risk of loss in all investment activity.

Catching Argentinian Disease

John Mauldin — Sat, 31 Oct 2009 02:47:00 GMT

Catching Argentinian Disease?
The Ascent of Money
The Independence of the Fed Threatened
A Few Quick Thoughts on the Dollar, GDP, and the Recession
Uruguay, Philadelphia, Orlando, and then...

I have been in South America this week, speaking nine times in five days, interspersed with lots of meetings. The conversation kept coming back to the prospects for the dollar, but I was just as interested in talking with money managers and business people who had experienced the hyperinflation of Argentina and Brazil. How could such a thing happen? As it turned out, I was reading a rather remarkable book that addressed that question. There are those who believe that the United States is headed for hyperinflation because of our large and growing government fiscal deficit and massive future liabilities (as much as $56 trillion) for Medicare and Social Security.

This week, we will look at the Argentinian experience and ask ourselves whether "it" - hyperinflation - can happen here.

The Ascent of Money

I will be quoting from Niall Ferguson's recent book, The Ascent of Money. I cannot recommend this book too highly. In fact, I rank it up with my all-time favorite book on economic history, Against the Gods, by the late (and sorely missed) Peter Bernstein. There are very few books I read twice. There are too many books and not enough time. This book I will have to read at least three times, and soon, and I have a lot of underlines and mark-ups in it already.

If there were one book I could require every member of the Congress to read, it would be this one. As I read it, I am struck again and again by how fragile and yet resilient our economic systems are. Fragile in the sense that governmental policy mistakes, no matter how well-intentioned, can destroy the wealth of a nation, and resilient in that it doesn't happen more often.

In his introduction Ferguson writes, "The first step towards understanding the complexities of the financial institutions and terminology is to find out where they came from. Only understand the origins of an institution or instrument and you will find its present day roles much easier to grasp."

As is often said, those who do not understand history are doomed to repeat it. If you want to understand what is happening in the economy, what the consequences of our choices could be, then I strongly suggest you get The Ascent of Money. It is easy to read, engaging, full of moments where you are led to pull together different ideas into an "Aha!" Ferguson is a brilliant writer and historian, and we are lucky to have this book at a time when it is sorely needed. (order it at Amazon.com)

As I have been writing, the United States in particular, and the developed world in general, are faced with a series of very unpleasant, if not downright bad choices. The time for good choices was ten years ago. Now we face the prospect of painful decisions, no matter what we do. It is not a matter of pain or no pain, of somehow avoiding the consequences of our bad decisions, it is simply deciding how much pain we will take and when, or allowing the pain to build up to a climactic event. Today we look at what I think would be the worst choice of all.

Catching Argentinian Disease

At the beginning of the 20^th century, Argentina was the seventh richest nation on earth. It's very name means "silver." "As rich as an Argentine" was a byword. Even after falling from the heights through a series of bad decisions, the country was still so wealthy that, in 1946 when new president Juan Peron first visited the central bank, he could remark that "There was so much gold you could barely walk through the corridors."

Argentina had actually defaulted on its debt in the late 19^th century, not once but twice! But still they managed to avoid destroying the currency and devastating the country. But in 1989, after years of massive budget deficits that were financed with borrowing from abroad and Argentinian citizens, the country was left with so much debt and no one was willing to lend it any more money, that the leaders felt compelled to resort to the printing press.

My Uruguayan friend and Latin American partner, Enrique Fynn, tells me of his experience of going to Buenos Aires and buying a pack of cigarettes one evening. He went into the store the next morning for another pack, and the price had doubled. He came back that evening and the price had doubled again (thankfully for his health, he has quit!). There were no prices on any items in the grocery stores. There was a man with a microphone who would announce the prices of various items, often increasing the price every few hours by 30% or more.

Workers would get their pay in cash and rush to the store to buy anything, as by the end of the week their pay would be worthless. Of course, shelves were empty. The US dollar was king, and could purchase things at amazing prices. I heard stories that were truly compelling. (It made me wish I had gone shopping in Buenos Aires at the time!)

Interestingly, the dollar is still the real medium of exchange. I was told by several people that if you want to buy a house for half a million dollars, you bring the physical cash to the closing. One person counts the money and the other checks the paperwork and title. Argentina has the second largest hoard of physical dollars in the world, only exceeded by Russia. Is it any wonder they are concerned with the value of the dollar?

Let's look at some quotes from Ferguson (emphasis mine):

"The economic history of Argentina in the twentieth century is an object lesson that all the resources in the world can be set at nought by financial mismanagement... To understand Argentina's economic decline, it is once again necessary to see that inflation was a political as much as a monetary phenomenon...

"To put it simply, there was no significant group with an interest in price stability...

"Inflation is a monetary phenomenon, as Milton Friedman said. But hyperinflation is always and everywhere a political phenomenon, in the sense that it cannot occur without a fundamental malfunction of a country's political economy."

Look at the chart below. Using realistic assumptions, It suggests that the annual US government fiscal deficit will approach $2 trillion in 2019. How can we come up with what looks to be about $15 trillion over the next ten years? The Argentinian answer was to print the money.

In the US, the short answer is that unless the US consumers become a massive saving machine, to the tune of 8% or more of GDP and rising each year, and willingly put their savings into US government debt, it's not going to happen. So sometime in the coming years, interest rates are likely to start to rise in order to compensate bond investors for what they perceive as risk. That will bring us to some very difficult and painful choices.

As I wrote a few weeks ago, this scenario could be averted IF the Obama administration produced a credible plan to lower the deficit over time and stuck to it. But today's thought process is about what happens if they don't.

Ferguson pointed out in the quotes above that hyperinflation is always and everywhere a political decision. Governments have to choose to print money. In theory and in practice, what would happen if the Fed decided to accommodate a politicized US government that wanted to spend money on favorite projects and support groups, maybe even deserving programs like health care or defense or pensions or Social Security? Money they could not borrow?

Then Peter Schiff and like-minded thinkers would be right. Once you start down that path, it is hard to stop short of the brink. Brazil got to 100% inflation per month and has really lowered that level over time, but it is not easy.

In such a scenario, you want to own hard assets. Gold. Foreign currencies. Stocks. Almost anything other than the currency that is being printed.

I was asked at almost every speech about that scenario. In Latin America, hyperinflation is not a theoretical issue; it has been reality. More than one person commented on that no one in US economics schools studies hyperinflation. It is required material in Latin America. For many Latin Americans, the dollar has been their safe haven. And now they are worried, with good reason.

For the record, I do not think the US will experience hyperinflation as long as the Fed maintains its independence. Read the speeches from various Fed governors and regional presidents. These are strong personalities, and they understand that going down that path ends in massive tears. Bernanke warned just a few weeks ago that the government needs to get serious about the fiscal deficit. Watch the rhetoric from the Fed heat up after his reconfirmation and the confirmation of two new governors in the first quarter.

The Fed has committed to buy a fixed amount of government debt in its quantitative easing program. That commitment will be finished by the end of the first quarter (if I remember correctly). Then comes the tricky part.

I have been writing for a long time that the main force in the economy right now is deflation. The Fed will fight deflation tooth and nail. But they don't have to buy government debt to fight deflation. They can buy mortgage securities, credit card securities, commercial paper, etc. That will have the effect of easing without encouraging the government to run massive deficits. And such debts are naturally self-liquidating, while government debt is not, at least not in the same way.

I believe the Fed will maintain its independence. Not to do so is to court economic disaster of the first order. These are bright and serious men and women. They get it.

The Independence of the Fed Threatened

The risk is that something changes to compromise their independence. And sadly, there is some risk. Let me quote my fishing buddy friend David Kotok:

"It's now official. The proposed legislation to reform America's financial service supervision includes granting the Secretary of the Treasury a veto over Section 13(3) emergency action by the Federal Reserve Board of Governors. If this becomes law, it will be a sad day for the independence of America's central bank.

"The Secretary of the Treasury, a very senior cabinet position, is appointed by the President and meets with the President in the Oval Office weekly. The governors of the Federal Reserve Board are also appointed by the President. Both cabinet officers and Federal Reserve governors are confirmed by the US Senate. There are supposed to be seven governors; politics has purposefully limited this to five throughout the three-year financial crisis period.

"The Federal Reserve governors are supposed to serve staggered 14-year terms with all seven seats filled. Instead, we have been governed by the present five-member, politically configured board.

"The original seven-governor construction was designed to insulate them from political pressure, for very good reasons. Decades of monetary history throughout the world have disclosed what happens when political influence on a central bank intensifies. The Weimar Republic and Zimbabwe are evidence of the worst inflationary effects of politics. The Great Depression in the US and the nearly two-decade deflationary recession in Japan demonstrate that monetary policy is not only inflation-prone. When central banks are under political influence you can get fire or you can get ice.

"In Japan, the central bank contends with two members of the cabinet sitting in on its deliberations. There is no way to know how much of the last 15 years of deflation and recession is attributable to the inside political pressures placed on the governors of the Bank of Japan. But there is evidence to suggest political influence, especially when you observe how little the Bank of Japan has engaged in asset expansion during this crisis."

This is the nose of the camel under the tent. Starting down this road is very worrisome indeed. I find it appalling that Tim Geithner and Larry Summers went along with this. This is a very clear attempt by the political class to put political pressure on the Fed. I hope the Fed responds with vigor. I can tell you that the officials of whom I am aware will not take kindly to pressure. And that might be an understatement.

(Yes, I am aware of the problems of the Fed being able to decide whom to bail out and why. It is not a perfect world. But better the Fed than Congress.)

All that being said, if the Fed starts to increase its buying of government debt above its initial commitment, then my "optimistic" scenario of a very rough economic patch, which I have been outlining the past few months, is far too rose-colored. I do not think it will happen, but I can guarantee you, I and a lot of other people will be watching.

A Few Quick Thoughts on the Dollar, GDP, and the Recession

Just a few quick notes. When world trade collapsed, so did the need for US dollars, which is what the world uses to transact business. The data looks like world trade is finding a bottom and maybe even recovering somewhat. That means there will be the need for more dollars. And since everybody and their mother are short the dollar, there could be a vicious snap-back rally. I am still bearish the US dollar (and the yen and the euro and the pound) over the long term, but there is the potential for a real rally here.

And my friend Mish Shedlock commented on the US GDP report, which said the US GDP rose 3.5%:

"Today the market is cheering over what is actually an ugly report. A misguided Cash-for-Clunkers added a one-time contribution of 1.66 percentage points to GDP. Auto sales have since collapsed so all the program did is move some demand forward. Government spending increased at 7.9 percent in the third quarter which is certainly nothing to cheer about. Personal income decreased $15.5 billion (0.5 percent), while real disposable personal income decreased 3.4 percent, in contrast to an increase of 3.8 percent last quarter. Those are horrible numbers. The savings rate is down, which no doubt has misguided economists cheering, but people spending more than they make is one of the things that got us into trouble. The only bright spot I can find is exports. However, even there we must not get too excited as imports rose much more."

John Williams notes that one-time stimulus or inventory items represented 92% of the reported quarterly growth. The nature of the stimulus-related gains was that they tended to steal business activity from the future. The months ahead are the future. Accordingly, fourth-quarter quarterly GDP change will likely turn negative, again. (The King Report)

And David Rosenberg writes: "Only economists see the recession as being over; the man on the street sees it a little differently, perhaps less enthused by the fact that a lower rate of inventory destocking is arithmetically underpinning GDP growth at this time. Put simply, a Wall Street Journal/NBC News poll just found that 58% of the public believe the economic recession still has a ways to go -- and that is up from 52% in September and means that the private investor, unlike the hedge fund manager, is not interested in adding risk to the portfolio even after a 60% surge in the equity market.

"Only 29% of those polled believe the economy has hit bottom -- imagine having that psychology with nearly zero interest rates, a bloated Fed balance sheet and unprecedented fiscal deficits (poll was taken from October 23-25). Nearly two in three (64%) said the rally in the stock market (still a bear market rally -- not the onset of a new bull market) has not swayed their view (or ours for that matter)."

Uruguay, Philadelphia, Orlando, and then...

I am finishing this letter in Montevideo, Uruguay. I have been in Buenos Aires, Sao Paulo, and Rio de Janeiro this week. I must say that Rio is beautiful, very green and lush with marvelous beaches, which I sadly only got to drive past. I will come again. I fly back Sunday and am home for a week, then speaking trips to Philadelphia and Orlando. Then my schedule only shows a few days in New York in early December for Festivus with the gang from Minyanville, and Europe in January. I am sure other things will come up, but I am looking forward to being home for awhile.

My friends at International Living have been writing about Uruguay, and I was really looking forward to visiting the country. I have spent a few days with partner Enrique Fynn in this delightful place. Turns out it is the Switzerland of South America. Reasonable bank secrecy laws, and trades zones where you are not taxed on any business you do outside of Uruguay. Many international companies set up their headquarters here. Beautiful beaches, friendly people, and the charm of a small country, plus what will be a brand new airport in a few weeks, which can get you several times a day to any part of the region, directly to Europe, and one hop away from any major city in the world. You can learn more about the country, and other countries you may want to live in or have a second home in, by subscribing to International Living.

One of the laugh lines I use in my speeches down here is that if the Fed actually does start to monetize the debt, I will have to move to Uruguay. I could make worse choices.

Have a great week. I think this weekend I will switch it up from the heavy reading I have been doing and find some science fiction. Reality is way too scary.

Your ready to be in his own bed analyst,

John Mauldin

Which ETF is best for YOU?

Adam Hewison — Fri, 30 Oct 2009 16:09:00 GMT

The five ETFs that we are referring to are going to play a major role in the future and you need to know about them today.

In this short video I show you the overriding trend and potential for each of these markets in the future.

As always our videos are free to watch and there is no need for registration.

http://www.ino.com/info/472/CD3678/&dp=0&l=0&campaignid=3

All the best,

Adam Hewison
President, INO.com
Co-creator, MarketClub

3rd QTR GDP Is Strong!

Chuck Butler — Fri, 30 Oct 2009 14:40:04 GMT

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In This Issue..

* Dollar gets sold after GDP report
* High yielders get bought!
* German Retail Sales decline...
* Real has wild swings!

And Now... Today's Pfennig!

3rd QTR GDP Is Strong!

Good day... And a Happy Friday to one and all! I can't believe how hard it rained here yesterday... Unbelievable! And me, with my cane, and not able to run, was stuck in it going from the car... Absolutely soaked! If I were a kid, I would have thought that to be fun! But, I'm not... It's still raining this morning too! UGH! Let's hope it stops in time for the Trick-or-Treaters!

OK... Well the rain fell on the dollar's parade yesterday too! And, just like I thought it would do... The dollar got sold like funnel cakes at a state fair, once the U.S. 3rd QTR GDP report printed... The dollar rally was stopped in its tracks, which meant that the "trading theme" that rewards the dollar when things look bad in the U.S. and punishes it when things look good, which is completely opposite of what it should do fundamental wise, was still in place!

3rd QTR GDP was 3.5%!!! Let's Party! Get on your red dress sweetheart we're going out dancing, we're going to party like it's 1999! Seriously, the Gov't officials, including Summers and Geithner think it's all seashells and balloons from here on out! So, why shouldn't we think the same? I mean they've never led us to the wrong side of the tracks have they? HAHAHA HAHAHAHAHAHA... And HAHAHAHAHAHAHA HAHAHAHAHA!

OK, don't get me wrong here, I'm glad the U.S. economy seems to be out of the recession/ depression... But, didn't we expect a bump in the economy? Didn't we think we would see growth by the end of the year, based on the stimulus and money supply extravaganza that went on the first part of this year? And... Based on the reports I saw, a large portion of the growth was actually a return of Consumer Spending in the quarter... Cash for Clunkers really helped the Consumer Spending along too!

But isn't it just like the people that win the lottery... Suddenly, they have all this cash... And they spend it until they have no cash and voila! They are back to having nothing to spend! That's how I think the U.S. economy will react once the stimulus and other monetary candy is withdrawn from the economy... I'm still pinning my colors to the mast of a double dip for the economy... We've got the first two parts... The negative growth, and now the positive growth... Where are we headed next? Only the Shadow knows!

We'll begin to see a glimpse of what's going to go on in the next couple of weeks, as the Fed's Quantitative Easing program has hit their ceiling of $300 Billion, and ended yesterday... The Fed's 7-month buying spree, remember they announced this plan while I was in Florida at spring training, seems to have put the lid on yields of Treasuries to allow the housing market some time to heal... But, as I told my publisher for the Currency Capitalist, Erika Nolan, when I met with her after the announcement... "the U.S. has just opened Pandora's Box of baaaaaaaaaddddddd things for the economy, for Japan has implemented this same program, but over 10 years ago, look how well that's turned out for them!"

Today's data brings us two of my faves... Personal Spending and Income... We'll see if the Consumer Spending continued in September or not...

There's a great headline to a story on the Bloomie this morning... The title reads: "Obama Bridge To Lasting Economic Expansion Risks Going Nowhere" A Bridge to nowhere... That sounds about right to me! It could be the Bridge Over Troubled Waters, or it could be the Bridge of Sighs... I still believe that the U.S. Gov't has spend Trillions taking us deeper into the abyss of a national debt, with little to show for it, except... The U.S. has ventured into the private sector deeper than any Gov't has before during this financial meltdown... Think they'll get out once it's over? HAHAHAHA HAHAHAHAHA! Not going to happen my friend!

OK, enough of that! It's a Friday for crying out loud, Chuck, can't you think of more pleasant things to talk about? Yes... Let's see... Oh yeah! I started telling you above about the non-dollar currency rally VS the dollar yesterday, so let's go back to that!

Well, there wasn't much to say other than the dollar got sold after the GDP report printed... It wasn't so much that the currencies rallied VS the dollar, as it was a sell off of the dollar, which led to a currency rally! The high yielding currencies of Australia, Brazil, New Zealand, and even Norway now that rate on the rise there, posted the best gains VS the dollar on the day. And that makes sense, right? I mean, haven't I been harping on the yield / interest rate differentials lately? And here's where they came out to play!

The data in the U.S. was good, which brought the risk takers out of the walls once again, and knowing that the U.S. interest rates are going to remain near zero for some time to come, they sold the dollar and those paltry yields that go with the dollar, and bought currencies that had a nice positive yield differential to the those paltry yields!

The Big dog, euro, as the offset currency to the dollar, obviously participated in this dollar sell off... The euro's gains were stopped this morning though, when German Retail Sales printed and unexpectedly declined in September. Remember, Germany's economy exited their recession in the 2nd QTR, albeit a nascent recovery at best... So, we'll have to keep an eye on Germany's nascent recovery to see if it "double dips" too!

Speaking of Brazil... Recently, the real has really shown its tendency to take a walk on the wild side when trading gets going... I'm talking about 3-5% swings good and bad! Whew! That's something to watch! The good news is... That even though the swings in the price of the real are wild, the overall trend continues to be good for real holders... I expect the real to react to rumors this morning that the Gov't will not throw out road blocks to impede the real's performance... That would be HUGE! And very welcomed by currency traders that trade the real always looking over their shoulders to see if the Gov't will throw out the road blocks... So, like I said, there are rumors this morning, that the Gov't will announce that they are not going to impede the real's rise at this time...

And then there was this... U.S. Treasury Sec. Tim Geithner, announced yesterday that he wants the power to not only tell a corporation that they are closed for business, but to also have the power to shrink Corporations that are not having problems! He will be the "death panel" that Barney Frank talked about a couple of months ago for non-financial institutions... Shake me, Wake me, when's it's over... Maybe I'm having a bad dream, folks...

To recap... The dollar's rally was stopped in its tracks by the U.S. 3rd QTR GDP which printed a 3.5% increase, and caused investors to seek higher yielding assets, thus selling dollars. German Retail Sales unexpectedly declined in September, thus stopping the euro from rallying further this morning. And the High Yielders get all the glory when investors realize that U.S. rates are going to remain near zero for some time to come... Aussie, Brazil, New Zealand lead the pack!

Currencies today 10/30/09: A$ .9155, kiwi .7310, C$ .9360, euro 1.4845, sterling 1.6540, Swiss .9840, rand 7.6750, krone 5.63, SEK 6.9875, forint 183.61, zloty 2.8525, koruna 17.83, RUB 29.02, yen 90.90, sing 1.3970, HKD 7.75, INR 47.03, China 6.8275, pesos 13.01, BRL 1.7325, dollar index 75.87, Oil $79.58, 10-year 3.62%, Silver $16.60, and Gold... $1,044.90

That's it for today... I'm writing from home this morning, as I have a doctor's appt. first thing before I go to work... The network was a little touchy this morning, and I wasn't sure I would get this out, but it has settled down now. Whew! Big Weekend for my beloved Missouri Tigers as they travel to Colorado. And my little buddy Alex, as his team travels to Webster Groves! HA! Good news in the local paper this morning, as the best player in baseball today, Albert Pujols announced that he wants to be a Cardinal for life! Our Blues just can't get on a roll, win one, lose one... UGH! So... Tomorrow is Halloween! I can't wait to see the little ones in their costumes! Our little Delaney Grace is Dorothy from the Wizard of Oz, with ruby red shoes, a basket and Toto too! She is so darn cute! I'll leave you with the thought of a little Dorothy coming to your door! I hope it dries out here soon... And I hope you have a Fantastico Friday and Ghoulish Weekend! BOO!

Chuck Butler
President
EverBank World Markets
1-800-926-4922
1-314-647-3837

I hate looking stupid

Steve Cook — Fri, 30 Oct 2009 13:32:00 GMT

Economics

   This Week’s Data

   Other

    Before getting too jiggy with yesterday’s GDP report, read this:
    http://www.businessinsider.com/chart-of-the-day-motor-vehicle-output-2009-10?utm_source=Triggermail&utm_medium=email&utm_campaign=Clusterstock%20Chart%20of%20the%20Day%2C%20Thursday%2C%2010%2F29%2F09
\

    And this (medium):
    http://www.capitalspectator.com/archives/2009/10/q3_gdp_is_up_bu.html#more

    Banks still are not lending--which does nothing for economic growth (graph):
    http://www.businessinsider.com/its-the-worst-ever-credit-crunch-on-main-street-2009-10

    US railroad car loadings are still declining (short):
    http://www.zerohedge.com/article/weekly-us-railroad-carloadings-down-148-cumulative-decline-180

Politics

Domestic

International War Against Radical Islam

The Market

    Technical

    Powerful rally yesterday. At the close, the DJIA (9962) had returned to a level above the lower boundary of its March to present up trend (9845-11827), but the S&P (1066) had not (1078-1322): gold traded back above the short term up trend line it broke on Wednesday and the VIX traded back below the down trend off its October 2008 high, but the dollar remained above the upper boundary of its down trend. So despite the power, the technical picture is not entirely clear. To be sure, another day like yesterday and all doubt about Market direction will be removed. But before seriously considering reversing Thursday’s trades, I need more technical clarity than we have.

    I thought this a good (and timely) article from The Street.com on technical analysis, in general, and volume, in particular:

    If people out there are still comparing volume figures now to what was "normal" over the past many years, they're missing the big picture. Volume is not going to average 1.6 billion shares on the NYSE anymore (as it did when there were 10,000 hedge funds worldwide and prop trading desks at every major sell-side firm).

Virtually the whole rally from the March low to present was done on less volume than the decline in price in 2008 and into the beginning of this year. Does one say that the whole 60% rally is null and void because it was on low volume? Of course not.

Welcome to a new era -- not of low volume, just lower volume. Fewer hedge funds. Less bulge bracket prop trading. Less public participation.

I see no technical analysis rules violated. But more important, are there really "rules" in technical analysis? If it's in a textbook, does it make it a "rule"? To me, it is but a suggestion of the author. And when it comes to volume analysis, I can find you an equal number of exceptions for every "rule" about it you find in the textbooks. Getting stuck on what one thinks is a TA rule is a sure recipe for losing money while charting.

If one makes money from looking at a chart, they will take the credit for the right call. If they lose money from looking at a chart, they will say technical analysis failed them. That's part of Behavioral Finance Theory and the Self-Attribution bias -- it's not the chart that failed them, nor the methodology itself. It's the improper interpretation of what one considers "rules,"
Case in point: Yesterday broke the S&P's uptrend line from the March low. Everyone knows that. But ask yourself: 1) Did breaking the uptrend line mean that the uptrend in the S&P was broken? 2) If a key level gets broken on a closing basis, is it really broken if the next morning the security or index gaps higher and then trades up all day to close back above the key level it broke the prior day? How you answer those questions will provide a clue as to how much you understand what charting is really about as opposed to reading TA textbooks and claiming that you're a technical analyst.

    The latest from Trader Mike:
    http://tradermike.net/2009/10/october_29_2009_stock_market_recap

   Fundamental

    Up date on the ‘beat’ rate:
    http://bespokeinvest.typepad.com/bespoke/2009/10/daily-earnings-trends.html

    This is a bit long but a great discussion on gold in the present environment:
    http://www.zerohedge.com/article/guest-post-bucking-trend

One of the biggest disadvantages of putting your bets down in black and white everyday is that when you are wrong, everyone knows it. And it sure looks like yesterday’s move to raise cash was W-R-O-N-G. The only possible good news is that I only raised cash by 5%--so I was stupid but just by a little bit.

    Actually, as I noted above, the technical picture, at least at the moment, is less clear than it appears on the surface. In addition, today is the last day of the fiscal year of many mutual and hedge funds; so there is some pressure to make fund valuations as of 10/31 as attractive as possible especially in light of their performance over the last year. I am not suggesting any ‘funny business’; but all other things being equal, if you were a fund manager would you want the prices of your holdings up or down at the close of this week?

That said, yesterday’s action makes me ponder two questions. First, does yesterday’s pin action (brought on by the better than expected GDP number reported yesterday morning [see Thursday’s Morning Call]) reflect an improvement in investor attitude on the economy? Following investors seeming indifference to the better than expected revenues reported this quarter, my assumption was that the 60%+ rally that we have had pretty much discounted the continuing but sluggish recovery expected over the six to nine months.

If Thursday’s Market performance belies that assumption, then I will have been wrong on more than just the technical picture. However, I am not going to concede the point after a one day Market move that might suggest otherwise. Let’s see how investors react to the economic data over the next couple of days--and if I am wrong, I’ll adapt.

The other question is, will the solid inverse relationship between the dollar and stock prices continue? As I pointed out above, while the dollar declined yesterday, it nevertheless closed above the down trend off its March high. And stocks smoked; so the relationship (down dollar, up stock prices) was there but just not as strong as I would have expected.

Perhaps I am splitting hairs, but I point out this minor inconsistency because I am having an increasingly tough time believing that the dollar/stock inverse relationship can go on ad infinitum. I believe that loose monetary policy and out of control spending have significant inflationary implications. I believe that this implies a weakening dollar. I believe that a weak dollar likely means higher gold and commodity prices. But I don’t believe that a declining dollar is good for stocks in the long run. I have no clue when that relationship breaks apart, although I had my self convinced it was starting earlier in the week. But may be not; may be there is another leg to go. As I said above, if I am wrong, I’ll adapt.

       Thoughts on Investing from Cramer—Five big mistakes investors make

    NEW YORK (TheStreet) -- In a special episode of his "Mad Money" TV show, Jim Cramer showed investors how to avoid losing money by noting the most common mistakes investors make.

He stressed the importance of investing with discipline, using rules to better recognize opportunities and avoid losing money.

Cramer said his first rule for investors is to not dig in your heels when you're wrong. Quoting the great economist John Maynard Keynes, Cramer said "when the facts change, I change my mind."

Digging in your heels and refusing to acknowledge that your investment thesis is wrong is a sure fire way to lose money, said Cramer. It's natural to be angry, but when the market's turned against you, investors need to adapt. Cramer said he's been repeatedly been chastised by critics and the media for changing his mind. In March 2009, Cramer called a bottom in the market at Dow 6,500 and came under intense scrutiny for his bullish call. But he said the facts were that unless most of the stocks in the Dow went to zero, the average just couldn't go much lower.

The facts changed, he said, and so did his outlook. A month later, the Dow was 1,500 points higher.

Cramer said investors must swallow their pride, admit when they're wrong, and move on if they ever expect to be successful.

Price Matters

Cramer said his next rule for investors is that price matters. He said even the companies you don't like at all can be bought, if the price gets low enough.

Cramer said he never advocates buying a stock where the fundamentals are deteriorating, but in between the best of breed companies and the worst of breed companies, there is a lot of room for opportunity if the price drops far enough.

Cramer said knowing the right price to buy a stock should be a sliding scale, based on how good the company is. The better the company, the more investors should be willing to pay for it.

Cramer said at their very worst, both Bank Of America (BAC Quote)which he also owns for his Action Alerts PLUS portfolio and Sprint (S Quote) were priced for bankruptcy.

That means that anyone who felt bankruptcy wasn't going to happen was able to get these companies at tremendous prices and has been rewarded handsomely.

Investors should also look for companies trying to raise capital through secondary offerings of stock, he said. Often these secondaries are priced below the true value of the company, allowing investors to buy in between 5% and 10% less than the previous day's closing price.

Cramer said price forces investors to make new judgments about bad merchandise, and investors need to be ready.

A Dose of Skepticism

When it comes to investing, don't assume everything you hear or read is the truth, said Cramer. Stocks themselves aren't misleading, he said, but the companies behind them can be.

Cramer told investors that there are strong and weak players in every sector. He said the weaker ones will almost always blame their problems on the entire industry. He also be skeptical when a weaker player said their shortcomings are due to an industrywide slowdown.

Cramer said investors can't assume every company in an industry is the same. He said some companies are better run than others, some sell overseas, others don't, the possibilities are endless. Cramer said investors need to look out for excuses.

True Upside Surprises

Cramer's next rule for investors was also about misdirection, only this time to the upside. He said that not all upside surprises are worth getting excited about. Cramer said that often what the media reports as "better-than-expected" results are not what the professionals on Wall Street were hoping for.

It can be confusing and frustrating for investors to see a company report what the media claims as an upside surprise, only to have shares plummet immediately after.

According to Cramer, there are two types of upside surprises: organic and manufactured. Organic surprises are ones stemming from higher-than-expected sales and improving fundamentals, while the latter comes from just a better bottom line, with no top-line growth.

In the case of a manufactured surprise, Cramer said many factors could be coming into play, such as cost cuts, changing tax rates, or stock buyback programs.

It's not a surprise if a company's "better" earnings come from fewer shares being on the market, he said. A true surprise, said Cramer, comes from better-than- expected sales and nothing else.

So-Called Expert Advice

Cramer's final rule for investors focused on TV pundits who criticize the market and tell you to avoid stocks at all costs.

Cramer said investors should never assume these "experts" are any more honest than those hyping up stocks. Having a negative outlook, he said, does not equal credibility.

Cramer said those who criticize the markets may not be trying to help you. While it may be hard to believe, he said mutual and hedge fund managers may actually want the markets down to short stocks or buy in at better prices.

    News on Stocks in Our Portfolios

    CME Group (Dividend Growth and Aggressive Growth Portfolios) reported third quarter operating earnings per share of $3.35 versus expectations $3.29 and $2.81 recorded in the comparable 2008 quarter.

    Colgate Palmolive (Dividend Growth Portfolio) reported third quarter earnings per share of $1.12 versus estimates of $1.11 and $.99 reported in the 2008 third quarter.

    ExxonMobil (Dividend Growth Portfolio) reported third quarter earnings per share of $.98 versus expectations of $1.08 and $2.58 reported in last year’s third quarter.

Currency Manipulation – Has It Helped Your Net Worth?

John M. McClure — Fri, 30 Oct 2009 13:08:00 GMT

Discussion on the Hill
Dollar Crisis Averted, But at What Cost?
The Cost of Global Dollar Reliance
A Year After TARP -- Was It Necessary?
Attaboy Jack!

In this letter, we are going to spend some time digging into the recent volatility of the U.S. dollar. In case you haven't noticed, the U.S. dollar roared back in 2008 only to resume its free fall in 2009. There are advantages and disadvantages to having a strong/weak dollar and some passionate arguments for/against various dollar policies. Historically, every great power in history has used a weak dollar to inflate their way out of paying off large amounts of debt.

Below is a recent discussion between Chairman Bernanke and Congress on the use of currency swaps as an apparent tool of the Fed to manipulate the currency market. It appears that the recent financial crisis and the fact that the U.S. dollar is the reserve currency of the world, gave the Fed a perfect opportunity to have its cake and eat it too. The recent drop and increased volatility in the U.S. dollar may mean that the Fed got more than it bargained for.

Question?
If you are invested in the S&P 500 in 2009 and it goes up 15% in value and at the same time the U.S. Dollar drops 16% in value, has your global net worth increased?

"Swap" Discussion on the Hill

A hearing in Congress on July 21, 2009 provided a unique insight into the Federal Reserve's actions at the beginning of the credit crisis. Here is a noteworthy exchange between Congressman Alan Grayson (D - Florida) and Fed Chair Ben Bernanke.

Grayson:
"Chairman Bernanke, I'm looking at the report you handed out this morning... There's a table on page 26 [of your report] that consists of [the Federal Reserve] balance sheet and one of your entries called central bank liquidity [currency] swaps shows an increase from 2007 from $24 billion to $553 billion ...by the end of 2008. What's that?"

Bernanke:
"Those are swaps (derivatives) done with foreign central banks, many [of which] are short dollars and [that would have had to] come into our markets looking for dollars, drive up interest rates and create volatility in our markets. What we have done... [is to] swap dollars for currencies [of 14 central banks']; they take the dollars and lend it out to banks to bring down interest rates in those jurisdictions." (What he didn't say was that such action also helped keep US interest rates down.)

Grayson:
"We looked at one of the arrangements, [one of which was] $9 billion for New Zealand, which works out to $3,000 per person [New Zealand resident]. Wouldn't it have been better to extend that kind of credit to Americans?"

Bernanke:
"...we are extending that kind of credit to Americans."

Grayson:
"...look at the next page which shows... a 20% increase in the nominal USD exchange rate at exactly the same time that you were handing out a half a trillion dollars to foreigners. Do you think that is a coincidence?"

Bernanke:
"... [Pause]...Yes."

It's an interesting question, despite how Bernanke answered it. Action contradicts his answer but in his defense, strengthening the dollar was probably not the goal of the Federal Reserve in taking this action - it was an unintended consequence.

Dollar Crisis Averted, But at What Cost?

In August, September and October, the US Dollar Index (USDX) appreciated 21% after falling 24% from late 2005 into early 2008. But if taming volatility was a motivator for the Federal Open Market Committee to sell swaps as Mr. Bernanke claimed, the strategy failed abysmally. The dollar shot up from 72 in early August 2008, before peaking at 90 in March 2009, after which it then lost 16%.

And the aftermath isn't pretty. The dollar is still falling and recently broke key support at 75, and there is little on the horizon to indicate that this trend will change anytime soon, especially given the moves by foreign central banks to shift away from the dollar (see articles in Related Reading below). Can anyone blame them? Current Federal Reserve and government policies and responses have been anything but dollar positive.

This month, the Bank of International Settlement (BIS) published a paper that attempted to answer this and other questions surrounding central bank actions entitled "The US Dollar Shortage in Global Banking and the International [read: Federal Reserve] Policy Response."

The paper wasted no time in getting down to brass tacks and asked some probing questions of its own.

The global financial crisis has shown just how unstable banks' sources of funding can become. Throughout the crisis, but particularly following the collapse of Lehman Brothers in September 2008, many banks faced severe difficulties securing short-term US dollar funding. In response, central banks around the world adopted extraordinary policy measures, including international swap arrangements with the US Federal Reserve, to enable them to provide US dollars to commercial banks in their respective jurisdictions. What caused this global shortage of US dollars? Which banking systems have been most affected? How could a shortage develop so quickly after dollar liquidity had been viewed as plentiful?

In a nutshell, when the crisis hit the dollar a shortage was the result caused from a trend that had become popular with foreign banks of taking increasingly larger US dollar positions, thereby creating significant short dollar positions among foreign banks. In Europe's case, "[the] banks' need for short-term US dollar funding was substantial at the onset of the [credit] crisis, at least $1.0 -$1.2 trillion by mid-2007."

And that was just Europe.

The Cost of Global Dollar Reliance

The origins of the US dollar shortage during the crisis are linked to the expansion since 2000 in banks' international balance sheets. The outstanding stock of banks' foreign claims grew from $10 trillion at the beginning of 2000 to $34 trillion by end-2007, a significant expansion even when scaled by global economic activity (Figure 1, left panel). The year-on-year growth in foreign claims approached 30% by mid-2007, up from around 10% in 2001. This acceleration took place during a period of financial innovation, which included the emergence of structured finance, the spread of "universal banking", which combines commercial and investment banking and proprietary trading activities, and significant growth in the hedge fund industry to which banks offer prime brokerage and other services.

So how big was the risk of the credit crisis on these foreign dollar positions?

Were all liabilities to non-banks treated as short-term funding, the upper-bound estimate would be $6.5 trillion.

Many of these dollar short positions held by foreign banks was the result of participation in complex derivatives in a market that had grown to around $600 trillion. This short-term funding liability was little more than one percent of the derivative total.

Figure 1

And it is this amount and potentially more that the Federal Reserve was attempting to cover in the action taken by the FOMC. In other words, the Federal Reserve became the buyer of last resort in an effort to avert further crises with the taxpayer, ultimately being on the hook for the tab!

The BIS paper highlighted just how little was known about the structure and complexities of international bank balance sheets and their dependence on one another thanks to financial globalization. It also exposed the risks that grew from this trend and growing use of foreign exchange swaps and other derivatives.

When the credit crisis hit and Lehman Brothers collapsed, short-term currency funding sources were seriously compromised, which many believe required that a buyer of last resort step into the fray. These problems became most acute in smaller countries like Iceland, that had become heavily reliant on complex derivatives and foreign banks to provide a funding backstop in case something went wrong. And in 2008, that is exactly what happened.

But what happens when the next crisis strikes? Will the Federal Reserve be ready and able to again act as buyer of last resort and provide necessary liquidity? And who assumes the risks of this action? As we have learned in the past year, it will be the US taxpayer.

This was just one event in a series of events that were part of a larger global crisis that some experts would have us believe threatened our financial system.

A Year After TARP - Was It Necessary?

Another quickly improvised solution to the 2008 crisis was the $700 billion Troubled Asset Relief Program (TARP), introduced by Secretary Treasurer Hank Paulson in September 2008. Without it, we were told, the financial fabric of our country would have been irrevocably torn with untold consequences. Given this supposed threat, Congress quickly approved TARP on October 3, 2008.

A year after TARP, what has it accomplished? A paper by Florida State University Professor Randall Holcombe published recently sought to address this question.

Figure 2 - Chart from the Federal Reserve showing the effect of TARP, a reduction in commercial and industrial bank lending by commercial banks, which is the opposite of the intention (we were told at the time) of the program. Based on the amount of money spent to date, this chart should make you sick to your stomach.

So what risks did the credit crisis pose based on these foreign dollar positions?

In his opinion, TARP was neither necessary nor has it worked (see Figure 2).

To look at the first question, consider what TARP was designed to do. Secretary Paulson said interbank lending had dried up because banks had toxic assets (mortgage-backed securities) clogging their portfolios. Because nobody knew what they were worth, banks were uncertain of the financial security of other banks. This uncertainty caused a reluctance to lend and prompted the financial markets to lock up.

The solution, Paulson argued, was to approve TARP and use $700 billion to buy the toxic assets. Replacing the assets with Treasury securities would fortify bank balance sheets and interbank lending would resume.

Dr. Holcombe pulls no punches in his synopsis.

It is easy to say the program wasn't necessary, despite Paulson's arguments, because the TARP money wasn't used to buy toxic assets. TARP money was instead used to buy preferred stock in banks, shoring up their balance sheets by giving the federal government part ownership of the banks.

Nine of the largest banks were forced to issue stock to the Treasury, paid for with TARP money, even though several of the banks tried to opt out. Secretary Paulson said that if some of the big banks participated and others didn't, it would identify their varying levels of weakness, which Paulson believed was undesirable.

Instead of buying up toxic assets, the TARP money was used to partially nationalize the banking industry. It was also used for a federal takeover of AIG (after it was initially rescued by the Fed) and the bailout of Chrysler and General Motors.

He admits that without this sizable taxpayer infusion some banks would have failed, but he believes that wouldn't have been so bad.

When firms take risks, they must balance the potential profits from success against the potential losses from failure, and the TARP support removes the last part of that balancing act. There may have been some dislocations in the short run from bank failures, but in the long run allowing them to go under preserves the incentive structure that fuels a market economy. Banks are financial intermediaries that match up borrowers and lenders. When a bank goes under, it does not reduce the amount of money available to borrowers, or prevent savers from providing money that can be lent. Other financial intermediaries are available to borrowers and lenders to replace the activities that failed banks would have performed.

We contacted Professor Holcombe this week to discuss his article with him. His comments provide an excellent TARP overview and epilog.

As to the stimulus package and bailouts, they are both counterproductive. As the economy now enters a recovery, the "stimulus" spending will divert resources from the private sector into government spending, which will slow the recovery.

In hindsight we can see the folly of the auto industry bailout. The justification was to give them a source of temporary funding so they could avoid bankruptcy, but they went into bankruptcy anyway. Now, GM is 61% owned by the federal government, which will make it harder for the company to survive long-term than if it had just gone through a regular bankruptcy proceeding last December rather than getting its first distribution of bailout money.

His comment that stimulus spending "will divert resources from the private sector (and real jobs creator) into government spending, which will slow recovery" is significant. That is exactly what happened during the Great Depression with FDR's New Deal (and other programs). It has also proven to be true as a result of the official response from the Japanese government following the breaking of its asset bubble in 1990 over the last two decades in Japan.

The huge difference in the economies of the U.S. in the 1930s and Japan in the 1990s is that complex derivative ticking time-bombs did not exist at the time, which will make the next crisis far more "interesting."

Definitions

Currency Swap
A currency swap is a financial derivative and an arrangement in which two parties exchange specific amounts of different currencies initially and a series of interest payments on the initial cash flows are exchanged. Often, one party will pay a fixed interest rate, while another will pay a floating exchange rate (though there may also be fixed-fixed and floating-floating arrangements). At the maturity of the swap, the principal amounts are exchanged back. Unlike an interest rate swap, the principal and interest are both exchanged in full in a currency swap. http://www.investorwords.com/1244/currency_swap.html

Derivatives
Warren Buffett describes them as "financial weapons of mass destruction" for good reason. A derivative is a financial contract whose value is derived from the performance of underlying market factors, such as interest rates, currency exchange rates, and commodity/equity prices. Derivative transactions include a wide assortment of financial contracts including structured debt obligations and deposits, swaps, futures, options, caps, floors, collars, forwards and various combinations thereof.

Related Stories and Links:

Alan Grayson and Ben Bernanke Video
http://www.youtube.com/watch?v=n0NYBTkE1yQ

US Dollar Shortage in Global Banking and the International Policy Response
http://www.bis.org/publ/work291.pdf?noframes=1

How the Federal Reserve Bailed Out the World
http://www.zerohedge.com/article/how-federal-reserve-bailed-out-world

A Year After TARP: $700 Billion Down the Drain - Holcombe
http://blog.mises.org/archives/010873.asp

Economist - Down with the Dollar, Why the Dollar Is Falling
http://ow.ly/15W3ht

Dollar to Hit 50 Yen, Cease as Reserve
http://ow.ly/v6hS

Russia Ready to Abandon Dollar in Oil, Gas Trade with China
http://ow.ly/v5Ru

Iran Joins List of Nations in Moving Away from the Dollar...
http://ow.ly/v5QZ

Attaboy Jack!

I put my dad on a plane back to Tennessee on Monday after enjoying another successful bird hunting trip with him. We had great weather, which made for incredible hunting. We recapped the entire experience with friends and family, while enjoying incredible southern cuisine. My new hunting dog Jack made it all possible by exceeding my wildest expectations and performing like an experienced dog well beyond his years. I owe a special thanks to my good friend Brian King for helping me plan a special pheasant and chukkar hunt for us on his ranch.

On our last day, I took my oldest daughter Sarah so she could share this special time with her Papaw. Below is a picture of Sarah and me as we stop for a rest.

I don't think I could have wiped that smile off her face.

My dad and I have been going on this hunt for 12 years and it seems like I enjoy each hunt more than the last. My father turns 70 in March and I know our bird hunting days are numbered, so I am blessed to spend this special time with my dad. For next year, I am in the planning stages of a two-week hunt across Idaho, Montana, North and South Dakota. If you are a bird hunter and can help me plan some stops along the way, I would welcome your call.

Working to grow your wealth,

John M. McClure
President & CEO
ProfitScore Capital Management, Inc.

P.S. If you would like to hire us to help you navigate this difficult bear market, below are three ways to contact us:

Complete our Private Client Group request form by clicking here http://profitscore.com/insight.aspx and submitting your contact information. (This is the most preferred method.)
Call us directly at (800) 731-5690.
Simply send us an email to info @ profitscore.com.

Someone will contact you within 24 hours of receiving your information.

Continuing to Find Opportunity in China

Ian Wyatt — Thu, 29 Oct 2009 15:33:00 GMT

Your Daily Profit

October, 29 2009

*****In Xi’an

*****Local Color

*****China Natural Gas

Fellow Investor,

We’ve landed in Xi’an, one of China’s biggest cities. Not long after touching down, we connected with my brother who flew in from Chengdu. He’s been living there for over a year now.

Xi'an appears to be undergoing continuous growth. No matter where you look, you see cranes in almost constant operation. Old buildings are being taken down and replaced with new ones. Much of the new construction is designed to look like the old, both inside the walled city center and outside of "downtown" near our hotel. Even the strip malls are built to look as though they are 1,000 years old.

View of Xi'an, China. These are "clear" skies.

The Xi’an area is best known for the Terracotta Army which guards the tomb of the first emperor of China. These life-sized clay warriors were buried in underground vaults over 2,000 years ago. Discovered in 1974, the vaults are still being excavated, and the warriors reassembled. It's estimated that there are over 8,000 hand made clay soldiers in three separate vaults.

*****Xi’an is a bustling city. Like Beijing, the weather has been warm in the 60s and cloudy most days. Both Xi’an and Beijing are located in valleys, surrounded by hills and mountains. While the locations provided protection from invaders centuries ago, the locations today helps contain the pollution and contribute to smog and cloud filled skies on most days. Since our arrival, we've seen blue sky only once. Whether this is due to pollution or weather is hard to say.

Not surprising, the roads are crowded all the time (I've seen worse though, in Nairobi, Kenya). Traffic lights and signs appear to be interpreted more as suggestions, rather than being considered law. Despite the chaotic roads, there are few accidents. And when there is a fender bender, the two individuals try to determine among themselves who is at fault. They bargain to come to an agreed upon settlement, paid in cash on the spot.

China certainly appears to be developing, but not developed. At popular tourist sites, we Westerners are outnumbered 50-to-1 by Chinese natives who are on vacation visiting the same sites. Our guide tells us that for most of these Chinese, this is their first visit to these places.

Travel has become increasingly popular among Chinese in the ten or twenty years as income has risen and the middle class has grown. Certainly domestic travel can be viewed as one measure of the local economy and for consumer sentiment. By my eyes, both appear strong.

*****As I mentioned on Monday, Xi’an is also home to one of my favorite Chinese companies, China Natural Gas (Nasdaq:CHNG). The recent sell-off in this stock has left the trailing P/E below 10. We picked up CHNG in my SmallCapInvestor PRO service back in May when it was trading at just $6.14. We knew natural gas plays in China presented great opportunities, but what really got us excited was a very brief mention that the company was looking to move from being a bulletin board stock to the Nasdaq. Based on our review of the company’s numbers we knew it was pretty much a sure thing and once it moved onto a major exchange the share price would take off. And it did. If you’ve been looking for a good entry point for China Natural Gas, the current price around $11 is attractive. (And if you’re looking for more stocks with potential like CHNG I invite you to check out my SmallCapInvestor PRO service. Click HERE for more.)

Until tomorrow,

Ian Wyatt

Editor

Daily Profit

Association of Investor Awareness - Week of 10/29/2009

Research & Editorial Staff — Thu, 29 Oct 2009 14:49:00 GMT

In This Issue:

Investors Are Deciding Which Way To Jump
Earnings Count More Than The GDP
Beat The Fixed Income Blues
A Dividend Honor Roll
If You Can't Beat Them...
The Bottom Line This Week

The past 30+ days was a weak period for stocks. Since our September newsletter, the Dow fell 0.6% and the Nasdaq dropped 2.3%.

However, investors have little cause to complain. The market delivered a 56% gain since March 9. At this point, a timeout could be a pause that refreshes. That's especially true since October has often been a tough month for stocks, particularly when it was preceded by a run-up. Another such shock was definitely not welcomed.

Investors Are Deciding Which Way To Jump

Of course, we may still have a correction after investors have a chance to consult their crystal balls and compare what they see coming in the economy with current stock values.

Pessimists think the economy won't justify the big gains we have seen so far, much less any additional advances. They point to the World Bank's estimate that the U.S. will grow only about 1.2% next year. If that level proves to be correct, many stocks are undoubtedly overpriced.

More bullish investors think the World Bank has such a poor track record with estimates that it should stop making them. Several economists with much better credentials put growth in the 3% to 4% range for 2010. If that mark proves to be correct, stocks still have some catching up to do.

Earnings Count More Than The GDP

Since we don't buy the market, we are not particularly concerned with what the overall growth rate proves to be, so long as it is above the zero mark. What we care most about are the earnings of companies we are following.

Fortunately, earnings for most of our recommendations are doing very nicely. That's no surprise since we have been favoring blue chip exporters that benefit when the value of the dollar declines.

That was good strategy. So far this year the dollar has dropped about 14% against a basket of foreign currencies, and our exporters are reporting solid sales increases.

The outlook for earnings is actually much better than the dollar's decline would suggest. During the tough recession, most companies cut costs so much that they were able to remain profitable through the worst of the troubles. Now that orders are increasing, nearly every dime is going directly to their bottom lines.

Beat The Fixed Income Blues

As you probably know all too well, the returns from fixed income investments are on the floor. Most money market funds pay under 1%. CDs are paying more, but not by much. Even longer term bonds typically return only about 3.3%. As one retired person we know lamented recently, "Those returns are driving us to the local soup kitchen."

We think the solution for most people who need current income is to move some money to successful stocks that pay attractive dividends. Several of our recommendations fit the bill. Some of them pay about twice what can be earned in the fixed income market.

Of course, there is no sense buying a stock that pays good dividends if it is likely to drop sharply in price. That's a common trap for investors who only look at yields. Since the yield is calculated by dividing the most recent dividend by a stock's current price, the number will soar if the price starts heading for the cellar.

To make matters worse. If the price is tanking, it probably means the company's earnings are also declining. In that case, the dividend will probably be cut. That happened at many of America's largest and most prosperous banks during this tough recession.

The way to minimize your risk is to select stocks that have good yields, and are also doing well in the market. If the companies have long histories of paying dividends, all the better. The cream of the crop raise their dividends every year. Here are three stocks that hit all the bases.

A Dividend Honor Roll

Kinder Morgan Energy Partners, L.P. (KMP) heads the list. http://finance.yahoo.com/q/bc?s=KMP The company owns and operates over 26,000 miles of oil, natural gas, and fuel pipelines in the U.S. In addition, the company has 150 terminals that store and transport petroleum, petrochemicals, coal and other bulk items by rail and truck.

Kinder Morgan also has a timely carbon dioxide business. Huge quantities of the greenhouse gas are now being pumped into older oil wells to increase their yields. Of course, the process also gets rid of the nasty gas. Talk about killing two birds with one stone.

Although Kinder Morgan trades like a stock on the NYSE, it is actually a limited partnership that distributes its available cash to investors each quarter. Over the past five years, the partnership had an attractive 6.5% average yield. Currently, the yield is an exceptional 7.4%. Best of all, only part of the payout is taxable.

When we look at Kinder Morgan's strong business and its excellent dividend, it is easy to see why it resisted the recent stock market sell-off. The company should make an excellent choice for investors who seek high current income plus a chance for long-term capital gains.

Consolidated Edison (ED) is also very attractive. http://finance.yahoo.com/q/bc?s=ED The company supplies electric power, natural gas, and steam to a total of over 4 million customers in New York, Pennsylvania, and New Jersey. The company also sells surplus power to other utilities in the Mid Atlantic region. Additionally, Con Ed designs and installs modern energy-efficient heating, ventilating, air conditioning, and lighting equipment throughout its service area.

There aren't many companies with a longer history of success than Con Ed. It was founded in 1884 after Thomas Edison proved that electric networks were feasible. More importantly to investors who seek income, the company raised its dividends 35 years in a row. That's an outstanding track record. The yield is currently an attractive 5.6%

Eli Lilly (LLY) was founded in 1876, which makes it one of the very few American companies with a longer history than Con Ed. http://finance.yahoo.com/q/bc?s=LLY Lilly has a large line of drugs that treat diabetes, attention-deficit disorder, schizophrenia, osteoporosis, several cancers, and cardiovascular problems – to name only a few. The company also has a full line of successful animal health care products.

Nevertheless, investors are nervous about the company due, in part, to the impact the proposed national health care program may have on drug company profits. Investors are also unhappy that Lilly's patent on Prozac expired a few years ago, and Zyprexa, its best selling drug today, will go off-patent in 2011. However, Lilly has a large drug development pipeline that will bring many new products to market over the next few years.

Eli Lilly currently pays a healthy 6.0% dividend. In addition, the company has declared dividends since 1885, and it has raised them for 42 years. Lilly more than qualifies as one of Standard & Poors' elite Dividend Aristocrats.

If You Can't Beat Them. . .

Speaking of large banks, Goldman Sachs (GS) is emerging from the financial service turmoil in fine shape. http://finance.yahoo.com/q/bc?s=GS Part of the reason is the banking meltdown removed several of its competitors. Now Goldman has a clear shot at rebound profits in many areas.

Goldman also shines because it is an international company that benefits from the expanding global economy that is growing several times faster than the U.S. China, for example, just announced that its growth rate reached an astounding 8.9%. Nearly all of Asia is also rolling along in high gear. As an international bank and trading company, economic growth will mean rising profits for Goldman.

Lastly, Goldman Sachs looks good for the very reason many people hate the company: its political connections are strong. Whatever you may think about that relationship, it should be worth millions of dollars in profits over the next several years.

Earnings are already on an upturn, an excellent achievement given the difficult climate that exists for banks. The yield is only 0.80%, but Goldman Sachs should be purchased for its potential appreciation, not for income.

The Bottom Line This Week

Notwithstanding the last few days, the stock market has continued to rise, but at a far slower rate than it did earlier this year. It does not surprise us to see some correction. Once it runs its course, however, we think the improving economy will justify another leg up for stocks.

A big problem many investors face today is a lack of good income opportunities. Everything from money market funds to long term Treasuries are paying very little.

On the other hand, some high quality stocks have attractive yields. Three that we like very much are Kinder Morgan Energy Partners, L.P., Consolidated Edison, and Eli Lilly.

Investors who have been looking for a promising bank to emerge from the financial service carnage should consider Goldman Sachs. We think the company has a lock on growth.

Until Next Time

The AIA "Advocate For Absolute Returns", a publication of The Association for Investor Awareness, Inc., tracks market trends, industry news, the SEC, global trade and finance and Washington developments for you because they affect your investments. But who doesn't? Many sources report these issues as abstract facts. We feel that's not enough. The AIA Advocate's job is to warn you of what's important and how these developments translate to ground-level forces and threats that directly affect your wealth as well as your current investment opportunities. Not just information, but information you can use. Until next time ...

My Hedge Fund Portfolio Keeps Moving Ahead

Bob Carlson — Thu, 29 Oct 2009 14:42:00 GMT

Hedge funds continue to make headlines, and most of them are not good. The big insider-trading case involved a hedge fund firm, and news stories indicate the investment process of the firm was to get an “information edge” that apparently included insider information on a regular basis. Forbes magazine had an article asking “How Dirty Are Hedge Funds?” Its answer was “filthy.”

The latest evidence for Forbes was an academic paper that concluded 21% of hedge funds lie about their legal and regulatory problems and 28% issue either incorrect or unverifiable information about other topics.

You can receive the benefits hedge funds are supposed to have without the high fees, lack of liquidity, uncertainty about investment strategies, and other disadvantages of hedge funds. My portfolio of mutual funds that have hedge fund qualities persists in meeting or surpassing my goals. The portfolio is delivering higher returns than the S&P 500 with less risk. It took a hit in the last half of 2008, but it did not fall as much as the indexes and most portfolios. It lost 13.25% for the last three months of 2008 and 18.49% for all of 2008. Though disappointing, the losses were far less than for the S&P 500.

In the rally, it bounced back faster, widening its long-term return above the S&P 500. It was up 9.88% for the three months ended September 30, 2009, and 4.79% for the prior 12 months. Its performance is ahead of the S&P 500 for all periods but the latest three months, and the portfolio has far less risk and volatility.

My “hedge fund” portfolio is composed of mutual funds that use strategies similar to those followed by the better hedge funds. The strategies include distressed asset investing, deep value investing, and tactical asset allocation. We also have funds that can hedge and leverage their portfolios and funds with "go anywhere" investment strategies. Most can raise cash when they perceive market risks to be high. The portfolio also has special assets such as high yield bonds, international bonds, and real estate investment trusts. What these funds have in common is investment strategies that differ greatly from the conventional approach of only buying stocks or bonds that closely resemble a given market index.

The differences these funds have from each other also are important. Over time different investment strategies have their good and bad returns during different periods. In academic terms, they have low correlations with each other. When a group of funds that are not correlated with each other are put together, they form a portfolio that has much smoother, steadier returns than a traditional portfolio. For example, over 10 years the hedge fund portfolio has about half the volatility as the S&P 500.

Another advantage of the portfolio is its low correlation with the S&P 500. That means our returns and net worth are not closely tied to the returns of the market indexes. While the returns from the stock market indexes have been flat or close to it for the last 10 years, the hedge fund portfolio has returned 8.68% annualized.

The quarter ending Sept. 30 was consistent with the portfolio’s history. Our return was less than the S&P 500 for the quarter, which is not surprising. Because of its diversification, the portfolio trails the stock indexes when there are strong bull rallies. The rest of the time, the portfolio’s returns equal or exceed those of the indexes.

This is a buy and hold portfolio. Because the funds are uncorrelated with each other, there is no reason to make adjustments for the market cycle. The fund managers do that for us. The only changes I make are when there are changes in the funds or when I discover a fund that will enhance the portfolio. For example, Schwab Hedged Equity changed its name and ticker and modified its strategy. Instead of keeping the new version, I recommended selling it and spreading the proceeds among the other funds.

The portfolio includes some non-traditional balanced funds such as Oakmark Equity & Income and FPA Crescent. Among the other funds are Hussman Strategic Growth, PIMCO All Assets, Wintergreen, and Berwyn Income.

The mutual fund “hedge fund” portfolio delivers what traditional hedge funds are supposed to. The portfolio’s fluctuations have a low correlation to the stock market indexes, but the returns equal or exceed those of stocks over the long term. It has the reasonable expenses of no-load mutual funds and their daily liquidity. Even the wealthy who meet the minimum income and net worth requirements for traditional hedge fund investing probably would be better off with this mutual fund portfolio.

A Crisis in the Kremlin

John Mauldin — Thu, 29 Oct 2009 14:26:00 GMT

Earlier this week, I sent out a piece that talked about the dangers of ignoring the big picture - even for the "bottom up" investor. Every once in a while, we all have to step away from the Dow Jones Industrial Average, housing prices and other indicators to look at what's going to influence these factors in the long term.

Today I give you a video about Russia and how a plan to fix the economy might throw off the political balance of power. I regard Moscow's situation as a valuable lesson for our country - also in the throes of an economic crisis - and for investors affected by global markets. Click here to watch this great video by my friends at STRATFOR, a global intelligence company. You can also sign up to get free weekly intelligence from them, so you don't have to depend on my occasional mail-out.

John Mauldin

3rd QTR GDP To Lift Our Spirits?

Chuck Butler — Thu, 29 Oct 2009 14:08:00 GMT

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In This Issue..

* Currencies rebound a bit VS the dollar..
* Bill Gross on the dollar...
* Norway raises rates!
* RBNZ lifts easing bias!

And Now... Today's Pfennig!

3rd QTR GDP To Lift Our Spirits?

Good day... And a Thunderin' Thursday to you once again! It's not raining at the moment, but rain is forecast for today, thus the Thunderin' Thursday name! Rain today, tomorrow and who knows when it will stop... I'm thinking of buying the blueprints to build an Ark!

Front and Center this morning, we have the non-dollar currencies showing some healing as stock futures are positive. What's driving this new found positive feeling in the risk assets? Well, it's all about the first reading of 3rd QTR GDP today, which... Is expected to show that the U.S. economy came out of the recession in the quarter. Of course, I'll be looking for the Gov't spending portion of the GDP, but other media outlets won't, and the markets will get back to looking for higher yields, which you can not get in the U.S.!

Speaking of higher yields... Norway's Norges Bank did indeedly do raise rates yesterday, making them the first European Central Bank to do so. The Norges Bank members chickened out and only opted for 25 Basis Points (BPS), when I thought they should go the full 50 BPS... But, hey! The Norges Bank is raising rates, right? Let's not get picky here! Is the European Central Bank raising rates? Is Sweden's Riksbank, or Switzerland's Central Bank raising rates? How about Canada? Or Japan? NO, NO, NO, NO, NO, NO and NO! Let's get to giving some love to the Norwegian krone!

So... Looking at the rate hike score card of major countries, we have Australia, and Norway... The exact two I told you months ago would be the first to raise rates this year, when most observers thought it would be in the first quarter of 2010... So, if the U.S. GDP is as strong as forecast (+3.2%) then investors and risk takers will be coming out of the walls again, and buying higher yielding assets... There's only a few places in the world they can go folks... Australia, New Zealand, Brazil, South Africa, the Eurozone, and Norway... The Euro wannabes of the Czech Republic, Poland and Hungary probably fall in there somewhere, but those countries are not at the top of the Hit Parade when people start looking for yield!

OK... So, the non-dollar currencies are seeing some healing this morning... The Big Dog, euro, had fallen to 1.4706 before the healing began, and is now 1.4750... The Aussie dollar (A$) had fallen to 89-cents and change, but has rebounded to .9055, as I write. And... If the trading theme remains in place, the dollar will get hammered on the positive GDP report this morning...

Well, yesterday it was PIMCO's Bill Gross's turn to give his thoughts about the dollar... Let's listen in... The dollar is an over-owned currency and likely to fall to an all-time low against major counterparts, Pacific Investment Management Co.'s Bill Gross said in an interview on CNBC.

"The Chinese, the Asians, have owned too many dollars for too long." The dollar becomes more and more owned and less and less desirable, so ultimately the direction is down. I don't sense stability in the dollar."

OK... Thanks Bill! Hey! Recall the other day when I gave you the list of "rumors" in the markets that deep-sixed the non-dollar currencies? One of the items on that list was the rumor that the tax credit for first time home buyers wouldn't be extended... Well, now there's a rumor going 'round that someone's underground, and she will rock, no wait! The rumor going around is that the tax credit will indeed by extended to April 2010... You heard it here first folks, remember that! HA!

And the folks over at the Royal Bank of Scotland (RBS) sent out a note to customers that "the euro remains in an uptrend, and investors should buy the currency when it weakens. It has dropped back to the middle of its last consolidation zone in late September and early August. In a bigger correction scenario it may make it down to 1.45-ish, but it is no longer a compelling sell, and medium term considerations favor buying dips."

Hmmm... Couldn't have said that better myself!

So... Let's get back to this thing with the risk assets... There must be quite a few of you missing class each day, for recently, there have been a ton of people telling me that I never talked about a risk asset sell off... WHAT? ARE YOU KIDDING ME? I've been talking about how stocks have been linked to currencies and commodities (the risk assets) for months now! And several months ago, I began to see the price to earnings ratios getting way out of whack (tech bubble like!) and began to talk about a stock market sell off that could adversely affect the price gains that the currencies and commodities had made since March...

I know that some of you believe that I only want to "talk up" the currencies to benefit me somehow... And would never write about a potential currency sell-off... Well I have written about it... And this isn't the first time either! I'm really pounding the keys right now, because the more I think about this, the more it ticks me off! I mean... Do these folks not recall my going through how to handle a currency sell-off? It went something like this...

If you bought currencies and precious metals to simply go with the flow and get out when the prices begin to decline to book your profits, then you simply want to watch the stocks to see if they put in a 4-day consecutive sell-off... That might be your indication... However, if you bought your currencies and precious metals to diversify your investment portfolio to: 1. not have just dollar denominated investments, 2. to provide a hedge against the potential of a further weakening in the dollar... Then you will simply want to batten down the hatches and ride this dollar strength out... And if you do anything, you might want to take this dollar strength as an opportunity to buy at cheaper levels!

Calm down, Chuck... Ok, I was gone for awhile but I'm back now... The real question is just why are stocks and currencies and commodities all being thrown into the same barrel marked Risk Assets? When fundamentals are in place, this isn't the case, for currencies and commodities have a low correlation with stocks, and they have different pricing mechanisms...

So, a return to fundamentals would be like manna from heaven for yours truly!

OK... Earlier this week I talked about the Bank of Canada officials jawboning the Canadian dollar / loonie lower... Well, they've done their job... The loonie is 2 full cents lower... I expect the markets to test the Bank of Canada (BOC) here, to see if they really want to keep the loonie from getting stronger...

The Reserve Bank of New Zealand (RBNZ) met last night, and while they officially removed their easing bias from their monetary statement, they did not come out and outright mention rate hikes.... In fact, the RBNZ said that there was "no urgency to begin withdrawing monetary policy stimulus" (low rates)... So, it was a two-handed monetary statement by the RBNZ... They removed the "easing bias" but didn't feel the urgency to move rates higher... But shoot Rudy! That's way better than the stuff they gave us at the last meeting, which was "we expect to keep the OCR (their Official Cash Rate / interest rate) at the current level until the second half of 2010"... Yes, Virginia, the RBNZ did improve their statement!

Yesterday, I talked about GMAC coming back to the well, and asking for more bailout money, to the tune of $12-15 Billion... This has some conspiracy undertones to it folks... You just have to think about GMAC and the bank they own, which in reality the taxpayers own! Well, the thoughts going around now is that GMAC, which has already gone to the well 2 times for bailout money, will get what they need, because the Gov't is "in too deep"... Oh great! Now we not only have the "too big to fail" thing, but the "in too deep" thing going for us taxpayers! Where do I sign up for more of this? I just can't get enough of Gov't owned former private sector businesses! NOT!

OK... So, like I said at the top, 3rd QTR GDP will print a preliminary figure this morning... And is expected to have gone from negative to +3.2%... That's quite a rise, don't you think? Personally, I think that it will be less than 3%, probably around 2.5%, and will have been made up of Government Sending... But don't let that get in the way of a feel good media blitz that will happen after the number is printed this morning!

U.S. New Home Sales declined in September for the first time since March... Does any one else feel that the best of the U.S economy during this recession / depression has passed us by, and that we'll be double dipping soon?

Well... With it being a Thursday, we will get the usual Weekly Initial Jobless Claims this morning... You know, this is some very disheartening data... The Weekly Initial Jobless Claims continue to remain above 500,000 each and every week! And the Continuing Claims continue near 6 million at 5.920 million! Who among us believes that the U.S. economy can REALLY recover as long as we have 16% unemployment rates?

To recap... The dollar rally continued throughout the day yesterday, but has stalled in the overnight markets, as the focus shifts to the U.S. 3rd QTR GDP, which is expected to be positive, thus technically taking the U.S. economy out of recession. This would bring the risk takers back into the markets, and thus the dollar would get hammered... The Reserve Bank of New Zealand lifted their "easing bias" but left rates unchanged, and U.S. New Homes Sales declined in September...

Gold is up $7 this morning, so it too is receiving some love, and healing!

Currencies today 10/29/09: A$ .9050, kiwi .7265, C$ .9280, euro 1.4750, sterling 1.6465, Swiss .9765, rand 7.8150, krone 5.7050, SEK 7.0170, forint 186, zloty 2.8880, koruna 17.92, RUB 29.27, yen 90.70, sing 1.3985, HKD 7.75, INR 47.21, China 6.8280, pesos 13.23, BRL 1.76, dollar index 76.26, Oil $77.83, 10-year 3.43%, Silver $16.33, and Gold... $1,035.50

That's it for today... Had a visitor yesterday... A very delightful person! It sure was nice to meet you Rebel! This past week has been the 80th anniversary of the 1929 stock market crash! I really am grateful for all of you readers that haven sent me notes this week with kind words... They are truly appreciated! A reader sent me a note yesterday giving me 3 cheers for not calling the Pay Guy a Czar... Yes, the Czars thing makes me ill! My trip to Cabo San Lucas might be nixed because of the blood clot they found in my leg... I hope not, I was really looking forward to going there! It's Thursday, so our little Christine will stop and bring us in breakfast sandwiches... Yeah for us! And on that note, I'll hit send... I hope it's dry where you are, but that your Thursday is still Thunderin'!

Chuck Butler
President
EverBank World Markets
1-800-926-4922
1-314-647-3837

Consumer Confidence Drops!

Chuck Butler — Wed, 28 Oct 2009 14:22:19 GMT

..But First, A Word From Our Sponsor..
Gain exposure to currencies of emerging BRIC countries-and don't lose a dime on market risk

* 4 BRIC currencies: Brazilian real, Russian ruble, Indian rupee, Chinese renminbi
* High upside potential
* No market risk to deposited principal
* Low $1,500 minimum deposit

Don't miss this unique opportunity. Deadline to buy the BRIC MarketSafe CD is Dec. 3rd, 2009. Apply today or learn more at http://www.everbank.com/001CertificatesMSBRIC.aspx?referId=11808
.

In This Issue..

* The dollar continues to hammer!
* Jim Rogers on the dollar rally...
* C. Fred Bergsten talks of a dollar alternative...
* Lord Monckton's thoughts...

And Now... Today's Pfennig!

Consumer Confidence Drops!

Good day... And a Wonderful Wednesday to you! It's still raining here... Quite frankly, I don't know how people that live in rainy areas do it! I don't mind rainy days, as long as they are sprinkled in with the days of sunshine!

Well... The dollar rally that began for a number of rumored reasons continued on yesterday... Remember when I said on Monday that the data this week should show us that the economy is healing somewhat, which would be bad for the dollar? Well, that thought got cold water thrown on it yesterday when Consumer Confidence surprisingly declined last month...

You know how I like to question just what people that were surveyed for this Consumer Confidence report are so confident about? Well, apparently, the Conference Board surveyed the wrong people this month! Consumer confidence in the U.S. declined in October to 47.7 versus expectations of a 53.5 reading. Both consumers' perceptions of current conditions and their expectations for the future declined. Hmmm...

So, Consumer Confidence is fading this month? That sure wasn't the outcome I was expecting... Sure, I would have questioned the dolts that were confident as people that obviously had no idea what was going on, but still, these people that get surveyed had not allowed negativity to enter their minds before, why was this month different? Maybe... Just maybe, people are waking up to smell the coffee that's brewing... And with that I mean, the deficit situation here in the U.S. and all the games the Gov't, the Fed, and Treasury are playing to pull the wool over our eyes... You think? Do you really think that's the case? Because if it is, then the next step is to stand up and shout out loud that you want Government to stop spending! Shout it, Shout it, Shout it out loud! And if they won't listen to you, fire them the next chance you get!

So... The dollar continues with this rally that began Monday mid-morning... One of our fave old friends, Jim Rogers was in the news last night... Let's listen in to what Jim had to say! "Everybody is pessimistic on the dollar, whenever you have everybody on the same side of the boat, you know what you have to do. We may have a rally in the dollar, a decline in Commodity prices or stock prices for a while." He went on to say that while there may be a rally in the dollar, it won't be "sustainable"

He also said something that goes right along with my "Treasury Bubble Story"... Rogers said, that he "certainly wouldn't be buying U.S. Treasuries, and couldn't imagine lending money to the U.S. government for long periods of time."

You know what? I don't think I could imagine that either! So... One has to wonder, just when the Chinese and Japanese begin to feel this way? It's not like we've spent the money and won't have a need to borrow again... The Gov't is finding new ways to spend money! The Budget Deficit is forecast to be $9 Trillion for the next 9 years! And that was before the Gov't got their hands on these "new ways to spend money"!

And getting back to what Jim Rogers said in about the dollar... Isn't this the same thing I've been warning about for a couple of months now? So, this shouldn't sound like anything new to Pfennig Readers... I've warned that the stock market was overbought, and that the U.S. economy was going to do a double dip, which would cause stocks to sell off, and that stocks would probably drag the other risk assets of non-dollar currencies and commodities along with them...

But again, this kind of move, just like the one in 2005, and the one from July 2008 to Feb 2009, will not be sustainable! There's trading themes, and there's trends that are moved by fundamentals... The fundamentals will win out eventually... And when the markets get all the excesses out of their system, the fundamentals will be there like that navy suit... Always in style, always dependable, always there for you!

This next story is very interesting indeed... Here's the skinny... C. Fred Bergsten, the former Treasury executive, is warning that dollar deficits might no longer be funded by foreign nations, including China! He also wrote in the current issue of the Council on Foreign Relations' Foreign Affairs magazine that he would recommend that the White House join with the international community in creating an alternative to the dollar for international trade... What? Are you kidding me?

This is not a joke folks... This is a real person, that is well respected... And he's telling the White House to help create an alternative to the dollar for international trade? That's like telling the fox he can guard the hen house!

That story leads me to this one... Quite a few readers have asked me to talk about this and while I wasn't sure I would, because it's so political, it now plays well with story I just told you about!

Have you heard of Lord Monckton? Well... He gave a speech in Minnesota last week, that you can find on U-Tube. In the speech he says that he has read the global climate change bill, and that if our President signs it, he will be signing away our sovereignty, our prosperity, our freedoms, for global rule...

So... We have the global rule rumors and the global currency rumors back to back! I'm not here to debate what Lord Monckton said, for all I know he's bang on with this thoughts... My thing is to point out that there's smoke... And you know me... Where there's smoke, there's fire...

Is this the method the U.S. will use to get us from beneath this deficit rock? I certainly hope not! And that's all I'll say about that! Now at least!

Remember my rant about allowing bad corporations to fail and not bailing them out? Well, I took a lot of heat on that one from some readers that didn't agree, and that's OK... But to my point... GMAC Financial Services and the Treasury Department are in advanced talks to prop up the lender with its third helping of taxpayer money.

The U.S. government is likely to inject $2.8 billion to $5.6 billion of capital into the Detroit company, on top of the $12.5 billion that GMAC has received since December 2008.

Another example of throwing good tax payer money at bad money...

Remember last week when I told you about the Pay guy (I refuse to call him a Czar!) was getting the Gov't involved in pay cuts for the bailed out firms? Hmmm... It was reported yesterday by the Wall Street Journal that while he cut total compensation by half, he substantially increased one important element -- regular salaries, according to a Wall Street Journal analysis. The move reflects the complexity of regulating something that mixes politics and economics. Yes, indeed it does!

So... I've gone on and on this morning about what we have to look forward to in our future (near?)... What about what's going on today? Well... As I said yesterday, Norway's Norges Bank will announce a rate hike this afternoon... They will be the first European Central Bank of raise rates, and the third overall Central Bank to raise them. We all know that the Reserve Bank of Australia (RBA) raised rates first... But who was second? Ahhh... In a not so publicized move, the Bank of Israel raised rates second!

Norway is experiencing accelerating home prices and the Norges Bank has to step in before another housing bubble gets started. No, the Norwegian economy isn't going great guns, but the recovery is going on, and a rate hike here would probably nip the housing price acceleration in the bud... The question remains of will the Norges Bank be aggressive with the rate hike and go for 50 Basis points (1/2%) or just 25 Basis Points (1/4%)? If they have any intestinal fortitude they'll go for the 50! But the markets expect them to be gradual about their approach to raising rates... And so, 25 BPS will probably be the announcement this afternoon.

Gold has really gotten the snot knocked out of it recently... Gold is trading more than $30 per ounce less than it was 10 days ago! And this plays well with the comment above about risk assets being dragged down by stocks... You know my thoughts on price drops in Gold... Need I say more?

And then there was this... Just when you thought the yield on the 10-year Treasury was going to keep moving higher... An invisible hand sweeps down and knocks the yield back 10 Basis points! Well... In this case, it's probably more "safe haven buying" driving the price up and the yield down, than it is hanky panky from the Fed... You would think that anyone that played this "safe haven" game before and got burned badly would not go down that road again... But... Maybe they didn't even realize that they took losses on their "safe haven" purchase! HA!

To recap... The dollar is on the warpath, as a drop in Consumer Confidence in the U.S. has investors dumping risk assets again. C. Fred Bergsten, former Treasury official, recommends the White House to participate in forming a new alternative currency for international trade and dump the dollar, and we talk about Lord Monckton's speech about the climate change bill... Norway will raise rates today, and safe haven buying seems to be on the docket once more.

Currencies today 10/27/09: A$ .9035, kiwi .7335, C$ .9315, euro 1.4780, sterling 1.6325, Swiss .9785, rand 7.7610, krone 5.7190, SEK 7.0425, forint 184.75, zloty 2.8830, koruna 17.8380, RUB 29.29, yen 91, sing 1.4015, HKD 7.7507, INR 47.35, China 6.8281, pesos 13.26, BRL 1.75, dollar index 76.24, Oil $78.86, 10-year 3.43%, Silver $16.46, and Gold... $1,033.05

That's it for today... Well... Thanks for all the kind notes regarding my cancer update... The did find the problem in my left leg... I have a blood clot! UGH! I'm not taking this one as well as I did the one in my right leg after my surgeries! But, we'll get it dealt with, and move on... I know that some of you don't like these health updates, but many do... I forgot a trip when I was talking about my upcoming travel yesterday... At the end of January I'll be heading to San Antonio... Time to batten down the hatches once again... And the World Series starts tonight... Good thing Colorado didn't make it to the World Series, they would be "snowed out"! OK... Time is here today... Time! I hope your Wednesday is Wonderful!

Chuck Butler
President
EverBank World Markets
1-800-926-4922
1-314-647-3837

Beyond the Sound Bite: An Interview with Alexander Young

Vinny Catalano, CFA — Wed, 28 Oct 2009 12:35:00 GMT

In my second interview with the International Equity Strategist for Standard and Poors we discussed the S&P economic outlook, the rebound in global trade, the advised investment focus on global cyclical leadership, and risks of an economic double dip.

The length of the interview is 12 minutes 05 seconds.

(Please visit the site to view this media)