Tuesday, December 27, 2011

Weapons of Mass destruction: Real ones this time!

Our American neighbours have suddenly become quite respectful. When North Korean dictator Kim Jong II died a few days ago, they approached the Chinese government and held a meeting about the possible risks associated with the transfer of power to the Korean heir to the throne. Both nations are concerned that there could be political unrest in North Korea. And North Korea has nuclear weapons.
Those of us who grew up in the cold war know that these risks are real. In the 1960’s they built fall-out shelters and the Distant Early Warning Line. Remember the Diefen-bunker? It was a radiation-proof fortress built in a desert near Brandon Manitoba to house government officials in event of a nuclear attack. Remember “the hole?” It is a mile-deep tunnel drilled into the Canadian Shield near North Bay Ontario. It was built to house the NORAD command centre: they said it could withstand a direct nuclear hit. In the 1960s, Canadians were ready for trouble and made an effort to defend themselves.
Am I ready? Are you ready? Of course we’re not ready! The previous generation was ready because they survived the depression and the war. We survived rock and roll and the “dot.com” bust. For us, nuclear weapons and political unrest are part of information overload. We’ll just keep on dancin’ and see what happens.
In my investment book, Beyond the Bull, I discuss how information overload destroys your long term rate of return. The key to improving your long term return is to be constantly looking for specific economic information that is relevant to your specific investment techniques. Anything that is not what you are looking for is irrelevant overload. But if you have no pre-planned investment techniques, all economic information becomes equal in value. None of it has value because it’s not tied to your action plan.
Americans have military techniques: when they, or their allies, feel threatened, American aircraft carriers move into the region near the threat. In this case, they’d like to move those carriers into the Yellow Sea. The Yellow Sea borders both Korea and China: hence, they are being very respectful to China. Perhaps those carriers that have just been freed up from supporting U.S. operations in Iraq will find their way to this new theatre.
Similarly, Canadian pension plan managers have investment techniques: when one area of the investment world is underperforming, they like to redeploy their investments to more lucrative assets. For example, their stock market assets have produced a low rate of return since 2000, bonds have produced a good solid rate of return, and gold has been stellar. They would like to move assets from the stock market to bonds and gold. But it takes even longer to move a giant pension fund out of the stock market than it takes to move a fleet of aircraft carriers. The pension funds are so big that their selling can drive the stock market down. They have to make their moves stealthily, under cover of bullish rhetoric and strong earnings.
Investors with less than $50 or $100 million don’t have to pussy-foot around like that. We can switch from stocks to bonds to gold and back easily. What most of us are missing is neither intelligence nor liquidity. Most of us need investment techniques that will help us separate valuable information from noise. Most of us need to be like the American military or the Canadian pensions: we need to know what kind of information we are looking for and how to act when we find it.

Monday, December 12, 2011

Greco-Roman Economics: Tragedy or Comedy?

Greece and Rome, once cultural centres of the western world, have become modern day theatres in the drama of world economics. The tragedy is the outrageous debt levels Italy and Greece chalked up and the naiveté of those who kept on lending them the money. The comedy is the performances of politicians and labour leaders scrambling to centre stage to present their lines on how to solve the problems.
“To be or not to be…” That is the question the European unity is asking itself. Whether ‘tis nobler in the mind to suffer the slings and arrows of outrageous debt levels and, by opposing them, give rise to a sea of troubles… The economic scene has dramatically shifted since last summer’s performance by Americans when they faced their country’s debt downgrade. One after another, self-righteous Senators and Congressmen marched into the spotlight and delivered their scathing political lines. I am told that, in international investment circles, Americans are considered to be narcissists: they focus too much on themselves and have surprisingly little interest or expertise in non-American economics. It must be difficult for them to see their stocks and bond markets rocking and rolling to the beat of a European concert. They are not used to having Greek and Italian politicians move their markets.
American politicians, like Canadian investors, are not in charge of this drama. We are part of a supportive audience, applauding on cue, anxiously waiting for the next act.
I wonder what’s going on back stage. I’m wondering if, while all eyes are focused on the obvious, if there’s not something subtle going on behind the scenes.
Subtlety #1. Consider, for a moment, the basic plot of both 2011 Econo-plays: Down Grade America, and The Wheels Fell Off the Euro Van. In both cases, governments spend far more that they earn. In both cases, they have to spend less – and (horror of horrors) they may have to raise taxes to earn more. Both these economic actions (austerity and increased taxation) tend to cool off an economy.
Subtlety #2. Pension fund managers, the ones who control many hundreds of billions of dollars in investments, like to have lots of money invested in the best performing financial assets, and much smaller amounts in the weaker performing assets. Since the year 2000, gold has been the best performer, bonds have been great supporting actors and the stock market has been the worst. Pension plans would dearly love the stock market to go up. But, when economies cool off, stock markets usually cool off too.
Subtlety #3. The Stock markets have been particularly volatile since this year. January 2011 saw the S&P500 at 1260 and it’s around 1260 now. (For you historians, it was 1260 in January 1999 too.) There have been wild up moves and wild down moves this year, but no real progress in either direction.
I am wondering if our friends, the pension fund managers, are taking advantage of the wild ups and downs of this year’s stock market drama, to quietly achieve their goal of reducing their stock market holdings. Pension funds like to move stealthily. Because they are so big, they need time to accumulate and distribute their gargantuan positions. And the Greco Roman drama being played out now, along with all its volatility and emotion, is giving them what they need: the opportunity to sell without being noticed.
Individual investors or small institutions like CastleMoore don’t need time. We can sell out or buy in quickly, whenever we observe danger or opportunity.
In my investment book, Beyond the Bull, I wrote about developing investment techniques: pre-planned procedures that you will follow so you can buy when opportunity presents itself or sell when markets become dangerous. Our techniques will be different from the techniques of the mega investors because we have liquidity and they don’t. But 2011’s wild gyrations and Greco-Roman Euro-drama have given them just what they need: an emotional distraction that allows them to quietly distribute billions of dollars of stocks. Readers who have access to your pension plan’s investments, check to see if they have reduced their exposure to the stock market in 2011. It’s what their prudent management plan should call for. The process of institutional selling in sideways markets is called “distribution.” It is always followed by a bear market. 2012 could prove to be a dramatic year too.