My Last Financial Forecasting Post

Two posts ago I mentioned that I do not want to create disposable content. One form of disposable content is financial forecasting. Years ago I did it. Sometimes I got things right and sometimes I got things wrong. In the end, the lesson I learned for myself personally is that although I was obsessed with finance for a few years, I no longer am. I discovered that I enjoy learning more about economics than the day to day market moves.

With that said, I did promise I would provide my thoughts on the stock market and where things might be heading. But this will be my last post on finance. I’m more interested in economics.

I currently have zero positions in the stock market. I did that for my own sanity, as I was spending too much time obsessing over things outside my control. I also don’t feel comfortable with the idea that people might lose money following my investment advice. Although my investment philosophy is far more conservative than most. When times are good, I under perform. When times are bad, I do quite well.

To do well when times are bad requires timing skills. These are skills I got right during the housing crisis and the stock market crash that followed. To think I will catch the next major move down and profit from it while focused on other interests, is not likely to happen. And since timing down legs comes with a cost of both time and money, I decided a few years ago to step away and pursue other hobbies.

With that long disclaimer behind me, here is my last financial forecast post.


Photo by Alex Proimos

Two Tidal Waves

When I think of what might happen in the next few years, I imagine two tidal waves. One wave is debt. One wave is technology. Each of these waves will strike. Which hits first will determine everything.

Debt Wave

Since the Great Recession, debt at every level has gone parabolic. Global debt is now over $100 Trillion. By suppressing interest rates, governments and central bankers have created an environment where lower financing costs, which could have been used to pay down debt, have instead been used to to become even more indebted. Interest rates have been rock bottom for years now and the debt levels continue to climb. Even at a low interest rate, financing costs to debt will at some point get to the levels where defaults are inevitable.

Central bankers have tried and continue to try to inflate their way out the debt. It hasn’t been working. Explaining their failure would be a post in itself. The short version is the more money printed, the more debt in the system, the more of that money is directed towards financing costs, malinvestment and speculation. This decreases monetary velocity and the result instead of being inflationary becomes deflationary. If this topic is of interest, seek out Irving Fisher’s Debt Deflation Theory.

We are now past the point of getting benefits from lower interest rates. Now comes the currency wars. Japan and European Union are working hard to devalue their currency against the US Dollar. OPEC is slashing the price of oil. The US Dollar is getting stronger. Besides cheaper gas, I see this having two major effects globally.

  1. All those emerging markets that borrowed US Dollars at low interest rates to fuel their expansion will now have to pay back those debts at a much higher rate since those debts are denominated in USD and the USD has gotten much stronger. This will be Japan’s carry trade story playing out all over again. Defaults are coming.
  2. Capital flight. Europe now has a negative interest rate. The misguided fools think this will encourage depositors to either spend or invest that money to spur the economy. Nope! What will happen is capital flight. Those deposits will start flowing towards higher and safer yields outside the continent.

Predicting which way the market goes is a guess. If the rest of the world goes into recession, we are likely to start seeing sovereign debt defaults. Interest rates can’t go lower. This could set off a global recession which leads our stock market lower. However, it is possible that investors around the globe looking to move capital to a safe haven decide to buy US equities. Not because they are a good value, but because a belief that the global corporations on the NYSE are the safest investment on the planet. Even more safe than US Treasuries. If that happens, the stock market could explode upwards, even as the world slips into recession.

I need to mention there is a risk that currency wars could lead to shooting wars. That would be a most pessimistic case. I’m not saying that will happen, but there are numerous parallels between the 1930s and today.

Technology Wave

The second half of the equation is technology. It is making our lives richer and safer and doing so at an ever increasing pace. I get lots of push back about my optimism and frankly I’m tired of debating it. The future is going to be awesome.

The fact that we are humans have never been able to imagine what that future will be, never stops the fact that we are constantly standing on the shoulders of giants and will continue to do so. We are progressing and at an accelerated rate. That doesn’t mean there wont be any problems. It means I am confident we will solve the problems of today with the technology of tomorrow. That is the way it has always been.

Here are a few of the sources that have provided me with the conviction that technology has and will continue to improve our lives at an even faster pace.

  1. Abundance: The Future Is Better Than You Think by Peter H. Diamandis
  2. The Rational Optimist: How Prosperity Evolves by Matt Ridley
  3. The Second Machine Age: Work, Progress, and Prosperity in a Time of Brilliant Technologies by Erik Brynjolfsson

Back to finance. If the gains from technology accelerate faster or at the same pace as the debt expansion, we could minimize, spread out or avoid the damage caused by the excessive debt discussed above. We tend to think of technology moving slowly and financial markets moving quickly. But Japan has been at near zero interest rates running massive deficits for 20+ years now. The US is at 6 years. How long can this go on? Beats me.

Last Words

I see two tidal waves coming. I just don’t know the speed. If I had to guess, I would say the debt wave will hit first. It could hit as soon as next year. Whether that causes the stock market to go straight down or straight up is something I don’t know. If it does go straight up, I don’t see it as sustainable. The reason being the debt defaults would be deflationary, which will cause asset prices to fall.

If my financial prediction happens to come true, it is not because I am a visionary. It is because I guessed right. I have no money on the line. If the market explodes up during a global recession, I will short it when it looks like it is losing steam. If the market tanks, I will go long and catch a bounce at the bottom. If those two low risk scenarios don’t present themselves, then I’ll continue to sit on the sidelines living a stress free life not glued to stock tickers. Win. Win. Win.


Forgetting What Type of Investor I Was

A few people have asked me why I stopped posting on finance. Until this week I didn’t really have a complete answer. Now I think it was because I forgot what type of investor I was. When I forgot, I started losing money. When I started losing money, I started losing interest.

All my biggest investment wins have come from betting against the market when valuations were extreme. During the dot-com era I got out of every stock before the collapse. I sold my house in San Diego with a huge profit at the peak of the housing boom. And I shorted the stock market prior to the 2008-2009 collapse. In each of those cases, I was exploiting economic events that were rare.

Then I lost my way. I became impatient.

Instead of waiting for the next bubble, I started betting against the bounce before the markets even had a chance to get overvalued. I failed to recognize just how far the Federal Reserve would go to pump up equities by destroying bond yields. Once the bailouts and aggressive monetary easing started, there was no putting the genie back in the bottle. At any hint of a market correction, a new tool would be announced and the markets would shoot up higher.


Money by Thomas Hawk

I closed out all my positions over 2 years ago. I came to the conclusion that nothing made sense to me and to focus my time elsewhere. Since then I’ve been studying economics while just briefly looking what is going on in the market. Stepping back from the day to day drama of the markets has increased my understanding of the current bull market.

Before investing decide what type of investor you are. Day trader, swing trader, value investor, mutual funds, penny stocks, bear market or whatever. Then do what it takes to get good at that style. Everything else is noise. I was successful when I took the opposite side of the bet when the markets got way overvalued. Then I changed my style without changing my strategy. Mistake.

Barry Ritholz starts each year off with a post not only fully disclosing his investing errors, but solutions on how he plans to avoid making those same mistakes going forward. This is a healthy strategy that I wish I had done. As investors we tend to remember how smart we were when we made money on an investment and how unlucky we were when we lost money. Protecting your ego is not a way to become a better investor.

I do expect to trade again at some point, but I’m in no rush. I still have more to learn. I do have an opinion on the current market environment, but I’ll save that for another post.


Financial Endgame

I was asked recently why I had not posted any 2012 Financial Predictions. The short answer is that my market timing skills have sucked since the end of 2009 and so I decided to stop doing predictions. It is my opinion that the markets are no longer driven by fundamentals and rule of law. They are now moved by policy, policy rumors and computers engaged in High Frequency Trading. Not just here in the United States, but globally. Last year was the first year in my post-college life where I did not buy or sell a single stock or bond.

At my heart, I still believe the world is still in for a monetary collapse of some sort. It could happen this year or in ten years. The world simply has too much debt and I believe there is no way for it all to be paid back. Although I have a deflationary bias for America, I learned from reading the excellent book Endgame: The End of the Debt SuperCycle and How It Changes Everything by John Mauldin that some countries are more likely to solve their massive debt problems with inflation.

Endgame: The End of the Debt SuperCycle and How It Changes Everything
Endgame: The End of the Debt SuperCycle and How It Changes Everything by John Mauldin

Boomerang: Travels in the New Third World
Boomerang: Travels in the New Third World by Michael Lewis is an excellent book that explores how different countries each have their own unique cultural response to the debt crisis. An investor today can’t simply look at bond yields and balance sheets. They need to understand not only their history, but the psychology of the citizens to predict possible policy outcomes. Predicting how another country will respond with an American bias could end up be a costly mistake.

Who collapses, how they collapse and in what sequence, could send the world and your investment portfolio incompletely different directions. There will be investors that will guess everything correctly and make ridiculous amounts of money. They will get on CNBC afterwards and tell you how it was obvious. Then 10,000 more viewers will open up options or FX accounts so they can be the next great investor.

One of the key things an investor must learn is what kind of investor they are. Well, I’ve learned that I”m not suited for guessing what sovereign countries and central bankers will do next. Beats me. And I’m not going to spend thousands of more hours trying to figure it out.

Financial Endgame (for this blog)

My true interest in finance has always been understanding and respecting risk. Sometimes I forgot that and lost money, but for the most part I’ve done OK. My love is in attacking biased conventional wisdom that exposes the investor to unnecessary risk. That is what I do best. That is where my focus will be in future financial posts.


How To Destroy The Wall Street Banks

There are over 10,000 banks and credit unions in the USA. Having a majority of the business go to four corrupt banks (Bank of America, Citibank, Wells Fargo and Chase) is not healthy for an economy. Want to destroy them? Read on.

Step 1 – Educate Yourself

What did the big Wall Street banks do that was so bad? Much, much too long for a post, but I will recommend watching The Inside Job as a primer. It is an outstanding documentary.

Inside Job

Other sources for financial education on the crisis include:

  • The Market Ticker
  • Mish’s Global Economic Trend Analysis.
  • Max Keiser
  • Matt Taibbi
  • Any interview with William K. Black. He led the prosecutions during the S&L Crisis.
  • The financial reporting for the TV show 60 Minutes.

Step 2 – Recognize There Will Be No Political Solution

Both parties, Congress and The White House are owned by Wall Street. They have been for many years now. There has been a revolving door policy between Treasury, The Federal Reserve and Wall Street. That will not change. There are a few honest members of Congress that understand the damage the large banks have caused, but they hold little power. They should be supported, but not counted on to make changes. The media and politicians continually frame issues in a left vs right paradigm to keep us separated. Don’t fall for it. Both sides are guilty.

Step 3 – Move Your Money

Change doesn’t happen on election day. It happens every time you spend or save money. You absolutely must move your deposit accounts to credit unions or a trusted local bank. If your credit cards carry no balance, move them as well. You can’t control who owns your mortgage and other loans. Focus on moving the other accounts. For more guidance visit Move Your Money.

Step 4 – Debt Decisions

If you do owe money to one of the large Wall Street banks, pay it off fast or default. Ideally you should honor your debts if you can. However, if your debt situation is too great to deal with in a reasonable time frame, seek out an attorney to help with debt restructuring or bankruptcy. This is not legal advice.

Step 5 – Starve Their ATMS

Now that you are away from the big banks, do not use their ATMs. Even if your bank covers the cost for you, seek out ATMs in your network. You don’t want any money flowing into their coffers, even if it doesn’t directly come from you. I always pull more money out the ATM than I need. Then I hide the money at home. This builds financial resilience as I always have free access to cash.

Step 6 – Spread the Word

Tell your friends and local businesses that you moved your money. Smaller banks do not have the marketing budget that the Wall Street banks have. Word of mouth is how they attract new customers.

Will it Work?

The big banks use a high amount of leverage. It may only take a 5 or 10% run on deposits to take down one of these institutions. I’m not a banking expert, so don’t quote me on the exact percent. When depositors pull money from a bank, their cash reserve ratio drops. When this gets too low, they are forced to raise money and if they can’t, the regulators come in and close them down.

Some would argue that these banks are already well below their reserve requirements and that they have been deemed “Too Big Too Fail“. Even if the regulators continue to let these banks violate banking laws, every dollar moved is one that can not contribute to future profits (or taxpayer losses).

They will not make another penny off my deposits or credit card business.


The Age of Deleveraging

I just finished reading a book from one of my financial mentors.

The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation
The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation is by A. Gary Shilling. Back when I used to spend hours every day watching the clowns on CNBC pump their fists about how great everything was, there were few voices of reason. One of them was Gary Shilling. Like me, he saw early on how the housing bubble was not just a subprime issue and how the losses would go beyond housing and damage the financial markets. That was a very unpopular opinion to have during the drunken days of the housing bubble.

The Art of Delveraging begins with Gary telling us about the 7 great calls he made during his career. Some Amazon reviewers seems to take issue with his bragging. I don’t. Gary has been successful because he often went against the consensus. This invites attacks right up until the moment you are proven right. I don’t know how many times I saw other financial experts rudely berate Gary on CNBC. He always kept his cool and came off as a true gentlemen. He earned my respect. If after ~50 years in the game he wants to write 100 pages saying what he got right without being interrupted, then God bless him.

Hopefully other readers will savior the wisdom of the 7 great calls. This is how a great researcher sized up the economic landscape at different points in our history. His greatest call in my opinion was buying long-term Treasury bonds from the very early 80s to the depth of the 2008-2009 financial crisis. In the early 1980s inflation was very high and so were interest rates. Shilling’s research showed that while everyone else was expecting more and more inflation that the opposite was true. By investing in high interest bonds, the value of your investment goes up when interest rates fall. And that is exactly what happened.

Most investors find Treasury bonds boring, because they focus on the interest. Gary focuses on appreciation. He writes:

A decline in yields from 4.0 percent in July 2010 to 3.0 percent may not sounds like much, but the bond price would appreciate 20 percent. If it occurs over two years, then two years’ worth of interest is collected, and the total return on the 30-year Treasury would be 28 percent. One a 30-year zero-coupon Treasury, which pays no interest but is issued at discount, the total return would be 34 percent.

If you’ve been actively following the banking and housing crisis over the past few years there are sections you might want to skim through. But for others, this book also serves as a great concise economic history book for the last decade.

Gary Shilling has been in the deflation camp since the early 1980s and is still there. After he makes his case for further deflation he concludes with 12 investments to sell or avoid and 10 investments to buy in the coming decade. This book serves as a good balance between the frat boy everything-is-wonderful nonsense in the financial media and the get-your-gun-the-end-of-the-world-is-near message coming out of the financial blogosphere.