My Online Password Strategy (2014)

My last post Scan, Encrypt, Store, Delete, Shred: Going Paperless! was about physically securing sensitive data in my home. The other half of a security plan is securing your online accounts. I am not an expert on security. My strategy is to be more secure than the vast majority of people on the Internet and do it in a way that is sustainable. We all know the problem. We either use easy to remember passwords or we reuse passwords across different sites or we become a ball of stress trying to recall which password we used with which site. Then we save passwords in our email folder and hope that it doesn’t get compromised.

Technology is always changing. What might have been considered a secure password a few years ago is now trivially easy to hack. In a few years, there may be new guidelines on passwords, but right now longer is better. And every password should be unique. Sites are being hacked all the time. When a site is hacked, the usernames and passwords are tested against other sites. You don’t want your health insurance password to be the same as your Amazon password and vice versa.

I used to have a “tough” password for important sites and an “easy” password for sites I didn’t care about. In retrospect that was a dumb approach. Compromise one of the important sites and the hackers could access all the other important sites. And my “tough” password was only 8 characters long with numbers and symbols, but because it wasn’t in the dictionary I felt comfortable with it. Processors are much faster now. That “tough” password is now trivially easy to break.

The Wikipedia has a good page on password strength and password cracking.

locks

Photo by Nathan Meijer

#1 Get a Password Manager

Passwords that are tough to crack are impossible to remember. They are also hard to type correctly. Password Managers not only help remember the passwords you use for different sites, but they are able to generate very secure passwords on your behalf. A good password manager will also be able to run a security analysis on your passwords to alert you when you are reusing a password or when a password isn’t secure enough.

There are several Password Managers. This CNET article covers a few. Which one you pick will depend upon your needs and devices. I’m not going to tell you which is best. Again I am not a security expert. I will say that whichever one you use is a step up from reusing short passwords.

#2 Create a Passphrase

The password you use to secure your password manager should be long, memorable and impossible for anyone else to guess. Mine is almost 30 characters long. An idea on creating a long passphrase is to use fictional characters, animals, numbers and string them together in a Mad Libs type sentence that is too silly to forget.

evilSPOCK.sings2.PANDAS_for$500

That passphrase is 31 characters long, memorable and impossible to guess. You should be able to create something equally as secure that you will not forget.

#3 Setup 2-Factor Authentication on Email

You can secure every password, but if someone hacks your email, they can start requesting lost passwords. Get 2 factor authentication. Read Two-factor authentication: What you need to know (FAQ) for a primer on the topic. The Two Factor Auth List has a list of email providers and other sites that offer this level of security.

#4 Change ALL Your Passwords

You can’t  assume that some hacker doesn’t already have one of your passwords already. Change them all. It will take time. Start with the sites that are most important to you. Use the Password Manager to generate the password. Here is an example of a 20 character password generated by my password manager.

!v8e5hzMmCYWc9DADmy9

Thankfully I don’t need to remember that or type it in by hand, because that task is now handled by the password manager.

If during this process you decide to close old accounts, still change the password first. You don’t want your old insecure password sitting on a database table* forgotten.

#5 Delete Old Emails

Even though you’ve changed your passwords, it is still a good idea to delete any old emails announcing you’ve created an account. Some have links to reset passwords in them. Delete them all and then empty the trash.

#6 Run a Security Test

A good password manager will have a security test. Run it until you pass. Once you pass, add a recurring event to your schedule to retest your security every so often. I retest my security every 4 months.

More Secure, But Not Perfect

If you follow the above steps, you will be far more secure than the average person on the Internet. If one of your sites is compromised, the damage is contained. Some argue that the Password Manager becomes the weak point in the security. Break that password and you have all the passwords. This is true. To minimize that risk, make sure your passphrase is secure (#2) and that you monitor developments in security from time to time.

The article “Severe” password manager attacks steal digital keys and data en masse talks about how some password managers were recently exploited. Most of the password managers were fixed. Despite those risks the article still advises:

On the whole, readers are likely better off using a password manager than they are using the same password for multiple sites. For that reason, Ars still recommends that people use a password manager. However, readers should remember that password managers represent a single point of failure that could lead to the complete compromise of virtually every website account they have. It’s not possible to know which managers are safer than others without a trusted third-party conducting a detailed assessment on each one. That said, well-known managers that have been available for years are probably more trustworthy than a newer one that was recently introduced into the market.

I put (2014) in the title of this post, because I expect security strategies will change at some point.

* When you create an account on a site, they are supposed to store your password in a secure manner. Meaning it should be encrypted on their database and not stored as plain text. That way if they are hacked and the hackers have a copy of the database, they won’t be able to make use of the passwords. Unfortunately, not every site uses best practices. OKCupid was storing 42 million user passwords in plain text. This is big reason why every password should be unique. I wonder how many of the OKCupid customers used the same password and email to access their online banking? 

Scan, Encrypt, Store, Delete, Shred: Going Paperless!

For as long as I can remember I’ve owned this file box. I’ve kept receipts, tax documents, my college transcript, auto records, insurance info, military paperwork and other important documentation. Not anymore. This week I borrowed a scanner and converted it all to digital. Then I encrypted everything and uploaded it to two cloud servers. Afterwards I deleted the local copies and  shredded all the papers.

For the first time in my adult life, I am 100% paperless. And it feels great.

Why Go Paperless?

When I went through my files, I saw my Social Security Number on many papers. There was also my birthdate, addresses, my signature and numerous other clues someone could use to steal my identity. Now I could go through the effort and expense of getting a vault that is fireproof and can’t be removed or a safe deposit box, but I prefer a free solution that allows me quick and secure access to my important data from anywhere in the world.

Brother ImageCenter ADS-2000 Desktop Scanner, 600 x 600 dpi, 50 Sheet Document Feeder
Brother ImageCenter ADS-2000 Desktop Scanner, 600 x 600 dpi, 50 Sheet Document Feeder – There are scanners at every price point.

#1 Scan Everything

After scanning everything into either PDF or an image file, I built a directory and started sorting. In addition to the files I scanned, I went folder by folder on my hard drive looking for anything that was sensitive data. If I didn’t need it, I deleted it. Otherwise I moved it into the new directory.

By the way, I gave the folder a unique name that would draw little attention. Even though I will encrypt this folder, I don’t want a name that will attract attention should one level of security be breached.

#2 Encrypt and Password Protect

The article How to Password Protect Files and Folders With Encryption provides some ideas on how to encrypt the folder. I used a passphrase that I know cold that is almost 30 characters in length that has never been written down anywhere. I do have a clue written down that only makes sense to me should I somehow forget part of it.

#3 Store on Cloud Servers

There are several free cloud server options out there. Their security isn’t stellar, which is one reason I did the encryption before uploading. I uploaded my encrypted file to two different ones. Each of these cloud servers is protected with a long unique password that only my password manager program knows. To get into that program requires another very long passphrase.

lock

Photo by Lok Leung

#4 Delete

At this point, all the sensitive data was still on my computer. It needed to delete in a way that someone with technical skills couldn’t recover. See when you delete files, they aren’t really deleted until those sectors of the drive are overwritten with new data. I used the free program Eraser (Windows). If you have a Mac, put the folder in the trash, then choose “Secure Empty Trash” from the “Finder” menu.

It is also important to delete any backup media with sensitive documents. I destroyed a few old CD backup burns.

#5 Shred

For years I had a cheap paper shredder. It did an OK job, but for this task I wanted a top shredder. I also did not want to spend an hour hand feeding a shredder fixing paper jams. Office Depot offers a service for 99 cents a pound that will securely and completely shred your documents.

Going Forward

All my bills now are paperless, so sensitive data won’t get intercepted in the mail. If something does come, I can deal with as it arrives in a secure manner. I now have the peace of mind knowing that if someone goes through my car, my home or my computer they won’t find any sensitive data.

I also understand my data is still not safe. Every doctor’s office where I wrote down personal data on a form is unlikely to be nearly as secure as I would like. Banks are being hacked all the time. And years ago it was common for schools to use a person’s SSN as a primary key on their database. Hack that database and you have a goldmine of data. There is nothing I can do about that, but I do know if there is a security breach it almost certainly won’t be from my end.

The second part of the security equation is minimizing the risk that my online accounts are hacked. That will be the topic of my next post.

Revising My Seattle Rent Outlook

In May I posted Ballard Rents – Don’t Believe the Hype! in which I gave my thoughts about the rent situation in Seattle. Although I am still confident that the near vertical increase in rents is about to come to an end, it might just be a brief pause before rents continue to gradually rise.

Seattle is between Vancouver, BC and San Francisco, CA. Two cities where the rents are higher. I don’t know much about Vancouver, but the cost of living in the Bay Area are very high compared to Seattle. Seattle like the Bay Area is a technology hub. Not every city is a tech magnet, but those that are will have a higher demand for housing from those with high salaries.

The problem with Canada and California is not only the high cost of living, but the taxes. Washington has no state income tax. This has and will continue to be a reason tech companies will migrate to Seattle. There are other states with no income taxes, but none that host a true tech city. Some say Austin has a growing tech presence, but it is not in the same league as Seattle. Plus it is friggin hot.

seattle-downtown

Seattle 

When I look at a map of the United States and I try to pick out tech cities that don’t have a high cost of living or onerous taxes and with temperate weather, only Seattle remains. Throw in the University of Washington which is graduating more and more skilled computer engineers every year and you can see that Seattle might be undervalued, which means rents may very well rise even after the current demand shortage is met.

Average Is Over: Powering America Beyond the Age of the Great Stagnation
Average Is Over: Powering America Beyond the Age of the Great Stagnation by Tyler Cowen

In the book Average is Over, economist Tyler Cowen made a prediction that certain cities where highly skilled workers live would become much more expensive and that there would be an economic migration where those not highly paid would move away. So much migration that in a generation, it might be seen as odd for someone with a low income to still reside in an expensive city.

The prediction made sense to me, because lower skilled labor will increasingly be replaced via automation, computers and eventually robotics. We’ve already got robots that can flip burgers and machines that dispense burritos in 1 minute. This trend will not only continue, but accelerate.

What I didn’t consider was just fast it would start to happen. The economic migration has already begun. The article Affordable Housing Draws Middle Class to Inland Cities goes into detail how the fastest growing cities in America are not the ones with most job opportunities for high wage earners, but places where the cost of living is low and housing inexpensive.

What Cowen articulates in his book is how the most important factor in deciding where to live is how much you have left in your paycheck once your bills are paid. Those with higher incomes will migrate to cities with other people with high incomes and enjoy the culture and entertainment opportunities it brings. Those without will move mostly South where their lower salaries go a lot further.

Seeing Seattle in this light, I now believe it will be one of those cities where the cost of living will be high.

UPDATE August 19, 2014: TechCrunch has an article supporting my view that Seattle is the non-Silicon Valley tech city.

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.

currency

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.

Getting More or Getting Nothing

Very shortly after my neighbors and I learned the new owners were going to evict all the tenants, a group was formed to fight the new developers. I wasn’t sure what the group was going to do. We were renters. The new owners wanted to make capital improvements to their property. In order for those improvements to take place, we had to leave. They owned the property. Most of the tenants were no longer on a lease and instead were on month-to-month options. And they are under no obligation to continue leasing units forever. This is a risk a renter takes.

To learn more about what this group was thinking, I went to an early meeting with a large number of my neighbors. From the start it was clear that their approach to the displacement would be conflict. They would be a thorn in the side of the new owners and maybe just maybe we could save our apartments from the developer upgrades.

I disliked the tone of what I heard. The were anti-development and pro-rent control. I see the developers that are coming to Ballard to either build new construction or upgrade existing structures as responding to market pressure. That isn’t greed. That is business. Our apartment complex is over 60 years old. At some point it will need capital improvements made. I believe in property rights. They encourage investment. I’m grateful there are developers out there building places I can rent. Rent control is an awful economic idea that discourages investment because it weakens property rights.

The problem with the high rents in Ballard isn’t caused by the developers. It is due to high demand. Developers are part of the solution. We have a rental shortage. This action will absolutely inconvenience me, but such is the risk of renting. When I was a homeowner, I had different risks.

This is Negotiating?

From afar I’ve monitored how the group “negotiated” with the developer. They using techniques such as picketing, marching, insults and personal attacks. At one point they even posted wanted signs with photos of the developers around the neighborhood.

I wonder what the leaders thought this would accomplish? Did they think the developers were going to stop the project after they were insulted?

Negotiation 101

Being hostile and emotional even when you feel you are morally right is not an effective way to negotiate. From the outstanding book Getting More: How You Can Negotiate to Succeed in Work and Life by Stuart Diamond:

Emotion is the enemy of effective negotiations and effective negotiators. People who are emotional stop listening. They often become unpredictable and rarely are able to focus on their goals. Because of that, they often hurt themselves and don’t meet their goals.

With negotiation you need to be aware of the needs of the other party. The developers had needs, but no one asked that question. More on that later.

Getting More: How You Can Negotiate to Succeed in Work and Life
Getting More: How You Can Negotiate to Succeed in Work and Life by Stuart Diamond is a book EVERYONE should read. Life is a negotiation. Learn how to do it effectively.

Economics, The Law and Reality

Before I outline how I would have negotiated with the developers, I first want to empathize with those tenants that feel they were wronged. Ballard in recent years has become a very desirable neighborhood. A lot of people want to move here. Many of those people that want to move here are willing to pay more than they would have in recent years. This demand has created a shortage of rentals, which has pushed rental costs up.

New construction will almost always demand a rental premium. It is the high rents that pay for the development. An industry report that I mentioned in the post Ballard Rents – Don’t Believe the Hype! states that new construction typically gets a rent premium of 40%. The flipside to this equation is that as buildings age they lose that premium. And since buildings do not last forever, there must be a steady supply of construction to not only keep up with population demands, but the wear and tear of construction itself. Nobel prize winning economist Robert Shiller touched on this in his book Irrational Exuberance.

The timing sucks for the tenants of my apartment complex, including myself. We are being displaced at time when supply has not caught up with demand. It absolutely will cost more to stay in Ballard. The good news is I do think the builders will overshoot at some point and rents will come down, but not in time for us.

Some have stated or implied that the developers have broken the law. If that is the case, then go to court. Although legal mistakes were made early on by the developer, I don’t see evidence that their current plans are illegal. You may not like the laws, but one would assume that a successful corporation has a talented legal staff on hand to guide them through development projects. It probably isn’t too likely that a handful of tenants will know the law better.

The reality is the tenants are being displaced so the developers can make capital improvements to the property. They will raise rents, not because they are evil, but because that is what the market wants at this time. You can argue with economics and the law, but the development will continue.

Negotiation Reboot

How could both parties have benefited from this situation? I have an idea. When the plans for eviction were announced in October 2013, almost all the tenants were off lease. They were paying month to month. This means they could leave with 20 days notice. Once the eviction was announced, the owners couldn’t write any new leases, because a tenant under lease can’t be evicted to make way for the new construction.

The worst financial case for the developer would have been had every tenant given 20 days notice in early October. There is lies the point of potential negotiation. We can’t stop the development, but we could have tried to collectively negotiate a lower rent to stay until the construction comes for our building. And before someone says you can’t negotiate rent, that isn’t true. I have lowered my rent and the rent of friends several times.

I heard a few months ago that half the tenants left on the news and the current vacancy rate is 57%. My rent is $875 a month and there are 138 units. Let us assume for easy math that everyone is paying the same rent. I don’t have a building schedule in front of me, so I’ll use 8 months as the average time a tenant had to leave. Some are sooner, some are longer.

  • $875 * 8 months * 138 units = $966,000 (maximum revenue to developer)
  • $875 * 0 months * 138 units = $0 (minimum revenue to developer)
  • $875 * 8 months *  69 units = $483,000 (50% vacancy revenue, which ended up happening)

For even math, I’ll use a 50% vacancy rate. This means the developers lost $483,000 in potential rent when tenants bolted. That also assumes the development has no delays. If delays happen the number will be higher.

What if collectively we would have negotiated for a $200 a month rent reduction to stay? We could run a spreadsheet on the scenarios, but the net benefit to the average renter would have been $1,600 (8 months * $200). What about to the builder? Let us say 20% of the tenants took off leaving an occupancy rate of 80%.

  • $675 * 8 months * 138 units * 80% = $596,160

In that case the builder comes out $113,160 greater assuming the project has no delays. For every month the project is delayed, they would collect $74,520 in rent. These are all back of napkin calculations. I don’t have all the data about rents, building schedules and vacancy rates.

The $200 was the first number that came to mind. It is a starting point to a conversation.

Last Words

I believe there was a path that could have benefited both parties. But it wasn’t taken. I probably should have asserted myself early on, but my pro-development, anti-rent control opinions would not have been accepted. They were angry and they wanted their voice heard. They talked negotiation, but in the end they got nothing.

Once again, I highly recommend the book Getting More. I only wish I had read it sooner in life.

Ballard Rents – Don’t Believe the Hype!

This is a follow up post to Trying to Cheer Up an Economic Idiot. In that post I outlined my opinion of what was happening in the red hot rental market of my Seattle neighborhood of Ballard. Unlike my neighbor, I don’t see the situation in Ballard as dire as he does. He believes that builders are driving up rents. I see the builders as responding to pent up demand and although new construction holds a rent premium, the increase in supply is the very thing we need to stabilize rent increases.

I want to thank Capitol Hill Seattle Blog for alerting me to the blog post If this is the calm before the storm… by apartment industry analysts Dupre + Scott. I want to highlight a few things on this report.

The report explains that new construction typically gets a rent premium of 40%. And in normal markets when building isn’t as high, this doesn’t have as much impact in the aggregate numbers. But development is high, so this makes it appear as if all rents are on a tear. They aren’t. Non-new construction rent is increasing at 5% per year. Still higher than inflation, but this is before the new supply of units hit the market.

Here is what they are saying about Ballard:

Ballard’s market vacancy is a mere 2.8%. But its gross vacancy rate is the highest in the region, at 17.3%. Now that’s downright scary, isn’t it? Yes and no. If Ballard was a city with 100,000 rental units and it had a 17% vacancy rate, then yes that would be scary. But there are fewer than 2,500 units in Ballard. That means there are 423 vacant units right now. And since developers increased the total supply of rental housing by more than 50% in Ballard over the past 18 months, it’s doing pretty well.

And they continue to build in Ballard. And they continue to build throughout Seattle. Their survey says that developers will be adding 7,000 new units in the next 6 months! Bring it on. Every tech worker with a fat paycheck signing a lease at one of these new apartment complexes is one less person bidding up existing rentals.

Ballard Locks

Ballard Locks

A side note about Seattle. Tech workers tend to be young and single. They not only want to live near work, but they ideally would like to live in a fun neighborhood full of other young and single people. Capitol Hill, Belltown, Lower Queen Anne and South Lake Union all fit that bill. Ballard really doesn’t. We are a little too far from the young and hip. I love Ballard, but would I love it as much if I were 25 with a fat paycheck? Probably not.

In the post I did last week, I said this:

Supply has been lagging demand for a few years. I not only expect it to catch up, but during booms builders have this history of building too much. This is good for renters.

It appears this might be happening. Not only does the title of the report suggests the industry is concerned, but it says that although only 15% of new apartments are offering concessions, the amount is increasing. What do Dupre + Scott predict?

We expect the use and size of concessions will grow significantly over the next six to twelve months

Significantly? I like the sound of that. They also say:

It’s good to be optimistic, but investors will likely find it more challenging than normal to raise rents between April and September.

As a renter that makes me smile. I love negotiating lower rent. Finally, I want those that don’t share my optimism to look at the last chart on the report. You will see an inverse relationship between apartment vacancies and rent. When vacancies rise, rents drop.

Vacancy rates are at or near an all-time low in Seattle. Construction of new apartment units is at a 21 year high. Supply is about to meet demand head on. Grab some popcorn.

Trying to Cheer Up an Economic Idiot

Last October I posted about my upcoming eviction. I live in the highly desirable neighborhood of Ballard in Seattle. In the past few years rents have increased and developers have been responding to this demand by building more and putting capital investment into existing structures. The apartment complex I live in was sold last year to a developer that plans on turning them into luxury apartments. Not only will the rents go up, but the construction is such that the tenants need to leave.

I get this and I’m not complaining. It is business. The fact is me and my neighbors have been paying below market rent for a few years now. When we move, we will be entering a market with higher rents.

Ballard

My neighborhood of Ballard.

I recently ran into a neighbor who was distraught about having to move. Even though we likely won’t have to leave until June or July, the neighbor has begun looking for new places. He asked if I had. I haven’t and I don’t plan to until the end date gets closer. He seemed puzzled, so I shared my 3 reasons why I’m holding on to the end.

  1. We are paying below market rent. My guess is we are underpaying by $200-$300 a month should we stay in Ballard. Every month we stay is a month we don’t have to fork over that money.
  2. There could be delays with the developer. It could take an extra month or several. I also reminded him that when the recession started in 2008 developers shelved construction plans for more than a year. Although the Seattle economy is super bullish now, it could always reverse. There are a number of things that could delay the construction. Again, every month we don’t leave is money in our pocket.
  3. As anyone can see that lives in Seattle, there is massive amounts of rental construction underway. This is especially true in Ballard. Lots of these buildings will completed this summer. If you combine the high demand from people moving into Seattle with very low interest rates, you get a commercial building boom. Although I don’t expect rents to drop immediately, I do think that increasing the supply of units available will relieve the upward pressure of rents. Basic supply and demand. Supply has been lagging demand for a few years. I not only expect it to catch up, but during booms builders have this history of building too much. This is good for renters.

My neighbor understood my first two points, but went ballistic on the third. He started yelling at me a bunch of economic nonsense about how increased supply always leads to increased costs. He also ranted other economic conspiracy nonsense. Too much for a single post.

Like so many people in Seattle, he lacks basic economic understanding. Increasing the supply of apartments with higher rents does not increase the rents everywhere. Those new apartment buildings are being constructed to deal with the current pent up demand. Those people are still moving to Seattle whether or not those apartments get built. And if they got a job offer from a tech company they can likely pay higher rent than most. That is exactly what has been going on in the past few years. Incoming high paid tech workers are bidding up the rental market.

As a renter, I see additional construction of rental units as a good thing. If the builders build too much, which is a possibility, we will start see rents come into line. If they don’t, then I’ll likely leave Ballard and pay less in rent.

I attempted to cheer up my neighbor and he was rude and angry towards me. I excused myself from the conversation telling him I couldn’t continue as I understood economics. There are reasons for my neighbor to be pessimistic. They are known. All I was attempting to do was provide some much needed balance to this discussion, but he wasn’t receptive. Lesson learned.

Car Repair Spreadsheet – Why Didn’t I Think of This Earlier?

I recently got nailed with a $1500 car repair bill. The big ticket item was replacing an EGR Valve. Now I know very little about cars and tend to tune out when mechanics start getting technical, so I didn’t recognize that this was the third time that I had to have my EGR Valve replaced in the last 3 years.

Now I keep meticulous records on my beloved VW Golf TDI, which I’ve named Silver Surfer. By meticulous records, I mean that I have this bulging folder with every receipt going all the way back to September 2001 when I bought the car.

Clearly my system failed.

Even knowing nothing about cars, I should have caught that the same part was being replaced 3 times in such a short period. Something else was causing the part to fail. My thick folder of receipts from six different mechanics across two states was too cumbersome to be useful. So today I spent a few hours doing what I should have done years ago. I created a spreadsheet for every service call done to my car. I created it using Google Docs, now called Google Drive, which is free.

Car repair Spreadsheet

After I created my auto spreadsheet, I chatted with my mechanic about Google Drive. Then I shared the sheet with them. Now he can see the what work has been done, when it was done and who did it. That is another diagnostic tool they can use the next time my car needs to be serviced. And because they know I’m tracking every action, they will be less likely to inflate the service requirements.

Even the act of creating this spreadsheet has made me more knowledgeable about cars. I was forced to look up a few items to increase my understanding before entering the data. I can now start intelligently being proactive about the needs of my car and not just blindly trusting the mechanic.

If you drive a car, I highly recommend that you create a quick spreadsheet for your car. You could save thousands. I would have.

If you drive a TDI or know diesel engines and see something that alarms you or have an idea on how I can save money in the future, please leave a comment.

Price Gouging is Good

I haven’t done a financial post in a long time, but I feel I need to defend what most people feel is indefensible: price gouging. What is price gouging? From the Wikipedia.

Price gouging is a pejorative term referring to a situation in which a seller prices goods or commodities much higher than is considered reasonable or fair. This rapid increase in prices occurs after a demand or supply shock: examples include price increases after hurricanes or other natural disasters. In precise, legal usage, it is the name of a crime that applies in some of the United States during civil emergencies.

This topic has surfaced due to the damage caused by Hurricane Sandy. Who can possibly oppose laws that protect victims of a natural disaster from being price gouged? Me and I’ll explain why.

Price gouging is not immoral. It is a normal economic response to a crisis situation when demand is high and supplies are low. When authorities prevent gouging, they remove or reduce the profit incentive for new competitors to increase supplies. The result is fewer entrepreneurs race to the crisis area, which keeps supplies low and delays recovery. The fastest way to get supplies to an area and restore normal prices is to allow price gouging.

The best thing for an area in desperate need of supplies is to have reports that massive price gouging is occurring. Why? Because entrepreneurs in neighboring areas will risk time, capitol and possible injury racing to the scene with those goods. The higher the profit incentive, the more entrepreneurs show up, which restore supplies and lowers the price quicker.

When authorities make or enforce laws against price gouging they discourage entrepreneurs from arriving to the scene with supplies. The price stays “fair”, but the recovery takes longer, because fewer players are willing to take risks when the profit margin is reduced. In addition, they also run legal risks of charging too much and finding themselves in court defending themselves. Better to stay home and not do anything.

It is also condescending for authorities to dictate price levels that free individuals can exchange with each other. If a family is without water or baby formula or insulin shots, then they should be free to pay whatever price it takes, because at that point in time those items do command a greater value.

Some will say that price gouging isn’t fair to the poor. But I would retort that not allowing those with more money to pay the higher price isn’t fair to them. At least when the higher prices are paid, that capital can be used to acquire more supplies, which will drive down prices. This ultimately benefits the poor as the crisis time is reduced.

If I haven’t convinced you then I highly recommend the EconTalk podcast Munger on Price Gouging.

Mike Munger of Duke University recounts the harrowing (and fascinating) experience of being in the path of a hurricane and the economic forces that were set in motion as a result. One of the most important is the import of urgent supplies when thousands of people are without electricity.

 

Meatloaf Economics

I got a comment on Facebook after I posted The Gyro Meatloaf Recipe about scaling down the recipe. The recipe is for a 3 pound meatloaf. My short answer was of course you can scale it down, but why would you?

It takes less than one hour to make a one pound meatloaf. That is heating the oven, mixing everything together and cooking time. A two pound meatloaf still takes one hour. As does a three pound meatloaf. So I make my meatloaf using 3 pounds of meat, because my baking tray isn’t suited to cook 4 pounds of meat.

Meatloaf is perfect for leftovers and for freezing. If you could interview my refrigerator, it would tell you that over 90% of the days in the last year I’ve had a meatloaf chilling inside her. *Are refrigerators feminine?

Cost and Time

Because I live in the Pacific Northwest, I can get grass pastured ground beef for about $6/lb. Add in a little onion, garlic and spices and a three pound meatloaf comes in at about $20 in material costs. If you use conventional beef, it will cost half that. For this example, let us say that the average portion is 1/3 of a pound or 5.33 ounces. That is 35 healthy grams of protein for just $2.22 (grass pastured) or $1.11 (conventional).

What is the cooking time per meal, assuming a portion size of 1/3 pound? Since each meatloaf takes an hour, a one pound meatloaf takes 20 minutes per portion. A two pound meatloaf takes 10 minutes per portion. A three pound meatloaf takes just 6.7 minutes per portion. Time economics dictate that you should cook the larger sized meatloaf.

Eating healthy on a consistent basis is not just picking the right food, it is also about balancing time and money. The meatloaf is slam dunk winner on time, money and nutrition. And meatloaf is also portable. I often will wrap a few pieces in foil and take them with me in a little cooler.

Now I am thinking that I need to buy another Pyrex tray. Two 3 pound meatloafs knock my time per meal down to 3.3 minutes. :)

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 Get Lower Rent

I ended the last post by stating:

Not everyone will get lower rent. Some people will be suckered into paying higher rent. Not me.

I am going to tell you how to get lower rent. First let me share my background on this topic. While still in San Diego, I negotiated $50 a month off a proposed rent increase. Then in 2009, I was able to get management at my Seattle apartment building to offer me a 5% reduction after first presenting me with a 3.5% increase. Later I was able to get another 10% reduction, but I left for a better deal. I have also helped several friends get their rent lowered.

Just this past month, I was advising a friend who was about to receive a monthly rent increase of $75. He was not in a position to move. He had too much stuff and not enough savings to put down a deposit on another apartment. I told him he had to bluff. The landlord needs to believe that you will move before they make a concession. My friend did exactly what I advised and was able to get his rent lowered by $25 a month. He turned a $900 a year increase into a $300 a year reduction. And he was bluffing. Had he really been able to move, I would have advised him to go for a greater reduction.

Crazy Landlord by Sean Ganann

How Do I Get Rent Reductions?

  1. I am an excellent tenant. I pay my rent a few days early every month. I’m quiet and I treat the management with kindness and respect.
  2. I am fully prepared to move at a moments notice. I own very little. I’ve got enough savings to pay new deposits and rent a van. I’ve even got all the boxes I’ll need. I keep them broken down and under my bed.
  3. The MOST IMPORTANT reason is that I ASK FOR A LOWER RENT. If you don’t ask for lower rent, then don’t expect it to be offered to you. The worst case scenario is that they say no.

Being Ready To Move

Although I have no problem bluffing during negotiations, it can make some people uncomfortable. The best way to build your confidence during rent negotiations is to be in a position to walk away. Sell or donate anything that is weighing you down. Have collapsed boxes and packing tape ready. I help all my friends move, so when I call on their help, I know they got my back.

How To Ask For a Rent Reduction

Step #1: Be Sweet – Get them on your side.

Getting them on your side is something you’ll be doing in every encounter with rental management. Always be polite. Never be confrontational. Be respectful. Remember names. This is something you will do on an ongoing basis. Don’t engage in community gossip.

I start negotiations by saying that I really like where I’m living and I don’t want to be forced to move. Don’t put rental management into a defensive position. Get them on your side.

Step #2: Be Smart – Provide reasons why the current rent or proposed rent increase will not work for you.

I once came in armed with data on the rents for every building within 2 blocks and said the rent increase was not justified and in fact should be lowered. I got the reduction. Once I even found a Craigslist posting for a similar unit in the same building with a lower rent.

It doesn’t have to even be comparable rent. It could be you had your work hours cut. Maybe your “brother” has offered a place for you to stay. The important thing in this step is to let them know that you’ve got other options. I even tell them that I don’t own much, so a move wouldn’t take long.

Step #3: Be Tough – Ask for them to reconsider the rental rate.

Reiterate that you like living there, you don’t want to be forced to move, but the rent offer is not acceptable. Then ask them to reconsider the rent. Unless you are dealing directly with the landlord, this request will get passed on from rental management to the owner. This is why it is a good habit to Be Sweet to the people in the rental office.

Rental price is not the only point of negotiation. If you are month to month, a landlord may request you sign a one year lease to get the rent reduction. This is a good thing. Negotiations have begun. Now you can negotiate the length of the lease. They may offer $75 off a month if you sign a one year lease. You could counter by saying 9 months at the $75 reduction or how about a full year with $100 off?

Final Words

Some landlords will not negotiate. It may be a foreign concept to them, but it never hurts to practice. Being ready to move is always the best defense against rent increases. Although this post was about rent specifically, the advice can be used to negotiate gym memberships, cell phone plans and other purchases.

By the way, I think every good tenant should negotiate for lower rent, not just those in financial hardship. Commercial real estate leases are negotiated all the time. Why not reduce your monthly expenses if all you have to do is ask?

Why I Dismiss Predictions of Rising Rents

About a month ago the “analysts” at Rent.com came out with a press release stating they expected rent prices to increase by a whopping 10% by the end of 2012. Their press release was picked up and reported across a wide variety of media sources. Even respected financial writer John Mauldin has referenced that number in his past two newsletters.

The problem with the number is it is complete nonsense. To predict rent prices will increase a full 10% by the end of 2012 fails basic arithmetic. It also fails a history lesson we learned just three years ago. I’m going to make the case that rents will NOT increase, and most likely drop as 2012 comes to a close.

What is the current state of the economy?

  1. Fuel prices are rising.
  2. Food prices are rising.
  3. Wages are static or declining.

Is short, there is too little money to support sustained rent increases. You see inflation has all sorts of feedback loops. People can not spend money that they haven’t earned, saved or borrowed. If more money is going towards fuel and food, then less money is available to spend elsewhere. The largest component of “elsewhere” is housing. In 2008, food and fuel spiked in price. Did rent go up? Nope. Rents fell and in some areas they fell hard.

I’m also surprised nobody called out the bias of Rent.com. They are financed by landlords that pay to have their properties listed. Of course landlords want to hear how they can pass on a 10% rent increase. This is just as biased as the predictions put out by the NAR (National Association of Realtors) during the housing boom.

Let us say that landlords read this press release and decided across the board to raise rents by 10%. It is a ludicrous assumption, but lets go with it for this example. What happens next? The same thing that happens whenever rents are too high. This is what happened in 2008.

  1. Young people return home to live with parents. That used to be a stigmatized. Now it is socially acceptable.
  2. People living alone find roommates. With social networking and Craigslist, this is MUCH easier to do than ever before.
  3. Older people on fixed incomes leave rentals and head for more affordable senior living or move in with family members.
  4. Houses that can’t be sold become rental opportunities.

Higher rents lead to higher vacancy which leads to lower rents. All this happened in 2008. Check out my November 2008 post The Softening Seattle Rental Market for a refresher. All throughout 2008, fuel and food prices were spiking. Consumers were forced to find ways to save money. They found cheaper housing. The same story is playing out right now in 2011.

But isn’t unemployment down? The government tells us that the unemployment rate is dropping, which if accurate would indicate a condition for rising rents. Without going into too much detail, that number is understated as workers that can’t find a job drop from the numbers after a while. A better number to look at is the Labor Participation Rate. Take a look that that chart below. It hasn’t stopped dropping since the start of the recession. This means there simply isn’t the wage support to absorb a 10% increase in rents.

Labor Participation Rate 2001-2011 (BLS)

What about rental vacancy rates? Is there reduced vacancy rates that would justify an increase in rents? No. In fact, look at the chart below. Vacancy rates are higher than they were 5 or 10 years ago. This is probably due to excess building and continued fallout from the housing bubble years.

Vacancy Rates
2000
2005
2007
2008
2009
Rental Units8.09.89.710.010.6
Homeowner Units1.61.92.72.82.6

Source: Census.gov Construction and Housing 979

Let me repeat something I’ve said before about inflation. Without a feedback loop to rising wages, inflation is unsustainable. When some prices rise, other will fall. Across the board, I am confidently predicting rent will fall by the end of 2012. Some landlords will raise their rent and they will chase good tenants away. Other landlords will lower their rents to attract those tenants. The net effect will not be an increase in rent.

Not everyone will get lower rent. Some people will be suckered into paying higher rent. Not me. In my next post, I am going to tell you how to get your rent lowered.

 

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
Inside Job

Other sources for financial education on the crisis include:

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.

Why I Do Not Believe HyperInflation is Coming to America

Over the past month I have read several articles by people smarter than me that believe hyperinflation or even sustained very high inflation is coming to America. Despite all the great arguments, I still have a fundamental problem with the thesis. How can a society continue to pay ever increasing amounts when wages are static or declining?

Where are people going to get the money?

  1. Not from wage increases, as severe currency devaluation would lead to rising costs that would certainly lead to more unemployment and further downward pressure on earnings.
  2. Credit? If the currency started tanking, there is no way the banks would keep open lines of cheap credit. Credit cards and revolving credit would cease to work. Why would a bank loan out $100 only to get paid back with a devalued currency? They own the hard assets. What is a fair legal interest rate in a hyper-inflationary scenario? That was a joke. I think their self preservation strategy will be to starve the economy of credit. Without an expansion of credit, I don’t see how hyperinflation can happen.
  3. Savings? Who has liquid savings in this country? Are we all going to run on the bank? Wouldn’t that drive the value of cash higher, especially if the bank pulls back on credit?

Fifty Billion Dollars by ZeroOne

If the citizens do not have the money or credit to buy gas at $15 a gallon, they won’t. There will be an immediate demand collapse and prices will fall. The only way hyperinflation can sustain itself is if there is a feedback loop that connects wages to prices.

In Zimbabwe, a country with hyperinflation, over 80% of the population is unemployed, so the government can print money and hand it out to the population. They don’t have credit and aren’t a real player in the global economy. We aren’t Zimbabwe. We are highly dependent upon credit, very tied into the global economy and without a way to tie wages to inflation.

Price pressures lead to margin collapse, layoffs and demand reduction. This reduces monetary velocity and causes prices to fall.

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.

Could Inflation in America Get Argentina Bad?

I haven’t posted much on finance lately as my interest in fitness and nutrition has held my attention. However, I have been thinking about inflation and if it could spread through the United States like it has started to in other countries. Argentina is expected to have 30% inflation in 2011. It has gotten so bad there that people are buying cars and parking them as a store of wealth.

With Ben Bernanke printing money via QE2, we are seeing food and oil prices rising. This is expected as printing money devalues our currency and we are forced to pay more for imports such as oil. In a food documentary I watched recently (forgot the name), it was estimated that 50% of the costs associated with conventional (non-organic) agriculture is fuel costs. So when Ben prints money, both your food and fuel bill go up.

I personally think Bernanke is an arrogant fool, but that is irrelevant. Will America see high inflation like the 1970s or Argentina? In order to answer this question I looked for similarities between modern Argentina and 1970s America. One thing stood out. In both cases there was a feedback loop between wages and rising prices via union representation.

Photo taken during my 2006 trip to Buenos Aires, Argentina.

In 1973 unions represented 24.0% of all American workers. Today that number is just 11.9%. As prices increased, unions were able to get cost of living increases. This fueled more inflation. According to Encyclopedia of the Nations, Argentina has a history of high union representation with a 35% participation rate in 2000.

In both 1970s America and modern Argentina there was high union representation and a method for increasing wages to respond to rising prices. Today that mechanism is gone in America. Does this mean prices can’t rise? No, but it means that if wages are stable or declining that the rise in some prices will be offset by price declines elsewhere. Maybe not at the same time, but eventually. When your grocery bill goes up and your paycheck and credit limit remains the same, you cut spending on something else, because you can’t spend or charge what you don’t have.

The fact that prices are rising in the thing we need versus the things we don’t need may seem awful, but Americans spend a lot more money on the things we don’t need than necessities. We become debt slaves to houses that are too big, attend colleges that cost too much, eat out in restaurants rather than learning how to cook and buy gas guzzling cars instead of getting a bus pass.

I could be wrong. Maybe the modern mechanism for inflation won’t be wages. Maybe it will be something else. I’ll explore that possibility in a future post.

2011 Financial Predictions

I wasn’t going to post my 2011 Financial Predictions given how horrific my 2010 ones were. Then I thought about it and decided to go forth for a few reasons.

  1. Even though 2010 was awful for me, I did call the entire 2008-2009 market crash. Prior to that I sold my house in San Diego at the absolute top and predicted housing would plummet. Note that a lot people now claim they saw it coming. That is nonsense. Very few people saw it and fewer acted on it.
  2. I started reading some of the financial predictions for 2011 and got bored to tears. The bulls are puffing their chests out, but that is to be expected. Everyone else seems to be hedging every prediction. Financial writers that I know are more bearish are setting easy targets and not what I think they truly believe.
  3. Predictions should be fun. I’m not a paid analyst for a hedge fund. I’m some guy in Seattle with web hosting. :)

Here we go.

  1. Recovery or Recession – Last year the government ran up a $2 Trillion deficit and it got us anemic growth. That game is about over. Austerity will hit us at the local, state and federal level. Not a lot, but enough to put us back into recession. Remember government spending contributes to GDP. It may not be officially recognized until 2012 that the recession started in 2011, but it is coming. Recession.
  2. Unemployment Rate – I doubt the states are going to get another huge stimulus or bailouts. This means layoffs for many government workers. The private sector is going to have to deal with increases in fuel costs due to Bernanke’s QE2 and new health care costs. These are disincentives to hiring. U3 will rise to 10.5% U6 will rise to 17.5%.
  3. 10 Year Treasury Rate – I’m going to be conservative on this one. It rises to 4% before dropping down to 3%.
  4. S & P 500 – The stock market is priced for recovery. I don’t believe the current recovery is anything more than borrowed government money and gadgets. Apple and Netflix can’t save the entire economy. My target low for the S&P 500 is 920.
  5. Real Estate – Big year down. Banks are going to start finally foreclosing on the squatters. Foreclosure-Gate could return. Local and state governments are going to unleash their attorney generals on the big banks to get owed property taxes. 15% down. Commercial real estate woes are going to come on strong in the second half of 2011.
  6. Oil - I did not expect Bernanke do another round of QE after the first one failed, but he did and as a result oil is increasing in price. It is rising because of a devalued currency, not increased demand. Speculators know how to push up the price of oil and then bail. I’m calling for oil to hit $110/bbl and then collapse to $70/bbl.
  7. Gold - I’ve been wrong the last two years. Let us go for 3 in a row. Gold drops to $1100/oz.
  8. US Dollar – I’m going bullish on the US Dollar this year. Deficit hawks will begin to be heard. Besides European debt problems, I think Japan is close to their breaking point. US Dollar index is at 80 now. I say it goes to 90.

Now I am going out on a limb to make some wild predictions.

  1. Japan Starts Printing – Frustrated by every attempt to devalue their currency and end 20+ years of deflation, Japan starts to openly hyper-inflate their currency.
  2. Ireland Goes Iceland – Ireland will throw out their leadership and default on their debt.
  3. Greece Defaults – They have a long history of defaulting on debts. This time is no different.
  4. Austerity Hits States Hard – Look for European style riots to show up in at least one state this year. My guess is Illinois is first.
  5. San Diego Files For Bankruptcy – Enron by the Sea is the first major city to declare bankruptcy.
  6. Housing Bubble Bursts Hard in Canada – Economic reality goes north.
  7. Bank of America Fails – One of the big four banks will be taken into receivership. I’m picking Bank of America.

Attack away or post your own predictions in the comments. Standard disclaimer: This is not investing advice. Do your own homework.

Reasons I’m Still Bearish

Call me a perma-bear if you must. I prefer to think of myself as a contrarian. The consensus in the main financial press is that we are in recovery and the stock market will continue rising into 2011. I’d love to join the cheerleaders, but I still see things different.

  1. Debts Are Too High – Not just our federal government, but across Europe and Japan too. States and cities have unsustainable debt loads. Consumers are loaded up debt. Don’t forget the massive amounts of student loan debts. We live in a credit society and the world is at or near the point of debt saturation. When every dollar raised or earned goes to debt service, defaults are certain. We never cleaned the system of bad debt during the 2008 financial crisis. It is still there only now it is much larger.
  2. No Driver For Employment – During the housing bubble we built too much capacity. Too many homes, malls and everything that goes in them. Governments hired too many workers with massive pension promises during the bull market and are starting to realize that growth was also unsustainable. Look for the next leg down in employment to come from government workers.
  3. Housing is Not Coming Back – Housing only got to the levels it did via insane lending practices, bubble psychology and the belief prices would always rise and never fall. None of those conditions exist. The only thing that prevented the housing market from total collapse has been the government allowing mark-to-fantasy accounting until the market recovers. In recent months, the Federal Reserve has conceded that housing is not coming back.
  4. Fraud Everywhere – One of my core beliefs is that a true recovery can not occur until the fraud from the previous crisis is addressed. It hasn’t been. In fact it has been rewarded. Sure speculators can drive stocks and commodities up, but true economic growth requires trust that laws are being enforced and stable rules.

A true recovery will not occur until honest accounting returns and unsustainable debts are recognized and written down. We should be outraged that our politicians have allowed the bankers to destroy the economy and then pass the debt onto us. But we aren’t. Most of us either don’t understand what is going on or just feel powerless to stop it.

Financial reporter Max Keiser understands what is happening and he is outraged.

Max Keiser rant

Reviewing My 2010 Financial Predicitions

Boy I blew it bad this year. We still have 3 trading days left in the year, but I’m throwing in the towel now. I could make excuses or tell you that I’m early, but I won’t. Let’s review my 2010 Financial Predictions.

Recovery or Double Dip Recession There is still too much debt in the system and no driver for job growth. It will be clear by mid year that all this talk of recovery is premature. Double Dip Recession.

Wrong. We are in recovery. Just turn on CNBC if you don’t believe me. All is well. Just ask President Obama, the bankers on Wall Street or the lobbyists in DC. Who needs employment when 1 out of 7 Americans now are on food stamps? That frees up disposable income to service debt to help the bankers. Gray skies are going to clear up, put on a happy face.

UnemploymentRate Because of the way the government calculatesunemployment, I expect the rates to stay somewhat flat, with a slight increase bias. U3 unemployment will end the year at 10.5%. U6 unemployment will jump to 18.5%.

Wrong. Using seasonally adjusted November numbers, U3 unemployment dropped from 10.0% to 9.8% this year. And U6 dropped from 17.2% to 17.0%. I love American ingenuity. Many people figured out that banks wouldn’t foreclose if they stopped making their mortgage payments, so they went out and bought more crap, which helped keep the economic juices flowing and took a dent out of unemployment.

30 Year Treasury Rate … the 30 year yield will rise to 5.5% and then fall to 3.5% if and when the market tanks.

Mostly Wrong. The 30 yield rose to 4.86% – not even close to 5.5%. However, it did fall 3.46%, only it didn’t require a decline in the stock market. Right for the wrong reason?

S&P 500 If I were basing this prediction strictly off valuations and macro-economics, Id say we were going to test the 666 low. But, I must take in account that the government will continue to allow banks to play shenanigans with accounting and they will backstop failure. Therefore my 2010 target low for the S&P 500 is 777.

Wrong. Not even close on this one. The government has backstopped failure, given the big banks money to play in the stock market and the honest accounting rules have still not been implemented. In September hedge fund manager David Tepper explained to CNBC how the new economy works. If things recover, stocks go up. If not, the Federal Reserve comes in with free money and stocks go up. Wee!

Real Estate …At some point banks will concede that home values will not return to the 2005-2007 levels for many years and start dumping properties. I think 2010 is the year that happens and will see a big leg down in home prices in 2010. Perhaps as high as 20%. Rents will keep falling and commercial real estate which has somehow avoided the laws of physics (so far)will tumble hard as well.

Wrong. The next hard leg down in real estate didn’t happen. Although I don’t have data for the 4th quarter, it appears prices were only marginally down. I guess all that nonsense I used to spew about price transparency and shadow inventory was just me being alarmist. Floreclosure-Gate? Never heard of it.

Oil The current price of oil is $80/bbl. It is based off a weak US dollar and a belief in an economic recovery. I think the recovery isnt going to happen and the US Dollar rises from here. Therefore, Ill put a $40/bbl price target on oil for sometime in 2010.

Wrong. Oil never got lower than $67/bbl this year. Can you feel the recovery? Or is that Bernanke debasing the currency with a second serving of Quantitative Easing?

Gold Gold is at $1092/oz now. Ill say it drops to $850/oz sometime in 2010. Before you gold nuts start slamming me with hate comments, please note that I was dead wrong last year. I could be dead wrong this year.

Wrong. Well I was right about being dead wrong. :) Gold is now in $1400/oz neighbrohood. It really is a good thing that governments don’t have a history of seizing gold during crisis situations. It would really suck to see a massive profit in metals taxed to nothing. Good thing our government rarely changes tax laws and is a friend of the individual investor.

US Dollar Trashing Americas financial woes was the meme for 2009. In 2010, I think the focus will go overseas. Yes our financial path is dreadful, but we are not alone. The dollar index will rise to 83 as we get at least onesovereigndebt default …

Right. The US Dollar went from 77.6 to 88.7, which surpassed my target. There were debt crises across Europe, but no default. When the long awaited default never happened and Ben announced QE2, our dollar sunk again.

As disastrous as my picks were in 2010, I stand 100% beside by general advice, which was at the very top of the post.

My general investing advice remains ultra conservative.

  1. Get out of DEBT.
  2. If you are out of debt, build your savings.
  3. Dont invest in the stock market until honesty is restored and valuations have returned to sanity.
  4. Dont buy a house yet. Rents are still falling and there is a huge shadow inventory that will get dumped on the market at some point.
  5. Go long skills and friendships. Develop skills that allow you to become more self sufficient and then share those skills with like minded friends.

You will not make money following that advice. It is a defensive strategy.

Will I do a 2011 Financial Predictions post? Given how horrific I did last year, I’d probably should quit. Right? All the top economists are saying 2011 is going to be a bullish year.

My One and Only Post on Sports Betting

I do not watch sports and the only gambling I do is on Wall Street. However, I am going to share with you a technique you can use to increase the odds that you will win a college football bet.

For the past 15 years I have been following the computer models designed by Jeff Sagarin. I do it because I like numbers and have a minor interest in how Ohio State does. His work is published on the USA Today website. Jeff is an MIT graduate that was an early pioneer in computer modeling of sports. My observation is that after about week 3 in a season, his models tend to be more accurate than the Vegas line. Well at least they have been for the games that I have followed, which is primarily Ohio State.

A month ago when Ohio State was ranked #1 in the country, Sagarin’s model disagreed. He didn’t even have them in the Top 10. When I added up the numbers, I knew it was very likely that #19 ranked Wisconsin would win. And they did.

Here is how you use the Sagarin model to determine how you should bet on college football. Note that Vegas sets the odds in a way that half the betters will lose every time. I would only use the model below when Sagarin disagrees with the Vegas line. By how much? That depends upon your risk tolerance. I personally don’t bet, so this is all academic for me.

For this example, I will use this Saturday’s Ohio State vs Iowa game.

Check With Vegas

Yahoo! Sports Odds shows that #8 Ohio State is favored by 3 points against #21 Iowa.

Check With Sagarin

Go to Jeff Sagarin computer ratings page on USAToday.com and select the College Football NCAA rating by team for the current season. Now you need 3 numbers: Home team rating, visitor rating and the home field advantage number.

Now add it up to see the what the computer ratings model believes the line should be.

Ohio State 85.96 – Iowa 82.87 = 3.09

The game is at Iowa, so we subtract 2.94, which gives Ohio State a 0.15 point advantage over Iowa.

Sagarin believes the game is even and that Ohio State should not have a 3 point advantage.

On an even bet, you should go with Ohio State. But on points, you should go with Iowa.

Is this method right every time? Absolutely not. This is gambling. The best time to use the Sagarin vs Vegas method is when the difference is significant. I wish I had saved the data from just prior to the Ohio State vs Wisconsin game. It was a slam dunk to bet on Wisconsin.

Sagarin also does modeling for other sports. I have not followed those numbers.

UPDATE: Ohio State won by exactly 3 points. Vegas got this game right, but using Sagarin’s ratings any OSU bettor would have paused to make that bet.

Save Money on Seattle Coffee With the Chinook Book

The 2011 Seattle/Puget Sound Chinook books are now out and they have some coupons in them that coffee fans should know about. For those that don’t know, the Chinook Book is a coupon book sold at PCC and the Town and Country Markets. It costs $20 and can pay for itself pretty quickly.

The coffee coupons in the 2011 Chinook Book are:

  • Aster Coffee
  • Caffe Ladro
  • Cafe Lulu
  • Caffe Fiore
  • Caffe Vita
  • Chocolati
  • Fremont Coffee Company
  • Fuel Coffee
  • Neptune Coffee
  • Urban Coffee Lounge
  • Victrola Coffee Roasters

The coupons are 2-for-1 or 50% offerings. So even if you get a $2 drink, you’ll pay for the book in espresso savings alone.

Clover Coffee at Aster by INeedCoffee / CoffeeHero

Keeping with the coffee theme, the Chinook book also has ice cream offers from places that make coffee ice cream using locally roasted coffee.

  • Bluebird
  • Full Tilt
  • Molly Moons
  • Peaks

My excellent tip to you is to encourage your non-coffee drinking friends to buy a Chinook book and then trade coupons. Take those coffee coupons off their hands in exchange for something they want that you wont use.

Sources:

Seattle Chinook Book – Official site.

PCC – Location page.

Town & Country Markets – Location page

The College Debt Alternative

This post is a follow up to The College Debt Trap where I pleaded the case to avoid becoming a debt slave to acquire a college degree. This post is about an alternate to college debt. If your Daddy, some scholarship or an employer is footing the bill then proceed with classes. Otherwise, read on.

I can count 3 things college provides.

  1. Knowledge in some program that may be utilized in future employment.
  2. Framework for the undisciplined learner.
  3. Certification that the student has completed the coursework for some program.

With the Internet, DVDs, books, lectures and other media, the colleges no longer have a lock on education. I can order a DVD set from Amazon that teaches me physics and then jump online to ask questions in a forum if I need help. Want to learn a foreign language? Many cities have community groups dedicated to foreign language instruction. Earlier this year I sat in a hospital lecture hall – side by side with doctors – and listened to a 3 hour lecture on nutrition. For free.

I could go on and on. Almost anything you want to learn you can without enrolling in college. That wasn’t true 10 years ago. The cost barrier for knowledge has plummeted outside the campuses.

College does provide a framework for the undisciplined learner. Sadly too many people need a test and a threat of a poor grade to motivate them into learning course material. Students throughout their learning career have been trained to follow orders instead of their passions. Committing to tens of thousands of dollars in debt to any learning without academic passion is foolish. Back when college was cheap, it made sense to find your calling during your freshman and sophomore years. Not anymore. Figure it out before you enroll. There are endless free or near free resources to help you

But you need a degree to get that job? Maybe but not necessarily. Sure there are many jobs where certification is an absolute must. However, I think we are the early stages of a trend where highly motivated people that work outside traditional education and can demonstrate their expertise on a topic will excel. How can one learn a subject, get experience in that field and not become buried in debt for life?

The Return of Apprenticeship

As more and more students wise up to the weakening value of a college degree, they will rediscover apprenticeship. Learn skills and gain important networking contacts by jumping into the field and working for a low wage or even free. The employer gets a passionate employee dirt cheap and the student learns what it is like to work in the field with a much shorter time commitment than college and without cost.

This summer I worked as a Technical Editor on a computer book that will be published this fall by Packt Publishing. I did it for free. This was an opportunity to test drive a new career working part time from home. My name and bio will appear in the book. If I decide to seek out a position as a Technical Editor, I’ll bring a copy of that book to the interview. The publisher and myself established a partnership that benefited us both. No professor required. That is the economics of apprenticeship.

The College Debt Trap

From time to time I will do a financial post on this site. These posts are not about getting rich. They are usually about minimizing risk and not doing something dumb. Using debt to finance college used to be a wise investment. Now – for many degrees – it is foolish.

Photo student debt pinata by Kate Raynes-Goldie

Earlier this year in the post Before Racing Back to College to Pile on More Debt, I posted a graph that clearly showed that although the costs of college has continued to increase at a rapid pace, the expected earnings for a degree peaked a decade ago! In other words, the ROI (return on investment) for a college degree has never been worse and continues to decline.

I know several people with over $100,000 in student loan debt that can’t find employment. The jobs they are applying for have pay rates that would give them just enough for food, rent, a car and interest payments on that debt. Some don’t even enjoy the careers they spent so much money earning degrees for.

What happens when you graduate, can’t find a job and then miss a few payments on your student loan debt? It dirties your credit history. This is a huge problem since many employers are now pulling credit reports on prospective job candidates. You may be perfectly qualified for the job, but because you got behind in your student loan payments during the worst job market in 70 years, that company won’t extend an offer because you are now a credit risk. Years of hard work can be undone in months when you don’t pay your debt overlords.

h/t The Housing Time Bomb

It gets worse. The Market Ticker recently posted on credit card marketing to college students in the post Colleges and Credit Cards. It seems colleges have been getting kickbacks from credit card companies when students rack up debts.

Can someone explain to me whyany student would go to such a college? Can someone explain to me why anyparent would provide any sort of financial or other assistance to their child to attend a schoolthat developed a program whereby the more their kid gets SCREWED by credit card interest THE MORE THE MONEY THE COLLEGE MAKES?

If senior citizens were the targets of these financial leeches there would be criminal charges. But we as a society don’t seem to have a problem with 18 year old freshmen, with very little real life experience, becoming lifetime debt slaves. Many people are finally waking up to the fact that debt sucks. We are at the end of a three generation credit expansion. Now comes the contraction. Asset values and wages are going to fall. However, student loan debt must still be paid back in full and with interest – even when the earning power of that degree declines.

Unlike other forms of debt, student loan debt can not be absolved in bankruptcy. It is with you for life. Leave college with too much debt and not enough earning power and you will be an indentured servant to interest payments for the rest of your life. I’m going to bet your parents or high school guidance counselor never told you that. Don’t take my word for it. Figure out what the true cost of your degree will be and a conservative estimate of what you can expect to earn should wages remain stagnant for 10 years. Back when college was fairly priced this was an easy gamble. Not anymore.

The price of college is no different than housing. It can not and will not rise forever. It is in a bubble phase and will at some point correct to the realities of what a degree is truly worth. It make take a few years or even a decade, but reality will set in and tuition will fall. In the meantime, what should the prospective student do? This entry is getting long, so I’ll share my ideas in the next post.

UPDATE: Check out this graphic on the problems and dangers of student loans. (h/t Dhammy)

Near Heart Attack

Earlier this morning I received an email from TD Ameritrade saying that my account had a negative balance. My face got numb and stomach tightened. No! No! It had been a few weeks since I last logged on. What happened? Quickly, I logged in and saw that both of my Ameritrade accounts had the balances that I remembered. There was no negative balance.

I called TD Ameritrade. Turns out I have a 3rd account that I opened back in 1999. I forgot all about it. I thought that my trading account from the dot-com days was closed. Nope. It was acquired by Ameritrade in some merger. They couldn’t close the account because I still owned 450 shares of Winstar. I worked for Winstar.

Back when Winstar laid everyone off and the stock tanked, I bought some shares dirt cheap as a lottery ticket that someone would acquire them. No one did and thus those shares are worthless.

Anyway, my 3rd account with TD Ameritrade is now closed. My heart rate is normal again.

My 401k Advice to the Unemployed

I’ve probably said something similar in the past, but I want to be clear about how I would invest my 401k if I recently lost my job. My strategy is based off hedging risk. The primary risks an unemployed worker with a retirement account faces is that they won’t get a job and that the stock market drops and so does their retirement account. How do protect yourself and hedge against that worst case scenario?

There are 2 possibilities for employment: stay unemployed (negative) or get hired (positive).

There are 2 possibilities for investments: goes up (positive) or goes down (negative).

Note that there is a correlation between hiring and a rising stock market. The easier it is to find a job, the more likely it is that the economy as a whole is improving and that could translate to rising investment portfolio. This also means there is a correlation between not get hired and the economy not recovering which could lead to a decline in investments.

The unemployed worker has already lost salaried income. To be long in the stock market just exposes you to more potential loss. You should be in cash. Most companies do not have an option to park your 401k money into cash. The good news is you no longer work for a company, so now you have the freedom to liberate your money.

  1. Rollover your 401k to a company like TD Ameritrade.
  2. Let it sit in cash until you establish new stable employment.

Once you are back in a stable job then reassess your investment strategy. And if the economy tanks and you can’t find a job, all your retirement money was protected! You lose nothing following this strategy. Note that every financial adviser will try and convince you to get into some investment, as they make their cut by keeping you fully vested in the market at all times. Ignore them and do your own homework.

I write this post because I do not see a driver for job growth and the stock market has rallied hard based off the belief in a recovery that I don’t see coming.

Vindication

In 2005 I watched the real estate craze from a front row seat in San Diego. My home value rocketed up to insane levels. Those with homes were drunk with excitement on how much money their home was worth. I got suspicious, just like I got suspicious during the craze of the dot-com days. After lots of research, which included reading the 2nd edition of Irrational Exuberance, I came to the very unpopular opinion that the party was about over and home prices would plummet.

Irrational Exuberance
Irrational Exuberance by Shiller, Robert J. – This is still one of the greatest books ever written on investor psychology. Highly recommended.

I was told by many people that:

  1. Real Estate never falls in value.
  2. Once you sell in California, you are forever priced out.
  3. I was making a mistake.

Well the house sold in early 2006 and I escaped to the rental market where I have been ever since. We all know what happened next. Real estate prices fell hard. However, up until yesterday I did not have a hard number to tell me what would have happened to me personally had I not sold my home.

My old house was sold in February 2010 for $200,000 LESS than what I sold it for in 2006. And this is after the new owner put $100,000 of upgrades into the home, including a swimming pool.

On March 9, 2006 in the post Won the Lottery, I said this:

Yesterday, I received the money for the sale of that house. It was A LOT of money. The amount of profit was insane. I am another winner in the California home seller lottery. The reason Im a winner is because Im not buying another home. More on that topic in another post.

Well that “another post” I referenced 4 years ago is today. The reason I didn’t buy another another home is because I believed a price collapse was coming. Prices did collapse and I got away clean. Vindication.

The Fitness Finance Analogy Updated

Over the past 15 years I’ve been known to say something like this:

Weight training is like a 401k. You don’t see the results right away, but over time they add up. Cardio is like a weekly paycheck. When the week is over, you no longer continue to accumulate benefits.

Given that I know more about finance and fitness, I’d like to update this analogy. A 401k is something one doesn’t draw upon until retirement and many employees are stuck in investment plans that are certain to lose them money in this secular bear market. Instead of 401k, I’ll use the term compound interest.

Cardio isn’t a weekly paycheck. It is far worse. Cardio is more like one of those high interest ghetto paycheck loans. You get the money now, but there are costs to incur later. Increased cortisol levels, slower metabolism, carbohydrate cravings, muscle loss, suppressed immunity, injuries and a host of other problems.

The new fitness finance analogy:

Weight training is like compound interest. You don’t see the results right away, but over time they add up. Cardio is like a high interest paycheck loan. The benefits you may see in the short term will be offset by costs in the future.

This Time Is Different – Eight Centuries of Financial Folly

I love reading financial history and analysis. If you dig through the site archives, you will find reviews to many books that would bore most individuals. Not me. I love the stuff. So when John Mauldin recently praised a book on the history of sovereign debt defaults and financial crises, I knew I had to buy it.

This Time Is Different: Eight Centuries of Financial Folly
This Time Is Different: Eight Centuries of Financial Folly by Carmen M. Reinhart and Kenneth S. Rogoff is a collection of amazing research on eight centuries of global financial data. I am humbled by the depth of the research in this book. However, the writing was extremely dry and pure academic. The authors took a topic that I adore and made it insufferable.

Michael Lewis, John Mauldin and Roger Lowenstein are all excellent financial researchers and they happen to be engaging writers. It can be done. The writers of This Time Is Different earned my trust with their research, but failed on analysis. This Time Is Different will certainly be used as a reference for better financial writers in the future.

Oil Prices – Here We Go Again

It is starting to look like 2008 again. Remember then? The economy was tanking and demand for oil was dropping, but somehow the traders on Wall Street were able to push oil to $147/bbl. They figured out a way to pump a bubble in oil just as the housing and stock market bubbles were popping. Once it was clear that we were heading into a deep recession oil prices plunged.

Today oil is at $87/bbl and a few of the traders I follow say it is going to $100/bbl this summer. Where is the demand? It isn’t there, but that is irrelevant. Traders know how to push the price of oil much higher in the short term and they will. The financial media is being loyal to their sponsors by convincing retail investors that higher oil prices are a sign of recovery. They did the same thing in 2008.

Photo recession #2 by mugley

Don’t believe the recovery story. Interest rates are rising and so is oil. Both are high cost factors for doing business. That means more business closings and more layoffs. This equates to further reduction in demand for oil.

Oil may very well be going to $100 this summer, but at some point someone must take delivery. When it is clear that there is no recovery, the price will collapse again. I’ve seen this play before.

Disclosure: I hold no long or short positions in oil. If it does spike over $100/bbl, I will most likely short oil.

Roger Lowenstein Coming to Seattle

My favorite financial writer Roger Lowenstein is coming to Seattle. On Monday April 12th, he will be giving a 90 minute lecture at Town Hall Seattle. Since a few of my readers live in Seattle and have an interest in finance, I thought I’d tell you about this event. I’ve already bought my ticket.

Details on the Anatomy of the Financial Collapse talk:

America’s biggest financial collapse since the Great Depression ended Wall Street as we knew it, says journalist Roger Lowenstein and we’re all to blame. Lowenstein, author of The End of Wall Street, indicts America for succumbing to the siren song of easy debt and speculative mortgages, and explains how rating agencies helped gift-wrap faulty loans that proved the ruin of investors and banks.

I’ve read three of Roger’s books and loved them all.

Origins of the Crash: The Great Bubble and Its Undoing
Origins of the Crash: The Great Bubble and Its Undoing

When Genius Failed: The Rise and Fall of Long-Term Capital Management
When Genius Failed: The Rise and Fall of Long-Term Capital Management

While America Aged: How Pension Debts Ruined General Motors, Stopped the NYC Subways, Bankrupted San Diego, and Loom as the Next Financial Crisis
While America Aged: How Pension Debts Ruined General Motors, Stopped the NYC Subways, Bankrupted San Diego, and Loom as the Next Financial Crisis

My reviews:

Origins of the Crash

When Genius Failed

While America Aged

Before Racing Back to College To Pile On More Debt

I know several people that are using the recession as an opportunity to pile up more student loans and get yet another college degree. Most are intelligent and qualified to do whatever they want, but think they are incapable because more and more professions now are requesting additional or specialized degrees. There is some truth to that, but the sad reality is the return on investment for college continues to get worse. Take a look at the graph below.

Looks like around the year 2000, college costs continued to rise rapidly and earnings stopped keeping pace. Going to college isn’t just about getting an education. There are many ways one can get an education. It is about making an investment in your future earning potential. And one must take in account that not everyone graduates. If you don’t graduate, you still have to pay those student loans back. Student loan debt can not be absolved in bankruptcy. You own it until you pay it off or die.

The primary lesson one should have learned from the past decade is that debt sucks. Returning to college to pile on still more debt when the value of the average degree has not kept pace with its costs is often a poor decision. Since most students are rarely paying for college directly from their own savings, the cost is burdened by someone else, be it family, an employer, the taxpayer or their future self.

What would I do if I wanted a college degree and didn’t want to become a debt slave? The same thing I did when I was 17. Join the military. Spend 3 years active or 6 years in the Reserves and Uncle Sam will pay for that degree. You’ll also become more mature, physically stronger, more self sufficient and you’ll have served your country. And best of all you won’t leave college buried in debt. I just read on the Army website that they even have a program to repay up to $65,000 of prior student loan debt. Seems like a sweet deal to me. Yes there are risks with the military, but there are non-combat Military Occupation Specialties.

My 2010 Financial Predictions

Not that anyone should care what I think, but I’m still bearish. I wish I could wake up one morning, review the data and become bullish, but I can’t. History tells us that true bull markets never start from valuations this high and that investor confidence is never restored until an effort has been made to clean up the fraud from the previous crisis. It hasn’t. Current stock market valuations are insanely high and the government is doing nothing to stop the rampantaccountingfraud. The current financial reform bill is flawed and investors know it. Therefore my thesis remains bearish.

My general investing advice remains ultra conservative.

  1. Get out of DEBT.
  2. If you are out of debt, build your savings.
  3. Don’t invest in the stock market until honesty is restored and valuations have returned to sanity.
  4. Don’t buy a house yet. Rents are still falling and there is a huge shadow inventory that will get dumped on the market at some point.
  5. Go long skills and friendships. Develop skills that allow you to become more self sufficient and then share those skills with like minded friends.

You will not make money following that advice. It is a defensive strategy. There is too much over capacity and debt in the system. And I don’t see any driver for employment in 2010. The Baby Boomers are now past peak spending years and taxes/fees will rise. The best way to win is not to lose.

With that general thesis behind me, here are some financialpredictions for 2010.

Recovery or Double Dip Recession – There is still too much debt in the system and no driver for job growth. It will be clear by mid year that all this talk of recovery is premature. Double Dip Recession.

UnemploymentRate – Because of the way the government calculatesunemployment, I expect the rates to stay somewhat flat, with a slight increase bias. U3 unemployment will end the year at 10.5%. U6 unemployment will jump to 18.5%.

30 Year Treasury Rate – China stopped buying our debt in October and Treasury is going to need to finance $5 Trillion this year ($2 Trillion for the deficit and $3 Trillion in roll-overs). How are we going to get buyers for all this debt? Two ways come to mind. The first is higher interest rates. The second is a stock market crash that scares investors into Treasuries, which would lower interest rates. My guess is the 30 year yield will rise to 5.5% and then fall to 3.5% if and when the market tanks.

S&P 500 – If I were basing this prediction strictly off valuations and macro-economics, I’d say we were going to test the 666 low. But, I must take in account that the government will continue to allow banks to play shenanigans with accounting and they will backstop failure. Therefore my 2010 target low for the S&P 500 is 777.

Real Estate – Holding foreclosed real estate on your books makes financial sense if you think you can get more for it at a later date. This is why banks have been building massive amounts of shadow inventory. They have also been reluctant to foreclose on manydelinquent home-owners (actually home owers). But unlike a stock, holding real estate has costs. Property taxes, upkeep and HOA fees continue to pile up for every property in the shadow inventory. At some point banks will concede that home values will not return to the 2005-2007 levels for many years and start dumping properties. I think 2010 is the year that happens and will see a big leg down in home prices in 2010. Perhaps as high as 20%. Rents will keep falling and commercial real estate which has somehow avoided the laws of physics (so far)will tumble hard as well.

Oil – The current price of oil is $80/bbl. It is based off a weak US dollar and a belief in an economic recovery. I think the recovery isn’t going to happen and the US Dollar rises from here. Therefore, I’ll put a $40/bbl price target on oil for sometime in 2010.

Gold – Gold had a tremendous run in 2009 and although it wouldn’t surprise me if it kept rising, I still remain acontrarian. Too many people are on the gold side now. When the average man on the street is rooting for an investment class like a sports team, be it tech stocks, real estate or gold, that often indicates a top and reversal. The same people that believed real state could only go up in price are now so-called experts in fiat currency history and areworshipingat the alter of Gold. Not me. Gold is at $1092/oz now. I’ll say it drops to $850/oz sometime in 2010. Before you gold nuts start slamming me with hate comments, please note that I was dead wrong last year. I could be dead wrong this year.

US Dollar – Trashing America’s financial woes was the meme for 2009. In 2010, I think the focus will go overseas. Yes our financial path is dreadful, but we are not alone. The dollar index will rise to 83 as we get at least onesovereigndebt default and the cracks in the China “miracle” economy begin to show.

I do have a favor for all you that are eager to attack mypredictions. Please include a link to yourpredictions (or post in the comments below). Comments with more than one link can take longer to post. If you don’t have a website, you can set one up in minutes at Tumblr.com with absolutely no coding knowledge.

Reviewing My 2009 Financial Predictions

It is time to review my 2009 Financial Predictions. It seems like a million years since I wrote that post.

S&P 500 By the end of 2009 it will hit633. This estimate is based solely off earnings ($42.26 x PE of 15). That is a conservative number. If you use a 12 PE, the number drops to 507. If Bernanke loses control of the long bond, this number will go below 500. The S&P 500 is at 931 now. The upside is very limited, where as the downside is serious.

What happened? The S&P 500 dropped down to 666 in March and then rallied up the rest of the year. The rally has been much longer and much stronger than I expected, but I did stick my neck out in January and predict a 32% decline in this index. We got a 28.5% decline before rebounding. I’d say it (almost) kissed my target.

Recovery, Recession or Depression in 2009? Depression. Until mark to market accounting is restored and the bailouts stop, monetary velocity will continue to plummet. The new Treasury Secretary appears to be another Hank Paulson and we are stuck with Bernanke until at least 2010.

Many economists are now saying the recession is over. Yet job losses continue and the consumer continues to cut back. Mish made a strong case that we are in a Depression back in September. My guess is we won’t know for a few years if this turns out to be a Depression, a double-dip recession or a recovery. For now, I’ll say I’m premature on my Depression call and say I missed this one. Note that I do think some areas of the country are clearly in a Depression, but the national picture is not as clear.

Real Estate Prices will continue to decline and decline at an INCREASING pace. As this happens bank lending will get tighter as their risk increases. Higher down payment requirements will force prices much lower. Those on the sidelines will continue to see home prices fall faster than they can save. There are $1Trillon in ALT-A resets. A massive wave of foreclosures is coming. The stigma of walking away from an underwater mortgage is going away as America becomes Bailout Nation. No recovery in 2009. If you must buy, the best deals will be new construction sold directly by distressed builders.

Real estate didn’t recover as I expected, but the foreclosures never came. Accounting fraud (aka Mark to Fantasy) continues. Banks that should have been shut down and forced to puke up foreclosed homes on the market were given billions of dollars. So millions of homes sit vacant while banks wait for asset prices to recover. They won’t. Although the foreclosure wave is being delayed (for now), there was no recovery in 2009. I got his one right.

Oilnailed it last year. Now with every central banker racing to devalue their currency this is going to difficult to predict. My wild guess is it goes down to $25/bbl before heading back up slowly.

Ouch. Oil is $79 and never came close to $25. I totally blew this one. Oil is up because the US Dollar is down and speculators are hording oil in parked tankers around the globe.

Unemployment U3 unemployment will hit 9%. U6 unemployment will hit 16%.

U3 is 10%. U6 is 17.2%. Unemployment hit my targets and kept going. Nailed this one.

Deflation, Inflation or Hyperinflation? Deflation. Asset prices will continue to fall as the leverage comes out of the system.

Asset prices are still falling. Credit is being yanked from the system at a historic rate. Credit is money. Banks are not lending. This is clearly deflation.

Gold All the experts seem to think it is going up. Im a contrarian. Im thinking deflation will be a more powerful force than every central banker devaluing their currencies. Gold drops to $600/oz.

I really blew this one. Turns out all the central bank devaluing was a more powerful force than deflation in 2009. All thisuncertaintyand fear ofsovereigndebt defaults caused gold to continue its rise. This was the biggest financial lesson I learned this year.

30-Year Bond This is the most important number. If it ramps America is hosed. Bernanke is using Quantitative Easing to push this number down. It is working for now. If it fails, look out below. I plan to have a post on this topic soon. Im going to bet against the grossly incompetent Bernanke and go with 4%.

Nailed this one too. Bernanke failed with his QuantitativeEasing. The 30 yield went from 2.8% to 4.7%.

Even though I missed oil and gold big time, I did have a caveat.

My picks for Gold and Oil are pure guesses and not true predictions. We are in uncharted economic territory now. Currencies are being devalued everywhere and at different rates. Everything else listed is a prediction.

So I have mixed results on my financialpredictionsfor 2009. What about 2010? Stay tuned. Not that anyone should listen to me, but I’ll have a 2010 financial post out before Monday morning.

I Don’t Know Karate, But I Know KA-RAZY!

The top financial story this month is the impending crash of the US Dollar. I do not know if the US Dollar will crash and if it does, when it would occur. Everyone seems to be looking at only half the equation. Let us discuss that half first.

Our deficits have exploded and our GDP has plummeted. Tax revenues are way down and spending is way up. In order for America to honor all its debt obligations at this point is going to take drastic painful steps, which I don’t think will happen in time. We may actually be past the point where we can mathematically not default in some manner.

Given all this our dollar should plummet and interest rates should be high. Although the US dollar is trading lower, it hasn’t crashed and interest rates are still low. If the likelihood of default is high, why aren’t interest rates higher? Is everyone blind to the mathematical reality or is something else going on?

Photo The Godfather by Auntie K

When one currency declines, another currency appreciates. So if the US Dollar crashes then the Euro and/or the Yen will appreciate. Prices we pay on imports will rise (oil) and our exports will be cheaper to our trading partners. Any country that relies on exports to the United States will see a severe decline in business. Less business means less money and a weaker economic situation, which will weaken their currency until a new equilibrium is found.

Does Asia or Europe want the US Dollar to depreciate? Absolutely not. We are all experiencing the Great Recession together. If the US Dollar tanks, it will kill their export business and greatly slow their chance for recovery. What the rest of the world wants is for America to show fiscal discipline and a recovery path that makes sense mathematically.

Enough about economics, let us move on to political stability. The higher unemployment rises, the less stable governments become. No one will lend to a government that they believe is unstable at anything other than an extremely high interest rate. Earlier this year I attended a lecture about geopolitics and economic stability. The speaker made a strong case that governments that were the least stable were those recently developed a middle class and then lost it during an economic crisis. Countries with a long history of a middle class are the least likely to overthrow governments during deep recessions. Young middle classes tend to be less stable. They finally get a taste of the good life and then have it taken away. Governments with a young middle class that rely on exporting to the United States could be destabilized if the US Dollar crashes.

One thing governments do to direct the rage of an unemployed population outward is to blame their trading partners and increase tariffs. If that isn’t enough, turn the trade war into a real war. It has happened before. It can happen again.

From Currency Deprecation and Global Imbalances by Michael Pettis:

Like in the 1930s, every country wants to devalue its currency relative to the currencies of its trading partners in order to boost domestic employment and take a larger share of foreign demand.But as we learned in the 1930s, it is by definition impossible for everyone to improve export competitiveness by devaluing.

 

So how will the disagreements be resolved?Almost certainly by an increase in trade conflicts.What many of the global participants have probably forgotten is that in a world of contracting demand, it is countries who control net demand who are in the strongest position to determine the outcome of a fight over trade.If the dollar is not allowed to depreciate in an orderly way against the currencies of all of its trading partners, trade tensions have no way to go but up.

Things are going to get ugly. How ugly and what type of ugly are the unknowns.

Post title is from the song The Payback by James Brown.

Time For Another Stock Market Crash?

I saw leaves falling from the trees today. Are we getting close to a stock market correction?

The market is WAY overvalued.

From Dave Rosenberg today:

The trailing price-earnings ratio on operating EPS is 26.5x. At the October 2007 highs, it was 18.8x. In addition, when the S&P 500 is trading north of a 26x P/E multiple on trailing operating earnings, history shows that at these high valuation levels, the market declines in the coming year 60% of the time.

The trailing price-earnings ratio on reported EPS is 184.2x. At the October 2007 highs, it was 23.4x.

Insider selling has never been higher.

From Most Recent Insider Selling/Buying Ratio Hits 95x on ZeroHedge:

…the most recent data indicates a ratio of 95x of insider selling $35 million to insiders buy of a whopping $367,720. If anyone has more definitive data, please advise, however a ratio of nearly 100x sellers to buyers is pretty conclusive of who is selling to the robots…

Unemployment is still rising.

How can there be a jobless recovery when the consumer is 70-72% of the economy?

Credit is still collapsing.

From US credit shrinks at Great Depression rate prompting fears of double-dip recession by Ambrose Evans-Pritchard:

Both bank credit and the M3 money supply in the United States have been contracting at rates comparable to the onset of the Great Depression since early summer, raising fears of a double-dip recession in 2010 and a slide into debt-deflation.

Bans are coming on high frequency and flash trading.

Large investment houses used super fast connections and a touch of fraud to drive this rally at breakneck speed. Looks like that advantage is about to end. From So Much For High Frequency Trading by Barry Ritholtz:

Flash trading is more like having access to private info from the sellers, knowing what they will accept, stepping in front of legitimate buyers, and then flipping the house to those buyers while capturing 0.001% of the transaction. No benefit to the seller, to the neighborhood or to anyone else all at a small cost to the buyer.

China will not decouple.

If you have 25 minutes, I highly encourage you to watch the video Outsourcing Unemployment. There is no way China is going to develop a consumer based economy in time to decouple from the American recession. It is a Potemkin Village.

If I were long in any stocks now, I’d be selling.

Freeing Up More Money For Coffee

Yeah, I may be peeved at the increasing prices of coffee these days, but I am still loyal to the bean. On September 1st my gym membership expired and they didn’t offer me any deals, so I left. What if I could liberate the $30 I was spending each month to lift weights and instead use that on buying more coffee?

I sort of had a plan on how I was going to do resistance training on the cheap. Seattle’s Green Lake Park has two sets of pull-up rings. Add in some push-ups and your cooking. Today I tested out my new gym and it was successful.

The “south branch” of the Green Lake gym.

I’m all about functional strength training using compound movements. For now this is all I need. After some mobility warm-ups, I did my first workout.

5 Pull Ups + 10 Push Ups repeated for 7 sets (30-40 seconds between sets)

Next time I plan on bringing a 16 pound medicine ball and adding squats. Since I do no cardio, this is enough of a workout for me. After a few months, I’m sure I’ll be itching to get back into my old gym. Or I may be heading to Home Depot to construct new equipment for my Green Lake gym. ;)

On the way back from “the gym”, I enjoyed espressos from both Neptune Coffee and Aster. I could get used to this. :)

How are you freeing up more money for coffee? Share your ideas in the comments.

Sources:

Green Lake Park – Seattle park and home of my new gym.

Neptune Coffee – My first espresso today.

Aster Coffee – My second espresso today.

Revisiting the Simplest Investing Rule

In the post Making The Simplest Investing Rule Even More Simple, I explained a rule for monitoring the S&P 500 weekly moving averages to spot buy and sell signals for long term investors. The rule comes from Karl Denninger at Market Ticker.

When the 20 WMA passes the 50 WMA by 1%, you buy into an index fund. When the 50 WMA exceeds the 20 WMA by 1%, you sell your positions and move into a cash position or fixed income position.

Last week, a buy signal trigger using this rule and a few people have asked me if it is time to get long. Let me start by saying that every rule works until it doesn’t. There is no such thing as a system that will work forever. It is my belief now that The Simplest Investing Rule is sending a false BUY signal. I think the recent run-up in the stock market has been manipulated by traders and does not reflect economic reality.

In the post Eye of the Hurricane, I listed my 2 criteria that must be met before I believe that a recovery is possible.

  1. Bad debt must be defaulted on and removed from the system. Mathematically we can not grow from these levels of debt.Denying the true value of assets is only delaying the reality. Japan went through a 20 year period of denial. We are in a deflationary period. Credit is being pulled from the system at a historic rate. We have too many houses, too many cars, too many malls and too many of about anything created via leveraged financing. There is no growth around the corner to absorb the excesses.
  2. The criminals must prosecuted. At the height of every bull market, there are individuals that play fast and loose with the law. Boesky andMilken in the 1980s. Bernie Ebbers and the boys atEnron during the dot-com days. There will be no market bottom until you start seeing old rich guys in handcuffs. Everyone knows the financial markets have been riddled with fraud for the past few years. Where are the arrests? The problem with this recession is not only have we not gone after the criminals, but the bailouts have created another wave of fraud. Until investors have their faith restored that laws will be enforced and the accounting is honest, they will not take risks, start companies and hire workers. They will sit on the sidelines.

Neither has happened. Nathan’s Economic Edge refers to both my criteria as Rule of Law.

For capital to form and concentrate IN A HEALTHY MANNER, the rule of law must be spelled out AND FOLLOWED. If the rules change over time, then those who have capital will look elsewhere to put their money to work.

Companies that should fail are being propped up. Consumers that make bad car purchase decisions are getting rewarded at the expense of others. The Federal Reserve is buying US Treasuries. Insolvent banks are keeping fictional home prices on their books. I could go on and on. America until recently was a country that followed Rule of Law. Now the rules change daily. Weak companies need to fail. Insolvent banks need to be shutdown. Asset prices need to be restored to pre-leverage values. Until that happens, capital will not flow and there will be no recovery.

The stock market is now priced for a extremely robust “V-shaped” recovery. The current P/E ratio on the S&P 500 is a staggering 145.

pe-ratio

My thesis remains the same. This is a credit (not inventory) based recession. Credit recessions arrive about every 3 generations (1873, 1930, now). Banks don’t want to lend. Consumers don’t want to borrow. Investors with capital are losing faith that Rule of Law is being followed. Foreigners have stopped buying the bulk of US Treasuries. Tax revenue has fell off a cliff. Monetary velocity is plummeting. Unemployment is still rising. Debt is exploding at all levels of government. I could rattle off stats for another 5,000 words. I won’t. The economic situation is ugly and getting uglier. And it isn’t just America. It is everywhere.

If you believe in the “green shoots” theory and that recovery is coming, please share with me in the comments where the growth driver will be coming from. Our economy is 70% consumer based. The consumer is tapped out.

If you held stocks from the 666 lows on the S&P 500, I’d being selling. You gained 50% in a few months. Don’t be a pig chasing an extra few percent.

Then again, I could be wrong.

Disclosure: I am invested in cash and short mutual funds (Prudent Bear and Grizzly Short).

Guest Financial Predictions by Derek Wilson

These are some financial predictions by my pal and former neighbor Derek Wilson. He doesn’t have a blog and asked that I put his picks on the record. My posting of his picks is not an endorsement. His 10 year timeline is much longer than anything I would attempt to predict.

  1. Residential housing: slow decline real terms: 1-2% average annual increase or 22% in 10 years
  2. Non energy commodities, more tied to economic cycle: agriculture/metals: light inflation 2-7%/year: up 48% in 10 years
  3. Gold: -10% to +15% swings, drop in physical demand offset by speculative holdings, up 100% over 10 years
  4. Wages: 22% higher in 10 years, 20% lower in real terms (9% higher vs CPI)
  5. Energy: oil 8% average inflation next ten years, potential 10-20% annual spikes offset occasionally by technology, without technology improvements, prices 80% higher in 10 years
  6. Interest rates: next 24 months, short term flat and low, afterwards driven by tax policy: a moderate tax rise with emphasis on spending cuts = mortgage rates in 6% range (short term in 3-4% range), moderate tax increases with no spending cuts = interest rates in 8-9% range (in a low wage inflation environment)
  7. Dollar value: annual loss of 2%, 18% loss over 10 years
  8. Stocks from 8/25/2009: 8% average return over next 5 years: can hit 2007 high again in 2014: 12% better than inflation over 10 years: up 116% over ten years,
  9. Inflation: real inflation over ten years 4.2%, CPI 2.9% : TIPS break even: govt CPI understates inflation by 1.5% year in most areas

Ranked by relative return:
Stocks over inflation 60%
Gold: 54% over inflation
Mid term/Long term bonds: (laddered) 49% over inflation: buy after rates rise in 3 years
Energy 37% over inflation
Non energy commodities 5% over inflation
Short term bonds 3% over inflation
Housing and Wages 2% over inflation
Foreigners holding in dollars: loss of 61% or 2% annual in real terms

Why America Wins

With a growing number of people dissing America these days, I thought I’d take the contrarian position and explain why America wins. Before I list the reasons, I think we need to explain what it means to win. To win is to be better the competition. It doesn’t mean things are getting better, because they aren’t. Everything is relative.

Whenever someone predicts the decline of America, I always ask compared to who? I’m not being argumentative, I really am interested in finding out. America certainly isn’t the best of everything, so why do we win?

  1. Welcome To Foreign Citizens – We take the best and brightest talents from around the planet and welcome them. Unlike other countries, we provide paths to citizenship, regardless of income level. Jared Diamond states in his book Collapse that 12% of Americans were born in a foreign country. He referred to our culture as having plasticity. We embrace and assimilate all cultures into our Melting Pot. Those ambitious immigrants can’t contribute to their home country.
  2. Open Accounting – This is bound to draw some chuckles at first, but stay with me. America historically does more to protect investors than anyone else. We go through periods of fraud (we are in one now), but we always emerge with more transparency. Emerging markets come and go. Investors chase high yield and make lots of money until the bottom falls out and the cycle repeats itself, only this time with a different emerging market. Anyone remember how Japan was going to be the dominant economic force 20 years ago? Turns out they were using shady accounting to hide loan losses and run everything from cash flow. Zero Hedge just posted Galbraith On China’s Drastically Overstated Trade Surplus. An economics professor has gone throw all the numbers and came to the conclusion that the China story may be riddled with fraud. Really? Bad loans being covered up through cash flow. Here we go again. I could go on and on. We tend to focus on our own problems and not notice that the fraud is just as bad and often worse in other countries. Winston Churchill once said: “You can always count on Americans to do the right thing – after they’ve tried everything else.” Other countries can’t make the same claim.
  3. Protected By Two Oceans and The US Navy – This idea came from George Friedman. We are protected from foreign invasion by two massive oceans. During the time periods when other countries are fighting wars and rebuilding from those wars, we keep growing. We have a geographical advantage over other countries. He states the US Navy controls every ocean on the planet. Every trade shipping lane is under our control. All the other navies in the world combined don’t match the power of the US Navy. We can shut down or choose not to defend any ocean we decide to. Free trade isn’t free. For another country to step up and displace America, they will have to resolve naval issues and building a Navy is extremely expensive and time consuming.

There are other reasons, but those three I think are unique. We recruit the best people and most investment and then we protect them. #2 is a real concern for me. The sooner America cleans up the fraud, the sooner we can win back the trust of the worlds investors and grow again.

I hope this post doesn’t come across as the ranting of a blind patriot. Maybe I’m wrong, but I don’t see any up and coming countries that will be to the world what America was to the world in the 20th century. Do you? I see great places to travel to, great places to retire to, but no place better for economic and personal freedom.

Secret Ways to Save Money With AT&T and Vonage

My phone bill was too much, so I decided to do something about it. I have a cell phone that uses AT&T Wireless and a land line with Vonage. From a quality and service standpoint, I am satisfied with both companies. Because I don’t use my phones much, I felt was paying too much each month. It was time to deal.

If you go to an AT&T store or look on their website, they will inform you that their lowest monthly plan is $39.99. The website has a $29.99 plan for senior citizens, but that doesn’t help me. So I called AT&T up and they told me about a plan that based off my usage would be ideal for $29.99 a month. Score.

My Vonage monthly fee was $24.99. The website lists a $17.99 account, but they charge you a $10 fee to switch. So I called up to cancel will the purpose of having them waive the fee to get me in the $17.99 account. That was my plan. Vonage then informed me of a $9.99 account and they gave me a month for free to stay. That plan is not listed on the Vonage site. Sweet.

Two phone calls yielded me $25 a month in savings and one free month of Vonage. Note that I am not a high use customer. These plans may end up costing others more money.

The Importance of College

I was digging through my old blog and came across this post from June 2004.

10 Years Ago Today – On 6/10/1994, I graduated from The Ohio State University. Although I’m proud of my school and degree, I will say that not once in my decade long working career did any employer ever check my old transcripts. And I will further say that nothing I learned in either the Business college or the Computer Science department assisted me in the workplace. EVERYTHING I do now to earn a paycheck, comes from skills I taught myself from books widely available at Barnes and Noble. No tutition or professor required.

For all you bright self-starters coming out of high-school, who are still not sure if you want to go to college, there is a message here.

With the recession well underway, I see a lot of people racing back to college. This makes perfect sense if your profession requires licensing. However, the biggest take away lesson of this decade should be that DEBT is to be avoided. Piling up more student loans is no longer the ticket to a high paying job. Access to knowledge is no longer being held hostage by the Universities. The internet has set it free.

This is just my opinion, but I believe being debt free during a deflationary credit collapse is more valuable than most degrees. I wonder what percent of college graduates would give back their degrees in exchange for having their student loan debt absolved?

The Millionaire Next Door

I was going through posts on my old blog and uncovered this financial book review. It was written in October 2004, which was a time when using leverage to flip condos was cool and saving money was boring. Boy have times changed.

The Millionaire Next Door
The Millionaire Next Door is by Thomas J. Stanley.

From October 2004:

I just finished reading the book The Millionaire Next Door. The core lesson is to be frugal. This is the classic case of preaching to the choir. I’m so frugal that I didn’t buy this book when it was first released in 1996. Instead I waited until the used price dropped to the $3 range. Waiting 8 years to save $17 — that’s frugal!

For the most part I think it’s a little long-winded, but it’s got some valuable lessons. The primary one is wealth comes from saving money and being frugal. Often those that live the rich lifestyle don’t save money and have lower net worths.

Who should read this book? If you are in a profession with a high income (over 100K), such a doctor, you should read this book. The other group that should read this book is wealthy couples with children. The book provides advice on how to be a good high-income parent and mistakes often made by wealthy families when raising children.

We now are learning that the rich lifestyle was fake. It was all demand pulled forward with massive amounts of debt. Now the bill is due. I’m glad I read this book back in 2004.

California Shrugged

I really don’t know why this news story isn’t getting more attention. The Peoples Republic of California is now paying state vendors with IOUs. These same state vendors do not have a clear path to convert these IOUs into money to meet payroll and other expenses. The same banks that defrauded the state for years are now refusing to accept these IOUs for payment.

iou-no-u-dont

Photo taken outside an ATM in San Diego yesterday.

The State of California is committing fraud and this is going to have devastating effects.

  1. Lawsuits – Any money the State of California thought it could save by kicking the can down the road will be eaten and more as these vendors descend on court houses. It is going to be a lawsuit frenzy in the Golden State.
  2. More Layoffs – If vendors can’t pay their employees and the state can’t pay them, then that will trigger more layoffs. Then the already cash-strapped California will have to pay unemployment benefits to those laid off. Someone didn’t think this through.
  3. Services Shutdown – If these vendors are being issued non-convertible tender, many will stop services until they get paid for services rendered. A lot of vendors work directly with protecting the safety of the citizens of California. Those planes that put out wildfires need to serviced.
  4. Pay Up Front - California just became a credit risk. Going forward all vendors will demand payment up front. No money, no work.

When you rip people off, they go on strike. The California situation reminds me of the book Atlas Shrugged. Only this time the strike is not being initiated by excessive regulation, but by lack of payment. I’m sure other state legislators are watching this closely. If they can avoid tough decisions by issuing paper promises, they will do the same.

Atlas Shrugged

Let us review the facts:

  • California represents 13% of GDP.
  • California can not pay its vendors.
  • California is issuing IOUs and banks are not accepting them.
  • President Obama has indicated there will be no federal bailout for California.
  • History tells us “where California goes, so goes the country”.

If you are long in the stock market now, you are a fool. The most important state to our nation’s economic health is nowcommitting financial fraud. This can not end well.

Eye of the Hurricane

I haven’t done a financial post in a while. There are a few reasons.

  1. My interests have moved. In addition to my new websiteCoffee Hero, I am also now researching nutrition and fitness with the same intensity I did for real estate in 2005-2006 and the stock market in 2007-2008.
  2. My thesis has not changed. I am still bearish.

Right now we are in the eye of the hurricane. For weeks we’ve heard economists talk about recovery and green shoots. Nonsense. Note that these economists are the same ones the missed the recession and credit crisis in the forecasts. For me, I need to see two things before I can believe a recovery is on the way.

  1. Bad debt must be defaulted on and removed from the system. Mathematically we can not grow from these levels of debt. Denying the true value of assets is only delaying the reality. Japan went through a 20 year period of denial. We are in a deflationary period. Credit is being pulled from the system at a historic rate. We have too many houses, too many cars, too many malls and too many of about anything created via leveraged financing. There is no growth around the corner to absorb the excesses.
  2. The criminals must prosecuted. At the height of every bull market, there are individuals that play fast and loose with the law.Boesky and Milken in the 1980s.Bernie Ebbers and the boys at Enron during the dot-com days. There will be no market bottom until you start seeing old rich guys in handcuffs. Everyone knows the financial markets have been riddled with fraud for the past few years. Where are the arrests? The problem with this recession is not only have we not gone after the criminals, but the bailouts have created another wave of fraud. Until investors have their faith restored that laws will be enforced and the accounting is honest, they will not take risks, start companies and hire workers. They will sit on the sidelines.

If you are still long the stock market now, I’d be selling. You got a nice bounce. The boys at the top are selling. From Insiders Exit Shares at the Fastest Pace in Two Years:

Sales by CEOs, directors and senior officers have accelerated to the highest level since June 2007, two months before credit markets froze, as the S&P 500 rebounded from its 12-year low in March. The increase is making investors more skittish because executives presumably have the best information about their companies prospects.

The captains of industry are telling you recovery is on the way, while they sell their stock to you. P/E ratios are now insanely high. The rally we have experienced is common in bear markets. The bounce between hope and fear is human nature.

I stand by my 2009 Financial Predictions. Even though I was too optimistic on unemployment, I think everything else still has a decent chance of playing out this year.

The Fat Tail

Last month I attended a lecture by Ian Bremmer about political risk and financial markets. It was interesting enough to inspire me to read his book.

The Fat Tail: The Power of Political Knowledge for Strategic Investing
The Fat Tail: The Power of Political Knowledge for Strategic Investing by Ian Bremmer will be helpful to investors that wish to understand political risk. The book is full of historical references on how political risk has impacted the financial markets. My favorite part was the analysis of governments that nationalize foreign investment and what can be done to minimize that risk.

If you invest in foreign markets, add this book to your reading list. Political interests and financial interests don’t always move in sync and understanding that could help you preserve cash.

My Reaction To What Bernanke Did Today

When I heard The Federal Reserve was going buy Treasuries (aka Quantitative Easing), I couldn’t help think of the final scene in The Planet of the Apes.

You maniacs!
You blew it up!
God damn you!
God damn you all to hell!

planetapes

Over on TickerForum.org, someone asked how to explain Quantitative Easing to the average American. User Mayorquimby said this:

Imagine you owe $20K on your credit card. Your interest is $500 a month. You can barely pay the interest. So you issue YOUR OWN credit card and LEND YOURSELF more money to pay your bills. And you expect your credit card company to INCREASE your line of credit (which is always MAXED) when the know full well that you’re paying them with money borrowed against yourself!!!!

Now imagine you are a country, not an individual. And instead of relying on your own population to buy that debt, you rely on foreign governments. Put yourself in the shoes of that foreign government that trusted us enough to park their savings into T-Bills.

What happens next?

When Fitness and Finance Intersect

Over the past month I’ve noticed my Glitter Gym has become less crowded. Each week I see less and less people. There are less members around in the mornings, late afternoons and even the weekend. Many of the people that go to my Glitter Gym hire personal trainers. When times are tough, people cut back on their personal trainer time. That is why my gym is emptying out.

I know a personal trainer in North Seattle that lost half his billable hours this year. This isn’t some punk kid with a newly minted certification. He has years of experience and in normal times – a full client list.

Photo getting-huge by Flickr user ericmcgregor.

One of the better trainers at my gym started doing high intensity 30 minute workouts for his clients. Can’t afford an hour? How about an extreme 30 minute workout? No talk. Lift and move. Go! The ironic thing is he will be taking a slight pay cut, but his clients will most likely do better under the budget option.

Besides the fact these trainers are are losing a lot of billable income, the other sad part is these same clients that spent hundreds and even thousands learning from these trainers, aren’t taking responsibility for their own fitness. As far as I can see, these people have stopped working out. They are gone. They never developed self motivation. From my post My Thoughts on Hiring a Person Trainer:

Motivation takes practice. Having a trainer push you, especially when you first start an exercise plan, can be very helpful. As one makes progress, self motivation should come easier. My advice is not to become completely dependent on a trainer for motivation. Push yourself. Just like any other exercise, it takes practice.

The final tragedy is with fewer people working out, there will be fewer Tales From the Glitter Gym. :-(

Not As Short As I Used To Be

At the beginning of the year I listed 633 as my 2009 target for the S &P 500. We came close to that last week. My plan all along has been to lighten up on my short positions as I get close to that target. On Friday, I reduced my short exposure from 90.1% to 68.2%. The pessimism bandwagon was starting to get too crowded.

MAS at 2

The latest S & P 500 earnings estimate has dropped from 42.26 to 32.41. With a conservative PE of 15 that puts the index at 486. I still think the stock market will continue to fall, but nothing moves in a straight line, so I decided to take some chips off the table. And if the market has a brief rally, I can always fully reload on the shorts.

Debt and Leverage

In the article Wall Street on the Tundra, financial writer Michael Lewis is able to brilliantly summarize the roots of the economic meltdown in just three sentences.

When you borrow a lot of money to create a false prosperity, you import the future into the present. It isnt the actual future so much as some grotesque silicon version of it. Leverage buys you a glimpse of a prosperity you havent really earned.

dump the debt by Flickr user Daveybot

Making The Simplest Investing Rule Even More Simple

Last April, I highlighted Karl Denninger’s amazingly simple rule for ordinary long term investors. Using his rule, long term investors would have sold their stocks and moved to fixed income back in January 2008 when the S & P 500 was at 1350. From The Simplest Investing Rule:

His rule which he learned from his Chicago days is to compare the 20 Week Moving Average to the 50 Week Moving Average. When the 20 WMA passes the 50 WMA by 1%, you buy into an index fund. When the 50 WMA exceeds the 20 WMA by 1%, you sell your positions and move into a cash position or fixed income position.

For those interested in this rule and its historical effectiveness, watch this 8 minute video.

Last Friday I met a guy who had lost a lot of money in the market and was in near panic. Even though he personally felt the market was going to go lower, he was still fully invested. Being the swell guy I am, I told him about The Simplest Investing Rule.

Then I saw his puzzled look when I mentioned weekly moving averages. He didn’t even know what the S & P 500 was. As simple as Karl’s rule is, I thought I would attempt to make it even MORE simple. Here goes.

This should take about 1 minute. It should be done once a week.

  1. Visit the 50 Week vs 20 Week chart on StockCharts.com.
  2. Find the 50 Week Moving Average (red) and the 20 Week Moving Average (green) on the upper left hand side of the chart.
  3. stock-spx-trim

  4. Using a calculator and the division key determine if either number exceeds the other by more than 1%. When the MA 20 exceeds the MA 50 by more than 1%, buy back into the market. When the MA 50 exceeds the MA 20 by more than 1%, sell your stocks and move into fixed income.

If you need help with the division, readHow to Find a Percentage of 2 Numbers.

There you have it. You now can use The Simplest Investing Rule to manage your money. You will never catch the absolute bottom and you won’t get out at the very top, but you will participate in bull markets and be protected in bear markets.

* DISCLAIMER: Thankfully, I am not a certified financial planner.

Santa Claus Rally – Hope You Got Out

From Christmas through the New Years, I told several people that stayed fully invested in the stock market that they received a holiday gift. That gift was the Santa Claus Rally. It was a wonderful chance to exit long positions and minimize the damage caused in October and November. The Santa Claus Rally as defined by the Investopedia:

A surge in the price of stocks that often occurs in the week between Christmas and New Year’s Day. There are numerous explanations for the Santa Claus Rally phenomenon, including tax considerations, happiness around Wall Street, people investing their Christmas bonuses and the fact that the pessimists are usually on vacation this week.

The Santa Claus Rally was not the foundation for the next bull market. It was your opportunity to get out of the stock market and move your money into fixed income. Sadly, the same people that ignored my advice back in July to get out of the stock market ignored my advice again. That 25% pop Santa gave you is all gone. Now the market is reaching new lows.

santa-claus-rally

S & P 500 chart from the November 2008 lows to the closing lows of February 2009

The take away lesson from 2008 should have been to understand and respect RISK. However, I am now seeing people that lost a lot of money in the market taking a Vegas-like double-down attitude. The reason you invest in stocks is because you believe they will rise in value, not because you are down and need to reach for yield to make your retirement goals.

Rallies can and do occur in bear markets. That doesn’t mean it is safe to get back in the pool. Look at the chart below if you want to see how easily an investor can be head-faked into thinking a bottom has formed.

star-step-decline500

Will The Housing Crisis Start a Civil War?

Catchy title, eh? I exaggerate, but there definitely is an undercurrent of hostility between different parties in the housing crisis. When I posted Mr. Microsoft vs Seattle Billy, the comments exploded. Some of the commenters were justifiably irate with Mr. Microsoft for deciding to walk away from his mortgage.

Then President Obama announced his mortgage plan and the anger level went up.

Whether or not this plan directly helps irresponsible home buyers is being debated all over the Internet. However, the perception is money will be taken from responsible tax payers and given to the irresponsible. Yesterday on CNBC, Rick Santelli went on a rant. Santelli is not a typical CNBC talking head. He is by far the smartest and most honest guy on the network. Rick Santelli is an outstanding journalist and the closest thing that network has to a Regular Joe.

rick-cnbc-tax-revolt500

Some quotes from the Santelli Tax Revolt Rant:

The government is promoting bad behavior!

This is America! How many of you people want to pay for your neighbor’s mortgage that has an extra bathroom and can’t pay their bills?

Rick Santelli even went as far to declare he would be organizing a Tea Party in Chicago. I read a few finance and investing web sites and there is a lot of support for this type of event. Someone has already started a blog to monitor The Chicago Tea Party.

So far the battle is between those that pay their mortgage and those that aren’t. But, there is a third group that should also be outraged. Those people that decided NOT to buy a home during the bubble should be livid. For years they were told they were missing out. Our society was drunk on rising home values. The renters that decided to be prudent were taunted. Look at this June 2005 cover from Time Magazine.

Time Mag Home Sweet Home cover

Why should be they be livid now? Well for years they paid higher rents as rental property was being converted to homes for sale. Often this group had to keep moving while a higher percentage of their income was directed at housing. Now these people will be taxed to pay for those bought homes that they couldn’t pay for. In other words, they will have to give their neighbor another housewarming gift.

It gets worse. Treasury, The Federal Reserve and politicians are now doing everything they can to stabilize home prices. Stable home prices are good if you already have a home and see that home as an investment vehicle. If you are in the market for a home, affordability is what you desire. Wonder why John McCain is so adamant about propping up home prices? Could it be he is having trouble selling his house?

The end game is homes values will return to 3x income. Down payments will be closer to 20%. Housing inventory will eventually drop to historical averages of ~6 months. Unfortunately, this process is going to take years to play out.

The Next Round of Real Estate Price Drops

Last September in the post Another Reason Real Estate Prices Will Drop Further, I outlined how the banks that got burned by easy lending would be forced to tighten their lending. At the time of the post, Fannie and Freddie were moving to a 10% down payment requirement.

It has only been a few months since then and the new guidelines have gotten tougher. Much tougher. From the article Home buyers to be dinged with new fees:

Under Fannie’s and Freddie’s new guidelines, even applicants who assumed their FICO scores would get them favorable rates will be charged more unless they can come up with down payments of 30 percent or higher. For example, a buyer with a 699 FICO score who can make a down payment of 25 percent will now get hit with a 1.5 percent “delivery” fee at closing under the new guidelines.

A buyer with a Fair Isaac Corp. FICO score between 700 and 720 will pay an extra three-quarters of a point. Even someone with a 739 FICO will get dinged with a quarter-point add-on.

30% down payment! I knew lending would move back to the 20% down model. Never did I think it would overshoot to 30% down. The point of a down payment is to protect the lender should the borrower walk away. A 20% down payment assures the lender feels some pain if they stop making payments.

With a 20% down payment, the lender has enough insurance that should they be forced to foreclose and resell the property that they don’t lose money. The only reason to go beyond 20% is because the lender feels the underlying asset (the home) will drop in value as much or almost as much as the down payment.

The new guidelines tell us that Fannie and Freddie are projecting a large housing price decline.

The article continues:

Applicants who seek to buy a condominium and cannot come up with a 25 percent down payment will be hit with a three-quarter point add-on penalty, no matter how high their credit score – simply because they are not purchasing a traditional detached, stand-alone home.

Condos are often purchased by first time home buyers. How are they going to come up with a 25% down payment to avoid the penalty? Prices have to fall. Even if they assume the 3/4 point penalty, that hit will be taken by the seller in the form of further price cuts. This will put even more condos underwater and cause more owners to walk away. This is going to crush the Downtown Miami.

What percent of home buyers will be affected by these fees? I tried to find updated FICO averages, but couldn’t. An average of sites that cited scores from 2006-2007, stated 42% are below 700 and only 18% are above 800. In other words, the new guidelines aren’t targeted at deadbeats. They target the majority of potential home buyers. It is Fannie and Freddie’s response to lending while housing prices are in free fall.

Instead of Makin’ Me Better, You Keep Me Makin’ Me Ill

Yesterday I stumbled across a ridiculous article on Yahoo! Finance called Retirement Guide for 20- and 30-Somethings. It was provided by SmartMoney and sponsored by Fidelity. Gee I wonder what their expert financial advice is at this time? Let me guess. They want you to be fully invested in the market.

Both Fidelity and SmartMoney pay their bills by convincing readers of two things:

  • They are experts and you are not.
  • That by not investing RIGHT NOW, you are missing out on great opportunities.

Once they’ve tricked you into thinking you are too stupid to save money, they then try and fill you with fear that you will die penniless living under the bridge in a cardboard box unless you put your money into the stock market RIGHT NOW!

What makes this particular article bad is the chart they use to support their thesis that you can’t time the market. Lets take a look at the 4 examples they cherry-picked from the last 100 years of stock data.

stock-recovery

Chart source: Ned Davis Research

That chart makes a good case for holding stocks in tough times. But that chart isn’t telling the full story.

  1. Market Crash ’29 – This is the most asinine case listed. The DJIA peaked at 381, dropped to 198 and then recovered to 294. Sounds good, right? Well, what they fail to mention in the above chart is the index tanked all they way down 41 by 1932. So the investor that got spooked and left the market at 198 did far better than the buy and hold sucker. The DJIA wouldn’t see 198 again until 1946!
  2. Financial Panic ’87 – This was a widely reported case of computers triggering off auto-sell orders while the economy was still robust. I’m not sure how spooked the average investor got compared to recessionary times.
  3. Asian Stock Market Crisis – The economy was in full tilt growth mode. I worked side by side with many day traders. No one cared. Pulling a financial crisis example from a non-recessionary time period is like saying your kids are well-behaved the week before Santa Claus comes.
  4. WTC / Pentagon Attacks – In the chart above they list a 25% gain if you bought after 9/21/2001. The DJIA was 8265 then. What happened after that spike? It tanked again. By Oct 2002, it was down to 7528. By March 2003, the index was still only at 7740. Again fixed income would have protected more money. With or without Al-Qaeda, it was a recession. Unemployment rises, earning fall and stock prices drop in a recession. This isn’t rocket science. And by the way, it now 2009 and the DJIA is at 7850, which is lower than the 2002 recovery number in the chart.

Before someone critiques me as picking the lows to support the case for fixed income in a recession, let me say that it was SmartMoney‘s thesis that one shouldn’t try and time the market. If they want to pick these dead cat bounces as proof that throwing your money into the stock market at the early stages of a recession is wise, then I am free to look past the bounce to see where the market stabilized. That is a far more conservative approach. It also frees up your money for other investment opportunities.

I wonder how many thousands of people read that article yesterday and didn’t think to even look at a chart to see how each of those examples played out.

Mr. Microsoft vs Seattle Billy

Some of my readers are already familiar with Seattle Billy. For those that missed those posts, here is all you need to know.

  • Bought a condo conversation at the absolute top of the Seattle real estate market.
  • He used an exotic loan to buy the place.
  • He was laid off 3 months ago.
  • He can’t find a job or interview.
  • He is directing all his unemployment benefits into mortgage payments.
  • He desperately wants to refinance his bloated mortgage.
  • Still doesn’t understand he overpaid and still believes his condo was a good investment.

Now let me introduce you to Mr. Microsoft. Mr. Microsoft is a friend of mine that if you haven’t guessed – works at Microsoft. Back in December, I put him contact with the Geldpress for an interview. Why was Mr. Microsoft interviewed for the post Seattle Housing – Microsoft Layoffs and Mortgage Walk Aways? Because he decided to stop paying his mortgage.

Let me give you an overview of Mr. Microsoft.

  • Bought a condo conversation at the absolute top of the Seattle real estate market.
  • Still fully employed in a high paying job.
  • Recognizes he overpaid and it was a poor investment.

Who is right and who is wrong? And are there shades of gray? When I covered Seattle Billy’s status, “Ed” commented:

It sounds like hes not smart enough to know that hes not that smart. So much for a lack of wisdom. The old saying ignorance is bliss will prove fatal in his case.

Tell him to cut his losses and walk out of the condo, live in a van and take showers at the YMCA until he finds a job. Keep a cell phone and stay under the radar from creditors.

Sounds like sound advice to me. The bank assumed way too much risk loaning a marginally employable individual with no money down hundreds of thousands of dollars to buy his old apartment.

What about Mr. Microsoft? Go read the comments over at the Geldpress to see the anger it generated. Commenter Mike L. said this:

He is going to intentionally not pay his mortgage for 6 months. Should he not be held responsible for the deal he signed? Could he have taken in a boarder?

He should also be taxed on the amount of mortgage that he will not be paying since its pretty much a gift from the tax payers.

He has no integrity if he lives there for 6 months free. Hes a thief, plain and simple.

Seattle Billy is unwilling to admit he made an awful business decision and has decided to keep his word, even to his own detriment. Mr. Microsoft knows he made a poor business decision. He put his emotions aside and did extensive legal and data research. He decided to not honor his agreement and walk away.

For many of us, our gut tells us that Seattle Billy is the honorable one doing the right thing. But we also know the banks that wrote these crazy loans are getting bailed out by the billions. They share a large part of the responsibility. As I said in the post The Lack of Trust in the New World Economy:

Every day we are hearing stories of people and corporations walking away from their obligations. Not only are they not being punished or shunned, they are being rewarded. We are waking up to a world where the people paying their bills are the suckers.

Since buying a home is a business decision, I looked into how businesses are responding to the economic downturn. I talked with an executive at a cash-rich national retailer. They have decided to renegotiate all their mall leases this year. They want a lower lease and they may decide to close stores if they don’t get concessions. They signed a lease, have the money and yet they still want a lower payment. It is purely a business decision.

What would I do if I had an exotic mortgage loan (2005-2007 vintage) and I was in the same situation as Seattle Billy and Mr. Microsoft?

  1. Collect data on what the fair market value comparable housing units. I actually know a lady that is afraid to see what condos are selling for in her building. She thinks if she doesn’t know then somehow her net worth is higher. This is childish. Get data. Get data trends. If you live in a multi-unit building, find out how stable the HOA is.
  2. Contact your mortgage company and ask for a principal reduction. Armed with data, you can tell them what the fair value should be and where it will be in 6 months. You do not want to refinance a bloated mortgage at a “good rate”. You want the principal dropped and let them know you are prepared to walk.

Would I walk? It depends. It definitely doesn’t cost anything to reach out to your mortgage company. If a few phone calls can get 50K or 150K knocked off your mortgage, then it is worth a try. Arm yourself with data and then try and broker a compromise. This acknowledges both parties made errors on the original agreement and you are trying to find a fair solution.

What if the mortgage company doesn’t want to renegotiate? Run the numbers. Find out what comparable rents are. Figure out what you think you can save a month in the rental market. Calculate how long it will take to make up the lost value in your home. At this point, math will tell you the right answer. This is a business decision.

What do I think will happen to Seattle Billy and Mr. Microsoft? Seattle Billy will eventually lose his condo and file for bankruptcy. Mr. Microsoft will most likely contact his mortgage company in a few months and get a serious principal reduction. If the mortgage company acts too late, Mr. Microsoft will slip into the rental market for several years while hoarding mounds of cash. Then at some point he will pounce on some distressed property that he’ll get for pennies on the dollar.

Mr. Microsoft versus Seattle Billy. Your thoughts?

An Update on Seattle Billy

Back in March, I posted an entry called The Financial Wisdom of Seattle Billy. He is a likable guy, but when it comes to financial decisions, he is the perfect gauge of what not to do. From that post:

Billy is a college graduate working a white-collar job. Billy is also a financial idiot and to me that is what makes him interesting.

Billy bought a condo at the absolute peak of the Seattle real estate market in 2007. Actually it was a condo conversion. He got the privilege of swapping his low rent payment for a bloated mortgage without having to hire a mover.

Now Billy is without a job. He was laid off 3 months ago. He can’t find a job. He can’t even find an interview. When I first met him, he explained to me how Seattle would not be affected by a downturn in the economy. He thought it was a California thing. I just let him keep talking.

I learned that Seattle Billy is directing all of his unemployment benefits into paying his bloated exotic mortgage and dipping into savings to survive. Instead of recognizing that he was duped into paying too much for his condo, he is now obsessed with refinancing. The idea of walking away or negotiating a principle reduction hasn’t even occurred to him. The bank that sold him the mortgage has been seized by the FDIC. The bank that now holds his mortgage is getting bailed out by the billions.

Some people can not learn through observation and research. They must get burned by the hot stove. I expect Seattle Billy will sell every asset he has to keep making payments on his condo. He will probably do something really dumb like borrow against his 401k, which is protected should be have to file bankruptcy at some point. Then one day he will realize he was duped by fraudsters into being a debt slave. But that might be another year or so. By then, I expect him to be angry, bitter and penniless.

Timing the Stock Market

I am not into Technical Analysis, nor do I care to be. My financial thesis is based off of valuations and statistics. Timing the daily or weekly movement is not something I am equipped to do. This means that although I believe the direction of the indexes will go down this year, I do not know what path it will take to get there or how long it will take.

If I had any long positions, I would use short term rallies to sell and move into fixed income. That is me. This market is not honest and the rules are changing daily. I am not a certified financial guy and nothing on this blog should be considered investment advice. Do your own homework.

I do have a lot of respect for those that do Technical Analysis. I just don’t have the constitution for it. Every now and then I find myself following the TA guys and getting nervous about some rally. Then I remind myself that I am not out to make money today, this week or even this month. My thesis may take months or a year to unfold. And when new macro-level data appears, I can alter that thesis.

I Just Woke Up From A Fuzzy Dream

I’ve bashed company managed 401Ks in the past. Now it feels like I’m kicking a corpse. Let me get one final punch in.

Today I received the year end statement for my company 401K. When I say “my company”, I mean the one I worked for from January 2002 – May 2006 and again from September 2007 – April 2008. Both times I left the company, I had the balance of my 401K moved to a self directed account with Ameritrade.

Smart move.

I know people that can’t be bothered with managing their retirement money. They set the contributions and then hope everything works out. I didn’t believe the market was honest and exited before the crash.

Here were the 2008 returns for the 4 diversified funds offered by my company.

  • -16.79% Conservative
  • -26.14% Moderate
  • -34.54% Growth
  • -40.61% Aggressive

When I look back at the 3 year returns, all these funds are still negative. In fact, none of these funds beat the FIXED INCOME FUND over a 1, 3, 5 or even 10 year time span. But fixed income is so boring, who would ever advise something that boring?

Sign of the Times – The Counter Offer

As deflationary pressure builds in the economy, cash becomes more valuable. It goes to reason that those with cash are now in a strong position to ask for a better deal. I have cash and like everyone else, I’d like a better deal. I decided to start making Counter Offers when confronted with a request for my cash.

I’ve been to Tijuana and Paraguay. I know how this game is played. Let the fun begin.

  1. Gym Membership – If you have a membership with a big name gym with an 800 phone number, I encourage you to call up and cancel your membership. When asked why you wish to cancel, tell them times are tough and you need to save money. They will almost certainly cut you some deal. If they don’t, you are always free to hang up and try again next month. I detailed this a while back in the post Glitter Gym Hijinks.

    Anyway, my current gym would not budge on price (too many New Years customers), so I asked them to extend my 3 month membership by 2 weeks. They did. That is 15% free, just for asking. Score!

  2. VOIP – My phone company Vonage did something very dumb. They sent me a direct mail offering me 2 months of free service if I come back and restart service. This was dumb, because I never left. So I called them up and asked to cancel my service. When they asked why, I told them so I could rejoin and get 2 months free with the offer I received in the mail. They kindly offered me 2 months free when I pointed this out to them. Score!
  3. Satellite Radio – My 4 year membership with XM was finally up. Now I love XM dearly, but I wasn’t about to let them know. I called up to cancel. I told them I like the service, but the online player has acted up since the merger (true) and the price is too high. They offered me a 50% rate reduction to extend for 1 year. Score!

I was 3 for 3 this week. When someone asks for your cash, make them a Counter Offer. Be prepared to hang up or walk away. The worst they can say is no.

You Can’t Hyperinflate Wages in a Global Economy

Whenever I hear someone say that we are going to have Hyperinflation, I respond that it is impossible because of wages. In the comments on my 2009 Financial Predictions I said:

…you cant hyperinflate wages in a global economy.

Think about it. If prices skyrocketed, would your wages? No, because at a certain price point, your job would be outsourced or eliminated. And without a job, you couldn’t afford to buy the goods that hyperinflated.

Guess what would happen next? Prices would plummet. This is a global economy. Employers will seek out the lowest cost for labor. Consumers will seek out the lowest price for goods and services. And where they intersect is the fair market value.

Karl from Market-Ticker wrote up a great blog today on this topic titled On “Hyperinflation”.

“Hyperinflation”, or even “Serious Inflation” (similar to what we had in the 1970s) is impossible without a means to transmit the rise in prices into wages.

Zimbabwe is currently hyperinflating their currency, but they aren’t really an active participant in the global economy. What is their unemployment rate? It was 80% in 2005. If this happened in America, Bernanke would be swinging from his heels like Mussolini.

Hyperinflation

The problem in America today is we are plagued with bad debt. Deflation is the way an economy cleanses itself of bad debt. Taking on more debt, wether you are an individual or government, just makes the problem worse later. The sooner bad debt is removed from the system, the sooner the recovery can start.

Simple Math Says Get Out of the Stock Market

I want to expand on my 2009 Financial Prediction for the S&P 500.

By the end of 2009 it will hit 633. This estimate is based solely off earnings ($42.26 x PE of 15).

Where did that $42.26 number come from? It is a collection of earnings estimates. Here is a graph that appeared in a recent John Mauldin newsletter.

sp500_estimates

Notice a trend? Historically in every downturn earnings estimates are too high and have to be continually lowered. Earnings are in free fall. Will estimates get lowered again once the horrific 4th Quarter numbers are out? Let us first assume that last estimate of $42.26 is dead on accurate.

Now we need to find a reasonable P/E ratio (price to earnings ratio). What is a good historic P/E in a period of economic contraction? Somewhere between 8 and 15. The 2001 recession had a P/E of around 22, but it was not consumer based. To me that number seems like an outlier. Given that interest rates are so low, I’m more inclined to think a P/E of 15 is fair value, but some think a P/E of 12 is more realistic.

  • $42.26 x 15 = 633.9
  • $42.26 x 12 = 507.12

As I write this post the S&P 500 is at 900. A 900 value would put the P/E at 21.3. I suppose if you think this looks like 2001 and you believe earnings estimates are not going to get lowered again – then buy stock.

However, what if these estimates which keep dropping , drop another 10% before bottoming? That would put the S&P 500 earnings at $38.

  • $38 x 15 = 570
  • $38 x 12 = 456

To be invested in the stock market now, you need to believe that earnings estimates are going to suddenly rise, the economy is going to improve and interest rates are going to stay this ridiculously low.

And to those who still think it is wise to buy and hold during a secular bear market, do the math. What percent of money will you lose in 2009 if your portfolio matches the performance of the S&P 500 and valuation moves to historic norms?

  • $42.26, P/E 15 = -30.0%
  • $42.26, P/E 12 = -43.7%
  • $38, P/E 15 = -38.7%
  • $38, P/E 12 = -49.3%

I’ll play devil’s advocate and throw in a number where the earnings estimates increase by 10% to $46.52.

  • $46.52, P/E 15 = -22.6%

OK, if earnings suddenly increase and interest rates stay this low, then a P/E of 22 might make sense.

  • $46.52, P/E 22 = +13.7%

Note that there hasn’t been a whisper of anyone raising their earnings estimates, so the above number is sheer hope. This is why I preach being in fixed income (savings, CDs, short-term Treasuries). The upside in the stock market is very limited and the downside is huge.

Sitting on the sidelines in 2009 could save you years of retirement income. And if I’m wrong, you can always jump back in the market later not having lost any money. If the clowns on CNBC are wrong, you’ll be working till your 75.

Standard disclaimer

2009 Financial Predictions

Here are my 2009 Financial Predictions. My general thesis is:

  • Cash is King
  • If You’re Long You’re Wrong.

S&P 500 – By the end of 2009 it will hit 633. This estimate is based solely off earnings ($42.26 x PE of 15). That is a conservative number. If you use a 12 PE, the number drops to 507. If Bernanke loses control of the long bond, this number will go below 500. The S&P 500 is at 931 now. The upside is very limited, where as the downside is serious.

Dow – I don’t invest in or against the DOW. Earnings in these global corporations are highly influenced by currency events. No prediction.

Recovery, Recession or Depression in 2009?Depression. Until mark to market accounting is restored and the bailouts stop, monetary velocity will continue to plummet. The new Treasury Secretary appears to be another Hank Paulson and we are stuck with Bernanke until at least 2010.

Real Estate – Prices will continue to decline and decline at an INCREASING pace. As this happens bank lending will get tighter as their risk increases. Higher down payment requirements will force prices much lower. Those on the sidelines will continue to see home prices fall faster than they can save. There are $1Trillon in ALT-A resets. A massive wave of foreclosures is coming. The stigma of walking away from an underwater mortgage is going away as America becomes Bailout Nation. No recovery in 2009. If you must buy, the best deals will be new construction sold directly by distressed builders.

Oil – I nailed it last year. Now with every central banker racing to devalue their currency this is going to difficult to predict. My wild guess is it goes down to $25/bbl before heading back up slowly.

Unemployment – U3 unemployment will hit 9%. U6 unemployment will hit 16%. Definitions here.

Deflation, Inflation or Hyperinflation?Deflation. Asset prices will continue to fall as the leverage comes out of the system.

Gold – All the experts seem to think it is going up. I’m a contrarian. I’m thinking deflation will be a more powerful force than every central banker devaluing their currencies. Gold drops to $600/oz.

30-Year Bond – This is the most important number. If it ramps America is hosed. Bernanke is using Quantitative Easing to push this number down. It is working for now. If it fails, look out below. I plan to have a post on this topic soon. I’m going to bet against the grossly incompetent Bernanke and go with 4%.

An Investing Strategy For 2009

Note that I am not a certified financial planner and you should do your own research. The advice below is what I would say to a close friend. There are no shortage of investing tips for 2009 on the Internet. Here goes another one.

  1. If you have debt, pay it off. Stop consuming.
  2. Exit all long positions in the stock market until trust is restored.
  3. Fixed Income is still the safest. Good old bank CDs. Money Market accounts. Short term Treasuries. You will not make money here, but more importantly you will not lose money here. If the economy improves and the stock market starts moving up, you can always jump back in. Missing the first few percents is worth it. Let someone else take that risk. Guessing the bottom has destroyed many investors.
  4. Prudent Bear and Grizzly Short are two mutual funds that make money in a bear market. These funds will make money as long as stock prices are falling. As soon as a recovery starts, you need to be out of these. If you don’t follow the market at all, then I would stay away from these.
  5. Bet against Bernanke with TBT. This is a high risk ETF that I will most likely be acquiring soon. There are a lot of banks, hedge funds and foreign governments holding US Treasuries. Our Federal Reserve has been leveraging up its balance sheet buying these to force interest rates down. If at some point any of these parties either stop buying Treasuries or if they try and dump them, interest rates will spike. TBT is a leveraged ETF that will double that spike for you. But if interest rates drop, you can lose. For me this is ETF is less about an investing thesis and more about insurance against Bernanke stupidity.

Disclosure: I own shares in both Prudent Bear and Grizzly Short. I also plan to buy TBT.

What are your 2009 Financial Predictions?

UPDATE (1/4/09): I realized after I published that there are 2 points I wish to make more clear.

  1. If you plan on buying new construction from distressed builders, make sure that if there is an HOA, that is solvent. That sweet deal you got on condo may backfire if you are the only paying into the HOA. Buildings require money from the HOA for parking garages, security, elevators and a host of other fees.
  2. My picks for Gold and Oil are pure guesses and not true predictions. We are in uncharted economic territory now. Currencies are being devalued everywhere and at different rates. Everything else listed is a prediction.

Jim Cramer, Me and One Week in July

On July 30th, CNBC’s Jim Cramer told his viewers: Yes, The Market Has Bottomed.

I am indeed sticking my neck out right here, right now, declaring emphatically that I believe the market will not revisit the panicked lows it hit on July 15. And I think anyone out there whos waiting for that low to be breached is in for a big disappointment, and [theyre] missing a great deal of upside.

Stop waiting, buy the next dip because I think it might be the last big one.

Cramer went on to recommend buying Lehman Brothers, Citigroup and Wachovia.

cramer-head

A week earlier on July 24th, I said Hope Your 401K is in Fixed Income.

In a bear market preservation of capital not appreciation of capital is your number one goal.

We know what happened next. The banks got smacked. Lehman Brothers went bust and the S&P 500 ended the year down 30% from that week in July. Cramer is a legendary stock picker from the last bull market. Well, if you read his book, you know it was actually his wife. The thing is we are in a secular bear market and his mad money skillz don’t seem to be working.

Jim Cramer is not alone. An entire generation of financial professionals grew up working in the longest bull market in history and its all they know. Jim is a performer for a network that makes money from advertisers whose sole mission is to keep you fully invested in the stock market all the time. Telling you to wait out the bear market in fixed income for a few years won’t pay the bills at CNBC or Fortune magazine.

Stay tuned for my 2009 financial thoughts post. Guess what? It is far from safe to get back in the pool.

Anatomy of a Good Trade

A few days ago I posted Anatomy of a Bad Trade, where I openly discussed the worst stock trade I ever did and the lessons I learned. This week I had a picture perfect trade, where I followed my rules and exited a position with a huge gain.

My rules:

  1. Look for beaten down UltraShort ETFs with price support that are on sale early in the week.
  2. Set stop loss in the event the price support fails.
  3. Lock in gain, preferably before the close on Friday.

Bought 90 SRS @78.22 on MON 12/8

Sold 90 SRS @99.78 on FRI 12/12

This time I didn’t get greedy on a Friday. Instead I exited the trade and locked in the gain. Good thing I did, because the stock tanked shortly afterward almost 20%. Now it is the weekend and I’m holding no leveraged ETFs in my account and I’m another $1,920 closer to retirement. This was a good week.

This is not investment advice, but I would not be surprised to see SRS do a similar moonshot move in the next week or two. Hit it and Quit It. Rinse and Repeat.

Anatomy of a Bad Trade

Occasionally I serve up a post on my investing successes. Now let me tell you about the worst trade I ever made and the lessons I learned.

On January 3, 2008, on the post My Drudge Report Oil Short Investment Tip, I wrote:

Ive noticed over the past few years that whenever a barrel of oil hits a new price threshold that the DrudgeReport will put out a big red banner or siren announcing it. And then something happens almost without fail in the following two weeks. The price drops.

After seeing this pattern play out over and over, I decided to make some money on it. The last three times I saw the oil headline on Drudge, I bought shares of DCR. DCR MACROSHARES OIL DOWN is an ETF that makes money as oil falls in price. I set a goal of 5-10% gains with a 2 week holding limit. As soon at it hits, I sell the shares. I try to avoid buying on a Friday as bad things that can spike oil often happen over the weekend.

Last December as oil was going higher and higher, I went on record saying the price would collapse by the end of the year. Deflation smacks commodities the hardest. What I never saw coming was the spike toward $150 a barrel. And the people at Macroshares never saw it either. Their leveraged ETF was not designed to handle spikes that high and the ETF stopped trading as the price approached $0.00.

bad trade

What did I do wrong?

  1. Going into the close on a FRIDAY, I already had a 10% gain. My own rules which I spelled out back in January, stated to close out the position after a 5-10% gain. It also warned of holding this ETF over the weekend as bad things that can spike oil often happen over the weekend.
  2. Over the weekend, bad things did happen to the price of oil and my $1500 gain quickly turned into a few thousand dollar loss. Instead of taking my lumps, I decided to hold the position. My swing trade became a long term investment just as oil was spiking. I was get hammered and I held.
  3. There was trouble over at MACROSHARES. I was too busy watching the price of oil. I had blind trust in the ETF. A press release was put out stating the ETF was going to close. I read it 3 weeks after it came out.

So I ended up selling for a $9,000 loss. Had I held until the ETF closed shop, I would have lost $16,000. Now that oil is falling like rock, it is a little ironic knowing that had MACROSHARES not bungled the ETF and had I slipped into a coma and woke up today, my investment would be up over $50 grand.

What are the lessons I learned?

  1. Don’t get greedy in the heat of battle. Emotion will try to overrule logic when the gains and losses are high or come on suddenly.
  2. Avoid holding leveraged ETFs over the weekend, especially if you already have a gain that you can easily lock in.
  3. Don’t have blind trust that the company offering the ETF knows what they are doing. Do spot checks for news stories or blogs being critical of their performance relative to the indexes they claim to match. Look for slippage.
  4. Take the small loss earlier. Buy and hold is for suckers. This is especially true for leveraged index ETFs. Unless you are confident the ticker is going up, get out. You can always buy it back later. Paying two commissions would have saved me thousands.

The biggest lesson I’ve learned from investing, which I must give credit to Nassim Nicholas Taleb, is awareness that it is human nature to credit our successes to our skills and our failures to luck. I lost $9,000 not because hedge funds started speculating in oil, Middle East tension or even that Macroshares was incompetent (which they were). I lost $9,000 because I was wrong.

The Lack of Trust in the New World Economy

I live in a nice apartment building in an upscale area of Seattle. This week I noticed fliers posted around the building announcing a contest. They are having a $100 drawing each month for residents that pay their rent on time. I had to inquire.

Me: I don’t understand the contest. Didn’t the residents sign an agreement stating they would pay their rent by the first of each month?

Her: Yes, but a lot of residents aren’t. So we are offering this contest as incentive.

Me: How many occupied units are in this building?

Her: 62.

Me: Don’t most people pay on time?

Her: It’s becoming a huge problem. A HUGE problem!

I really shouldn’t be surprised. In the age of the bailouts and foreclosures, the societal pressure to pay your own way is fading fast. Take on a mortgage that is too much? Stop paying it. Loan billions out to bad credit risks? Get a bailout and let the taxpayers eat the loss.

Every day we are hearing stories of people and corporations walking away from their obligations. Not only are they not being punished or shunned, they are being rewarded. We are waking up to a world where the people paying their bills are the suckers. My building feels they need to reward renters for doing what they already contractually agreed to do.

Everything the Treasury and Federal Reserve has done to increase lending has backfired. They have created a situation where nobody trusts each other. No economy can grow when banks don’t trust companies, investors don’t trust balance sheets, companies don’t trust their customers and the citizens don’t trust their government.

The Softening Seattle Rental Market

Yeah, home prices are falling. That is old news. I’m more interested in what is going on in the rental market. When I went looking for a rental unit back in May, there was little offered and the prices were somewhat higher than I would have liked.

rent sign

Photo For Rent – Reduced??!! by Flickr user Kelly Sims

Since moving to the Upper Queen Anne area of Seattle in May, I have noticed more and more places available for rent in my neighborhood. Places with FOR RENT signs that filled in days, now have the sign out for weeks. I was talking with MarketMan over at the GeldPress about this recently and here are our thoughts.

  1. Younger adults are staying longer or moving back in with their parents. As job opportunities for recent graduates dry up, it is becoming more acceptable to stay with mom and dad and extra year or two.
  2. Getting a roommate is becoming more popular. With sites like Craigslist, it is very easy for homeowners struggling to make mortgage payments to rent out a room. The renter saves money and doesn’t enter the traditional rental market.
  3. Homes where the owner can’t sell, become rental properties. During the boom, people bought multiple properties with flipping on the mind. Now these properties aren’t selling and often sitting empty. Some owners are giving up on the prospect of selling and are putting these houses into the rental market.

Less demand and increased supply appears to softening the rental market in my neighborhood. How about yours? Where do you live and what are you seeing?

Short Term Bear, Long Term Bull

In prior posts, I have stated that I am a Short Term Bear and a Long Term Bull. But, I never really explained what I meant. The Short Term Bear part now appears obvious as the country moves from recession to depression. Why a Long Term Bull?

My basic thesis is politicians create problems and engineers solve them. History moves through three stages.

  1. Problem
  2. Solution
  3. Benefit (which leads to the next Problem and cycle repeats)

Let us use WW2 as an example. The Problem is that pesky Hitler is running around Europe causing problems. Politicians failed in their task to both prevent a war and to make sure we were adequately prepared for a war should one start. The Solution wasn’t really strong leadership. It was engineers cracking codes, massive improvements in aviation and the atom bomb. The Benefit was peace in Europe, which led us to the next Problem of the Cold War.

engineers

Photo Inventors Bell and Edison by Flickr user mharrsch

I’m not a history major, but I can think of at least a dozen cases where engineers have put their brain power to work to create solutions for problems created or made worse by government. So government fails to prevent 9/11 and a year later an unmanned drone with the name of Hellfire blows up a terrorist taking a drive through the Yemen countryside. Engineers to the rescue.

This is why I consider myself post-political. I no longer care which party wins an election. History tells us both sides will make mistakes and make problems worse. And my reading of history tells me that engineers will come in and clean up the mess.

I understand this thesis is highly simplistic, but I think it explains my Short Term Bear and Long Term Bull statement. Of course it doesn’t cover every event in history. It is just a guide.

At this moment there are thousands of engineers working on today’s problems such as energy and health care. Maybe the next advancement will double fuel economy or perhaps cure diabetes. Whatever it is will very likely have a major impact of society.

However, my confidence that engineers will solve the current financial problem with inventions and productivity gains has never been lower. The numbers are simply too large and growing daily. Since I’m starting to drift off topic, I’ll save that discussion for another blog.

Not Stocks and Not Real Estate Part 2

In Not Stocks and Not Real Estate Part 1, I threw out the idea that the next bull market might not be in stocks or real estate. What will the next bull market be in? I have some smart readers that I hope will add comments to this post, but I’d like to kick off the discussion with a few possibilities.

  1. High Yielding Corporate Bonds – It seems bonds get sexy every 15 years or so and we are about due. Good companies still need cash to operate and in a deflationary environment cash becomes more scarce. In order to attract cash and compete with the safety of government bonds, yields would rise. In the most recent newsletter by John Mauldin (Leverage in an 8 Letter Word), he shows charts of AAA corporate debt selling for 70 cents on the dollar. Interest on high-yield bonds is now approaching 20%.
  2. The problem here is this market is no where near as efficient as the equity markets. Is there an ETF out there that is buying up fire-sale corporate debt from solid companies? And can I buy call options on them?

  3. Gold and Gold Miners – As debt piles up on the balance sheets federal governments around the globe, the risk of monkeying around with currencies increases. What happens when these debts exceed the ability to repay them?
  4. The problem is here is commodities keep falling in a deflationary environment. Mish seems to think Gold may have found a bottom. The Sovereign Speculator likes the idea of buying physical gold at distressed prices, but not yet. I really don’t want to buy Gold. It is taxed higher and pays no dividends. Miners hold more appeal to me, but it is something I know little about and would have to research a lot more before investing in that sector.

  5. Private Placement Capital – My pal Mattdoes private placement investments that have good returns.
  6. The problem is here is I’m not an accredited high net worth investor. Big investors get opportunities for big returns. An ideal situation here would be to invest in a fund that places the money into several projects. As cash becomes king, I think those types of funds will become more popular, especially when banks are too frightened to lend money.

  7. Short The EURO – If we can’t figure out the next bull market opportunity, then perhaps just betting against Europe is the way to go? The Geldpress makes the case and shows how one can profit from a declining EURO in Euro Problems – Short the Euro. I do not know if this ETF has counterparty risk.

Again this post is just to get the discussion started. I have no opinions on the next bull market opportunity. I am currently in research mode. Investing in bonds, currencies and commodities may or may not be the next bull market. If so this will be the first time I’ve stepped outside stocks and real estate.

Looking in new directions can be profitable. In my post Fooled By Randomness, I mentioned John Paulson. He saw something in 2006 that in retrospect seems so obvious now. He believed subprime debt was highly overvalued and discovered a way to short it. He made an estimated $3-$4 Billion on that bet.

Not Stocks and Not Real Estate Part 1

One of the hottest topics in finance and real estate is calling a bottom. Whether you believe the bottom is now or much lower, investors all seem eager to get in at the bottom. And this makes sense. Why buy today what you can get for cheaper in the future?

Something is bothering me about finding that bottom. There seems to be a believe common among both bulls and bears that if you correctly guess that bottom, you will be able to then go long and ride the next bull market up. I may be completely wrong on this, but I’m starting to think stocks and real estate are not going to spike upwards from the bottom.

Residential real estate is easy enough to understand. The belief that homes are a good investment has been shattered for the next two generations. Anyone that has had their home listed for sale for a year or more starts to hate home ownership. Preparing your home every Sunday for an open house where nobody comes has a scarring event. You dream of the day you can rent. Although I think there will be silly good deals in new construction from distressed builders, I don’t see home values beating inflation by much for decades.

Stocks seems to be where everyone expects the bull market to occur. I don’t know about that. The killer bull market of 1982-2000 was based off cheap credit, global savings, fraudulent accounting and leverage. Sure there were massive productivity gains and technological advancement, but how much was financial engineering and how much was real engineering?

In a post-deflation world where financial markets are heavily regulated and the leverage is much less, how fast can we honestly expect equity markets to advance? Is it possible the average investor having been fooled twice will be reluctant to invest in stocks?

If not stocks or real estate, then what? This is what I’ve been thinking about for the past month. Continued in Not Stocks and Not Real Estate Part 2.

He Bought At The Bottom

I love talking to people about investing. Listening to what people are doing and how they interpret the financial news is very helpful to me. Being a contrarian has been profitable to me.

In the last month, I’ve talked to several people about the stock market. Here are some of the things I’ve heard.

  • I bought at the bottom. – A very smart engineer said with complete confidence, that he fully invested into the stock market at the bottom. When I inquired how he knew it was the bottom, he seemed puzzled as if the market couldn’t drop below the late October lows. Note that since we talked it already has. Other than the 1987 computer glitch crash, I have yet to find a market bottom formed from the massive day to day swings in price action that we are seeing today. When the market roars back on a single day or week, it is often not a reaction to positive news, but a squeeze on those shorting stocks. Once the squeeze ends, the stocks resume their downward channel.
  • It’ll come back in three years. – A lady in software training informed me that all the losses in the market are troubling, but she is confident the market will return it all in three years. I asked how she arrived at three years. Her response was that it always comes back.
  • It doesn’t matter, since I have a long time before retiring. – I’ve already covered this silly statement. If retirement is delayed by years, then it does matter.

When I put my house up for sale in 2005, I heard similar nonsense. Houses could only go up. Home prices never go down. People just repeat what they hear without checking their sources. And often what they heard was some nonsense they saw or read from the financial media, which make its money from advertisers whose goal is to keep you fully invested in the market at all times.

Market bottoms come after capitulation. Here in Seattle, I haven’t even heard the faint whisper of capitulation. We got a ways to go before bottoming. I’m still calling for an S&P 500 of 600.

Oil Hits $55

A year ago it seemed everyone thought oil would keep going up in price. I heard predictions for $200 and even $300 a barrel. Would would have guessed one year ago that oil would be down to $55? That would be me.

From my 2008 Predictions post on MarketTicker on 12/27/2007:

OIL = $55
President Mitt

Even though I was dead wrong on Romney winning the 2008 election, I nailed the fact oil would hit $55 by the end of 2008. This calls for a celebration dance.

I promise not to bring out the dancing banana until the S&P 500 hits 600 or Paulson is lynched. Whichever comes first.

You Hit It Once, Then Break Away Clean

Some guys go fishing and have fishing tales. I don’t fish. I invest. Here is my tale.

Across the field of battered stocks was EEV. EEV is an UltraShort of the Emerging Markets. I know I said I wouldn’t touch the ultra-shorts because of the counterparty risk, but I couldn’t resist. The stock had dropped $100 in just a few days. I could feel a snap back was coming.

I finally moved a baby 401K of $5K away from the fixed income plan of my former employer. By Tuesday I noticed the check had been deposited into my self-directed account at Ameritrade. I had hunting money and EEV was looking like a sweet target.

Bought 70 EEV @70.00

Then EEV exploded upwards. $80. $90. $100. Should I sell? This thing could go to $200 or back down to $70 or lower. Or the entire ETF could explode and it could go to $0. Lock in the gain and walk away.

Sold 70 EEV @101.50

Minus two commissions my baby 401K is now worth $7205. A 44% gain in 48 hours. The hunt was good.

Not a Certified Financial Planner

Since I have quite a few posts on investing, I thought it was appropriate that I add a disclaimer. I am not a Certified Financial Planner. I’m just a regular Joe with an interest in economics. Although I have a Finance degree from the diploma mill known as The Ohio State University, everything that I apply to investing today was knowledge obtained since 2004.

No post on this site shall be construed as investment advice. This site is about me. I invest. Therefore I blog about investing. I know my risk tolerance and how much time and effort I am willing to devote to investing. What works for me, may not work for you.

I will continue to trash the advice of certified financial planners as they continue to peddle the industry lie.

As my friend Mattwould say – don’t invest in anything you don’t understand. That especially includes the stock market. Knowing what you don’t know is the most liberating thing about investing. When professionals try and convince you that they know, you should be skeptical.

That is all.

Financial Logic Fails

This weekend I talked to several people regarding the current state of the markets. They all remembered that I had called for this correction and advised moving their money into fixed income. Most didn’t take my warning and lost a lot of money in their 401k account. But that was yesterday, let’s talk about today.

In this post I want to respond to the most common responses I’ve heard to the current market correction.

It’s Over Now, It Can’t Go Lower

Yes it can and I believe it will. My S&P 500 target is 600. The forward P/E as of last Friday was 20.2. This is not a good start for a market bottom. Historically, a good bottom should see P/E rations between 8-12. I’ll take 15. But 20? No way. Every day another company comes out and lowers estimates. Stocks are coming down.

It Doesn’t Matter Since I’m Not Near Retirement

There are really two goals for retirement. The first is to retire with as much money as possible and the second is to retire as soon as possible. Being fully invested in stocks during a secular bear markets is not a smart way to achieve retirement goals. Every few years Wall Street plays its shenanigans, you don’t need to play during these periods. Fixed income is the best defensive move.

I Can’t Sell Now

Yes you can. The ONLY reason to hold stocks now is you believe they are going higher. Not higher in 30 years, but higher now.

Stock Will Go Higher, The Bottom Is In

To this crowd I ask them to tell me what their 1 year target on the S&P 500 is. They usually don’t have a target. If they do, I ask them how they arrive at that number with estimates being revised downward weekly and dividends in free fall.

Picking a New S&P 500 Target

Back when the S&P 500 was much higher, I announced my target for this index was 1000. From my July 15, 2008 post Shooting the Messenger:

I see the S&P 500 dropping to 1000 by the end of the year. The P/E ratio is still too high as corporate profits are declining. I plan on staying short until this target is reached. At which point, Ill lock some gains and move to fixed income.

Then Hanky Bernanke put a ban on shorting financials and I knew from history this meant a false bottom would be set into the market. This idiotic action caused me to lower my target to 900 on September 28, 2008. From the post Can I Have Another Piece of Chocolate Cake?:

The bailout may provide a little bounce, but it wont hold. The deleveraging of the largest credit expansion in history will continue. My target for the S&P 500 was 1000. Now Im lowering it to 900. If your 401K is in equities, either move your money to fixed income or get ready for a punch in the nose.

Last Friday my price target for the S&P 500 hit. The market closed at 899. I tried to exit half my short positions, but I didn’t read the Grizzly Short prospectus and was two hours late putting in the sell order. Lesson learned.

Since Friday I’ve seen even more shenanigans going on with bailouts. None of the bailout steps I’ve seen taken will bring an open and honest accounting standard. There is no trust, nor should there be. My original target for the S&P 500 was based completely on earnings. I felt and still do that P/E ratios are still too high, especially as the economy slows. My estimates were not based upon a credit crisis caused and fueled by continued dishonest accounting.

Bernanke and Paulson seem not to grasp an important fact about the success of America. One of the main reasons America is successful is because we protect the interests of the investors through open and honest accounting standards. It is never perfect, but when a problem surfaces, we fix it and fix it first. This attracts the capital needed to grow our economy and help America prosper. There is big problem in the credit markets and until there is transparency it is only going to get worse.

I am not holding a single share of stock until this nonsense stops. It’s like playing Monopoly with a 4 year old. This is not a safe climate for investing. We are no different than Venezuela at this point as we nationalize banks, Freddie, Fannie and AIG. You want to invest your retirement in this environment? Not me. Why try and bottom guess this market? Fixed income is the safest place to be.

I now need two new S&P 500 targets. A honest target and a shenanigans target.

The honest target assumes all the games stop and bad banks are closed and healthy banks are allowed to pick their bones clean. The sooner America comes to its senses on this, the sooner the recovery can begin. And if we show leadership before Europe and Asia does, then we can attract global investment first.

Sovereign Speculator ran the numbers in the post Stocks are very expensive. Mr. Market is still in denial.

Looking at past episodes, the odds are strong that Mr. Market pays less than $12 per share for 2008 earnings by the end of 2009: an index value of 588 using our 08 estimate.

Using Elliott Wave analysis, Mish from Global Economic Trend Analysis comes in with a similar number.

The target of 600 is an estimate based on an approximate retrace of 62% of the peak of Wave B (.38 * 1576 = 599).

What are my new S&P 500 targets? My honest target is now 800 and my shenanigans target is 600. And note that this target is not when I go long. It is the target on when I’ll move out of my short positions and fully into fixed income. Until the 20 Week Moving Average exceeds the 50 Week Moving Average by 1% and we have honesty again, I will not go long.

Investing 101 – The 401K

In the post Investing 101 – Before You Invest, I gave my thoughts on how I approach post-tax investing. Now I want to cover the other side, which is pre-tax investing in a 401K or similar plan.

Many workers are down big time in their 401K this year. Although it sucks to take a big hit on any investment, losing money in a retirement account isn’t quite the sting as losing the same amount of money in a post-tax account. I’ll explain.

Before you make or lose a dime in a 401K account, here is what you have going for you:

  1. Delay federal income tax on your contribution until retirement.
  2. Delay or eliminate state and local income tax on your contribution until retirement.
  3. Employer matching. Not every employee gets this, but it is a sweet deal. Your fund may be down, but because your company matched generously, your 401k may be still higher than your contributions.
  4. Money you don’t spend. It is far more difficult to spend 401k money early than anything you put in your checking account. Without this forced discipline approach many workers would just spend their entire paycheck.
  5. Protected in bankruptcy. If you file for bankruptcy, your 401K earnings are protected. If you are in financial trouble, resist the urge to dip into your 401K unless it really makes sense.

Post-tax investing is quite different.

  1. Already paid federal income tax on it.
  2. Already paid state and local income tax on it.
  3. No employer matching.
  4. Requires more discipline to not spend it.
  5. Not in protected in bankruptcy.
  6. As you make profits, you pay capital gains tax.

This is why although the dollar loss maybe the same, I feel far worse when it happens to my post-tax account. The money I lose in a post-tax investment is money I’ve already paid taxes on and delayed purchases with. So if your 401K is down this year, I hope this makes you feel a little better.

How do I approach 401K contributions? I max it out and max it out early. Because I always have at least 6 months salary in savings, I can direct the maximum amount into a retirement account. And if I decided to quit my job in May, I can leave knowing my 401K has been taken care of for that calendar year.

Let me give an example of maxing it out early. One of my employers did not implement a 401k plan until October. They graciously offered equal matching. While all the other employees were directing 5% of their paycheck toward the plan, I put the majority of my paycheck in it. Instantly doubling my money before the calendar year ended. I kept up the aggressive contributions into next year, quit my job in May and ended up with two full years of contributions in 8 months with matching. Sweet!

How do I invest in company 401K plans? That is a full topic in itself, but one of my beliefs is that risk in equities is much higher than is being represented by so-called financial experts. Anything you can’t afford to lose should be in fixed-income. Know your risk tolerance. Don’t reach for yield if you can’t stomach the loss, especially as you get closer to retirement.

The best thing about losing your job is you can move your 401K money away from your company selected plan and into a self-directed account. I really like TD Ameritrade, but there are other online brokerages. From this account I can buy and sell stocks or numerous mutual funds. Unlike an employer plan, your investment options are almost unlimited. You can even set up your account to trade options. TD Ameritrade offers investment classes and will help you pick funds if you need help. If you do ask for help, be honest with your risk tolerance.

In the post Mr. Financial Planner – Go Home and Get Your Shine Box!, I showed how the best performing fund offered by my employer yielded just 0.97%. Meanwhile, my TD Ameritrade account allowed me to invest in bear funds such as Prudent Bear and Grizzly Short, which had much higher returns.

This is getting to be a long post, so I’ll wrap up with a quick summary.

  1. Max out your 401K.
  2. Avoid borrowing against the 401K since it is protected in bankruptcy.
  3. Respect risk.
  4. Don’t get as bummed out when losses occur. At least you didn’t pay taxes on that money and often times half of it was free money from your employer.
  5. As soon as you leave a job, move your money into your own self-directed account, such as TD Ameritrade. Do not roll it into the 401K plan of your new employer.

Investing 101 – The Biggest Lesson

This post is a follow-up to Investing 101 – Before You Invest.

The biggest lesson I’ve learned in the last few years is what I call the Baby Boomer Lie. I’ve covered this on other posts, so forgive me for repeating it. Baby Boomers were fortunate enough to enter their high income years early in the 1982-2000 bull market. Even the 1987 crash could not derail this bull market. Everybody was making money. You couldn’t lose. Stocks went from boring investments to wining lottery tickets.

Look at the DJIA (Dow Jones) chart from 1982 – 2000. The lesson that I refer to as the Baby Boomer Lie was that stocks were not only safer investments, but that they can be expected to generate a higher rate of return that other investments. Although it was true from 1982-2000, this investing wisdom is not always true.

bull market

Larger Image

The gurus of that era wrote books and some got gigs on TV. They became our financial mentors. Unfortunately, they have a jaded view of history. Once stocks have a high valuation, as measured by P/E ratio, the average expected return falls below fixed income and the probability of a major price correction increases. In my opinion, today’s market resembles the choppy market of 1964-1982. Learning investing from the bull market gurus is going to be painful in this market.

bear market
Larger Image

No one post can say everything about investing. It is far too complicated of a topic, but if I were to recommend one single book it would be Bull’s Eye Investing: Targeting Real Returns in a Smoke and Mirrors Market by John F. Mauldin. Mauldin does an amazing job of explaining investing. The last few chapters are about picking a hedge fund and can be ignored by most readers.
Bull's Eye Investing: Targeting Real Returns in a Smoke and Mirrors Market

John Mauldin borrows information from Ed Easterling. If you prefer a more academic book on investing, then read Unexpected Returns: Understanding Secular Stock Market Cycles by Ed Easterling
Unexpected Returns: Understanding Secular Stock Market Cycles

I enjoyed both books, but prefered Mauldin’s writing style. John Mauldin also has an email financial newsletter that I highly recommend. He writes one per week and then has a guest writer write a second one. Although the guest writers vary widely, the one John puts out Saturday morning is the single best weekly financial analysis that I currently read.

Investing 101 – Before You Invest

Considering last week was my most profitable week ever investing, it wasn’t surprising that a few people approached me with questions on investing. It should be noted that although I’m doing great right now, I was dead wrong on equities in 2006 and oil in early 2008.

I’m not an investment professional, nor do I want to be. I’m a contrarian by nature with an interest in financial history and investor psychology. In today’s market, that seems to be the special sauce. Yet I’m not arrogant enough to believe I have everything figured out. Financial history has a long list of highly successful investors that died penniless.

With those caveats behind me, here are my thoughts about what one should do before they begin investing.

I have different thoughts on 401k investing, so this post is just about post-tax investing. Before you consider post-tax investing, I think you should be 100% debt-free (except mortgage) and have 6 months of expenses saved and readily available in a savings or checking account. This will disqualify the majority of people.

If you have credit card debt, owe money to friends, or still have car payments, you should tackle those debts first. I would also include any student loan debt, unless you are getting tax deductions on it. The reason for this is when you invest there is a risk associated with achieving an expected return, but there is no guessing the amount of interest you will be paying on your debt. So if your credit card carries an 11% interest rate, paying that debt off early is a sure savings, whereas investing is always going to carry risk.

Out of Debt

Photo Out of Debt by FLICKR user Garrettc.

This is the sequence on how I would pay debt:

  1. All minimum payments first. You never want to incur a late or missing payment fee.
  2. Friends and Family. Although these loans tend to be interest free, I would pay them back next. Citibank isn’t going to bail you out of jail or donate a kidney to you. Your friends and family might. Don’t let a money issue ruin a relationship.
  3. Highest interest rate to lowest interest rate. Throw all guns at the highest interest rate debt. Everything else should get the minimum payment. The only exception here is if a debt is within striking distance of being paid in full.

In addition to being debt-free, I also think it is comforting to not live paycheck to paycheck. Having six months of expenses saved up brings such piece of mind. For almost a decade I’ve had at least six months of savings in my checking account. If an employer ever mistreated me, I had the freedom to walk at a moments notice (and I have).

If more employees had 6 months of savings, my guess is employers would treat their workers much better. I picked six months because it allows enough time to look for a new job, even move across country and take a mini-vacation while you can. ;)

OK, so you are debt free and have six months of savings, how shall one go about investing? More on that in the next post.

Walk Away and Taste the Pain, Come Again Some Other Day

On Monday when the market crashed, I was away from my computer. I missed the entire event. In fact I was having lunch with Market Man from the Geldpress, who is also bearish on the market. While most investors had their ass handed to them, my portfolio set a single day record. Of course a single day is just noise, which is why I gave back half my gains from Monday the very next day.

The direction for the stock market indexes is down, but the path is not straight.

From FLICKR user pingnews.com “The War of Wealth” by Strobridge & Co. Lith., ca. 1895 (LOC)

Bear markets are brutal. Buy and hold strategies will seriously damage you in a secular bear market. If you do not feel comfortable shorting the market, whether directly or in a managed fund, the best place to be is in a fixed income fund. Return of capital is more important now than return on capital. Your goal should be to have cash at the bottom.

Can I Have Another Piece of Chocolate Cake?

How does the bailout change my outlook on investing in the next year? Not much. Kirk on Reasons Unbeknowst asked this question in the post The Most Predictable Meltdown in History:

Would you rather get punched in the nose hard once or would you prefer a good slap in the face every morning for a year?

As I write this post it looks like our lawmakers are going to pass a bailout plan. In other words, they have decided we will be getting a good slap in the face every morning. Kicking the can forward and passing the debt forward to some future date. Is this the right move? In a post earlier this week, Jim and myself listed how the smart guys in the room are lining up on this issue.

I’ve learned a lot about markets and finance from these three. These are my main economic mentors for the past year and they don’t agree. Mauldin thinks we crash if don’t get the bailout. Denninger thinks we crash if don’t add transparency immediately. Both men are highly experienced traders and it is possible they are both right.

The end result may be that half the investors lose faith in the markets when their side doesn’t prevail. That may enough to cause a crash. Half want immediate honesty. The other half wants massive amounts of cash immediately.

The Sovereign Speculator sums up the state of the market brilliantly in the post Credit markets iced over. Put your head between your knees.

If the fundamentals were not so horrible and stock prices not so high (with earnings falling off a cliff, real PEs are in the stratosphere and dividend yields are pathetic), this would be a promising time to go long, at least for a trade. As is, that would be Russian Roulette, because it would be hard to imagine a market more primed to absolutely crash than this one.

My quick scorecard looks like this:

  • Lack of trust in US markets.
  • Real PEs way too high given the slowdown in the economy.
  • Tax revenues declining.
  • Unemployment rising.
  • Home prices still too high given tighter lending standards and huge inventories.
  • Bans on stock shorting makes a crash scenario much more likely. (EX: China down 65% in 3 months)

The bailout may provide a little bounce, but it won’t hold. The deleveraging of the largest credit expansion in history will continue. My target for the S&P 500 was 1000. Now I’m lowering it to 900. If your 401K is in equities, either move your money to fixed income or get ready for a punch in the nose.

Even though I’m a long-term bull on America, I can’t help but to think of this line from the Crowded House song Chocolate Cake when I see all the bailouts.

Now the excess of fat on your American bones
Will cushion the impact as you sink like a stone

Trying to Understand George Soros

Although I could care less about what George Soros thinks politically, I do have an interest in understanding how his mind works when it comes to investing. George Soros is a legendary investor that has made billions. One characteristic I’ve learned he has is the ability to immediately divorce himself from all prior positions and look at data with fresh eyes. Unlike the bubble-heads on CNBC, Soros is known for changing his opinion and not tying up his ego with prior calls. I was hoping I could better understand him with his latest book, but it failed to deliver.

The Crash of 2008 and What it Means: The New Paradigm for Financial Markets
The Crash of 2008 and What it Means: The New Paradigm for Financial Markets by George Soros is a mixed bag. In part of the book he painstakingly tries to explain reflexivity as it applies to financial markets. As much as I tried to understand it, his failure to use analogies and clear writing made it confusing to me. The Reflexivity, financial markets, and economic theory section on his Wikipedia page did a better job of explaining reflexivity than his book.

The rest of the book had economic outlooks. The book was released in May 2008 and the banking crisis had already started. That is kind of like making a game predicition during half-time. He is also a proponent of the theory that this time when the USA slips into recession, the rest of the world will decouple and be OK. That has already started to prove false.

My recommendation is avoid this book and just read his Wikipedia page.

And Here Is What Happened When They Decided To Cut Loose

Something about the proposed Paulson $700 Billion bailout doesn’t seem right. You have very smart people making sound arguments against it, but I’m starting to wonder if there is another motive behind the bailout.

I can’t help but think of Law 3 from the book The 48 Laws of Power by Robert Greene:

Law 3 – Conceal Your Intentions

Keep people off-balance and in the dark by never revealing the purpose behind your actions. If they have no clue what you are up to, they cannot prepare a defense. Guide them far enough down the wrong path, envelope them in enough smoke, and by the time they realize your intentions, it will be too late.

When I hear Paulson, Bernanke and Bush discuss the banking crisis, I can’t help but to think of this Law. Get the public hot and bothered over executive compensation or some other minor issues while the real plan unfolds. What is the real intent?

I did several more hours of reading and found an alternate theory which makes more sense to me. Granted I am an arm-chair economist, so I could be 100% wrong. I’ll do my best to explain my current thoughts.

  1. The United States runs a deficit to the tune of $2 Billion a day. To get the $2 Billion, we sell Treasuries. Most of the $2 Billion comes from China.
  2. Moving $2 Billion worth of Treasuries every day is not an easy task. The Federal Reserve hands this task out to Primary Dealers. Primary Dealers (PD) are large banks and investment houses. The Federal Reserve of New York has a full list of Primary Dealers.
  3. As the economy slows the projected annual deficit is expected to get large. By some estimates it could be as high as $1 Trillion next year. This means the PD’s will need to sell a lot more Treasuries to fund our government.
  4. Some PDs have already gone under and there is speculation that more failures may be imminent.
  5. If our need to sell Treasuries will be greater next year and there is the risk that we can lose a few PDs, then the government runs the risk of not having a way to fund itself. In other words, Paulson and Bernanke fear the next Primary Dealer failure could impair the ability of the United States to raise money.
  6. So the $700 Billion would go directly to the Primary Dealers to push Treasuries to make up for the projected $1 Trillion deficit. In exchange the PDs would then get to unload $700 Billion in toxic loans. Stressed banks that aren’t PDs would be left to implode and have their assets picked clean by the PDs.

This theory is my overview of many comments I read over on Ticker Forum in 2 threads:

The big question that is still left unanswered to me is why doesn’t the Federal Reserve of New York start finding new stronger financial institutions to become Primary Dealers? Are the banks that weak or are they out of time? The Federal Reserve is often called the banker of bankers. Doesn’t it make sense that they would back a plan that would show favoritism to their Primary Dealers?

This post is speculation, but it makes more sense that what I’ve heard from our leaders. How would most Americans respond knowing that our country is a slave to foreign bankers? Ignorance is an easier pill to digest than living within our means.

Watching Wall Street and Waiting

Saturday evening I posted As Soon As I Get My Head, which summarized my thoughts and concerns on what might happen in a post-Paulson bailout world. Even though I’m hedged to profit from a stock market decline or crash, nobody is protected if we have a total banking collapse. I had a bad night sleep imagining what would happen if the $62 Trillion credit deriviative market started to unwind. The leverage that allowed us to buy homes with no money down and then see those homes double or triple in value was exciting on the way up, but it is going to sting on the way down.

Last Wednesday, I got out of all UltraShort ETFs that have counterparty risk. The Geldpress just released a good article explaining my concerns with these investments. From Proshares biggest counterparty risk is US Government:

It is the counterparties, and not Proshares, that actually does the shorting of the market or index. And the counterparty risk associated with Proshares ETFs is the risk that these counterparties will become insolvent and not be able to pay the agreed upon inverse returns.

In other words, the market tanks and you pop the champagne cork thinking you are silly rich only to find out the counterparty blew up and you lost all your money.

After 9/11, I stocked up on canned food, water and other items. After Katrina, I increased my stockpile. Since then I’ve moved three times and my emergency provisions have been reduced greatly. The biggest emergency situation that I have had to deal with was the San Diego fires of 2003. The fires tore through San Diego faster than anyone expected. When an emergency strikes, you can be certain that you won’t be able to stop time and run to Costco.

Photo of the 2007 San Diego fires from FLICKR user slworking2

We may or may not have an Argentina style banking crisis, but ignoring the possibility isn’t wise. Bad unexpected things can happen. And they can happen very quickly. After I woke up from my bad night of sleep, I asked myself what I would do if I knew a hurricane or fire could hit me in the next week or so. Here is what I did today:

  • Pulled $500 out of an ATM. Will do this everyday this week. In a crisis, you can’t be certain your credit or debit cards will work or be accepted. Cash is accepted everywhere – for now.
  • Made sure my car had a full tank. Oil has since spiked $25/barrel.
  • Loaded up the refrigerator. Bought lots of canned tuna, dry beans and bottled water.

Do I think something bad is going to happen? No, but if it does, I want to be prepared. Once I feel the crisis has passed, I’ll start spending the cash or re-deposit it in the bank. The food and water will be consumed. No loss. Just greater piece of mind and hopefully a better night of sleep tonight.

As Soon As I Get My Head Round You

All day long I’ve reading, researching and thinking about Paulson’s No Banker Left Behind Plan and what is going to happen to the economy. This post isn’t about the guilty parties that got us in this bailout mess or why this plan is a going to be a disaster. Instead I want to try and guess how this all ends. As a student of economic history, I think we may be fast approaching a pivotal moment.

I see three possible outcomes:

  1. Paulson and Bernanke will succeed and the market and economy will be put right back on track.
  2. Deflation. (Cash is king, Debt is slavery)
  3. Hyper-Inflation. (Cash is trash, Debt becomes -relatively- cheaper)

Outcome one is a fairy tale. If you are long in equities now, you are betting against history.

Up until the bailout, I’ve been firmly in the deflation camp. Deflation is not declining prices, but a decline in the money supply caused by a destruction of credit. Loans go bad, banks collapse and lending tightens. This causes a restriction of the money supply and thus deflation. Despite Bernanke and Paulson’s tough inflation talk over the past year, it is now clear by their actions that they fear an all out deflationary collapse.

Is the bailout going to be inflationary? Are they going to print their way out of this mess? Throw around enough cash to make devalued assets worth elevated prices by devaluing the currency. This option would punish those with savings to alleviate the pain felt by those with debt. I have a tough time believing bankers would shoot themselves, but anything is possible. Also it may be easy to inflate asset prices such as homes, but in a global economy, how can one inflate all salaries to pay for those assets? I don’t think you can.

Maybe Thomas Jefferson’s banking warning holds the answer?

I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered.

I’m still in the deflation camp, but as someone with zero debt and savings that could be my wishful thinking and bias. I’m going to keep reading and thinking about this. A possible deflationary collapse mixed with a stock market that put in shorting bans is a volatile recipe for a stock market crash.

My Counter Party Is Over

Back in March, I wrote one of the most popular posts on this site titled Ultra ETFs and Counterparty Risk. It is a long detailed post where I outlined my concern that if a seismic shock to the financial world hit, I wouldn’t be completely confident that leveraged ETFs would survive.

Today AIG was bailed out. Karl Denninger sent out an alarm last night on how this move basically put a target on all firms that have exposure to CDS risk. He predicted that hedge funds could short these firms into default.

What happened today?

  • Morgan Stanley was down 24%.
  • Goldman Sachs was down 14%.
  • The Russian market dropped so much they closed it.
  • Gold set a one day record.
  • T-Bill rates dropped to 1950s levels.
  • S&P 500 dropped 4.7%. NASDAQ was down 4.9%.

Meanwhile our lawmakers and Presidential candidates are clueless to what is going on. They were warned. They failed to take action and now world financial markets are getting rocked. Is this the seismic shock? I don’t know, but I do know that I don’t want any counterparty exposure at this moment. I hate to be right about the direction of the market (down) and be wiped out because I was right. That would really suck.

Today I closed out my last two positions in UltraShort ETFs. Although I’m about 95% confident they will survive, that isn’t enough. I still believe the market will drop further, so I’ll be adding to my positions in the Prudent Bear and the Grizzly Short funds.

If the leveraged ETFs survive this financial crisis, I hope to use them again. But for now, my counterparty is over.

Another Reason Real Estate Prices Will Drop Further

In the post Irrational on the Way Up, Rational on the Way Down?, I touched on the psychology of would be home buyers that watch prices drop faster than they can save money. Saving money and delaying purchase will become more and more popular. Meanwhile the inventories of unsold homes will continue to increase. Besides psychology and high home supply, there is another reason why home prices are going to fall further. Lending is about to get very tight.

When I bought my first home in May 2001, all I needed was a 5% down payment. I had saved enough money to put 10% down, but I didn’t need it. And since I served 6 years in the Army National Guard, I was also eligible for some military program, but I didn’t need it. The bank that under wrote my mortgage liked my credit score, salary and felt a 5% down payment protected them.

home

As real estate prices rose, the banks decided they no longer needed a 5% down payment. If the underlying asset is appreciating at such a fast rate then – if the owner defaults – they could always sell the house at a profit.

Then the banks got real stupid and started writing loans without proof of income. They wanted the fees and again they could always resell the home at a profit if the owner defaulted, because real estate can only go up. Right? Wrong.

Well we know what happened next. Waves of foreclosures and banks taking back properties they can not sell. The inventory on the MLS is getting larger while the REO (bank owned) shadow inventory is growing at an even more rapid pace. In a video earlier this year, Mr. Mortgage stated that 97.5% of all homes put up for sale at auction are being taken right back by the same bank – because the bids are too low.

The music will stop. It already stopped for IndyMac. Other banks will fail. When they do, more inventory will be dumped onto the market. But this post isn’t about inventory, it’s about lending.

Lending is about to get very tight. Not a little, but a lot. The days of 0% down are gone. The days of 5% down for many markets will be gone as well. Mr. Mortgage is reporting that Fannie/Freddie is moving to a 10% down payment requirement.

Requiring an extra 5% down in the hardest hit states will take many potential buyers out of the market. This would be yet another blow to fragile markets around the nation. Fannie and Freddie are handling some 75% of all loans in the US now and even a seemingly slighttightening of guidelines can have devastating effects.

10% down may be just the beginning.

We know savings are very low in this country right now. Perhaps nearing an all time low. Huge inventories + no savings + stricter down payment requirements = Big price reductions are coming. How will banks respond to underwriting mortgages when they underlying assets keep falling in value? They will either ask for proof of a higher salary or more likely demand a higher down payment. The bank will not want to be under water should you walk away from the home. A larger down payment protects them should you decide to walk away.

Are we going back to the days of 20% down payments? If we are, what kind of house can you afford? The prices of homes today are based off the expectation of easy credit and low down payments. What makes a $700,000 home worth $700,000? Is it no proof of income and a 0% down payment? Or is it 3x income with a 20% down payment? Something needs to correct or this equation doesn’t work. Prices have to come down.

I’ve said it before and I’m sure I’ll say it again. In a deflationary environment, cash is king. If you want to buy a house, save your money, because the bank may not loan you all you need.

Irrational on the Way Up, Rational on the Way Down?

I’m continually amazed on how otherwise intelligent people fail to learn the lessons of history. Whenever an asset class gets into an inflated bubble, the bubble does top out and the blowback is a bitch. Prices do not settle to fair market. They overshoot. Home prices will not settle gracefully to fair market values. They will go lower.

Here is why. The normal way to buy a home is to first save up enough money for a down payment. During the bubble years, homes were appreciating at a faster rate than one could save money. Lenders then lowered the standards and this pushed values even higher. They threw gasoline on the fire. Anyone that sat on the sidelines was punished for missing out on the appreciation. Credit was king and cash was trash.

Now we are seeing the opposite. Home prices are now depreciating at a faster rate than one can build savings. So every month that passes by, the saver is able to afford a better home. Ironically, being a renter and staying out of the market is now the fastest way to build (future) home equity. Credit is drying up and soon cash will be king.

One of my financial mentors Karl Denninger wrote this today:

What this means for you is that if you think home prices will “bottom” in the next six to nine months you are sadly mistaken and are about to get a very expensive and nasty lesson in the reality of economics.

In addition we are likely to see an overshoot in prices – perhaps by 1/4 to 1/2 of the “height” of the bubble. If so, that would take inflation-adjusted home prices down to around $100,000, which is a decline of another fifty to sixty percent – not 30% – from today’s prices.

In a normal market, the future home buyer can pull out a calculator to determine when it is time to buy a house. When an asset bubble collapses, one also needs to figure out the market sentiment. Look at the chart below.

Back in March, I listed 4 rules for Picking a Real Estate Bottom. I would add market sentiment as a loose 5th rule. Be aware of it. Listen. Save money and be patient. That million dollar condo with the view won’t be a million at the bottom.

Financial Book Picks

In the last few years I’ve read quite a few books that are related to finance. Here are my favorites broken down by sub-genre.

Basic Investing

Bull's Eye Investing: Targeting Real Returns in a Smoke and Mirrors Market
Bull’s Eye Investing: Targeting Real Returns in a Smoke and Mirrors Market by John F. Mauldin is my pick for the average person that wants to invest in the stock market. John Mauldin makes heavy use of charts and the work of Ed Easterling and lays out probable returns based off of certain conditions. If you are rightfully skeptical when you are told the big lie that stocks always go up in the long term, this is the book for you.

Financial History

Origins of the Crash: The Great Bubble and Its Undoing
Origins of the Crash: The Great Bubble and Its Undoing by Roger Lowenstein is my pick for the best financial history book. Roger is the best financial historian there is and is probably better known for his book When Genius Failed: The Rise and Fall of Long-Term Capital Management. I loved both books, but think Origins of the Crash is a more interesting time period that more people will relate to than the 1998 LTCM crisis.

Philosophy

Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets
Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets by Nassim Nicholas Taleb explores how humans undervalue unexpected events. I loved this book when I reviewed it back in March and plan to read it again some day. The chapter on the Black Swan was later expanded into a full book. Read Fooled by Randomness first, then tackle the Black Swan.

Trading Psychology

Reminiscences of a Stock Operator (Wiley Investment Classics)
Reminiscences of a Stock Operator (Wiley Investment Classics) by Edwin Lefvre the story of legendary trader Jesse Livermore and was written back in 1922. If you think you want to be an active investor, I highly recommend reading this book. This is a book that traders on Wall Street will read multiple times throughout their career.

A Little Bit of Everything

More Than You Know: Finding Financial Wisdom in Unconventional Places (Updated and Expanded) (Columbia Business School Publishing)
More Than You Know: Finding Financial Wisdom in Unconventional Places (Updated and Expanded) (Columbia Business School Publishing) by Michael J. Mauboussin is a great mix of philosophy, psychology and statistics easily explained across 30 essays. If your reading time is limited and you want to expose yourself to a little of each of these topics, then this is the book you want.

What finance books would you add to the list?

Won The Lottery Revisited

On March 9th, 2006 after receiving the money from the sale of my house in San Diego County, I wrote in the post Won The Lottery :

Yesterday, I received the money for the sale of that house. It was A LOT of money. The amount of profit was insane. I am another winner in the California home seller lottery. The reason Im a winner is because Im not buying another home.

At the time I was told by several people that once a person sells in California they are forever priced out of the market. Home prices could only go up in value. I was told that I was making a mistake. I disagreed.

While living in my gated community I suspected something was wrong. I saw neighbors using home equity loans to buy boats, replacing perfectly good landscaping with even more perfect landscaping and taking international trips. Then I saw how the lending standards went from solid to outright silly (illegal).

Something wasn’t right in the market and most people seemed too drunk off of appreciation to notice anything.

The stock market will continue to go up as long as there is at least one more buyer willing to pay a higher price for that stock. Having already lowered lending to fraudulent standards and with interest rates at historically low standards, it was just a matter of time before there would be no next buyer to push up the home prices. Home price appreciation can not exceed salary appreciation in the long term. This is a lesson IndyMac and other banks are learning as they implode or write down billions in losses.

Mish is reporting the latest housing numbers on Record Declines in Case-Shiller Index. San Diego from peak to today has already dropped 28.9%. It was irrational on the way up, it will be irrational on the way down.

Irrational Exuberance
Irrational Exuberance by Robert J. Shiller is the book that connected the dots for me. This is a classic book on investor psychology. The second edition has a full chapter that deals specifically with real estate. It was written just prior to the housing decline. I still recall clowns like Jim Cramer mocking him and his predictions.

Yesterday I was asked when I was going to buy next. I really don’t know the answer, but I threw out a guess of 3 years. When home prices were appreciating, people couldn’t save fast enough to keep pace with rising prices. Now we have the reverse situation. Prices are falling faster than most people can save. The net result is the longer one sits on the sidelines saving money, the better the home they will be able to buy when prices do bottom.

When will real estate bottom? Read my thoughts on Picking a Real Estate Bottom.

Financial History Repeating Itself

Back in March I reviewed a financial history book called Devil Take the Hindmost. In that post I listed how America 2008 was starting to look like Japan 1990. One of the items I mentioned was in regards to accounting.

2. Central bankers turned a blind eye to banks that wouldnt write down bad debt.

The Big Picture is reporting that FASB is delaying the Off-Balance Sheet Rule for a year. Ritholtz is a student of financial history and one of my financial mentors. He brilliantly states:

The longer they wait, the worse it ultimately will be. The long Japanese Recession (1989-2003) was caused by precisely this refusal to take the markdown, and engage in all manner of delays, excuses, procrastinations. Eee-diots — This only will make it worse!

When the people with capital to invest no longer trust the accounting, they withhold further investment. Without new investment you aren’t going to pull out of a recession.

One of the reasons America has always been an economic superpower is because we’ve always held a high standard when it comes to accounting and protecting the interest of investors. We make mistakes, but those mistakes are recognized and ultimately fixed.

Today FASB stated that we know the books are cooked, but we are going to turn a blind eye. This is banana republic accounting. And it is one of the reasons I don’t hold a single long position in any stock right now.

Hope Your 401K is in Fixed Income

Three months I mentioned in the post Mr. Financial Planner – Go Home and Get Your Shine Box! how 100% of my company-managed 401K was in the Fixed Income fund.

The statement lists the returns for all the investment options I had at my disposal. My Cash Fixed Fund earned just a 0.97% return. But that was enough to make it the best performing fund on the list. Every other fund lost money. All the stock funds lost between 8% and 17% during that same time period. All the bond funds lost money too. So did the packaged allocations, including the Conservative option which lost over 3%.

My latest statement once again shows that almost all the funds lost money except the Fixed Income. In a bear market preservation of capital not appreciation of capital is your number one goal.

Don’t Cry For Me and My Diesel Engine

About a week before 9/11, I made one of the most fortunate consumer choices of my life. Although I had already decided to buy a silver VW Golf hatchback, I didn’t know if I should get the gasoline or the diesel engine. Having never owned a diesel engine, I was concerned I wouldn’t find a diesel pump and I’d run out of fuel and the engine would lock up. My only experience with diesel vehicles were those panic-filled moments trying to return a rented U-Haul truck when I struggled to find a diesel pump.

2001 VW Golf TDI

The reason one buys diesel over gasoline is diesel engines not only last twice as long, but the fuel economy is much better. Here is a quick comparison of the 2001 VW Golf models:

City MPG

  • Gasoline: 22-24
  • Diesel: 34-42

Highway MPG

  • Gasoline: 28-31
  • Diesel: 45-49

I chose fuel economy over convenience and bought the diesel. Finding diesel stations turned out to be quite easy. Once you start looking for them, you see them everywhere. I even took a road trip from San Diego through the American Southwest with no problem. Going 600+ miles on a tank of fuel is a nice thing.

Well we all know what happened next to the price of fuel. And in the last two years diesel has increased at an even faster rate than gasoline. Diesel is now $5 a gallon here in Seattle. When I tell people I drive a diesel they give me a sad look like my dog just died. Should they be empathetic to me? Let’s run the numbers.

Here are some rough calculations to determine if I made the correct purchase. Below are my assumptions:

  • 90,000 miles driven
  • Average MPG City Gasoline = 23, Diesel = 38 (median number)
  • Average MPG Highway Gasoline = 29.5, Diesel = 47 (median number)
  • Driving ratio = 50% City, 50% Highway
  • Average Gasoline Price 2001-present San Diego/Seattle = $2.80 *
  • Average Diesel Price 2001-present San Diego/Seattle = $3.00 *
  • Current Gasoline Price Seattle = $4.25
  • Current Diesel Price Seattle = $5.00

From 2001 – present:

  • Gasoline Fuel Cost = $9600.00
  • Diesel Fuel Cost = $6352.94

On fuel costs alone, the diesel engine saved me $3247.06 so far. And if I used those savings to buy stock in oil companies that number really explodes. :)

What about now? Here is the cost to drive 100 miles with todays fuel prices.

  • Gasoline Fuel Cost = $16.19
  • Diesel Fuel Cost = $11.76

So even with diesel being priced 75 cents more per gallon, I’m still way ahead on fuel savings. So please don’t cry for me and my diesel engine. I’m crying for you.

* based off my memory of fuel costs averaged together since 2001

Hedging Financial Risk For First Time Homebuyers?

A few people in Seattle have asked me if this is the right time to buy a house. They don’t really want my answer. They want to buy and want me to agree with that decision. My needs and their needs are not the same. My goal (at this time) is to maximize investment, not to be a homeowner.

One lady I know is tired of moving. She wants to have children and wants her own house. I’m a single guy with no debt. My plan is to wait it out and buy a kick ass place at the bottom. She has a biological clock that can’t be reconciled with inventory levels. She needs to buy a house in order for her to be comfortable with being a new mother.

I started mentioning to her how sophisticated investors could hedge risk by trading Case-Shiller futures on the Chicago Mercantile Exchange. Too difficult. Robert Shiller mentioned in Irrational Exuberance how someday regular home buyers would be able to purchase insurance to protect themselves against home price declines. However, that day hasn’t arrived yet.

There are some financially smart people that read this blog. Do you have any ideas on how a first time home buyer could hedge against the risk that their home might drop by 20% in value in less than 5 years? There has to be a way the average Joe can easily offset some of the risk associated with the largest purchase they will ever make.

Shooting The Messenger

Don’t blame me. It isn’t my fault your home price is plummeting, your 401K is getting rocked and your bank is in trouble. I’m just a student of financial history and saw things differently than the bubble-heads on CNBC. I still have a lot to learn and I’m often wrong (oil). However, it is starting to look like I got three things right.

  1. Real Estate Price Correction – I sold my house and went into the rental market.
  2. Bear Stock Market - Exited long positions. Moved 401K to a self-directed account with Ameritrade. Bought into bear funds and ultra short ETFs. Was a bit early, but all positions are now clearly in the green.
  3. Banks Would Fail - Was a customer of IndyMAC. Researched their stability and came to the conclusion they would fail. Pulled money out in March. Although the money was insured, I was not one of the people inconvenienced. If the “W bank” falls under their Capital Requirement, a lot of people here in Seattle will be inconvenienced and if they have more than 100K, they will be screwed.

Now what?

The real estate market still has further to fall. There is simply too much inventory and pricing still reflects the easy credit financing which is now gone. The Big Picture reports today that the Mortgage Insurance Industry is saying that 70% of Previous Buyers Don’t Qualify. Prices will fall to the historical levels of three times income with a 20% down payment. It may take 3 years to get there. If you are renting, save your money. Cash will be King in a tight lending environment. There is no dishonor in renting.

I see the S&P 500 dropping to 1000 by the end of the year. The P/E ratio is still too high as corporate profits are declining. I plan on staying short until this target is reached. At which point, I’ll lock some gains and move to fixed income.

Every few months I will confirm my bank still has a good rating with Safe and Sound. If it falls, I’ll move my money. I spent hours on the phone with IndyMAC back in March closing out my CD. I can only imagine the hell their current customers are going through right now.

I am a long term bull on the American economy, but right now we have to deal with the hangover of partying too hard with easy credit.

UPDATE (7/27/08): Turns out Safe and Sound may not have updated and accurate data on the health of a bank. Don’t Count On The “Safe & Sound” Rating Of Bankrate.Com

True Job Insurance Means Shorting Your Own Company Part 2

After posting True Job Insurance Means Shorting Your Own Company earlier this week I realized it raised some questions that weren’t answered in the post.

DHammy stated accurately:

I think its unlikely anyone is going to follow this advice. People just arent able to see how big that gap is between what they know and what they think they know.

In addition to not seeing the how big that gap is, some will see the concept of buying options too complicated to pursue. This all comes down to how important it is to hedge that risk. If you’ve deemed it important to have that hedge, but are overwhelmed by the financial complexity, then take it one step at a time.

  1. Open an online brokerage account. I use Ameritrade and love their user interface. It is clean and easy to understand.
  2. Have your account set up to trade options.
  3. Ask your broker to assist you with buying LEAPS. Ameritrade has many local offices and is very helpful. I once went into an office and spent 30 minutes with them learning about how to trade fixed income securities.

Matt’s comment got me thinking as well.

How about never joining a company, but creating your own and investing in it?

I should have been more clear. Shorting your own company is NOT an investment strategy. It is a hedging strategy. It is protection for the event you don’t want to happen. Only use a small amount of money you are willing to lose. Think of it like car insurance. You have coverage and hope to never use it.

Matt also brings up the self-employed angle. If you are self-employed or work for a private company, then you do not have the option of shorting your employer. What should be your hedging strategy here? I would advise buying long-term puts on a same sector ETF. If your company is in healthcare, then buy puts on something like ProShares Ultra Health Care ETF.

Before I get attacked on this point, let me invent a hypothetical situation to use as an example. Sue quits her job and decides to start her own luggage business. She pools her money and loans to start production on her product line. Then 9/11 hits. Nobody is traveling. Nobody is buying luggage. Her business is wiped out before her first sale. The undervalued unexpected event hit her hard. Had Sue purchased some long term puts on a travel related sector such as airlines, she would be much better off. And it wouldn’t have cost her much money.

IndyMAC Is Gone, Who Warned Ya?

On 3/17/2008 I posted IndyMac I’m Never Coming Back.

IndyMac has the lowest rating a bank can receive with Safe and Sound ratings. After seeing Bear Stearns implode in days, I didnt need much encouragement to close that account out immediately.

Then on 7/2/2008, I followed it up with IndyMAC – Dead Bank Walking?

Tonight after the market closed the FDIC came in and closed IndyMAC. This is the 2nd largest bank closure in United States history. My guess is there is a much bigger bank in wings that will go under. I’ll repeat the question:

Do you know how safe your bank is?

UPDATE (7/27/08): Turns out Safe and Sound may not have updated and accurate data on the health of a bank. Don’t Count On The “Safe & Sound” Rating Of Bankrate.Com