Jimmy's Trading Room

The 2011 J. P. Morgan Global ETF Handbook

2011-04-12T05:35:00.001-07:00

The 2011 J. P. Morgan Global ETF Handbook

Covered Call Strategies

2011-04-03T03:55:00.000-07:00

Sell 4 weeks/5 weeks covered call for stock when VIX is under 20 , SPX is up trend and no earning report for the stock in contract month.
During first two weeks ( weeks 3 in 5 weeks contract ), buy back the options whn its value drop to 20% of the original premium or less.
During week 3 ( week 4 of 5 weeks cycle ) of contract period, buy back the options when the ask is 10% or less of the original premium.
During week 4 ( last week ) of the contract , buy back the option at any price if we feel necessity to sell the underlying equity immediately.
If at any time during the contract period you have reasons to believe that a stock will drop dramatically in price, buy back the option at any price, sell the stock , and immediately move the cash into another period.
Rolling down when buy XYZ@38, sell $40 call at $2. One week later price drop to $35 nad option value drop to $.40 ( drop to 20% of value). At the same time the $35 strike is selling at $2.0. Rolling down generate additional $160. If the stock above $35 after expired, income =$200+$160,loss from stock $38-$35 = $300.Profit $60.
Hit the double strategy :Buy back the options when t meet our 20%/10% requirements, sell the same option strike and month again if stock and option price up.
Convert dead money to cash profits, consider when there is dark cloud hanging over the stock.There is nothing wrong with selling a stock that is not performing.Closed all the position.
Exit strategies near expiration Friday, if price at or in the money, you can either rolling out(Rule price In the money ), rolling out and up( Rule price ITM ) or no action.

Trading VIX Options

2011-04-03T01:42:00.000-07:00

Steven Smith of TheStreet.com has a video interview up in which he asks Brian Overby for his thoughts on how to trade VIX options.

Overby, who is Director of Education at TradeKing and authors an informative options blog, Options Guy, tackles some of the idiosyncrasies of the VIX and has some excellent suggestions for those who insist on trading the volatility index. Frankly, there is close to 100% overlap between what he says and what I believe about the VIX.

I recommend clicking through to the video, but in a nutshell, Overby’s thinking boils down to the following:

VIX options do not follow the (cash) VIX index
To understand the price action in VIX options, look at VIX futures
When trading VIX options, trade the front month (closest contracts to expiration)
Trade VIX options when the VIX is at the extremes of its trading range
Utilize a mean reversion trading strategy
Look to sell vertical spreads (sell puts when the VIX is low; sell calls when the VIX is high)

10 Rules Of Investment Classic

2011-03-09T06:51:00.000-08:00

1. Markets tend to return to the mean over time
When stocks go too far in one direction, they come back. Euphoria and pessimism can cloud people's heads. It's easy to get caught up in the heat of the moment and lose perspective.

2. Excesses in one direction will lead to an opposite excess in the other direction
Think of the market baseline as attached to a rubber string. Any action to far in one direction
not only brings you back to the baseline, but leads to an overshoot in the opposite direction.

3. There are no new eras -- excesses are never permanent
Whatever the latest hot sector is, it eventually overheats, mean reverts, and then overshoots.
Look at how far the emerging markets and BRIC nations ran over the past 6 years, only to get
cut in half.As the fever builds, a chorus of "this time it's different" will be heard, even if those exact words are never used. And of course, it -- Human Nature -- never is different.

4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways
Regardless of how hot a sector is, don't expect a plateau to work off the excesses. Profits are
locked in by selling, and that invariably leads to a significant correction -- eventually. comes.

5. The public buys the most at the top and the least at the bottom
That's why contrarian-minded investors can make good money if they follow the sentiment
indicators and have good timing.Watch Investors Intelligence (measuring the mood of more than 100 investment newsletter writers) and the American Association of Individual Investors survey.

6. Fear and greed are stronger than long-term resolve
Investors can be their own worst enemy, particularly when emotions take hold. Gains "make
us exuberant; they enhance well-being and promote optimism," says Santa Clara University
finance professor Meir Statman. His studies of investor behavior show that "Losses bring
sadness, disgust, fear, regret. Fear increases the sense of risk and some react by shunning
stocks."

7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names
Hence, why breadth and volume are so important. Think of it as strength in numbers. Broad
momentum is hard to stop, Farrell observes. Watch for when momentum channels into a
small number of stocks ("Nifty 50" stocks).

8. Bear markets have three stages -- sharp down, reflexive rebound and a drawn-out fundamental downtrend
I would suggest that as of August 2008, we are on our third reflexive rebound -- the Januuary
rate cuts, the Bear Stearns low in March, and now the Fannie/Freddie rescue lows of July.
Even with these sporadic rallies end, we have yet to see the long drawn out fundamental
portion of the Bear Market.

9. When all the experts and forecasts agree -- something else is going to happen
As Stovall, the S&P investment strategist, puts it: "If everybody's optimistic, who is left to
buy? If everybody's pessimistic, who's left to sell?"
Going against the herd as Farrell repeatedly suggests can be very profitable, especially for
patient buyers who raise cash from frothy markets and reinvest it when sentiment is darkest.
10. Bull markets are more fun than bear markets

Especially if you are long only or mandated to be full invested. Those with more flexible
charters might squeek out a smile or two here and there

High Valutaion

2011-02-18T18:45:00.000-08:00

Last week, the S&P 500 Index ascended to a Shiller P/E in excess of 24 (this "cyclically-adjusted P/E" or CAPE represents the ratio of the S&P 500 to 10-year average earnings, adjusted for inflation)
Based on our standard methodology (elaborated in numerous prior weekly comments), we presently estimate that the S&P 500 is priced to achieve an average total return over the coming decade of just 3.15% annually. Again, we've seen weaker projected returns over the past decade. But then again, the S&P 500 lost about 5% annually in the decade following the 2000 peak, and even including the recent advance, has achieved an annual total return since 2000 of almost exactly zero. So despite periodic speculative runs, rich valuations have an annoying way of ruining the fun. Equally important, even during extended speculative periods as we observed in the late-1990's, those advances have tended to suffer deep and abrupt intermediate-term corrections once elevated valuations are joined by overbought conditions, over bullish sentiment, and rising interest rates, as we observe today.----John P. Hussman, Ph.D.

Paulson Latest Holdings

2011-02-15T06:26:00.000-08:00

Full breakdown of holdings as of Dec. 31 (full green row highlight is new position).

Bull, Sideways and Bear Market

2011-02-07T23:01:00.000-08:00

Japan Bear Market

Starting in the late 1980s, over a 14-year period, Japanese stocks declined 8.2 percent a year. This decline was driven by a complete collapse of both earnings – which declined 5.3 percent a year – and P/Es, which declined 3 percent a year. Japanese stocks were in a bear market because stocks were expensive, and earnings declined over a long period of time. In bear markets both P/Es and earnings decline.

The P/E journey from one extreme to the other is completely responsible for sideways and bull markets: P/E ascent from low to high causes bull markets, and P/E descent from high to low is responsible for the roller-coaster ride of sideways markets.

Bear markets happened when you had two conditions in place, a high starting P/E and prolonged economic distress; together they are a lethal combination. High P/Es reflect high investor expectations for the economy. Economic blues such as runaway inflation, severe deflation, declining or stagnating earnings, or a combination of these things sour these high expectations. Instead of an above-average economy, investors wake up to an economy that is below average. Presto, a bear market has started.

Let's examine the only secular bear market in the twentieth century in the United States: the period of the Great Depression. P/Es declined from 19 to 9, at a rate of about 12.5 percent a year, and earnings growth was not there to soften the blow, since earnings declined 28.1 percent a year. Thus stock prices declined by 37.5 percent a year!

Red Flags Commonly Used to Insinuate Fraud

2011-02-04T03:51:00.000-08:00

A. Financial

SAIC documents do not match SEC.
SAT documents do not match SEC.
Low R&D expense, especially when company has unique technologies. BORN
Unusually low accounts payable position. ZSTN
High margins compared to competitors.
Allegations of low credit rating when SEC filings look pristine. CCME

B. Internal Controls/Corporate Governance

Ineffective internal controls, especially when issue exists for an extended period of time. SKBI
High CFO turnover. CSKI
Resignation of several members of the board of directors. BORN
High auditor turnover, especially if company goes back to old auditor.

C. Ownership Structure Issues

A significant delay in meeting registered capital requirements upon an RTO transaction. This could imply that original players were not comfortable infusing capital into a company. WKBT
Desire to switch ownership structure to a variable interest entity (VIE) from a foreign invested enterprise (FIE). ONP, CHGY. This could insinuate difficulties in securing capital from original players of the the RTO transaction.
Illegal corporate structure as defined by PRC law. CEU note

D. Share transactions

Several equity offerings within a tight time period.
Company raises money when it has excess capacity
IPO that priced well below desired price, yet company does not cancel or delay offering. BORN
Company raises money despite adequate cash balance. CBP note
Company raises money despite contradictory comments in filings and press releases. TSTC note
Equity offerings at low valuations when balance sheet is healthy and at least 30% EPS growth is expected. RTO stocks in general.

E. Miscellaneous

High land right use. LTUS
Company won’t disclose sellers related to certain transactions. CGA
Company won’t disclose address or names of retail locations, distributors and subsidiaries.
Lies about date of establishment of acquired business.
Negative commentary by media outlets in PRC. KGJI note
IPO rejected in the PRC if firm claims to be a leader. KGJI
Inadequate Website. CEU note
Low executive salary.
Regulatory interventions (SEC, PCAOB, etc).

Suggested Steps Companies Should Consider to Establish Credibility

A. Financial

Disclose SAT through an independent source. PRC law, as it relates to annual inspection process among several governmental bodies, implies that for FIE, SAIC should match SAT. However, a linear relationship for VIE between SAIC and SAT filings can not be assumed which is why SAT verification is particularly important for VIE company structures.
Reconcile SAT/SAIC filings with SEC fillings when they do no match.
Auditor should make a statement verifying they saw cash and SAT information and obtain this information independently. Access to documents should be made available at any time without company knowledge to avoid speculation that company has had time to employ fraudulent short-term measures.
Also consider giving an independent source random access to SAT filings and cash balances.
If you have engaged in tax avoidance schemes request a letter from PRC government forgiving past indiscretions and/or just settle the issue. ( we understand this may not be practical). Ideally, this should be done before going public.
Request a letter from the PRC that SAT filings are in line with SEC filings.

B. Internal Controls/Corporate Governance

Retain a Top 10 auditor (Top 4 is the most ideal)
Ideally, internal controls should be in check from day one. Even if a company can’t afford a top auditor on a full time basis one should at least be retained to implement effective internal controls such is the case with CBP. Internal control procedures should also be promptly reevaluated upon the completion of acquisitions.
Qualified Board of Directors should be in place upon going public.
Consider an independent advisory panel

C. Share Transactions

Do not issue equity at absurd valuations when you have (a) ample cash on hand, a healthy current ratio, a healthy cash ratio and (b) guidance or EPS estimates that imply at least 30% EPS growth.

Additionally, make a statement that you will not have to issue equity in order to grow EPS and stand by these words, unlike TSTC and SPU. If you do issue equity, reduce the share raise by utilizing cash so that healthy EPS growth will still occur.
Consider the use of some debt over equity when possible

D. Establish Investor Confidence

Issue EPS guidance. NEWN FSIN ALN GFRE (Ideally, for upcoming quarter and year)
Implement buy back programs when valuations are low as a way to increase EPS growth. CHBT CFSG ZSTN FMCN
Release monthly reports on status of buy back program.
Management buys stock. CMFO CCME
Declare special or quarterly dividend. CCME
Issue annual reports with letter from Chairman of the Board
Pay proper taxes
At some point, dual list shares

Clues that an Equity Raise is on The Horizon

Be aware that boiler plate language insinuating that current capital is sufficient to maintain current operations can offer a false sense of security vs. explicit language in SEC documents inferring that a company does see a need for an equity raise.
Look for contradictions in press releases that infer no need for capital vs. opposite jargon in SEC documents.
Compare “liquidity” sections in SEC documents to “risk disclosure” sections for contradictions regarding a potential need for capital.
Look for changes in statements about the need for capital when the level of business has remained unchanged/increased, yet liquidity standing has not seen significant changes.
Company has never raised money since going public.
Sudden cancellation to attending investment conferences and not returning calls or emails. This could imply that a company is in a quiet period. YUII note
No Q&A section during earnings conference calls can also signify that a company is in a quiet period. SPU
The “Offering” document filed with the SEC includes the proposed share amount of a potential offering, the amount of funds to be raised and the expected offering price.
When a foreign invested enterprise (FIE) has not met its registered capital requirements. WKBT note
When a company plans to switch to FIE from a variable interest entity (VIE). VLOV note
A company that grows by acquisition.
A company is at full capacity. CHGY
Requesting the removal of anti dilution provisions TPI note
Company with liquidity issues AKRK note

Value And Bubble Charts

2011-02-01T19:13:00.001-08:00

David Druz 10 Years Trading Returns

2011-01-28T19:07:00.000-08:00

Use this as a benchmark, if you are in the zone that generate higher than normal return, be careful, payback period is coming.....

S&P Composite Trend

2011-01-22T18:23:00.000-08:00

The Problem Of Credit Expansion

2011-01-15T18:32:00.000-08:00

"Every serious discussion of the problem of credit expansion must start from the distinction between two classes of credit: commodity credit and circulation credit. Commodity credit is the transfer of savings from the hands of the original saver into those of the entrepreneurs who plan to use these funds in production. The original saver has saved money by not consuming what he could have consumed by spending it for consumption. He transfers purchasing power to the debtor and thus enables the latter to buy these nonconsumed commodities for use in further production. Thus, the amount of commodity credit is strictly limited by the amount of saving, i.e. abstention from consumption. Additional credit can only be granted to the extent that additional savings have been accumulated. The whole process does not affect the purchasing power of the monetary unit.

"Circulation credit is granted out of funds especially created for this purpose by the banks. It increases the amount of money substitutes, of things which are taken and spent by the public in the same way in which they deal with money proper. It increases the buying power of the debtors. The debtors enter the market of factors of production with an additional demand, which would not have existed except for the creation of such banknotes and deposits. It is the main tool of policies aiming at cheap or easy money."

---

"Every deviation from the prices, wage rates and interest rates which would prevail on the unhampered market must lead to disturbances of the economic equilibrium. This disturbance, brought about by attempts to depress the interest rate artificially, is precisely the cause of the crisis. The ultimate cause, therefore, of the phenomenon of wave after wave of economic ups and downs is ideological in character. The cycles will not disappear so long as people believe that the rate of interest may be reduced, not through the accumulation of capital [i.e. savings made available for productive investment], but by banking policy."

"The calculation of entrepreneurs is misguided by the issue of additional fiduciary media. The greater this quantity of fiduciary money, the more factors of production have been firmly committed in the form of investments which appeared profitable only because of the artificially reduced interest rate and which prove to be unprofitable [as soon as] the interest rate has again been raised. Great losses are sustained as a result of misdirected capital investments. Many new structures remain unfinished. Others, already completed, close down operations. Still others are carried on because, after writing off losses which represent a waste of capital, operation of the existing structure pays at least something.

"It may well be asked whether the damage inflicted by misguiding entrepreneurial activity by artificially lowering the loan rate would be greater if the crisis were permitted to run its course. Certainly many saved by the intervention would be sacrificed in the panic, but if such enterprises were permitted to fail, others would prosper. Still, the total loss brought about by the "boom" (which the crisis did not produce, but only made evident) is largely due to the fact that factors of production were expended for fixed investments which, in the light of economic conditions, were not the most urgent. If banks emerge from the crisis unscathed, or only slightly weakened, what remains to restrain them from embarking once more on an attempt to reduce artificially the interest rate on loans and expand circulation credit?

"The discrepancy between what the entrepreneurs do and what the unhampered market would have prescribed becomes evident in the crisis. The fact that each crisis, with its unpleasant consequences, is followed once more by a new "boom," which must eventually expend itself as another crisis, is due only to the circumstances that the ideology which dominates all influential groups - political economists, politicians, statesmen, the press and the business world - not only sanctions, but also demands, the expansion of circulation credit."

Ludwig von Mises, Monetary Stabilization and Cyclical Policy (1928)
Historical note - The Great Depression began the following year.

"If the market rate of interest is reduced by credit expansion, many projects which were previously deemed unprofitable get the appearance of profitability. The entrepreneur who embarks upon their execution must, however, very soon discover that his calculations were based on erroneous assumptions. However, as the banks do not stop expanding credit and providing business with 'easy money,' the entrepreneurs see no cause to worry. Everybody feels happy and is convinced that now finally mankind has overcome the gloomy state of scarcity and reached everlasting prosperity.

"In fact, all this amazing wealth is fragile, a castle built on the sands of illusion. The artificial prosperity cannot last because the lowering of the rate of interest, purely technical as it was and not corresponding to the real state of the market data, has misled entrepreneurial calculations. Deluded by false reckoning, businessmen have expanded their activities beyond the limits drawn by the state of society's wealth. In short, they have squandered scarce capital by malinvestment.

"The sooner one stops, the less grievous are the damages inflicted and the losses suffered. Public opinion is utterly wrong in its appraisal of the [business] cycle. The artificial boom is not prosperity, but the deceptive appearance of good business. Its illusions lead people astray and cause malinvestment and the consumption of unreal apparent gains which amount to virtual consumption of capital. The depression is the necessary process of readjusting the structure of business activities to the real state of the market data, i.e., the supply of capital goods and the valuations of the public. The depression is the first step on the return to normal conditions, the beginning of recovery and the foundation of real prosperity based on the solid production of goods and not on the sands of credit expansion.

"It is vain to object that the public favors the policy of cheap money. The masses are misled by the assertions of pseudo-experts that cheap money can make them prosperous at no expense whatever. They do not realize that investment can be expanded only to the extent that more capital is accumulated by savings. What counts in reality is not fairy tales, but people's conduct. If men are not prepared to save more by cutting down their current consumption, the means for a substantial expansion of investment are lacking. These means cannot be provided by printing banknotes or by loans on the bank books.

"If one does not terminate the expansionist policy in time by a return to balanced budgets, by abstaining from government borrowing, and by letting the market determine the height of interest rates, one chooses the German way of 1923."

Ludwig von Mises, The Trade Cycle and Credit Expansion: The Economic Consequences of Cheap Money (1946).

Historical note - Von Mises recognized that inflation is not simply a monetary issue but a fiscal one. While conditions in 1946 did not reflect the credit strains that presently keep monetary velocity in check, fiscal conditions were similar, with war-related deficits peaking at just over 10% of GDP. It is often forgotten that in the U.S., the CPI, which had averaged only about 2% inflation prior to 1946, shot to an inflation rate of over 20% by 1948. The S&P 500 plunged, and despite a dividend yield exceeding 4%, it would not durably exceed its 1946 peak until 1950

Will it repeat again ?

2011-01-15T18:06:00.001-08:00

Current chart of the Dow you can certainly see a similar "ABC" type rally from the March 2009 low much like occurred in the mid 1970's and way back in the 1915-1917 time period. "A" was a 74% rise while "B" was a 15% pullback which has been followed by a 23% rise so far for "C". Meanwhile a 61.8% Retrace (red line) from the Dow's current high would be around 8500 which would be a 28% correction while a 78.6% Retrace (blue line) would be around 7600 and a 35% correction.

Super Cycle

2011-01-14T23:22:00.001-08:00

The Characteristics of Autumn Investment Cycle (start of last autumn cycle was April 12, 1982 ended January 14, 2000):

Confidence level: increasing confidence, extreme confidence and then euphoria in the markets and business cycles. “Euphoria” is defined by the dot.com market of the late 1990′s.
Inflation level: falling throughout the period. Although inflation in prices rose to some extent during this period, wages and asset value “kept up” with inflation (and most of all, the price of debt) and in some investments overtook it.
Credit level: massive increase in credit, especially to the consumer. I think we all realize the growth in the US was driven by the creation of credit and thus debt to the consumer. However, income rose enough to pay off debt and thus create more debt and the cycle continued.
Interest rates: interest rates fall during this phase. Because of the wide growth, credit is cheap and available to all. During this time, interest rates do not need to be brought artificially low by government as growth and expansion sets the rate.
Best investments: stocks, bonds and real estate. All these investments did very well during this period, surpassing inflation.
Indication of season change: bull market peak for DOW and bottom for gold. In inflation-adjusted terms, the DOW peak was 1-15-2000.

The Characteristics of Winter Investment Cycle (start of the winter cycle was January 15, 2000):

Confidence level: concern, then, fear, panic, and despair. We are between concern and fear right now. By the end of 2010, we will be in full fear mode.
Inflation level: fall of inflation quickens into outright deflation. The government is trying hard to fight against this. We are in stagflation at best right now. We will have inflation in prices because of a currency crisis, not economic growth. We are experiencing a deflation in debt (or credit). As discussed above, groovygirl believes we will experience a hyperinflationary depression, defined as a hyperinflation in prices and deflation in debt causing a contraction in economic growth.
Credit availability: following credit crunch, virtually, no credit. We are in credit crunch mode right now. It will continue to freeze and then disappear. The only credit available will be government mandated.
Interest rates: fall in credit crunch, then rise, then fall much lower. We are in the first falling mode right now. For housing, I don’t think they will rise again as the government will mandate it to try and keep the housing market afloat. However, the rate of return on bonds will rise (as this is the only way they will sell) and this rise will affect certain sectors of business. Mainly, it means, no growth and no investment.
Best investments: gold, cash, and then also bonds after credit crunch. (Because we have a completely floating fiat currency system in the world now, “cash” will be better held in some currencies more than others or precious metals.)
Indication of season change to Spring: bottom in DOW. Remember, we will have a currency crisis and hyperinflationary depression (deflation in credit/debt availability and inflation in prices/expenses). It is possible to have a DOW at 30,000 with no additional real value. The stock market will continue to lose value throughout this season. A good stat to judge a low in the DOW with the fiat Dollar gimmicks taken out is the gold/DOW ratio.

Cloud Stocks

2011-01-14T17:49:00.000-08:00

Cloud technology looks set to become the next game changer. Stock to look into are :

VMWare, Inc. (NYSE:VMW)

Riverbed Technology Inc. (Nasdaq:RVBD)

F5 Networks Inc. (Nasdaq:FFIV)

EMC Corp (NYSE:EMC) is another great pure cloud play.

IICN Premier Provider of Solutions ( As of now under value )

2010-11-19T20:45:00.000-08:00

10x45 Bargain Hunter: Stock Screener for Value Investors, June 14, 2010

Why Quantitative Easing is Likely to Trigger a Collapse of the U.S. Dollar

2010-11-06T19:07:00.000-07:00

John P. Hussman, Ph.D.
All rights reserved and actively enforced.
Reprint Policy

A week ago, the Federal Reserve initiated a new program of "quantitative easing" (QE), with the Fed purchasing U.S. Treasury securities and paying for those securities by creating billions of dollars in new monetary base. Treasury bond prices surged on the action. With the U.S. economy predictably weakening, this second round of quantitative easing appears likely to continue. Unfortunately, the unintended side effect of this policy shift is likely to be an abrupt collapse in the foreign exchange value of the U.S. dollar.

How exchange rates are determined - a primer

To understand how currencies fluctuate, it's helpful to understand two forms of "parity" that operate in the foreign exchange markets.

1) Purchasing Power Parity (PPP): This describes the tendency for long-term exchange rate movements to reflect long-term changes in relative price levels between countries. Suppose for simplicity that a given basket of goods costs $10 in the U.S., and costs FC40 in some other country (where FC is simply a unit of foreign currency). If the goods are identical and can be transported costlessly without any barriers, one would expect that $10 = FC40, or that $1 = FC4. So the exchange rate would satisfy purchasing power parity if one dollar traded for 4 units of foreign currency.

Suppose the foreign country is highly inflationary, so that the price of that basket of goods increases to FC60, while the U.S. experiences no corresponding inflation. PPP suggests that the exchange rate should track the relative price levels between the two countries, resulting in a new exchange rate of $1 = FC6. This would be a "strengthening" or "appreciation" in the dollar, since each dollar would command a greater amount of foreign currency. Conversely, this would be a "weakening" or "depreciation" in the foreign currency, since each unit of FC would command fewer dollars.

More generally, goods and services are not identical across countries and cannot be moved costlessly, so PPP is only a long-term tendency, and is not enforced at every point in time. Still, there is a strong tendency for exchange rate movements, in the long run, to reflect relative inflation rates of inflation between countries. Countries with high rates of inflation tend to depreciate over time, relative to countries with lower rates of inflation, and this depreciation is in nearly direct proportion to the relative changes in price levels (particularly when one uses price indices of tradeable goods).

2) Interest Rate Parity: This describes the tendency for exchange rates to move in a way that offsets expected differences in interest rate returns. Suppose that interest rates in the U.S. are 2%, and interest rates in the foreign country are 5%. If the exchange rate was expected to remain perfectly constant, and there were no barriers to capital movements, investors would have a strong tendency to buy the foreign currency in order to earn the higher interest rate. Of course, the exchange rate would not remain constant, as investors would tend to bid up the foreign currency. In fact, there would be a tendency to bid up the foreign currency until it was sufficiently elevated today that a 3% annual depreciation would be expected in the future. At that point investors would be indifferent, since the 2% interest rate available in the U.S. would be equivalent to the 5% interest - 3% depreciation expected in the foreign currency. From a foreigners perspective, the 5% interest rate available in that country would be equivalent to the 2% interest + 3% appreciation expected in the U.S. dollar.

The key idea is that purchasing power parity holds in the long-run in order to align the prices of internationally traded goods and services, while interest rate parity tends to maintain shorter-term equilibrium in the capital markets. Both are important determinants of currency fluctuations because currencies are both a means of payment and a store of value. You can find a practical example of how PPP and interest rate parity combine to determine exchange rates in Valuing Foreign Currencies, published in September 2000. At the time, I argued that the euro, then at $0.85, was deeply undervalued - and included the following chart. The volatile red line is the $/euro exchange rate (data for the German mark is used prior to 1999), the blue line is PPP, and the thin line is our calculation of the value of the euro implied by interest rates as well as price levels.

Since inflation rates as well as nominal interest rates are important in determining exchange rates, one would expect that real, after-inflation rates are also important. Indeed, this is true - and with a little bit of algebra, one can show that a currency should deviate PPP by an amount that reflects the difference in real interest rates expected between the two countries over time. Currencies with relatively high real interest rates will tend to trade well above PPP, while currencies with low or negative real interest rates will tend to trade below their PPP values.

Why quantitative easing is likely to trigger a collapse of the U.S. dollar

Consider a situation in which there is zero anticipated inflation in both the U.S. and in a given foreign country. In this situation, PPP implies a flat long-term profile for exchange rates, because there is no pressure in the goods market for currency values to change over time. Meanwhile, suppose that interest rates (say, on 10-year government notes) in the U.S. and the foreign country are both at 4%. In this situation, an investor in the U.S. expects a 4% return from domestic Treasury notes, and with no expected currency appreciation, also expects a 4% return from investing in the foreign country. In this situation, both PPP and interest rate parity can be satisfied with an exchange rate that simply remains constant.

In contrast, quantitative easing can be expected to create a remarkably different situation. The Fed's purchase of Treasury securities and creation of base money is occurring in an environment where fiscal deficits are already out of control, while two-thirds of the Fed's balance sheet already represents Fannie and Freddie Mac securities that need to be bailed out by the Treasury. This makes it enormously difficult to reverse the Fed's transactions - because the Fed is not simply determining whether a given stock of government liabilities will take the form of Treasury bonds or currency. It is instead effectively printing new money to finance ongoing spending for fiscal deficits and the bailout of the GSEs. At the same time, the fact that it is operating in a weak economy and a near-term deflationary environment means that nominal interest rates are being pressed down at the same time that long-term inflationary prospects are escalating.

From the standpoint of the two parity conditions, the very long-term implication of quantitative easing is a gradual devaluation of the U.S. dollar (an increase in the dollar price $/FC of foreign currency). If this increased inflation risk was reflected in interest rates (so that real interest rates were held constant), the U.S. dollar would simply move along that gradually sloped PPP line, and likewise, foreign currencies would gradually appreciate against the dollar.

However, because of economic weakness and credit strains, coupled with the demand for Treasuries by the Fed, quantitative easing instead moves U.S. interest rates in the opposite direction, falling rather than rising. From the standpoint of interest rate parity, capital market equilibrium then requires the U.S. dollar to depreciate immediately, by a sufficient amount to set up the expectation of future appreciation in order to offset the shortfall of U.S. interest rate returns.

In short, quantitative easing is likely to induce what the late MIT economist Rudiger Dornbusch described as "exchange rate overshooting" - a large and abrupt shift in the spot exchange rate that occurs in order to align long-term equilibrium in the market for goods and services with short-term equilibrium in the capital markets.

This adjustment is depicted in the diagram below. In response to the monetary shock, a modest but long-term depreciation in the dollar (a rise in the U.S. dollar price of foreign currency) is required, depicted by the blue line. However, since nominal interest rates in the U.S. actually decline, ongoing equilibrium in the capital market requires that the U.S. dollar must be expected to appreciate over time by enough to offset the lost interest. As a result, quantitative easing is likely to result in an abrupt "jump depreciation" of the U.S. dollar (that is, a spike in the value of foreign currencies).

Frankly, I've always thought Dornbush's use of the word "overshooting" was unfortunate, because it implies that the exchange rate move is an overreaction, when that is not at all the case. Overshooting refers to the tendency of the spot exchange rate to move beyond its long-term PPP value, but this move is in fact approprate, efficient, and required in order to align the returns that investors can expect in each currency. So it is important to avoid misinterpretation - the policy of quantitative easing is likely to force a large adjustment on the U.S. dollar because the Federal Reserve is choosing to lay a heavier hand on the Treasury bond market than would result from economic conditions alone. The resulting shift in interest rates and long-term inflation prospects combine to dramatically reduce the attractiveness of the U.S. dollar. A significant and relatively abrupt devaluation is then required, in an amount sufficient to set up expectations of a U.S. dollar appreciation over time.

Just to avoid misinterpretation, I am not suggesting that there is a near-term risk of inflation, nor am I suggesting that quantitative easing is inflationary per se. The primary driver of long-term inflation pressure has always been, and continues to be, growth in the total quantity of government liabilities (both monetary base and government debt) for purposes that do not expand the productive capacity of the economy. This total quantity is determined by fiscal policy, and the form of those liabilities hardly matters because currency and government debt are close substitutes in the portfolios of individuals. So the argument here is not that quantitative easing will create inflation which will hurt the dollar. The argument is more subtle. It is that we are running a fiscal policy that is long run (though not short-run) inflationary, and that the monetary policy of quantitative easing prevents longer term interest rates from acting as an adjustment variable, since the Fed is essentially announcing that it will lean on the Treasury bond market. By suppressing Treasury yields, the Fed forces the exchange rate to bear the full weight of the adjustment.

Importantly, the Fed's policy need not suppress real interest rates by more than a percent or two to create dramatic pressure on the dollar. One way to think about the price jump required by exchange rate overshooting is to think about a long-term bond. If a 10-year zero-coupon bond with a $100 face is priced to deliver 0% annually, it will have a price of $100. If investors suddenly demand the bond to be priced to deliver 2% annually, the bond must experience an immediate drop in price to $82. Once that price drop occurs, the selling pressure on the bond will abate, since it will now be expected to appreciate at a 2% annual rate.

My impression is that Ben Bernanke has little sense of the damage he is about to provoke. A central banker who talks about throwing money from helicopters is not only arrogant but foolish. Nearly a century ago, the great economist Ludwig von Mises observed that massive central bank easing is invariably a form of cowardice that attempts to avoid the need to restructure debt or correct fiscal deficits, avoiding wiser but more difficult choices by instead destroying the value of the currency.

Von Mises wrote, "A government always finds itself obliged to resort to inflationary measures when it cannot negotiate loans and dare not levy taxes, because it has reason to fear that it will forfeit approval of the policy it is following if it reveals too soon the financial and general economic consequences of that policy. Thus inflation becomes the most important psychological resource of any economic policy whose consequences have to be concealed; and so in this sense it can be called an instrument of unpopular, that is, of antidemocratic policy, since by misleading public opinion it makes possible the continued existence of a system of government that would have no hope of the consent of the people if the circumstances were clearly laid before them. That is the political function of inflation. When governments do not think it necessary to accommodate their expenditure and arrogate to themselves the right of making up the deficit by issuing notes, their ideology is merely a disguised absolutism."

As a side note, von Mises also cautioned against the misconception that destroying the value of a currency would have a sustainable benefit for the economy, writing "If the depreciation is desired in order to 'stimulate production' and to make exportation easier and importation more difficult in relation to other countries, then it must be borne in mind that the 'beneficial effects' on trade of the depreciation of money only last so long as the depreciation has not affected all commodities and services. Once the adjustment is completed, then these 'beneficial effects' disappear. If it is desired to retain them permanently, continual resort must be had to fresh diminutions of the purchasing power of money."

Market Climate

As of last week, the Market Climate for stocks was characterized by unfavorable valuations, unfavorable market action, and unfavorable economic pressures. I've noted for weeks that the damage to market action was not quite to the level that would create urgent downside concerns. However, the deterioration we observed last week suggests a more urgent shift to defensive positioning. For our part, the Strategic Growth Fund remains fully hedged at present.

In bonds, the Market Climate was characterized last week by unfavorable yield levels but favorable yield pressures. Treasury securities have advanced sharply on the initial quantitative easing purchases by the Fed. Meanwhile, the jump in unemployment claims to 500,000 and the surprising drop in the Philadelphia Fed index are both consistent with the weakening economic conditions that are clearly implied by leading measures. If anything, those deteriorations appear to be early, not late-stage observations. As I've noted regularly in recent commentaries, normal lead-times would suggest a deterioration in the ISM Purchasing Managers Index in the August-September data, while new claims for unemployment typically have an even longer lag, which would normally make us expect strains closer to October. Suffice it to say that the much earlier deterioration in economic measures is not encouraging, but it also opens up the possibility that we may see some misleading "improvement" in the data in the next few weeks before we get into the more typical window of deterioration.

As one might infer from the content of this week's remarks, my view is that the quick initiation of quantitative easing by the Federal Reserve has significantly changed the prospects for foreign currencies and by extension, precious metals. For the past couple of months, I've observed that deflation risks in response to fresh economic weakness were likely to provoke weakness in the commodity area, even if long-term inflationary concerns were accurate. However, my impression is that the Fed's immediate initiation of quantitative easing may cause investors to take deflation concerns "off the table." This is important, because even as we observe economic deterioration, the potential for a "deflationary scare" is likely to be more muted than we might have expected without explicit quantitative easing actions.

This doesn't entirely remove those risks, of course, particularly if we begin to observe a spike in credit spreads (which would be associated with default concerns and a likely drop in monetary velocity), but it clearly changes the environment. Gold stocks and the XAU have essentially gone nowhere since May. Last week, in response to a favorable shift in the Market Climate for precious metals and currencies (largely resulting from the shift in Fed policy and interest rates), we increased our exposure to precious metals in the Strategic Total Return Fund toward 10% of assets, and raised our exposure to foreign currencies to about 5% of assets. This is still not an aggressive stance, and we would prefer the opportunity to accumulate a larger exposure on substantial price weakness, if it occurs. But as this week's comment makes clear, the Federal Reserve has begun to play with fire, the effects of which I doubt Bernanke fully appreciates.

Good policy is not rocket science. It begins with the refusal to make people pay for mistakes that are not their own. This economy continues to struggle with a fundamental problem, which is that debt obligations exceed the ability to service them. While policy makers have done everything to preserve the patterns of spending and consumption that created the problem in the first place, we have done nothing to restructure those obligations.

To the extent that we observe fresh credit problems, we should not pursue the same policies. Instead, we should focus on restructuring debt. Let the bank bondholders fail, and defend depositors and customers through the standard procedures that the FDIC has followed for decades. Deal with the debt of Fannie Mae and Freddie Mac by asserting that there is no explicit government guarantee, and let the holders of the mortgage pools receive precisely what they are entitled to receive without public funds. At the same time, expand the role of the FHA to provide explicit government guarantees for future mortgages in return for actuarily fair risk-based premiums, and require mortgage originators to retain a piece of the mortgage loan, along with appropriate capital requirements, and the stipulation that this retained portion bears the first loss if the mortgage goes bad. Finally, refuse to trot self-interested bank and Wall Street executives in front of the public to extort the nation through fear of the word "failure." Banks fail all the time and customers don't lose a cent. The only implication of failure is that stock and bondholders of reckless institutions aren't rewarded for their malinvestment at public expense.

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Prospectuses for the Hussman Strategic Growth Fund and the Hussman Strategic Total Return Fund, as well as Fund reports and other information, are available by clicking "The Funds" menu button from any page of this website.

Bernanke Leaps into a Liquidity Trap

2010-11-06T18:52:00.000-07:00

John P. Hussman, Ph.D. www.hussmanfunds.com

"There is the possibility ... that after the rate of interest has fallen to a certain level, liquidity preference is virtually absolute in the sense that almost everyone prefers cash to holding a debt at so low a rate of interest. In this event, the monetary authority would have lost effective control." - John Maynard Keynes, The General Theory

One of the many controversies regarding Keynesian economic theory centers around the idea of a "liquidity trap." Apart from suggesting the potential risk, Keynes himself did not focus much of his analysis on the idea, so much of what passes for debate is based on the ideas of economists other than Keynes, particularly Keynes' contemporary John Hicks. In the Hicksian interpretation of the liquidity trap, monetary policy transmits its effect on the real economy by way of interest rates. In that view, the loss of monetary control occurs because, at some point, a further reduction of interest rates fails to stimulate additional demand for capital investment.

Alternatively, monetary policy might transmit its effect on the real economy by directly altering the quantity of funds available to lend. In that view, a liquidity trap would be characterized by the failure of real investment and output to expand in response to increases in the monetary base (currency and reserves).

In either case, the hallmark of a liquidity trap is that holdings of money become "infinitely elastic." As the monetary base is increased, banks, corporations, and individuals simply choose to hold onto those additional money balances, with no effect on the real economy. The typical Econ 101 chart of this is drawn in terms of "liquidity preference," that is, desired cash holdings plotted against interest rates. When interest rates are high, people choose to hold less cash because cash doesn't earn interest. As interest rates decline toward zero (and especially if the Fed chooses to pay banks interest on cash reserves, which is presently the case), there is no effective difference between holding riskless debt securities (say, Treasury bills) and riskless cash balances, so additional cash balances are simply kept idle.

Velocity

A related way to think about a liquidity trap is in terms of monetary velocity: nominal GDP divided by the monetary base. (The identity, which is true by definition, is M * V = P * Y - the monetary base times velocity is equal to the price level times real output).

Velocity is just the dollar value of GDP that the economy produces per dollar of monetary base. You can also think of velocity as the number of times that one dollar "turns over" each year to purchase goods and services in the economy. Rising velocity implies that money is "turning over" more rapidly, so that nominal GDP is increasing faster than the stock of money. If velocity rises, holding the quantity of money constant, you'll observe either growth in real output or inflation. Falling velocity implies that a given stock of money is being hoarded, so that nominal GDP is growing slower than the stock of money. If velocity falls, holding the quantity of money constant, you'll observe either a decline in real GDP or deflation.

The belief that an increase in the money supply will result in an increase in GDP relies on the assumption that velocity will not decline in proportion to the increase in money. Unfortunately for the proponents of "quantitative easing," this assumption fails spectacularly in the data - both in the U.S. and internationally - particularly at a zero interest rate.

How to Spot a Liquidity Trap

The chart below plots the velocity of the U.S. monetary base against interest rates since 1947. Since high money holdings correspond to low velocity, the graph is simply the mirror image of the theoretical chart above.

Few theoretical relationships in economics hold quite this well. Recall that a Keynesian liquidity trap occurs at the point when interest rates become so low that cash balances are passively held regardless of their size. The relationship between interest rates and velocity therefore goes flat at low interest rates, since increases in the money stock simply produce a proportional decline in velocity, without requiring any further decline in yields. Notice the cluster of observations where the interest rate is zero? Those are the most recent data points.

One might argue that while short-term interest rates are essentially zero, long-term interest rates are not, which might leave some room for a "Hicksian" effect from QE - that is, a boost to investment and economic activity in response to a further decline in long-term interest rates. The problem here is that longer-term interest rates, in an expectations sense, are already essentially at zero. The remaining yield on longer-term bonds is a risk premium that is commensurate with U.S. interest-rate volatility (Japanese risk premiums are lower, but they also have nearly zero interest-rate variability). So QE at this point represents little but an effort to drive risk premiums to levels that are inadequate to compensate investors for risk. This is unlikely to go well. Moreover, as noted below, the precise level of long-term interest rates is not the main constraint on borrowing here. The key issues are the rational desire to reduce debt loads, and the inadequacy of profitable investment opportunities in an economy flooded with excess capacity.

One of the most fascinating aspects of the current debate about monetary policy is the belief that changes in the money stock are tightly related either to GDP growth or inflation at all. Look at the historical data and you will find no evidence of it. Over the years, I've repeatedly emphasized that inflation is primarily a reflection of fiscal policy - specifically, growth in the outstanding quantity of government liabilities, regardless of their form, in order to finance unproductive spending. Look at the experience of the 1970s (which followed large expansions in transfer payments), as well as every historical hyperinflation, and you'll find massive increases in government spending that were made without regard to productivity (Germany's hyperinflation, for instance, was provoked by continuous wage payments to striking workers).

Likewise, real economic growth has no observable correlation with growth in the monetary base (the correlation is actually slightly negative but insignificant). Rather, economic growth is the result of hundreds of millions of individual decision-makers, each acting in their best interests to shift their consumption plans, saving, and investment in response to desirable opportunities that they face. Their behavior cannot simply be induced by changes in the money supply or in interest rates, absent those desirable opportunities.

You can see why monetary-base manipulations have so little effect on GDP by examining U.S. data since 1947. Expand the quantity of base money, and it turns out that velocity falls in nearly direct proportion. The cluster of points at the bottom right reflect the most recent data.

[Geek's Note: The slope of the relationship plotted above is approximately -1, while the Y intercept is just over 6%, which makes sense, and reflects the long-term growth of nominal GDP, virtually independent of variations in the monetary base. For example, 6% growth in nominal GDP is consistent with 0% M and 6% V, 5% M and 1% V, 10% M and -4% V, etc. There is somewhat more scatter in 3-year, 2-year and 1-year charts, but it is random scatter. If expansions in base money were correlated with predictably higher GDP growth, and contractions in base money were correlated with predictably lower GDP growth, the slope of the line would be flatter and the fit would still be reasonably good. We don't observe this.]

Just to drive the point home, the chart below presents the same historical relationship in Japanese data over the past two decades. One wonders why anyone expects quantitative easing in the U.S. to be any less futile than it was in Japan.

Simply put, monetary policy is far less effective in affecting real (or even nominal) economic activity than investors seem to believe. The main effect of a change in the monetary base is to change monetary velocity and short-term interest rates. Once short-term interest rates drop to zero, further expansions in base money simply induce a proportional collapse in velocity.

I should emphasize that the Federal Reserve does have an essential role in providing liquidity during periods of crisis, such as bank runs, when people are rapidly converting bank deposits into currency. Undoubtedly, we would have preferred the Fed to have provided that liquidity in recent years through open-market operations using Treasury securities, rather than outright purchases of the debt securities of insolvent financial institutions, which the public is now on the hook to make whole. The Fed should not be in the insolvency bailout game. Outside of open-market operations using Treasuries, Fed loans during a crisis should be exactly that, loans - and preferably following Bagehot's Rule ("lend freely but at a high rate of interest"). Moreover, those loans must be senior to any obligation to bank bondholders - the public's claim should precede private claims. In any event, when liquidity constraints are truly binding, the Fed has an essential function in the economy.

At present, however, the governors of the Fed are creating massive distortions in the financial markets with little hope of improving real economic growth or employment. There is no question that the Fed has the ability to affect the supply of base money, and can affect the level of long-term interest rates, given a sufficient volume of intervention. The real issue is that neither of these factors is currently imposing a binding constraint on economic growth, so there is no benefit in relaxing them further. The Fed is pushing on a string.

Toy Blocks

Certain economic equations and regularities make it tempting to assume that there are simple cause-effect relationships that would allow a policy maker to directly manipulate prices and output. While the Fed can control the monetary base, the behavior of prices and output is based on a whole range of factors outside of the Fed's control. Except at the shortest maturities, interest rates are also a function of factors well beyond monetary policy.

Analysts and even policy makers often ignore equilibrium, preferring to think only in terms of demand, or only in terms of supply. For example, it is widely believed that lower real interest rates will result in higher economic growth. But in fact, the historical correlation between real interest rates and GDP growth has been positive - on balance, higher real interest rates are associated with higher economic growth over the following year. This is because higher rates reflect strong demand for loans and an abundance of desirable investment projects. Of course, nobody would propose a policy of raising real interest rates to stimulate economic activity, because they would recognize that higher real interest rates were an effect of strong loan demand, and could not be used to cause it. Yet despite the fact that loan demand is weak at present, due to the lack of desirable investment projects and the desire to reduce debt loads (which has in turn contributed to keeping interest rates low), the Fed seems to believe that it can eliminate these problems simply by depressing interest rates further. Memo to Ben Bernanke: Loan demand is inelastic here, and for good reason. Whatever happened to thinking in terms of equilibrium?

Neither economic growth nor the demand for loans is a simple function of interest rates. If consumers wish to reduce their debt, and companies do not have a desirable menu of potential investments, there is little benefit in reducing interest rates by another percentage point, because the precise cost of borrowing is not the issue. The current thinking by the FOMC seems to treat individual economic actors as little, unthinking toy blocks that can be moved into the desired positions at will. Instead, our policy makers should be carefully examining the constraints and interests that are important to people, and act in a way that responsibly addresses those constraints.

A good example of this "toy block" thinking is the notion of forcing individuals to spend more and save less by increasing people's expectations about inflation (which would drive real interest rates to negative levels). As I noted last week, if one examines economic history, one quickly discovers that just as lower nominal interest rates are associated with lower monetary velocity, negative real interest rates are associated with lower velocity of commodities (hoarding). Look at the price of gold since 1975. When real interest rates have been negative (even simply measured as the 3-month Treasury bill yield minus trailing annual CPI inflation), gold prices have appreciated at a 20.7% annual rate. In contrast, when real interest rates have been positive, gold has appreciated at just 2.1% annually. The tendency toward commodity hoarding is particularly strong when economic conditions are very weak and desirable options for real investment are not available. When real interest rates have been negative and the Purchasing Managers Index has been below 50, the XAU gold index has appreciated at an 85.7% annual rate, compared with a rate of just 0.1% when neither has been true. Despite these tendencies, investors should be aware that the volatility of gold stocks can often be intolerable, so finer methods of analysis are also essential.

Quantitative easing promises to have little effect except to provoke commodity hoarding, a decline in bond yields to levels that reflect nothing but risk premiums for maturity risk, and an expansion in stock valuations to levels that have rarely been sustained for long (the current Shiller P/E of 22 for the S&P 500 has typically been followed by 5- to 10-year total returns below 5% annually). The Fed is not helping the economy, it is encouraging a bubble in risky assets, and an increasingly unstable one at that. The Fed has now placed itself in the position where small changes in its announced policy could have disastrous effects on a whole range of financial markets. This is not sound economic thinking but misguided tinkering with the stability of the economy.

Implications for Policy

In 1978, MIT economist Nathaniel Mass developed a framework for the liquidity trap based on microeconomic theory - rational decisions made at the level of individual consumers and firms. The economic dynamics resulting from the model he suggested seem strikingly familiar in the context of the recent economic downturn. They offer a useful way to think about the current economic environment and appropriate policy responses that might be taken.

"The theory revolves around a set of forces that for a period of time promote cumulative expansion of capital formation, but eventually lead to overexpansion of capital production capacity and then into a situation where excess capacity strongly counteracts expansionary monetary policies.

"The capital boom followed by depression runs much longer than the usual short-term business cycle, and is powerfully driven by capital investment interactions. The weak impact of monetary stimulus on real activity arises because additional money has little force in stimulating additional capital investment during a period of general overcapacity. Instead, money is withheld in idle balances when profitable investment opportunities are scarce."

In one illustration of the model, Mass introduces a monetary stimulus much like what Alan Greenspan engineered following the 2000-2002 recession (which was also preceded by an unusually large buildup of excess capacity, leading to an investment-led downturn). Though Greenspan's easy-money policy didn't prompt a great deal of business investment, it did help to fuel the expansion in another form of investment, specifically housing. Mass describes the resulting economic dynamics:

"Following the monetary intervention, relatively easy money provides a greater incentive to order capital... But now the overcapacity that characterizes the peak in the production of capital goods reaches an even higher level than without the stimulus. This overcapacity eventually makes further investment even less attractive and causes the decline in capital output to proceed from a higher peak and at a faster pace. Due to persistent excess capital which cannot be reduced as fast as labor can be cut back to alleviate excess production, unemployment actually remains higher on the average following the drop in production."

In what reads today as a further warning against Bernanke-style quantitative easing, Mass observed:

"Even aggressive monetary intervention can do little to correct excess capital... Once excess capacity develops, the forces that previously led to aggressive expansion are almost played out. Efforts to prolong high investment can produce even more excess capital and lead to a more pronounced readjustment later."

Mass concluded his 1978 paper with an observation from economist Robert Gordon:

"Why was the recovery of the 1930's so slow and halting in the United States, and why did it stop so far short of full employment? We have seen that the trouble lay primarily in the lack of inducement to invest. Even with abnormally low interest rates, the economy was unable to generate a volume of investment high enough to raise aggregate demand to the full employment level."

I've generally been critical of Keynes' willingness to advocate government spending regardless of its quality, which focused too little on the long-term effects of diverting private resources to potentially unproductive uses. His remark that "In the long-run we are all dead" was a reflection of this indifference. Still, I do believe that fiscal responses can be useful in a protracted economic downturn, and can include projects such as public infrastructure, incentives for research and development, and investment incentives in sectors that are not burdened with overcapacity. Additional deficit spending is harmful when it fails to produce a stream of future output sufficient to service the debt, so the expected productivity of these projects is the essential consideration. Given present economic conditions, it appears clear that Keynes was right about the dangers of easy monetary policy when an economic downturn results from overcapacity. As I noted last week in The Recklessness of Quantitative Easing, better options are available on the fiscal menu.

QE2

2010-11-05T19:47:00.000-07:00

From Richard Russell:

“Right now, we’re seeing the results of a bubble in Fed-created liquidity. When the water continues to pour into a bath-tub, everything — the rubber ducks, the plastic boats, the soap bars — float up with the water line. This goes on until either the water flows over the tub and onto the floor — or mom comes in and pulls the plug. I think that’s what we’re experiencing now in the markets. Everything tradeable, stocks, bonds, gold, silver, commodities in general are rising. I call it an all-around mega-bubble. It will continue until someone, purposely, or by mistake, pulls the plug. There are only two items which seem immune to the surging liquidity. The two items are home prices and unemployment. But there’s another possibility. Build a tower out of children’s blocks. You can build that tower just so high, and at some point the last block is too much. The tower shudders, it tilts and falls over.”

2010-09-22T07:42:00.001-07:00

Boeckh Investment Letter, Volume 2.14: US Government Debt 092110

Setiment Cycle

2010-09-18T23:59:00.000-07:00

Definition of Deflation, Inflation and Hyperinflation

2010-09-18T20:50:00.000-07:00

Deflation: A decrease in the prices of goods and services, usually tied to a contraction of money in circulation. Formal deflation is measured in terms of year-to-year change.

Inflation: An increase in the prices of goods and services, usually tied to an increase of money in circulation.

Hyperinflation: Extreme inflation, minimally in excess of four-digit annual percent change, where the involved currency becomes worthless. A fairly crude definition of hyperinflation is a circumstance, where, due to extremely rapid price increases, the largest pre-hyperinflation bank note ($100 bill in the United States) becomes worth more as functional toilet paper/tissue than as currency.

Gross Debt in G7 Ecomomies

2010-09-06T06:57:00.000-07:00

Practice Deep Learning to Master Trading Skills

2010-08-28T22:10:00.000-07:00

Deep Practice gives an overview of what kind of practice seems to build myelin and gives examples from sources as diverse as skateboarders, the Bronte sisters, and Renaissance artists. Coyle’s term Deep Practice is in most ways similar to Ericsson’s Deliberate Practice and my own notion of Intentional Practice. He culls three rules of Deep Practice:

1. Chunk it up: Basically this consists of breaking things into pieces that are more easily done or thought about. It also includes listening to and/or absorbing the whole before breaking the skill down and includes changing the material to make it easier, for example, slowing down a difficult musical passage.

2. Repeat it. This is pretty self-explanatory, but also not as simple as it sounds.

3. Learn to Feel it. This includes sensing (and remembering!) how something feels when it is done right, but also developing awareness of how it feels to struggle.

Secular US Market Cycle

2010-08-28T20:12:00.000-07:00

Four Formulas A Trader Must Master

2010-08-28T19:18:00.000-07:00

1) Risk of Ruin

Risk of ruin = [ {1-(W-L)}/{1+(W-L)}] Power of U
W = Probability of winning, L= Probability of losing and U= # of units of money on the account.
E.g W is 56%, L is 44%, U is 5 .
Risk of ruin = [ {1-(0.56-0.44)}/{1+(0.56-0.44)}] power of 5 = 30%

You must avoiding risk of ruin, achieve ZERO% risk of ruin. E.g Using 20 U and min 63% W, and min 1.5 win to loss trade.

2) Expectancy

Expected return $$ = [ P of winning x Ave win/Ave loss ]-[P of loasing x Ave win/Ave loss ]
High Expectancy can be achieve with low accuracy e.g 30% but high Ave Win vs Ave Loss
Trend Trading min Positive expectancy with P of winning 34% with 3 to 1 Win/Loss ratio.

3) Holy Grail = Positive Expectancy x Opportunities

4) Kelly Formula

Kelly Formula F= (R+1)*P-1)/R

P= % accuracy of the system winning

R= Ratio of winning trade to losing trade

E.g Accuracy P 65% and win R 1.3 size of loss
F= (1.3+1)*0.65-1)/1.3= 85%

How to adjust a long stock position

2010-08-01T01:12:00.000-07:00

To create a trade that profits if stays in a range, and if Vol stays the same or drops.

Here’s the trade example.

I own 100 shares of PCP, currently trading at $107.79. (My price is $121.40)
+1 Sep $105 put.
+4 Sep $120 call.
-5 Sep $110 call.

The P&L looks like this after I added the options, below: Notice that this trade is ‘profitable’ in the range that I anticipate. If the underlying stays in the range as I predict, my trade that is currently around -$1,400 will be -$300. Then in Sep, I can put on a similar trade again as long as my predictions have not changed. I now have a limited risk trade that I can manage or stop out if PCP should rally hard. Synthetically, you’ve created a broken wing butterfly (long stock and long put is long call +1 $105call / –5 $110 call / +4 $120 call).

Count Test

2010-07-31T22:44:00.000-07:00

Last Bull Standing 2011

2010-07-17T20:47:00.000-07:00

One of the most important contributions made in the science of market analysis is the series of equity market rhythms known as the Kress Cycles. The one who discovered these cycles, Samuel J. “Bud” Kress, has done for cycle theory what virtually no one else been able to accomplish, namely discovering a series of inter-related “hard” cycles that are all harmonically related and which provide an accurate context from which to view the past, present and future financial and economic climate.

Kress accurately predicted the top of the secular bull market in 2000 with his cycles as well as the credit crisis of 2007-2008. He also called the bottom in March 2009 and, more recently, forecast an interim top for April 2010. For the last 10 years, Bud has published a series of interim reports – roughly once per year – called “Special Editions” (available through his SineScope advisory service, 15 Phoenix Ave., Morristown, NJ 07960). Previous Special Editions have provided important context for the bear market of 2000-2002, the recovery bull market of 2003-2007 and the most recent credit crisis and bear market. His Special Edition VII published in 2008 entitled, “Final Opportunity 2009,” projected that the following year 2009 would be the last year to begin a long term liquidation of conventional equities for those who failed to do so at the all-time double high in 2007. Special Edition VIII of 2009 was titled, “Remaining Five Years: 2010-2014” and discussed the potential for a bear market in 2010, a mini cyclical recovery bull market in 2011, and a once-in-a-century three year period of historic change, turmoil and dislocations to begin in 2012 and persist until 2014.

His latest Special Edition (the ninth one) has just been released and is entitled, “Last Bull Standing 2011.” It may well go down as being the most important one yet, for if Mr. Kress is correct in his prognosis, we will soon enter the final phase of the financial market recovery as the last of the key yearly cycles peaks next year.

Kress predicts that 2011 will culminate the dominance of the U.S. financial and economic system and begin a depression, the magnitude of which will be matched only by the one of 1930-1933. As such, the time between now and late 2011 will represent perhaps the last opportunity for investors to build (or rebuild) balance sheets and portfolios before the final crashing phase of Kress’s namesake 120-year cycle.

In his latest report, Kress reminds us that sound market analysis is more critical today than has typically been the case. As Kress points out, “Due to the inherent buy mind set bias, a dearth of sell recommendations exist. The critical time began at the turn of the [21st] century, and has become even more so in the most recent years.” He further asserts that “Identifying the time cycles determining the market’s directional behavior is the most basic, objective and unbiased means of predictive value to mitigate risk and enhance return thereby avoiding the debilitating pitfalls of conventional wisdom.” While Special Edition IX contains much of the information provided in the previous two, it also provides an insightful overview of the most influential yearly cycles and their inter-related positions and contains a series of graphic exhibits depicting the cycles’ positions to each other, making it easy to see how the cycles will influence the coming years.

Kress begins his discussion with the famous 120-year cycle, the first of which began in the mid 1770s when America gained its independence from England after prolonged, depressed economic conditions and the Revolutionary War. The second 120-year cycle began in the mid 1890s after the country’s first major depression and the commencement of the Spanish American War. “This heralded the transition of the U.S.A. from an agricultural based economy to a manufacturing based economy,” writes Kress, “and is referred to as the Industrial Revolution.” Kress emphasizes the importance of the 120-year cycle in facilitating revolutions, whether they be of the military or cultural variety. As such, the 120-year Kress Cycle has also become known as the Revolutionary Cycle. It’s next bottom is scheduled for 2014.

In the latest Special Edition, Kress predicts the coming 120-year cycle bottom could bring with it America’s third “great” depression, a World War III equivalent and a third (social?) revolution. The emphasis is laid on the number three, for as Kress points out, when it comes to the cycles – as well as life in generally – events typically come in threes.

Next in the order of Kress Cycles is the 60-year cycle, which is a constituent of the 120-year cycle. As Kress observes, “It equates to the average duration of the underlying economic super cycle. Since it is variable in duration, it is more appropriately referred to as the K Wave.” He goes on to point out that it comprises the gamut of economic activity from boom to bust as indicated by the stages of credit utilization – re-inflation, inflation, hyper inflation, disinflation, deflation, depression, and then the cycle begins anew. The second 60-year cycle in 1954 began the post-WWII economic expansion, peaking in 1984 and beginning the transition of the United States from a manufacturing to a service based economy. The current 60-year cycle also bottoms in 2014 along with the 120-year cycle.

Kress also discusses the 30-year and 40-year cycles in the latest Special Edition. His discussion of the significant 12-year cycle, the most recent one of which began in late 2002, is especially important. He notes that the tenth and final 12-year cycle which began in 2002 and peaked in 2008 with the “credit crash” began economic decline and deflation. The latest 12-year cycle bottoms in 2014 to form the bottom of the 120-year cycle.

Kress completes his overview of the key yearly cycles with a treatment of the 6-year and 4-year cycles, which form the smallest components of the 120-year Grand Super Cycle. The secondary component of the 12-year cycle is the 6-year cycle, which last bottomed in late 2002 and is scheduled to peak in the latter part of 2011. Meanwhile the third and final 4-year cycle bottoms later this year, and as Kress states, its advance will form the peak of the second and final 6-year cycle later next year. “This,” writes Kress, “should be the final, albeit mini, bull market of the post-WWII expansion and the beginning of two to three years of once-in-a-century potential turmoil, transition and change in the U.S.A.” As he also concludes, “The declining effect of the 120-year Grand Super cycle is evident and disarming.”

Elsewhere in the latest Special Edition, Kress includes an incisive discussion of the deflationary trend which began in 2008 and which he predicts will accelerate after 2011 in the final years of the 120-year cycle. “Deflation,” he says, “is effectively liquidation. Economic determination, being what it is, declining change becomes pervasively evident as the ‘system’ purges the excess accumulated since the post-WWII economic expansion with the beginning of the second 60-year economic super cycle of the 120-year Grand Super Cycle; the fourth (complete) since the beginning of the U.S.A. as we know it today.”

The inflationary phase of the 120-year cycle was accompanied by a characteristic Lebensweisheit, or philosophy, and was represented by essentially an expansionist mindset. But as Kress presciently observes, the current deflationary trend has its own unique philosophical outlook, namely one of contraction. “The declining economic condition,” writes Kress, “is euphemistically referred to as the ‘new normal’ and the mind set has changed to ‘going green’ which implies reverting back to nature; basics. The transition and purging is eliminating CO2 from carbon based fuels to solar, wind and grain based fuels. Debt is being liquidated to repair corporate and individual balance sheets; individuals are eliminating body fat by reducing food intake and emphasizing natural foods. A litany of purging, contractions, liquidation, etc. is evident in life around us when one steps back and views life today objectively and uncompromised.”

This leads Kress to ask, “Where will the U.S.A. as we know it today and our life styles be in 2014 with revolutionary change?” As Kress points out, the potential historic change could very well confirm the validity of the adage that “everything comes in threes.” The potential for a once-in-a-century revolutionary transition begins with the peak of the final year 6-year cycle in 2012 to being three years of potential turmoil, culminating with the 120-year cycle bottom in 2014. “Three institutions govern our lifestyle – economic, political, and social,” he writes. “The first 120-year revolution was political; the second was economic; so the third should most likely be social.” He predicts the coming third great revolution will witness the establishment of a fully socialist government in the U.S.

The final part of the latest Special Edition contains an overview of how an investor should position his portfolio with a view to the upcoming 120-year cycle bottom. Kress covers commodities, ETFs, options and equities, the weighting of each position being determined by the individual investor’s risk/return position and personal preference.

He lays special emphasis on gold, observing that it tends to benefit from the two economic extremes of hyperinflation and hyperdeflation. For the 14-year period of hyperinflation from 1967 to 1981, gold increased approximately 23 times in terms of price. After its correction following the 1980 price peak, it bottomed in early 2000 – 14 years prior to the 120-year cycle low scheduled for 2014 – and also at the beginning of economic contraction and deflation. “If gold increased at the same level in the current fourteen years as it did in the previous fourteen years,” he says, “gold has the potential upwards of $6,000 an ounce.” Kress advises that gold shouldn’t be traded but should be administered with the same mindset as with conventional equities during the previous half century, namely “hold for the long term and buy on corrections.”

Kress aptly concludes his latest Special Edition with these words, “Never before in a lifetime has a change in traditional mindset and approach preempted all historic priorities if continuing investment success is to be achieved.”

Cycles

Over the years I’ve been asked by many readers what I consider to be the best books on stock market cycles that I can recommend. While there are many excellent works out there on the subject of technical and fundamental analysis, chart reading, etc., precious few have addressed the subject of market cycles. Of the relatively few books on cycles that are available, most don’t even merit mentioning. I’ve read only one book in the genre that I can recommend – The K Wave by David Knox Barker – but even that one doesn’t deal directly with stock market cycles but instead with the economic long wave. I’m pleased to announce, however, that after nearly 10 years of research and one year of writing, I’ve completed a book on the subject that I believe will meet the critical demands of most cycle students. It’s entitled, The Stock Market Cycles, and is available for sale at:

http://clifdroke.com/books/Stock_Market.html

Clif Droke is the editor of the three times weekly Momentum Strategies Report newsletter, published since 1997, which covers U.S. equity markets and various stock sectors, natural resources, money supply and bank credit trends, the dollar and the U.S. economy. The forecasts are made using a unique proprietary blend of analytical methods involving cycles, internal momentum and moving average systems, as well as investor sentiment. He is also the author of numerous books, including most recently “The Stock Market Cycles.” For more information visit www.clifdroke.com

13 Risk Perception Factors

2010-06-19T22:29:00.000-07:00

Trust
Risk vs Benefit
Control
Choice
Is the risk natural or human made ?
Pain and Suffering
Uncertainty
Catastrophic or chronic
Can it happen to me ?
Is the risk new or familiar
Risk to children
Personification
Fairness

The Frog in the Frying Pan

2010-06-12T21:08:00.000-07:00

Investors are good at absorbing short-term information, but they are much less successful at absorbing bigger structural trends and understanding when secular breaks have occurred.
Perhaps investors are like the proverbial frogs in the frying pan, who do not notice the slow, incremental changes occurring around them.There are three large structural changes that have been slowly but steadily happening. Going forward, the US economy will have to deal with:
(1) higher volatility,
(2) lower trend growth,
and (3) higher structural levels of unemployment.

The Frog in the Frying Pan | John Mauldin | Safehaven.com

Exchange Traded Notes - An Alternative To ETFs

2010-06-05T21:23:00.001-07:00

Exchange Traded Notes - An Alternative To ETFs

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Investing in the Sugar Shortage

2010-06-05T00:10:00.001-07:00

# iPath Dow Jones-UBS Sugar Subindex Total Return (NYSE: SGG): The exchange-traded note (ETN) tracks the performance of sugar without the hassle of additional fees
.# iPath Dow Jones-UBS Softs Subindex Total Return (NYSE: JJS): This is also an ETN, but offers broader exposure to the soft commodities market. The portfolio consists of sugar, coffee and cotton, with sugar accounting for approximately 46% of it.
# Cosan Limited ADR (NYSE: CZZ): If you prefer to play an individual sugar stock, take a look at Brazilian company, Cosan. It’s the largest producer and processor of sugar cane and offers a more direct route into the market.

Investing in the Sugar Shortage

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Is Time To Accumulate Sugar

2010-06-04T20:35:00.001-07:00

The commercials is accumualting just like end Jan'09

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GDP Formula

2010-05-30T04:27:00.001-07:00

GDP = C + I + G + (Net Exports)
Which is to say, that Gross Domestic Product in a country is equal to total Consumption (personal and business) plus Investments plus Government Spending plus next exports. This equation is known as an identity equation. It is true for all countries and times.Now, gentle reader, I am going to spare you a few pages of algebra and cut to the chase.
Let's divide a country's economy into three sections, private, government and exports. If you play with the variables a little bit you find that you get the following equation.Domestic Private Sector Financial Balance + Governmental Fiscal Balance - the Current Account Balance (or Trade Deficit/Surplus) = 0This equation was introduced to you a few months ago in an Outside the Box written by Rob Parenteau.

We are going to review this briefly, as it is VERY important. Paragraphs in quotes will be from that letter. As Rob noted, "...keep in mind this is an accounting identity, not a theory. If it is wrong, then five centuries of double entry book keeping must also be wrong."By Domestic Private Sector Financial Balance we mean the net balance of business and consumers.

Are they borrowing money or paying down debt? Government Fiscal Balance is the same: is the government borrowing or paying down debt? And the Current Account Balance is the trade deficit or surplus.The implications are simple. The three items have to add up to zero. That means you cannot have both surpluses in the private and government sectors and run a trade deficit. You have to have a trade surplus.Let's make this simple.

Let's say that the private sector runs a $100 surplus (they pay down debt) as does the government. Now, we subtract the trade balance. To make the equation come to zero it means that there must be a $200 trade surplus.$100 (private debt reduction) + $100 (government debt reduction) - $200 (trade surplus) = 0.But what if the country wanted to run a $100 trade deficit? Then that means that either private or public debt would have to increase by $100. The numbers have to add up to zero. One way for that to happen would be:$50 (private debt reduction) + (-$150) (government deficit) - (-$100) (trade deficit) = 0. Remember that we are adding a negative number and subtracting a negative number.Bottom line.

You can run a trade deficit, reduce government debt and reduce private debt but not all three at the same time. Choose two. Choose carefully. And before we get into the implications, let's look at yet another equation, although this is somewhat simpler.Delta ForceThere are two and only two, ways that you can grow your economy. You can either increase your population or increase your productivity. That's it.The Greek letter "Delta" is the symbol for change.

So if you want to change your GDP you write that as:Δ GDP = Δ Population + Δ Productivity

If you are a country facing a population decline (like Japan) that means to keep your GDP growing you have to increase your productivity even more. That is why I have written so much about demographics over the years. Population growth (or the lack thereof) is very important. Russia is facing a very serious problem over the next 20 years that will require either a significant increase in productivity or large immigration to stave off a collapsing economy.

Russia's population has declined by almost 7 million in the last 19 years to 142 million. UN estimates are that it may shrink by about a third in the next 40 years. But that's another story for another letter.One last economic insight.

You cannot grow your debt faster than nominal GDP forever. At some point, the market begins to think you will not be able to pay your debts back. This is no different than the fact that a family cannot grow its debt faster than its income ability to pay the debt back. At some point, you run out of the ability to borrow more money as lenders "just say no."As a family's or country's debts grow, the carrying cost or interest expenses rise.

At some point, the interest expense consumes an ever larger portion of the budget. Increasing the debt increases the interest expense eventually to the breaking point. There are limits.

Six Impossible Things | John Mauldin | Safehaven.com

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Soverign Debt

2010-05-30T04:12:00.001-07:00

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PE at Market Bottom

2010-05-01T20:06:00.001-07:00

Reason being, the 2009 low did not represent a value low as has been seen at all other secular bear market bottoms. That value is representative of the dividend yield being roughly equal to the P.E. ratio. It is a fact that at true secular bear markets the dividend yield and the price earnings ratios will be roughly equal. As an example, in 1932 the yield on the S&P 500 was 10.50% and the P.E. was just under 10. In 1942 the yield was 8.71% and the P.E. was 7.3. At the 1974 bottom the yield was 5.9% and the P.E. was 7.24. Even at the 1982 low the yield was 6.2% with a P.E. of 6.9. At the March 2009 low the P.E. was 23.77 with a dividend yield of 3.58. At the October 2002 low the P.E. was 29.95 and the yield was 1.98. As you can see, neither the 2002 low nor the 2009 low represented the great values that have been seen at previous secular bear market bottoms.

Market Update | Tim Wood | Safehaven.com

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DEBT TO GDP

2010-05-01T19:46:00.001-07:00

"While fiscal problems need to be tackled soon, how to do that without seriously jeopardising the incipient economic recovery is the current key challenge for fiscal authorities."

They start by dealing with the growth in fiscal (government) deficits and the growth in debt. The US has exploded from a fiscal deficit of 2.8% to 10.4% today, with only a small 1.3% reduction for 2011 projected. Debt will explode (the correct word!) from 62% of GDP to an estimated 100% of GDP by the end of 2011. Remember that Rogoff and Reinhart show that when the ratio of debt to GDP rises above 90%, there seems to be a reduction of about 1% in GDP. The authors of this paper, and others, suggest that this might come from the cost of the public debt crowding out productive private investment.

Think about that for a moment. We are on an almost certain path to a debt level of 100% of GDP in less than two years. If trend growth has been a yearly rise of 3.5% in GDP, then we are reducing that growth to 2.5% at best. And 2.5% trend GDP growth will NOT get us back to full employment. We are locking in high unemployment for a very long time, and just when some one million people will soon be falling off the extended unemployment compensation rolls.

Government transfer payments of some type now make up more than 20% of all household income. That is set up to fall rather significantly over the year ahead unless unemployment payments are extended beyond the current 99 weeks. There seems to be little desire in Congress for such a measure. That will be a significant headwind to consumer spending.

Government debt-to-GDP for Britain will double from 47% in 2007 to 94% in 2011 and rise 10% a year unless serious fiscal measures are taken. Greece's level will swell from 104% to 130%, so the US and Britain are working hard to catch up to Greece, a dubious race indeed. Spain is set to rise from 42% to 74% and "only" 5% a year thereafter; but their economy is in recession, so GDP is shrinking and unemployment is 20%. Portugal? 71% to 97% in the next two years, and there is almost no way Portugal can grow its way out of its problems.

Japan will end 2011 with a debt ratio of 204% and growing by 9% a year. They are taking almost all the savings of the country into government bonds, crowding out productive private capital. Reinhart and Rogoff, with whom you should by now be familiar, note that three years after a typical banking crisis the absolute level of public debt is 86% higher, but in many cases of severe crisis the debt could grow by as much as 300%. Ireland has more than tripled its debt in just five years.

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Elliott Wave price projections - Summary table

2010-04-17T19:54:00.001-07:00

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S&P 500 Ten Year Forward Real Returns based on PE

2010-03-29T22:50:00.001-07:00

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Trend Following

2010-02-19T05:27:00.001-08:00

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10 Penny Stock Websites You Need To Know For 2010

2010-01-30T19:08:00.001-08:00

1. Reaper Trades

2. Investors Live

3. Pink Sheets

4. Stock Promoters

5. Stock Reads

6. The Technical Trader

7. Investors Underground

8. Kabam

9. InvestorsHub.com

10. BoardCentral.com

http://www.timothysykes.com/

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Get Creative With Alternative Weighting ETFs

2009-09-17T06:16:00.001-07:00

Alternative #1:
Equal Weighting

This approach is strikingly simple: Just divide the money between all the stocks in an index equally. If your index consists of 50 stocks, each one gets 2 percent.

Equal weighting treats all stocks the same.

Equal weighting was pioneered by Rydex, which offers a series of ETFs using this methodology. Rydex S&P Equal Weight ETF (RSP) owns the same stocks as the S&P 500 but with equal-weighting rather than cap-weighting.

Comparing SPY vs. RSP reveals how big the difference in returns can be ...

In the first eight months of 2009, SPY (including dividends) was up 15 percent. RSP gained 29 percent during the same period.

How does this happen?

The smaller-cap stocks get a bigger weighting in RSP than they do in SPY. And those stocks have done generally better this year than most of the mega-cap issues. This isn't always the case. But equal weighting clearly had a huge positive impact so far this year.

In addition to RSP, here are some other equal-weighted ETFs you might want to consider:

SPDR S&P Biotech ETF (XBI)

First Trust Nasdaq-100 Equal Weighted Fund (QQEW)

SPDR S&P Semiconductor ETF (XSD)

Alternative #2 and #3:
Dividend and Earnings Weighting

If you love income, then you'll probably want to tilt your portfolio toward the stocks with a record of growing their dividends. So take a look at the ETFs offered by WisdomTree.

WisdomTree argues that, by design, cap-weighted ETFs are forced to buy high and sell low. Here's why that's true:

The higher a stock's market capitalization (shares outstanding multiplied by the share price), the more shares a cap-weighted ETF buys. If those share prices decline, the market capitalization of the stock declines as well. Consequently, they are replaced with higher-cap stocks when the ETF rebalances its portfolio.

WisdomTree's solution is a set of indexes that use fundamental factors like dividends and earnings to allocate among stocks. They think this will lead to better long-term results, and they have a lot of research to support their point.

Fundamental factors are more objective than stock prices.

One advantage of this approach is that dividends and earnings are much more objective than stock prices as a way of measuring a company's success. We've all seen stocks launched into orbit by irrational investors chasing surging stock prices, only to come crashing back down.

Dividends aren't so easily manipulated. And screening for companies with consistent earnings can help weed out the money-losing and speculative ones.

WisdomTree has a whole family of ETFs that follow variations on this theme. Some of the most popular are:

WisdomTree Dividend excluding Financials (DTN)

WisdomTree India Earnings Fund (EPI)

WisdomTree Emerging Markets SmallCap Dividend (DGS)

Alternative #4:
Revenue Weighting

Another methodology is offered by a company called RevenueShares. The name gives away their strategy: Stocks in their ETFs are weighted by revenue.

Revenue is even more resistant to manipulation than earnings. In accounting lingo, it's the "top line" of money coming in. Public companies are required to disclose it in their SEC filings, so the information is readily available.

Revenue is what makes companies grow.

RevenueShares says that weighting stocks by their revenue can deliver attractive returns over time. Though of course it doesn't mean their strategy will work all the time. Here are some of the best-known RevenueShares ETFs:

RevenueShares Small Cap (RWJ)

RevenueShares Mid Cap (RWK)

RevenueShares Large Cap (RWL)

Alternative #5:
Combinations of Fundamental Weightings

Alternatives #2 — #4 discussed above are sometimes referred to as fundamental weighting. Rob Arnott, of Research Affiliates, has created fundamentally weighted indexes using a combination of factors such as sales, book value, dividends, and cash flow. And he has teamed up with FTSE to offer the FTSE-RAFI indexes.

Some of the ETFs using this approach include:

PowerShares FTSE-RAFI US 1000 (PRF)

PowerShares FTSE-RAFI Emerging Markets (PXH)

PowerShares FTSE-RAFI US 1500 Small-Mid (PRFZ)

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Trading Secrets

2009-08-15T20:48:00.001-07:00

US Presidential Cycle Strategy. 100% track record is to buy a Dow Jones Industrial Average Index on 1Jan of the third year and keep the position until end of the year.

2nd trading strategy is buy the S&P500 index on 1 Oct in the second year and hold then this position open until the end of Dec in the fourth year.

3rd trading strategy is buy S&P 500 index on 1 June and sell on 31 Dec , 13 of the past 14 presidential terms positive return.

Buy a S&P 500 index two days before Rosh Hasanah or St Patrick's and close the trade out the day after this holy day.

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US Bear Market Bottoms

2009-08-14T21:00:00.001-07:00

Trend 1 : The History Books.Uncanny knack of bottoming out in Oct. Second markets simply not end in the fifth year of the decade.Howerver a bear market likely end in second or eighth year of the decade.Since 1932 , the average length of bear market is around 12 months, the average drop in those 12 months is 26%.US market has a habit of bottoming out in the first or second years of the presidential term.

Trend 2 : Rock bottom valuation .PE falls of around 10.http://irrationalexuberance.com/

Trend 3 : Extreme volatility and negative investor sentiment. VIX Index in range of 40-50.

Trend 4 :The 200 MA test. Fall way below 200 MA. If you bought the S&P every time if fell 20% below it 200MA in the past 33 years, than a month later you would have been in the profit of average gain 10%.

Trend 5 : Early signs of economic improvement. When copper hit bottom, automotive sales start to rise and inventory levels are low.

Trend 6 : Bond Market Rally.Government bonds and corporate bonds rally on average 10 and 4 months before equity markets finally hit their bottom.

Trend 7 : McClellan Summation Index. MSO below minus 500.http://www.mcoscillator.com/

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Bull Market Top 15 Leading Indicators

2009-08-10T00:08:00.001-07:00

Equity inflows into mutual fund spikes. http://www.trimtabs.com/site/index.php
Volatility index at low between 20 to 10. http://stockcharts.com/h-sc/ui?c=$vix
Advancing/declining stocks. http://stockcharts.com/def/servlet/Favorites.CServlet?obj=msummary&cmd=show&disp=SXA
Coppock indicators. http://www.investorschronicle.co.uk/MarketsAndSectors/Markets/article/20090706/a5f06932-6a33-11de-9d12-0015171400aa/Stable-doors-and-horses.jsp
Economic cycle and presential cycle. Bull cycle all start between 3 to 8 months before the start of pre-election years.
Bull Market corrections normally 10%.
US recession average 10 months, longest last 16 months. When monetary policy being tighten and oil proce increase, the US has fallen into recession.Inverted yield curve.
Sentiment indicators - put/call ratio. http://stockcharts.com/h-sc/ui?s=$CPC
Sentiment Indicator - financial advisers surveys.http://www.investorsintelligence.com/x/default.html
US consumer confidence. Extremely bullish 115, bearish below 75, Y2008 years low is 38. http://www.conference-board.org/
IPO markets and M&A activity.
Dow Jones Industrial Average/Nasdaq index ratio. Low ration mean investors more aggressive.

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The S-Chips Are Cheap

2009-07-25T18:52:00.001-07:00

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Tangible Common Equity for Beginners

2009-07-18T20:21:00.001-07:00

You may have seen in the news that the government is thinking about exchanging its “preferred stock” in Citigroup for “common stock.” Here’s one of many articles. Which, if you are at all sensible and have any sense of proportion in your life, should be complete gobbledygook. The first part of this article will try to explain the gobbledy good; advanced readers can skim it. The second part will offer some of the usual commentary.

Banks, like all companies, have balance sheets. On one side they have assets – stuff they own. On the other side they have liabilities – money they owe other people – and equity. Equity can be thought of in two ways. First, it is the money that the initial owners put in to start the business; before you can borrow money from someone else, you usually have to have some money or other assets of your own that you put in. Added to that money are retained earnings – all the profits the company has made but has not paid out to the owners as dividends. Second, equity is what is left over after you pay off all your creditors. If you sold the assets and paid off the liabilities, the rest would go to the company’s owners.

That equity “belongs” to the owners of the company; if it’s a publicly-owned company, those are the shareholders. The market value of the equity is the total amount that people would pay today to own all of that balance sheet equity: it’s the total number of shares times the share price. The market value of equity is generally different from the “book value” (balance sheet value) of equity, because if you own a company, you own not only today’s equity, but also all the profits the company will make in the future. Under certain circumstances the market value of equity can be less than the book value of equity – that’s the case if investors think that the company’s management is destroying value, or that the book value of equity on the balance sheet inflates its true worth.

The complication is that there are different kinds of equity. The way to think about this is to think about the various ways that companies can raise cash from investors. At one extreme there is secured debt: the company goes to a bank, takes out a loan, and pledges some of its assets as collateral. If it doesn’t repay the loan, the bank gets the collateral. Then there is unsecured debt: the company issues a bond, which is just a promise to pay in the future, and the investor pays money for this bond, hoping to be repaid with interest. At the other extreme there are common shares. These give you no rights in particular, except the right to control the company, through the board of directors. Conceptually, the common shareholders own the equity, and benefit from the future profits, but the company has no obligation to give them any of the equity, or to pay out any of the profits as dividends. Then in between debt and common shares there are these things called preferred shares, which come in many flavors. Preferred shares are like debt: they may pay a required dividend, which is like interest on a debt; there may be rules on when they have to be bought back by the company, such as in case of a major transaction. They are also like equity: in case of bankruptcy, preferred shareholders only get paid back only after all the debt holders have been paid back; in some cases, preferred shares can be converted for common shares at a predetermined price, which allows preferred shareholders to benefit if the common stock goes up in value.

In summary, there is a spectrum of instruments through which companies raise money, and these instruments have differing priority in making claims on the company. They also differ in how likely the investor is to be paid back. Secured debt comes first, common shares come last, and everything else comes in between.

Trust me, we’re getting closer to the question I started with.

Ordinarily, you don’t need to debate whether preferred shares should count as debt or equity. However, for banks in particular, there is a concept called capital adequacy. A capital adequacy ratio is the ratio between some measure of capital to total assets. Imagine for a moment that there was only one kind of debt – say, deposits – and one kind of capital – ordinary shares. Say my bank has $100 in assets. As we all know, assets can go up or down in value. If I have $90 in debt, then I have $10 in capital, and my ratio is 10%. This means that my assets could fall in value by up to 10% and I would still be able to pay back my depositors. If, instead, I have $99 in debt, then my ratio is only 1%. If my assets fall by more than 1% in value, I won’t be able to pay back my depositors, I’ll be insolvent, and the FDIC will take me over so it can pay off the deposit guarantees at minimum risk to itself. This is why the capital adequacy ratio matters, especially to bank regulators. What minimum capital ratios should be is a complex topic, most of which I will avoid, but you can see why they matter.

The part I can’t avoid is how the capital – the numerator of the ratio – is calculated. As I said above, there are many different types of capital. Besides common shares and preferred shares, believe it or not, you can count deferred tax assets (credits you gain by losing money in one year, which you can apply against taxes in future years where you make money) as capital. One commonly used measure of capital is called Tier 1 Capital, which includes common shares, preferred shares, and deferred tax assets. A less commonly used measure is Tangible Common Equity (TCE), which includes only common shares. Obviously, TCE will yield a lower percentage than Tier 1.

Which of these measures is better? That’s sort of an arbitrary question. The fact that you change the numbers you type into your spreadsheet doesn’t change the actual health of the bank any. They just measure different things. Each one measures the ability of the bank to withstand losses before its ability to pay off its liabilities starts getting compromised. One difference between the two is whether you count preferred shares as liabilities, which depends on how bad you think it is that preferred shareholders don’t get their money back. Another difference depends on what you think the deferred tax credits are worth in a worst-case scenario. In any case, the skeptics, like Friedman Billings Ramsey, have been insisting since the beginning of the crisis that TCE is the proper measure of bank solvency. And most immediately, Tim Geithner has said that the new bank stress tests will focus on TCE. So if your bank doesn’t have enough TCE, it will fail the stress test, and then . . . who knows what the administration has the stomach to do.

Getting back to the current situation . . . The initial government investments in Citigroup, back in October and November, were in the form of preferred shares. Between the two bailouts, the government put in $45 billion in cash and got $52 billion in preferred stock (the $7 billion difference was the fee for the guarantee on $300 billion of Citi assets). That preferred stock was designed to be much closer to debt than to equity: it pays a dividend (5% or 8%), it cannot be converted into common stock (so it cannot dilute the existing shareholders), it has no voting rights, and it carries a penalty if it isn’t bought back within five years. In fact, it is hard to distinguish from debt, except perhaps for the fact that, if Citi defaults on it (cannot buy the shares back) we don’t need to worry about systemic instability, because the government can absorb the loss. As preferred stock, these bailouts boosted Citi’s Tier 1 capital, but not its TCE.

Because of the newly perceived need for TCE, the bailout plan under discussion is to convert some of the preferred stock into common stock. Citi wouldn’t actually get any new cash from the government, but it would be relieved some of the dividend payments (currently close to $3 billion per year), and of the obligation to buy back the shares in five years. (For the impact on Citi’s capital ratios, see FT Alphaville.) This is a real benefit to the bank’s bottom line, and hence to the common shareholders. At the same time, though, Citi would issue new common shares to the government, diluting the existing common shareholders (meaning that they now own a smaller percentage of the bank than before). In theory, the amount by which the shareholders in aggregate are better off should balance the amount of dilution to the existing shareholders.

The trick is deciding what price to convert the shares at. All of Citi’s common shares today are worth around $12 billion, so if you converted $52 billion of preferred shares into common, the government would suddenly own over 80% of Citi. (In the conversion, you divide the value of the preferred stock you are converting by the price of the common stock, and that yields the number of common shares the government now owns.) The Geithner team is still continuing the Paulson policy of avoiding anything that looks like nationalization, so the talk is that the government ownership will be capped at 40%; that means the government could only convert about $8 billion of its preferred stock. There will probably be some clever manipulation of the numbers to say that the preferred stock is actually worth less than $52 billion, or that it should be converted at a higher price than the current market price of the stock. (This seems like a blatant subsidy to me, since new investors buying large blocks of stock in a public company typically pay less than the current market price.) There is also talk of trying to get some of Citi’s other preferred stock holders to convert as well, because the more they convert, the more common shares, and hence the more the government can have without going over the 40% limit.

I still don’t understand why people care so much about whether the government owns more or less than 50% of the common shares. This just seems like a fig leaf. The more important issue which people can argue about is whether government is controlling Citigroup’s day-to-day operations. (Some say that’s good, some say it’s bad.) According to The New York Times, this is already happening. Alternatively, if you want to minimize government control, the government could tie its own hands; for example, no matter what its percentage ownership, the government’s stock purchase agreement could say that it has the right to appoint a minority of the board of directors but no more than that.

I think the situation we want to avoid is what is going on at AIG, where the government owns 80% of the company but still seems to be negotiating at arm’s length with the company. This is the worst of all worlds, because even though it already bears the vast majority of the losses, and has the power to clean up AIG (by writing down all its assets to their worst-case scenario values and then recapitalizing the firm sufficiently), the government is treating AIG like an independent entity. For example, if the government did a radical cleanup, it’s hard to see how AIG would still be in danager of ratings downgrades – which are the immediate problem it faces. But that story may have to wait for another post.

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Japan is a rapidly aging nation !

2009-07-11T19:20:00.001-07:00

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Potential Shortage of capital to Fund Treasuries

2009-07-11T19:18:00.001-07:00

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Dennis Gartman Trading Rules

2009-06-26T22:03:00.001-07:00

Dennis Gartman’s trading rules:

1. Never, Ever, Ever, Under Any Circumstance, Add to a Losing Position… not ever, not never! Adding to losing positions is trading’s carcinogen; it is trading’s driving while intoxicated. It will lead to ruin. Count on it!

2. Trade Like a Wizened Mercenary Soldier: We must fight on the winning side, not on the side we may believe to be correct economically.

3. Mental Capital Trumps Real Capital: Capital comes in two types, mental and real, and the former is far more valuable than the latter. Holding losing positions costs measurable real capital, but it costs immeasurable mental capital.

4. This Is Not a Business of Buying Low and Selling High; it is, however, a business of buying high and selling higher. Strength tends to beget strength, and weakness, weakness.

5. In Bull Markets One Can Only Be Long or Neutral, and in bear markets, one can only be short or neutral. This may seem self-evident; few understand it however, and fewer still embrace it.

6. “Markets Can Remain Illogical Far Longer Than You or I Can Remain Solvent.” These are Keynes’ words, and illogic does often reign, despite what the academics would have us believe.

7. Buy Markets That Show the Greatest Strength; Sell Markets That Show the Greatest Weakness: Metaphorically, when bearish we need to throw rocks into the wettest paper sacks, for they break most easily. When bullish we need to sail the strongest winds, for they carry the farthest.

8. Think Like a Fundamentalist; Trade Like a Simple Technician: The fundamentals may drive a market and we need to understand them, but if the chart is not bullish, why be bullish? Be bullish when the technicals and fundamentals, as you understand them, run in tandem.

9. Trading Runs in Cycles, Some Good, Most Bad: Trade large and aggressively when trading well; trade small and ever smaller when trading poorly. In “good times,” even errors turn to profits; in “bad times,” the most well-researched trade will go awry. This is the nature of trading; accept it and move on.

10. Keep Your Technical Systems Simple: Complicated systems breed confusion; simplicity breeds elegance. The great traders we’ve known have the simplest methods of trading. There is a correlation here!

11. In Trading/Investing, An Understanding of Mass Psychology Is Often More Important Than an Understanding of Economics: Simply put, “When they are cryin’, you should be buyin’! And when they are yellin’, you should be sellin’!”

12. Bear Market Corrections Are More Violent and Far Swifter Than Bull Market Corrections: Why they are is still a mystery to us, but they are; we accept it as fact and we move on.

13. There Is Never Just One Cockroach: The lesson of bad news on most stocks is that more shall follow… usually hard upon and always with detrimental effect upon price, until such time as panic prevails and the weakest hands finally exit their positions.

14. Be Patient with Winning Trades; Be Enormously Impatient with Losing Trades: The older we get, the more small losses we take each year… and our profits grow accordingly.

15. Do More of That Which Is Working and Less of That Which Is Not: This works in life as well as trading. Do the things that have been proven of merit. Add to winning trades; cut back or eliminate losing ones. If there is a “secret” to trading (and of life), this is it.

16. All Rules Are Meant To Be Broken…. but only very, very infrequently. Genius comes in knowing how truly infrequently one can do so and still prosper.

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Currency ETF List- A detailed list of currency ETFs

2009-05-21T07:04:00.001-07:00

Currency ETF List- A detailed list of currency ETFs

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How to Capitalize on the Coffee Guys’ Mistakes

2009-05-14T06:21:00.001-07:00

Now I would be the last guy to tell you to buy coffee or sugar futures, because, quite frankly, I am terrified of getting an e-mail asking what to do with the truckload of beans that just showed up.But these are most enlightened times, and there are Exchange Traded Funds (ETFs), Exchange Traded Commodities (ETCs) and Exchange Traded Notes (ETNs) for most everything these days, including coffee.

The name (oddly enough) is the iPath Dow Jones-AIG Coffee Total Return Sub-Index (JO:NYSE). The fund has been falling pretty much nonstop on the idea that coffee was going to tank. But now that coffee is clearly still the drug of choice, I suspect those fortunes are about to experience a real sea change.Last price on my ticker is $39.01 a share and quite frankly, the volume is as thin as all get out. But if a body were to enter tenderly over several days, I imagine they could enjoy quite a ride.

Today's Taipan Daily

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Jeremy Grantham Says Stocks Going To Moon

2009-05-09T00:40:00.001-07:00

Jeremy Grantham was one of the few forecasters to call the crash, He was also one of the few to call the bottom two months ago–publishing “Reinvesting While Terrified” on the exact day the market bottomed. And now, in his quarterly letter, the great Grantham has a surprise for those expecting a return to unremitting gloom: He’s (mostly) bullish!

Grantham adds: In a rally to 1000 or so, the normal commercial bullish bias of the market will of course reassert itself, and everyone and his dog will be claiming it as the next major multi-year bull market. But such an event – a true lasting bull market – is most unlikely. A large rally here is far more likely to prove a last hurrah … a codicil on the great bullishness we have had since the early 90s or, even in some respects, since the early 80s. The rally, if it occurs, will set us up for a long, drawn-out disappointment not only in the economy, but also in the stock markets of the developed world.It all sounds plausible, maybe my gut says he is right, but is following his forecast a smart way to invest when you don’t have unlimited capital? Perhaps following his lead, taking the big bet, will be a great reward, but perhaps not. The smart money says to let the market lead, then follow.

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Beat The Market

2009-04-30T20:33:00.001-07:00

1) Bearlish Zones : When Moody's average Baa bond yield minus S&P earning yield are greater than 4.6%.
Neutral Zones : Between 3.45 AND 4.6%
Bullish Zones : Below 3.4%

Yield Data:
http://online.barrons.com/mktlab

2) Stocks are bullish when S&P earning yield at 95% or more than the average yield of 90-day tresury bills and 10 years US government notes.
Neutral to Bullish : between 85% to 95%
Negative Zone :Less than 85%

3) Combine Model :

Buy Condition #1 : Remain invested if both Baa bond method and US Government Bond method lie within their most bullish zone.
Buy Condition #2 : Remain invested if either Baa bond method and US Government Bond method lie within their most bullish zone.

If both model neither not in bullish zone not the time to invest aggressively in stock
Stay clear when both model lie in most negative zone.

4) Stock market is likely to perform well during periods in which # of stock advance in price exceed # of decline.( Advance/Decline line )
http://online.barrons.com/public/page/9_0210-trddiary.html
Example :

Market Advance/Decline Totals
Week ended last Friday compared to previous Friday

Weekly Comp.	NYSE	Alternext	Nasdaq

Total Issues	3,229	681	3,041
Advances	1,653	396	1,415
Declines	1,527	227	1,549
Unchanged	49	58	77
New Highs	19	13	40
New Lows	7	0	48

Weekly Breath Reading for NYSE = (Advance - Decline) divided by the total issues.

Next step : calculate the six week expontial MA.
Smoothing constant =6 weeks +1 divide by 2 is 0.286.
Start with 6 weeks moving average, e.g
1. Multiply .286 times this weeks actual price e.g 60 , minus previous week 55. x0.286 * 5 ( 60-55 ) = 1.43.
2. add 1.43 to 55 = 56.43 new EMA
3. Next week 61, 0.286* 4.57 ( 61- 56.43) + 56.43 = 57.73

Buy or hold when 6 weeks EMA above 0.25 or 25%
SEll when the EMA decline to -0.5 (-5%)

Combine Model
1. Buy when either modles in most bullish zoen with EMA above 25%.
2. Unteill EMA decline to -5% and bond model fallen below most nullish zone or both modles in most bearish zone.

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Ten Principles for a Black Swan-Proof World

2009-04-09T18:35:00.001-07:00

From FT.com today:

Ten principles for a Black Swan-proof world

By Nassim Nicholas Taleb

Published: April 7 2009

1. What is fragile should break early while it is still small. Nothing should ever become too big to fail. Evolution in economic life helps those with the maximum amount of hidden risks – and hence the most fragile – become the biggest.

2. No socialisation of losses and privatisation of gains. Whatever may need to be bailed out should be nationalised; whatever does not need a bail-out should be free, small and risk-bearing. We have managed to combine the worst of capitalism and socialism. In France in the 1980s, the socialists took over the banks. In the US in the 2000s, the banks took over the government. This is surreal.

3. People who were driving a school bus blindfolded (and crashed it) should never be given a new bus. The economics establishment (universities, regulators, central bankers, government officials, various organisations staffed with economists) lost its legitimacy with the failure of the system. It is irresponsible and foolish to put our trust in the ability of such experts to get us out of this mess. Instead, find the smart people whose hands are clean.

4. Do not let someone making an “incentive” bonus manage a nuclear plant – or your financial risks. Odds are he would cut every corner on safety to show “profits” while claiming to be “conservative”. Bonuses do not accommodate the hidden risks of blow-ups. It is the asymmetry of the bonus system that got us here. No incentives without disincentives: capitalism is about rewards and punishments, not just rewards.

5. Counter-balance complexity with simplicity. Complexity from globalisation and highly networked economic life needs to be countered by simplicity in financial products. The complex economy is already a form of leverage: the leverage of efficiency. Such systems survive thanks to slack and redundancy; adding debt produces wild and dangerous gyrations and leaves no room for error. Capitalism cannot avoid fads and bubbles: equity bubbles (as in 2000) have proved to be mild; debt bubbles are vicious.

6. Do not give children sticks of dynamite, even if they come with a warning . Complex derivatives need to be banned because nobody understands them and few are rational enough to know it. Citizens must be protected from themselves, from bankers selling them “hedging” products, and from gullible regulators who listen to economic theorists.

7. Only Ponzi schemes should depend on confidence. Governments should never need to “restore confidence”. Cascading rumours are a product of complex systems. Governments cannot stop the rumours. Simply, we need to be in a position to shrug off rumours, be robust in the face of them.

8. Do not give an addict more drugs if he has withdrawal pains. Using leverage to cure the problems of too much leverage is not homeopathy, it is denial. The debt crisis is not a temporary problem, it is a structural one. We need rehab.

9. Citizens should not depend on financial assets or fallible “expert” advice for their retirement. Economic life should be definancialised. We should learn not to use markets as storehouses of value: they do not harbour the certainties that normal citizens require. Citizens should experience anxiety about their own businesses (which they control), not their investments (which they do not control).

10. Make an omelette with the broken eggs. Finally, this crisis cannot be fixed with makeshift repairs, no more than a boat with a rotten hull can be fixed with ad-hoc patches. We need to rebuild the hull with new (stronger) materials; we will have to remake the system before it does so itself. Let us move voluntarily into Capitalism 2.0 by helping what needs to be broken break on its own, converting debt into equity, marginalising the economics and business school establishments, shutting down the “Nobel” in economics, banning leveraged buyouts, putting bankers where they belong, clawing back the bonuses of those who got us here, and teaching people to navigate a world with fewer certainties.

Then we will see an economic life closer to our biological environment: smaller companies, richer ecology, no leverage. A world in which entrepreneurs, not bankers, take the risks and companies are born and die every day without making the news.

In other words, a place more resistant to black swans.

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Guru Investor Strategies

2009-04-04T22:14:00.001-07:00

Graham :

P/E no greater than 15.
P/E x P/B not exceed 22
Current ratio < 2, less than 2 is utility or telecom
Long term debt < Value of the Assets ( Net current assets )
Sa;es > 340M
30 to 50% below real value
10 years EPS growth >30%
Total debt/equity ratio < 100% , Utilities,phone, railroads <230%
Continue Dividend

John Neff :

P/E >40% of market average < 60% of market average
EPS growth >7%<20%,
Futures EPS growth rate >6% current year AND >6% for long term
Sales growth > 70% of EPS growth rate, <70% of EPS growth rate but >7%
Total return/P/E > ( Market total return/P/E) x2, or > ( Industrial total return/ P/E) x2
Free cash flow > 0
EPS by quarter ( Q1 most recent q, Q5= 5 q ago), Q1>Q5 and Q2>Q6, and Q3>Q7, and Q4>Q8

David Dreman :

P/E in bottom 20% of the market
Price/Cash flow ratio in bottom 20% of market
Price/Book Ratio in bottom 20% of market
Price/Dividend Ratio in bottom 20% of market
Market cap among 1,500 largest publicly traded stocks
EPS Q1 >EPS Q2
EPS growth in the immediate past and future, EPS growth from Q3 to Q1 > S&P 500 growth Q3 to Q1 and projected growth for this year > S&P 500 growth for this year
Current ratio > Industry average or > 2
Payout ratio < average historical payout ratio
ROE > 27% or top third of 1,500 largest -cap stocks.
Pre tax margin > 22% to 8%
Yield > Dow yield +1 %
DEbt to Equity ratio =0 but <20%

Warren Buffet:

Earning Predictability ( Y1 most recent years, Y10 10 years ago), Y1>Y2>Y3>Y4...Y10 and no years with negative EPS ( A dip from a prior year's earning that no more than 45% , also acceptable but o years negative EPS)
Long term debt < 2 times earning or <2 < 5
ROE ( Average over the last 10 years) > 15%
Return on Total capital ( ROTC ) > 12%
FCF >0
Utilization of RE, return of Retained Earning > 15% or >12<15%
Initial Rate of Return ( Earning Yield ) = EPS/P, > long term T-bond yield)
Return on equity >15% or >12<15%
EPS growth >15% or >12%<15%
Average final return ( Expected ROE+ Expected EPS)/2 >15% or >12%<15%

Peter Lynch:

PEG and Yield adjusted PEG>0<0.5 or >0.5<1
Change in Inventory , financial or Service Co not applicable,change in inventory/sales is negative or zero or positive but less than 5
Total debt-Equity ratio financial or Service Co not applicable,D/E < 30%, or >30<50%, or >50<80%
For Financial stocks : Equity to Asset Ratio > 5% or >13.5%. ROA > 1%
P/E for fast Growers, Sales >$1 billion and PE < 40
EPS growth for fast growers > 20<25% or >25<50%.
Stalwarts ( Earning growth 10 to 20% and annual sales $2billion or more ). EPS >0
Yield > S&P yield and > 3%
Bonus Criteria: FCF to Current ratio > 35%
Net Cash per share to Current Ratio >30<40% or >40<50

Kenneth L Fisher:

Price/Sales Ratio, Noncyclical and Tech stcoks : PSR < 0.75, PSR >0.75<1.5 are good vale. Cyclical stocks : PSR <0.4. > 0.4<0.8 are good value.
Total debt/equity ratio <40%
Price/Research Ratio <5 best, >5<10 Pass, >10<15 ok.
Price/Sales for super stock, Noncyclical and Tech <0.75, Cyclical <0.4
Inflation adjusted EPS growth > 15%
FCF > 0
3 years ave net Profit Margin > 5%

Martin Zweig:

PE Ratio >5 and <43 and <3x Market PE
Revenue growth >85% of EPS growth or Revenue growth > 30% per year
Current EPS >0
EPS for quarter one year ago >0
Growth from Q1 to Q5 >0
Annual Earning Persistance , Y1>Y2>..Y5.
Earning growth for past 4 quarter compare with previous year quarter must > 50%
Long term EPS growth > 15 Pass or > 30% best case
Growth Q5 to Q1 >30% and > Historical growth rate
D/E < Industrial average
Insider sell = 0 AND buy > 3

James O' Shaughnessy

Market Cap >$ 150M
EPS Persistance , Y1>Y2>.....Y5
PSR <1.5
In top 50 stocks of passing the three criteria

Value Strategies

Market Cap >$ 1billion
Cash flow per share > Market average cash flow/share
Share outstanding > Market average shares outstanding
Trailing 12-Month sales > ( Market average sales (TTM)) x 1.5
Dividend Yield in top 50 passing the previous four criteria

Joel Greenblatt:

Determine Return on Capital ( Earning before interest and taxes)/(Net working capital + Net Fixed asset)
Determine Earning Yield ( Earning before interest and taxes)/( Enterprise value)
ROE + EY among 20 lowers of eligible stocks

Joseph Piotroski:

B/M in top 20% of market
ROA >0
ROA most recent year>ROA previous year
CF>0
CF from operation > Net income
LTD/A for most recent year < previous year
CR recent year> previous year
Number of share outstanding in most recent year < previous year
GM recent > previous year
Asset turnover recent > previous year

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Gauging the Turn in Dollar, Gold and Oil

2009-03-20T19:05:00.001-07:00

Technically, the ensuing positive correlation between the USD and global equities suggests an acceleration of the dollar sell-off as equities extend their recovery (albeit still deemed a bear market bounce). Indices would have to rally by more than 27%-28% from this months lows to 845-855 in the S&P500, 4,460-4,500 in the FTSE-100, 4,680-4,700 in the Dax-30 and 9,000-9,100 in the Nikkei-225.

Safe Haven | Gauging the Turn in Dollar, Gold and Oil

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S&P 1871 to Present

2009-03-20T06:25:00.001-07:00

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Reflation Investing - Which Currencies Benefit?

2009-03-19T06:25:00.001-07:00

Not surprisingly, gold has been a main beneficiary of the trends we see. Because industrial activity is likely to lag in this "recovery," gold being a precious metal with low industrial use, is a barometer of the money being printed. As reflationary efforts take hold, the money is likely to flow to other commodities - we see trends of that already - before possibly reaching corporate earnings. The Australian dollar is highly correlated with the price of gold; we like the Australian dollar as a reflation play because the Australian economy is highly sensitive to the price of commodities; Australia is also a large exporter of commodities to China, the one country that can afford its stimulus plan. Australia is fiscally in much better shape than the U.S., although it also has a high current account deficit. That current account deficit worked against the Australian dollar when commodity prices imploded, but may cause the Australian dollar to have a more pronounced upward move as the world reflates. We like Australia's smaller neighbor New Zealand, especially because the government there has had much more of a hands off approach to the global crisis; as a result, similar to Australia, the New Zealand dollar was harder hit during the downturn, but may benefit at an above average rate in a reflationary phase.

Safe Haven | Reflation Investing - Which Currencies Benefit?

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2 Months Rallies

2009-03-13T20:14:00.001-07:00

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PE vs Returns ( 100 Years )

2009-02-28T17:55:00.001-08:00

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Bear Market Recoveries Since 1950

2009-02-27T20:00:00.001-08:00

dshort.com: Bear Market Recoveries Since 1950

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Unemployment-SP-Composite-since-1948

2009-02-27T19:54:00.001-08:00

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Bear-markets-comparison

2009-02-27T18:42:00.001-08:00

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The Final Currency To Top Out

2009-02-27T18:11:00.001-08:00

When the rest of the world gets fewer dollars from a shrinking trade deficit, the value of the Dollar strengthens. The US now is embarking on a path to an astronomically high budget deficit that will have the complete opposite effect. Instead of foreigners being flush with Dollars to re-invest in the United States, they are lacking Dollars at the very time that we need their Dollars the most - to fund the US government's deficit. This can only have one effect on the Dollar - that is for it to FALL.The US Dollar should have been falling during the last 18 months as interest rates were slashed and our fundamentals were the worst in the world. Common sense always prevails, and anyone still expecting the Dollar to remain strong and deflation to be headline news is going to be shocked.

Safe Haven | The Final Currency To Top Out

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Chris Martenson | chapters - The Crash Course

2009-02-17T05:26:00.001-08:00

The Crash CourseReady to learn everything you need to know about the economy in the shortest amount of time?The Crash Course is a condensed online version of Chris Martenson's "End of Money" seminar.What is it?The Crash Course seeks to provide you with a baseline understanding of the economy so that you can better appreciate the risks that we all face. The Intro below is separated from the rest of the sections because you'll only need to see it once...it tells you about how the Crash Course came to be.How long will it take?

Chris Martenson | chapters - The Crash Course - chapters, Crash Course, Economy, Energy, environment, Peak Oil, videos

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Warren Buffett Interpreation Of Financial Statement.

2009-02-16T04:25:00.001-08:00

Income Statement

Gross profit should be more than 50%.Avoid less than 20%.
SGA , must consistant % of gross profit.Avoid consistently high SGA expenses co.
R&D, high R&D have an inherent flaw in competitive advantage.
Depreciation,very real expense and should always be included in any calculation of earning.Look for low depreciation.. e.g P&G only 7%.
Interest expenses, look for less than 15% of operation income. Lower % in the industrial, better competitive advantage.
Income before tax,using pre-tax income for analysis.
Income taxes paid, US in 2008 about 35% of income, use this to counter check,e.g pre-tax income*35% compare to income tax paid.
Net earning, looking for uptrend, look for % of revenue in up trend.E.g KO earn 21%, look for more than 20%, except bank, high % high risk.

Balance Sheet

Shareholders' Equity ( Net worth,book value) , is all the assets substrate all the liability.
Current Assest(Working Assest) , look for cash generate from ongoing business., no debt.
Inventory, look for inventory and net earning corresponding rise.
Prepaid Expenses e.g Insurance.
Current ration : Current asset/current liability. Look for greater than 1.Some good earning power co, e.g KO has ratio of 0.95.
Goodwill, buying amount over the book value.
Long term investment, value of long term investment that more than a year,e.g stock. bond,real estate, invest in co subsidiaries.State at cost of market price whichever lower.
Short term debt, when borrow short term and invest long term, problem occure when shorten interest increase higher than long term invest return.When invest in bank , look for less than 60% of short term debt over long term debt.
Long term debt, look for min long term debt, yearly earning able to pay off all of it long term debt with 3 to 4 years.
Minority interest, represents it value of buy over co that the co did not won.
Debt to shareholders' equity ration is total liabilities/shareholder equity.Look for less than 0.8 unless is back about 10.
Prefer and common stock carried in balance as par value, any money in excess of apr that was paid when company sold the stock is "paid in capital".Look for absence of preferred stock.
Retained earning,accumulate no,look for growth, or it invest wisely.
Treasury stock, share that buy back by the co.Good indicator.
Return on shareholders' equity, is net earning/SE,higher the better, history of strong earning with negative SE, ok.

Cash Flow Statement

Total cash from operating , is net income + depreciation + Amortization.
Net change is cash is Total cash from OA +IA +FA.
Capital Expenditure, look for low #, e.g KO only 19% of total earning, less than 50% of annual net earning.

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Gold up trend likely for next few months.

2009-02-12T06:56:00.001-08:00

The speculative element to golds surge is reflected in the 138% increase attained by speculative net longs in gold futures to a 9-month high of 155,306 contracts (see above chart). Speculative longs as a percentage of total open interest reached 52%, the highest since July, suggesting further upside remains ahead. Interestingly, the record high in golds net speculative longs was reached in December 2007, three months before the metal hit its all time highs. The 3-month lag between golds net longs and multi-year highs also took place in 2006. Thus, even if speculative net longs regain record territory above 200K contracts, prices may have at least 2-3 months of upward momentum. The prospects for $1,200-1,300 gold by end of Q3 remain underpinned by a set of cogent fundamental variables involving currencies, interest rates and the global economy. Meanwhile, even as the divergence between gold and oil begins to fade, any oil-friendly dynamics are seen positive for gold's luster.

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China Investment Watch List

2009-02-09T02:08:00.001-08:00

China Aerospace International Holding , H-Share OTC:CAIF
Jiangxi Hongdu Aviation Industry , 600316,A-Shares.
Jiangnan Heavy Industry Co, 600072,a-Shares.Aircarft carrier.
China Life Insurance Co.Ltd ,HKG 2628, NYSE LFC.
Aluminum Corp of China Ltd , NYSE ACH
Focus Media Holding Ltd, NASDAQ FMCN
PetroChina NYSE PTR.
China Railway Erju Co, 600528 A-shares,List in HK.
Ctrip.con NASDAQ CTRP
COFCO International HKG 0506
Oriental Food Holding Singapore
Nanning Sugar MFG SHE000911 A-shares
American Dairy Inc NYSE ADY
Chaoda Modern Agriculture Ltd HKG 0682 H-shares
Pine Agritech Ltd Singapore
China Medicl Tech NASDAQ CMED

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The Oldest, Most Trusted Technician in the World Is Telling You to Sell Now

2009-02-05T04:25:00.001-08:00

The oldest, most trusted technician in the world is telling you to sell now.Recession? Depression? Nascent recovery? Market bottom? Dead cat bounce?

Bad News and Worse

I could point out the worst GDP reading in a quarter century (except I think I already have several times over the past few weeks). I could read you chapter and verse on current unemployment (7.2% according to the government, already cresting 12% according to some more “inclusive” calculations).

I could quote no less a luminary than British Prime Minister Gordon Brown, who confessed in the House of Commons that we are truly mired in a great depression akin to the 1930s. (The apparatchiks at #10 Downing Street are desperately trying to retract the statement, but I’m afraid that this particular cat is out of the bag, through the door, and out of sight down the street already.)

Or I could simply go back to Charles Dow’s tenet 4: “The Transports must confirm the Industrials.”

The Facts of the Matter

If you look at the Dow Jones Industrial Average for the past few days, you can’t help but see the fact that last Monday’s low of 7867.37 beat the previous low of 7909.03 set on Jan. 23.

If you look to the Dow Transports’ chart you can see consecutive lower lows of 2926.66 on Jan. 27 and 2865.58 on Feb. 2.

The Only Sane Solution (and a Sure Shot at Triple-Digit Gains)

The trend is already in place. The counter-reaction is ending. The next leg down has been signaled and confirmed. The only protective tactic that makes any sense is to buy puts against both the Industrials and Transports similar to the ones I have asked WaveStrength Options Weekly (WOW) readers to purchase.

Today's Taipan Daily

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ProShares Ultra-Short 20+ Treasury Fund (TBT)

2009-01-31T19:30:00.001-08:00

The central banks/governments around the entire world are fighting the credit crisis with everything and the kitchen sink. Some of the efforts will take hold, encouraging a bit of risk taking activity. That means money will come out of treasuries and go somewhere... whether it's A-grade debt, foreign bonds, emerging bonds, preferred debt, convertible debt. In other words, the money does not have to flow into stocks for the ProShares Ultra-Short 20+ Treasury Fund (TBT) to thrive; it just has to leave U.S. treasuries... and I believe that it will.

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Geithner, China, and the Specter of Technical Insolvency

2009-01-27T05:39:00.001-08:00

Even including the TARP 1 injection of capital of $230 billion into the banking system and the further $200 billion of capital injected by private investors and sovereign wealth funds since the start of the crisis, the overall banking system would still be borderline insolvent.Moreover, in order to restore the capital of the banking system to the previous level of $1.4 trillion (a level close to the 8% capital requirement of Basel II) an additional $1.4 trillion of private and public/government capital would have to be injected in the banking system to restore safe credit growth. If a reform of the regime of regulation of banking institutions were to argue that banks and broker dealers need more than the Basel II 8% criteria to operate safely even more than $1.4 trillion of new capital will have to be injected in the banking system.Thus, even the release of TARP 2 (another $350 billion) and its use to recapitalize banks only would not be sufficient to restore the capital of banks and broker dealers to internationally accepted capital ratios. A TARP 3 and 4 of up to $1.05 trillion (assuming generously that all of TARP 2 goes to banks and broker dealers) may be needed to restore capital ratios to adequate levels.

Safe Haven | Geithner, China, and the Specter of Technical Insolvency

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Banks of America

2009-01-21T06:30:00.001-08:00

Investors who have been pining for a chance to buy into the beleaguered banking sector may have a bit longer to wait. Just this past Friday holders of Bank of America's (NYSE: BAC) stock were greeted with the reporting of the company's first quarterly loss ($1.79 billion) since 1991. To make matters worse, the company cut its quarterly dividend from $.32 to $.01. The loss prompted a new rescue package totaling $138 billion, which comes on the heels of the recent round of government injected capital of $25 billion last year.

That level of distress has forced the shares of the largest U.S. bank by assets down 74% in the last 6 months. But it's not just BofA that has been suffering lately; the Financial Select Sector SPDR (NYSE: XLF) has nearly 2/3 of its value in that same time period.

So why have financials suffered so much in the past year and is now a good time to jump in? After all, with losses like those it's hard to imagine how the sector wouldn't offer a good opportunity, even if just from a contrarian's perspective. But there are three factors that belie the inclination to pony up new cash at this time.

First, investors must understand that Citigroup (NYSE: C), Wells Fargo (NYSE: WFC), et al could all be named "Bank of America," as they have become de facto wards of the state. Government investment in the financial sector goes hand in hand with government control. That means lending practices, dividend payouts and compensation packages will now be highly influenced by the government. Unless you view the post office or DMV as models of efficiency, this wouldn't seem the best path back to corporate health.

Second, since there appears to be no imminent end to their write downs, many of these banks will likely need to raise yet more capital from the government in the future. More capital injections mean more dilution to the existing shareholders.

And finally, investors must realize that before these financial companies can begin to return profits to their investors, the government must get paid back first.

It is not until the housing market bottoms and the unemployment rate plateaus that the economy can begin to stabilize. That would help place a floor under banks' assets and put an end to their seemingly endless parade of write downs. Only then can investors accurately access the value of banking shares. Until then it is advisable to avoid trying to catch the proverbial falling dagger.

Safe Haven | Banks of America

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Something’s Happening Here (With The Price of Oil)

2009-01-21T06:20:00.001-08:00

As you read this, huge supertankers filled with oil are moored off the coast of Scotland and the Gulf of Mexico. The question is why... and what it could mean for oil-related profit opportunities in 2009.

Something’s Happening Here...

Something very strange is going on with the price of oil. Not just in terms of straight-up price, but in regard to the huge discrepancy between the near-month and far-month futures contracts.
As I write, the going price for near-month West Texas Intermediate crude is $36.51 per barrel. The December 2009 contract, on the other hand, is trading at $55.13.

That is a monster spread. We’re talking a difference of more than $18 a barrel between spot crude – the stuff you can buy in the cash market – and crude slated for delivery at the end of this year.

The technical name for this situation is contango. That’s what they call it when a forward-month commodity contract is trading at a higher price than the near month. (You don’t really need to know this right now, but the opposite of contango, when near-term prices are higher than the back months, is backwardation.)

The reason this is strange is because of the massive profit opportunity embedded in the crude market.

Assuming you had the means, you could go out right now and sell millions of dollars worth of December crude contracts at $55 dollars a barrel... buy the equivalent amount in the cash market for $37 a barrel or less... and then just wait until it’s time to deliver the oil (and lock in your $18 profit).

The only hitch in the deal is finding a place to store the stuff. If you were to buy crude on the cheap now, you would have to take delivery and store it until late November (or whatever month your delivery date rolls in, when you close the trade and take your locked-in profit).
.........................

Today's Taipan Daily

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Bank Functionally Bankrupt

2009-01-21T05:56:00.001-08:00

The banks, that is.

XLF (the financial sector spyder) yesterday, down 16.5%. That's impressive, but what's even more impressive is the loss in some of the components, to wit:

BAC, down 28.9%
Citigroup, down 20%
Goldman Sachs, down 18.9%
JP Morgan, down 20.7%
Morgan Stanley, down 15.9%
State Street, down 59% (!)
Wells Fargo, down 23.8%

Those are one day losses folks. In one day anywhere from twenty percent to more than half of these firms was wiped out. If you hold their stock, I hope you're prepared for what you see when you look online at your account.

Why did this happen?

Quite simply the market calls all bets.

Paulson, just last week, gave an interview in which he defended the TARP and said that they had "stabilized the financial system."

The market said in response:

Let me make this very clear - the market is saying very loudly that the common stocks of these firms are going to zero. They are all functionally bankrupt, right here, right now, with their current capital structure, and have been for months.

That's the market's pronouncement as of yesterday - and as you can probably surmise I agree with it, given that I've been calling for cramdowns of the debt structure in these firms as the proper means to resolve the excessive bad debt problem for more than a year. Such a move would inherently destroy all value in the common and preferred stock (at the same time it resolves the firm's - and the nation's - bad debt.)

The Market Ticker

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The Muddle Through Middle

2009-01-17T19:00:00.001-08:00

Now, we come to the third scenario and -- no surprise to long-time readers -- the one I think is most likely. I think that after we climb out of recession, we Muddle Through for an extended period of time. Follow my reasoning, and remember that I am often wrong but seldom in doubt! And please allow me some room to speculate. I can guarantee that I have some (or most) of the particulars wrong. But I think I have the general direction we are heading in.

We are in a serious recession. We have to allow time for both the housing market and the credit markets to heal. This will take at least two years. I think we have permanently seared the psyche of the American consumer. Consumer spending is likely to drop at least 6-7% over the next two years, and maybe more. The combination of all three bubbles (consumer spending, credit, and housing), which were made possible by increasing leverage and poor lending standards, is by definition deflationary. (I know, I keep repeating, but most readers do not really get the rather disturbing implications.)

The US government in general and the Fed in particular will react to the problem. Most of the government stimulus, other than that used to reliquefy the banking system, build useful infrastructure, and encourage small business to expand, will be wasted or have little short-term effect. The Fed (and central banks around the world), on the other hand, do have the potential to succeed with a "shock and awe" type of stimulus program.

Pension plans, endowments, insurance companies, and individual investors who are counting on 8% long-term compound returns from their stock portfolios are as likely to be disappointed in the next five years as they were in the last ten. The environment I am describing is one of compressing price to earnings ratios, much like the period from 1974 to 1982.

This environment is going to force the creation of new investment programs and products based on income generation. And that is one of the forces that will bring about a real recovery in the middle of the next decade. Investment capital will be made available to businesses that can generate low double-digit or high single-digit returns, as well as new technologies with the promise to deliver new paths to profits.

The second major force will be the arrival of new waves of technological change. We will see a biotech revolution beyond our current comprehension. It has the real potential for solving a great deal of the Medicare entitlement program problems. For instance, it is likely we will have a real cure for Alzheimer's within five years. Since that is as much as 7% of US medical costs, that can create a real cost reduction. The same for heart disease, obesity, cancer, and a host of other medical conditions that will start to be dealt with by a new generation of therapies. That is going to create a new, very real bull market in biotech.

I expect to see a new generation of wireless broadband that powers whole new industries. And it will not just be green tech, but entirely new forms of energy generation that drive the cost of energy down and, combined with other new technologies, make electric cars practical. And along about the end of the decade, the nanotech world begins to really get into gear.

And just as the tightly wound, low P/E ratios of the early '80s gave way to a spring-loaded major bull market as new technologies became the driver for a whole new set of public companies, we could (and should!) see a repeat of that performance. There is a new bull market in our future.

The problem is getting from where we are today to that next dawn. The definition of insanity is to keep repeating what you have done in the past and expect a different result. We are in a long-term secular bear market. P/E ratios are going to decline over time to low double digits. Hoping that stocks somehow rebound to new highs and that the economy is going to go back to what we saw in 1982-1999 or 2003-2006 is not a strategy. You need to be proactive and take charge of your portfolio, looking for absolute-return types of investments for the next 4-5 years. Simply using a traditional 60-40 split of stocks and bonds is not going to get you to retirement nirvana. It will lead to retirement hell.

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Is America Broke Part II -- The Debt God

2009-01-06T04:20:00.001-08:00

* Federal Reserve Notes circulate as the currency
* The currency is secured by Treasury Bonds
* Fractional Reserves are money required to be held by the bank
* The reserve requirements go from zero, to 3%, to 10% * Federal Reserve notes (cash) are the main reserve deposit
* The U.S. Treasury has an account at the Fed
* The Fed holds U.S. government securities in its accounts
* The Fed conducts open market operation by buying or selling Treasury securities Where the Money Comes FromTrillions of dollars are on deposit around the world. I remember as a kid that a million dollars was a big deal. Today, billions of dollars are tossed around without the blink of any eye. Trillions are now the topic de jour.

Where does all this money come from?

There are a couple of parts to the answer.The process begins with the Treasury Department creating a bond, which is now done electronically. Treasury bonds are debt obligations of the Federal government to repay a loan, which includes both the principle amount of the loan and the interest on the loan.

The Treasury sells bonds to the public and other buyers - Japan and China being the largest players, accounting for over 40% of our debt issue. The bonds not purchased by these buyers are deposited by the Treasury with the Federal Reserve. When the Fed accepts the bonds from the Treasury, it lists the bonds on its books as an asset.

The Fed assumes the government will make good on its promise to pay back the loan. This is based on the belief that the government's power to tax the people is sufficient collateral.Because the Fed now has an assetthat it didn't have before receiving the Treasury bond, the Fed can create a liability that is offset by its new asset. The liability that the Fed creates is a Federal Reserve check. It gives the Treasury the check in payment or in exchange for the Treasury Bonds.

The Fed loans the government money by purchasing Treasury Bonds.However, where did the Fed get the money to have deposited on account to cover this check, especially if one goes back to the beginning of the Federal Reserve and the creation of the first Federal Reserve Notes?Also, recall that Federal Reserve Notes are secured by Treasury Bonds - bonds that the Fed buys with the same Federal Reserve Notes the bonds secure. It sounds a bit circuitous to say the least.

The money was created by the very act of the Fed offering the Treasury a loan, and the Treasury accepting the loan. The Federal Reserve's check is endorsed by the Treasury and is deposited in one of the government's accounts. The government can then use the deposits to write checks against, to pay for government expenses.

Safe Haven | Is America Broke Part II -- The Debt God

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Debt Deflation Bear Market Update Part I: 2009 Windup - Eric Janszen - iTulip.com

2009-01-04T02:55:00.001-08:00

Will these market and economic anomalies diminish, the markets recover, and the economy return to normal within the timescale of the 50 or 60 year old buy-and-hold stock investor? Perhaps, but more likely a transformation of the entire structure of the global markets and economy is starting that will take decades to resolve.In my view, these historic events will next year be complicated by political responses to high unemployment globally, and it is reasonable to expect that some of these responses will not be entirely constructive.

The stock market buy-and-hold era ended in 1998. In a world where the so-called business cycle is dominated by bubbles, inflation, crashes, deflation, recession, and reflations and all manner of government interference, stock market timing, and sector analysis, will continue to be the key to making money. In fact, across the broad stroke of American history, there is never a period when markets are not either largely or entirely influenced by the actions of government. For hundreds of years the US has either been at war, recovering from war, growing asset bubbles, crashing asset bubbles, recovering from asset bubbles, or mucking around with the monetary system–entering the gold standard, leaving the gold standard, entering into a new global monetary regime, leaving that regime– endlessly. How can markets possibly be efficient if they are perpetually driven by large-scale events produced by government policies? The idea is profoundly naive.

Debt Deflation Bear Market Update Part I: 2009 Windup - Eric Janszen - iTulip.com

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Debt Deflation Bear Market Update Part I: 2009 Windup - Eric Janszen - iTulip.com

2009-01-04T02:30:00.001-08:00

That forecast back in 2001 was complicated by the housing bubble, the most idiotic and irresponsible act of government economic manipulation in world history and completely beyond me to predict. Not even in my darkest dreams did I think our Federal Reserve and banking regulators could be so stupid: bursting real estate bubbles bring down banking systems and economies. They did in the US in the 1870s and 1930s, in Japan since the 1990s, and many other nations as well. The US 2002 to 2006 housing bubble extended the tax cut, rate cut, dollar devaluation reflation boom by two of years longer than the 1930s version sans housing bubble. As you can see, that extension made the collapse we are seeing today considerably more severe.

Now we have a post bubble reflation boom crashing around the fake boom created by the technology stock bubble- two crashes nested one within the other– thus the terrific cascading financial and economic collapse we see today.We wrote dozens of occasionally over-the-top, but always factual and data driven, warnings on iTulip.com since March 2006 to try to scare readers out of the stock market. As it turns out, we were able to determine and notify subscribers on Dec. 27, 2007 when the DJIA was trading at 13,365 that, if they were for some crazy reason still in the market, that was it: the last chance to get out.

Debt Deflation Bear Market Update Part I: 2009 Windup - Eric Janszen - iTulip.com

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Past Financial Crises

2009-01-03T03:49:00.001-08:00

Broadly speaking, financial crises are protracted affairs. More often than not, the aftermath of severe financial crises share three characteristics. First, asset market collapses are deep and prolonged. Real housing price declines average 35 percent stretched out over six years, while equity price collapses average 55 percent over a downturn of about three and a half years. Second, the aftermath of banking crises is associated with profound declines in output and employment. The unemployment rate rises an average of 7 percentage points over the down phase of the cycle, which lasts on average over four years. Output falls (from peak to trough) an average of over 9 percent, although the duration of the downturn, averaging roughly two years, is considerably shorter than for unemployment. Third, the real value of government debt tends to explode, rising an average of 86 percent in the major post-World War II episodes.

Thoughts from the Frontline

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JimRogers

2009-01-02T18:07:00.001-08:00

Embedded Video

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The 10 Laws of Lifetime Growth

2008-12-31T00:50:00.001-08:00

THE LAWSof Lifetime Growth:

LAW ONE: Always make your future bigger than your past. Find out more

LAW TWO: Always make your learning greater than your experience. Find out more

LAW THREE: Always make your contribution bigger than your reward. Find out more

LAW FOUR: Always make your performance greater than your applause. Find out more

LAW FIVE: Always make your gratitude greater than your success. Find out more

LAW SIX: Always make your enjoyment greater than your effort. Find out more

LAW SEVEN: Always make your cooperation greater than your status. Find out more

LAW EIGHT: Always make your confidence greater than your comfort. Find out more

LAW NINE: Always make your purpose greater than your money. Find out more

LAW TEN: Always make your questions bigger than your answers. Find out more

The 10 Laws of Lifetime Growth

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"Official" US Unemployment Rate circled in red below

2008-12-23T06:08:00.001-08:00

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Oil

2008-12-13T18:16:00.001-08:00

Russia will need $70 oil. These countries are going to need to produce and sell what they can, which is in conflict with the need to control production and move prices higher.So far, the OPEC nations are not cutting back any significant amount of production compared with the destruction in demand. Oil is backing up in the system. Energy economist Philip Verleger suggests that OPEC should execute an "astounding 7.7 million barrels per day" just to restore market balance today. Global demand is down by over 5 million barrels a day to 81.6 million barrels a day. Non-OPEC countries produce almost 50 million barrels of oil. OPEC produces roughly 31 million, plus there are some other OPEC sources of about 5 million barrels equivalent in natural gas liquids. Thus, Verleger says OPEC oil production needs to drop by almost 25%, to somewhere under 24 million barrels a day. Think Iran or Venezuela will cut that much, given their need for cash to fund their regimes? Will Russia join OPEC and cut production? It will be interesting to watch Iran and Venezuela in the coming year scramble to maintain power.

Thoughts from the Frontline

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Value ?

2008-12-12T19:34:00.001-08:00

One year ago Royal Bank of Scotland (RBS) paid $100bn for ABN Amro. For this amount it could now buy:- Citibank $22.5bn- Morgan Stanley $10.5bn- Goldman Sachs $21bn- Merrill Lynch $12.3bn- Deutsche Bank $13bn- Barclays $12.7bnAnd still have $8bn change which would allow you to pick up:- GM- Ford- Chrysler and- The Honda F1 Team

Michael Covel: Trend Following

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2008-12-10T05:35:00.001-08:00

Stock Cycles

2008-11-21T18:28:00.001-08:00

So here we are in the 700's in the S&P500 in fall 2008, when according to the four year cycle we should be seeing bull market highs. Timing-wise the bottom of this ordinary bear market should be two years away. Based on the 752 close on 20 November 2008 (see blue cross in figure) we are essentially already at the bottom. Based on the latter assessment, I pulled the trigger and deployed most of my cash into the S&P500 on 20 November 2008. Only time will tell whether this was a wise move.

Safe Haven | Stock Cycles

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Buy When There is Blood in the Streets!

2008-11-16T18:25:00.001-08:00

If we continue to follow the earlier decade's road map we should see a feeble recovery in 2009 followed by another collapse in 2010. Another feeble rise could get underway in 2011 and then we plunge to our final lows in 2012. The scary alternative is that a feeble recovery into 2009 is followed by a further collapse to new lows and while we follow the road map the final lows of 2012 are made some 40 to 50 per cent below today's lows. We certainly hope not but it is possible if things do not go well in attempting to restructure the world. But right now the scenario still calls for a rebound into 2009.

Safe Haven | Buy When There is Blood in the Streets!

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US Accoubt Balance

2008-11-08T20:50:00.001-08:00

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A November Low Forming?

2008-11-08T20:47:00.001-08:00

The US Dollar acting like 1991The US Dollar has rallied sharply much like it did in 1991 and there were banking and real estate problems back then too during the Savings and Loan crisis but that rally failed and the USD made new lows the following year, and I expect a similar outcome once the Dollar turns down soon.

Safe Haven | A November Low Forming?

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Will Fortune Favour The Brave In This Climate?

2008-11-07T17:31:00.001-08:00

Mr George: Gold is at US$730 per ounce today. My expectation is that the price will be three times higher - that is, between US$2,000 and US$2,500 per ounce - in 2010 to 2012. The reason is simply that the amount of paper money created in order to stave off the crisis and reflate the banking system will take about 18 months to feed through into inflation, and that the value of the US$ will again fall sharply as a result. In addition, low or even zero interest rates will favour gold and other commodities. I also expect oil to rebound from the current low levels to at least US$200 within 2-3 years.

Safe Haven | Will Fortune Favour The Brave In This Climate?

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Turning

2008-11-05T05:04:00.001-08:00

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As Yen Soars, Currency ETFs Ride Wave - News In Focus

2008-11-02T00:58:00.001-07:00

With the yen reaching new highs against the dollar, exchange-traded products tracking the currency's rise are prospering.In fact, the three portfolios' performance has beaten almost every other ETF tracked so far this year heading into Friday. The only exceptions have been leveraged and inverse funds.One of the outperformers is actually an exchange-traded note, the iPath JPY/USD Exchange Rate ETN (NYSE: JYN). The other two are the Rydex Currency Shares Japanese Yen Trust (NYSE: FXY) and the WisdomTree Dreyfus Japanese Yen Fund (NYSE: JYF).

As Yen Soars, Currency ETFs Ride Wave - News In Focus

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S&P Index

2008-10-26T19:08:00.001-07:00

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Stock Picks

2008-10-17T18:40:00.001-07:00

You know my game plan, which is to buy egregious amounts of The Mosaic Company (MOS: 33.66 +1.51%) , National-Oilwell Varco, Inc. (NOV: 25.58 +8.71%) , (TBT: 63.617 +1.14%) and (UYG: 10.33 +1.18%) , while holding ample supplies of cash.

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10 Bullish Charts, Signals, Indicators

2008-10-10T19:57:00.001-07:00

Earlier this week, we discussed several anecdotal pieces of evidence that suggested we were closer to the bottom then the top.Today, we look at specific data and charts that can provide some insight as to how extreme these present levels are. All these suggest to us that we are increasingly close to a bottom that can be purchased for an upside trade of 20-30% from these levels.NOTE: We scale in over time, in 10% increments, and recognize that the bottoming process can take several months to several quarters to complete. Hence, slowly buying in is the key.

The Big Picture | 10 Bullish Charts, Signals, Indicators

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Global Stock Markets Index

2008-10-10T19:26:00.001-07:00

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AUDSGD 10 Years Chart

2008-10-08T07:17:00.001-07:00

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Trading VIX Options

10 Rules Of Investment Classic

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Red Flags Commonly Used to Insinuate Fraud

Value And Bubble Charts

David Druz 10 Years Trading Returns

S&P Composite Trend

The Problem Of Credit Expansion

Will it repeat again ?

Super Cycle

Cloud Stocks

Why Quantitative Easing is Likely to Trigger a Collapse of the U.S. Dollar

Bernanke Leaps into a Liquidity Trap

Velocity

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Toy Blocks

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QE2

Setiment Cycle

Definition of Deflation, Inflation and Hyperinflation

Gross Debt in G7 Ecomomies

Practice Deep Learning to Master Trading Skills

Secular US Market Cycle

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Count Test

Last Bull Standing 2011

13 Risk Perception Factors

The Frog in the Frying Pan

Exchange Traded Notes - An Alternative To ETFs

Investing in the Sugar Shortage

Is Time To Accumulate Sugar

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Venture Dudes

Video Blogs I watch

Trading Secrets

US Bear Market Bottoms

Bull Market Top 15 Leading Indicators

The S-Chips Are Cheap

Tangible Common Equity for Beginners

Japan is a rapidly aging nation !

Potential Shortage of capital to Fund Treasuries

Dennis Gartman Trading Rules

Currency ETF List- A detailed list of currency ETFs

How to Capitalize on the Coffee Guys’ Mistakes

Jeremy Grantham Says Stocks Going To Moon

Beat The Market

Ten Principles for a Black Swan-Proof World

Guru Investor Strategies

Gauging the Turn in Dollar, Gold and Oil

S&P 1871 to Present

Reflation Investing - Which Currencies Benefit?

2 Months Rallies

PE vs Returns ( 100 Years )

Bear Market Recoveries Since 1950

Unemployment-SP-Composite-since-1948

Bear-markets-comparison

The Final Currency To Top Out

Chris Martenson | chapters - The Crash Course

Warren Buffett Interpreation Of Financial Statement.

Gold up trend likely for next few months.

China Investment Watch List

The Oldest, Most Trusted Technician in the World Is Telling You to Sell Now

ProShares Ultra-Short 20+ Treasury Fund (TBT)

Geithner, China, and the Specter of Technical Insolvency