Juggling Dynamite

Gold extending its longest slump in four years as hedge-fund managers made the biggest ever bet against the precious metal and investor assets declined. Here is a direct link.

An article in the Globe and Mail on Thurs underlines a key point perpetually overlooked in financial commentary. The Canadian Pension Plan Investment Board (CPPIB) announced that it was able to make a 10% return in 2012 (gross before all management fees and expenses) thanks to the late year rebound in foreign stock and bond holdings. See: CPP fund returns top 10 percent

“The chief actuary of Canada has affirmed that the CPPIB is sustainable over the next 75 years if it earns an average of 4 per cent real annual returns after inflation. CPPIB said Thursday its 10-year real rate of return after inflation is 5.5 per cent, while it’s five-year rate of return is just 2.4 per cent, due mostly to large losses in fiscal 2009 when financial markets collapsed and CPPIB posted a 19-per-cent loss for the year [my bold added].”

A couple of crucial points here. First of all as a continually funded plan on a monthly basis from all Canadian workers, the CPPIB can afford to assume a multi-decade long investment horizon–and it does. CEO Wiseman said CPPIB plans to become a public advocate for long-term investing around the globe, saying funds like CPPIB have a “natural multi-generational nature”. And they do. Individuals however do not; and this is the meat of the challenge facing real life investors who must be concerned with 5, 10, 15 and 20 year time frames from today.

Secular bear periods like the one stocks have been working through since 2000 start from periods of extreme over-valutaion. Over 17 to 20 years they move through a series of heart-thumping gyrations of up and then down cycles, up and then down cycles–moving between prior cycle highs and prior cycle lows. In the end through the healing of time, these cycles finally compress excessively high valuations back down to once-in-20-year investment opportunities by the secular bear end.

Today, just over 5 years since the last uber-optimistic peak in 2007, we find stock valuations once more at extreme over-valuations for the 3rd time in the past 15 years. In the wake of financially suicidal central bank intervention, this up-cycle has no doubt been extended (just as sub-prime securitization extended the 2003-2007 up cycle to an equally incredible peak and unforgiving crash). But history promises anyone who will heed it that the most probable path ahead is a trip back to retest prior cycles lows (to wit 2003 and 2009) at least one more time ahead in the not too distant future.

And here is the rub: it is the down cycles that dictate the reward or lack there of for the entire round trip. An investor (or a fund like the CPP) can make double digit returns every year for 4 and 5 years, and then lose all or nearly all of the benefit of those gains in just the one or two down-years that comes in each market cycle. After huge stock returns in the later 90′s, the 2001-2002 bear market took back all of the gains earned by stocks above T-bills since 1996. After huge gains again in 2003, 2004, 2005, 2006, 2007, the bear market of 2008-09 took back all of the cycle gains made over the preceding 12 years, all the way back to 1995!

In other words, one could have missed out on 15 years of stock investing from 1996 all the way through early 2009 and made more net gains sitting in cash equivalents than riding the secular roller coaster of risk. For individuals this reality is even more acute than for pensions. Because individuals are highly vulnerable to the market cycles that impact our life savings over 5 to 20 years. We do not have endless cycles to make up for lost gains and we rarely possess the emotional stamina to sit patiently through horrific down cycles without jumping out near bottoms and doing permanent harm. This means that in real life, people fare far worse than market returns suggest.

As boring as it may sound, the truth about real life investing is that 2.4% a year earned over 5 years on a wild stock market ride that looks like the below chart, is much less valuable–much more full of personal risk– than 2.4% a year earned slowly but gradually in cash like deposits.

For those who are taking a victory lap today because they have just recently managed to make back some of their losses for the third time in the past 15 years–the truth is that they have not done well. Nor have they been adequately rewarded for incredible capital and personal risks taken. In secular bears, egos and intellect aside, less risk ends up being more–more money and more peace of mind.

Danielle was a guest today with Phil Mackesy of Talk Digital Network, discussing recent trends in the world economy and markets. You can listen to an audio clip of the segment here.

“The expense of art has gotten crazy,” said Michael Novogratz, Fortress principal & director, explaining how to spot a bubble in the market. Here is a direct link. As Novogratz explains the obvious Central Bank built bubble in the art market today, realize these comments are equally applicable to stocks at present levels, for all of the same reasons. Although CNBC and the financial-tainment world are much less tolerant of anyone uttering such warnings about their bread and butter: stock speculation.

As stocks strive to whistle past the grave yard yet another day, the US dollar and US bonds continue to attract liquidity focused, relative “safe haven” capital flows. Precious metals are not. Touching 83.90 today, the US dollar Index is now at the highest level since 2010 just before the Fed’s anxious QE experiments knocked the greenback lower. With the Euro, Yen and Canadian dollar all falling(Canadian manufacturing sales for March disappointing this morning, down for 3 of the past 4 months), no economies are looking immune from the global recession.

Peter Bofinger, economist from the German Council of Economic Experts, tells CNBC that he is concerned that the worst of the euro zone crisis is not over and it is spreading to the core. Here is direct link.

Seems like hardly a week goes by now, without at least one international think tank or commentator talking about lofty-looking Canadian realty prices and the over-exposure of Canadian banks and taxpayers via the CMHC underwriting of high leverage loans.  Stats on Canadian mortgage mania the past few years, are leading some to acknowledge that “maybe Canadian banks are not quite so conservative as conventional wisdom has it”. See: Is the Canadian housing market falling apart?

Not surprising really. As shown in the beside chart, price increases over the past decade have been truly epic in Canada. Experience in other countries reminds of the negative effects now likely on the great white north’s economy and other asset markets:

 

“While a falling housing market and subsequent wave of defaults would surely hit the income statements of Canadian banks, they may not have the same level of mortgage exposure as U.S. banks did because the government backstops so many of the mortgages. What’s more, Canada’s banking sector is so concentrated that the country would almost surely rescue any bank that did run into trouble because of mortgages.

No doubt there are hedge fund managers quietly scheming to short the housing bubble. There are Canadian REITs, for example, that would suffer in a hard landing for housing. Home builders, too. The broader Canadian stock market might suffer if home owners lose much of their wealth and find they need to sell equities to make up for the losses. The Royal Bank of Canada has a lot of uninsured mortgage exposure in the provinces that contain Vancouver and Toronto…”

“The bubble seems fairly obvious, even if it’s existence is still disputed within Canada. Canadian home prices are up nearly 100 percent since 2000. The price-to-rent ratios in major urban population centers are through the roof. In British Columbia, home prices rose 163 percent in the decade from 2001 to 2011, according to a study by the International Monetary Fund…

what we’re learning is that Canada didn’t avoid a housing bubble and financial crisis—it’s just that the Canadian crash is “on tape delay.”

Gross: Never have investors reached so high in price for so low a return. Never have investors stooped so low for so much risk.

— PIMCO (@PIMCO) May 14, 2013

As stocks move through their now typical Groovy Tuesday ramp I think it is helpful to look at reality-based things that actually strengthen the real world, like education.

Public television and TED, the non-profit organization devoted to Ideas Worth Spreading, share a deep commitment to addressing the high school dropout crisis. The TED Talks Education one-hour program brings together a diverse group of teachers and education advocates delivering short, high-impact talks on the theme of teaching and learning. These original TED Talks are given by thought leaders including Geoffrey Canada, Bill Gates, Rita F. Pierson, Dr. Angela Lee Duckworth and Sir Ken Robinson.

Here is a direct link.

Watch TED Talks Education on PBS. See more from TED Talks Education.

After nearly 5 months of tweeting from the international space station, Canadian astronaut, commander and musician, Chris Hadfield truly developed a rock star like following for himself and the space program. His remarkable eighty-one videos attracted 22 million views for the Canadian Space Agency whose website traffic is up 70 per cent over the past 12 months. See more on their accomplishments here. As a parting piece, Hadfield recorded this revised version of David Bowie’s Space Oddity on board the Space Station.  Here is a direct link.

And with Elon Musk’s vision and perseverance in developing reusable rockets to radically reduce the cost of space travel through Spacex,(to the anger and chagrin of all the nay-sayers of course) the universe is coming that much closer.

The Economist reports on recent trends and innovations in the area of energy innovation. Yes we can. Here is a direct audio link.

Believe it or not carbon-dioxide levels are rising. The U.N. has stated the world has entered a new danger zone on carbon dioxide as global concentration passes 400 ppm. Here is a direct link.

The Tesla Model S electric car is the best performing car ever tested by Consumer Reports. I have sat in this car and I have to say it is stunning in every way. Its so exciting to see what can be accomplished once people stop insisting it can’t be done and get on with intelligent innovation. Here is a direct link.

“College costs have been rising nearly 5% a year for the past 10 years—more than double the rate of inflation. The annual cost for a four-year public college or university is now almost $9,000 a year for in-state residents and $22,000 for out-of-state residents, according to the College Board. Private colleges charge two or three times as much.

All these schools face rising costs for health insurance, technology, faculty and infrastructure but public institutions also suffer from a decline in state and local government financing.

Still, that doesn’t seem to have hurt the paychecks of the presidents of public universities. Their median pay packages jumped 5% to $441,392 for the 2011-2012 fiscal year, and a growing number of those presidents took in more than $1 million, according to an analysis by the Chronicle of Higher Education.”

See video discussion here: Presidents at Universities make millions as tuitions soar

A major impediment in America’s return to prosperity lies in its publicly-funded system that loans to wealthy, non-productive bankers at .75% and individuals trying to acquire necessary training and education at 6.8%! In addition, banks and other corporations bask in the limited liability of their corporate structure. Where needed they can declare bankruptcy and walk away from liabilities and excessive debt. Student debtors are afforded no such relief. The jobless recovery since the great recession has sent millions of unemployed workers scampering to retrain. But even where hopefuls are unable to find work after graduating, education loans cannot be discharged in bankruptcy.

While median household income is just 8% higher on an inflation adjusted basis over the past 33 years (50K vs 46K in 1980) tuition costs over the same period have increased more than 100%.

Student debt for graduating seniors now exceeds $26,000 per person and up more than 40% in the past 7 years. At the end of 2012, more than 30% of student borrowers were at least 90 days behind on their payments. As we have been reminded in other areas over the past 6 years, loans that cannot be repaid simply won’t. But banks have once more made incredible short-term profits securitizing buckets of the bad paper and selling them off to pensions and other desperate souls gasping for income.

Meanwhile the overall economy continues to suffer from a mounting pool of people who simply cannot get an economic foothold. The debt load on young people is constraining their ability to form households, start families and buy homes. The status quo keeps trying to extract profits from a human herd that is now increasingly milked dry. More than enough debts have been amassed bailing out the banking system. Time to direct stimulus efforts to an affordable public education system along with debt and rate relief for students. Time to invest in the future through the workforce. See: Student debt and the crushing of the American dream

“A CERTAIN drama has become familiar in the United States (and some other advanced industrialized countries): Bankers encourage people to borrow beyond their means, preying especially on those who are financially unsophisticated. They use their political influence to get favorable treatment of one form or another. Debts mount. Journalists record the human toll. Then comes bewilderment: How could we let this happen again? Officials promise to fix things. Something is done about the most egregious abuses. People move on, reassured that the crisis has abated, but suspecting that it will recur soon.

The crisis that is about to break out involves student debt and how we finance higher education. Like the housing crisis that preceded it, this crisis is intimately connected to America’s soaring inequality, and how, as Americans on the bottom rungs of the ladder strive to climb up, they are inevitably pulled down — some to a point even lower than where they began.

This new crisis is emerging even before the last one has been resolved, and the two are becoming intertwined.”

“Steve Eisman, the hedge fund manager who famously bet against mortgages in the United States in the run up to the 2008 financial crash, has recommended investors now bet against Canada’s mortgage lenders and banks.

Eisman, founder and portfolio manager of hedge fund Emrys Partners, rose to prominence with subprime mortgage bets that were chronicled by Michael Lewis in the book “Big Short”…

Fears remain that Canadians aren’t listening as the ratio of credit market debt (such as mortgages) to disposable income continues to rise, according to Statistics Canada, reaching 165.0 percent in the last quarter, compared with 164.7 percent in the previous.” See: Canada’s housing market: the next big short?

Canadian home prices have doubled over the past 10 years (7% price appreciation per year), a rate of growth some 40% above the 5% a year long term average since 1980: “Canada is a commodity producer, and commodities have done very well in the past decade, so, in part, strong price gains in Canadian real estate might be a side effect” says Stein. A side effect that is due for a correction with the on-going global downturn in global commodity demand.