Sunday, March 30, 2008

Fear or Greed (today)?

This is a very non-analytical discussion of how I have been feeling about the markets. Sometimes I sit down and do research. You know, go and get actual numbers from reliable sources and analyze what they say. Other times I just think about the general news and events and work to a conclusion based on the “how it feels” method. I have had some successes and failures using both methods. This piece is about the current state of my “how it feels” method. This can change with one news story because fear and greed are very powerful impulses.

Most professionals will tell you to pick good companies and invest for the long term. That’s probably great advice, but I don’t want to see my net worth collapse with the market, even if it is temporary. So I try to keep up with what’s going on in the markets and react accordingly. I find it exciting to watch the financial news each day as the stock market gyrates between hope (greed) and fear. Up 400 on the DOW one day, down 300 the next. Listening to the traders on money shows is interesting as they banter about their proposals for moneymaking trades. Take this position today, then get out and take that one next week. I wonder how many non-professional stock traders, common folk like me, actually trade like this? When watching CNBC one needs to remember whether one is a trader or an investor. Fast Money, Mad Money, buybuybuy – sellsellsell. “Start buying the financials because they haven’t been this cheep in decades”. I have been hearing that for months while they continue to decline. If I had a share of JPM for every time I heard that…. It seems no one wants to think about the lost revenue sources for the financials. All they talk about is write-downs – when will the write-downs be over. But when the write-downs are over, then what? How much of that precious fee income from the originate-and-distribute model will be coming back on line in the near future? How can they replace it with net interest income if they are short capital from the write-downs? What about fees from off-balance sheet commercial paper entities? What about the smaller regional banks that financed local real estate developers? Is now really the time to be buying financials with all of these unanswered questions? Not in my book, but I am a very nervous type of investor. I thought it was time to buy the financials in 2002 or thereabout when I purchased some JPM. I did pretty well with it and sold it in February 2007 because I got nervous. Sometimes it’s good to be nervous. I think there will be a time to get back in, especially JPM and perhaps BAC, but for me there are too many questions right now. In fact, there are so many questions that I went, and still am, short the financials in general. I may get burned, but I think it is a better play right now than going long financials. So far gains from this position have offset losses from long positions I have, so taking this position helps to hedge my little portfolio.

What is going on in the commodity markets? “The commodity play is real, it’s all caused by skyrocketing demand for global resources.” China, India, billions of new consumers. This skyrocketing demand suddenly happened over the past nine months? What about the past 5 years of global prosperity – wasn’t demand skyrocketing then? I don’t know, and I haven’t crunched the numbers, but if you step back and look at this objectively I think there is a lot of risk in those markets. Stocks down, treasuries and commodities up, and this is because of global demand? If that were the case then why are global stocks down and treasuries up at the same time? Wouldn’t global stock markets be up because of all of this global demand? Perhaps this is just the latest place for the “fast money” to park while the credit markets work out the current turmoil. Using the “how it feels” methodology I am afraid of commodities right now because it is possible that this is the next asset bubble to burst. That’s easy for me to say because I am not a big commodity investor anyway (in fact, I am not a big investor period). I’m sure there is some validity to the global demand story and, in fact, there have been articles in the press lately questioning whether a Malthusian catastrophe is in the works. So commodity prices should probably be on the rise, but the sudden skyrocketing of prices seems a bit overdone to this amateur, especially on the heels of what appears to be some serious economic weakness. Commodity prices are also being pressured by the falling dollar, but how much more does that have to go (better hope not much)? Of course, had I invested more in commodities I would have made more money, assuming I would know when to get out.

If you are living on a fixed income right now you are likely to be worried (unless of course it is a very large fixed income). Treasury and CD rates are very low and anything else in the credit markets is too scary right now, so how do you get income without risking your nest egg? This is one of the prices being paid for the orgy of debt we had over the past seven years. It seems counter intuitive at first that interest rates should be low (perhaps even negative in real terms) after we had a debt binge, but this is because the Federal Reserve has been flooding the markets with liquidity in the hopes of avoiding a major financial collapse while investors are bidding up the prices of treasury securities as they run for cover from riskier investments. So while it is not easy to get credit right now if you are looking to borrow, at the same time the typical safe investments for retirees and others on a fixed income are paying less and less interest. Perhaps some Fannie or Freddie securities or municipals make sense, although the tax advantage of municipals to investors on a fixed income may not be worth the low yields.

Oh yes, and there is inflation. I really don’t care what the CPI, PCE, PIG or SHI! say, filling up the car, the cupboard, and the heating oil tank have taken a much bigger bite out of my income on a percentage basis this year than any other in memory. That is inflation no matter what you call it. I was at the bagel store the other day and there was a sign up saying that due to the rise in the cost of flour bagel prices have been increased – a lot. The last time I started to see this kind of thing on a regular basis was back in the days of double-digit inflation. Not that we are having double-digit inflation now, but the memory is disturbing. Even if price increases slow down, they have already increased a lot.

So what do I do? I wish I had the “right” answer. I am still very nervous about where this whole credit crisis thing ends up. I did some reflecting and I decided that I needed to deal with the fear and greed issue. I thought about all of the credit market news and the financial bailouts, the falling real estate prices (sales were up some 2.7% in February – “maybe we are seeing a bottom!”), soft employment numbers (my most important indicator), and weak capital spending, and I decided that there is a lot of risk in all of the markets right now. Of course, when things are really bad is when you are supposed to have courage and get in, and countering all of the bad news is the totality of all of the Federal Reserve and federal government actions being taken to avoid a financial disaster. But when was the last time I though there was a real possibility of a financial disaster???? That’s enough for me – fear it is, today. The gains I may give up by sitting this one out are easily outweighed by the potential losses. So I have hedged my portfolio by reducing exposure to equities and going short on some general and selective indexes so that when the market goes up I don’t, but when the market goes down I don’t. I may also do a little gorilla trading here and there to try to juice returns as I can. The rest has been reallocated to those lousy-return safe investments like treasuries and FDIC insured CDs for now. As they mature I will be on the prowl for better returns, but with caution. Perhaps some high dividend yield stocks hedged with shorts on a lower yielding equity index. If I miss a big upswing in the stock market I will be less well off than had I been more aggressive and motivated by greed. If I miss a big drop I’ll feel really smart and then start buying. In the meantime I will keep watching all of those economic indicators, including the general tone and gyrations of the CNBC talking heads, as my “how it feels” indicator evolves.

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Dan said...

"If you are living on a fixed income right now you are likely to be worried (unless of course it is a very large fixed income). Treasury and CD rates are very low and anything else in the credit markets is too scary right now, so how do you get income without risking your nest egg?"

That’s a good question, and it seems everyone has an answer or at lest an opinion. My problem is that I don’t have a nest egg, It all went into my first nest that I bought more then a year and a half ago, which in hind sight was a bad idea but who was to know the bottom was going to fall out of the real-estate market? (Well the players who where inflating it at the same time they where shorting it, but I digress…)

And this is where the inflation murkiness gets me, so the effects of inflation can be felt in real time, but if my fixed income is biased on the numbers that say nothings amiss, in the next few years I'll start to see a decrease in my real income and that does not bode well for creating a nest egg for the next time its ripe for investing since it seems I'll be missing the current one regardless.

What was that Obama was saying that the the unequal distribution of excess is "no accident."?

Palermo's Blog said...

Dan - I had a few friends who bought just before the downturn in 1990, and they were under water on their homes for a few years. But the market came back and today the homes are worth much more than they cost even after the current downturn.

Inflation is a problem, and I'm feeling it too. It's one reason I think the downturn will be worse than predicted by those calling for a short slowdown and recovery this year.

Dan said...

From what I had been hearing up until a month or so ago was that many hoped that consumer spending would tem the tide and soften the fall. But now even those numbers aren't looking to good, it would seem that the feeling of inflation and the droop in their home values are making people finally taking note of how much debt they really have and are starting to pull back. It sounds like any recovery is going to be sluggish if for no other reason then ordinary people acting more rationale then normal.

But at least some of us will be getting stimulus checks from China, but I think I'll just put it under the mature for when the Chinese decided to call the debt in.

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