sorry we have been “off air”

still working out web problems

in any event, fed action yesterday, today’s numbers, yen at 15 year high

all bad news

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putting out the peach baskets in the front yard

to collect all the money falling from our new business

the long await website is LIVE

http://www.keliherconsulting.com/

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July 4, 2010 letter installment 3

II. The Present

II. The Present
July 4, 2010
The markets
A second top was put in the last few months just over 11,000. 
It is more likely than not that the March 2009 low of 6,500 will be broken in the next couple of years (keep in mind I said 60-90 days in 2006 and it did not happen for 2 years).
The economy
The credit markets are not working.
The only reason any of the major banks are considered solvent is because they are no longer required to account for the losses on the book value of assets. 
There will be massive bank failures in the next twelve months.
The gimmicks that have supported both residential and commercial real estate have about run their course and another significant leg down is underway.
Deflation will be taking hold as time wipes out the last resources of the unemployed (this figure is closer to 20% than it is to under 10%)
There is no aggregate backlog of demand for goods or services.  The demand backlog is largely from those who are incapable of buying and without prospects of being able to buy in the future.
Government spending and job creation will keep the economy alive just as it did in the 1930s.  There is way too much damage in the private sector in particular servicing current debt for private spending to increase in the short run.
Macro thoughts
There will be a backlash in the 2010 election with Republicans gaining seats.  The Republicans will win the 2012 Presidential election.  Why?  Because it is impossible for there to be a quick fix to any of the economic problems facing the world.  Thus opposition parties will be able to claim that the party in power’s policies have failed.  I think this “blame the other guy” politics will continue through the next decade’s elections with each party in power being unable to “fix” things.
The problems in Greece are systemic in the EU.  The bailouts have just begun and the size of the bailouts are as underestimated as where the problems attributed to subprime in 2007.

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July 4, 2010 letter

The Past

I. The Past
July 4, 2006
The letter
The first 4th of July letter was composed four years ago.  In it I shared my concerns that the massive real estate bubble was bursting, that the stock market was grossly overvalued and that there existed a ticking time bomb in the credit markets of hyper-leveraged derivative structures known as structured finance.  I noted that a multi-year recession was imminent and that a traditional “diversified portfolio” of stocks would not prove to be diversified at all in the upcoming meltdown
The lessons
I learned
All forecasts are dynamic and must be altered as events dictate.  I was correct that the market would collapse.  However in July 2006, the Dow was at about 11,000.  In the next fifteen months the Dow moved higher as the news got worse.  The Dow in fact topped not at 11,000 but instead at 14, 300 in October 2007.  It was not until October 2008 that the floor really dropped. 
Being right does not ensure being profitable.  I was short Fannie Mae for years.  I knew it was insolvent yet trading in the 70s.  I watched it drop to the teens.  I saw Bear Stearns fail.  I then saw Fannie Mae double in value in 3 days (from 17 to 35) in March 2008.  It hit 35 on its way below a dollar in three months.
It is better to do nothing in most instances.  Wait until the odds are really in your favor.  Then wait some more.  Then when you move, make it a smaller investment than you think.
The market is always open the next day (this is a variation of the prior) in essence, there will always be another great opportunity, so don’t lament the ones you miss.
Other lessons
Daily, weekly, monthly and yearly balances are inconsequential.  The only time that matters in investing is the time when you are converting a higher risk asset into cash.
It is imperative to understand the bias underlying any summary information.  In particular, one must focus on the incentives of those providing information.  Some examples:
• The investment bankers saying there were no problems just days before their companies disappeared (Devil’s Casino is a good book about Lehman’s implosion)
• Anything coming from government officials stating that things are improving, that problems are contained, etc.  The goal of any and all such announcements is not to inform, it is instead to influence.  In a macro sense, it is absolutely appropriate for government officials to mislead the public.  If the government at any point had said the financial system is failing, it would have had the same consequences as yelling fire in a crowded theater.  Thus, the government is lying for the collective good.  As individuals we must not be deceived.
There is little statistical significance to things touted as “never happening”.  For instance, recall the statistics showing “real estate never goes down on a national basis.” 
Keep your mind open to different ideas, in particular those that are significantly different than those shared by the crowd.  Read The Big Short and Crisis Economics to see how wide spread the warnings were about structured finance problems

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for those that enjoyed The Big Short

some more “real world” on mortgage-backed collateralized debt obligation

In an email sent to an acquaintance in January 2007 and included in the SEC’s complaint, Tourre appears to be describing his role in, and thoughts about, an investment deal, dubbed ABACUS 2007-AC1, between a German bank and a Manhattan hedge fund manager, Paulson & Co.

“More and more leverage in the system, the whole building is about to collapse anytime now … Only potential survivor, the fabulous Fab … standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications.”

In its April 16 civil suit, the SEC accused Goldman and Tourre of defrauding investors in a mortgage-backed collateralized debt obligation. Specifically, the SEC said, Goldman failed to tell investors that Paulson helped to design the CDO instrument, a synthetic grab bag of mortgage-pool-linked side bets pegged to whether the pools defaulted. Paulson hoped and figured the subprime mortgages in the CDO would go south because, as a short seller, the hedge fund stood to profit on the ABACUS trade if the CDO failed. On the other side of the trade was an investor who was betting on, not against, the mortgage pools, but who never knew that Paulson, an aggressive short-seller monumentally bearish on the housing market, had a hand in picking them.

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