Some Ramblings About the Economy:

January 31, 2008

As the credit orgy ends, and the excess leverage of the past years unwinds, few people have experienced any real pain. Big banks such as Citigroup have lost tens of billions, but who cares? There were rich Asian and Middle Eastern investors flush with cash who were happy to infuse it into Citi for a big chunk of equity. The only people hurt by this were existing Citi shareholders.

What happens to all of that “money” we thought we had when houses were priced higher? Individuals felt rich for two reasons: first, their personal balance sheets looked great because their houses were worth a fortune. Second, people extracted all the equity they could from their houses to consume. Ok, that’s all over now, so what happened to all that money people thought they had? Did it just evaporate? The velocity-of-money effects that pushed everything higher should now be working in reverse.

But the good thing about having a central bank and a paper currency is that you can literally create more money out of thin air. By lowering interest rates, issuing repos with junk as collateral, deficit spending, accepting a bunch of Asian money, the broad monetary base is being replenished.

If the Fed can pull us out of this mess without any real pain I will be shocked. It just doesn’t seem possible that you could unwind from a massive debt bubble without a recession. There just has to be some pain.

Middle class people in this country are hurting. They work night and day and yet their incomes, in real terms, are declining. Worse, they are consuming themselves into incredible amounts of debt and saving nothing. If we acknowledge that much of this consumption was financed with debt and was unsustainable, how can we possibly get out of it with a quick fix? It seems obvious to me that people need to stop spending so much — they need to downsize.

If people actually started to do this though, a long recession would be almost unavoidable. There are very powerful interests all over the world that will fight this with all their money-printing might. Because of the demographic issue facing the rich world, everyone is terrified of what happens if the US consumer has a change in outlook and starts to save instead of consume.

Ok…. None of this is news. What do we do with our money now?

Here are two important themes that shape my views. They could be completely wrong, by the way, so feel free to trash them in the comments (or to me in person) if you disagree.

1) As anybody who reads this blog knows, I think we will have lots of inflation in the coming years. Inflation of 3-4% may not seem like a lot, but if it is sustained over a multi-year period the cumulative effects will be huge. My prediction is that gold will resume its standing as a currency and will continue to gain value against paper currencies all over the world. Or, you could look at it this way: paper currencies will lose purchasing power while gold maintains its value.

2) Because of #1, US Treasuries look massively overvalued to me. They are priced as if we are going to experience deflation, something which the Fed will do absolutely anything (including trashing the value of the currency) to prevent.

3) “Emerging” economies all over the world have realized that the way to improve their standards of living is through markets. Capitalism, in one form or another, is on a tear across the world. You can’t have free markets without strong private property rights. These laws are being strengthened all over the world… especially in the BRIC countries (well, maybe not Russia).

What this means is that stocks will be a great way to make money! US Multinationals will probably do well, but we are seeing the emergence of new multinationals coming from what we use to call “the third world.” Personally, I think the Indian stock market will be a fabulous way to make money in the coming decades. As with the United States during its industrialization (18th & 19th Centuries), the path to prosperity was anything if not volatile. Same thing will happen in India and China – there will be huge booms and busts. The key is to be liquid and prepared to buy after the next crash.

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4Q ’07 Portfolio Review

January 30, 2008

This post is way late and A LOT has happened since 12/31/07! So, to keep things relevant, I will show some performance numbers but focus most of my commentary on how I am positioned as of the end of January, 2008.

Here’s the full year compounded monthly return of my portfolio compared to the S&P 500:

 

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Notes:

  • Between 12/31/07 and 1/29/08, my portfolio has declined by 8.2%. The S&P 500 declined 7% during the same period.
  • My two best performing stocks of Q4 ’07 were both in the agriculture sector: John Deere (up 23%) and Potash Corp of Saskatchewan (up 31%)

Over the last few days I have been raising cash in my portfolio.I think we will have a bear market this year and I want to be prepared to buy stocks later on when they are cheaper.

Here’s how my portfolio is allocated today:

     

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    allocation-chart.jpg

    Noteworthy Changes:

  • I have brought my cash position to 35% of the portfolio
  • Gold is right at my target allocation of 10%
  • I am still extremely “underweight” the financial sector. I’m sure there will be a time to buy financials at some point this year, but I still think there’s a huge amount of risk there.
  • Even though I have a lot in the materials sector, I have actually lightened up here by selling my position in Compania Vale do Rio Doce (Valle). My largest holding in this sector is now Potash Corp.
  • A note about agriculture: John Deere and Potash have become incredibly popular stocks and everyone is talking about them. I realize there is risk here and I am prepared for a correction. I have not sold any for two reasons. First, I have big gains (still short term) and I don’t want to pay tax. Second, the growth prospects for these companies (especially Potash) are HUGE. I think the stocks are priced as if the ag-boom will not continue.

    The Scientists Speak: money and “stuff” do not make us happy

    January 28, 2008

    Check out this review of a new book: “The How of Happiness: A Scientific Approach to Getting the Life You Want” by Sonja Lyubomirsky. The message of the book seems to be similar to the popular “Stumbling on Happiness” by Daniel Gilbert, which I recommend.

    The research and conclusions from these books is very compelling and more constructive, I think, than many of these self-help books that constantly make the bestseller lists. In this book, Lyubomirsky shows that a lot of our happiness is genetic — we are genetically predisposed to be happy or to be gloomy. But, there’s still hope for those predisposed to gloominess – we can affect at least 50% of our happiness through our own actions.

    When it comes to money, beyond a certain level of income and material comfort, additional money does not make us happy. Many people actually become less happy as they climb the income ladder because they are more inclined to compare their success to that of other people. Have you ever found out that one of your colleagues, someone who does essentially the same work you do, makes more money than you? This happened to me shortly after I started my job at the bank about a year and a half ago. I found an offer letter sitting on the fax machine. The person was hired at the same level as I was and would be doing essentially the same thing – but her offer was 11% higher than mine. I was angry and depressed for the rest of the day; mad at myself for not negotiating better, resentful of my colleague, etc., etc. It’s ridiculous that seeing this letter would take me down from my good feelings about my new job but it did all the same.

    As I see it, one great irony of our culture is that so many of the things we strive for actually make us unhappy. We run up lots of credit card debt buying stuff. The fancy new TV probably makes us less happy… we would be better off if we didn’t watch so much and instead spent the time doing activities with people we like. Many people work jobs they hate just so they can afford to consume a lot of junk they don’t need and doesn’t make them happy anyway. In my opinion, you shouldn’t spend the majority of your life doing something that isn’t fulfilling or working with people you can’t stand.

    I think it actually takes conscientious effort to live by the lessons of these books. Living in NYC, it can be tough not to constantly compare your economic situation with everyone else’s. I have stayed sane – and actually prospered – in this environment by choosing to live below my means and save money. To accomplish this on a modest income in NYC is challenging. I know many people who make more money than I do but actually save less. These people often have huge credit card debt that they are unwilling to pay down. It might work for them, but that lifestyle would make me anxious and miserable.


    Indexing Capital Gains for Inflation

    January 24, 2008

    Follow the link for a great article by Richard Bahn of the Cato Institute called “Inflation and the Tax Man”

    The fact that capital gains are not indexed for inflation has always irritated me. Now that Rudi Giuliani (who I’m not necessarily in favor of) has made this part of his tax proposals, the idea has gotten a lot more press. Here’s an excerpt from the article:

    Assume you purchased a common stock in a company in 1984 for $100 a share and sold it in 2007 for $200 a share. Have you received any “income” from the sale of the shares of stock? The IRS would say “yes,” but this is clearly wrong. The IRS will claim that you had a $100 per share capital gain on the stock in the above example, yet actually the increase was solely a result of inflation. Because you cannot buy more goods and services with $200 now than you could have with $100 in 1984, you have had no “income” or wealth accretion.

    The debate centers on the definition of income. The 16th Amendment to the Constitution states, “The Congress shall have the power to lay and collect taxes on incomes,” and the Fifth Amendment clearly states, “No person shall . . . be deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use without just compensation.”

    If the portion of a capital gain due solely to inflation is not income, then taxation without inflation-indexing is an unconstitutional taking of property. Income is commonly defined as, “the amount of money or its equivalent received during a period of time in exchange for labor or services from the sale of goods or property, or as profit from financial investments.”

    It is not likely that many judges or members of Congress would find it in their personal, political, or the national interest to argue that phantom gains are “income.” After all, most Americans do understand the meaning of income, even if some in Washington do not.

    This would make for an interesting Supreme Court case.  Chances are, the only way the IRS would find out you were indexing your capital gains for inflation is if you told them in a note on your return.  I could be mistaken but I don’t think Schedule D audits are very common…  after a few years, nobody has any idea what their basis is in anything.


    Don’t Panic!

    January 23, 2008

    A friend of mine came to me today and said she was going to move her entire 401k into bonds and make all future contributions to a money market fund “until the bear market is over”. Without telling her specifically what to buy (because I have no idea), I was able to convince her out of this crazy notion.

    Here are some quick thoughts on how I think you should allocate your 401k:
    You should come up with an asset allocation (stocks, bonds, commodities, gold, real estate, etc.) based on the number of years until you can retire. Run the model once per year and reallocate accordingly. All 401k contributions out of your paycheck should go into equity mutual funds, regardless of your age.

    Especially for Retirement Accounts, Take the Long Term View:
    For those of us with a long time to go before retirement, we should take a very long-term perspective with our retirement accounts. That means continuous buying of “growth” stocks – emerging markets in particular. Ten years from now we won’t be able to see the difference between stock prices in December 2007 and January 2008 – in future real terms, the difference will be meaningless. But the return you get from incremental purchases at these discounted prices will be huge. Consider that you can buy shares of the same fund for 20% less than you could a month ago. If emerging markets continue to fall… even better! Over the long term, you can make a fortune by “dollar-cost-averaging” into emerging markets. You make money (by buying) when stocks are down, not when they are up.

    ** My 4Q 2007 Portfolio Review has been delayed because my broker won’t provide my December 2007 statement. Once I get it in the next couple of days I can crunch the numbers. Writing about the good returns I earned in 2007 will be bittersweet considering that I’ve given a big chunk of them back in the first two weeks of 2008!


    Home Office Update

    January 19, 2008

    I put together my new computer today. Got the whole thing up and running in less than an hour! Don’t want to jinx it but I remember how years ago setting up a new computer was an exercise in frustration — nothing worked and it was impossible to connect to the internet.  Props to Dell for what has been a great experience so far!

    blog-002.jpg

    In my usual style, I basically just threw this together — there are wires running everywhere, especially under the desk. But one of the goals of this home office project is to get organized. Good organization is an absolute necessity for my CPA business. But it’s also important for everything else. First thing for this computer:  make sure my anti-virus software is working and  sign up for online automatic hard drive backup.


    Toxic Energy at Work

    January 18, 2008

    [rant]

    I normally don’t write about work because it could get me in trouble. But this rant is mostly harmless so I should be ok.

    *****

    My job at the bank is mostly “back office”; everyone on my floor is in a similar capacity. On my floor, there aren’t many people who actually seem enthusiastic about their work. In fact, many people mope around and seem to be half asleep. I am very fortunate that my direct group is nothing like this, but I feel sorry for my colleagues who aren’t so lucky.

    I’ve been thinking about this because I’ve been observing how a “new hire” is being assimilated into one of the groups that sits near me. She has spent the entire week looking over people’s shoulders, presumably learning about systems and work she is supposed to assume. There is zero enthusiasm coming from the people in her group. It’s as if they are saying “here’s a nasty process that isn’t important but you will need to do it. Moreover, it’s so tedious that I can barely muster the energy to explain it to you.” Imagine starting a new job and experiencing this type of toxic and soporific energy from your new colleagues!!

    Aside from the negativity of this approach, there is also a laziness and impracticality of training people this way – I suspect most people would agree. If you’re going to give me a process that needs to be done on a recurring basis, freaking sit down and type up documentation! It’s quite clear why the trainer wouldn’t want to do this… it’s hard work to document a process. It requires you to actually think about it. Worse, it requires you to be organized and think about the big picture. Instead of this method, I constantly see people being trained by watching someone else flip through Excel files.

    What about this instead: when a person is given a process to own, hand them a detailed document which explains the necessary steps and where to find all source files, etc. Make sure you include an overview section that succinctly says what the process is supposed to accomplish. Then let the person spend a few hours going through the document and the associated files. The trainer should be available to enthusiastically answer any questions the person will have along the way. This way, the questions will be informed and pointed. I guarantee this would be a far, far more productive way of training someone.

    So, as I gear up to leave my job for grad school this summer, I plan to hand documents to anybody I’m training on my processes. If I have to train someone on things which are tedious and dull, I will have a big cup of coffee beforehand so I sound enthusiastic and high-energy.

    Bottom Line: if you are bored by your job, get a new one… or at least try your best to hide it!