MarketVVizard's Market Thoughts

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Top 860. Jan 30, 2004 5:07 AM

» Austrian - Re:

In response to message posted by Normxxx:

Normxxx,

I firmly agree with you. On the whole, the baby boomer generation is in deep financial trouble. The government knows it and is definitely targeting the financial markets and various asset inflation to paper over a structural mess. I think THE goal of all the monetary pumping and govt spending is to inflate out of this kind of mess, similar to the crys to "monetize the debt" in the 1970's. The big problem is the severe global imbalances which Stephen Roach writes about so elequently.

This is a favorite quote of mine with very profound implications :

"The fate of the world economy is now totally dependent on the U.S. Stock Market, whose growth is dependent on about 50 stocks, half of which have no reported earnings."
Paul Volcher
September 1999

Slightly off the Pension topic, but deeply relevant to an understanding of the dynamics in the global market place. Kind of how did we get here, what the major players are doing, and how they may react. Below is an outstanding article offering very interesting historic perspective to our current financial situation, illustrating how policy actions impact economies in a fiat money world. I’ve read this article four times and get something new each time.

Embedded in this article is the inflation/deflation argument, the case for gold, the gold correction, the euro correction, the need for global economic reform, the underlying reason for the stock market bubble, and the global credit bubble.

I urge a very careful read.

Regards,

-- Austrian

International Perspective, by Marshall Auerback

A Growing Weak Dollar Constituency…As Long As There’s No Collapse
January 27, 2004

From the early 1970's onward, American industrialists have been concerned about competitive inroads from lower wage countries on a rapid path toward modernization. In the 1980's the focus was on Japan and its successful takeover of a long succession of consumer durable goods markets (autos, TV's, etc.) and some high tech markets (semiconductors) that were developed initially by US firms. By the 1990's concerns were rife that imports of an ever widening range of goods from lower wage countries, particularly in the Far East, would "hollow out" America's industrial base.

Throughout most of the post-war period, a number of Treasury Secretaries conducted economic policy with an eye toward preventing a loss of US competitiveness. Faced with calls for protectionism from firms and workers whose industries and jobs were at risk, these former Treasury regimes were biased toward a low dollar exchange rate which would enhance the position of US industries in world trade without running the risk of trade wars posed by protectionist solutions. Most of these Treasury Secretaries remembered an earlier era when the US ran current account surpluses and was the world's largest creditor nation. They also had the experiences of the so-called Third World debt crisis of the 1980s in mind and the corresponding fear of debt trap dynamics. In other words, dollar devaluation was grounded in sound economic theory, rather than desperation. It was pro-active, rather than reactive.

Under Treasury Secretary Rubin, all of this changed. Secretary Rubin differed in his focus: trade competitiveness was seldom cited as an issue; instead, he emphasized the support a strong dollar gives to domestic financial markets. We see this clearly in an interview Mr. Rubin granted to the New York Times, September 29th, 1996.

Mexico was still boiling when Rubin faced his second potential political disaster, the fall of the dollar to below 80 yen. For Rubin, this was more familiar territory: he had supervised the currency traders at Goldman, and he knew both the fiscal and political risks. "These kinds of occurrences are not without consequences," Rubin said. A declining dollar tends to drive investors out of American stocks, bonds and Treasury debt, putting pressure on the federal government to raise interest rates. "It would take a while to show up, but I'm certain it would have happened," he said.

From Rubin’s perspective, a strong dollar was always desirable to the extent that it encouraged short run speculative trend following capital inflows which buoyed domestic stock and bond markets and kept domestic interest rates low. The corollary of was that a weak dollar from any level was dangerous in that it would reverse such capital flows which could, to use Rubin's words, “drive investors out of American stocks, bonds and Treasury debt”. A loss of competitiveness, a rising current account deficit, and a growing net debtor position, all associated with a very strong dollar, were, in Rubin’s eyes, always be outweighed by any potential risks from destabilizing capital flows out of US stocks and bonds.

Rubin’s “strong dollar” policy became too successful. Notwithstanding mounting external imbalances in the US economy, a significant rise in foreign holdings of US debt, the dollar rose inexorably throughout the latter part of the 1990s and the early part of the new century. The mantra “a strong dollar is always in the interests of the US economy” took on status in the forex markets akin to the Catholic catechism, but the ultimate effect was to encourage yet greater reliance on short term speculative capital, thereby propagating greater potential financial fragility in the US economy. As the bubble grew bigger, and the external imbalances mounted, the need for a weaker dollar became manifest. However, Rubin’s successors generally eschewed the notion of pursuing a policy of devaluation on the grounds that an Asian-type financial crisis might lurk behind any sign of that the US was abandoning its ostensible commitment to a strong currency.

There were other unhealthy side-effects from this policy. Rubin's policy of encouraging a strong dollar for financial market reasons had the dangerous effect of undermining political support for free-trade initiatives. Previously, the soft-dollar approach, notably under James Baker’s tenure, had provided some grease for the wheels of progress toward consistent reductions in trade barriers, by soothing the worries of US industrialists that this would lead to rapid erosion of domestic market shares and making them lick their chops for opportunities to export into previously blocked markets with the low dollar as an inducement. Having the CEOs on board helped mitigate or offset the consistent opposition of the trade unions. By 2000-2001, the lofty dollar and recessionary business conditions had caused the business community from top to bottom to align more in favor of stopping or rolling back the free-trade tide which, unsurprisingly, has led to a rapid increase in global protectionism, even as the dollar began its gentle decline in 2002.

If anything, the surprise of the past 2 years has been the absence of a long anticipated Asian-style financial crisis, in spite of persistent dollar weakness, a vicious bear market, and a significant increase in American financial profligacy. Indeed, since the recovery in the US stock market last March, Treasury Secretary Snow, the ostensible “custodian” of the strong dollar policy, has abandoned even the pretence of being interested in it. Similarly Fed Governor Ben Bernanke has gone as far as celebrating the American central bank’s ability to print endless dollars to ward off any incipient deflationary threats. The current environment, therefore, seems to be the Washington’s economic equivalent of having its cake and eating it too. Stock markets have recovered robustly since last March and the ten year bond yield is now hovering around 4 per cent (back to pre-“Bernanke put” levels in fact).

It is true that, but for the massive support of the Asian central banking community, we would not be experiencing this benign set of circumstances. Fed Foreign (“Custody”) Holdings of Treasury, Agency Debt have increased $102.85 billion in 10 weeks, or better than 50 per cent annualized. Over the 52 weeks, custody holdings were up an astonishing $247 billion, or 29 per cent, year-over-year.

But the dirty little secret in today’s markets is that the Asians have grown to love a weaker dollar as well. Whilst the dollar has lost one-third of its value against the euro and the Australian dollar, 20 per cent against the yen and sterling and 18 per cent against the Canadian dollar, against the most important of emerging market currencies, China's renminbi, the dollar has moved not at all. The Hong Kong dollar and Malaysian ringgit are also fixed. But even the Indian rupee, Korean won, Taiwanese and Singaporean dollars and Russian ruble have barely moved since tumbling during the 1997/98 financial crisis, which implies that emerging Asia is also reaping substantial competitive gains from the dollar’s decline at the primary expense of Europe. These countries can pursue a devaluationist policy on the quiet, with little of the political pressures that greeted such moves when adopted in the 1980s or 1990s.

And the US does appear to be deriving some benefits from its pursuit of a weaker dollar on the external side (although in the broader context of economic history, it hardly seems appropriate to call last November’s “mere” $38bn trade deficit substantial progress). In a recent piece, we noted the gap between accelerating US consumer cyclical demand and a sluggish US consumer goods production response, which suggested an impending surge in US imports. Based on the ISM monthly survey data, which is a diffusion index that by its very construction acts as a leading indicator for the Commerce Department import data, we anticipated a 15-20% pace of import growth as Q4 2003 data was released, which in turn led us to forecast a rapidly accelerating trade deficit.

With the recent release of November’s trade data, we have confirmation of the expected import surge. The shocker was an unanticipated surge in exports. The Sept/Nov. export data now displays a point to point surge of 47 per cent growth at an annualized rate, and a 3 month trailing average growth rate of 19 per cent.

Of course, before one gets too carried away with the current state of affairs, it is important to note that even with the marginally improving American trade picture, US imports are now nearly twice the size of US exports. If US import growth settles down in the 5-10 per cent range, US export growth will have to run in the 10-20 per cent range to simply keep the trade balance stable at Q4 2003 levels. Given the slack pace of final demand outside China and the US, this means an awful lot of pressure on foreign firms trying to preserve global market share against firms based in a country with a 16 per cent depreciation on a broad currency basis (Fed definition), and a 33 per cent depreciation on a major currency basis.

It appears only a matter of time before the ECB cracks and begins to join the game of global competitive currency devaluations, which would likely upset this delicate balance, a state of affairs that has enabled US and Asian capital markets to levitate in spite of the persistent weak dollar trend (which has taken currencies such as the renminbi down in its wake). For whilst the weak dollar constituency is growing in Asia, there are signs of a backlash elsewhere: The Bank of Canada just eased and has signaled the possibility of further cuts reflecting concerns about the strong Canadian dollar on its economy. The Norwegian monetary authorities have signaled likewise for months. Late last week, all currencies fluctuated widely as Reuters cited an unidentified European diplomatic source saying that a further strengthening of the euro could lead to a looser monetary policy, in spite of ECB President Trichet’s stern rejoinders to the contrary. Trichet himself has recently noted falling inflationary pressures, which implies a bias toward imminent easing.

Of course, it is important to note that however much the Asian central banks have grown to love a gently declining dollar, they have no interest in witnessing a collapse. The Asian official sector has in effect acted as a buffer between private speculative capital (which continues to wash its collective hands of the dollar), and the Asian and American industrialists, which are deriving benefits from a slowly declining currency, but who would be the first casualties of a dollar collapse (given the deflationary impact of the latter through the sharply higher long rates it would ultimately produce). The massive dollar support operations of the Asian central banks have preserved low long term US rates, and helped to sustain an ongoing market for Asian exporters, but at a cost of perpetuating growing American financial profligacy (to a degree that even President Bush is beginning to pay attention to it) Since global final demand remains quite sloppy outside of the US and China, it must be the case that US and emerging Asian exporters are stealing global market share away from European firms especially, and Japanese firms to a lesser extent, which may be reflected in the increasingly anxious tones of German and French industrialists, fretting about the euro’s ongoing surge against the dollar.

Moreover, the pervasive Asian central banks’ purchases of dollars to hold down their local currencies have had the mechanistic effect of boosting domestic money supply, and in effect engendering a series of mini-domestic credit bubbles throughout Asia, especially China. So we now have a new kind of “Goldilocks” scenario: a gently declining dollar, whose “not too hot, not too cold” descent enables US monetary authorities to perpetuate lower interest rates/higher bond prices, in turn creating a broad Asian-American constituency for ongoing US dollar weakness.

This appears to run counter to all economic theory, but in the context of a rapidly spreading global credit bubble, one can see the short term attractions. However, whilst the monetary consequences of a weaker dollar have turned out to be surprisingly expansionary in Asia, such expansion appears thus far insufficient to reduce the US current account deficit. All that is happening is that we are seeing faster global economic expansion on the back of a still overextended US consumer, rapidly rising commodity prices, significant increases in global capital expenditure, all of which will probably end in worldwide overheating and a dollar collapse as the indebted US economy finally reaps the consequences of the higher rates brought about by such an inherently unstable policy.

Indeed, should the very recent spate of dollar strength continue, it might begin to unravel this “happy” state of affairs insofar as it removes the incentive for foreign central banks to continue to buy US dollar bonds, as the need for dollar support operations diminish. We use the word “happy” guardedly, since it is clear that even if the dollar resumes its decline, the underlying problem of indebtedness remains. The expansion of credit is an increase in debt. When debt levels are low a credit expansion which increases debt does not leave a legacy which later suffocates demand, since the resulting still low level of debt is not yet a problem. But when debt levels are very high the increases in debt created by credit expansion soon act as a burden on demand. It follows from the above that, as the level of debt relative to income rises, it should take larger expansions of credit to achieve any given percentage increase in demand, since the now high and climbing debt burden acts as a countervailing force to depress demand.

Arguably, it is the US mortgage rate which is the key price in the world economy, as keeping the US consumer happy and liquid has been the key to keeping the global economy afloat amid all the excess capacity in the world. That means US long-term rates cannot be permitted to rise for now, but instead must work gradually lower, and the way that happens with so much government debt being issued is for the rest of the world to absorb it, which means the dollar must stay weak enough to encourage all those purchases from the foreign official sector. But this process simply puts off the inevitable denouement for the US economy, whilst simultaneously introducing an element of monetary instability into Asia. The efforts of U.S. policy makers to avoid a full unwinding of the 1990’s stock market bubble through the encouragement of a credit bubble and a housing bubble has, despite something of a recovery, made both conditions worse. Today private debt is higher relative to income than it was two or three years ago and core inflation has fallen to only 1 per cent. China’s capital expenditure is way above trend and authorities there are voicing concerns.

The embrace of a weak dollar has in effect placed both countries today closer to the Fisherian debt deflation dynamics which created prolonged stagnation and repeated recession in Japan. Therefore, the real risk is that today’s global credit blow-off ultimately places everybody closer to debt deflation dynamics and greater currency instability, hardly a conducive backdrop to perpetuate the current sanguine state of affairs in today’s capital markets.

-- posted by Austrian

Pakistan Scientist Admits Selling Nuclear Secrets

Top 861. Feb 2, 2004 9:02 AM

» MarketVVizard - Pakistan Scientist Admits Selling Nuclear Secrets

Feb 2, 7:51 AM (ET)

By Mike Collett-White
ISLAMABAD, Pakistan (Reuters) - The father of Pakistan's atomic bomb has confessed to selling nuclear secrets to Iran, Libya and North Korea, but authorities have yet to decide if the national hero will go on trial, officials said Monday.

Top scientist Abdul Qadeer Khan was sacked as adviser to the prime minister Saturday and is the main suspect in a two-month investigation into allegations that individuals passed on Pakistan's nuclear weapons secrets to third countries.

Seven suspects are still under investigation, but senior former military and intelligence officials -- who experts say must have known about Khan's activities -- are not being questioned.

Putting Khan on trial is a sensitive issue in Pakistan, where he is revered as a national hero and the father of not only the country's, but the Islamic world's atomic bomb.

"He (Khan) has admitted these things," said a military official on condition of anonymity, referring to allegations Khan peddled nuclear secrets to Iran, Libya and North Korea during the late 1980s and early 1990s.

"It has yet to be decided whether he goes on trial or not."

Intelligence sources said the evidence against Khan was strong enough to formally charge him, and included a statement from a key middleman in Dubai that could prove damning.

His lavish lifestyle, minutely detailed in the English-language local media, may also be used against him.

But Western diplomats and analysts say a trial would open a "Pandora's box" for Pakistan and in particular its powerful military, which was likely to be implicated in any case.

The intelligence community also believes Khan's daughter may have gone abroad with material that could compromise the military. The 69-year-old Khan has been kept under 24-hour watch and has yet to speak publicly since the probe began.

CLUES FROM IRAN, LIBYA

Pakistan launched its investigation more than two months ago after the U.N. nuclear watchdog, the International Atomic Energy Agency, found evidence pointing to Pakistani involvement in Iran's nuclear program.

Designs used in Libyan and North Korean nuclear programs are also believed to have come from Pakistan.

The international community hopes the probe will help expose a global network of secret nuclear proliferators amid fears sensitive technology could fall into the hands of terrorists.

The decision to single out Khan marks a major turnaround in Pakistani policy. In January, 2003, the government rushed to his defense, dismissing as "concocted and fabricated speculation" newspaper reports linking him to illegal proliferation.

The widely read Urdu-language press has criticized the handling of the case, and accuses President Pervez Musharraf of blindly following America's agenda after he supported its war in Afghanistan and vowed to crack down on Islamic militancy.

"Whatever reason the government gives to justify its actions, the nation will consider it a step toward completion of the American agenda in this region," the Nawa-i-Waqt daily wrote.

But senior officials say that public opinion may swing behind the government if Khan's guilt can be proved beyond doubt.

Musharraf is expected to address the nation, probably early next week, once the investigation is completed.

Khan was a key architect of Pakistan's atomic program from the 1970s up to the first nuclear tests in 1998. The program was developed in response to India's.

The Pakistani military said at the weekend that no illegal proliferation had occurred since the establishment of the National Command Authority, which controls Pakistan's nuclear arsenal, in February, 2000.

It added that Pakistan would not curtail its nuclear weapons program as a result of the investigation.

Abdul Qadeer Khan, the father of Pakistan's atomic bomb, has confessed to selling nuclear secrets to Iran, Libya and North Korea, but authorities have yet to decide if the national hero will go on trial, officials said February 2, 2004. Khan was sacked as adviser to the prime minister Saturday and is the main suspect in a two-month investigation into allegations that individuals passed on Pakistan's nuclear weapons secrets to third countries.

-- posted by MarketVVizard

Top 862. Feb 2, 2004 9:53 AM

» MarketVVizard - Dinner with Faber

Not sure who this originally came from but these are his notes from a recent encounter with Faber:
________________________________________________
Here are some notes I scribbled down during the Marc Faber dinner last nite. I went to the dinner not so much because I'm a Faber fan, but more to visit with a whole lot of old friends...so my notes need to be filtered accordingly ;-)

Faber started his spiel by noting that investors need only to make one investment decision a decade and then go to sleep...given the nature of booms and busts. If investors had purchased gold at the end of the gold standard when it was trading for $35 in 1971...they could've held it for about a decade and sold it when it peaked at $850 in the early 1980's. Then if they had shifted that money into Japanese stocks, they could have gone to sleep until 1989 and sold the Japanese stocks at their peak when the Japanese market was greater than the U.S., U.K., and German markets combined. Then investors should have bought the S&P and Nasdaq at the beginning of 1990 and gone to sleep for another decade...and then sold at the peak in 2000. So what should investors be shifting their money into for this decade? Hint...China and commodities ;-)

Chatted about how China is similar to the U.S. in the 1864-1900 time period. When America entered into the global economy, canals and railroads allowed grains to enter the world market...which resulted in deflation as grain prices collapsed more than 50%...and which ended up bankrupting European agriculture. Lower prices, however, resulted in a deflationary boom as real wages for American workers rose. Today, the same thing is happening in China...via huge deflation in the manufacturing sector...while real incomes in China are booming.

Chatted about how debt/GDP in the U.S typically hovered in the 120% range since 1940...but the credit expansion wave of the 1980-1990's has led to debt/GDP soaring to 300%. Said it isn't sustainable, especially in a deflationary period...and stated it will end with massive defaults. Also talked about the tremendous imbalances in the ballooning trade deficit.

Spoke about the accelerating growth in China, where per capita income is growing at a historically unprecedented rate. Said cities are now able to industrialize much more quickly due to the increase in technology and communications...and noted how it only took Shanghai 12 years to become a modern city. Expects 15 more Shanghais to develop in the next decade in China. Says Hong Kong is already losing its influence as a financial center.

Noted that China will become the workshop of the world due to its low wages, while India becomes the service provider of the world. As China grows, they are squeezing out the rest of Asia...which played a big part in the Asian crisis of 1997. Said even if China agreed to devalue its currency by 50%, production still wouldn't shift elsewhere, because they still would have the lowest wages given the huge populations flocking from rural areas to the cities to work in the factories.

Said the most promising sectors for investment in China are housing, tourism, food (China will increasingly become a large importer of food products and other commodities), financial services, advertising, distribution, health and personal care products, entertainment, and media. Said local companies will squeeze the multinationals.

Said tourism will be Asia's most promising growth industry. Joked that 100% of the residents of England travel due to their terrible food and weather, but less than 1% of the population of China currently travels...which will represent huge potential in the future.

Discussed China's potential oil demand, which will continue to pressure oil prices higher. Noted how all of Asia has 3.6 billion people in contrast to 285 million in the U.S., but how U.S. consumption of oil is 12 time higher than Asia's consumption currently. As China's quality of life continues to improve, there will be a tremendous surge in their oil consumption...similar to the U.S. oil intensive path of the first half of the 20th century. (Given those comments, I asked him about PetroChina. He haughtily dismissed the company as having no reserves and said it would be better to invest in small oil drilling companies.)

Talked about bond prices peaking worldwide in 2003...and said he would short the Japanese government bond market...as he expects Japanese rates to rise to 4.5%. Noted that Japanese stocks yield more than their bonds...and he would buy Japanese stocks, as he expects them to outperform U.S. stocks in the future. Noted that Asian non-financials free cash flow generation has been steadily increasing over the last several years and that "the mother of de- leveraging has been occurring in Asia" with net debt/equity falling dramatically since 1997. Noted again how Japanese stocks used to make up more than 50% of the world's market cap...and now represents only 8%, while the U.S. now accounts for 53% of the world market cap...and he expects that to fall to 20-25% due to either a stock market collapse or continued currency weakness.

Said he expects the U.S. stock market to stay in a trading range for years like 1964-1982...where there were big swings, but not much net gain. Noted that the accelerating speed of change and the large hedge fund industry will lead to very volatile financial markets around the world. Said U.S. investors should invest internationally and diversify into other currencies and consider investing in gold, silver, commodities and real estate...and that the ideal way of making money over the next decade is to start with lots of money...and hope you don't lose it ;-)

-- posted by MarketVVizard

Top 863. Feb 2, 2004 10:06 AM

» MarketVVizard - Hussman

February 2, 2004

George Parker's Rules of the Game

John P. Hussman, Ph.D.

All rights reserved and actively enforced.

On a rainy day in the summer of 1883, 16-year old George Parker modified an old card game for the entertainment of his friends and called it “Banking.” He would eventually found Parker Brothers, maker of games like Monopoly and Trivial Pursuit.

As Philip Orbanes writes in The Game Makers, Parker saw business itself like a game - its outcome had a certain amount of unpredictability, but was more or less influenced by the quality of the moves you make. That line of thinking led him to a dozen business principles.

• Know your goal and reach for it

• Find winning moves

• Play by the rules but capitalize on them

• Learn from failure, build upon success

• When faced with a choice, make the move with the most potential benefit versus risk

• When luck runs against you, hold emotion in check and set up for your next advance

• Never hesitate long enough to give your opponents an advantage (paraphrased)

• Seek help if the game threatens to overwhelm you

• Bet heavily when the odds are long in your favor

• If opportunity narrows, focus on your strengths

• Be a gracious winner or loser. Don't be petty. Share what you learn.

• Ignore principles 1 to 11 at your peril!

(Philip E. Orbanes, The Game Makers – The Story of Parker Brothers)

One of the interesting features of this list is that at first glance, the items seem to be almost obvious, even trivial. But if you take the time to carefully think through each item in the context of your own successes or failures, they suddenly become enormously insightful, and you start to question how many people actually put ideas like these into practice.

For example, it's striking how many investors seem to need assurance as to which direction the market is headed. They believe that knowing the future direction of the market is the key to their success. But that direction really is not knowable with any amount of statistical significance (which is why we don't rely on forecasts). Instead, the key to good investing rests on exactly the kinds of elements that Parker suggests. Here are a few that seem particularly relevant:

Know your goal and reach for it

If your goal is to catch every market advance and avoid every market decline, and you actually know how to attain that objective, great. We have no idea how to do that here at Hussman Funds. So, we focus on a goal that we believe is attainable – investing for long-term returns while managing risk; achieving strong returns over the full market cycle with less downside risk than a passive approach. Knowing your goal (and believing that it can be attained through actions that you can control) can't be underestimated.

Find winning moves

As I've written frequently over the years, the key to success in just about everything is daily action. You find a set of actions that you believe will produce good results if you follow them consistently, and then you follow them consistently. Too many investors put their capital at risk based on beliefs – even hunches – that they have never verified with any sort of historical data or analysis, or that would be impossible to verify at all. For us, it's critical to know both the average result, and the potential range of results, that we can expect from a given action.

For example, one of our most consistent day-to-day actions is the attempt to purchase stocks with some combination of favorable valuation and market action during periods of short-term weakness, and to replace less attractive holdings on short-term strength. By doing that, we're constantly trying to improve the value and market action inherent in our portfolios at points of opportunity. Very simply, you can't buy low and sell high, on average, if your daily actions aren't designed to force you to buy low and sell high on average.

When faced with a choice, make the move with the most potential benefit versus risk

Again, this seems almost pedantically obvious. But all too frequently, investors make decisions based only on potential benefit, or without any careful reflection about potential benefits and risks at all. Probably the two most frequent questions in my day-to-day “self talk” while managing the Hussman Funds are ones I learned from Chess: 1) What is the opportunity? and 2) What is threatened? If you don't constantly ask those questions, you can miss outstanding chances to add value or avoid losses.

Bet heavily when the odds are long in your favor

This is an extremely important principle, but one that has to be modified somewhat for the financial markets. The crucial modification is that you should never, ever take an investment position that would be successful if you're right but would lead to unacceptable losses if you're wrong. With that modification, Parker's rule on this is probably one of the most important principles for successful investing that you'll find.

Very simply, good investing requires taking greater amounts of risk when the return per unit of risk is likely to be high, on average, and taking smaller amounts of risk when the return per unit of risk is likely to be low, on average. Too many investors believe that every risk is worth taking (witness buy-and-hold investors), or hold a position that they're very uncomfortable with because they're scared to miss out on any further gains (why not sell a portion of it?!?) The key is simple: vary the size of the risk exposure based on the average return/risk you can expect.

If you read the Prospectus of either the Hussman Strategic Growth Fund or the Hussman Strategic Total Return Fund (and we highly encourage that), you'll see exactly this principle in action. We wrote those Prospectuses to allow the flexibility to take risks in proportion to the return per unit of risk that can be expected in each Market Climate we identify. In the most favorable Climate (favorable valuations and favorable market action), you'll find that we allow the Funds to take greater amounts of market risk, but in a way that allows for the possibility of being entirely wrong. The investment part of the job requires research – finding find good opportunities. The risk management part of the job requires humility – knowing you'll sometimes be dead wrong, and factoring that in so that the potential losses are acceptable.

For instance, the Strategic Growth Fund can take a certain amount of leverage. But it can do this only by holding a few percent of assets in call options. That way, we can participate to a greater extent in the market advances that frequently occur in that Climate, but if the market plunges, our additional losses as a result of that leverage are limited to the few percent invested in calls. In the Strategic Total Return Fund, we've written in the ability to purchase Treasury STRIPS (essentially zero-coupon bonds) in the most favorable Market Climate, but we also limit the expected duration of the portfolio (to about 15 years) even in that most aggressive Climate.

In contrast, both Funds have the ability to reduce their exposure to stock and bond market fluctuations during less favorable Market Climates (some combination of unfavorable valuations and unfavorable market action).

In short, we vary our exposure to risk based on the average return/risk profile of each Climate we identify. Parker's rules make sense to us – the way to earn high returns per unit of risk over the long-term is to take greater amounts of risk in conditions where the return per unit of risk tends to be high, and to take smaller amounts of risk otherwise. This also goes back to finding winning moves. A strategy that does not systematically force you to take more risk when the return/risk is high and less otherwise is probably not a strategy that's likely to earn a high overall return/risk profile over time.

Share what you learn

Though I try not to discuss proprietary aspects of our approach, one of the joys of writing these weekly comments is finding ideas that I think will be useful to others. I hope that I'm occasionally successful at that.

Market Climate

The Market Climate for stocks remains characterized by unusually unfavorable valuations but still modestly favorable market action. Last week's plunge in the Dow Transportation index was troubling, because it was so far out of line with other market action that it suggested an important shortfall in final demand. Particularly with energy prices still fairly benign, the weakness in the Transports suggests that whatever increase in output we're seeing is taking the form of inventory rebuilding rather than sales. Still, that divergence is not at all sufficient to move our measures of market action to a negative condition.

To the contrary, the fact that those measures remain modestly positive (combined with a generally falling interest rate environment, a relatively low CBOE volatility index, and a decent market pullback) creates an interesting, if very short term, positive condition for the market. Regardless of valuations, this set of conditions has generally been associated with an above-average return per unit of risk over the following couple of weeks. Essentially, the market tends to produce a snap-back rally, which may or may not be sustained beyond that couple of weeks. While we don't rely on that as a forecast, and neither should you, the historical tendency is strong enough that we purchased a moderate number of index call options last week (a fraction of 1% of assets).

The overall position in the Strategic Growth Fund, then, is as follows. The Fund remains fully invested in stocks that we believe have some combination of favorable valuation and favorable market action. About half of that exposure is hedged against the impact of market fluctuations with an offsetting short sale in the S&P 100 Index and the Russell 2000. In addition, the Fund now has a “straddle” – long both put options and call options. In the event of a substantial market decline, the puts in that straddle would increase the overall hedge to about 70% of portfolio value, meaning that we would expect to be exposed to only about 30% of the market's further losses. In the event of a substantial market advance, the calls in that straddle would reduce our overall hedge to about 30% of portfolio value, meaning that we would expect to be exposed to about 70% of the market's gains. The cost of that straddle is currently less than 1% of portfolio value. To the extent that the volatility of the market falls short of the already fairly low volatility implied in the options, we would expect to experience time decay in that 1% that we could not make up through management of the position. Though you probably don't want to try this all at home, this is fairly standard stuff for us.

In short, we continue to see some initial breakdowns that could very well lead to a negative shift in the Market Climate if they persist. At the same time, the particular set of conditions we observe have created a very short-term positive for the market that we've responded to in a limited way. We certainly don't rely on a market advance here, but as always, we try to align our investment position with the profile of opportunities and risks we observe.

In bonds, the Market Climate remains characterized by modestly unfavorable valuations and modestly unfavorable market action. The Strategic Total Return Fund continues to hold a duration of about 2 years, meaning that a 100 basis point shift in interest rates would affect the Fund's value by about 2% on account of bond price fluctuations. The Climate for precious metals shares has improved modestly given the recent weakness in gold stock prices and a fairly benign interest rate picture, so the Fund has a few percent of its assets in that area, and we would be inclined to add to those positions modestly on further weakness in gold shares.

-- posted by MarketVVizard

Top 864. Feb 3, 2004 11:57 AM

» Normxxx - Re: Re: The Beginning Of The End

In response to message posted by Austrian:

Everyone's sinking in a sea of debt. So all of the CBs (Chinese and Europe excepted, so far) are opting for inflation. But 1-2 billion Chinese, Indians, and others looking for work are a vast deflationary force. How this plays out is anybody's guess-- we've never been here before. But it is an unstable equilibrium.

In the meantime, the chipping away at workers (and retiree's) benefits continues apace.

Companies Limit Health Coverage of Many Retirees

By MILT FREUDENHEIM | February 3, 2004

Employers have unleashed a new wave of cutbacks in company-paid health benefits for retirees, with a growing number of companies saying that retirees can retain coverage only if they are willing to bear the full cost themselves.

Scores of companies in the last two years, including the telecommunications equipment giants Lucent Technologies and Alcatel and a big electric utility, TXU, have ended medical benefits for some or all of their retirees and instead offered to let them buy coverage through a group plan. This coverage is often more expensive than many retirees can afford.

Experts expect that the trend, driven by the fast-rising cost of health care, will continue, despite the billions of dollars that the government will distribute to companies that maintain retiree health coverage when the new Medicare drug benefit begins in two years. In contrast to pension financing, companies are not obligated to set aside funds to pay for retirees' health benefits, and the health plans can usually be changed or terminated at the company's choosing, with no appeal available to the retirees.

The costs can be a shock. According to surveys by benefits consultants, companies that offer health benefits to retirees typically have subsidized about 60 percent of the premium. Losing that support all at once can mean hundreds of dollars a month in unexpected costs.

Moreover, in dropping their subsidies, many companies push retirees into insurance pools that are separate from those of younger, healthier workers, executives said. That lowers the company's costs for insuring its current workers, while raising the premiums charged to retirees even further.

James Norby, president of the National Retiree Legislative Network, an advocacy group that is urging Congress to strengthen legal protections for retired workers, said companies that charged for formerly covered benefits had found "a clever way of getting out of the contract they made to people who had been retired for 15 or 20 years."

Employers that are shifting costs to their retirees often present the change as a benefit: although the company is no longer subsidizing coverage, premiums are usually lower than for individual policies, and the retirees do not have to worry about being rejected by insurers because of their age or prior health problems.

The emergence of these plans "is a very significant trend," said Frank McArdle, a health policy expert with the Hewitt Associates benefits consulting firm in Washington. "Even though it's not subsidized health coverage, retirees, particularly early retirees under age 65, still have access to a group product that they could not readily duplicate on their own." Those with medical problems are often rejected by commercial insurers, he noted.

But those considerations are little comfort to some early retirees. Eloise Bolt, 56, who took early retirement in October 2002 from her job as an information technology project manager at TXU in Dallas, said that she was "really hurt and really angry" when her monthly insurance premium — which also covers her self-employed husband — soared from the $100 she had paid when she was working.

According to Ms. Bolt, TXU said that the $100 represented 20 percent of the total premium, and that on retirement after 24 years with the company, she would be paying 60 percent. But instead of rising to $300 or so, as she had expected, her monthly premium jumped to $659, and rose to $725 this month, with a higher deductible.

"The math does not work out," said Ms. Bolt, who abandoned her retirement plans and took a $9-an-hour job as a secretary to pay for the insurance.

Debbie Dennis, a TXU vice president, said that retirees' premiums were figured separately from those of active employees and then "segmented" within the retiree group according to age, length of service, medical history and actuaries' estimates of a person's future use of health services.

When TXU trimmed its retiree benefits at the start of 2002, the company announced that all employees hired since Jan. 1 of that year would have to pay the full cost of health benefits when they retired. Like other companies, TXU — which has 12,000 employees and 8,000 retirees — is encouraging younger workers to save for their future health costs. TXU is promoting participation in the company's 401(k) retirement plan. It matches employee contributions up to 6 percent of their salary.

"New employees can plan for these costs with money in their savings plan," Ms. Dennis said. "They will still have access to the lower cost of the company's buying power."

-- posted by Normxxx

Top 865. Feb 3, 2004 1:10 PM

» MarketVVizard - Trades

The covered portion of my NVLS short (from $43) was put to me for a nice profit. Uncovered portion is now showing a 24% gain (not bad for a few weeks work). I'm adjusting the stop to $34 to lock in those gains, but I've been amazed at the selling pressure in NVLS. To me this is an early indication of where tech and the economy is headed (SOX should lead everything else). Has the NASDAQ peaked? Time will tell, but its looking like it right now:

I will be using the next rally to open new short positions on companies that I believe will go bankrupt over the next 2 years.

-- posted by MarketVVizard

Top 866. Feb 4, 2004 5:40 AM

» Austrian - Re: Re: Re: The Beginning Of The End

In response to message posted by Normxxx:

Everyone's sinking in a sea of debt. So all of the CBs (Chinese and Europe excepted, so far) are opting for inflation. But 1-2 billion Chinese, Indians, and others looking for work are a vast deflationary force. How this plays out is anybody's guess-- we've never been here before. But it is an unstable equilibrium.

History is very unkind to these unstable equilibrium. Any book on bubbles or manias offer insight on how these types of excesses resolve themselves. The resolution is always difficult. The easiest read is Bonner's Financial Reckoning Day.
http://www.amazon.com/exec/obidos/tg/sim...

This is one of the foundation arguments for the secular shift into commodities, along with a declining dollar, industrialization of India and China, and substantial under investment in commodities over the last 20 years due to low prices.

My personal play, is similar to Faber's advice, finding the next big thing and sticking with it. Based on my secular shift posts of so long ago, I am long Gold, Silver, Natural Gas, Oil and forgetting them for a while.

Regards,

-- Austrian

-- posted by Austrian

Top 867. Feb 4, 2004 9:20 AM

» Normxxx - Re: The Beginning Of The End~~~

In response to message posted by Austrian:

There's the rub, you can't forget them. If deflation wins out, the prices of commodities will drop like a rock, as they did not so long ago.

-- posted by Normxxx

Top 868. Feb 4, 2004 12:11 PM

» pbradford6 - Re: Re: The Beginning Of The End~~~

In response to message posted by Normxxx

There's the rub, you can't forget them. If deflation wins out, the prices of commodities will drop like a rock, as they did not so long ago.

Those who proclaim inflation is just around the corner have been singing that song for over a year. The market just hasn't validated their position. A recent example:

I bought a 1997 Cavalier Chevrolet for my son 5 yrs. ago for $9,999.00 plus tax and license. He is still is in school, and I helped him again buy the same car with more standard equipment for $8,999.00! I had a GM credit card which gave me credit of another $1,370.00 making the price unbelievable low for a new 2004 auto. We sold his old car for $1750. to one of his friends.

I agree that there still exists the possibility of a real deflationary spell in the world's economy. That said, I don't know how that can happen when the Fed can continue upping the money supply until they realize their goal of reinflation.

If Austrian is correct and commodities are the place to be, does that hold true with residential real estate? I would like to believe in Austrian’s prediction so that I can purchase a more substantial home. Austrian, how about giving me a guarantee that residential property will continue to rise? smile smile

-- posted by pbradford6