Playing off of my last post on mutual funds, I wanted to say something about diversification. Wall Street, FA’s, and basically anyone involved with finance has increasingly banged into us the idea of diversification. It’s the old theory of “don’t put all your eggs in one basket”. While this is a great way to reduce risk, it’s also a great way to put a ceiling on returns. Take a minute to think about some of the richest people in the world, many of which happen to be in finance. Bill Gates–Microsoft. Carlos Slim–Mexican Telecoms. Warren Buffett–Berkshire Hathaway. The list is long as fuck, but you get the idea. All these guys were/are FAR from diversified. They focused on one area, and crushed it. While diversification is good for someone who can’t afford to lose, it’s not very useful for those looking to really make some money.
Why do you invest your savings? Not to have the smallest losses, but to have the biggest returns. If you hand your money off to a broker who is WILD good at trading options, why would you want him to invest some of your money in commodities? This isn’t to say you shouldn’t keep some money invested in safe assets, such as Treasuries/gold/low-volatility currencies, but if you think the tech industry is going to skyrocket, what’s the point of having 50% exposure to tech stocks and 50% exposure to say, utility stocks? Like life in general, you should stick to what you’re good at with investing. You can’t allow emotions to dictate your trades, and you can’t be good at every strategy. Speaking of which, just handed in some homework for an econ class, part of which was a problem about diversification. If I split my exposure to half China and half US, my expected utility is greater than just investing in the US! Dope! I think Jing Zhang woulda been pissed if I wrote “fuck that” as my answer.
Sarkozy: Do we know what we’re doing? Merkel: Shut the fuck up…
About two days ago I had a friend ask me for some help for an interview he’s got coming up. The guy he’s been connecting with sent him one of his weekly write-ups about the current economic/market conditions and told him that’s the sort of thing he’d have to start knowing. Here’s basically what I talked to him about (this will be a long post, I’m trying to be in-depth so anyone can follow).
For starters, the sovereign debt crisis in Europe is the most important thing going on right now. I’ll get into how it affects the US in a minute. Greece is the most likely default case of anyone right now, as CDSs on greek debt have about a 450 bp spread (i.e., expensive as shit to buy those CDS’s, b/c there’s a very high probability of default). The ECB/IMF/EFSF (European Financial Stability Facility) are continuing to pump money into its bond markets, as well as Italian, Spanish, and Portuguese bonds. Whether they think Greece will ever be able to repay this debt is almost irrelevant (they won’t), so these cash flows are being used to keep rates from ballooning and to stop a full on default. Worst case scenario is Greece defaults, which triggers CDS payouts (not good for the US), margin calls, and significant flight from European sovereign debt. The last part of course could see defaults by more important countries such as Spain and Italy, but that is less likely (I refuse to say highly unlikely b/c as you can see this shit has never really been seen before). The main problem is European banks, who hold a huge amount of these sovereign bonds. If we see a restructuring of sorts, or huge drops in bond prices, these banks will have to make enormous writedowns. After this, further possible events include major drops in equity and bond prices of these banks as investors flee from fear the banks will have liquidity, or even solvency issues. This of course is a classic self-fulfilling prophecy: investors fear they’ll lose big from these banks, so they dump them, which of course causes the actual problem they feared in the first place.
The US comes into this directly in two ways. First, US banks have written a colossal amount of CDS’s for European banks over the past 3-4 years. As of early July, we’ve sold $34 bln, $54 bln, and $41 bln in Greek, Irish, and Portuguese debt CDS’s alone. That’s not even counting CDS’s on European banks. If there’s widespread default (again, unlikely, but possible), then the US will be losing BIG on those payouts. The second way is economic rather than financial. Europe is one of our main trading partners, and if they enter a recession (probably will), we’ll be taking a big hit in export losses and possibly face import shortages as production slows down there. This also ties into emerging markets (esp. China), as expectations are quickly rising that we’ll see a pretty hard landing in a year or two. In other words, nearly every country is facing stagnant (or negative) growth for a few years, which… is bad.
For those who’ve wanted to actually stay in a good mood, and therefore haven’t watched the news in awhile, the main political/economic topics right now are the US debt level, and our struggling economy. Before I get into this, let me make on thing clear: you cannot solve a debt crisis in a recession. Whether or not the media/politicians have been playing up the debt situation, I really have yet to see any issues arise from the ACTUAL debt level itself. Obviously the track we’re on is unsustainable and blah blah blah, but I’m talking over the course of a couple years. Our gov’t is having no trouble at all borrowing money; the 10YR Treasury is still sub-2%… from a buy&hold/investment standpoint that is absolutely outrageous. It just goes to show that when the world is freaking out, everyone looks to the US.
As much as I hate to say it, the real issue is the political system. I’m not saying we need to raise taxes or cut spending or whatever the buzzwords are right now, I mean the political process is absolutely KILLING our economy right now. It took over half a year for the debt limit to be raised, literally up to the last possible moment. The next day, BAM! Equities plummeted and Treasury yields approached record lows (and to my utter disbelief, reached those lows a few weeks later). This of course wasn’t expected, as the pundits had been chirping “yields will pop as the world realizes we can’t repay our debt!”. Bull. Fucking. Shit. This isn’t a series of graphs relating debt levels to interest rates or whatever, this is real life. What’s more, we have an entire year before election season, and you can bet your sweet ass no politician will be willing to make the tough decisions if it means pissing off their voters.
The debt ceiling squabble was one of the most atrocious displays of leadership I’ve ever seen, and I’m not exaggerating. The hard decisions weren’t even close to being made. If I remember correctly, we raised the debt ceiling by about $1.5 trillion and promised to cut about $2 trillion over the next 10 years. I don’t even have to do the math to see that $2 trillion over 10 years is a joke when we’re projecting a $1.5 trillion deficit in 2011 alone. If anything, all we did was push the decisions off for another few months. The debt level itself isn’t the immediate issue, it’s the perception that our leaders are unable to make the necessary decisions to get the US on the right path.
This perception is twofold. On one side we had non-stop political bashing occurring all summer long, with both sides bickering over what should be cut, what’s off the table, and who’s to blame for our national debt’s recent surge. On the other side, we have a country who is on the brink of relapsing into recession (sidenote: I don’t know why, but I think the term double-dip is so fucking stupid). Unemployment is STILL above 9%, and won’t return to normal levels for awhile. What’s more, I believe the drop we’re seeing in equities is due to people realizing the Fed has run out of bullets. Which is another way of saying that their policies aren’t doing what they said they would. Rant:
Let me get this straight. The Fed is making sure rates stay low, which is a good thing to have. But jesus christ have you not opened your eyes? I’m usually agree with the Fed/Bernanke, but what the fuck. Rates are at all time lows! And nobody is borrowing! Not only are rates at all time lows, but they’re there without your doing. People aren’t arbitraging Treasuries, they’re using them as a bank. If we have another international recession, Treasuries are gonna continue to be the safest asset. So what is the point of more bond buying? Does buying the 10YR down to 1.85 from 2 and the 30 from 3.1 to 2.9 really do anything? Rates are there. Save the ammo. God damn.
Alright back to the main point, bulls are currently pointing to corporate profits and equity levels as the main reason why we shouldn’t end up in a recession. I think that that is exactly why we’re entering a recession. Corporations are preparing for the worst by hoarding cash and laying people off. The majority of them will weather the storm to come, but people as a whole are left out to dry. If everyone is scared to lose their job, they’re gonna take whatever pay they get and hold onto it. Which, ya know… doesn’t help the economy grow. The uncertainty that’s clouding everything is all hanging on one major thing–Europe. People are waiting for Merkel/Sarkozy/anyone to come out and save the day. Obviously if they had the strategy to end all strategies for fixing the European debt crisis, we’d have heard about it already. As of today, Germany has said they’re capping their bailout funds at 221 billion euros, which gives the EFSF about 450 billion euros when recapitalization is needed (for both banks and the various countries who will undoubtedly need them).
I’m pretty lost right now, so I’m just gonna end this here. I’ll go back and go through each area more in depth throughout the next week(s), but this is a dece start. As you can see, everything is connected, even more so than 4 years ago. My prediction: we’re not gonna see an end to this until the EU is literally on the brink of collapse. That’ll be an interesting time… hopefully I have a job by then.
Bernanke mentioned in yesterday’s speech that further Fed action might be required. Basically, the recovery is slower than expected. Some sectors are growing while others remain stagnant, things are not that dopies right now, but should be getting more chron in the next two quarters. Today’s 10-year note auction produced a yield of 2.967. The drop also caused the May 10-years, which yield 3.125, to be pushed up 1/4 to 101 11/32. Justin Lederer of Cantor Fitzgerald said, “With the future uncertain, investors are grabbing as much yield as possible, even if we aren’t at amazing yield levels. The market is playing it safe right now.” Ya, that explains it. The bid-to-cover today was 3.23, above the average of 3.09.
Dogshit numbers over the past couple weeks have been dominating equities. The Dow closed 21.87 points lower than yesterday, at 12,048.90. The S&P fell another 5.38 points to 1,278, with a lot of people saying 1,200 could be a dangerous level and could prompt a sell-off. Let’s fuckin’ hope not. It’s gonna be interesting to see what happens when QE2 wraps up this month. The 2-year/30-year spread was down today to 3.83 from 3.85 yesterday, the high since March. The prospect of continued low interest rates has been pushing this spread as the economic data has supported continued Fed intervention. For clarification, people are continuing to buy more 2-years than 30-years on the hopes that QE will be extended and prices will go up, which widens that spread.