A good day to awaken the sleeping giant

Today is a good day to awaken the sleeping giant.

Despite the years I spent as a Canadian, a not always comfortable neighbor of the Americans, I can say without reservation that the Americans can do almost anything that they together set their mind to. It is true there are a great many challenges facing our American friends and some appear daunting. Yet, theirs is a young nation, barely an adolescent among nations, and like a young lion moving out on the field, bloodied by battle though it may be, it is vigorous and strong. The only limitation of its capability are the willpower of it's people and the imagination of its leadership.

As a leading nation in the global community The United States carries a great responsibility and with it a great burden. Their economy is a pace setter in the global context. In that context they have created their current difficulties and sent them out into the world to as a plague. They have also been the engine of tremendous productivity upon which rest many of the most fabulous opportunities to further the human condition in a way almost unprecedented in history.

Today the US stands at a crossroads there are decisions which need to be made which will set the tone and lay a foundation for the next fifty years. Fortunately The U.S. has a new leader who is prepared to call on America’s better angels and best legacies, calling on Americans to dig deep and together build the kind of nation, and world, that their forbearers envisioned.

The American dream is not only American. We have the global opportunity to achieve improvements in trade and prosperity which underpin the opportunities for peace and human rights the world over. If we have the imagination to undertake the journey, we can achieve a global village where people are free to travel and trade and prosper. If we have the wit we can include all of humanity in the spoils of the real war; the war on poverty, ignorance, pollution and disenfranchisement of peoples globally.

In recent years there has come a growing awareness that world-wide we breathe the same air, drink the same water and consume the same resources. If there is a lesson to be learned in the current financial crisis it is that we also share and rely on a global economy. To solve the economic woes of the world we must work together to rebuild the confidence to move our global economy forward and distribute the benefits globally.

The United States has come through a dark period, it has been a period where the government of the United States has preyed on the fear raised by terrorism, restricting human rights and sweeping the wealth of nations into ever fewer hands. It appeared for a time that “the land of the free and the home of the brave” was in danger of becoming instead, the land of the chained, and the home of the scared.

Rather than inviting his nation to rise up and meet the challenge, their former leader ordered the building of walls and encouraged Americans to cower behind them. It has been a time when the resources of that proud nation have been committed not to the greater good but the greed of an elite few.

When President Obama speaks to his people of sacrifices and hard work ahead; when he conjures up the images of the tremendous achievements of his nation in the face of past difficulties and says “yes we can” he is calling for the waking of the same sleeping giant that Admiral Yamamoto feared on the morning of the Pearl Harbor attack; The tremendous spirit and will power of the American people. He is calling on nothing less than the collective power of human potential working together for monumental achievement.

It is indeed time to awaken the sleeping giant. It is time that governments and peoples right around the world pick up their tools and set about building a better future, awakening the human potential, working together to invite our global village to a feast where the is none denied a seat.

Media drives Pyschology, Psychlogy drives markets

If you can create the belief that there will be an economic collapse, you can in fact create that collapse. Psychology rules markets; modern communication creates un-unprecedented linkage in global media. Global media drives global psychology. Media hysteria triggered by the meltdown of the housing market in the US has created an un-unprecedented global financial slowdown. The meltdown itself was a localized phenomenon which does not even affect all U.S. Markets uniformly.

As a result of this media barrage, consumer sentiment worldwide is at or near historical lows, even in countries which have solid fundamentals and are still doing well. If consumers believe there will be a recession they will withdraw from the market and bingo, you will have your recession.

I have been living in Hong Kong these past several years. When I look back at Canada based on the statistics, I see a country which is in sound financial condition. I see a banking system respected as the srongest and most liquid in the world; I see a government which has pursued a stable course and an economy which has proven remarkably stable; I see a country with solid fundamentals.

While I was in Canada over the recent Christmas season I was surprised to find people experiencing a level of fear and concern completely out of sync with these realities. I noted the lemmings of the press jumping headfirst into their prognostication of disaster; I came to the realization that Canadians are so exposed to US media that they seem unable to separate their own news from the noise.

It is true that there is reason for concern as Canada’s largest trading partner is in a period of upheaval and economic restructuring. It is also true that Canada remains well positioned and is very competitive as the currency has softened along with commodity prices. Going forward even the most negative projections see unemployment remaining below historical averages and the recession, if it turns out there is one, looks to be shallow and short lived in Canada.

The meltdown in U.S. real estate and financial markets is not really a cyclical event but rather is the result of failed policies of the Bush and Republican administration driven by the Freidman based neo-conservative agenda.

The concept that the market would be self regulating assumes that the government will not interfere before, during, or after markets correct which has been proven false by a government which intervenes before, during, and after market corrections.

This is not surprising as no one can realistically assume that the government will not attempt to control the economy using monetary policy. Further, in a modern media environment what government would be willing to stand still for starvation and dislocation of the masses leading to chaos, rather than intervene to protect it’s tax base, population, and political survival?

International ratings agencies have made the statement that they have maintained the highest rating on U.S. government debt on the basis of thier faith the U.S. Government would provide the economy support required to protect thier tax base. A statement of faith which seems vindicated with the ongoing series of interventions and bailouts.

The newly minted U.S. administration is preparing to deliver on a dramatic restructuring of the U.S. system from pensions to healthcare and infrastructure. Crafting a much needed “new deal” to re-invigorate the middle class and put the country back on a solid footing to return to a growing economy.

Fortunately for Canadians the last decade and a half of fiscal restraint, paying down debt, pre-funding retirement and pension plans and running surplus budgets have put Canada in a good position to weather the storm from the U.S. and remain on stable footing.

One of the most important things to remember is this: Over the longer haul fundamentals always win out. Yes we go through periods of hysteria when the fundamentals of value seem to be lost. Yet, always at the end fundamentals win out. When markets rise too rapidly the bubble bursts and markets again seek to find fundamental values, similarly when markets overshoot and are oversold they tend to rapidly advance before calm returns. If you are watching fundamentals you will see lots of opportunity to profit.

You can be certain that if you continue to invest in and hold investments which are based in strong fundamentals you will reap the harvest you need over time. No one can predict market timing but experience shows that investors who attempt to time the markets are usually out of the market during the rapid recovery periods after the markets bottom. If you are not in the market you do not gain the advantage.

If you are looking for action items for these times, they are counter intuitive. Buy when other are selling; Always invest based on fundamentals; Don’t be a media or news driven lemming, selling along with the crowd; Evaluate opportunities based on fundamentals, especially when the pundits are ignoring them; Save when others are spending. Take the long view even when the press says the world will end tomorrow; and finally to quote Kipling “keep your head when all of those around you are losing theirs ”. Remember that time is implacable, whether it is your friend or foe depends on you.

If you do these things, no one can guarantee you will win all the time, but on balance you will win, and you will win big...

Market Meltdown, What went wrong

Global Markets June 2007 – Oct 2008 what went wrong?

The debacle in Global equity and financial markets which unfolded between June of 07 and October of 08 was brought about by four major fundamental problems. The problems during this cyclic event series were not new.

The fundamental problems were a hyper inflation of energy costs due to speculation; Failures in regulation by local, state and federal regulators in the United States and elsewhere; Unmitigated and unregulated risks in the trading of long term ( mortgage backed) securities financed with short term paper and pressure on the American economy from deficit spending and the Iraq war. These primary factors played out in the market to bring about a once in a century financial debacle in global markets.

The global media effectively stood in the theatre yelling fire adding their own hysteria to spreading panic and mayhem, ensuring that the conflagration would spread to grip as broad a population as possible. There is no news value like blood in the street.

“Deregulation at any cost; political dogma left markets vulnerable… and the wolves watching the sheep.”

Conservative thinking has long favored unfettered competition and insists that the government should maintain a minimalist approach to any intervention in the “free market” economy. Deregulation at any cost; this political dogma unfortunately left markets vulnerable, and the wolves in charge of watching the sheep.

A dogmatic anti government and regulatory environment fostered by the outgoing Bush (league) Administration has left segments of the U.S financial markets virtually unregulated. The non bank players in the capital commercial paper and bond trading markets are almost completely unregulated. Changes in the capital requirements for Investment dealers and investment bankers during 2005 allowed for dramatic increases in leverage while reducing capital requirements. At the same time financial institutions were allowed to begin monitoring their own compliance with capital requirements and risks to their capital position rather than being subject to government staff audit.

Investment dealers and investment bankers suffering pressure on revenues from online trading, low cost brokers and banks entering the trading business, turned to securitizing mortgages and other long term income securities packaging, selling and trading the resulting derivatives. The distribution of these securities throughout the global banking and investment banking system multiplied the leverage on already higher risk securities.

Huge portfolios of increasingly risky subprime securities were held as an increasing component of more heavily leveraged capital of investment bankers, hedge funds and other market participants. Investment bankers and other market participants financed these long term securities with inexpensive 30 and 90 day short term commercial paper. Doubling up on the underlying leverage in the securities and compromising the capital of every institution holding the securities. Due to negligent regulation this increasing risk was neither recognized nor disclosed.

“Borrow and spend economics has led to record deficits and has put the American economy under continually increasing inflationary pressure and economic drag across the past five years.”

Conservative rhetoric would suggest that when Republican governments have control the government would lower taxes, control speeding and govern over a favorable economy with expansionist tendencies which in turn would be self-regulating and bad actors in the economy would be punished with economic pin or failure.

Unfortunately Republicans also favour huge military budgets and of course this also allows, or causes military adventurism which has been exhibited almost constantly during the last five republican presidencies. While Republicans accuse Democrats of tax and spend economics, the outgoing Bush regime actually drove through tax cuts while presiding over and unprecedented increase in military and other federal government spending. As a result, borrow and spend economics has led to record deficits and has put the American economy under ever increasing inflationary pressure.

As the cost of the war and other negative effects of the “borrow and spend” driven deficits were applying increasing drag on the US Economy. To prevent or defer the damage from these policies the US federal has pursued a low interest rate policy to overcome the increasing economic drag by supplying high levels of liquidity to the financial markets though the sale of US Treasury bonds in addition to maintaining very low overnight lending rates. While added liquidity normally will spur growth it also expands the money supply and adds to the inflationary pressures in the economy.

“The speculation based oil price spike removed all elasticity from economies round the globe.”

Though the global economy appears to be a series of unrelated events and activities, in reality billions of participants engage in economic activity based on the inter-relationship of a large number of related factors and drivers.

Energy costs are a primary factor of all economic activity. When energy costs rise far enough outside a normal trading range, the global economy cannot sustain growth and begins to slow. If the cost of energy rises far enough the global economy will go into shock and rapidly contract.
Whether a price shock is caused by supply constriction, (such as during the Oil embargo and the formation of the OPEC oil cartel during the 1970s) or with rampant speculation, (as occurred during the run up of oil prices during 2007-08 from $75 per barrel to $140 per barrel) the results will be the same.

Over the past eighteen months the inflationary pressures on food supplies and all other commodities were driven in large measure by energy costs. The speculation driven oil price spike removed all elasticity from economies round the globe as resources were redirected from growth and investment to consumption as the costs overtook free cash flow in the economy bringing the threat of a recession to the US economy. Any recession in the US economy will normally result in a global slowdown.

This is not unprecedented. During the early 1970’s a similar oil price shock shook the world’s economy and ushered in an era of rapid inflation, economic dislocation, high unemployment, followed by a stagnant global economy combined with inflation ( stagflation) and huge increases in government spending and deficits.

“The spike in the cost of oil was the trigger bringing down the house of cards.”

The problems in the mortgage and housing market and the underlying economy in the US were the result of deficient regulation and the constant increase in the money supply required to maintain growth in the face of the increasing drag on the US economy caused by “borrow and spend” economic policy and military adventurism. A triggering event was required to begin the slide. Over the past 18 months the spike in the cost of oil was the trigger bringing down the house of cards.

The US economy was already under severe stress and, as a result of high mortgage debt loads there was very little elasticity left in the economy. When the dollar fell and high gas prices began to impact American consumers, the economy immediately began to lose steam.
Once the slide began the underlying problems in the economy impacted consumers and began to trigger defaults and foreclosures of mortgages the housing market prices softened sharply. Predictably the riskier mortgages were the most subject to failure and the sub-prime mortgage meltdown was underway.

As the number of foreclosures rose, the number of distressed sales in the market undermined real estate prices dramatically. This resulted in more borrowers walking away from mortgages where the property was suddenly worth less than the mortgage. Due to the combination of high debt loads and falling prices, consumers could no longer finance their way out of trouble. The situation reached a threshold where the rising number of foreclosures and falling real-estate prices undermined the value of sub-prime mortgages as a class.

Prior to large scale securitization of mortgages which began during the past decade, mortgages tended to be traded only between industry participants and mortgage backed securities were traded on a much more limited basis, primarily between institutions involved in the market. With the aggressive securitization of mortgages a greater specter was unleashed. The securitized mortgage investment products were sold far and wide as being low risk mortgage investments rather than the highly leveraged derivatives they really were.

“A progressive collapse of global financial markets, stopping this juggernaut will require the sustained and combined efforts of governments on a global basis…”

The regulatory shortcomings and unforeseen and undisclosed increasing risks of derivate trading combined with aggressive increases in liquidity as a monetary policy to combat the slowing effects all combined to weaken the US Economy and set the stage for a collapse. When the price of oil and other commodities began to spike the US economy began to stall. A progressive collapse of global financial markets triggered the stall and near collapse of the global credit and banking system. Stopping this juggernaut will require the sustained and combined efforts of governments on a global basis.

When the stalling US Economy exposed the underlying problems in sub-prime mortgages and the resulting foreclosures began to climb in earnest, this stall initiated freefall in the mortgage and housing markets causing increased foreclosures of prime mortgages as more and more properties were valued at less than the mortgaged amount. Even in the case of prime mortgages. As the number percentages of foreclosures caused massive write-off’s the entire class of mortgages and real-estate backed securities came under threat. In the global financial system real-estate, mortgages and mortgage backed securities are the most widely-held securities because they are generally the most secure of investments other than gold. Thus the very foundation of the global financial system was brought to the edge of a cliff.

“At this point, accounting rules and banking capital rules designed to protect the system actually became the engines powering the nosedive.”

To protect depositors and investors, worldwide banks and financial institutions make daily calculations of their capital position and are regulated on minimum capital requirements, they must report any deficiency. Accounting rules require that any publicly traded security must be included in these calculations (marked to post) at the market closing price on a daily basis.

As a result of massive holdings of these securities in the underlying capital of banks, insurance companies and other financial institutions, when the weakest of the players were forced to liquidate portfolios for pennies on the dollar, all of the players saw the immediate vaporization of the value of the underlying mortgage securities in their portfolios.

As the shares of financial institutions are traded on the basis of their capital strength and resultant earnings ability, the value of the shares of these institutions fell dramatically aat the same time as they were in a position needing equity to shore up their balance sheets and finding it increasingly difficult to raise.

In a global trading environment, US mortgage backed securities are held in large positions all over the world. As the US is the largest economy in the world, the size of these securities

holdings represented a very significant percentage of the portfolios of financial institutions. This was especially true of the British and European institutions Further. Britain and the EU have pursuied similar economic and deregulatory policies under conservative governments following the American lead over the last decade. As a result, although the underlying economies of EU and British economies seem sounder their financial systems were under the same threat as the US system.

“If Lehman brother’s could be allowed to fail, no institution was safe”

After the collapse and sale of Bear Stearns the financial system was dangling by a very thin thread. Although the capital of many institutions was under threat, the markets generally remained confident that The US Government would prevent the collapse of major financial institutions. When the US government stood by over that fateful weekend and neglected, failed or otherwise, made the decision not to prevent the bankruptcy of Lehman Brothers a new element was introduced, terror.

If an institution as large as Lehman Brother’s could be allowed to fail, no institution was safe, as the underlying market for securities continued in a full power nosedive. In this moment confidence in the major banks was shattered and the credit system which underwrites world trade stalled and was nearly shut down as banks could no longer trust each other to complete credit and loan arrangements between themselves. This was an unprecedented moment indeed!
How the American authorities could have failed to recognize the effect of their inaction is unfathomable. It was not the first ,and by no means the last evidence of stupidity, cupidity and political dogma blurring reality on the part of the US Government.

Had they stepped in and prevented the Lehman bankruptcy they probably could have avoided or reduced the size of the various bailout packages which governments have needed to apply globally to recover confidence in the system. If you stop a fire quickly it avoids it racing out of control. On that weekend the US government failed even to make the attempt to snuff out this blaze.

The incredible volatility, the temporary stall in the credit markets, the deepening prospect of global recession as a result of the loss of trillions of dollars of wealth by billions of individuals and the requirements for massive interventions are the price we all pay for the failure to prevent the collapse of confidence in the financial and credit systems.

It is not useful here to further detail the technical processes by which the market was turned on itself and, in a fit of panic, completed the work of undermining confidence generally. It is enough to say that when the pillars of the economy were tossed and shaken in the dark moments on the trading floor it was every man for himself. Like a flock of lemmings the brokers, managers and traders followed each other into the drink. Valuations and fundamentals have been completely ignored during the carnage.

In order to support values at the current there would need to be a drop of profits a magnitude greater than there is any realistic probability of seeing. In fact solid blue chip companies often bear the brunt of damage in a panic because these are the companies with sufficient liquidity to be able to be sold in a panic.

“The global media effectively stood in the theatre yelling fire, adding their own hysteria to spreading panic and mayhem, ensuring that the conflagration would spread to grip as broad a population as possible. There is no news value like blood in the street.”

What passes as financial news is really nothing more than sensational editorial and analysis of sort term and day by day trading trends which are irrelevant to anyone who is not in the market selling on a given day. I suppose it is useful to know when there is a sale on the shares of good companies, however we really don’t need people yelling fire in crowded theatres panicking the crowds, raising hysteria and turning the crowd into a mob.

Looking on the bright side of the financial storm we have suffered, and still are enduring, for long term investors economic and market fundamentals will eventually win out. Companies of value will continue their march forward recovering lost ground and move on to new highs. There will be both winners and losers as a result of this period and the winners will be the ones who own the stock as the markets recover.

If there we a single piece of advice I would offer to the average investor it would be shut off the economic news, there is little entertainment value in the editorializing and short term thinking which passes for analysis and dominates this segment. It will at best give you heartburn and at worst spur you into doing something stupid. Yes if you really need to sell you need to be paying attention, however it is more than a little late to be selling now.

If your investment horizon is less than five years, you generally should not be investing in the stock market because you are gambling rather than investing. The problem is that hindsight is always 20/20. Yes it is possible to see the causes of the market debacle we have been enduring, after the fact. Yes it is useful to understand why it happened. I t may help you to see the signs at some future time.

Looking forward however is probably more useful. Remember, over the long haul fundamentals will win out, they always eventually do. Your best course of action as an investor is to buy value in investments, whenever you can afford to, with moneys you can afford to leave untouched for periods of at least five years.

“The fundamentals for continued global economic expansion in the long term remain in place and, as always, fundamentals always win out in the end.”

What went wrong? The adage “those who refuse to learn history are destined to repeat it” is as apparent as ever. When governments and regulators ignore their responsibility to act as referee’ end ensure prudent policies of disclosure and oversight; when fraudulent and deceitful practices are tolerated as in the granting of mortgages beyond the value of properties and there is no enforcement of existing rules; when speculation is allowed to run unfettered even as the market participants recognize that speculation rather than value is driving the market; and when governments and regulators take no steps to reign in the speculators and protect the general societal interest., the results in the market are carnage, mayhem, panic and yes in economic terms “ blood in the street”.

Another result is unprecedented opportunity for every one left standing. The fundamentals for continued global economic expansion in the long term remain in place and, fundamental value always wins in the end.