This past week’s approximately $2 trillion pledge of support for their financial markets by the Europeans has stabilized the global financial markets somewhat. Commercial paper and LIBOR rates have fallen a bit. All is not well however. US mortgage rates rose by a half per cent. This may further weaken the housing market and send another tsunami wave through bank balance sheets.

By the way, if the Europeans are going to spend $2 trillion to “fix” their financial problems, how in the world will a measly $700 billion fix the financial problems in the US? After all, the US is the epicenter of the financial earthquake. US taxpayers should be prepared for at least a $5 to $7 trillion bill.

Houston, We May Have a Problem

I believe there may be a major problem ahead that most people in the financial markets are ignoring. In order to pay for the trillions of dollars the US will need for a financial bailout, the government will need to sell Treasuries. The majority of Treasuries are bought by foreign investors. I question whether they will show up at the Treasury auctions.

After all, foreign countries have major funding needs of their own. The huge European bailout package means that the Euro zone countries will need to sell lots of their own debt. With the growing global slowdown, Asian countries, such as China, will be trying to prop up their own economies with massive infrastructure spending. Will any of the foreign investors who normally buy Treasuries show up or will they be too busy funding their own countries needs? If they don’t show, the US will have to simply “print” the money to purchase the Treasuries. Can you say inflation? 

Wall Street Management?

I read with amusement this week the scathing farewell letter from hedge fund king, Andrew Lahde of Lahde Capital. Mr. Lahde is retiring on top, being one of the very few hedge fund managers to have foreseen the mess we are now in. One of his funds last year returned an amazing 870%! In his farewell letter, he blasted the “idiots” who were running the big banks.

Mr. Lahde hit the nail on the head with his description. Instead of choosing policies that favored the long-term growth and stability of their firms, Wall Street management chose policies that maximized short-term profits and damn the future. By maximizing short-term profits, management made sure they hit all the incentive-laden targets to increase their own compensation.

We are all going to be paying heavily for the greed of Wall Street management. What gets me even more angry is their arrogance. Not one of these executives has the chutzpa to stand up and say what they did was wrong or to say they’re sorry. Perhaps Elton John had it right when he sang, “Sorry seems to be the hardest word”.

Financial Panic

This Wall Street mis-management has led to chaos in the financial markets. Make no mistake, we have been living through a full-blown financial panic. This panic compares with the big panics of the last century, in 1907 and 1929. This panic has much in common with the great banking panics of the past. As in other past panics, the poor quality of lending in the preceding boom has been revealed.

What occurred in prior financial panics should sound familiar to us. Prior panics have included rumors of foundering financial giants, the flight to the highest quality and most liquid credit instruments, concerns about counterparty risk, the wholesale dumping of (supposedly) riskier assets regardless of price, international contagion, and a heightened sense of the fragility of the entire financial system.

The only difference between our current financial panic and past financial panics is that our modern- day financial system is more complex and more leveraged than in the past. For instance, the panic of 1907 was cured by one man – J. P. Morgan. It would be nice to have a J. P. Morgan solve our problems today, but that is no longer possible.

Do What Warren Buffett Says

There is nothing we can do now about the past misdeeds of Wall Street. We, as investors, have to figure out what to do now with our money.

The recent dive in stock prices certainly is harming the long-term case for stocks. If you adjust for inflation, the S&P 500 index is back to where it was in June 1997! I believe this confirms what I have always told people my entire career – never invest in a S&P 500 index fund. An index fund is just a lazy person’s attempt to get rich. It just does not work. An investor has to put forth effort in order to be a successful investor and spend time doing research like we do here at Oxbury Publishing.

I challenge anyone to show me a successful long-term investor that became successful by investing in a broad index fund. Speaking of successful long-term investors, Warren Buffett wrote an op-ed piece for Friday’s New York Times. In his piece, Mr. Buffett told investors that he is making long-term investments into American companies with his own money right now.

I believe that Mr. Buffett is correct. This is an excellent time to begin accumulating shares in high-quality companies. The one addition I would make to what Mr. Buffett said is that I believe that there are even bigger bargains available in foreign stock markets, particularly the emerging markets.

Contrary Indicators

There have been some contrary indicators which have appeared recently that have me thinking positively about the future direction of stocks. One obvious indicator is CNBC’s Jim Cramer. When has he ever been right in the long-term? He recently told people to get out of the stock market if they need their money in the next five years. I immediately thought – “Gee,maybe the market will bounce back sooner than I thought!”.

Then there is the recent massive liquidations of all sort of mutual funds by investors. In fact, Trim Tabs said in mid-October that liquidations for the month of October were the highest ever for any month since their records began. That panic selling is definitely a positive indicator to me.

I have also heard anecdotally that some people, instead of rolling over their 401k from a previous employer to another custodian, are simply cashing out their 401k distribution. These people are paying the taxes, penalties, etc. and taking the cash! The reason? These people are terrified of all the financial institutions and financial markets. If the dumbest of the dumb are doing this, I feel that better days for equity investors are just around the corner.

Tony D’Altorio
Analyst, Oxbury Research