WHY SAY THOSE THINGS ABOUT CHINA?
We did not like the tone of Treasury Secretary Geithner who recently quoted President Obama’s statements against China in his answers to congress’ questions…neither did the U.S. Treasury bond market.
The Obama administration’s anti-Chinese rhetoric was answered by China and Russia at the World Economic Forum last week in Switzerland. At that event, both Chinese Premier Wen and Russian President Putin railed against the U.S. mismanagement of its financial affairs, which has led to the global banking crisis and economic suffering around the globe.
This rhetoric on both sides sounds disturbingly like the precursor to a trade war. Investors should keep in mind that there are political elements in every country which are economically short sighted, and want protectionism to further the financial goals of their membership. There will be intense lobbying for such an outcome for groups all over the world. The question is whether politicians answer the siren call of protectionism.
We expect to see more social disruptions, mainly in Europe, and less in Asia, as more people lobby for protectionism. Already, France and Britain are having anti-foreign worker rallies…we all know blaming foreigners is a very old and disreputable political trick.
If trade wars break out, then there will be a long depression probably followed and exacerbated by a runaway inflation. The inflation has the potential to bankrupt many and cause widespread suffering among the middle class. A good example of this was the inflation experienced during Weimar Germany after World War I.
Throughout history, there have been several cases where the desperation of the middle class creates social upheaval, and gives rise to "a man on horseback", one who can lead the people out of misery and to increased power and prosperity. In the 20th century alone, several such men (Mussolini, Hitler, Franco, Lenin and others) came to power during times of social upheaval and economic dislocation. These men often rose to prominence by mythologizing the past of their nation, and making it appear that the nation had to reclaim their rightful place as a leader in the world order. Looking to regain national dignity and respect, the people rallied behind the "man on horseback" whoever he was, and granted him authority to create change. In general, nationalist, protectionist policies tend to erode the standard of living, and can wreak havoc on economies…in any country.
IF YOU WANT A GOOD LAUGH, GO BACK AND LOOK AT THE U.S. GOVERNMENT’S OFFICIAL ANNOUNCEMENTS OF INFLATION AND GDP DATA, AND THEN CHECK THE SUBSEQUENT REVISIONS.
Most respected economists expected a 5-6% decrease in GDP in the 4th quarter of 2008. The data came in at 3.8% because it was boosted by a rise in inventories of goods that were produced but not sold in the quarter. Clearly, a build up of inventories that are not sold is a bad economic data point. This time, the government used it to boost a flagging GDP report. If one excludes this adjustment, GDP fell by 5.1% after inflation in the quarter.
The GDP growth rate has fallen from its peak by more than 8 percentage points. It is just a matter of time until economists, many of whom use the rule of a peak to trough decrease of 10% in GDP to define a depression, will be admitting what we have been saying for quite a while…this is a depression.
IF WE ARE LUCKY, THE DEPRESSION ENDS IN EARLY 2010. MORE LIKELY, THE DEPRESSION ENDS IN LATE 2010.
IF A SERIOUS TRADE WAR BREAKS OUT, THE DEPRESSION COULD LAST FOR MANY MORE YEARS.
It is not fun to say, and not fun to hear, but we believe that the truth trumps "break it to them gently" political verbiage.
IN SPITE OF THE BAD ECONOMIC OUTLOOK, WE EXPECT RALLIES OF 25%, AND PERHAPS A FEW RALLIES OF 40% AS THE MARKET CONTINUES ITS DECLINE.
During the major decline in the U.S. market in the 1930’s, and in the Japanese market in the 1990’s, many rallies occurred. It is common for declining markets to put on frequent 25% rallies and the occasional 40% rally. I believe Japan had 13 rallies of 25% and 5 rallies of 40% during their 13 year decline.
We suggest investors try to use these rallies to their advantage…but remember be alert and very quick to take profits. The rally that began in the U.S. after bottoming in November was one of these. Now, the market is again getting oversold and we would not be surprised to see another U.S. and Asian stock market rally begin soon.
In our opinion, these are only rallies and not new bull markets. Take some trading profits but remember that the big market bottom has not occurred yet.
We continue to hold gold shares as the safe haven investment while more and more countries report financial problems. As a currency comes under attack (think Iceland, Britain, and others), people flock to gold, the ultimate currency. They sell the local currency and seek the safety of gold. Thus far this year, gold shares have greatly outperformed the market (as measured by the S&P 500) which was down 8.4% in January. We see forthcoming opportunities to trade U.S. and foreign growth stocks as the occasional 25% market rally develops. We do not see a long term market bottom for a few more quarters, and thus we see no long term investment opportunities apart from gold. We do, however, see profit opportunities in gold and in trading opportunities on both the long and short sides.
Our largest investment position continues to be cash held in Tbills and other conservative interest bearing instruments.
IT IS TIME TO REVISIT THE CUSTODY/BROKERAGE ISSUE
WHAT HAPPENS SHOULD THE FINANCIAL INSTITUTION THAT HOLDS YOUR ASSETS BECOME INSOLVENT?
In several of our letters last year, we discussed the issue of account custodianship, encouraging investors to understand the account agreements and investor protection provisions with their financial institutions.
Most U.S. bank account holders are very aware of FDIC and the up to $250,000 insurance it provides on bank deposits. Correspondingly, U.S. brokerage account holders have Securities Investor Protection Corporation (SIPC) insurance insuring their deposits. SIPC’s limits only protect account holders up to $500,000 (up to $100,000 cash and up to $400,000 in securities). For larger U.S. brokerage account holders, the firms usually provide some sort of excess SIPC insurance. Many U.S. brokers and investment banks used Customer Asset Protection Company (CAPCO), a company set up by a consortium of brokers to provide insurance on customer deposits above the SIPC’s $500,000 limits.
We have always doubted that a group of brokers could insure each other if the entire system were stressed. It comes as no surprise to us that after the Lehman Brothers bankruptcy, CAPCO has announced that they will not renew their brokerage firm surety bonds when they expire on February 16, 2009. So, as of that date, CAPCO’s member brokerage firms will have to get excess SIPC insurance from some other carrier.
At Guild Investment Management, we spent many hours with our attorneys, reviewing several firms’ brokerage and bank account agreements. The bottom line is that while governmental insurance is better than it was, it is not sufficient for larger depositors. Our preference is to choose a custodian where depositors’ assets are held in trust/custodial accounts, and not on leveraged balance sheets of financial institutions, nor lent or pledged to others.
If you are an investor with accounts that exceed government sponsored insurance limits, please do not hesitate to contact our offices. The financial landscape has changed considerably in the past year. Governments and central banks around the world have spent a lot of money backstopping failing institutions, and increasing government insurance limits. This has improved depositor protections; however the issue still requires your attention…especially if you have large balances on deposit.
Thanks for listening.
Monty Guild and Tony Danaher