Updated
@ 11:00 p.m. EST, Sunday, December 9, 2007 [reminiscence added December 12, 2007].
WELCOME TO TRUE CONTRARIAN! I will attempt to create an entertaining, readable, and hopefully refreshing viewpoint a few times each month. Each issue will feature my intermediate-term financial outlook, my long-term financial outlook, and a personal reminiscence.
If knowledge can create problems, it is not through ignorance that we can solve them. --Isaac Asimov
THE WORLDWIDE HOUSING BUBBLE CONTINUES TO BE ALMOST COMPLETELY MISUNDERSTOOD (December 9, 2007): There has been a lot of foolish talk in the media about how to "solve" the problem with the U.S. housing market. The most absurd proposals have been suggested and even taken seriously by many, such as President Bush's ridiculous idea to freeze adjustable-rate mortgages at their initial teaser rate. Therefore, it is important to consider why these plans are doomed to failure, and what is really going on in the global housing market.
To begin with, whenever two parties agree voluntarily to a business agreement, the agreement has the force of law. At least, that is the assumption in a capitalist society. Obviously George Bush loves to criticize others for interfering with the free market, whereas he can act like even more of a socialist than Chavez or Castro if it suits his political purposes, or if he thinks it will help to elect a few more Republicans to Congress in 2008. The Democrats are no better, as they keep thinking up newer and "better" ways to expand upon Bush's original misconceived plan.
One truly ironic implication that has not been discussed at all by the media is that Bush worked so hard to get Samuel Alito and John Roberts appointed to the Supreme Court. While there was a lot of nonsense in the mainstream media about their beliefs on abortion and other irrelevant issues, the real and probably the only reason that Bush pushed so hard for their appointment to the Supreme Court was so that they would be certain to declare unconstitutional exactly the kind of illegal government interference that is epitomized by his asinine scheme to rewrite mortgage contracts without the explicit consent of both parties.
One only needs half a brain to realize the impact that this legislation will have on the willingness of lenders to write future mortgage agreements, knowing that the government can simply modify them at will. The whole point of having a legal system based upon principles such as contract law is so that private individuals can make agreements with full faith and confidence, knowing that they will be upheld by the government, rather than being upended by political powers as happens routinely in many other parts of the world.
As for whether this legislation will "help to ease" the housing crisis, I had to laugh out loud at the comments by many poorly informed members of Congress about how the new law would probably be "too late to solve" the problem. This shows an incredible misunderstanding of what the housing bubble is, and why it is such a serious issue. The reason that the housing bubble is so dangerous is that probably the single most important asset class in the United States, which is residential real estate, is selling for twice its fair value. This is hardly a local issue: in England and Ireland, real estate is selling for three times its fair value.
For those who don't believe that real estate is selling for two times its fair value, consider that fifteen years ago you could have bought virtually any property in the U.S. for 20% down and immediately rented it out at a price which would exceed the mortgage and real estate taxes combined. However, if you were to buy a property today--even the very same property you could have bought 15 years ago--for 20% down, and then you were to immediately rent it out, the rent would cover only about half of your total mortgage and tax payments. Since rents have been increasing with economic growth, this proves that real-estate prices are twice what they should be--and twice what they will be in several years, no matter what anyone does or doesn't do.
Whenever any major asset class is selling at a price which is either far above or far below fair value, it is an inevitable fact of the financial markets that sooner or later it will be selling at fair value. Trying to prevent this is like trying to repeal snow in Minnesota in the winter, or trying to legislate against hurricanes in Florida. Regardless of what anyone in Washington, D.C. or anywhere else tries to do, real estate around the world will continue to decline at least until it reaches fair value, and quite possibly below that level, as severely overvalued assets generally become strongly undervalued. That is simply how the financial markets have always worked, and how they always will work.
If there is any blame to be assessed, it should be placed on those who permitted the housing bubble to become so inflated in the first place. I would like to know where President Bush was in 2004 when he could have done something meaningful about rapidly rising home prices. I certainly don't remember him, or almost anyone else for that matter besides myself and a few other "cranks", talking about why it was a serious problem at that time.
Imagine climbing to the top of Mount Everest and then complaining all the way down about what a long walk it is to get to the bottom of the mountain, and then passing legislation to make it an even slower walk down.
Beam me up, Scotty--there's surely no intelligent life around here!
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GLOBAL ASSETS ARE PRICING IN A MOST DANGEROUS ASSUMPTION (November 26, 2007): The prices of everything from crude oil to gold mining shares to emerging-market equities to Chinese art to Dublin real estate are all making the same basic assumption: that the U.S. dollar will continue to decline in value. While this appears to be the safest bet imaginable, it also seemed to be a "sure thing" in December 2004, just before the U.S. dollar staged a strong rebound which lasted for nearly a year and which had a profound effect on the global financial markets.
This time, there are even more people who are "certain" of a continued decline in the U.S. dollar, and literally trillions of dollars worldwide that has been invested directly or indirectly upon that expectation. In fact, the anticipation of a weaker greenback is so ingrained in the minds of many global investors that practically everyone has acted to protect their portfolios against a falling U.S. dollar, even though a rising U.S. dollar is likely a far greater threat. Multi-decade peaks for most commodities and for many equity sector groups would soon lead to sharp pullbacks if the U.S. dollar were to suddenly rally over the next several months.
Whenever a nearly unanimous consensus of investors is lined up on the same side of any given trade, it is virtually always the point at which it is most likely that the market will move sharply in the opposite direction. Just a few months ago, many amateur currency traders such as Japanese housewives were betting on a weaker Japanese yen and a stronger Australian/New Zealand dollar. The sudden resurgence in the yen and a decline for the Australian and New Zealand dollars forced this "yen carry trade" to be busted, but instead of closing their positions entirely, these speculators after being badly burned (financially speaking, of course) merely switched to being short the U.S. dollar and long various emerging-market currencies such as the Brazilian real and the South African rand. You can easily guess whether they will be burned yet again.
The financial markets always load up with the maximum possible number of participants before they then frustrate the collective expectations of those participants. This is not going to be the first exception to the rule. With so much money betting directly or indirectly on a weaker U.S. dollar, the financial markets are poised to move dramatically in precisely the opposite direction. Exactly when this will happen is uncertain, but since so few are prepared for it to occur, it is likely to be sooner rather than later.
FINALLY, A SINCERE THANK YOU to Barron's for featuring me on page 50 of their November 19, 2007 issue, which is currently on newsstands worldwide.
CURRENT ASSET ALLOCATION (December 9, 2007): My own personal funds are currently allocated as follows: LONG POSITIONS: stable value fund (retirement fund with stable principal paying variable interest, currently 5.00%), 5.5%; municipal bonds, including MYJ, 2.5%; Treasuries between 2 and 10 years in duration, such as IEI and IEF, 0%; TOC, 1% (bought at a 15% discount); gold and silver coins and related metals collectibles, 6%; other collectibles, 0.5%; cash and cash equivalents including a long position in VMSXX and in the PayPal money-market fund, 7%; SHORT POSITIONS: Nasdaq-equivalent (QQQQ, SMH, NDX, GOOG, in that order) and related shorts, 50.5%; short EWM, 1%; short ILF, 1%; short GLD, 17.5%; short GDX, 2.5%; short USO, 3.5%; short BIK, 1.5%.
REMINISCENCE OF THE WEEK (December 12, 2007): When I was in high school, the father of one of my best friends became my buddy. His name was Jack Martin, and we shared a love of music. Especially during my college years and for a few years thereafter, we went to see some truly great jazz and folk performers together: Count Basie; Pete Seeger with Arlo Guthrie; Oscar Peterson; Ahmad Jamal; Anita O'Day with Harry "Sweets" Edison; the Modern Jazz Quartet. I especially remember a concert in a small, crowded club in downtown Baltimore featuring the great jazz violinist Stephane Grappelli; during a break between sets, the violinist's forty-something backup band took a much-needed break, while Mr. Grappelli himself, at that time in his mid-70s, played jazz piano throughout the intermission.
My favorite time with Jack was a fine early summer day in 1984. We drove early in the morning to a waterfall in western Maryland where we sat and talked about life for several hours. In the afternoon, we went to visit a friend of his who had four musical children. They each performed a classical piece in turn on their various instruments, starting with the youngest, as I accompanied them on the piano. The oldest one, about sixteen years of age, played Bach's Violin Concerto #2; this well-known work has a piano reduction that would have been impossible for me to sightread competently if I had not practically memorized it several years earlier to win a statewide competition with a violinist friend in high school. All of us shared a delicious and leisurely dinner together before we returned home. Either before or since, I cannot recall a more memorable day.
