Wednesday, March 10, 2010

Snap Trading

Congratulations are in order. Our government has managed to create another economic bubble. The Fed Funds rate has been at zero for close to a year and a half. Our elected officials are pumping over one and a half trillion dollars in to the economy this year with the expectation of continued largess carrying over for many years. Also, we are engaged in at least two wars not counting the war on terror, the war on drugs and the war on fair home prices.

Debt, unsound fiscal policy and war have a very stimulating effect on the economy but they can't last forever. Especially with our government presently insolvent with over $10 trillion in stated debt and an albatross of $60 trillion in unstated Enron style off balance sheet promises.

Mathematically, this false economy must end eventually. But strangely many see a bright future ahead for our nation. Investors have priced many sectors of our housing stock, commodities and our stock market to overvaluation yet again. Hence we are in another bubble. Therefore, I am approaching market neutral in my "sleep at night" portfolio . I refuse to buy overpriced assets.

In my last post I explained how our country has progressed in 2 generations from a society that thinks of investments in 3 dimensions to the baby boomers that are only capable of one dimensional economic thought. We use the advice of salespeople to make our investment decisions as Wall Street is taking a larger and larger portion of our gains.

Speaking of these salespeople, I just read a post by Nobel Laurette Paul Krugman. Dr. Krugman does very well in generating speaking and book fees and presently has found a nitch as the proponent of bigger government. He is a salesperson of the financial elite because his one dimensional thinking is being used by many people to make investment and policy decisions.

His latest post on his blog suggests that we don't need to worry about our country's present account deficit because at current interest rates our nation's debt will only account for 7% of government expenses in a few years. He says that at the current short term borrowing rate of 1.4% this country has nothing to fear borrowing large amounts of money from foreign nations.

This is the way it works. He states his opinion. He gains attention. He makes lots of money giving speeches and writing books. In 5 years no one will note whether his current thinking was right or wrong. Our nation of linear thinkers does not even look side to side, much less at the past. We are destined to repeat history again and again. Bubble after bubble as policy makers rack up monstrous debt to be paid by our children to hostile foreign nations.

I wish Krugman's call could be a wager in Las Vegas as an over or under bet. I would bet the over position. In my mind it would be a totally riskless wager. I also know that Krugman would take the "over" position also. He may make sensational statements to gain notoriety but he is no fool. If he could wager he would bet on the interest on the national debt as a much bigger percentage of government spending than 7% in the next 5-7 years. His assessment that government's 1.4% rate of borrowing will remain in place in the future is infantile at best.

Our government is churning over it's debt in short term vehicles. This short term policy is a huge structural problem and can't possibly continue forever. Our politicians are financing ultra long term debt in short term treasuries that are being purchased by hostile foreign nations. This is definately a problem and Krugman should understand this.

So why does he make the sensational statement then. Because he is a salesman. Just like everyone else that is giving you information.

I would like to take this a step further. Suppose we have a nation of Krugmans. One dimensional thinkers that see events change in a line and not as a trend. They would never be able to predict a bubble because a bubble is a curve. This is why no one in our present society has been able to predict any major turn in the economy.

In my opinion the only predictions that are important are the turns and in the future we are destined to have a lot of turns.

Investors in this country have a fixed focus on a goal that is straight ahead. Kind of like a herd of wildebeests following their leader across the plain. Our country's investors are a herd of mindless animals running in a straight line following the advice from Dr. Krugman, Wall Street, The National Association of Realtors, The Media and just about anyone that can make make a profit off our financially incompetent populace. Everyone is happily moving in a straight line knowing that the taxpayer ATM is the magic that will lead us to prosperity. Just like the homeowner ATM led us to prosperity during the housing bubble.

So what is an investor to do?

I say invest in the snap.

Given the current market metrics there is one thing that is under priced now in relation to the future. That is volatility. There is no value in the market now and The Herd has unrealistic expectations of the future.

I am a value investor so as the S & P index moves higher above fair value I am buying hedges on my stock holdings. Generic hedges on my large cap, market leaders with low debt. Once I get to market neutral at S & P 1200 it's not like I'm going to sit out this market. I'm going to start buying into volatility.

There are many ETF's on the market now that track just about everything. Most are not suitable long term investments but many have tremendous volatility. Presently I am slowly moving into FXP and UNG. These are both at historical lows. FXP is a short on a portion of the Chinese stock market and UNG is long on natural gas futures. I am dollar cost averaging very small amounts of capital into each.

You might say this is gambling. I say if you are significantly long on this market you are gambling a lot more.

I choose an ETF that is at a historical low that is backed by an asset base that is currently trending close to a 52 week low.

Natural gas futures are trending toward multi years lows while UNG is at an all time low.

If UNG trended down for another 6 months maybe I would end up with 5% of my portfolio in the investment. If I get the snap back to fair value my investment could make 30%. A 1.5% portfolio profit. 4 of these profits a year and that will equal the performance of the S & P per year over the next ten years.

Remember this volatility play is only on the table while the market is significantly overpriced. If stocks go under fair value I sell my generic hedges protecting my stock investments and make a profit. If stocks go significantly below fair value I buy more stock. If we stay in a bubble I take a small portion of my portfolio and play the snap. My goal is to stay with The Herd and equal the 6% to 6 1/2% gains in the stock market over the next 7 to 10 years. But I choose to take those gains in a straight line and without risk.

I would like to note that to make my intended goal without risk, I choose to avoid long term bonds like the plague. There is presently just to much distortion in the market. But I will invest in the volatility of long term bonds as interest rates vacillate wildly over the next few years as the government distorts the market. Presently I am slowly buying a small position in TLT, an ETF that is long on long term treasury bonds. I sold off my treasury short last year at a very nice gain thanks to The Herd.

Back and forth, back and forth over the next few years. You will deal with it by taking Rolaids. I will make a little profit while I wait for The Herd to start climbing the next interest rate mega bubble in 5 to 7 years. That is when it will get challenging.

But for now my premise is that if stock prices are forced to overvaluation by investors that have unrealistic expectations of the future then this will cause volatility. My goal is to trend with the S & P index. But as an investor that hates risk I must smooth out the wild gyrations that will occur in the stock market over the next 5 to 7 years. My gain will be in a straight line as I use the two dimensional surface of the investment plain. The Herd's movement will be a frenetic two dimensional zig zag as their linear focus is diverted from the salespeople, to the government to the dysfunctional markets that are being created by bad government policy.

Buy and hold does not seem to be a prudent way to invest in this market.

I remember talking to day traders back in 1997. They were buying and selling stocks and stock options. It didn't make sense to me at the time. The volatile stocks that they were trading were the ones that were likely to go to zero. One stock investment goes to zero and that wipes out a lot of capital.

Now that we have ETF's and massive volatility on the horizon day trading makes sense. If I start to buy into VXX, a direct investment in VIX volatility futures at a 52 year low there is no chance of it going to zero and wiping me out. As it is being sold off, The Herd is running away from the 52 week low as they are tethered to an elastic band tied to historical fair value. As that band stretches it becomes harder and harder for The Herd to pull away. The farther from historical fair value and the further beyond the 52 week low then theoretically the harder the snap back.

The future of stock and stocklike investments will be one of high volatility as the market gyrates wildly over the next 10 years making below average historical gains. Probably on average about 6 to 6 1/2% increases a year. But those gains will not be linear like the advice of the salespeople. Those gains will come after a stock market roller coaster with The Herd running large distances for very little gains.

During periods in which the market is overvalued I plan on making small profits on the long distances that The Herd will be running as they race back and forth across the investment plain.

The Herd is trained to follow the salespeople. Destined to run wildly toward the oasis of golden prosperity that will be created by the massive debt from the Taxpayer ATM. But using ultra long term debt funded by hostile foreign nations to buy votes in the next election does not seem like a solution to me. Call me crazy, but it seems like a bit of an ethical problem in the short term and it is definitely a structural problem over the long term.

Dr. Krugman will cheer, "just another $10 trillion of debt to China will bring us closer."

But like a mirage in the distance, adding more debt to our already over leveraged nation will keep true prosperity just out of reach.

In 7 years when The Herd is exhausted from running they will find themselves at the bottom of a mountain. This will be the beginning of the next interest rate mega bubble.

Dr. Krugman's legacy will be the crushing debt that our children will be destined to carry to the top.

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