The Sane Investor

September 30th, 2008

So after the House Bill to pass the $700 billion bailout failed yesterday, congressmen scrambled to try and salvage the package as the Dow plummeted almost 800 points.  Personally, I don´t understand why this is such a big deal.  The Dow also went up a cumulative 700 points when Paulson and Bernanke announced the plan in the first place, so frankly I just see this as the market correcting itself given that the bill didn´t pass.  However, the fact that I don´t think it´s a big deal doesn´t change anything.  People are freaked out now, and powers that be are going to make sure this thing gets passed.

Let´s Talk About The Logic Of Watching the Market to Determine Legislation

Frankly, to look at the stock market to determine legislation is like having two kids playing chicken over a pool.  At the same time that one is trying to gauge the reactions of the other to determine his actions, the other kid is doing the same thing.  Thus, although Congress looks at the way the market fell and sees impetus to pass the legislation, they didn´t take in to account the fact that the market was watching them the entire time.  I mean, $700 billion is a lot of money.  I can imagine why people would sell off when they thought that it was a done deal and then that turned out not to be the case.  But for people that don´t really understand how this works, I could understand why you would see the cause and effect.  What they´re not really thinking about is how the market reacted when they first announced bailout (like I said earlier, up 700).  You sum the net of those reactions (up then down), taking in to account that the overall direction is negative right now, and you basically have a wash.

I´ve Closed My Underperforms On Financials for the Time Being

When companies like Microsoft, which essentially has no debt, step out and start saying that this needs to happen, that really gets congressmen in to a fervor.  Because of the fact that so many companies have stepped out in favor of the legislation, and the general statements from everyone surrounding the bill, I feel like this deal is in the bag.  In light of this, I´ve closed almost all of my financial underperforms on my Motley Fool CAPS profile (blade5adj).  I´ve also opened up some new long positions in financials, but especially underperform short and doubleshort calls in the sector.  I also included some underperforms in long treasury ETFs, since as this legislation gets passed I think there will be some strong movement away from treasuries, especially as the market rebounds.

These are really short term positions, and I´m hoping to coast out the upswing in financials and use that as an opportunity to re-establish some of my underperforms in the sector.  I left open my underperform calls in regional banks, since I feel like this is by far the most susceptible for a downfall, as a hedge in case something crazy happens with the legislation.

Why I Won´t Close My Gold and Silver Positions

Based on the amount debt that this would add to the budget deficit, I think it´s very possible that this legislation could add a huge positive to getting in to precious metals as a dollar hedge.  Like I talked about yesterday, this bailout may get people to start questioning the U.S. Government as a lender, and this would serve further to increase yields on Treasuries and move people in to precious metals.  Because of this, at this point I see precious metals as a win-win right now.  I´d be hesitant to have my money in cash at this point, since the bill passage might spark a fall in the dollar, especially as the initial excitement of the bill starts to wear off.

It´s A Mistake, But What Can You Do

I´m definitely strongly against the legislation, but being myself a price taker rather than a price maker, all I can really do is react to the market.  Although I think this bill will definitely cause a short-term boost in the market, the long term outlook from my perspective is negative, and if anything this will just prolong the downfall.  I think when the short ban ends this October 2nd, the effect will be negligible.  I think there´s just too much downside risk to shorting financials with the prospect of the bailout bill getting passed looming, so I don´t expect that to have much of an effect on the market´s direction.  However, don´t let yourself be tricked in to thinking that the uptick of the market after the bill gets passed is the signal that we´ve hit a bottom.  The way things have been going, we´re just getting started.

Disclosure: the author of this article is long SIL, GOOG, FCX, DGP, SLV, SKF

Questions? Comments? E-mail me at thesaneinvestor@yahoo.com

All material copyright

© 2008 Andrew Jarmon

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September 29th, 2008

If you´ve been reading my blog at all lately, you´ve noticed that I´ve dramatically changed my position from what it was when I started writing.  I´ve always been a really optimistic guy, and in general I typically feel that people are typically good and that innovation can always solve problems.  I still believe that, and like I wrote in my article ¨Anatomy of a Falling Market: What Has to Happen Before Things Turn Bullish¨, I still feel like alternative energy is our best shot at getting in to a bull market.  That being said, there´s too much downside risk to try and go long on anything right now, unless it´s precious metals or mining companies.  It´s not a game of making money, it´s a game of not losing as much as the next guy.

You can look at a company´s profile on a site like Yahoo! Finance, but no matter how much you think that company is historically undervalued, right now that doesn´t really matter.  The reason is, we´re in the middle of something that historically has no precedent.  You can point to the Great Depression and the massive deleveraging that happened then, but in reality, the market we see today lookes nothing like it did then.  This is a link to a picture of what the New York Stock Exchange looked like in the late 1920s.  This is a picture of what it looks like today.  Notice anything different?

It´s kind of a cheeky comparison, but I think that it actually is very powerful to see how totally different the world we live in today is from back then.  Markets move way quicker than they ever could have back then, if for nothing else than the fact that we have tools like the internet that let us access information from practically anywhere.  To give you an idea of this, I´m studying abroad right now in Buenos Aires, Argentina, and I can log on and see all the same news that you´re seeing in the United States, trade stocks, and basically stay updated real time.  That´s pretty crazy when you think about it.

When Investment Banking Dies, The Game Has Changed

I don´t think people talk about this enough, but the fact of the matter is, companies like Lehman Brothers have been around for 158 years.  To suddenly be looking at a world where investment banking as it used to exist just simply does not means that the game is changing, and that´s why historical precedent doesn´t make a difference anymore.  The fact is, yes, you could buy right now, and if you made some smart decisions, you could have turned a nice little gain in a year plus.  But to buy in right now is just silly, especially considering the amount of damage that a bailout could do even if it was passed.  I talked about it in a previous post, and I still believe it right now.  Passing the bailout proposal would be like sacrificing the foundation of a building to save the 50th floor…It just doesn´t make sense.  When you throw in to question the debt rating of the United States government, it´s no longer a question of ¨how do we save a few banks¨ but rather ¨how do we justify our way of life¨.

It´s grim, but I can tell you that the only reason that our GDP is even marginally sustainable is the amount of foreign investment we get.  Our savings rate is not even close to what it would be to sustain ourselves, and there´s only so long that you can keep on doing that before those foreign investors start going ¨hmm, why are we pumping money in to a system that logically can´t exist forever?¨.  Granted their stock markets and capital systems might be a higher risk, but the way things have been going that might not be the case for too long.  If we see foreign investors start dumping the dollar and US debt, we´ve got a whole lot more problems on our plate than if AIG fails.

Gold and SIlver

I can´t stress this enough, but in general, the only real outlet that you can go to is to get over to gold and silver, and if you´re particulary daring, look at some precious metal mining stocks.  The fact of the matter is, the textbook play for a bear market and volatility is to go to safe havens like gold.  If you´re trying to beat the market, even if you don´t make any money in gold, if the market falls 15%, you just beat the market by 15%.  That´s why I say that it´s not about making money right now, it´s about not losing it.

Boris Sobolev wrote a really good article on Seeking Alpha talking about gold, and how it´s going to get its major play if people start losing their faith in fiat currency (i.e. currency like the US dolar that has value because everyone gives it that value).  That´s why if we see this bailout come about, you´re going to keep hearing me push gold and silver, since I think it´ll be your protection against some serious instability that a lack of faith in the government´s debt paying abilities could cause.  If the bailout doesn´t happen, I still think gold and silver are great buys, because if nothing else I think they definitely won´t lose you any money in the coming months.  If you ask me, that´s about all you can ask for right now.

Disclosure: the author of this article is long SIL, GOOG, FCX, DGP, SLV, SKF

Questions? Comments? E-mail me at thesaneinvestor@yahoo.com

All material copyright

© 2008 Andrew Jarmon

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September 23rd, 2008

So the proposal currently being circulated through Congress to ¨save the economy¨ has a lot of people really wondering what´s going to happen. The proposition is mostly criticized for the lack of any additional oversight to the banking industry, the sheer magnitude of the plan (between $700 billion and $1 trillion), and the tricky little clause that I´m sure you´ve already read about:

“Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency,”

On the one hand, I can sort of understand it: there are likely some very significant issues that are going to be popping up, and I´m sure that Paulson is worried that by the time he gets through the consensus building process, it will already be too late or Democrats might have snuck in some provisions that he would not approve of.

As of right now, according to the New York Times the response to the bill has been less than stellar.  In many ways, this is very understandable.  Very rarely do things ever get past Congress without getting changed somehow, and with the rage that this has caused in the American populace, I´m guessing that most Senators and Congressmen are realizing that something this massive with no changes is political suicide.

The Direction Is Uncertain at Best

It´s hard to step in and say where the economy is going to go, not to mention what the U.S. government is going to do about it.  I will say that all the uncertainty that this has caused has made Americans extremely uncomfortable, especially with the election so close.  The fact of the matter is, Wall Street has never been a revered part of the U.S. market structure, since most Americans see them as greedy suits that´ll do anything to make a buck and earn their big bonus.  I´m frankly conflicted, since most of my friends are trying to go in to Investment Banking, and I had more than once considered it.  The market has made our decisions a little bit easier though.

Since they are not exactly a beloved part of the U.S., I think a lot Americans are thinking about it, and are wondering why they should suffer to fix a problem that in many ways the financial innovation from Wall Street created.  I think Mike ¨Mish¨ Shedlock hits the nail squarely on the head in his blog when he cites Bank of America´s recent criticism of whom the proposed legislation seems to benefit most.  He summarizes it all by saying ¨Everyone wants more¨.  It would seem as though moral hazard has already permeated the system when banks feel like they ¨deserve¨ more.

Don´t get me wrong, I think innovation and change is great, even if sometimes it goes in the wrong direction.  On that topic though, I feel like the people that caused that innovation should suffer for their mistakes.  There´s a huge part of market recovery that´s dependent on people feeling like things can´t get any worse, and by trying to build up a floor on the financial crisis, the question becomes whether or not the U.S. Government is actually preventing a speedy recovery.

Instead of Questioning Banks, People Are Now Questioning the Greenback

The failure of banks is always a big issue, because it not only causes a loss of money and jobs, but it also weighs on investor and consumer confidence.  Thus, it´s understandable why the U.S. Government would attempt to reduce the amount of banks that would collapse in an attempt to better stem the extreme lack of confidence that would result from a one-week total collapse like we almost saw last week.

The only problem is that by risking the strength of the dollar with the prospect of taking on a potential $1 trillion to the budget deficit that is already over $500 billion, the question becomes whether the government would be risking the stability of the overall foundation of the structure to save a couple of buildings.  Indeed, if lenders began questioning the Federal Government´s credit quality, things would be a lot worse than if a behemoth like Washington Mutual (NYSE: WM) or Wachovia (NYSE: WB) collapsed.  By not waiting until it´s a sure fire thing that we´re entering in to a recession and that the financial system is in serious jeopardy, it could be possible that the Federal Government is jumping on board far too early and not letting justice be served to companies that may have helped cause this crisis.

They Also Could Be Nipping It In The Bud

This is why I consider this a no-win market: you never know what the effect in the markets will be.  Thus, even if it won´t result in a more stable financial system, if it is perceived to result in a more stable financial system, there are some serious gains that you could be missing out by not jumping on board.  There are definitely some very big companies, including General Electric (NYSE: GE), that have been pushed to 52 week lows and could lead you to some spectacular short term returns if the market rebounds.

That being said, if things turn down again, it could be a very aggressive push to a bottom that would make your speculative buys look absolutely ridiculous.  Although this could be a really great market to make some short term bets, especially if you´re hedging yourself properly (I´m switching my recommendation to S&P 500 ultra shorts (SDS) since Proshares Financial Ultra Short (NYSE: SKF) has been dubitable with the shorting ban), the room for error is almost non-existent, so if you´re a small portfolio investor like me, this isn´t a market you can work with.

Volatility Pushes People in to Safe Havens

We´ve already seen gold and silver make some impressive gains, and if this up and down roller coaster ride continues, that should continue as well.  If you´re looking for ways to get in to those plays, I wrote an article back in July called Preparing for the Worst: How I´d Insure Against the Dollar.


What I will say on the equity front is that companies that were put on the short ban list, and especially those that requested to be added later (companies like General Electric (NYSE: GE), General Motors (NYSE: GM) and Ford (NYSE: F)) are going to be targets once the ban gets lifted on October 2nd.

More specifically with General Electric, which didn´t have a positive insider trading trend in August (about half buy half sell on slightly higher than normal volume), the question would become whether the company actually is weak and is thus trying to stave off the wolves for a while, or if they really have been irrationally beaten down (you´d really have to wait and see the September numbers.  If you see some really positive insider buying, that could be a good indication that it´s the latter).

Regardless, I sort of wonder whether the short ban is like tying up the water hose: it prevents the flow for a while, but when it finally does get released, it gets released in a big way.

It´s Speculation, Not Investing Right Now

If you´re going to try and do some short term plays, you can play with fire by trying to pick up American International Group (NYSE: AIG), Fannie Mae of Freddie Mac or basically any other financial out there.  As far as actually being able to make rational decisions, I think tech stocks like Google (NYSE: GOOG) would be safe bets, since you at least know if you´re forced to go in to a long position with them that you´re not going to be too far off base if we see some really major crashes.

I´ve picked some speculative mining stocks like Apex Silver Mines (AMEX: SIL), which actually payed off in a big way today as silver continued to rise.  The key if you want to get in to the speculative mining companies is to find stocks that have been beaten down because they´re holding a big chunk of debt (with SIL, it comes in both short term and long term debt).  Thus, as the price of silver or gold continues to rally up, the once dire prospects for these companies starts to look better and better.  I would be hesitant to go too long on them though, because just since the price of the commodity they mine is going up doesn´t necessarily mean they´ll be able to stay solvent.

In general, I think we´ll probably stay in this weird speculative limbo until some solid numbers on the economy start coming out.  If you see some good news, we could see some definite short term rallies, but some bad news will bring the house of cards crashing down.  Where I´m basically at right now is that there is far too much downside in the market to make a long position seem that rational.  Even though historically these stocks might be well priced, we haven´t even hit a recession yet.  Think what they´d do if that happened.  We´re talking fire sale, and I don´t want to miss out on it, even if that means missing the short ups along the way.

Disclosure: the author of this article is long SIL, GOOG, FCX, DGP, SLV, SKF

Questions? Comments? E-mail me at thesaneinvestor@yahoo.com

All material copyright

© 2008 Andrew Jarmon

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