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As the Monty Python show used to
say:
"And now for something
completely different"
Here you are, living in the Gulf States. You may be the
savvy businessman, the expatriate professional, or anyone with
capital to invest.
If you earn and save in dirhams,
riyals, etc. then like it or not, you’re linked to the US$ and
the US economy, neither of which I am particularly sanguine
about. Therefore, active investor or not, this newsletter
concerns you.
Why? I’ll tell you. I spent several years in Dubai in the
1990s and now live in Canada. When I returned to Canada in
2001, I took some time off to do some serious research into
the investment world in general, as I wanted to, among other
things, manage my own portfolio. I discovered what I believe
are some truths about investing:
- Analysts don’t know very much, and
certainly can’t predict the future. More importantly,
they make money by helping sell you stuff, whether they
believe in it or not. Remember Jack Grubman at Solomon Smith
Barney giving high ratings to stocks he thought personally
were either a “dog”, “piece of junk” or “piece of shit”,
respectively. Investors Business Daily (April 26, 2001)
reported "A full 88% of brokerage analysts said the
companies they cover would retaliate against a sell
recommendation by cutting their firms out of stock offerings
and merger deals, a Reuters' survey found. Only 1% of all
recommendations are sells."
- Economists don’t know very much,
and certainly can’t predict the future. Case in
point: The Economist magazine, in 1998, featured oil on one
of its covers, when oil was $12 per barrel. The outlooks for
oil, it prognosticated, was that it was likely headed for $5
and forebode doom and gloom. Well, that was just about the
bottom, oil prices soon turned upwards and reached $35
within a couple of years.
- Wall Street, the mainstream
financial media and high-priced investment advisors only
exist to sell you product, for commissions. The
primary mission for capital markets, as they evolved, was to
be a more efficient mechanism for funding public companies
and creating a fair secondary market for issued shares (the
Efficient Markets Hypothesis). Which is what the markets do,
efficiently and honestly. Yeah, right!
- Warren Buffett (of Berkshire
Hathaway, and the second richest American at $ 42.9 billion)
has found the missing “Weapon of Mass Destruction”.
Which is what he calls the derivatives market, a $ 125-150
trillion largely unregulated
global lava of hot money, of which the US accounts for $ 67
trillion. Remember, when Long Term Capital Management went
under (and almost took the US financial system with it), its
derivative exposure was only $ 1.25 billion.
By the way, Long Term Capital Management had
two Nobel Prize Winning Economists on its team, which
re-emphasises my point about how much economists know.
Which is also why, in a panel discussion of 4
economists, you will probably get 5 different
opinions on the same outlook, as one of them may well
change their mind mid-way…
- Mutual funds are a real racket,
even apart from the conflict of interest scandals currently
plaguing them in the US. In numerous studies, it has
been demonstrated that only a statistically insignificant
percentage of fund managers beat their benchmark index over
an extended period of time. In Burton Malkiel’s famous book,
“A Random Walk Down Wall Street”, he shows how a portfolio
derived from stocks picked by a blindfolded chimpanzee,
throwing darts at a newspaper listing of NYSE stocks,
outperformed the majority of funds.
- Ya takes your risks… There
is no escaping this maxim. Your rewards are linked directly
to the risks you take. The S&P 500 currently trades at
twice historical norms and NASDAQ trades at 135 time
earnings. Enjoyed good returns in 2003? You deserved them,
since you were willing to take such a high level of risk.
Want to play double or quits in 2004?
- Fear and Greed. The high
potent recipes that drive all investors. As the legendary
Benjamin Graham observed there are two types of investors,
whether big or small: those who don’t know where they are
going and those who don’t know that they don’t know!
What’s my point? Well,
most people don’t have the time or patience to do the detailed
research to understand the overall macro-economic environment,
determine the optimal asset allocation based on their
preferred level of risk and identify pockets of extra-ordinary
opportunities that occur from time to time.
Even if you wanted to, misinformation, bias and the quality
of information create stochastic noise that clouds judgment.
As an example, you saw completely different versions of the
Iraq war depending on whether you watched the US networks, BBC
or Al-Jezeera.
So, I want to provide you with an alternative perspective
that you will not normally come across in your daily routine.
This may add value to you or not, depending on what you choose
to do with it.
To which you may ask, who are
you? I am a graduate of the London School of
Economics, with a Bachelor of Science degree (Honours) in
Economics. I am a Certified General Accountant, a Canadian
professional accounting designation equivalent to a CPA in the
US. I have been a CFO of a publicly listed Canadian company,
managed a fund investing in North America and the Middle East,
been a Director of Investments for a large conglomerate based
in the Middle East and have my own consulting company
providing strategic planning and financial advisory services
to clients in various countries.
Whew!
Without the optics above, I'm just an investor with a
perspective that you may find interesting. I have my biases
and self-interest, which I will disclose as appropriate. But,
let's first establish a dialogue and see where it goes.
Let's see if you knew about the
following:
- Sir John Templeton, the founder of the Templeton Funds
(now part of Franklin Templeton Resources advising on $ 248
billion in assets) is calling on investors to avoid US
equities.
- Bill Gross, the Managing Director of PIMCO (a US asset
management firm with assets of $ 350 billion) telling
investors to avoid all US equities and bonds
- Warren Buffett, the second richest man in the US, is
investing heavily in foreign currencies for the first time
ever, to reduce Berkshire Hathaway’s exposure to the US $.
He is, alongwith Bill Gates, a large investor in physical
silver and silver equities.
- Corporate insiders (Directors and Officers) in US
companies sold $59 worth of shares in their own company for
every $ 1 they bought, in October 2003 (total sales: US $3.2
billion, total purchases: $ 59 million), reports the Globe
and Mail ("Rising inside sales the gloomy cloud on stock
horizon", November 10, 2003). This was the lowest level of
buying by insiders since July 1995. October was the sixth
month in a row that the sell:buy ratio has been above 20 to
1, a bearish period longer than any since 2000.How can this be after the highest GDP growth
in the 3rd quarter in 19 years??!! When everyone is waiting
for the economy to surge back, why are insiders selling like
there is no tomorrow. And should you be buying what they are
selling...
- George Soros, who made $ 1 billion betting against the
British pound, is reportedly betting heavily against the
US$.
It is my belief that, despite the torrid growth in US GDP
reported over the last two quarters and the cheerleading in
the mainstream financial media, the US economic is poised at a
critical cross-road.
The massive monetary and fiscal stimulus provided over the
last two years should have ensured that the economy was on a
sustained path to growth. But it won’t do what it should and
is not creating the 150,000 jobs per month needed just to keep
the unemployment rate steady or the 250,000 jobs the US
economy should provide when working at full steam.
In December, following the hottest growth quarter in 19
years, the economy produced a pitiful 8,000 jobs. In January
it produced 93,000 and in February it produced 21,000, way
below economists expectations. Surprised?
But where have we seen something like this before? In
Japan. In 1990, the Japanese economy, real estate and equity
markets values peaked and the air started to go out of the
bubble. The government then did everything in its power to
stimulate the economy (just like the US government is
currently doing).
The chart below shows the how the two markets performed for
1 year leading to the top of the bubble and for 4 years after
the bubble:
Week 0 (on the bottom) and Index Value 100 (on the Y axis)
are the tops for each stock market index. The chart shows how
the markets performed, in % terms, after their respective
crashes. Visit the link provided for a detailed analysis of
this fascinating bit of economic history.
The Nikkei went from a peak of 40,000 (Index value 100) to
about 18,000 (Index value 45) four years later (1994). Nasdaq
went from a peak of 5,200 (Index Value 100) to about 2,000
(Index value 40) currently.
Interestingly, the Nikkei tried to rally four times within
that period, as have the US market indices. For 2 years after
the crash, the Japanese consumer and investor were convinced
that things would turn around.
The history lesson: The Nikkei fell
further, after the chart ends above in 1994, from 18,000 in
1994 to below 10,000 in 2003. This was despite massive
on-going intervention by the government, the Bank of Japan and
a 1% growth rate over most of the decade.
I’m not saying that the US markets will mirror Japan’s
experience exactly. I am saying that Japan did everything in
its power to stimulate the economy but failed. It is not clear
that, despite all the cheerleading in the mainstream financial
media, that the US economy can deliver the sustained momentum
that the US equity markets have already priced in.
As reported in Fortune magazine’s Feb 23 2004 issue (“Stock
Market Bubble, Take Two”), Jeremy Grantham, Chairman of a $56
billion investment management firm, reports research showing
that in all 27 previous
asset bubbles, the market gave back more than 100% of the
gains it made during the bubble.
If history holds true this time,
the Dow Jones Index would have to drop to 4000!
Instead, it’s déjŕ vu...all over again! As an example of
euphoria and irrationality, consider this item in Fortune
Magazine, February 23, 2004 (“When Bad Companies Go Up”):
Guardian Life created an index to monitor the stock prices of
US firms currently under Federal Government/SEC investigation
for possible fraud and accounting irregularities, in order to
gauge the “mood of the market”.
These equities should have
collapsed, after all the scandals at Enron, World Com, Tyco,
etc., right? Instead, the index increased by 59.8% in 2003,
twice the rise in the S&P of 28.7%. Surely, its not
“irrational exuberance”…all over again?!
As we develop our dialogue, I will provide you information
on why investors may need to look beyond traditional
diversification asset categories based on my belief that we
are living in unprecedented and dangerous economic times.
It is a time to safeguard assets
and also, for the thinking investor, the time to make (or
enhance) fortunes.
Quoting Stephen Roach of Morgan
Stanley (Global Economic Forum, February 17, 2004): “Modern
day central banking is on the brink of systemic
failure.”
I realise that many overseas investors have fled the US and
invested back in their home countries or in regional
investment hubs, such as Dubai. Still, their economies are
tied to the fate of the global economy and certain currencies
are US$ linked. Thus, they are still dependent on how things
progress in the US, unless they take further active steps to
diversify away from linkage to the US$.
If the US $ continues to decline, and the economy is unable
to meet the very high expectations set up by the US equity
markets, then the precious (gold, silver, platinum, etc.) and
base metals (copper, nickel, zinc, etc.) will continue to
benefit.
Gold, which bottomed at $ 256 in 2001 now stands around $
400 as investors seek haven from the decline in the US $.
Silver is currently at $7, from a low of $ 4 in 2001. Copper,
platinum and nickel are at multi-year highs, driven by Chinese
demand.
Gold prices and the US$ generally move in opposite
directions. Gold performs well in times of uncertainty,
inflation, deflation and is the ultimate store of value. It
has throughout history been a currency in its own right and
competes as an alternate store of value to paper (fiat) money.
Until 1971, the value of the US $ was directly linked to the
price of gold.
Gold is in a primary bull market, recovering from a
prolonged bear market and will benefit from economic turmoil,
global uncertainties regarding terrorism and US$ weakness.
As Yogi Berra said, it is very
difficult to make predictions, particularly about the
future.
In spite of this challenge, I believe that for many
investors Canadian equities, particularly in the precious
metals and other resource sectors, provide a potential for
extra-ordinary returns while providing a hedge (through
Canadian dollar investments) against the US$.
I will provide you information on why
you might consider moving some of your assets into Canada
(perhaps 3-5%), how to do so and the potential of the resource
sector. You would have the opportunity to benefit from
the rise in the prices of precious and base metals, and
because you are investing in Canadian Dollars, you hedge
against the US$ at the same time, which would enhance your
returns substantially, if existing trends continue.
In the next newsletter, we’ll explore further the US
economy, and investment opportunities in
Canada.
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