Monday, September 14, 2009

Great Depression 2.0: Is It Over?

It's almost a year since I wrote Great Depression v2.0: Missing Piece Of The Puzzle.

Let's review main points. We have only one full blown worldwide Great Depression for comparison: 1928 - 1938 (there is a point of view that it only ended in 1942). There are also two known to me depressions which were not international: depression of 1873-1879 in US and Great Japanese Depression: started in 1989, still counting.

There is a one thing in common in these three. Each one had three components: real estate boom which went bust, financial crisis and structural crisis. A lot was written about first two, but structural crisis somehow avoids economists attention. Which is unfortunate, because it's a key. There are a lot of examples of financial crises, which were resolved relatively quickly. There are examples of real estate crises which didn't crush economies: 1990 - 1991 in USA, 2003 in UK and plenty of others.

Structural crisis is different. It's created when some new technology, or market change, or combination of both change the way significant part of economy works. Initially there is a boom, new technology creates new jobs, new demand for products. But later on, old industries are getting killed by new technologies. In ideal case, economy adapts quickly enough to the change, no other big crises happens and everybody is happy. Examples: personal computer revolution of 1980s, first phase of internet revolution in the end of 1990s. Below are not so ideal cases.

By 1873 in US there was a huge buildup of railroads. A lot of money was invested in them and associated real estate. Railroads changed the way economy worked, creating structural crisis. Whole industries (for example, cattle runs, pony express mail, shipping between East and West Coast around the Horn) were about to be destroyed. Maybe this process could be less destructive, but in 1873 country adopted the Gold Standard, triggering severe deflation and financial crisis. Real estate crisis quickly followed.

By 1928 developed world mostly switched from horse to internal combustion engine in transport and agriculture. It was a huge structural change, which was going relatively smoothly. But in the end of 1920s US was hit by real estate crisis, and stock market drop in 1929 created financial crisis. Welcome, Great Depression. Structural change was worldwide, so was the depression.

By 1989 Japan reached great success as an exporter of excellent and inexpensive products. Japanese companies became world leaders in car, heavy equipment, electronics manufacturing. Unfortunately, internal economy changed slower than export-oriented, sometimes economists joke that there are two economies in the country. Japanese, extremely conservative people, invested most of their savings in real estate. Some money started moving to the stock market in 1980s, including a lot of foreign money. There were two bubbles in Japan by 1989: real estate (several blocks in the center of Tokyo were priced higher than all real estate in California) and stock market (P/E of Nikkei was, if I remember it right, around 57!). It's the longest running depression in the modern world now.

Bernanke just said that recession is technically over. Great. If we get out of this crisis next year, I will be first to propose to install giant gilded statue of mister Bernanke right in front of Federal Reserve building. I have my doubts though. The three depressions mentioned above didn't finish until structural imbalances were worked out. It takes time. Japanese Great Depression is an example what happens when government and Central Bank try to fix depression using financial tools alone: nothing. I just hope that people of Japan started necessary structural changes by voting LDP out of power.

Current structural crisis is a result of double whammy: internet plus globalization. A lot of good things happened as a result of two, including fast development of poor countries, including China. But this development also created huge imbalances. There are whole industries which have to downsize and restructure. First of all, everything related to information. Newspapers, TV, magazines, music, phone services, books. Another imbalance: prices of commodities. Most of them are overpriced, compared to historical trends. Mining industries and agriculture didn't keep up production with demand. But they will catch up, eventually. Big imbalances need long time to be worked out.

Of course, we can hope that governments and central banks of the world managed to fix current crisis and everything is going to be just fine soon. Hard to believe though.

How depression affects investments? Long term, it depends on societies, governments and central banks making right decisions and not trying to hide problems under the carpet. That's the difference between Great Depression of 1930s and Japanese Great Depression. Let's suppose we are going American way, not Japanese way. If it's true, now is the time to buy, buy, buy. Despite the high probability that we have several years of worldwide depression ahead of us. Best time to buy stocks in 1930s was in the middle of 1932, when Great Depression was just flexing its muscles. Current depression is running faster than before, my assumption is that we are in the equivalent of 1932 now.

What to buy? Forget about commodities. Long term, they are dead as an investment class. Depression = deflation, forget about other inflation fighting investments. Invest in the future, in new technologies. Most of the tech companies don't have any debt and have a lot of cash. Cash is the king during deflation. Some of the companies will fail, some will win, but as a class, techs will win. Banks will win, they can get money from Fed. Sin always wins, tobacco companies pay huge dividends and usually do great in crisis. Don't know about anything else.

The danger is, as usual, in assumptions. If we go Japanese way, cash is the only way to go. I'm betting on American way.

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Tuesday, September 8, 2009

Gold Prices are a Sign of Nothing

Jim Cramer said today on "Stop Trading" that Gold Prices are a Sign of "Robust" Economic Growth.

I have several objections to this.

First: there are no signs of economic growth. Things are getting worse slower, that's all recovery I see so far. Potential headwinds are strong, including the most dangerous, deflation, which is almost forgotten among the noise about coming hyperinflation. I don't know when higher inflation is coming (hope soon!), but so far we have deflation, plain and simple.

Second: gold is a security investment. Higher prices of gold mean that people afraid of something and buy the most reliable (from their point of view) form of money storage. Or maybe traders anticipate such behavior of people and try to front run the trend.

Third: industrial demand for gold is a very small part of gold demand. Most of the gold is consumed as investment (hoarding) or as jewelry. And significant part of gold which is counted as jewelry is actually bought as investment. Especially in Asia. But currently jewelry demand for gold is down, in some months it's negative (people sell more gold as scrap than buy). And the biggest importer of gold, India, reduced imports this year at least by 50%. Which means that quoted price of gold is actually price of futures and has little relation to supply/demand of physical gold.

Growing price of gold means only one thing: there is a change of supply/demand balance of gold futures. For investors not related to gold trade, it means nothing.

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Thursday, September 3, 2009

Starting Netflix

I started Netflix (NFLX) position today. There are several reasons for my decision.

I am a happy customer. They have great selection of movies, service is excellent, subscription price is unbelievable low.

Business model is unique. Blockbuster tried to do the same and failed. Rental kiosks serve different customers, they are not big competitors.

Company has a great financial position. Balance sheet looks great, earnings are growing.

The main asset of the company, however, is Netflix Culture Manifesto. When most companies treat their employees like replaceable parts at best and often like dirt, this company understands that great people make great company.

Of course, opportunity helps. I waited for an entry point and here you are! YouTube deal with movie studies is not certain, wouldn't happen for months. It also doesn't even touch main reason people subscribe to Netflix: great selection of movies on DVDs and great service. Web content delivery might be important in future, Netflix makes money from DVD rentals now. But YouTube news pressed NFLX down. Good entry point.

YouTube belongs to Google(GOOG).

Full disclosure: at the time of publication author had long positions in both NFLX and GOOG. Positions can change any time.

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Wednesday, September 2, 2009

Should I Stay Or Should I Go?

Market went down for two days and failed to have snapback rally on the third. If I had more time for trading now, it would be perfect setup for Jim Altucher's 3x2 quant trade. Unfortunately, I can't sit at the trading screen.

Is it correction? Is it an opportunity? As usual, we'll see later. Some would claim they made a great call some would be silent. It's really hard to make a call here, because last month was a month of panic buying by big guys. Market now in their hands. If they think they bought enough, we are going to have a correction or sideways market. If they need to buy more, market is going up.

Honestly, I remember only one buying panic which was bigger: first half of March 2000.

Doug Kass predicts 10% pullback. Great! If so, I'm a big buyer. Even bigger if market drops another 5%. I'm all in on another 5%. We are in the market which mimics 1932, in compressed form. Which means: "buy, buy, buy". But discipline says: "wait for a pullback".

There are two big clouds on the horizon. First one is looming tax increases in US. Most of Bush tax cuts expire in 2010, which will be a huge hit for recovering (maybe) economy. I wasn't a big fan of those cuts, but raising taxes in time of crisis is bad. Actually, it's insane, but I'm afraid that current administration will go for it.

But federal taxes won't be up for a year. Another cloud might be much closer. We have a bubble in China. Many (most) refuse to recognize it. They ignore simple arithmetics: more than 20% drop in exports can't match 6% growth in export depended economy. No way, no how. The only question now how this bubble will end. If it deflates slowly, world economy is OK. We'll see significant drop in commodity prices, which really would most economies. Unfortunately, most bubbles in economy end up with the bang. And that's scary. Sharp drop in Chinese stock market would be bad by itself, but sharp drop in commodity prices might create a worldwide disaster, especially in commodity depended economies. I don't mind if Venezuela or Russia lack money for their ambitious political projects. Problems in Brazil, Argentina, Chile, South Africa might threaten their stability, which is much worse.

Anyway, I'm still bullish. 10% pullback? Gimme!

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