Value Investing Forum

How is risk trade being on/off different from bull/bear?

I've been reading more from Minsky/Keen paradigm and they seem to place a greater emphasis on the fractional reserve aspect of money creation in their models as opposed to central bank. That seems to tie in well with the low velocity. All the Fed has managed to do is to reduce the effects of debt deflation.

Regarding commodities, I have no doubt that the investment banks are having an effect on commodity prices (I recall someone in 07 or 08 commenting that Morgan Stanley was the biggest oil company in America.) That doesn't change the effects of the future of commodities. I'm in agreement with Grantham that markets are not terribly effective in dealing with long term supply issues. I believe commodities in general are underpriced but I don't have any straight forward way to quantify that. I do think we'll be seeing price pressure for two key reasons:

1) Increased demand (particularly China and India here who have emerging economies and lots of people)

2) Increased production costs (due to the fact that we've already tapped the low hanging fruit)

These combined should give upward price pressure.

How does that turn into an investment thesis? I have no idea. Aside from things like gold and silver, it's not practical nor economical to invest directly into the assets themselves (how much iron would you need to have to have a sizable position?). I'm reluctant to try out futures unless I had access to more longer term ones. So the only option left are companies that own assets.

FIFOkid wrote:

I think  the group here should also be collaborating about ways to spot
when the risk trade is on and off. I advised in April the market had no
bullish follow through on data that should have been extremely bullish
for the higher beta names which prompted me to raise cash to 50% and
just been in trading mode since then.

What do you mean by "risk trade is on and off"? Is this a TA call or something? I haven't heard that terminology before.

I totally agree on Europe. It's an ugly situation and none of the solutions seem to be all that good. There interesting question, to me, is how much CDS exposure there is in the European banking system. I know there's a lot of that junk written on Greek debt. I have no doubt there's probably a good chunk written on Spain, Italy, etc. But what's the exposure? I've never seen numbers. (I don't know if anyone knows to be honest.)

I don't think the underlying supply for most commodities is an issue
and much of the data related to it misleading and changes like the
direction of the wind.

Can you elaborate on this? I've seen evidence for at least copper, iron and oil already. Plus you have to factor in the increased demand as China and India's economies develop. There's a lot of people there. And the world population is still growing.

But I'm in agreement about preferring not to short dividend stocks. I haven't as of yet and unless I found a great opportunity, I wouldn't do it. I don't know if Chanos did actually short XOM or not; that may have been in the broader context of "value traps".

krackerjack121, after reading Jeremy Grantham's pieces on commodities I think the realities of finite resources is finally going to have a real effect. So I think you're right about that aspect. I'm just not sure how to play them. I think the idea of using companies that own those resources is a nice idea.

What concerns me about E&P companies are some recent comments James Chanos made. See here. In particular, see pages 11 and 12 on the slide show.

Minimally, I'd want to grapple with those issues before considering an oil company.

I'd be lying if I said I wasn't pessimistic either. My wife and I fall more on the "as self sufficient and sustainable as possible" side of things than most mid-20 yr old couples in order to hedge against major macro problems. But that falls into our own sense of stewardship, a "create more consume less" and "leave things better than you found them" values. 

You'd be amazed on how much produce you can grow yourself with very little space. But that's another forum discussion alltogether! 

Post edited 11:20 pm – October 24, 2011 by somrh

My fear is I will be hailed the resident bear. Now that I've actually found some economic thinkers that don't have their heads up their (well, you know), I'm now much more sympathetic to macro calls. The landscape isn't pretty.

1) Debt Problems

Financial "innovation" (which I think is code for "we're going to screw you") has lead to a dramatic increase in debt levels worldwide, both in government and private sectors. Take a look at both US and Austrailia run up in debt (Figure 1):

Empirical and theoretical reasons why the GFC is not behind us

We're in a deleveraging recession and many other places in the world are due for deleveraging. The last deleveraging recession the US had was the 1930's. And our debt levels are much higher now than they were then. For a more detailed discussion of deleveraging recessions, see McKinsey's study:

Debt and deleveraging: The global credit bubble and its economic consequences (pdf)

Minimally, this makes for an uncertain landscape. But we could see a further collapse in asset prices and declining or slow growing GDP as individuals, governments and businesses bring debt down to more appropriate levels.

2) The Boomer Effect

I heard about this idea years ago. The San Fransicsco Fed recently came out with a study that actually gives some evidence for the idea.

Boomer Retirement: Headwinds for U.S. Equity Markets?

If the trend continues, we should expect to see more money coming out of the markets (and hence, price declines) over the next few years. Based on their model, it will bottom out in 2025 (as far as P/E is concerned. If earnings increase then prices should follow suit.) They expect from 2010 to 2021 a negative 13% return on the S&P 500 over the entire period. Call that a lost decade. But that's just what their model says.

So that's a glimpse of the bear case.

I think Graeme's dividend stock suggestions are pretty good. I've considered PFM and VIG (US dividend acheivers… these track 10 year consecutive dividend increases) and DWX which is an international version (I think they use a 5 year criteria.)

I'm also considering emerging markets which folks like GMO think may be a strong candidate for investment. Wisdom Tree has some interesting emerging market ETF's. I've been considering DEM, DGS, and EPI (as I'm not entirely sure how to navigate emerging markets as of yet.)

The nice thing about emerging markets is that they don't have debt problems because nobody will loan them money! (hyperbolically speaking).

I personally am using AEDFX for event-driven investing (merger, bankruptcy, spin-off, etc) which should be a more market neutral strategy. That might be an interesting option for you.

A couple of random comments about what you're doing:

1) Municipals – I read an article a few years ago that argued that default rates for municipalities might be higher in the future. They suggested historically municipalities were reluctant to default since they don't want to screw their constituency. But now that insurance companies are insuring many of these bonds, municipalities might be more willilng to screw the insurance company. And with tight budgets, this could become a more common occurrence.

But I'm not in the top income tax bracket so I don't have any reason to follow up.

2) Short-term assets – I've seen some short term funds actually have credit default swaps as a means of beefing up their income. So that's something to look for. If a few of these blow up, it could wipe out much of  your money. Personally I'd avoid the things. Take a fine comb to the funds' holdings and see if there is anything in there that looks fishy. That would be my concern at least.