On the Sidelines With Cash

[Gone to Colorado]

I am amazed at the level of knowledge and insight of those who post regularly to piggington.com. After sifting through many posts on this website and others, it is apparent that there are quite a few people who believe not only that the San Diego market will crash but that there will be tremendous opportunities for those who can pay cash for a house.

As I see it, there are two possibilities for this market, both driven by how the Fed handles the day of reckoning when foreigners quit buying our bonds and supporting our spending habits in this country.

Will the Fed flood the system with dollars to prevent house prices from going down, accepting inflation and the possible loss of the dollar’s status as the world’s reserve currency for the sake of propping up overleveraged homeowners?

Or will the Fed defend the dollar and allow home prices to fall dramatically for the sake of our standing with the rest of the world, at the cost of the U.S. consumer and homeowner?

Given the present climate in Washington, DC, I am skeptical that our leadership will do anything other than pander to their constituencies, the rest of the world be da*#ed.

Perhaps I have oversimplified the possibilities, but I would like to read what you all think will happen and the best investments (i.e. bonds, commodities, stocks) to make for each scenario for people with cash. Additionally, is there another way this could play out?

[powayseller]

Great question. The Fed doesn’t care if homeowners lose equity or end up in foreclosure. The links are in one of my other posts. The Fed is concerned with the economy as a whole, with the national numbers. They’ll only intervene if the calamity causes risk to the financial system. The Fed has wiped their hands clean of any involvement in asset bubbles, by claiming they cannot predict them anyway.

The questions is: don’t they know that when the housing bubble collapses, it can take the economy down with it?

I’m still trying to figure out where to put my money. So much is unknown. Will China stop buying our debt? How long will the consumer stay strong? How will the Fed react to the data they use for their monetary decisions? How will the economy react to the Fed’s policies? Nobody knows how any of this will play out. Guessing is all we can do.

Diversification is the least risky bet. You won’t lose all your money at least. Bet all your money on one thing, like gold, and you’ll lose it all when gold goes down. Put it all in a CD, and you lose value if inflation picks up.

It makes sense that commodities (think lumber, cement, lead, sugar, coffee, metals, oil) which have a great supply lag due to lag of popularity in recent years, are poised for their bull market. Each asset has a cycle, and the commodity boom which began 8 years ago still has some life left?

It makes sense to diversity into different currencies (yuan, euro, swiss francs), as Warren Buffett did. What I really like about him, besides his intelligence and wisdom, is that he is a straight shooter. He bet billions of dollars against the USD by hedging against it. Last year this caused him to lose a billion $s, or so, as he was early in his bet. It makes sense to hold some equity in Berkshire Hathaway (the B shares are under $3K each), and let the oracle of Omaha do the investing for you.

I believe the Fed is flooding the system with dollars, as well as defending the dollar, but not for the reasons you suggest. The Fed doesn’t care if Susie Q loses her home, only that she might stop shopping to stimulate the economy.

The Fed is flooding the system with dollars, because the government needs more money to pay for the entitlements, military spending (we’re in 100 countries!), the interest on our national debt, and the trade deficit. The only way to pay for it all is to keep injecting money into the system. If one of the big banks does fail, or Fannie Mae needs a taxpayer bailout, there will be another huge injection of money. I believe it’s done electronically now, so there is no real printing of money to increase the money supply.

The Fed needs to keep the dollar’s value high, to keep foreigners buying the dollar. By setting short-term rates high, they hope that long-term rates follow along (which they haven’t always done lately). Imagine if the Fed lowered the interest rate back to 1%. Now that Japan and Europe have raised their rates (somewhere above 2%?), China could just go buy euros or yen, and if they stop buying our 10-yr and 30-yr bonds. Then who will finance our debt? The Fed may also be concerned about the recent interest in gold. Gold buying is higher than can just be accounted for by jewelry and industrial demand. Investors are fleeing to precious metals because they feel insecure about the dollar. The Fed must stop that rush to the exits.

The Fed is also concerned about inflation, or so they say. Assuming that real inflation is 8%, and not the 2% they claim, they have more reason to be concerned than they let on. Commodity prices, esp. oil have really inched up, and will just keep going higher. Oil production is at peak capacity, oil field production is waning every year, and demand from China is growing rapidly. This supply-demand imbalance will keep growing, and oil has nowhere to go but way up. Again, this will cause inflationary pressures, because oil is essential in making products, running industrial machinery, in farming (fertilizers, operating tractors), transporting goods across the country, for the health of the airline and auto industry. As commodity prices rise, eventually the cost is passed on in goods and services, increasing inflation. (Of course, rising oil prices are not reflected in the CPI, so it doesn’t matter to the Feds that Americans are squeezed by high heating costs and gas bills.) So to reduce inflation, they must keep raising interest rates.

Is there a reason to think that interest rates could go to 6%, 7%, 8%? Why not? I think the important indicators, such as commodity prices, and FCB purchases of our bonds, will determine how high they must go.

[powayseller]

Housing Slowdown Welcomed by Fed as a way to bring growth back to potential.

[Anonymous]

It is my opinion that the Fed has directly targeted the housing market. They realize what a big picture problem negative savings rates are, which are being driven by
home equity extraction. Greenspan has said this directly in the past, “history has not been kind to protracted periods of low risk premiums” was I think the exact quote.

They risk a far bigger problem for the economy as a whole if they let this go much farther. They could bankrupt generations of people and have a huge depression on their hands if the % of growth in asset value and employment gets more concentrated in housing than it is now. Any disruption at a higher level would be even more devastating that what it could be from here. They are putting a stop to this as we speak.

There is a time for cash, and it is now. It is possible that you could lose a bit to inflation doing this. There are times when the best you can do is tread water. It is impossible to always have the perfect investment mix to maximize every dollar.

Last year, I sat in cash in my main stock trading account for 5 months but then went in and made a 19.2% return by years end. Obviously not a great return, but not too bad considering the way the year played out overall. This illustrates that if you time investments properly, sitting in cash in between them is prudent. I am sitting in cash ( T-bills ) in those stock accounts now also, as I think a drop in stock is at hand due mostly to the rising interest rates. This fall should setup a nice buy point again due to long term cycles that are due.

As a futures trader I would not recommend chasing gold and oil here. These markets may go higher, but are very extended. Also, seasonally gold tends to sell off at this time of the year. It is not following the seasonal pattern at the moment, but could revert to it. From my experience it is best to have as much going for you as you can in one direction before investing. Gold at this point does not have that, even though it could continue higher. The typical seasonal low time period for Gold is August, so look then for an entry on the long side.

I have been shorting the bonds as they have been dropping, and have been nicely rewarded for that. It has been my view that we have been putting in a long term top in the 30 year bond over the last several months. This recent break is appearing to confirm that. Short-term though we are very oversold. Also, we are approaching the time frame where highs in rates for the year have typically occurred.

If you can find a good CTA, that is one possible diversification angle. However, be leery of the Hedge Funds here. Many of them are highly leveraged in real estate, and this drop in the bonds is in my opinion these people exiting their longs there. It is also possible this drop is some unwinding of the foreigners in the carry trade. Although, this is tough to quantify.

If the Hedges decide to run from real estate, we will have a very interesting scenario on our hands. It is hard to move billions fast. If they try to, very sharp volatile moves are going to happen.

Sorry if I rambled on here a bit. I just wanted to chime in.

[docteur]

I also think now is the time to be in cash. I believe the solution to this quagmire we find ourselves in, which took a long time to create, will also take a long time to unwind. It will be accomplished through a balancing act of slowly raising interest rates (to give folks time to accomodate) on the one hand and an attempt through other measures to soften the fall of real estate on the other.

I think we will have a soft landing but on a very long and slippery runway and it will seem like an eternity until we finally stop skidding. And all the while the passengers will be wondering: Are we going off the runway? Is the plane going to explode? Are we all going to die?

I once read that the folks who survive plane crashes are the ones who go over all the possible scenarios they can think in their minds of before they even take off. People who do that are prepared, people who don’t just freeze when tragedy strikes and sit in a daze for several seconds because their minds have nothing to grab onto to create a solution to the problem before them. And it’s those few seconds of non action that is their demise.

None of us knows what’s going to happen but as long as we continue to discuss as many possible scenarios as we can along with solutions, we will be prepared and will survive whatever befalls us – whether it be a crash, a hard landing or some other unknown scenario.

Whatever happens, I believe it will happen slowly at first and then pick up momentum but hopefully at some point, a trend (a way out) will emerge that we all can take advantage of. Right now there is still a lot of uncertainty in the air and where there is doubt, I say just get out (of the stock market, commodities and real estate).

Cash is king because the solution to our dilemma isn’t clear…yet. But continuing to discuss the various scenarios and rehearsing what we would do in any given situation, is the best way to survive until something clearly starts to unfold.

[powayseller]

Even if that cash is losing 3% annually due to inflation?

What about stock in Berkshire Hathaway, publicly traded payday lenders and pawn shops (will do well in a recession), commodity index funds (supply-demand imbalances favor commodities going nowhere but up), euros/yuan/swiss francs (as dollar loses value)?

What do you all think about these alternatives?

[docteur]

I think Chris stated it pretty elegantly via his actions in the market. He waited until it was clear to him that is was time to pounce and he did. Then losing 3% per year to inflation turned into gaining 19%+ because a good idea surfaced and he acted on it. He was patient until it was time to act.

You have to stalk an investment idea. Lie in wait until you can cull one from the herd. Don’t invest just because you think you are losing via inflation. One good investment idea can make that loss up tenfold.

Besides, if you go into short term treasuries, you are not losing (if you believe the government inflation numbers) you are simply parking your money. When it comes to investing, patience is the most valuable virtue you can have.

It is far better to wait until you are absolutely sure, then back up the truck. Gains are made in short bursts, when the timing is right and you have the certainty of your actions. Wait for the opportunity to show up…and when it does, you will be ready.

As far as your alternatives go, BRK-B is probably the only one I would consider (I am pretty conservative) and the only reason I would consider it is they have lots and lots of cash! They can weather some pretty bad financial storms or some pretty bad investments (WB has made some horrendous mistakes in his career but his good ideas have far outweighed his bad ones).

The bottom line for me is there is tons of conflicting information out there. Again, nobody really knows for sure what’s going to happen. Nobody. You just have to trust your gut meter (after due consideration of all the alternatives) and go with it.

Like Little Big Man said “Sometimes the magic works and sometimes it doesn’t.”

[powayseller]

I absolutely do not believe the government inflation numbers, but not because I’m a cynic by nature. I’m actually pretty trusting, and question things which don’t make sense. So I ask myself, how can inflation be 2%, when most things I buy are going up 10% – 20% per year: housing, health insurance, higher education, gas and heating oil, property taxes? These are the big ticket items that we all need to pay for. So what if clothes from China go down every year? That doesn’t balance it out at all, if I only spend 5% of my income on clothes? Meanwhile, I spend 75% of my income on stuff that’s going up at a pretty good clip. Now tell me, what is inflation really?

Although we are 75% in cash right now, I believe we are losing 3% annually, at least, to inflation. Oh well, at least I still have my principal, right?

I can’t do what ChrisJ did. He’s a clever trader. I’m a conservative value investor. I only lost $4K in tech stocks, because I bought Lucent after it crashed off its lofty heights, to $7/share, and then it went down to $2.50. I bought BKR.B and UPS during the tech runup. Someone like me can’t just back up a truck and expect to pile on something good. I need a long-term idea I can hold onto. For example, in 2000, I got into 6 different index funds, and I am up quite a bit. Now I want to get out of those funds, find some recession proof stocks, and diversify out of the US Dollar. I’m not a daytrader. Just a good old-fashioned buy-hold investor.

[docteur]

Your take on inflation is a good one. How does it impact your personal budget, your bottom line? There are so many ways to calculate the real impact of it, I guess the best gauge is the impact increasing prices have on you and your family.

And yes, you still do have your principal, which is 50% of the investment battle! Remember, the most important rule of investing…Protect thy Principal.

Let’s say you lose 3% to inflation per year, being fully invested in short term T-Bills for three years, waiting patiently for a good idea to surface. And then you hit on one and over the next couple of years, you gain 30%. I’ll take that risk anytime.

Anyway, while you are waiting and given your conservative nature (as is mine), I would stick with BRK-B (great for buy hold investors), index funds and again, short term treasuries (all relatively liquid).

However, if long term interest rates ever get lofty again, (if I remember right, in the early eighties the 30 year T-Bond hit about 15% and I believe prime was north of 20%) I’d jump in for the long haul because that kind of consistent return ain’t bad (the key word being consistent).

I guess all I can say is keep doing what you are doing. Again, no one has all the answers. Trust yourself and your own particular investment style will lead you to another great round of investment ideas.

And don’t sell stuff that is still heading north until it starts going south. Trying to anticipate markets is real, real tough. I just let the trend emerge and hope that I have caught the bulk of the move. Sell the bad stuff, not the good stuff (like your current index funds).

Anyway, it sounds to me like you’re doing pretty well on your own so far and I’d say the best advice you can take is from your inner self. Trust your gut. It’s gotten you this far without any major financial disasters and the more savvy you become, the better you’ll do.

[Anonymous]

Poway

Here is a very specific idea for you as far as an investment this year. Historically the very best time to buy stocks is in the fall of mid presidential term/congressional election years. This year is one of those. On or about October 1st, look to find the most undervalued stocks of the Dow 30 ( pick ) 5 of them. Make sure none of them is losing money (GM) is eliminated for example. Divide the amount of money you have for stocks into 1/5’s in terms of dollars and buy those 5 stocks. Hold them until April 1st of the next year, then sell all of them.

This has been the strongest seasonal stock play that exists since the 50’s. The actual play is to hold them for 2 years, but there is a strong tendency for big declines mid year,in years ending in 7, so 2007 is one of those.

There may be other plays out there stock wise that would be better, but this is an approach that historically has worked very well. I will be doing this trade myself. Assuming I am still active in this forum, I will be more than willing to tell you what these stocks are at that time. However, I may not be. There is much written on the web about this tendency so research it.

You would be wise IMO to exit now, as a decline is upon us which will setup this seasonal buy trade this fall. I exited all stocks about 30 days ago, due to the weakness in bonds, and seasonal tendency for a drop at this time.

I am not trying to be a know it all as any trader that has been at it as long as I have has been crunched a few times. However, this is a very conservative value oriented investment approach that has consistently outperformed the market as a whole.

As far as your comments on inflation, I think I tend to agree. I do not know what the real rate is, but it does seem like it is more than what is being reported. My favorite phrase is the CPI ex food and energy! That basically says, if we take out the things that are causing inflation, then there is not a big inflation problem.

That is like saying if you kept the basketballs of the court, the opposing team would have a hard time scoring a basket!

[powayseller]

ChrisJ, I have used the Dogs of the Dow approach myself. Except I tweaked it, and used those Dogs that I thought had a better hope of recovery. My mistake was holding on too long. Delphi, DuPont and Caterpillar were 3 of the stocks I picked at that time. I just sold CAT, and the money I made almost made up for the money I lost on Delphi:) I will make sure I do it right next time!

What do you think about commodities, or the Jim Rogers International Commodities Index Fund? The supply-demand imbalance should cause a bull run for commodities for many more years.

[Anonymous]

Poway

This is not the Dogs of the Dow Theory, as that does not work as well as what I am talking about. Also, it does not time the entry. The Dogs made I think about 3% last year, whereas this approach as per my prior posts made 19.2%. CAT was one of the stocks I had, but those other two were not. There are better valuation numbers than the Dogs theory suggests.

Also, Jan is not a good time generally to get long stocks, which is another flaw of the Dogs Theory, as it resets it’s stocks at a time where going to cash is usually a better decision.

Unfortunately, this is really not the right forum for this type of dailogue. I am sorry for bringing this up, and thankful to Rich for not sensoring it. It is off topic. I have given you enough hints for you to best research on your own whether this approach suits you.

You seem tenacious so go for it. Best of luck.

As to commodities, I am a professional futures trader so I always have thoughts on that. However, again it seems to be off topic. I do not want to abuse the privelege of being in here chatting.

One thought in general which applies to all things such as real estate right now. Too many people chase the latest hot hand, such as housing right now. In general, these hot commodities are no different. Many of them are very extended now. The time to have been there is past, so there is alot of risk now. You need to be there before the herd.

Long term I do not know. I work in 6 months or less time windows in trading so my long term views are worthless.

Cash is a good place right at the moment as per what we discussed before.

[powayseller]

I checked my Vanguard index funds, to make my Sell move today. I realized they are all doing well, and may not be at a high PE. I’ve owned all since May and August of 1999: Pacific, European, Emerging Market, Small Cap Growth, Small Cap Value. All have gone up 50% – 100% since I bought them. Is there any reason to think they are overvalued? Perhaps there is a good run left in them. I made a good move: back in 1999, when everyone was piling into money-losing tech stocks, I loaded up on out-of-favor index funds.

I did sell my stocks: CAT (from $37.81 in 2000 to $79.06 today0, RUBO ($6.13 in 2000 to $9.35 today), and UPS (from $55 to $82 today). I sold Gillette ($21 down to $13) and Proctor and Gamble ($55 then and now). Overall, I am up ahead somewhat. I mention these stocks to give an indication that I ran against the herd, and it worked out okay for me. So far.

Now the question is: is there a compelling reason to hang on to those index funds? I don’t know how to find the PE of the foreigns ones. The Small Cap index pes are 19 and 24, so perhaps ripe for a sell. I will wait to sell the index funds until I can evaluate any feedback I get here.

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