Agora Financial’s Rude Awakening

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Laguna Beach, California

• Markets collapse under weight of abysmal economic data,
• Buffett’s “buy and hold” Berkshire eats dust as the markets tank,
• AIG-Whiz…we told ‘em so, hedging your paper money bets and more…

Joel Bowman, reporting from Taipei, Taiwan…

“And the beauty about the whole thing is that the Taiwanese dollar is in freefall,” explained your editor’s new landlady. “Your rent, since you’re paying it in U.S. dollars, will only get cheaper in the short run.”

Compared to our own English, Regina speaks with an impeccable second-tongue. Compared to our Mandarin, she’s a bona fide Taiwanese Shakespeare.

“And what about in the long run?” we dared to ask. “If the greenback slips, slides or backflips off a cliff?”

“That’s why you’re girlfriend earns the local currency,” Regina replied. “It’s called hedging your bets.”

“I see,” we offered, “It’s also why some people choose to hold a good portion of their wealth in gold, kind of an anti-paper currency hedge.”

“What did you say you did for a job again, Mr. Joel?”

“Nothing of consequence, Mrs. Regina.”

“You’re not a spy are you?”

“Not that I know of.”

“Good enough for me. The apartment’s yours.”

(For the interested reader, the New Taiwan Dollar is currently testing multi-decade lows against the greenback. Most analysts expecting a further selloff as the global recession pressures the Asian economies.)

Fresh from his impromptu FX trading class, your editor returned to his temporary home, back at the hotel, to check on the daily market data.

“Autos, Financials Lead Stocks Lower,” read one paper. “Dow Plunges Another 280 Points,” concluded another. Hmm…just another day on Wall Street, we thought.

Stock futures are down ahead of today’s opening bell on expectations U.S. payroll reports will reveal the worst employment levels in 60 years. Pretty soon, we suspect, the crazies on NYC corners will begin trading in their optimistic “Recession is Nigh” placards for “Depression is Here” ones.

Even the best traders are feeling the pinch, as Eric points out in today’s column. And, if the Optimistic Oracle of Omaha can’t squeeze a dime out of the market using his much-lauded buy-and-hold strategy, how can us mere mortals expect to? Eric provides some insights below…

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But only for an extremely short time.

Since we don’t have much time, let’s get right down to the details of this options service and how it’s performed over the past nine years.

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The Death of “Buy-and-Hold”
By Eric J. Fry

Stock prices are falling even faster than Alan Greenspan’s reputation or Warren’s Buffet’s mystique. Come to think of it, they are all falling at about the same pace. Hmmm…it’s as if they’re all one and the same.

Greenspan’s reputation – like AIG’s share price – is already in shambles. In fact a move to zero might be an uptick. Warren Buffett, on the other hand, still boasts a rabid following, as well as a few billion dollars in the bank. So let’s weep not for Warren.

Even so, this formerly glistening icon of “buy and hold” has become a bit tarnished. Buffett’s genius, we are now discovering, correlates quite highly with the S&P 500 Index. His genius is not quite as highly correlated with the S&P 500 as, say, Bill Miller’s, the former investment genius at the Legg Mason Value Fund. (For a little background, please click here). But an observable relationship exists, nonetheless.

Your editor would not dare to minimize Buffett’s investment acumen, nor to detract from the man’s considerable financial achievements – that’s Mr. Market’s job. Your editor would only point out that “buy and hold” works brilliantly in rising stock markets, and works particularly brilliantly in the rising stock markets of post-World War II Superpowers in the midst of a once-in-a-lifetime economic boom.

By contrast, “buy and hold” works poorly in falling stock markets, and works particularly poorly in the falling stock markets of pre-Great Depression Superpowers in the midst of a once-in-a-lifetime economic collapse.

We would remind our readers that Warren Buffett, an investment genius, learned his craft at the feet of Benjamin Graham, also an investment genius. Warren Buffett applied Graham’s principles during the greatest economic boom in American history and became a multi-billionaire. Benjamin Graham applied Graham’s principles during the greatest economic disaster in American history and became bankrupt.

Look behind almost any investment genius, dear investor, and you would be likely to find one or two coins that came up heads. That’s why your editors here at the Rude Awakening tend to distrust genius, especially their own. But they do trust the potential for adverse outcomes…and therefore, attempt to make money by not losing it. We have never been fans of buy-and-hold, even when it appeared to be working during the last 15 years.

Buy-and-hold worked well for most Japanese investors until 1989, when the Nikkei reached its all-time high. Since then, however, buy-and-hold has produced a loss of 81% – that’s a return of MINUS 8% per year…for 20 years!.

Buy-and-hold also worked quite nicely for Warren Buffett, at least until last September. Since then, this tactic has produced less than optimal results. Berkshire Hathaway’s stock has lost more than half its value since then. But more to the point, the stocks that Berkshire Hathaway owns have also tumbled in value.

In fact, according to blogger Jeff Matthews, Buffett’s massive investment portfolio, accumulated over more than two decades, is nursing a loss. That’s right, Buffett is posting a “down number.”

Publicly, Buffett claims not to care about the daily [or weekly, or monthly, or yearly, or decadely] fluctuations of Berkshire’s investment portfolio. “The market value of the bonds and stocks that we continue to hold suffered a significant decline along with the general market,” writes the Oracle of Omaha in this year’s annual letter to shareholders. “This does not bother Charlie and me.”

Ummm…right. We would guess that Buffett, in private, might be a wee bit annoyed that his net worth just dropped by more than $34 billion.

Not so, says he!

“We enjoy such price declines,” Buffett claims, “[assuming] we have funds available to increase our positions. Long ago, Ben Graham taught me that ‘Price is what you pay; value is what you get.’”

Cute phrase. Marginally delusional.

Value is a moving target, determined by millions of investors in dozens of countries. Furthermore, value is influenced by booms, busts, wars and government caprice. Admittedly, share prices tend to fluctuate more than underlying economic values. But an investor who buys “value” without acute sensitivity to price is an investor who will spend a career behind the counter of McDonald’s. (Or if he’s really, really lucky, such an investor might spend a couple of decades running a legendary mutual fund and THEN working behind the counter of McDonald’s).

But we suppose that Buffet can afford to write such claptrap. By our count, the man’s wealth still totals more than $29 billion – and that’s based solely on the price [not the same thing as “value”] of his Berkshire Hathaway stock. We’d guess he also holds billions of dollars more in assets in the form of houses, cars and cases of Cherry Coke.

So we do not gather here today to weep for Warren Buffett, but rather to mourn the death of “buy and hold.” Which leads us to wonder, what tactic is likely to take its place? What process/strategy will create the next generation of investment geniuses?

Buying low is certainly an important component. But unless you remember to sell high, you’ll never be a genius. Furthermore, it is important to remember that you have to take what the market gives you. And if it only gives you falling stocks, you won’t find too many investment geniuses. Doing nothing at all is sometimes the best course of action. The Oracle himself says as much. “Lethargy bordering on sloth remains the cornerstone of our investment style,” Buffett once remarked. Pity he did not apply a greater dose of lethargy to his recent investment activities. If he had, he might have avoided his woefully ill-timed purchases of ConocoPhillips, General Electric and Goldman Sachs.

Perhaps, therefore, we should begin doing what Buffett SAYS, not what he DOES.

To emphasize the value of lethargy, we would remind our readers that a hypothetical Japanese investor who moved his money into a passbook savings account on January 1, 1990, would have amassed about seven times as much capital as an investor who left his money in the stock market. Closer to home, buying the Vanguard Prime Money Market Fund on any day since June 30, 1995 would have produced a greater return than buying the Vanguard S&P 500 Index Fund.

To be sure, many stocks here in the US and elsewhere are now cheap enough to warrant making some initial buys. And probably, many of the stocks that an investor buys today will be worth holding for many years. But that’s not “buy-and-hold.” That’s “buy and watch out.”

A final point: For those investors who are still resisting the urge to buy anything, may we suggest one sale: Treasury Bonds.

Please check in next week as we examine the parlous state of American public finances, and why the best trade ticket to write on Treasury bonds for the next few years might be the one that says “SELL” at the top.

Joel’s Note: As Eric eloquently points out, we’re in for a tough few years ahead…to say the least. (If Buffet can’t make a dime in this market with the old “buy and hold,” how can you hope to?) Well, that’s simple…you don’t just blindly buy and hold. Instead, you employ a bear market strategy, something to help protect your capital during the days ahead. And what’s more, a good strategy will actually MAKE you money while the market tanks.

We suggest arming yourself with Dan Amoss’ Strategic Short Report. His readers raked in the profits last year while the major indexes plummeted. (Their Lehman Bros. put options made 450%, for example.) Can you afford to miss that? Read his Bear Market Strategy report right here.

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We said it first, so we’ll say it again. The AIG bailout repulsed your editors from the very beginning…and we told you so. The item below first appeared in the September 17, 2008 edition of the Rude Awakening. Please enjoy this stroll down memory lane…

Did You Notice…? AIG-Whiz!
By Eric J. Fry

I just loaned $283 to AIG…I and every other American. And the funny thing is; no one asked our permission. The Federal Reserve simply took our money and handed it to a group of individuals who have demonstrated the ability to lose billions of dollars faster than almost anyone on the planet.

I would rather have tossed the money in a wishing well…not only for the wishes, but also because the wishing well will repay the loan sooner. The Fed’s $85 billion “investment” in AIG is just the latest chapter of the American financial tragedy – a sordid tale that begins with the extreme greed of a few and ends with the widespread suffering of the many.

The Fed did what it had to do. It protected the millions of individuals and institutions who relied on the insurance policies of one of the world’s largest insurance companies. But let’s hope the tragedy does not end with an $85 billion bailout. Let’s hope our sordid story contains a few more tragic chapters, like ones that feature tales of AIG’s executive officers shedding tears of remorse on their prison dungarees.

Retribution cannot return the billions of dollars that innocent individuals have lost, but it can compensate somewhat for all of our $283 loans. To quote John Lennon, “You may say I’m a dreamer, but I’m not the only one.”

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In fact, this is so easy to do, once I show you how this works you’ll wonder why you’ve ever held stocks in any other way…

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[Rude Endnote: The futures market tells us to look for a lower open on Wall Street today. The Dow broke through the 6,600 level yesterday…and both European and Asian investors took that as their cue to exit local stocks.

Japan’s Nikkei 225 fell 3.5% while Hong Kong’s Hang Seng dipped 2.4%. And the Aussie market – when will those battlers get a break? – slid again. The All Ordinaries index fell another 1.18% to close on 3,111 points. Ouch!

Last we checked, London’s FTSE was down a smidge, about 0.4%, while France’s CAC and Germany’s DAX were underwater around 0.8% each.

Things look a little better in the commodities pits. Oil is closing in on $45 as we write and gold is up to $937 after a small, overnight rally of about $5.

We’ll be back with our regular weekend wrap tomorrow.

Until then…

Cheers,

Joel Bowman

The Rude Awakening
aussiejoel@the-rude-awakening.com