Don't Just Do Something, Stand There

by: Tim Price posted on: August 08, 2008 | about stocks: RBS / XLF    
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“No.” – Amy Carter (President Jimmy Carter’s daughter), when asked by a reporter if she had any message for the children of America.

 At some point over the last quarter century, politicians, administrators, regulators and bureaucrats appear to have uniformly succumbed to the simple-minded doctrine that people have become allergic to any form of loss. Politics, and investment markets for that matter, have become largely infantilised. It is difficult otherwise to account for such widespread belief in things like the ‘Greenspan put’ – a putative strategy in defence of the stock market that, like so many other presumptions about this most over-rated of central bankers, was a colossal failure in its inability to prevent the Nasdaq index from falling by roughly 80% between 2000 and 2002.

As Lord Overstone famously said, no warning can save a people determined to grow suddenly rich. In the 1990s it was technology stocks. Thanks in no small part to the Greenspan era of ultra-low interest rates, the most recent decade brought us a bubble in property. The deflation of that bubble is now occupying the tiny minds at the Treasury – the same people (collective term: a shamble ? Or perhaps a dither) who rushed to the defence of a second-tier bank that happened to employ Labour voters in a North of England constituency. The latest wheeze, “announced” and then hurriedly un-announced, is to suspend stamp duty, the better to allow first time buyers to lose their shirts in a rapidly collapsing residential property market.

About the only good thing you can say about the US property market is that the UK property market looks uglier. In his latest quarterly letter, GMO’s Jeremy Grantham reveals all. Median US house prices relative to median family income peaked just before 2005 at above three standard deviations above the norm.

There is more good news to the extent that the overdue correction is now well under way: Grantham suggests that US property prices need to fall by 17%, or stay flat for four years, to reach fair value. It is in the nature of bubbles, however, that price trends can overshoot on the downside just as they did on the way up, so a presumption of simply a fair value conclusion to the property crisis may be somewhat optimistic. Nevertheless, the US property outlook is an oasis of sun-kissed loveliness by comparison to that of the UK. For us benighted Brits, Grantham suggests, UK residential property prices would have to fall by 38% overnight, or stay flat for some seven years, to approximate to fair value. Again, the belief that this phantasmagorical mess ends neatly at fair value, rather than well below it (like the last three property busts) could be delusional. A good job the men from the government are here to help.

While reading Mohamed El-Erian’s considered account of our age of turbulence, ‘When Markets Collide’ (McGraw-Hill, 2008) one paragraph in particular leapt out at me. In the interests of not taking Mr. El-Erian’s words out of context, it is reprinted here in full:

In financial circles, the most-often-heard concern is that repeated attempts by officials to “bail out” markets eats away at the integrity and credibility of mechanisms of market discipline. You will hear the concern that the attempts to rescue investors from their foolish investments will simply encourage them to take even more thoughtless risk in future; insuring deposits at banks will weaken the incentive for depositors to carry out an adequate level of due diligence; and providing official emergency lending to countries and companies will encourage others to assume excessive indebtedness in the knowledge that they will be rescued from their foolish decisions.

 Future generations will find within that text the germ of a particularly quaint idea – that depositors at banks can now undertake any remotely adequate level of due diligence upon those banks whatsoever. A banking specialist Ph.D who has spent twenty years at Bank College studying nothing but banks, who lives on a river bank and commutes every day to Bank, and whose every waking second is committed to understanding and analysing banks, would struggle, even if presented with the entire resources of every credit ratings agency in the world, to conduct due diligence upon banks consistent with making an informed assessment of the risks they hold and the risk they represent.

Royal Bank of Scotland (RBS), which on Friday reported the first loss in its 40-year history as a public company, and which wrote down its credit book by £5.9 billion, and which in June raised £12 billion in the biggest ever rights issue in European history, was telling investors as recently as February that it had no need to raise new capital.

In the middle of a historic credit bust caused by the foolish decisions of bankers and their managers, there comes a point where there is no essential difference between incompetence (we do not know what really sits on our balance sheet) and outright lies (we won’t tell you what really sits on our balance sheet) – certainly no essential difference as far as their shareholders are concerned. So Mr. El-Erian was also right, in Thursday’s Financial Times, to suggest that it was, in the words of the headline, “Time to act boldly and sort strong banks from weak”. But that presupposes that a) there are any strong banks, and that b) the political will exists to allow the market’s invisible hand to show the greediest or most incompetent bankers the red card. The jury is still out on a) and as regards b), the omens from the most recent policy pronouncements on stamp duty – fire soundbite, ready, aim – do not exactly inspire confidence.

The housing market should be allowed to find a floor without the intervention of politicians. One could say the same thing about the banks, but that would be to ignore the apparent outbreak of ‘loss allergy’ that so transfixes our current administrations. This is undoubtedly a challenging environment. Cometh the hour, cometh the man. But as things stand, the phrase “lions led by donkeys” springs to mind.

Portfolio update

The performance, and asset allocation, of the model portfolio that we use as a template for discretionary client portfolios are shown in the accompanying PDF document. 2008 has proven more difficult and the markets even more volatile than we feared. Nevertheless, the portfolio is showing a modest positive return for the year to date and – unlike a 100% cash position – offers the potential for more substantial gains in the event of markets stabilising.

We continue to believe that this is a market that will show more respect for the pursuit of capital preservation rather than capital growth strategies. We obviously believe that investors’ interests will be well served by a combination of asset class diversity and a concentration on defensive investment, a focus solely on high quality assets and managers, and the pursuit of absolute rather than market-relative returns.

Equities are currently enjoying a bear market rally but the extent and depth of the fundamentals (weaker house prices; ‘walking wounded’ banks; what looks like synchronised global recession) warrants continued caution. We would like to be more positive, but the facts don’t support that sort of stance. If it looks like a duck, sounds like a duck, walks like a duck, and has ‘duck’ on its passport, there’s a better than average chance that it might just be a duck. This looks, sounds, and feels like a bear market of quite some duration to come.

This article has 29 comments! Add yours below...

Tim Price

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This article has 29 comments:

  •  
    sr9web
    Aug 08 04:56 PM
    The worst of all possible scenarios is when you are dealing with incompetant liars.

    Because they are incompetant, the screw up and because they are liars, they lie to you about it.

    Then, because the are incompetant (and so the lies they tell are not very good ones) once the facts come out, you can easily see that they were lying. So, you confront them with their lies....

    But, because they are incompetant, thay can't understand how YOU can tell they are lying (they think they are being clever).

    And so, they lie to you even more and they GET ANGRY with you when you insist:

    a) they are lying
    b) you've found them out
    and
    c) they didn't do a very good job - either in the primary task or the subsequent lies

    Suffice it to say, if they have any type of power over you, they'll try to relaliate in some way - so as to show that YOU are the problem - not their incompetance or their lies.
  •  
    StupidityAnd
    Greed
    Aug 08 05:01 PM
    The fact that the fundamentals don't support a return to bullishness has no relevance whatsoever. The entire might of the US political machine, those in the private sector that have profited from the most recent counterfeit expansion of wealth, and the media this has fueled the whole thing have pooled their resources to "spin" another upward drive in the market. That's great because when it starts to peter out, as it surely will, the opportunity to short will be a gift.
  •  
    StupidityAnd
    Greed
    Aug 08 05:06 PM
    Ps I spotted the fact that the heads of the big banks where lying through there teeth 3 months ago during the last set of earnings reports. Everyone was talking about the "March bottom" and that the worst was behind us. Of course when people started to figure it out we hit a new low. The idiocy of this recent move just goes to show why Americans no longer deserve to sit at the head of the world table. Their own greed will be their undoing.
  •  
    Caltorguy
    Aug 08 06:15 PM
    While I am all for letting chickens come home to roost, isn't that what essentially happened in 1929? Credit collapsed and governments said "who cares" and what followed was a decade of economic contraction and a bout of deflation so nasty it took a world war to end it. People sure learned their lesson - people still alive from that era still have trouble spending money with a clear conscience.
  •  
    otbricki
    Aug 08 06:58 PM
    Yup. The Neocon Libertarian Gold Standard Zealots don't have a memory that stretches back to the Great Depression, and as such don't realize that there are worse things than a fiat currency controlled by a central bank.

  •  
    icandoitdon
    Aug 08 07:02 PM
    people today have no trouble spending money with a clear conscience, whether they have it to spend or not. and if they don't have it there are legions of lenders willing to lend it to them. the notion of risk is antiquated in todays world. the only ones at risk are taxpayers.

    this is a government and federal reserve that rewards the ignorant and penalizes the prudent. anyone who thinks that markets for credit and/or investing can flourish in such a dysfunctional climate is dreaming.

  •  
    otbricki
    Aug 08 07:07 PM
    Undertaking a diversified defensive strategy is NOT the same as just standing there. It is very much active management and is key to being in position to benefit from a market turn. Unlike Mr. Price I am not going to engage in the foolishness of trying to predict when that turn might occur.
  •  
    tim price
    Aug 08 07:12 PM
    My Website
    Unfortunately, Muffy, you have missed the point of my "headline". I am not advocating that investors "just stand there" - rather, that administrators (your Fed, my Bank of England) just let well alone and allow the markets to do their job. Equally unfortunately, I suspect that neither party will be able to. That leaves us, obviously, to manage our capital and portfolios as best we can ourselves.
  •  
    otbricki
    Aug 08 07:12 PM
    Unfortunately it is the leaders of commerce that are the leaders of imprudence, and are the beneficiaries of the bailout. Joe Mainstreet is paying the penalty, just like he did in the S&L crisis 20 years ago.

  •  
    tim price
    Aug 08 07:20 PM
    My Website
    I should now perhaps add that there are probably few things worse, in my opinion, than a fiat currency in whatever form. The US Dollar lost 98% of its real purchasing power during the last century. This crisis ends poorly, particularly for taxpayers. Happily for owners of gold, they don't pay taxes, to the extent that there is no government of Gold, and no region of Gold. When will people wake up to the broad theft of the commons that bailing out Wall Street & the City represents ?
  •  
    buyitcheaper
    Aug 08 08:14 PM
    This was a short busting rally event. Hope everyone sold into it.
  •  
    investor88
    Aug 08 09:57 PM
    Excellent article. Noted that Jeremy Grantham says US and UK are overpriced by 17% and 38% respectively which requires sharp drops or staying at current levels for 4yrs and 7 yrs respectively. Logical conclusion that this current rally is probably a bear market rally and that this bear market may last for some time, probably in terms of years rather than quarters.
  •  
    Paulo
    Aug 08 10:18 PM
    Regarding the specifics concerning Royal Bank of Scotland (RBS) which is mentioned as having floated the largest rights issue in European history this summer after telling everyone earlier earlier in the year that there was no need to raise new capital, 95% of RBS is owned by institutional investors and the rights issue was 95% subscribed (much better outcome than a number of other banks).

    If you owned RBS as a retail investor in the form of ADRs, you may have received this agenda after the annual meeting had been held to vote on it and discovered that the ADR holders had no rights and what rights they had would be sold at market by the underwriter.

    But you did not have to do nothing and stand there, Mr. Price. You could have sold your diluted common stock and bought RBS preferreds which recently declined from an issue price of $25 to just over $10 (and have almost doubled since as of today).

    I do not know whether RBS is going bust, but it is sure an interesting ride!!
  •  
    iThinkBig
    Aug 09 06:51 AM
    My Website
    It all starts at the top of government. While I realize serving in Washington or London is distasteful, we must do what we must. Caltorguy is correct about the implications of global monetary imbalance. Add 1908 to the list leading to WWI. In today's game it's West and East competing for the international monetary peg with some risk multipliers called nuclear proliferation, nuclear blackmail and energy crisis caused by the delluded or despots.
  •  
    jjason
    Aug 09 09:08 AM
    No Comment. None.
  •  
    User 138602
    Aug 09 09:20 AM
    talk is cheap and you sure seem enjoy bashing everyone and the system.you are all taxpayers and voters.we pay taxes because we don t have the choice but why do you vote?you are all cxobras,ready to strike but when elections are coming all the cobras are suddenly charmed by all those politicians (most of them lawyers synonym of liars) and collect your votes. not voting is also an act,stop talking and don t vote.
  •  
    truthinvesti
    ng
    Aug 09 09:49 AM
    My Website
    I politely disagree.This is a GREAT time to invest in stocks. I have ahieved well over double digit returns on my bargain bin thread documented on my free website.I have doe this by ignoring financials and retailers fo the most part and investing in tech and consumer goods companies and pharma WHEN IT is Appropriately priced.In 200 and 2007 ANYTHING you bought went up but liek Buffett says When the tide comes in you find out who is swimming naked. When the price is right BUY.Last week we bought BA and MSFT and were rewarded with huge gains A few weeks back it was KO under 50 and PG around 60. Be patient and strike
  •  
    fatcat
    Aug 09 09:55 AM
    12% inflation for 3 yrs. with flat or lower home prices in those yrs and the crisis is solved.This is the Bernanke thought process..
  •  
    notsosmart
    Aug 09 11:26 AM
    My Website
    no one can stop the rising tide of "good times" i bailed @ 14,000 dj.started back in cautiously 11,000 dj..its all a game now.think for yourself & dont listen to anybody about anything.all have an agenda.everybody wants their hand in your pocket.
  •  
    Jimbo
    Aug 09 12:48 PM
    Bravo, Mr. Price. A very good exposition of the problem. It's a wicked world Caveat Emptor.
  •  
    Toddbank
    Aug 09 01:58 PM
    My Website
    I live in Southern New Hampshire. A very strong market in an area called the "Gold Coast" duye to the high number of fairly well-off people. The R.E. Mkt here is broken: near desperation! I doubt it will recover for years. I get a lot of requests for loans. Most people are clearly delusional to the extreme! There will be a lot more blood on Main Street and SWall Street before we finally muddle out of this mess! Todd
  •  
    LiquidSoapDi
    spenser
    Aug 09 02:26 PM
    My Website
    At sr9web:

    You kind of hurt your case when you misspell incompetent over and over...
  •  
    Kunst
    Aug 09 06:00 PM
    tim price: "The US Dollar lost 98% of its real purchasing power during the last century."

    This really is a bit specious. It may take $50 today to purchase what $1 bought in 1908 (e.g., bread or gold), but incomes have effectively increased by a greater factor. Certainly the quality and quantity of what is available to purchase and the overall standard of living today are much higher than 100 years ago.

    Saying the purchasing power of the US dollar has dropped 98% is far different than saying the purchasing power of US citizens has dropped 98%, or at all.
  •  
    MarkMedayski
    Aug 09 06:47 PM
    What he wrote and withwhat I agree,in the market terms would soundapproximately like this:

    SELL:FTSE,NIKKEI,DOW,D... enough?


    BUY:OIL,LUMBER,GAS,GOL... enough?


    Long live the bear market,let's put black Armani suit on our bear baby as he will make us rich!Hurra a new class of milionaires!!!
  •  
    jlounsbury59
    Aug 09 10:34 PM
    My Website
    Kunst - - -

    I agree with your good observation on the purchasing value of the dollar. A week ago I published an article in SA which showed the decline in the inflation adjusted price of industrial commodities over the past 60 years. The article discussed the prospects for a commodity bubble and whether the long term price decline for commodities could be ending.
  •  
    bearfund
    Aug 09 11:40 PM
    To the commenter who writes "Neocon Libertarian ..." - where can I learn more about these people? And perhaps about the Lutheran Pope and the honest politicians as well.

    As for whether there's anything worse than the fiat money and central banking system, you're right; there is. Take the same system and add the death penalty for anyone bartering or possessing in quantities beyond their immediate needs gold, silver, food, oil, or anything else that could possibly function as a store of value. That would be worse. No need to tell your central banker friends, though; I'm sure they've got such a law drafted and ready to go and are just waiting for the right crisi-tunity to stuff it down our throats.
  •  
    msaghirmd
    Aug 11 10:14 AM
    My Website
    Florida, Michigan,, California are already in a depression. My latest blog post has a few articles detailing the South Florida Depression. It is getting bad. www.miamicondoforum.co...
  •  
    StupidityAnd
    Greed
    Aug 12 08:13 PM
    Yes but... Crammer said the market has bottomed, Kudlow says we have a "Goldilocks" economy and Maria Bartiromo always manages to interview bullish portfolio managers who's livelihoods depend on a healthy market. What more do need to convince you that all is well?

    [ED: edited for abusive language]
  •  
    Gob
    Aug 16 01:56 AM
    My Website
    Copying and pasting the same faggoty screed into multiple posts. How pathetic.


    On Aug 12 08:13 PM StupidityAnd Greed wrote:

    > Yes but... Crammer said the market has bottomed, Kudlow says we have
    > a "Goldilocks" economy and Maria Bartiromo always manages to interview
    > bullish portfolio managers who's livelihoods depend on a healthy
    > market. What more do need to convince you that all is well? CNBC
    > is a piece of immoral garbage and a big part of the cancer of greed
    > and consumption that corrupts the US to it's core. I love how they
    > are trying to fuel the greed needed to pump the market by airing
    > half a dozen programs glorifying excess and conspicuous consumption.
    > What a pathetic society!
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