Peter Dag & Friends: July 2013

7/22/13

IS EUROPE GOING IN THE DIRECTION OF DETROIT?

Trends in debt-to-GDP ratio (source: ZeroHedge, Eurostat):
•Euroarea: 92.2%, up from 88.2% a year ago
••Greece: 160.5%, up from 136.5% a year ago
••Italy: 130.3%; up from 123.8% a year ago
••Portugal: 127.2%, up from 112.3% a year ago
••Ireland: 125.1%, up from 106.8% a year ago
••Spain: 88.2%, up from 73.0% a year ago
••Netherlands: 72.0%, up from 66.7% a year ago Scary!

George Dagnino, PhD Editor,
The Peter Dag Portfolio.
Since 1977
2009 Market Timer of the Year by Timer Digest
Portfolio manager

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7/21/13

LONG-TERM ECONOMIC AND INVESTMENT TRENDS: INVESTMENT IMPLICATIONS

In order to establish a long-term investment strategy, it is crucial for the investor to closely follow the current level of real short-term interest rates. We have seen that if real short-term interest rates are below 1.4, or short-term interest rates are considerably less than twice the level of inflation, the following conditions are likely to happen in almost any country.
• Rising inflation
• Rising commodities
• Volatile economic and financial cycles
• Very low productivity growth
• Very poor economic growth
• The tendency of corporations to raise prices rather than invest to improve productivity
• Low investment in technologies
• Soaring real estate prices
• Soaring land prices
• Rising art and coin prices
• Soaring long-term interest rates and sagging bond prices
• Soaring short-term interest rates
• Frequent protracted declines in stock prices with equities declining 20 to 40%

On the other hand, the above trends are reversed when real short-term interest rates are close to 1.4 or above this level, or short-term interest rates are close to two times the level of inflation.

The message of this chapter is that interest rates, their level and their trend, represent an important element to guide your investment strategy. Their careful interpretation provides a useful tool to develop a successful investment program. Higher than average real interest rates tell the investor that policymakers are determined to keep inflation under control and therefore maintain stable economic conditions. These economic conditions are usually associated with a strong currency. These are ideal times to invest in financial assets (for instance, bonds and stocks) and avoid hard assets (real estate, art, coins, precious metals and commodities). Furthermore, if short-term interest rates are close to 5-6%, the markets are confirming that the policies followed in a country are sound and there are no problems on the horizon.

If real short-term interest rates are very low, or worse, interest rates are below inflation, the implication is that the country is in serious trouble and monetary authorities are following an easy money policy to hide the problems. This is achieved, as will be discussed in the chapter covering the Federal Reserve and Central Banks, by letting the money supply grow very rapidly and keeping real interest rates very low. The odds favor higher inflation, higher commodities, unstable economic conditions and a weak currency. Investing in hard assets is the investment strategy that would likely be successful in this environment. Last but not least, avoid investing in countries with weak currencies. Always give preference for countries with strong currencies.

As the reader is beginning to realize, there are many forces that impact investment strategies. The trend in the economy, its growth, and its momentum, are the major determining factors. The level and trend, not only of interest rates, but also of real short-term interest rates and long-term interest rates provide crucial clues on the risk and opportunities of stocks and types of assets to be invested in. High and low real interest rates are driven of course by monetary policy. This will be discussed in great detail in the next chapter dealing with the Federal Reserve. That is one of the most crucial parameters for developing an investment strategy. The trend in stock prices and of the currency reflects all these forces. For this reason we will place the analysis and investment in stock prices as one of the last chapters after having analyzed all the forces that have a profound impact on their trend.

But first we have to explain how the Federal Reserve or the central bank of a country impacts the growth and liquidity and the level of interest rates. Then we will see how the action of the Fed translates into trends in commodities and inflation. We will then be ready to look at investment in bonds, and finally we will examine how the stock market is impacted by all these factors and develop some guidelines to minimize risk in portfolio management.

(From Chapter 5 of my book Profiting in Bull or Bear Markets. Published also in Mandarin and on sale in China. The book is available at Amazon.com).

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7/19/13

Observations

In the last issue I wrote about balance, the Aristotelian Golden Mean. From the e-mails I received I realize now I wrote an un-balanced Observations.

No, I am not planning to retire. I am still too young at heart and I have too much passion for my work to even consider such an option.

I started playing tennis when I was a teenager. I liked the sport and the attention I was getting as I was becoming stronger. Being balanced was not my concern.

Our tennis club was inside ancient Roman walls (they are hollow to allow the Roman soldiers to move to different places). The locker rooms were inside and the tennis courts were close to the walls. The reason is that the building code in Rome forbids buildings to be erected within 200 yards of them.

I spent my days at the club basking in the sun and playing tennis. My grades, as you may suspect, were hurting. At the Italian amateur championship (lasting two weeks with 300 players participating from all over the country) I was ranked number one. And I won.

I could not stop playing tennis. It was so much fun. One day, however, a charming, unbelievably beautiful young lady came to the club to ask for information on how to become a member. I jumped from my leisurely position and ran to answer her questions. I was not alone. Several friends tried to be helpful too.

Then she left. After 20 minutes I told myself I could not lose her. I jumped on my scooter and after canvassing the many streets she could have taken, I saw her. I asked her if she wanted a lift. She did.

We started dating. I became more dedicated to my difficult studies, the most challenging degree at the University of Rome with a 40% success rate. She helped me. She encouraged me. She was there for me and supported my efforts. Tennis ceased to be a priority.

Finally my academic results improved.

One day I received the invitation to do research in a US university. It was my chance to see a new world and its people. After a few months she joined me, and Kathi and I got married. She gave balance to my life.

(This Observations appeared in the 9-11-2006 issue of The Peter Dag Portfolio ).

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7/12/13

Observations

I delayed the project several times. I had to do it. It was getting too late in the season. I had to varnish the toe rails of my Sabre 38. A lengthy exercise.

Every morning, for three consecutive sunny days, I applied a coat in 85 degrees. I was leaning for about 3 hours for each coat. My back did not hurt and my head did not spin when I got up. This made me feel good. By the way, you can only drink water when you do this job.

Before painting, I jogged for half an hour to a store close by to have breakfast. I also jogged to go to lunch after I finished varnishing.

In the afternoon I had the chance to talk to Jim, a superb sailor who helped me take the boat to Annapolis from Hilton Head, where I bought it. He bought an old Bristol, fixed it up and now it looks like new. He sold his house and now lives on his boat. Jerry too has been living on a boat for some time. But he confessed he was ready to go back to work again. He seemed to have reached an important decision.

Ted also decided, at least in the foreseeable future, that living on a boat in Annapolis is better than cruising the Caribbean. I became slowly part of the life at the marina. People have different priorities and problems. Or so it seems. This is where we escape to find relief from the pressures of life and to place issues into perspective. A sailboat and the Bay offer the perfect setting.

Should I also live the rest of my life on a boat? Cruising from port to port? It sounds romantic and fascinating. But my answer, to my surprise, is “I am not sure”.

The challenge of life is about achieving a delicate balance of how we capture what the world has to offer --Aristotle’s golden mean. Too much of anything burns us out. Money, food, entertainment, exercise, sailing. I like my sailing escapades. But I also love to come back and become immersed again in other aspects of life such as the pressures of the daily market swings.

When my mind gets into a dreadful loop, I find an escape in thinking how well I varnished the toe rails.

(This Observations appeared in the 8-28-2006 issue of The Peter Dag Portfolio ).

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7/4/13

Observations

There have been wars in the Middle East for decades with no foreseeable end. They are expanding again with ugly nuances (global terrorism). No solutions are in sight. What is the problem?

“We are in the early stages of what I would describe as the third world war,” Mr. Gingrich states. He is a superb thinker, so we must listen carefully to what he is saying. It implies the total destruction of the enemy, a feat still going on right now in the Middle East.

A Financial Times columnist suggests, however, the struggle between western capitalism and Islamism may end up looking a lot more like the cold war between the West and the Soviet Union.

Military action was not the solution then and was never employed to any meaningful degree against the Soviets. In those days the threat came from Soviet missiles. Now from poor religious fanatics and terrorists.

Communism eventually imploded because its economic system was obsolete and could not compete with that of the West. We won peacefully because our system was producing more wealth. This is a concept convincingly and scholarly stated in the two books The Rise and Fall of Great Powers and in The Birth of Plenty.

We are solving the wrong problem, which has been defined in religious terms. The current solution is to assert religious rights with whatever means. Destroy and kill. Kill and destroy, reminiscing the Dark Ages of man.

If you define the problem, however, as caused by desperate poverty, then the solution is totally different. Why don’t our leaders realize they are pursuing the solution to the wrong problem?

We have to invest money to build wealth in the region. Not to destroy and kill. War creates hate. We need to help the Middle Eastern people because they are poor and to assist them with the necessary infrastructures. Their history shows convincingly they do not know how.

They are desperately poor. Desperate people act desperately. Let’s show them the benefits of wealth. The Muslims in the USA and India understand this idea. Let’s try to solve the real problem and achieve peace!

(This Observations appeared in the 8-14-2006 issue of The Peter Dag Portfolio ).

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