For someone along with Greenspan created the single biggest housing bubble (in size) in human history so far, bailing out all the guilty parties and mopping up all the mistakes with even greater mistakes through printing of more free money, he is “coined” as the savior of the economy from another great depression. A country does not attain prosperity through devaluing its own currency. Such acts when the confidence game is up will be met with great consequence. I have no doubts that history in the future will not have kind words for Bernanke, nor Greenspan (whose reputation has already been turning thru this financial crisis).

Aren’t you glad that banks are paying back all the TARP money? I guess all of them are hopeful eternally, and wishing that all the option ARM and alt-A borrowers will be paying back more when they start to reset to 25-year amortization schedule, starting now until the end of 2011. I think banks are very likely to negotiate all the option ARM mortgages back to 30 years or longer if possible. However, the biggest problem is that once the mortgages are re-negotiated, the mortgage payment will NO LONGER be less than the prevailing rent. Furthermore, who is going to pay down more principal towards a property that is already 10% to 20% under-water? I expect that the two factors combined will cause significant portion of the borrowers to simply walk away, or become home squatters to take advantage of one year of free rent through foreclosure process.

So when the hands of banks are tight, and they will tighten even more on the new loans. Some will probably go under and join the weekly FDIC’s Friday parade, and some may come back and ask for government money again. Ha, except that for the second time when they want to dip the “honey pot” again, the money will not be available because American and politicians will be so upset and simply shut down the institutions. If they are able to sustain without asking for more money, you can be sure that lending in economy will take a dive, driving USA onto the same Japanese-style deflationary track. But don’t worry, our beloved Helicopter Bernanke will come in his helicopter in a hurry, bombing free money from the sky at the fastest speed. It is likely that in the not-too-distant future, we will see a more volatile stock market, dropping at first due to the resurgence of financial crisis, and then zoom back up and onto new highs (higher than 2007) due to out-right devaluation of US dollar.

By the end of 2010, US fiscal deficit will probably end at 13.5 trillion dollars or more. The speed that it will increase will be exponentially faster until it collapses. Before US goes full speed on this exponential debt curve, there may be still a chance of stopping before the point of no return. But such opportunity does not exist as long as Bernanke is still in office as Federal Reserve chairman. I guess Greenspan will be remembered as the Bubble Man, while Bernanke may be remembered as the Bubble-death Man, who would blow up the final bubble in $US and US bonds, without any further ability for US to attract/wield global capital.

I have written about Hindenburg omen (H.O.) before on my site at 1stMillionAt33.com in 2006. Although in 2006 H.O. signal did generate a 7% declines out of the stock market, it was by no means a “stock market crash”. The current Hindenburg omen was triggered on June 6th 2008, and has been confirmed by subsequent repeated H.O. signals. The previous confirmed H.O. was in October of 2007, and stock markets definitely had a serious correction afterwards. The success rate for H.O. is only about 25%, or 1 crash in every 4 signals, and it will last for about 120 days during which it could crash. But if you could avoid those mini-crash period as a buy & hold investor, you obviously will do so much better.

If you study the details of H.O. signal, it indicates an unhealthy stock market advance, with both new 52-week highs and new 52-week lows among different companies going on simultaneously in the stock market. The resolution for an unhealthy stock market is often a substantial decline (if it happens). It’s obvious that in the current state of stock market, the financial companies are breaking new lows, while energy stocks are breaking new highs. Isn’t that a bit scary with the crude oil advance stopped at $140? What’s going to propel the general stock market indexes higher, when crude oil is knocked out by the fear of a slowdown in global growth?

With stock market technicians that I follow, Frank Barbera, Bill Cara, Jack Chen, Bob Hoye, and John Hussman all jumping into the bearish camp, I am fearful that a decline is just about anytime.

You’d better watch out, you’d better not cry …. Unfortunately, I am guessing that Bernanke Santa Claus will not be able to save this one.

Best luck.

Frugal at 1stMillionAt33.com

Reading over so many current/future proposals from politicians and bloggers, I have my own thoughts in this. For sure, there simply isn’t a solution without pain. But there can certainly be solutions that are more fair and less pain.

One of the most fair and easiest way to help propping up the housing market is to subsidize all the buying or holding cost for primary residences. Instead of helping on the sell-side directly, the government can help the buy-side. Of course, the subsidy will indirectly go into sellers. But the solution is market-based.

Why is this a fair solution? For sellers, there is simply no direct bailout. For anyone who chooses to buy, the buying decision is done on the open market where everyone else is competing on the same ground with subsidy, and existing real estate investors will also be helped with a more stable housing price. For any renters who choose not to buy and take up the subsidy, their decision is solely of their own based upon their evaluation of the current housing market and personal circumstances.

What kind of subsidy will make sense? The easiest way is certainly done through mortgage interest reduction or tax deduction. The tax deduction cannot be limited by the amount of adjusted gross income, and has to be actually beneficial on top of the existing standard deductions. By reducing the overall housing cost, government will encourage more of it, and prop up the housing market.

Since 65% to 70% of the Americans are home owners, most of this housing aid will effectively become a tax cut for middle class. I suggest that 50% of the total amount of both property tax and mortgage interest from primary residence can be used as a tax credit (rather than tax deduction in the itemized section). Here are some examples of the housing aid scenarios, with loan interest at 6%:

1. $700K home in California with 20% down for someone with tax bracket at 28%:
Because loan amount is $560K, the interest is $42K a year, and the additional tax subsidy amount will be roughly (50% – 28%) * $42K / 12 months = $616 a month. This monthly subsidy will effectively lower the interest rate from 6% ($3357) to 4.25% ($2755). That will be a tremendous stimulus.

2. $500K home with 20% down for someone with tax bracket at 15%:
The additional tax subsidy amount will be roughly (50% – 15%) * $500K * (1-20%) * 6.00% / 12 months = $700 a month. This monthly subsidy will effectively lower the interest rate from 6% ($1852 payment) to 3% ($1686 payment). This is an even better deal for lower income people.

Effectively speaking, this tax cut will target middle-class home owners specifically. Using the assumption of a median home value of $240K, and an average tax bracket of 15%, this tax aid comes to be about $4032 dollar per family household, 110 million US households, with 70% home owners, it will be about $300 billion annually. I’m not going to re-do my numbers here, but probably instead of 50%, one could go for 40% of the interests as tax credit. This will adjust this bill from $300 billion to about $214 billion. I hesitate to go to much lower, simply because in California, where most of the housing problems are, you have to be at 25% to 28% tax bracket to afford the homes. Since one is already getting existing tax benefits at 25% to 28% through itemized deduction, the 40% as tax credit will only give 15% to 12% additional benefit.

Bottomline, this printing of tax money will be truly the best way of distributing the helicopter money, since it goes to the homeowners directly without discrimination, AND it is also tax-progressive. The rich who has a bigger loan do get a lot more, but only because they are paying a lot more for their home. But the middle class will not be left out at all, and will enjoy the biggest piece of the tax reduction. This will effectively encourage home purchase/consumption, and props up housing market. The solution is also market-based without ANY bailouts to those people who abuse the mortgage markets.

In respect to Republican tax position, this is a market-based solution. In respect to Democrat tax position, this is a tax aid for most of their incumbents. In respect to stock markets and US economy from Keynesian economics, this is a huge positive. Tax cuts stimulate economy. On the other hand, money from direct taxpayer bailouts go into the pockets of these fraudulent bankers and homeowners, and continue to encourage moral hazards and speculation.

Frugal at 1stMillionAt33.com

I hate to sell any of my stocks right now, but things just simply do NOT look good. Tuesday opening may be down again it appears for the following reasons:
1. Financial sectors in Europe are crushed on Monday. All global markets have plunged from 4% to 8% on Monday. I have expected emerging markets to fall. But the problem is that they just started falling, with US stocks already breaking supports. Now, I just can’t imagine what would happen when emerging markets are 20%. Will US stocks be 30+% off instead??

2. US dollar index is rising STEEPLY to 76.866 (10:18 on Jan 21). This is ESPECIALLY scary. As I have said many times, for US stock markets to go up, US dollar MUST fall. Here are the currency quotes that I’ve obtained, ALL breaking recent high/low with US dollar gaining strength, except YEN:
EUR vs USD at 1.4485
USD vs JPY at 105.87
GBP vs USD at 1.9458
USD vs AUD at 0.8628
USD vs CAD at 1.0320
This is F***ing scary now, because yen carry trade unwind is in FULL force.

Initially, I expected that precious metal sectors may be spared. My expectation came from the observation of the recent stock market fall as the new year opens. All markets fell, but precious metals went straight up. The currency markets indicated the same phenomenon as of now. However, energy markets later were not spared. Now precious metals stocks have corrected with gold spot almost reaching an all time high and have pulled back to $867. If gold price breaks $850 and then $835, along with Yen strengthening, then I think the black swan dive will be here with us.

Once the market opens on Tuesday, I tentavely think that I probably will purchase puts for February or March expiration (but maybe it’s too late already). The markets show no signs of improving. The last rally on last Wednesday kind of surpised me on the lack of followed-thru, because this sick market canNOT even rally for 1 day. That particular rally was intraday, and was LESS than 1 day. Maybe it is time to face the truth.

I don’t know how ugly this market will get. But the markets are probably more over-sold than the bottom in the last bear market of 2002/2003. Jumping out of the window maybe is the best way to avoid this train wreck now. (Boy, I’m not even panicking at this point. I don’t want to see how low this thing will go when I panic.)

I spend some time shopping for wireless routers, and found a really good deal at target.com for the latest and greatest 802.11n router. It’s a D-link 802.11n router, and it’s only $40. If anyone is thinking of getting a new router, this N router is as cheap as other G/A/B router.

For those who are not familiar with 802.11 wireless technologies, 802.11b is the slowest. 802.11g is faster than 802.11b and the most common choice now. 802.11a is the least compatible and rare. And the new 802.11n is about 5X faster than 802.11g, and will be the next generation wireless technology for everyone’s home. Using 802.11n, one can probably transfer big files wirelessly at a very fast speed. More importantly, I believe in the next 2 to 3 years, you can watch HD TV wireless “everywhere” in your home. The speed of 802.11n is sufficiently to support multiple MPEG2 HD quality channels (not to mention that if you use MPEG4, you get more than double of that). There are still difficulties for wireless TV due to potential intermittent transmission quality. However, I think those problems can easily be solved, if you simply buffer a lot of video by combining the storage capacity of the hard disk from your PVR (personal video recording) system with 802.11n.

Anyway. It’s probably too much tech talk for someone simply looking for a cheap router. And in case if you are interested in the main companies who provide these wireless technologies, they are ATHR, BRCM, MRVL, listed in alphabetical order. I don’t advise buying any of those high-tech stocks however. But if you think of buying them, you may choose ATHR which is a very focused and strong player. Their design seems to be some 40% better in terms of cost than the competitors.

By the way, I wouldn’t worry so much about the “draft” N. 802.11n has been around for at least 1.5 years now, that I think any shipping products should be like 98% compatible with the final approved standard, if not 100%.

Don’t know if any of you picked up some shares in CGMFX or CGMRX when I first blogged about Ken Heebner and his funds back in April 2007. Heebner moves faster than you can track him. At that time, he was bearish on real estate stocks, bullish on mining and infrastructure stocks, neutral and slighly bullish on brokerage financial stocks. I think I checked his holdings, and he was holding brokerage stocks at one time. But he got out quickly for sure, and both of his CGMFX and CGMRX (supposedly a real estate fund) are showing big holdings in energy/infrastructure names. Yeah, he moves FAST.

If there is a second example of failure of Efficient Market Hypothesis (EMH) besides Warren Buffet, I would say Heebner is high on the list. He has beaten indexes year after year for so many years now. Incredibly record. I have to seriously consider buying his CGMFX really. Maybe EMH is garbage. Or at least it’s a garbage theory definitely to Heebner and the fund holders personally. Some people I guess can really time the market. And timing the market with a big mutual fund portfolio is certainly much harder than a small individual portfolio.

Don’t invest just based on my advice. Caution is always advised. Disclosure: I currently don’t hold CGMFX or CGMRX, but I wish I did 10 years ago.

Here is the direct link to the Burea of the Labor Statistics. In the first paragraph:

Employment rose in September, and the unemployment rate was essentially
unchanged at 4.7 percent, the Bureau of Labor Statistics of the U.S. Department
of Labor reported today. Nonfarm payroll employment rose by 110,000 following
increases of 93,000 in July and 89,000 in August (as revised). In September,
health care, food services, and professional and technical services continued
to add jobs, while employment trended down in manufacturing and construction.
Average hourly earnings rose by 7 cents, or 0.4 percent.

Remember that just last month BLS reported that

And that gave away all the excuses for Fed Reserve to cut interest rate. But since $US dollar was free falling. I guess BLS September report becomes the latest booster to $US. The “supposed” error in the August number was close to 100% of the value.

Well, but in the last paragraph of the BLS September Job report, here lies the March revision, downward by 297,000 jobs. It doesn’t take a stupid to figure out that something is quite off. Maybe the birth & death statistics model used by BLS has been skewed heavily towards birth of new jobs, rather than death of old jobs? Here is the last paragraph:

Preliminary Estimates of Benchmark Revisions to the Establishment Survey

In accordance with usual practice, the Bureau of Labor Statistics is announcing its preliminary estimates of the upcoming annual bench-mark revision to the establishment survey employment series. The final benchmark revision will be issued on February 1, 2008, with the publication of the January 2008 Employment Situation news release.|

Each year, the Current Employment Statistics (CES) survey employment estimates are benchmarked to comprehensive counts of employment for the month of March derived from state unemployment insurance tax records that nearly all employers are required to file. For national CES employment series, the annual benchmark revisions over the last 10 years have averaged plus or minus two-tenths of one percent at the total nonfarm level. The preliminary estimate of the benchmark revision for March 2007 is -297,000 (-0.2 percent) for total nonfarm employment.
….

All of the above fishy numbers plus the timing of the reports only tell me that BLS apparently is closely cooperating with other branches of government to financially engineer the markets.

One word, spending (which is the default Keynesian economic solution).

What kind of spending depends on the agenda of voters. However, I think the following industry will probably benefit:

1. Infrastructure: anything that rebuilds the energy, transportation infrastructure, and/or constructions of some sort should benefit. Water and alternative energy are the ones that I can think of, but there can be many other area.
2. Healthcare: with aging boomers, spending in pharmaceutical and healthcare industry probably would increase more than other service industries.
3. Military: with the continuing diversion of strained foreign relationship in Middle East, the military expenses may be ongoing.

By more spending, government could compensate the shortfall of employment in the private industries. Many dollars will go wasted and beefed up unscrupulous government contract bidders/government officials, but they will be just the “necessary evils” that incur as part of the process.

So everything can be made whole? How can any free money/job be created without any consequences? Well, the answer would be that US dollar will continue its descent, and dilute any US dollar holders. I expect that Federal Reserve will continue to support profligate spending in Washington by monetization. By buying up long term treasury bonds, and keeping long term interest rate low, Federal Reserve can keep a higher P/E ratio for stock market, and laying support for crumbling housing market. The only thing that will get destroyed in this gradual process is the value of US dollar. Let’s say the supply of US dollar doubles overnight. Congress can use the new additional trillions of US dollars to boost up the economy, at the expense of diluting the US dollar value by 50%. The obvious losers will be the US dollar and bond holders (China & Japan of course). The lost wealth will then be transferred via government spending to various beneficiaries. The tiny nest egg built by middle class people will be made smaller due to inflation, while the rich and the powerful simply gets even richer in the wealth redistribution process.

Since US government will not dilute US dollar by 50% overnight, it is up to you and me to guard our precious capital against inflation (and tax if possible) before the process is complete.

I don’t know whether it’s alarming to you, but US debt ceiling is going to increase from 8.965 trillion to 9.815 trillion. As far as I can recall, since 2000, such increase in the debt ceiling has become more frequent, and the amount of increase is getting bigger too. Trillion of US dollars goes by really fast in the USA. For any financing shortfall that foreigners and foreign central banks don’t take up, they will end up as pure monetization in the US financial system, and manifest itself as direct inflation. And inflation is the “best policy” for government, since you get to steal another 30% to 50% back via “capital gain”, plus that you can cover yourself up by fudging statistics and the best liar teams at Federal Reserve and BLS, and cut the unofficial inflation rate in half easily. Great, huh? The only thing that US needs to make sure is that it can prolong the confidence game (in US dollar) for as long as possible so that the dilution can last without running into the end-game of hyper-inflation.

For one thing, because the long term bond markets are not collapsing or dropping dramatically after Fed raising interest rate, while the short term interest rates are falling, it appears to be a good sign that Fed still having everything under control for now, except on US dollar index cutting through multi-years support at 80. But based on Bob Hoye’s historical analysis (pg.2 at this link), such post-bubble yield curve steepening is more ominous rather than a bullish sign. Bob’s recent forecast has been quite accurate, and I would trust his words as a market historian rather than Mark Hulbert’s who has been putting out 8 to 9 bullish articles out of 10 this year. Such yield curve steepning according to Bob Hoye is simply part of the post-bubble credit contraction process. Certainly, if long term bond yields start to go up much more, they will simply deepen the housing recession. Now, I don’t care about how accurate the predicative power of yield curve. It is simply a black-and-white matter that housing markets will get worse if the bond yields go up. With the housing bubble unfolding, my only attention would be the absolute level of the long term bond yields, rather than whether the curve is inverted or not.

By the way, if I didn’t make it clear in my yesterday’s post on “is it 1998 or 1970?”, I will now. I believe that more of the emerging markets will be in the 1998-style progression, while more of the senior markets will be in the 1970-style. I think US stock market will be going thru an extended period of sideway with possibly a bullish slant, with $US falling gradually. The best thing for US dollar holders should be trading in this sideway market to make up the $US fall in purchasing power. But you do need to wait for a round of cleansing before jumping into it.

Best luck, and have patience.

While I remain suspicious American consumer’s continuing willingness/ability to pile on debt, I give more credence to the other leg the bulls stand on: strong global growth. Nowhere is this more evident than in China. The Shanghai stock market made consecutive new highs last week to end at 5108. Again recall that not too long ago the ubiquitous worry was for an implosion in the China to bring down global markets. The fact is, since the July 19th peak in US and the rest of world markets, SSEC has gained over 25%. On Friday, FXI, the FTSE/Xinhua 25 ETF, also made a new high, finally confirming the move in Shanghai.

Let me clarify my view on the Chinese market. Many have compared it to the Nasdaq bubble based on price trajectory alone. I will not debate that point. I will even grant that the Chinese market is in a bubble. But in my opinion, that misses the point entirely. Bubbles are grand money making opportunities, during both the expansion and implosion phases if you know which side of the market you’re on! So let’s put emotions aside and look at some relevant recent developments.

First of all, let’s look at some negative factors.

• Chinese exporters enjoy a rebate of value added tax. On June 20, China announced that it will reduce tax rebates on exports of high energy-consuming, resource-intensive and environmentally-harmful products. The measure will take effect around September/October. Given that Chinese exports amounts to 30-40% of its GDP, lowering the rebate is a far more effective way to slow down its red-hot economy than raising interest rates.
• Of course, they can do both at the same time! Chinese CPI was a blistering 5.6% for the month of July. The index was paced by food, especially pork , prices. In response, the PBoC (People’s Bank of China) raised deposit rates by 0.27% to 3.6%, and lending rates by 0.18% to 7.02%. It was the fourth raise this year.
• I’ve always held the non-convertibility of the Yuan as a positive since the individual investor has few choices besides the domestic stocks. For example, some key state owned enterprises have listing in both Hong Kong (H shares, aka red chips) and Shanghai (A shares). But the A shares are far more expensive than H shares because there is too much money chasing the same shares. Two weeks ago I would have said that the day that the Yuan becomes fully convertible would be the top in the Chinese stock market as individual investors diversify out of the country en masse. In a surprise move last week, China declared it would allow individual investors investing abroad, starting with Hong Kong. The news sent the Hong Kong’s Hang Seng index up 10% last week with broader Asian markets following suite. Of course, some capital will be diverted away from the A shares market; on the other hand, this is gradual approach eliminates future shocks. It cools down the domestic market and relieves some exchange rate pressure at the same time – a stroke of genius really.
• The Bank of China (BOC, not to be confused with PBoC, the central bank) and its Hong Kong arm disclosed that they hold $11.25 bn of CDO’s based on US subprime mortgages. The Industrial and Commercial Bank is on the hook for $1.23 bn.
• Recalls of Chinese products, from tooth paste to sea food to toys with lead paints, are grabbing headlines everywhere.

The intriguing thing is that all these happened prior to last week where the Shanghai market had five consecutive up days. You can chalk it up to irrationality but the price action is to be respected nonetheless. In a way, it shows the power of liquidity since Chinese citizens are still pouring money stocks. Let’s now look a few positive factors.

• One of the signs of excess that bears love to point to was the number of new stock trading accounts opened daily. It was somewhere around 100k before the last correction in May. Well, with the market at new highs, that number has increased to 150k or so – TDAmeritrade/eTrade, take that! Anyway, I never understood that logic behind that particular argument in the first place. Common sense says that the flow of money should peak well after the peak of number of accounts open. Besides, while 100k or 150k per day is a huge number, the number of potential investors in China is, well, huger!
• If you’re wondering where all the juice in the Chinese market is from, just look at how fast Chinese wages are growing:
  

  Combined annual wages reached 2.34 trillion yuan ($308 billion) at the end of last year, up from 1.32 trillion ($173 billion) in 2002, representing an average annual rate of increase of 13.5% after inflation, according to a report from state-owned Chinanews.com.cn on official figures released at a meeting put on recently by the China Association for Labor Studies.

  Note this double digit increase is after inflation has been taken factored in. In coastal cities, annual wage increase in the high teens for the college-educated, 25-35 crowd is common. This increased wealth fuels the equity market both by fattening companies’ bottom line from increased consumption, and by channeling disposable income into the stock market.

• Finally, while the health of the export sector may give investors doubts, recent advances in SSEC have been lead by RE developers/construction companies.

Despite new highs in SSEC as well as a clear non-correlation between Shanghai and the rest of global markets investor continue to shun Chinese stocks as indicated by the growing discount in the MS A shares closed-end fund (CAF) that now stands at 20%. For whatever it’s worth, my own view is that aside from the threat of a weak Christmas shopping season in the US, the prospects remain rosy until the Olympics next August.

Disclosure: I own FXI and CAF.

Here is a chart of the 2000 high-tech bubble:

The important thing to note here is that it took about 1.5 year for the Shanghai index to double from 1000 to 2000. But it is only taking 0.5 year for it to almost double again from 2000 to 3841. If it’s 0.75 year (or in less than 3 months from now), this index would be on a super-exponential curve: the time for each doubling shrinks by half. In fact, the curve is closing to 4000 level faster than 3 months away. A super-exponential curve is destined to crash if you are familiar with my “Why stock markets crash” article.

Once again, stock markets are probably due a bigger fall in my opinion. Watch out below.

Effectively Short:
1. Put on 8000 Russell 2000 index option, expiring 03/17/07 at $780.
2. Put on 10000 S&P 500 index option, expiring 03/17/07 at $1330.
3. Put on 6000 S&P 500 index option, expiring 03/17/07 at $1400.
4. Sold Call on 8000 Russel 2000 index option, expiring 03/17/07 at $700.
5. Sold Call on 6000 S&P 500 index option, expiring 03/17/07 at $1250.
6. Sold Call on 10000 S&P 500 index option, expiring 03/17/07 at $1330.

Whether Hussman had gains or losses from these trades, it really depends on how well he timed the market. First, I’m just going to study the hedging strategy these options provide to his portfolio.

His long position basically cancel out short position #2, without regard to the difference in the calendar dates. The rest of positions, only Put can provide full downside protection. Selling calls only allow your downside protection to the strike price. The thing to note here is that at the time when this report is out (12/31/06 I supposed), the price for S&P 500 was at 1418.30, and Russell 2000 was at 787.66. If you take a look at the calls that were sold, all of them were deep in the money. When deep-in-the-money calls are sold, it basically amounts to short-selling with less time premium (but more downside protection to the strike price). The puts that were purchased were mostly at-the-money. With this combination of calls & puts, Hussman is able to provide a downside protection from both of his calls & puts, assuming that S&P 500 stays above 1250/1330, and Russell 2000 stays above 700. The total hedging power assuming that S&P 500 stays above 1330 would be roughly (6000 + 6000 + 10000) * $100 per contract * S&P 500 value + (8000 + 8000) * $100 per contract * Russell 2000 value = 4.38 billion. (S&P 500 and Russell 2000 values are from 12/31/06). Or 2.96 billion if S&P 500 falls below 1330, but stays above 1250. Since the total NAV is 2.84 billion, and total common stock value is $2.89 billion, Hussman had his portfolio fully hedged.

Now if I look at the actual gain/loss from his positions, his effectively long position lost about $5.8 million, and his puts lost about $5.1 million, while his sold calls lost about $8.8 million. If he has not closed out his hedging positions since 12/31/06, his hedging positions would be losing more money by now since overall the market has moved higher. Obviously, his long stock positions are moving higher too to counter the losses from the hedges. But with a total loss of about $19.7 million, he is able to pretty much fully hedge a portfolio value of $2843 million or 2.843 billion. That’s a loss of about 0.7% (on 12/31/06).

Such hedging strategies definitely provide a very good protection when the market falls. However, because of the hedging, Hussman strategic growth fund has been underperforming the general market in the last 2 to 3 years. Such is the cost of being a market timer when the market does not cooperate with your actions.

In the next post “The price of a free(?) hedge”, I will look at my own hedging strategies using stock options of calls & puts in a similar fashion that Hussman has done. It’s certainly much easier to study what others do than putting everything in action. One can be so grandiose about the term hedging, but after all, what it really means is selling out in a certain way. Whether this “certain way” is smart or not, the performance will speak for itself.

P.S. By the way, the pricing/cost between options on futures market and options on stock market is similar (or else someone can arbitrate between the two). The only difference in cost may be simply the brokerage commissions.

I think the headline news about yen carry trade blowing up the stock market is most likely a big smoke screen. Why? Such yen strengthening has happened several times in March of the past years. You can read more about March repatriation in this link.

There are probably just two kinds of people in the forex. One is short term traders who trade in & out where 0.1% change in exchange rate can be 100% of their profits/loss. The other kind is hedger. These people don’t really trade, but properly hedge their currency positions through currency exchange swap/futures. They don’t care that much about rise and fall because they are mostly properly hedged in the given long timeframe. For these yen carry trades to work, they must be hedgers. They cannot possibly borrow lots of money for a long term, and rely on the currency market to stay the same.

Why is that when Yen strengthened some 30+% from year 2002 to year 2005, and no one said anything about yen carry trades? Such yen carry trades have been going on for a long time even before I opened my forex account back in year 2001. And a 30% change in currency exchange rate would have generated 15X loss for someone in currency forex, leveraging 50X (which is probably on the conservative side for forex traders. www.mgforex.com where I opened my account allows retail investors to leverage 400X. Institutional trades can probably go higher.). Here is the Yahoo chart of Yen vs $US for the past 5 years:

I think either there is something else bigger that is lurking behind, or the news media simply grabs whatever exotic but explainable things to confuse the regular folks further. Most likely $US will strengthen against Yen after April 1st if the history is of any guide. Does that mean that the stock market & news media will be “manipulated” upwards once $US starts to strengthen after April 1st?

Let us wait and see.

Of the group, I like the current chart of NAT (yielding 15.9%) the most: It bounced off its 200 dma recently within the confines of a well formed triangle.

Cramer vs. the futures market
On the other hand, Jim Cramer has this to say about Frontline and the rest of the tanker companies (subscription required for the whole article)

Frontline and the rest of the big tanker stocks have yields that are can’t miss, right? I don’t think so. Bloomberg has a great story this morning about how the excessive building in tankers could lead to repossession of the giant ships when the new fleets, the biggest additions in 50 years, hit the market. Big yields are always seductive. I got caught up in one two years ago, Fording Coal, 12%; can’t miss. But there’s always a price to be paid for these things, and an outsized yield is often more of a red flag than a opportunity. I can’t tell you how many times people asked me about these stocks on “Mad Money” when oil was going up. They figured rates had to go up. But these tanker stocks are levered to tanker building’s supply and demand, not oil prices. Now oil prices are plunging and tanker rates are…

Depending on your opinion of Cramer, this could be construed as a positive for this sector I couldn’t find the Bloomberg article he was referring to; however, my cursory glance at the Imarex tanker futures which go out to calendar year 09 did not reveal anything alarming. So I’ll leave you to decide who to believe.

According to its latest letter to shareholders, NAT currently operates 12 double-hull, suezmax tankers with a low break-even of $9,500 per ship per day. The single-hull tankers are facing mandatory phasing out by 2010 (remember Exxon Valdez?). Perhaps the “excessive building in tankers” is related? Anyhow, the chart by itself was convincing enough for me. Crucially, with a clearly defined trend line, it’s easy to figure out where my stop loss should be.

As always, please do your own research before making any financial decisions.

Tim Wood at financialsense has a very detailed article explaining how Dow Theory can be used to predict the stock market. Here is only a short paragraph from his full article:

Here’s how this works and why. The thinking is that in the economy, goods produced must be shipped. To gauge an accurate read on the economy, production should move hand in hand with shipping. If industrial production is rising, then it stands to reason shipping should be on the rise as well. If industrial production is rising, but shipping is slowing, then it signals something is wrong with the normal flow of the markets. Perhaps excess product has been manufactured, but sales (as measured by shipping) are lagging. If goods are being shipped at a rising clip, but production is falling off, it signals something is wrong with the economy, that perhaps shipping is soon going to follow production lower since there won’t be as much product to ship. If the decision-makers who produce goods based upon orders, or expected orders, are Bearish, it will be reflected in a declining Dow Industrials index. So, for a healthy economy, both the Industrials and the Transports should rise in sync.

I checked into the Yahoo charts. And you can probably guess how the story goes. Dow Transport is NOT confirming the rise in Dow Jones. Something really fishy. This chart is simply confirming what the news in truck business slowdown telling us. WATCH OUT!

(Click on the figure to go to Yahoo’s original chart.)

If you want to listen to me, you could do so. You can sell TODAY or TOMORROW, and buy back later (at least after 1 week I believe).

Why? I think people will want to lock in their gains for the past 4 to 6 months. Plus that Xmas retails seem to be bad.

And then, after the selling, it will go back up and push for record high again. These talking heads on Wallstreet will keep saying Bernanke will be lowering interest rates very soon (which I don’t believe that he will do after probably mid-March or even till May).

I think I will lighten just a little of my own portfolio, since I’m still under-investing in the general stock market.

Here is what James (who also posts regular here) is saying:

** We are finally getting some clues from commercials in regards to the stock-market: there was significant commercial selling in the Dow Jones and the Nasdaq-100. The stock-market looks like it has made/making a top. Notice also that commercials are buyers of the VIX, this again is forecasting that a healthy dose of volatility / fear is coming to the market indicative of price declines. Will the decline come in the last week of 2006? I would assume not, as the trading is light ahead of the holidays, but I am far from certain. In any case, if it doesn’t come in 2006, watch out in 2007.

Right now the only index that looks anything close to being bullish is the Russell 2000 with commercials currently at a total of 6,793 contracts NET long; as long as we remain above 5,000 I am less bearish than what I would otherwise be. But that could change by the end of this week for all I know, so keep checking the data, because when/if the markets do breakdown they will not wait around.

** Crude oil is not doing much, but remains setup for a rally. Commercials are buyers of gold during the most recent pull-back, I do not see a setup yet, but it is getting close.

** The US dollar broke down while being setup for a rally, this was unusual and presented a buying opportunity. The setup continues to point to higher prices for this market.

I disagree with him that market will top here. I still do not believe that market will top here. I think there is even a slight chance for S&P 500 to come close or exceed its all time high before falling BIG time. That’s simply about 5% up and then S&P 500 will hit 1500. And the entire wallstreet will probably go partying in the first quarter, which would be the time to sell.

I do worry a little about James’ comments on $US rallying. I’m holding tight to my precious metal positions, but I’m still neutral. If a potential war with Israel and Iran breaks out, precious metals should be UP. Other than that, I am still in a holding pattern.

Right now, I believe the following three scenarios could unfold for precious metals & oil & general stock markets (in all scenarios, I believe that stock market will be going up overall in Jan/Feb, and maybe even March. I’ve explained my reasons already.):

1. 30% chance: War between Israel and Iran breaks out in the first or second quarter. Precious metals and oil go up. Stock market goes down first, comes back and rally but fail (lower high), and goes down towards at least October 2007. Precious metals will begin its second phase of rising which according to elliot wave will be the longer wave. In this scenario, precious metals may be falling before the war.
2. 40% chance: No wars. Stock market corrects one to three times with small magnitude. S&P 500 exceeds all time high, while maybe NASDAQ reaches above 2500. Then stock market corrects by 15% or more. In the meantime (starting from Jan), oil stocks rise with smaller magnitude. Precious metals rally are either contained/failed. Then all sectors fall along with general market. Precious metals then make another significant bottom possibly after next June/July. The PM rise after that will be however very solid. It should be that “the train is leaving the station”.
3. 30% chance: anything that I cannot come up with.

I’m guessing that there is a 80% chance of me making myself a big fool, when I look back on this outlook, . The above scenarios are based upon my believes of

1. The correction in precious metal sector is probably NOT long enough. I would feel more comfortable if the correction last at least some 12 months, which would be after May 2007. If it’s 10 months, maybe it’s okay. 10 months will put the next bottom at the end of Feb 2007. The current correction seems to have bottomed in 5 months from May to Oct. I think that’s a little short after a semi-parabolic move in gold/HUI from Jan 1st to May. (I hate parabolic moves. It means it’s game over after the fall. However, I do not certify the May move in gold as fully parabolic.) Maybe all the weak hands have dropped out by now. I do hope that I’m wrong on this. According to Mark Hulbert’s sentiment study, contrarians are pointing to precious metals outperforming stock market somewhat next year. By the way, seasonally before Chinese New Year on Feb 18 2007 should be strong for physical gold markets.
2. I believe that oil sector will FALL along with general stock markets. The fall will be associated with the economy slowdown. The fall may be limited in magnitude. Crude oil would not surpass $80 anytime soon, unless there is a prolonged war between Israel and Iran. Oil stocks however will gradually outperform crude oil due to $45 oil price expectation adjustment. 2008 and beyond should be very good years for oil sectors if oil can consolidate solidly in the first half of 2007.
3. I don’t believe the top of the stock market is in. But I don’t believe stock market can keep its happy face for too long either. I think some people is going to cry uncle next year. And uncle Sam will respond too (if not responding already). Again, I can be wrong.
4. I think it will be necessary for Bernanke to cut interest rates next year. So somehow somebody needs to hammer Wallstreet talking heads and tell them that there is an economy slowdown. Probably Fed’s strategy was to get the stock markets up first so that there is enough room for falling. Bernanke will use that chance to lower interest rate to save the housing market. But long term bond market MUST co-operate. If bond market is not scared by slowdown/deflation talk, then Bernanke will be unable to lower interest rate. Is this the reasons that Bernanke et al went to China recently? It is very possible that bond market does not cooperate, which probably would mean that $US is falling, or gold is rising, or oil is rising, or maybe neither. I do believe that there is just not much more rooms for 10 year and 30 year bond yields to fall further, even if they fall.

Alright, this is really getting too long.

1. The maximum loss that one can deduct per year is $3000 (married filing jointly) or $1500 (filing separately). By the way, The US government should really index this number by inflation. It has been this low for so many years.
2. You should try to sell the minimum number of positions, without impacting your overall investing portfolio/direction/philosophy.
3. Don’t fall into wash sale trap, selling the same stock, and buying back within a month.
4. In order to avoid wash sale trap, you can use this opportunity to swap with other technically stronger stocks in the similar sectors. Or you can use sector ETF instead of individual stocks.

Another tax tip that most people don’t pay attention to is the tax rate differences between long term/short term capital gain. Because long term capital gain is taxed at a lower rate, it also means that long term capital loss will offset less tax than short term capital loss (whenever you have some long term capital gain to be offset). Your long term capital loss will be equivalent to short term loss when you don’t have any long term gain, but only losses. In that case, all losses will be deducting against your highest tax bracket income.

Therefore, for tax purpose, you should try to take short term capital loss, while retaining long term capital gain. In principle, the two best scenarios for taxes are to show either a short and/or long term loss without any long term gain, or a long term gain (+ any short term gain but not loss). For example, if you have two stocks A & B. In stock A, you have made $3000, while in stock B, you have lost $3000. If you let them offset each other in the same year, you get $0. If you somehow make the gain to become a long term gain, and take the gain in a different tax year (1/1 and 12/31), you will actually gain some $300 from tax. How so? Take $3000 loss in one year, assuming that you don’t have any long term gain to be offset, then $3000 short or long term loss will be deducting against your highest tax bracket income. Then taking the $3000 long term gain in another year will be taxed at 20%. Assuming your tax bracket is at 28% to 33%, you can gain $240 to $390 in tax difference (after-tax money). A general tax strategy can be that you alternate between showing losses and long term (+short term) capital gain. But obviously, $3000 tax loss is too small of a room to play out such strategy for most people.

In summary, don’t “waste” your long term capital gain by shrinking it with losses. Move the losses to another year. The only exception to this is when you are hitting AMT or alternative minimum tax. But with Congress expanding the AMT deduction, most likely you won’t hit AMT unless your capital gain is above roughly $30000. In that case, you can use my tax calculator to exactly figure out whether you will hit AMT or not.

VIX Background

The Volatility Index (VIX) was created by the Chicago Board Options Exchange (CBOE) in 1993; according to the CBOE, the ‘VIX measures market expectation of near term volatility conveyed by index option prices of the S&P 500.

In 2004 VIX futures were made available for trading providing investors with a unique opportunity to speculate on volatility. In general a rising VIX index is correlated with a declining stock-market while a declining VIX index is correlated with a rising stock-market.

(In the chart above, the missing data is a result of the VIX not meeting CFTC’s reporting requirements)

Recent Activity

As the VIX made new lows in November, commercials were big buyers (green rectangle) while large & small traders were sellers in the marketplace; meanwhile the stock-market was at new yearly highs. In other words, investors were becoming very complacent as commercials were buyers of volatility at these low levels. Soon after, volatility returned into the market place as the VIX broke out and went on to rally around 2.5%. As the VIX broke out, the Dow Jones declined around 200 points in two days.

Over the last two weeks net-commercial position decreased by 1,044 contracts but remains elevated at a total net-long position of 2,895 contracts. Watch for this week’s COT report for more clues on future direction for the VIX and consequently the stock-market.

Broad Markets

Russell 2000 [ http://www.buythebottom.com/rut.html ]
Net-commercial position decreased by 828 contracts. This is starting to look like a repeat of the commercial setup before May’s meltdown. Simply put commercials are sellers and large traders are buyers. As soon as the yellow line (net-commercials) crosses below the white dashed-line I would then start to look for a top in the stock-market. From the chart it would be logical to expect this setup in the early part of 2007.

S&P 500 [ http://www.buythebottom.com/spx.html ]
Net-commercial position decreased slightly by 440 contracts.

NASDAQ 100 [ http://www.buythebottom.com/ndx.html ]
Net-commercial position increased once more, this time by 1,252 contracts. What I find very interesting is that large traders are also big buyers over the last few weeks, which means that small-traders are responsible for all of the selling. This is a bullish setup in contrast to the other indexes.

Dow Jones [ http://www.buythebottom.com/indu.html ]
Net-commercial position continues to hover around the -22,000 level, increasing marginally this week by 117 contracts.

I would not expect a top in the stock-market just yet, especially when you look at the Nasdaq-100 chart, but the tide is slowly turning as best seen in the Russell 2000 chart.

Commodities

Crude Oil [ http://www.buythebottom.com/wtic.html ]
Net-commercial position increased by 4,343 contracts. I should note that commercials were buyers as oil rallied from $59 to $63. Meanwhile large traders were also buyers in the market, which leaves the small-traders as the lone sellers. Overall crude is setup for a rally, so keep watch for reversals and breakout opportunities.

Gold [ http://www.buythebottom.com/gold.html ]
Net-commercial position decreased by 2,444 contracts. From the commercial perspective I do not see a meaningful rally before we see a correction/consolidation.

Currencies

US Dollar [ http://www.buythebottom.com/usd.html ]
Net-commercial position decreased by 3,292 contracts. This is a critical point for the US dollar index, if commercials continue selling after the recent breakdown; this will be a big negative for this market. Unless that happens, look for higher prices as the dollar is setup for a rally.

Crude Oil [ http://www.buythebottom.com/wtic.html ]

Net-commercial position increased by 8,088 contracts last week. This marks the end to three consecutive weeks of commercial selling, totaling a 29,056 contract net-decrease between November 7th and November 21st.

Looking back at the oil market, the commercial setup remains to the upside barring a new wave of commercial selling; so keep an eye out on this week’s COT data. On a shorter-term basis, the oil ETF (above) is displaying a bull-flag pattern. Confirmation of this pattern will take place when/if USO moves above the 54.5 – 55 dollar range. If oil indeed breaks out, this will – in my mind – confirm a bottom set around November 20th. If not, then we could expect another push down, perhaps re-testing the lows. Notice the green-arrows; each one represents a false-breakdown…which I find typical in a market that is setup to rally.

This market has been setup for at least a month now, yet there is hardly any sign of a rally. In spite of this, keep in mind that patience is a virtue; a rally may be literally hours away. Pay close attention to this market, the lack of volatility over the last four/five days is a telling sign that a big move is imminent: up or down.

Broad Markets

Russell 2000 [ http://www.buythebottom.com/rut.html ]
Net-commercial position decreased by 208 contracts.

S&P 500 [ http://www.buythebottom.com/spx.html ]
Net-commercial position decreased by 7,797 contracts.

NASDAQ 100 [ http://www.buythebottom.com/ndx.html ]
Net-commercial position increased by 194 contracts.

Dow Jones [ http://www.buythebottom.com/indu.html ]
Net-commercial position decreased by 635 contracts.

From a commercial perspective, the Russell 2000 and NASDAQ 100 look descent while the S&P500 is deteriorating and the Dow Jones remains largely unchanged in negative territory for the last little while. It looks like the markets will continue higher for now, until we see significant selling in the NDX and RUT.

Also of important note, commercials are recent buyers of the VIX (volatility index). In other words watch out for additional volatility to enter the market which typically translates into lower prices for stocks. In other words, watch the VIX, if commercials maintain their elevated net-long position, be wary of market declines. If on the other hand commercials sell volatility, I would anticipate less volatility in the near-future which typically translates into higher prices for stocks. I will advise everybody on the mailing list about the VIX position when the COT data is released.

Commodities

Gold [ http://www.buythebottom.com/gold.html ]
Net-commercial position increased by 1,252. From a long-term perspective I am bullish on gold, but in the intermediate-term I am turned off by the recent wave of commercial selling. As of right now I am somewhere between neutral and bearish on this market. All that means is that from a commercial-perspective I currently see more downside than upside potential.

Currencies

US Dollar [ http://www.buythebottom.com/usd.html ]
Net-commercial position increased by 8,833 contracts. What I find interesting is that this market declined from $87 to $85 as commercials were big sellers. However, right after that, commercials turned around and started buying the US Dollar index, rather aggressively might I add. And during this buying, the USD actually broke down and is only now finding support in the $82 area. The USD index is setup for a rally as long as commercials remain buyers at this level. With the current commercial setup I do not expect the selling pressure to continue much longer, I would watch for a bottom and a subsequent rally to materialize.

What do I mean exactly? It’s the two classes of shares that have different amount of voting power (class A and class B for that matter). With the exception of Berkshire Hathaway (Warren Buffett’s company), Class B shares are not available to public, but insiders and management, while having more voting power, often 10X. Class A shares are the ordinary shares that trade in the stock market for ordinary folks like us, and only has 1X voting power. In Google’s case,

With Class B shares having 10 times the voting power of Class A shares, the three executives together control more than one-third of Google’s voting power. Combined with the shares held by directors and management, the group controls nearly two-thirds of the voting power.

As argued in the MarketWatch article, there may be some few examples like media where this kind of structure makes some sense for maintaining media independence. But power always finds its way to money. And I am afraid that IPO to the stock market is becoming increasingly like an ATM machine for all the founders in these new companies. How does the whole scheme work?

1. Create a great company like Google, and then IPO. Through stock market valuation, your wealth immediately expands by at least 10X since annual profits of the company if valued at P/E ratio of 10 will get a market cap of 10X times the annual earning.
2. But you want to IPO and sell shares, and don’t want to give up controls. So you create two classes of shares with 1X and 10X voting power before or at the time of IPO. For example, if you only own 30% of the company, you can have 3% in class B, and 27% in class A. Selling off 27% of the company makes you immediately rich. And yet you still retain about 30% voting power.
3. Why not 50% or more voting power? You don’t want to be too controversial or too obvious to be appearing as greedy. You can partner with another founder, and/or people close to the top. With voting power over 50% or close to 50%, now you can make an ATM machine out of the stock market.
4. Since you are either the CEO, CTO, chairman, or essentially an employee of the “public” company, you will be granting stock options or restricted stock shares to yourself. How much stock option? Well, as much as you want to, since you plus all the people who have B shares can pretty much override any shareholders’ votes.
5. Since you have an unlimited supply of stock options of your own company (through step #4), you never need to hold your stock options for more gains. Just sell them whenever volatility of the stock offers you some gain.
6. Selling your stock options are also a great source of positive cashflow into your own company. For every share of stock option, the company gets the price paid for the strike price, and you get the rest. And of course, one invisible shareholder pays for those with his or her hard-earned cash.
7. If there are problems with share dilution through such process, your company can buyback the shares you sold. Essentially earnings of the company can be recycled through buyback programs into your own pocket. Suppose for every share of stock option that you sold, your company buys it back to create zero dilution, you will pocket all the option gain, while the earning of the company is effectively funneled into your pocket. Totally legal money laundering.

Now, if you are truly aggressive, you can grant or authorize large amount of additional shares of your company at a single time. For example, if you start with owning 12% of the company, with 2% class A, and 10% class B shares (10X voting power), with the rest of 88% sold to public and trading as class A share, your voting power is 100% + 2% divided by (88% + 100%+2%) = 53.7%, enough to always vote the things in the way you wanted. Now, if you just continually grants yourself options of some 10% additional of the company. After 10 years if you haven’t sold anything, you will have 10 years * 10% + 2% class A share + 10% class B shares out of a total of 200%, basically taking back 50% of your own company again after you IPO and sold off 88% of your own company.

How do I know this? Because I’ve seen at least one of those 200 companies (not Google, yet?) in action that did something similar to what I just described, except with different percentage numbers and number of years.

There is a saying: power tends to corrupt, and absolute power corrupts absolutely. I don’t know about you, but if I have an ATM machine that I can constantly withdraw cash without any deposit, I will almost definitely take good advantage of it. Won’t you? Certainly, I would appear to have some stake in my own company, but I don’t need it to be more than 50% to raise eyebrows, since I would have already more than 50% of the voting power.

I think this is the most pure form of greed if it is all acted out. Sadly our stock market system allows it. How can there be two classes of shareholders is really beyond me.

If you’re on my site for the first time, I welcome you to take a look at my SiteMap or look through my categories and popular posts at the left column.

Onto the Festival of Stocks, posts are listed in the order of submission. Since majority of the posts are of high quality, I won’t be highlighting any to make differentiation.

1. Long or Short Capital presents 2×2 Matrix: Less & More. Commentary on Google, Yahoo, Clear Channel, and newspaper.
2. “D”igital Breakfast presents Small Cap Value Pick – Basic Energy Services (BAS). A value play which has bounced off support.
3. HedgeFundDomain presents The Essence of Price. An argument for trading based on price-only.
4. Market Poetry presents How to Get Rich Without Going Crazy. Very cool poem on investing and the Market. Refreshing reading.
5. Debt Free presents Motorola vs. Apple for World Domination? Some observation on the strategies and competitions among the two tech companies.
6. RDoctor Medical Portal presents Insurance Expert Discusses Health Care Crisis. Sort of. An interview with Hank Stern on the state of healthcare.
7. Scatterbox at stevensilvers.com presents The big picture behind congressional investigations that are going to create new corporate scandals. Political wins of Democrats mean a hard time for frauds in big business.
8. CONTROLLED GREED.com presents Kerkorian Unloads all of GM. Have you heard about this yet? Check it out.
9. Stock Market Beat presents Don’t Hold Your Breath Waiting for More Semiconductor Buyouts. I agree with Trent’s analysis.
10. TradeRadar Operator presents Use ETFs to profit in down markets as well as up markets. Using ETFs that either long or short the market can help you time the market easily. Well, that’s assuming that you are right about the timing of the market. That’s probably the hard part.
11. Sox First presents How does Google stop turning evil? Pick a partner! Never really understand Google’s philosophy. Don’t do Evil? That’s a very tough word to define. You might as well use a tautological definition: whatever Google doesn’t do.
12. China Law Blog presents China’s “Hottest” Companies. A list of great companies publically trading in Asia.
13. StockReply presents Automotive War. From the analysis, I will certainly buy Toyota over GM or Ford for the long term.

That’s all for this week. Next week, Festival of Stocks will be hosted at Endless Gibberish Personal Finance Blog. Remember to check it out.

1. The Hurricane Season: A war in the Middle East will cause oil market to spike. To have a war in the Middle East together with a devastating hurricane is an economic suicide. The crude oil price may spike to above $100 easily due to the combination of the two factors. Therefore, I will not consider any war in the hurricane season which starts officially on June 1st, and finishes in the end November. In fact, I will make sure that the war or the most intensive part of the war finishes before the start of the hurricane season.
2. Christmas shopping seasons: About 70% of the GDP in the USA is due to consumer spending. And 20% or more of the retail sales are done in this period, starting the Black Friday right after Thanksgiving. A terrorist would choose to attack during this season, while a US war planner would never choose to start a war near the start of the holiday shopping seasons. Definitely after Christmas and New Year. US economy is very dependent on consumers to carry the load.
3. The weather factor: I am not so sure how the weather is in Iran, but at Iraq, it was pretty tough to fight a war in hot summer for US soldiers on the ground, wearing gas mask, and/or carrying heavy equipment. This is probably one of the reasons that war with Iraq started in March. Even though I am fairly certain that US will not deploy ground force into Iran, I suppose that staying away from the start of hurricane season and hot weather in the summer (April to June) is simply a good idea.

Now if you assume that the most intensive part of the war will last for one month or in the worst case two months, and give sufficient time for the financial markets to stablize, you will probably want to move the start of the war earlier to account the the duration of its effects. Given all the above factors, I would say that the start of the war should be from mid-January to May 1st, the latest.

Furthermore, we have an election this year in November. It would look very bad to the party in power if they start a war to right after the election is over. Since you will need a couple of months to engineer and direct the media coverage to focus on the Iran issues (which cannot start after Christmas shopping is all done), you are probably looking at end of February the earliest. You definitely want the public opinions to be on your side with any wars, so that you don’t incur further political cost to the party in power.

The final strategic timeframe therefore would be about from the end of February to end of April, only two months. In fact, I’m sure the war with Iraq went through similar reasoning. The timing of a war with Iran should have similar timing as Iraq. Within this timeframe, as a war planner, I am fairly certain that it should be always earlier the better. There are many uncertainties in a war, and with an earlier start, you give yourself a better margin away from the hurrican season, and to deal with anything that could happen.

Since Mr. Bush will finish his second term in 2008, will you choose to start something that you may not be able to finish cleaning up in 2008? Or will you rather choose to clean up by your own ways while you are still in power from 2007 to 2008?

IF there is a war with Iran, end of February to March in 2007 should have the highest probability as the starting date. We will NOT see any signs right now. In January 2007, if we start to see media coverage on stirring Iran issues on nuclear arms, then we should be really careful on watch for such potential unfolding event. With stock markets going higher and higher this time around, next February would be the “ideal” time technically speaking for a big fall if a war occurs.

I hate to see any wars, and I hope that a war does not happen. In fact, if we go through the end of May without a war happening in 2007, I think a war with Iran will probably no chance of happening until 2010 or later (if conflicts persist and worsen). Of course, that is also assuming that Mr. Bush is not crazy or stubborn enough to try again in 2008. Let us hope that peace prevails.

P.S. I’ve turned off the comment section. I probably look very stupid, talking about Iran wars now. In any case, I will prefer to be looking stupid, rather than any occurrence of wars. Me stupid is fine. Wars are not fine, not humane, and simply the most TERRIBLE action humans can engage in. If you have any comments, you can email them to me. I will selectively re-post your comments later.

The CEOs and the board directors have long forgotten who are the true owners of the companies. Not only that, they have gone at length to shut out shareholders’ voice. Often you need to have at least 5% to propose any shareholder resolution to be voted at the shareholder meetings. Very often, you see dilutive actions by the management requesting for additional stock option grants and/or share grants for the purpose of enriching their and partially lower level employee’s pockets. And most share buybacks are simply recyling of cash from corporate cash pile into management’s pocket through which share dilution due to selling by management becomes less pronounced.

Do you vote when you receive your proxy statements? Do let your vote count. The only way we can make ourselves heard is through voting. If you don’t vote, the management of these big corporations will continue to disrespect shareholders as the true owners of the companies, and either embezzle your money via elaborate schemes or by outright extravagant compensation.

The same is true for politics. November election is coming up. VOTE! Apathy in democracy dramatically reduces the effectiveness of a democratic system. Exercize your basic rights as a citizen. Exercize your rights as the shareholder.

If you own GG Goldcorp shares, I hope you will support Rob McEwen in his legal fights against the management in Goldcorp. You can sign up your shares by faxing in your information to them. I have already done so.

Yes, I’m the owner, don’t I get to vote at least? Who is to deprive my right as the owner telling me that they are smarter than I am, and that I should not get any say on this acquisition matter?

At www.billcara.com, you can follow the latest details of this legal fight. After Enron, it is simply outrageous for such disrepecting CEO and management at GG to exist. But they got their hands in the honey pot, and they just won’t let go.

REITs
Real estate investment trusts are a very popular sector in the past five years along with the bubblicious housing market. REITs (and other income trusts, MLPs) can be thought of as straddling both stocks and bonds. They are ultra long maturity fixed income plays that also reflect the value of the underlying assets. You will not find them in the portfolios at Fund Advice, but they are included in many other plans including that of Index Fund Advisor. A typical allocation would be in the range of 5-10%. There are at least four ETFs of REITs (IYR, ICF, VNQ and RWR) as well as numerous mutual funds available. Current yields of the ETFs are 3-4%.

My thinking on REITs has been evolving. I have been wary of the housing bubble as I have written elsewhere; therefore, it was natural to be concerned about the value of the underlying real estate. On the other hand, REITs are not the same as residential housing, there are apartment/commercial/nursing home/forestry REITs that may be quite resilient. The price action certainly supports the latter view. The chart below compares IYR (iShares DJ Real Esteat Index ETF) with ^HGX (Philly housing index, mostly home builders). You can see that IYR has been steadily increasing with little volatility since 2003 even as the home builders peaked last summer and the apparent deflation of the housing bubble.

More information on REITs can be found here and here.

MLPs and CANROYs
Master Limited Partnerships (MLPs) are similar to REITs in that they do not pay income taxes, and their shares trade on the major stock exchanges just like regular stocks. However, REITs and MLPs are different in structure. Unlike REITs, which are a special type of corporation, MLPs are partnerships. MLPs get special tax treatment. An MLP does not incur income taxes. Its income is allocated among all partners in proportion to their ownership interest. To qualify for the tax benefit, 90 percent of an MLP’s income must come from activities in real estate, commodities, or natural resources such as mining, timber or energy production and related activities. However, MLPs may not be suitable for IRAs and other tax-sheltered accounts.

CANROYs stands for Canadian royalty trusts. More often than not they are oil/gas operators which ties into the commodity theme below. They grabbed dividend investors’ attention during 2003/2004 because many of their payouts were equating to 15% to 20% yields. Now, because so many investors are on to them, share prices have gone up, dropping yields for most to the 6% to 12% range.

Frugal has written on both topics:
Master Limited Partnership – Great Dividend Savers
List of High Yield Dividend Stocks (Up to 18.6%)
Royalty Trusts – Get Paid Royalties w/o Paying (Much) Taxes

Commodities
“Commodity” is a wide-ranging term encompassing hydrocarbon fuels (oil, gas, coal), metals (precious and base), soft goods (grains, sugar), etc. They tracked by at least three major indices: the Commodity Research Bureau (CRB) index, the DJ/AIG commodity index and the Goldman Sachs Commodity indices. All have shown tremendous appreciation since1999.

If you have been following my other articles, you would have known that I’m heavily over weighted in precious metals (PMs) and the energy complex. One attraction of PMs is their lack of correlation to either general equities or bonds according to this study by the highly regarded Ibbotson Associates. I have yet to write a big picture overview for the PM sector, but I urge readers to visit the PM related sites I have linked to in the side bar.

Anyone had to fill up gas in the last two years would understand my preoccupation with the energy sector. I subscribe to the “peak oil” theory which basically states that the world’s reserve of cheap oil has already/is going to run out soon. Again, this is a topic deserving of at least several posts of its own, and I won’t go into much details here.

Hot Commodities : How Anyone Can Invest Profitably in the World’s Best Market Jim Rogers was the best selling author of Adventure Capitalist and Investment Biker. He was also partner to Soros in the legendary Quantum fund. “Rogers also offers practical advice and information for beginners, including the best resources, how to read the commodities reports in the newspaper or on television, the various ways to open an account, information on index funds (such as Rogers’ own index fund that he started in 1998), mechanisms, terminology, and other vital details people must know before investing. Clearly written and entertaining.” — Amazon review

There are two ways to gain exposure to commodities: buy the commodities themselves, or buy stocks in the commodity producing (including exploration) companies. In the first category, the Pimco commodity real return strategy fund (PCRDX and family), the newly launched Deutsch Bank commodity index ETF (DBC) and the more recent iSharies GSCI trust (GSG) are convenient ways for participating through the commodity futures market. For PMs specifically, there are three index ETFs (GLD and IAU for gold, SLV for silver), and a close end fund (CEF, the Central Canada Fund) for both gold and silver. For crude oil, there is USO. Buying the actual commodity eschews individual company risks and may offer short term trading opportunities.

Stocks in the commodity producing (or exploration) companies are more volatile, usually carry some political and management risk, but also offer a healthy leverage to the underlying commodity as they come to be more and more valued on their secure reserves. There are many mutual funds and ETFs available in this area. For precious metals, ASA, GDX and GGN are traded on US exchanges; XGD is traded in Toronto. Gold mutual fund performances in various time periods can be viewed here.

I have spill the most ink in this section because in my view its lack of representation is the biggest weakness in Merriman’s portfolios. Currently, my own target allocation is 30% general domestic equities, 30% general international equities, 10% commodities and 30% bonds. In my actively managed accounts however, PM and energy shares are weighted much more heavily.

Municipal bonds, foreign bonds/currencies, income producing closed-end funds
I’m lumping all these together under the big umbrella as alternatives in the fixed income category. A great site to do research on them is ETFconnect.com.

For individuals in high tax brackets and whose bond allocation are in taxable accounts, municipal bonds offer superior return as the income is tax free at the federal and state (if bonds are from the state you reside in) level. There are closed-end funds that offer very respectable yields (5-6% with leverage).

The US$ has been trending downward since 2000, although the decline was interrupted since the beginning of 2005, longer term it would have to lose value (against gold and Asian currencies most probably) in order to pay for the Social Security and Medicare obligations. It won’t happen in a linear fashion or overnight, but diversification into foreigh bonds or currencies seems prudent and consistent with the basic tenets of asset allocation.

The Dollar Crisis: Causes, Consequences, Cures , Revised and Updated Posterity may remember The Dollar Crisis as a seminal book in the field of 21st century economics. Indeed, rarely has a book offered such a grim yet, well argued view of the current economic situation facing the world.”– Steven Irvine, FinanceAsia

“Duncan writes like a man who’s already seen tomorrow.” — James Grant, Grant’s Interest Rate Observer

One can purshase foreign bond mutual funds. I currently own OIBAX ( it has a front load). Some no load alternatives are PSAFX (has ~15% PM, my wife owns), BEGBX, PFBDX, PEMDX, LSGLX, etc. There are plenty of closed-end funds in this area, again the best bet is to do a search on ETFconnect.com. Yields of high single digit can be expected. On the currency side, Everbank offers foreign currency CD’s (single currency CD’s with a minimum of $10k, index CD’s from 20k) that are worth looking into.

A big part of my approach is top-down, macroeconomic based. Frankly, I see the US and to a lesser extent, global economy on very shaky ground. A central theme of our economic system strings together (over)consumption of the US consumer, Asian and Middle Eastern trade surpluses and recycling of these surpluses into US debt instruments. A crack in this chain would bring painful adjustments for everyone involved.

I see the US consumer as the weak link in this symbiotic relationship. Unless you spent the last year in a cave, you are well aware of the drastic slowdown in the housing market all around. But a “soft landing” remains the current consensus. Although many home builder stocks have lost 50% or more from their peak they have stabilized since July. I, however, count myself in the camp that thinks the unwinding from this historic housing bubble is far from over. The next phase of decline, may well involve lenders and mortgage backed securities (MBS) such as this latest news on bonds from Countrywide Financial suggests. [Disclaimer: I’m shorting BZH and LEND.]

“What a load of crap!” I can hear you say, “What about the Dow’s daily new highs?!” I admit I didn’t see that one coming. I have some positions in bear market funds. Even though I’m net long the market, watching this relentless upward march in the major indices has put a knot in my stomach the size of which I never imagined possible.

So it finally brings us to the term “ideological bear” which to me is a state of being bearish, yet gored by this bull too many times to go seriously short. Funny, maybe, unless you are in the same shoes. After much soul searching though, I still see this rally fueled by liquidity akin to the post Y2K “melt-up”. Of course, if we’re closer to 1995 than 1999 there will be a tremendous opportunity lost. Alas, only time will tell.

On Stock Market Investing

When you look at the financial reports of any public traded companies, there are income statement, cashflow statement, and balance sheet. The cashflow statement indicates how the company manages its cash, while the income statement tells you how the company is earning/losing its money. Normally, you would like to see both good positive earning and cashflow. However, both cases of a positive earning with a negative cashflow, and a negative earning with a positive cashflow are possible. And it is important to understand the difference.

A positive cashflow simply means that incoming cash is greater than outgoing cash. It means that the entire process of the business has enough cash to self-sustained itself. However, how much it earns from the process is an entirely different story. The earning or income is the actual real profits assuming that all booked entries can be collected from customers. It is all of your revenues minus all of your expenses. So when the collectibles pile up without any trend of going down, or that the revenues are generated through vendor financing, it is a big sign of danger ahead for possible big “extraordinary” write-off of past booked revenues. Such booked revenues are of low-quality revenues which usually don’t translate into positive cashflow. Some companies do this kind of extraordinary write-offs of past booked revenues regularly, and it’s almost like a regular recurring expense. You should never invest in such companies.

On Real Estate Investing

In the case of real estate investing, if you can generate both positive cashflow and positive earning, it is a great investment indeed. But if you generate positive earning with a negative cashflow, I think it is still pretty good. Such scenario can arise when the rent you collected cannot cover the all the expenses including mortgage. Since mortgage payment has two components: principal and interest. If your collected rent covers beyond the amount of interest charge, but does not cover fully the principal paid down, I think it is still very good real estate investment. The only downside is that you will be forced to put your saving away into the principal balance of this mortgage. You should also account for tax reduction that you can get properly. It’s best if you file a W-4 to reduce the your withholding amount if you work full-time, but is also a part-time real estate investor. Otherwise, you should manage the cashflow carefully on an annual basis (for tax refund), instead of monthly basis.

But if you are a real estate investor who uses negative amortization loan to improve your cashflow, while counting on housing market to go up 7+% every year, I advise you to look at your “income statement” carefully. A positive cashflow does NOT equal to positive earning. Your net earning is reduced by the amount of additional interest debt accumulated. I assume that you understand the difference between payment rate and interest rate in a negative amortization loan. Any advertised rate that is below 1% + 10-year treasury bond yield (about 1+4.7% now) is most likely a payment rate, not the actual interest rate. Payment rate is the teaser rate you will be paying initially. It’s not the interest rate at which you are charged for. To find out your net earning, you should probably use the interest rate and simply calculate how much you would earn on a presumed interest-only loan without any principal paid. When your net earning is not positive, I would only advise positively on such deals under two kinds of scenarios:

1. A very good reason to believe that your collected rent can soon catch up to produce a positive earning.
2. A very good reason to believe that the housing price can keep going up to make up the shortfall of your negative earning.

Usually, it’s not that easy to predict either the rental or housing markets with very high accuracy. I’m more conservative, and therefore my suggestion for most circumstances whether to invest in a real estate deal is when you can produce a positive earning or breakeven right from the beginning, and not relying on the increases in either rental or housing markets. Or at the minimum, your breakeven collected rent should not be more than 5 to 10% of your starting rent. At 10%, you will need to increase your rent by 5% for consecutive two years to get to the breakeven point. That may be quite a lot to ask from your tenants.

Many real estate workshops or books emphasizes two points: No Money Down and Postive Cashflow. I can understand why those are their key selling points, because to sell to the mass who may have money/cashflow problem themselves, the two points are music to their ears. I’m not saying that those two points are not important. But I think a positive earning is the MOST important thing than anything else.

And the last important thing that many real estate investors don’t account for is calculating the cost of down payment. Some people don’t even pay attention to down payment. They think if they put down more and borrow less, they can make a real estate deal to be earning-positive. That is certainly a wrong perspective. The more down payment you put down, the less loan you borrowed, but the more invisible opportunity cost you pay. You can use my Rent vs Buy Calculator to determine how much opportunity cost you are paying. It accounts for the opportunity cost by allowing you to enter your own assumed investment return and your own tax rate. It will accurately account for the opportunity cost that you will pay (using your own assumption). You can put in your assumed collected rent to find out whether the deal will positively earn you money (along with assumptions of rent & housing inflation).

For mutual funds, the buy/sell trading fee is usually much higher (about $20) than stock commission, unless you open an individual account at Vanguard or whichever fund family that you decide to purchase. Outside of having accounts at the fund company, I only know of FirsTrade that offers free buy/sell of Vanguard funds (send me email for referal code to get 5 free trades). The message here is that depending on how/where you buy your ETF/mutual funds, the commission fee will have a higher impact.

At last, with ETF, it’s much easier to do “Short Against The Box“. You can open a short position via buying puts or selling calls or short-selling your own shares. There is some caveat in doing such trades. You can find out the details at the end of this article. ETFs allow a swing trader to trade a market or a sector easily, and can unlock any long term gain partially through short sales.

Here is a great article written by the author of The Four Pillars of Investing on the comparison of ETF and mutual funds. Take a look and see what he thinks.

You can research any ETF at ETF connect. Yahoo finance provides easy search for both ETF & mutual funds.

If you’re on my site for the first time, I welcome you to take a look at my SiteMap or look through my categories and popular posts at the left column.

Onto the Festival of Stocks, posts are listed in the order of submission. Since majority of the posts are of high quality, I won’t be highlighting any to make differentiation.

1. Value Investor Blog presents A Little Gem Among Subprime Lenders. Lots of details on DFC, an attractive niche player in the subprime mortgage lending market with a conservative business model, a solid balance sheet and a safe income stream.
2. Free Money Finance presents Update on My Three CEOs. FMF updates on three stocks (DIS, HD, JPM) with good management.
3. Gannon on Investing presents On a New High and an Old Price. Gannon talks about how owning the wrong stocks in Dow or other stocks may not give you the new high (of Dow).
4. ValueBlogger.com presents Home Depot (HD): Valuation First, Emotion Second . According to Kevin, Home Depot is undervalued.
5. Fat Pitch Financials presents Parlux Fragrances (PARL) Shareholder Nussdorf Challenges Perry Ellis Sale. Glenn Nussdorf, a big shareholder, challenges Parlux Fragrances’ management.
6. Bryan C. Fleming .com presents Counting Cold Hard Cash. Bryan counts his cash pile for various allocation.
7. Controlled Greed.com presents Buying Walter Industries (WLT). Controlled Greed makes his move on this valued stock.
8. Value Investing, and a Few Cigar Butts presents Margin of Safety. Mike talks about how to do value investing, and avoid some common mistakes made by most investors.
9. Investing in the Middle Way presents XAU put/call ratio. ML takes a look at XAU put/call ratio to gauge the current sentiment in the precious metal equity market.
10. One Guy’s Investment presents Takeover or Blockbuster? (LGF). A detailed discussion about LGF.
11. Calculated Risk presents Concerns Rising about Corporate Profits. Is the corporate earnings going to peak, when Q3 earning reports are just right around the corner?
12. 1stMillionAt33.com presents Money Managers: Things that You Should Know & Ask. This is my own post on how you should approach to hiring your own money manager.

That’s all for this week. Next week, Festival of Stocks will be hosted at Value Discipline. Remember to check it out.

I started subscribing to it at the very beginning of its “premium service” since the end of year of 2005. Initially, Eric Hommelberg had two lists. One is portfolio list, and another is watch list. Probably because the things that he added to watch list were going up a lot since gold was in a strong bull market. So around the beginning of 2006, he lumped the two lists into one list, and used the good performance from the watch list as part of his new portfolio/watch list. Although he only added those stocks to his watch list, and did not formally recommend those stocks, his new list of portfolio/watch list is full of good performing stocks.

And then in June 2006, he no longer display the full list of his recommendation of discovery portfolio and exploration portfolio. Instead in the newsletter and website, he only displays Discovery Top-10 portfolio. He still does new recommendations that go into the “Top-10″ portfolio list. But by not showing all those bad performers, an image of good performance can be created. If you recommend sufficient number of stocks, probabilistically speaking your chances of recommending a good performer goes up. And then if you selectively filter out the bad ones, certainly the list will be all good performers.

Nothing in any of the list in his newsletters is bogus. But the image created through selective lumping and filtering at different time is very deceiving. I just hate newsletters when they start to mess around with the images of their performance. If you cannot even be straight and forward about your performance record, what other things I can trust. Yes, if you dig hard enough, you may still find out the historical performance record. But as soon as a newsletter gives you that tough job of producing the actual performance number, you know that probably such numbers are not as enticing as the newsletter wants you to believe in.

Have I made money from www.golddrivers.com? Nope. His original portfolio/watch list is more than 20 small cap stocks, mostly trading at Canadian markets. It’s tough for an individual to pay $30+ commission each to buy every recommended stock. Some of his timing has been off too. He projected HUI to reach 430, while HUI peaked at around 400. Calls to buy a couple of stocks in 2006 has resulted (not small) losses too (but a few did make money).

Seeing that the lists in golddriver.com newsletter are filtered without displaying the original lists, I don’t think I will subscribe to his newsletter again. I don’t want to deal with people who try to do a good marketing. I want to deal with people who are straightforward about themselves.

I think I learned one more thing about stock newsletters. Never go for some newsletters that have LOTS of recommendation. First, a lot of recommendation is simply not practical for any readers to buy into. Secondly, lots of recommendation are usually prone to be filtered in some appealing way.

That’s my $99 subscription fee + all of my stock losses.

P.S. I’ve got all of the past golddriver.com newsletters saved to prove my case. Only if you’re so interested to find out the details, I can share bits with you as not to violate any copyrights.

I’m sure that most people working in the high-tech industry came very close to strike riches if not already. From 1990 to 2000, it had been terrific years for high-tech. If you were able to catch (and cash out) the ride, you would have done great. Sometimes, being at the right place at the right time is all it matters. In a bull market, you usually don’t need to be smart or selective about your choice to come close to riches. But more importantly I recognized that it was not because I was smarter, but because I was at the right place at the right time. Recognizing the macro-economic trend and riding on the prevailing secular bull market is usually more important than individual stock/real estate selection (which you can usually employ sector ETF/mutual fund without selecting individual stocks).

P.S. I certainly missed the real estate boom totally. The real estate was already beyond the previous peak on the inflation adjusted in 2000/2001, and I was afraid to buy into the peak. It turned out that it is the most gigantic boom/bubble in the human history in terms of dollar.

And hindsight is always 20/20, .

I think it is safe to say that there will be great uncertainty in 2007 due to the unfolding slowdown in the housing market. I would say, RUN at the first sign of a significant market correction. I am putting 2007 as another dangerous year like 2000 if not more dangerous due to the size of the current housing bubble. But I also think it is possible for Fed to work 24/7 already, blowing up commodity market, buying up treasury bonds & GSE bonds, to postpone the unfolding crisis to 2009. When the high-tech bubble bursted in 2000, Fed simply created another huge housing asset bubble to replace it. I cannot really imagine what would turn out eventually. The next wave of money flow is simply going to be bigger for sure.

Make sure you read the counter argument by Mark Hulbert for refuting the following chart. I agree with him completely.

Such big reversal in the gold market happened before, but certainly it is not welcomed by any bulls. While I did expect the decline of crude oil (to $65, but not down to $62), I did not expect such a dramatic reversal in gold. In fact, the timing of such event is simply too suspicious. The entire week going towards the quadruple witching day experienced big selling pressure.

With the big loss of Amaranth hedge fund in the natural gas, things are really grim for commodity right now.

What is my own forecast now?

Gold/Silver: Change to Hold from Buy. Expecting another washout possibly with HUI down to 265, and spot gold down to 550 before a sustainable rally.

General market: Intermediate-term (4 to 5 months) Strong Buy. Adding short-term (~2 to 4 weeks) Sell. Long-term (6+ months) Sell (not so sure yet).

Oil: Change from Hold to possibly short-term Buy in maybe 1 to 3 weeks.

I think the commodity correction probably needs to be more extended, but maybe not much more downside. An extended sideway action of some 2 to 6 months may be in store. Put in simple layman’s term, you probably don’t need to rush in for any new cash. I do hope that a renewed bull in commodity will coincide with a renewed bear in stock market in about another 6 months.

I am still evaluating whether commodity market in general began its bear market descent in May. However, history shows that a “phase change” is never so short in duration. Certainly, commodity market cannot be called a bubble simply due to the participation rate. However, I do not reject the thesis from bears. One must be open-minded to all possibilities. If the bear market began, then it should be the time to liquidate instead of catching more falling knives.

Unfortunately, the emotional part about investing is often a learning AND re-learning process. Most likely you will make similar mistakes many times until either you finally get it right, or you run out of your play money, or you get sick of doing it. Any of the three resolutions is good, assuming that you don’t become an addicted gambler and keep bringing more play money onto the table for more loss.

• Follow the daily news in MarketWatch.com and/or theStreet.com.
• Pull out some charts at BigCharts.com or StockCharts.com.
• Read some financial reports at Yahoo finance quote centers.
• Be more familiar with various sectors, such as pharmaceutical, high-tech, consumer-staple, etc.

• Your percentage loss should decrease down to the level of about how market fluctuate, or preferably smaller by the use of cash and bond.
• You should start to construct your own trading/investing rules, or other people’s rules should echo with you strongly.

I google searched three very good trading rules here. You should look over them.

• 10 biggest mistakes made by investors
• 12 top trading rules from BigPicture.
• Trading rules from stockcharts.com.

And I wrote about The Worst Mistake that a Trader can Make: Average Down which is described in ALL of the above 3 links (may not be in exact words). Why do I call it the worst mistake? Because among all mistakes that you can make, this is the only one that can potentially WIPE OUT your entire portfolio. All the other ones can hit you with big losses. But this particular mistake can really bring you down.
I heard about a real story from my uncle. He said one of his friends kept averaging down by using margin, and then mortgage the house, and eventually everything was wiped out through the bear market of 2002. Don’t be an attached gambler!

That’s it for today. If you have any other good tips, please add to the comment sections. I got some of the trading rules pointers from Millionaire Now, but I couldn’t get the URL from his site. So I resort to finding the original source instead.

To give you a summary, essentially using value line research, it has been shown that predicting stock market return in the next 3 to 5 years is actually “easier” than predicting the market in the short term. In the very short term, no one knows for certain whether the stock market will go up or down tomorrow. There are theories that stock market is more like random walk, and it is unpredictable. And if stock market is truly 100% efficient, there will not be any profitable opportunity that you can exploit, and therefore, you won’t be able to predict the short term direction of the market for profitable opportunities. Efficient Market Hypothesis (EMH) is almost golden in my opinion. But there are several cracks. One of which is exactly described in this article. It is simply easier to predict stock market for a longer timeframe, than a shorter timeframe. Why is that??

It means there are really information extractable from the current state of stock market and economy. While in the short term, you may not be able to predict the direction or amount of return. In the longer term, there are indeed investable information that you can extract. In my opinion, EMH has no concept of time, and I kind of agree that looking at every instant in the market, everything is indeed efficiently priced. But when you start to expand your time horizon longer, EMH will start to fail because there are some historical and current states in the market that can be extracted and extrapolated into the future, which cannot be reflected in the next minute or second.

Why do you want to invest (certain) stocks for the long term, instead of doing short term trading? This is the biggest reason that I believe. Because when you are able to identify and select certain stocks or sectors based on the current and past information, you will be able to outperform the market given enough time span for those information to unfold.

What was the prediction from the MarketWatch.com article for the stock market in year 2011 (5 years from now)? It appears to be not too good (go and read it yourself). I believe that US stock market in general is still in the secular bear market (but should have a short term rally towards the year end)? Currently US stock market is in the short cyclical bull market which is probably about to end quite soon in less than 6 months. Looking much further out, I don’t think the return adjusted by inflation will be great in the stock market. I don’t think index investing will make you rich in the next five or even ten years. You should be lucky to just preserve your buying power.

Just my two cents.

Didier Sornette is a UCLA (University of California at Los Angeles) geophysics professor.  For him to write such a book with his arcane mathematical model is almost outright weird.  Such is the inter-disciplinary nature in the advanced studies of scientific frontier.  The scientific frontier here is essentially the studies related to complex systems, not an informative name but descriptive nevertheless.  Mathematicians have not been able to sort out many of the complex systems in nature.  The mathematical study of complex systems is called chaos theory.  Here is a pointer to the introduction of chaos theory.  Many of nonlinear dynamic complex systems have tremendous amount of random inputs and numerous known or unknown rules, and yet exhibiting some simple order or behavior.  Some systems has very few simple rules, and yet exhibiting much more complex results.  One of the better known studies in chaos theory is Fractals.  Within the complex systems, sometimes there exists one or many strange attractors.  I can’t find any good webpages on strange attractors.  Here is from wikipedia.  Essentially, the attractor is (one of) the convergence of the most initial states evolved through time.  There are many books on Chaos Theory if you’re interested.  Lots of math involved, but extremely interesting.  In any case, let me regress to this particular study of the complex system: Stock Market.

Through Sornette’s study on predicting earthquake and phase changes (from liquid to solid, etc), he applied his knowledge to this critical phenomenon of a stock market crash event.  Here, “critical” carries more of the mathematical meaning of having some orders of derivative undefined (usually the 1st order, which is the slope of the curve) or discontinous.  After such critical event, things no longer behave the same way.  You can pretty much concatenate a different function after that point.  By observing the information network among traders which gives rise to the inherent fractal nature in the stock market price, Sornette was able to come up with a simple model for the behaviors of financial bubbles (equation 18, pg.335), where P(T) is the price of the financial product in time=T:

log( P(T) ) = A + B ((Tc – T)^m) (1 + C cos(w log((Tc-T) + beta) )) for bubbles, and

log( P(T) ) = A + B ((T - Tc)^m) (1 + C cos(w log((T-Tc) + beta) )) for anti-bubbles or deflation of the bubble.

where A, B, C, m, beta, and Tc are modelling constants.  In the special case of C=0, no price oscillation, the equation simplifies to

log( P(T) ) = A + B ((Tc – T)^m) for bubbles

For the following discussion, I will only use the simplified equation.  Obviously, for the swing traders, oscillation in the price is extremely important to identify the local peak and valley in the prices for sell & buy points.

Noting from the boldfaced equation, Tc is the Crash Time.  At T=Tc, the value of 0^m becomes undefined.  If you take the derivative respect to T for both sides, you get

d (P(T)) / dP = 1 / P(T) = – B m (Tc – T)^(m-1) * (dT / dP) or

dP / P(T) = – B m (Tc – T)^(m-1) dT or

dP / dT = -B m (Tc – T)^(m-1) * P(T) or

dP / dT = b / ((Tc – T)^n) * P(T),

where both b and n are positive, T < Tc, for a bubble

Essentially, this is a super-exponential function.  An exponential function has its increase in price proportional to the price (dP/dT is proportional to P(T) ).  A super-exponential function increases even faster than exponential function.  As time increases towards Tc, the rate of increase or dP/dT increases even faster.  The term that is multiplied to P(T) races towards infinity as T approaches Tc.  For obvious reason, no physical processes can have a rate of increase infinitely large.  At such rate of increase, the price P(T) is bound to be busted.

Let’s plug in some numbers into the dP/dT equation.  Assuming that b=1, and n=2, when Tc-T =1, dP/dT = P(T).  When Tc-T=0.5, closer to crash point, dP/dT=4P(T), or dP=4P(T)dT.  When Tc-T=0.25, even closer to crash point, dP=16P(T)dT.  Putting into discrete terms, the time it takes for the price to double (again and again) exponentially shrinks shorter, or can be expressed as

dP / P(T) = b / ((Tc – T)^n) * dT

Alright, I’m very sorry if I have lost all of you.  Just remember this: a Bubble-like behavior is such that the time it takes for the price to double (again and again) exponentially shrinks shorter. By the way, it doesn’t need to do a double to qualify. You can substitute double by any percentage amount of increase, more or less, as long as the time to achieve that multiple shrinks exponentially. In some way, a bubble closely resembles a money-making pyramid scheme. In a pyramid scheme, the late comers funnels their money to the early comers. Since the growth of the pyramid is exponential, that is the growth rate is porportional to the current size of the participants, very soon the pyramid runs out of new participants, stops growing and is unable to bring money to the late participants.

In the book, Sornette is not that crazy yet to ask readers to go through all of these derivations. The only equation that you will find are the very first 2 or 3 equations. The rest is my contribution (or dis-contribution for more confusion). Now let’s go back and answer this question of Why Stock Market Crash. In the evolution of the bubble, as described by the so-called log-periodic power law equation, the bubble experiences an unsustainable exponential growth. The bubble may collapse earlier due to a help from external factors or events, due to its inherent instability going towards the crashing peak. However, bubble is destined to collapse because of its own weight. Nothing in nature can have a growth rate reaching infinity as dictated by the equation. And nothing can grow exponentially indefinitely when the resource or money to participate in the market is finite. Actually, another term in the technical analysis of stocks is that the price has gone parabolic. I believe parabolic, a 2nd order function, is simply used as an approximation to this super-exponential model. The key observation again is that price increases faster even with less time. Using NASDAQ 2000 bubble as an example, the price for NASDAQ took more than 3 years to double to about 2500, and then it only took about 6 months for another double to complete. Such growth is indicative of the existence of a bubble.

So don’t blame anyone on any stock market crash. What goes up must come down. That is simply the law of mathematics and physics. That’s the way it works. It is so much better to have a steady growth than an unsustainable growth. However, bubbles are repeated throughout the history, and it is probably inherent in the human nature of greed and fear in the fight of grabbing ever increasing returns.

Want more predictions from this book. In fact, I will be posting more on the unsustainable human population growth and its derived consequences. In the last chapter of the book, Sornette has applied his model to various other sets of data, and based on the data fitting, the growth era of human may stop at around 2050. What does that mean for the human race as a whole? Read my future posts. By the way, his prediction on USA real estate market bubble is set to peak around summer 2006. I guess that is turning out to be quite close so far. Some may date the peak of this bubble at November 2005. It depends. I personally believe that the current cycle of real estate has peaked already.

Here is another article from Washington Post on PPT. That’s the only two articles from traditional established media that I’ve ever read on PPT. From what I heard, PPT will come in and place BIG market orders on S&P 500 (or other index) futures or options market, and lift/reverse the entire market through that. Those future/option markets don’t require direct ownership of the stocks, so that they can be more “politically neutral” to the stocks.

I rushed this post out on Thursday so that you can hear about PPT from me first, . Now I got to go back and work on my short positions, which PPT is trying to screw me on. Definitely unfair to small investors & free money for big wallstreet firms.

A BIG moral hazard by the way.

Because of the size of my portfolio, and the lack of my time to manage it, I feel the need to rely on external advices. I began subscribing various stock newsletters since two years ago. Very often, I put my own money at stake to experiment with the advices by stock newsletters, and more often than not, I lost many thousand dollars beyond a couple of hundred dollars in the subscription price. If you read any advices on stocks on my website, they have been filtered through me and my thousand dollars loss. But the experience of experimenting with different stock newsletters have been simply a very painful process of loss. Until today, I probably have lost more than five thousand dollars at the minimum relying on the advices from the bad stock newsletters.

In case you run into some of the following stock newsletters, you may not want to subscribe to them after my painful loss.  By not subscribing, it could save you from lots of dollar from stock loss:

1. www.changewave.com: a newsletter ChangeWave by Tobin Smith. He has a couple of category for aggressive investors for which he doesn’t put any performance number. Initially, I took his words. After losing more than 75% on EVOL, I finally saw what those categories were for. A dumping place for his recommendations that went bad. Maybe through the process of “natural selection”, the stocks that survive his recommendation give a good performance to his stock newsletters. I must give him a little credit on getting me started on my own research into the high yield dividend stocks. But anyone could have pulled a couple of his recommendation from a simple finance yahoo search.
2. www.soundadvice-newsletter.com: a newsletter Sound Advice by Gray Cardiff. This one is almost like a scam, or his customer service is very poor. Personally, his advices sounded more like copy-cat and unconvincing to me. By his refund policy, you should be able to get a full refund during the lifetime of the subscription. Great advertising indeed. If you have taken his words, you may fall right into his trap. I couldn’t get any refund through repeated contact to the newsletter. Luckily before the 60 days of credit card dispute period is up, I disputed the charge through credit card company and got the full refund. And still absolutely no news from this newsletter.
3. www.intelligencereport.com: a newsletter Intelligence Report by Richard C Young. This guy gives you probably close to 100 stocks, and probably some 40 mutual funds. He will add & subtract from his list, but he doesn’t keep a performance number since recommendation. Guess why? Because they don’t seem to be not that good. I did the due diligence of going back on his recommendations over two years period from his newsletter archives. I found out that overall the performance is not that great compared to other better newsletters. If you don’t show your performance number for buy & sell, there is probably not much to show anyway.

So far, the best stock newsletters that I have subscribed in my opinion are

1. Capital & Crisis by Chris Meyer
2. Outstanding Investments by Justice Little & Kevin Kerr

Both of the stock newsletters make pretty good stock recommendation, and their understanding of the stock & capital market is simply superb.

If you know any bad stock newsletter, or any good stock newsletters, please share your recommendation with me & others by leaving a comment. Thanks.

Again, a reminder on my legal disclaimer.  All advices are provided AS IT IS, and are based purely on my personal experiences.  Your experiences can vary, and the products mentioned can change better or worse over time too.

I don’t know about you, but when I look at this short list, I almost feel depressed by the low yield. In fact, out of all these stocks, I would probably only suggest buying VZ, PFE, and just maybe MO (if you don’t care about the ethical ramification). Financial stocks are usually the higher dividend-paying stocks these days. However I don’t like financial stocks because I believe going forward financial stocks may constitute a lesser percentage in terms of market capitalization of the total market (which means that they may underperform).

Okay, here is my list:

This list doesn’t include any REIT, which are historically good dividend paying stocks except now. I hope you find this list useful. And if you do make money off this list, please consider donating something here through PayPal (I can’t imagine you doing that now, but maybe after you’ve earned your first $5K dividends….), and/or at least leave a comment for appreciation. This list is actually part of my recipe for my yet-to-be money management company, in respect to the part for the high dividend yield investments. Aren’t you glad you just save 1% for the management fee either from me or from someone else?

This list is by no means exhaustive. You can use them as the starting point of your research to find more similar business and stocks. At the minimum, you must look at the dividend paying history to get a feel of the true dividend paying rate, because some stocks may potentially have a distorted higher or lower dividend yield shown above due to a temporary high or low dividend payment. Also, please DON’T rush out and buy the highest yield stocks on this list. Here are some of the things that you should heed:

1. The yield is usually proportional to the (downside) risk. The best example to illustrate this is SGU falling 80% in a single day on Oct 18, 2004. Right before the fall, SGU was paying 10.8% dividend yield.
2. Pay attention to diversify among stocks from various sectors, so that the probability of getting hit on all stocks all at once is smaller.
3. Plot out the yield curve & stock price on the same chart if possible. It will tell you whether stock prices went up because of increasing dividend payouts or because of a shrinking yield due to reasons such as investor frothiness (PTR & ERF used to pay out 11% to 14%). In the latter case, your current entry will be more riskier when the investors change their expectation for worse.
4. You can potentially run into having too much foreign dividend and end up getting 15% less from the yield that you deserve. (No, I’m not kidding here. I’m forced to cut back and sell my dividend stocks so that I don’t hit the limit in respect to this tax rule. At 13.4% yield, investing $30K will exceed the limit.)

I’m not providing any performance numbers because I believe one must always do one’s own diligent research before buying stocks. But I can tell you from my own experiences that I made a lot of money from these stocks, more than $11000 in actual dividends (not including any non-dividend distributions such as royalty payments) in the year of 2005. Most of my dividend stocks return in excess of 15% annualized, and many exceed 20% or more due to stock price appreciation besides dividends. By the way, if you find some names on this list that don’t have such a great overall return, I’ve only included them simply because their short-term setbacks may actually be good buying opportunities.

Also, if you blog on any stocks on this list or similar stocks to them, I appreciate that you respect my contribution since it took quite some time & resources over past two years to collect these information. A link in your article that links back to this original post will do.

As the final conclusion to my dividend series, here are all the previous posts related to my dividend investing. There are many different tax issues involved and discussed in the series. That’s part of the invisible price that you need to pay for investing in such stocks:

1. My dividend investing ($11775.91 for 2005)
2. Master Limited Partnership – Great Dividend Savers
3. Royalty Trusts – Get Paid Royalties w/o Paying (Much) Taxes
4. REIT as an Alternative Dividend Investment
5. Foreign Taxes Withheld Problem (this is not part of the series, but most likely you will face the same problem.)

And I apologize to not giving this list to you sooner since my very first original post, which only gave out good and general information, but not much details. It served only to catch your eyes. I wanted to complete this series sooner, but I have been simply overhelmed by all of my blogging and non-blogging activities. Since the stock market seems to be reaching a bottom here, it is actually better that I’m providing this list at such time.

A quiz: do you know which stocks tend to go up, and which stocks tend to go down a little when the stock market have a strong bounce up? If you have studied my dividend investing series carefully, and have been watching these stocks for sometime, you should be able to answer this question confidently. Okay, a hint for you, what are more like bonds?

Just repeat of my legal disclaimer here: I don’t assume any responsibility for your investment decisions based upon anything on http://www.1stmillionat33.com/. The advices here are provided “AS IS”, and readers are advised to obtain further research or consultation.

1. Equity REIT: This includes residential, retail/commercial, office/industrial, and some smaller categories like healthcare, self-storage, and hotel REIT. There are companies out there, specializing in each category, and a few are diversified REIT that owns several kinds. Their income comes from leasing out of their owned properties.
2. Mortgage REIT: These kinds of REIT invest in mortgage securities, such as Fannie Mae and Freddie Mac. These companies take advantage of the yield difference by using short term funds to invest in long term bonds and produce earning by the yield difference. When times are good, they’re like a money-printing machine. But when the yield curve flattens or even inverts, looks down below when the dividends are cut. In fact, I wouldn’t touch these companies at all, since the “asset-back” mortgage securities are often back by overvalued assets. I fear for the non-return of my total principal.
3. Hybrid REIT: Hybrid REIT combines investment in both equity and mortgage REIT.

REIT usually is a fairly good way to obtain a stable dividend income, while at the same time, your money is invested in an inflation-hedged real estate property. Both the current dividend income and the principal money in the real estate property will rise along inflation. In this regard, REIT is an excellent choice of investment between stocks that only provide inflation hedges without much dividend incomes, and bonds that only provide a stable fixed income without any inflation hedges. In fact, the performance of REIT in the last five years of roughly 20% a year attests to its stellar investing characteristics.

In the recent past before roughly 2001, REIT used to be paying out a fairly high dividend usually north of 7%, up to 12%. I invested in REIT in year 1999 to probably 2001. Since then, I stopped investing in REIT for the following reasons:

1. I owned my home, and to prevent further real estate exposure, I don’t want to invest in REIT in respect to my asset allocation.
2. The yield on REIT is relatively low, and keeps getting lower as the REIT stock prices keep going up much faster than the actual income to be distributed as dividends. When I first started investing in REIT, the bigger names had close to 7% yield, while the smaller names can have up to 12% yield. Now, the bigger names have a paltry yield of 3%, and it’s simply too low for my taste. Here is the historical yield range for REIT, and as you can see that REIT is yielding at the lowest in years.
3. Obviously, if and when the real estate prices go down because of a housing market correction, REIT stocks will inevitably go down because of the shrinking property values. Especially if REIT stocks go back to the historical average yield of roughly 6% to 7% for bigger names, REIT stocks could fall very hard. For example, for a current yield of 3.25%, and a stock price of $100, and assume it’s total dividend stay the same at $3.25 per share. If the dividend yield reverts back to 6.5%, the stock price needs to fall back to $50 since $50 * 6.5% = $3.25 per share. In other words, majority of the REIT stock capital gain is coming from the shrinking of the yield due to the perception of the rising real estate. CNN Money also agrees with me on that REITs are getting riskier at this point.

To read more on REIT investing, here are a couple of good resources:

1. For Canadian REIT investors, here is an excellent source of information from Deloitte.
2. Investopedia explains how REIT can be properly evaluated using its FFO.
3. A brief intro from Forbes on REIT investing.

Now, the most interesting trade was on a cross-listing on both US & Canadian stock market. This stock had an ask of $9.73 for 400 shares, and was less liquid. I gave up waiting, and hit the ask with 500 shares. The next thing that I knew was it took a little bit longer than usual to get my shares appeared on my screen, and I still had an ask of 100 share at $9.73. But the price immediately jumped to $9.90. I think there were some impatient buyers who later placed market orders on this stock without looking. Despite that on Canadian market, both the bid & ask prices were pretty close to $9.73 or slightly higher, market makers were simply merciless. There were no attempts of pulling closer the bid/ask. After my order of $9.73 gone thru, the next couple of buys were at $9.90, $10.30, $10.30 again. Yeah, and the ask was still staying at $9.73 (my partial order of 100 shares) in the meantime. If you just calculate the difference, $10.30 / $9.73 -1 is 5.9%! 5.9% is sometimes all the profit that you could glean from the market, and some guys just gave it for free to the sellers (or the market makers). My guess is that maybe an arbitrage was done across US & Canadian market, and someone pocketed some 4% of profit without risk. Hey, I didn’t see $10.30 price in Canadian market at all for the whole day (adjusted for currency exchange).
I advise not to use market order except only in highly traded stocks with big trading volume. Even with limit orders, I advise highly against having an open pending order in the market, while you are not in front of the screen. The best ways to buy stocks is to buy them while you watch. You can either use market order for highly liquid stock, or use limit orders to try to hit the ask/buy price and below the ask/buy size. If you use limit orders while you’re not watching the market, most of the time there are only two scenarios:

1. You didn’t get your limit order executed because your price was TOO LOW for buys, or TOO HIGH for sells.
2. You got your limit orders, when the market PLUNGED right through your buy order happily for the corresponding sellers, or the market ZOOMED right through your sell order happily for the corresponding buyers. Yes, you got your orders filled, but they’re immediately either in a substantial losing position, or with lack of substantial profits (in the zooming case).

Of course, you could put a limit order that is closer to the market price, but how would you know what’s the market price, if you’re not watching? And only for stock genius or by pure trading luck, your limit order got executed near the local minimum or local maximum. That seldom happens however, especially if you’re not watching. I suggest that at the minimum, one should watch how and where the market opens, before put in any limit orders. At least, that way, you have adjusted the opening difference from yesterday, and can be in the ball-park range.