Financial Endgame

I was asked recently why I had not posted any 2012 Financial Predictions. The short answer is that my market timing skills have sucked since the end of 2009 and so I decided to stop doing predictions. It is my opinion that the markets are no longer driven by fundamentals and rule of law. They are now moved by policy, policy rumors, and computers engaged in High-Frequency Trading. Not just here in the United States, but globally. Last year was the first year in my post-college life where I did not buy or sell a single stock or bond.

At my heart, I still believe the world is still in for a monetary collapse of some sort. It could happen this year or in ten years. The world simply has too much debt and I believe there is no way for it all to be paid back. Although I have a deflationary bias for America, I learned from reading the excellent book Endgame: The End of the Debt SuperCycle and How It Changes Everything by John Mauldin that some countries are more likely to solve their massive debt problems with inflation.

Endgame: The End of the Debt SuperCycle and How It Changes Everything
Endgame: The End of the Debt SuperCycle and How It Changes Everything by John Mauldin

Boomerang: Travels in the New Third World
Boomerang: Travels in the New Third World by Michael Lewis is an excellent book that explores how different countries each have their own unique cultural response to the debt crisis. An investor today can’t simply look at bond yields and balance sheets. They need to understand not only their history, but the psychology of the citizens to predict possible policy outcomes. Predicting how another country will respond with an American bias could end up be a costly mistake.

Who collapses, how they collapse and in what sequence, could send the world and your investment portfolio in completely different directions. There will be investors that will guess everything correctly and make ridiculous amounts of money. They will get on CNBC afterward and tell you how it was obvious. Then 10,000 more viewers will open up options or FX accounts so they can be the next great investor.

One of the key things an investor must learn is what kind of investor they are. Well, I’ve learned that I’m not suited for guessing what sovereign countries and central bankers will do next. Beats me. And I’m not going to spend thousands of more hours trying to figure it out.

Financial Endgame (for this blog)

My true interest in finance has always been understanding and respecting risk. Sometimes I forgot that and lost money, but for the most part, I’ve done OK. My love is in attacking biased conventional wisdom that exposes the investor to unnecessary risk. That is what I do best. That is where my focus will be in future financial posts.


Add yours

  1. MAS,

    Have you read about Modern Monetary Theory? It seems like only description of the current financial system that both makes sense and has some predictive power- not in the sense of market timing, but more along the lines of why Europe is falling apart and the seams and the US and Japan are seeing low interest rates and deflation. I found Warren Mosler’s 7 Deady Innocent Frauds to be an excellent and eye-opening book. Once you read it you feel like you’ve ‘taken the red pill’. It might help you get your predictive mojo back 🙂

    The book (and his very interesting blog) is here:


  2. @Karl – There are too many possible outcomes. Mosler is at one extreme. It may happen that way. Or it may not. These are policy arguments, which may or may not have any relevance on the endgame. I’m not going to waste any more time believing that if I do more research that I’ll be able to time endgame.

  3. MAS,

    I see I made MMT sound like better investment advice above which I didn’t mean to do. What you say makes sense and I agree that there’s no point trying to time markets or guess what the politicians are going to do. You comment about biased conventional wisdom is why I thought to bring up MMT.

    What I find appealing about it is that it builds off an attempt to understand how the financial system really operates and as such is descriptive rather than prescriptive. For example, just understanding that banks don’t lend reserves and in fact create deposits when they make a loan helps to explain a great deal of current interest rate and inflation levels. Or understanding that a currency issuing government isn’t revenue constrained also clears up a lot of confusion about why things work they way they do and why anybody who bases their economics on a household debt model is starting with a fundamental mistake.

    In that sense MMT isn’t simply a different way of reading tea leaves to guess when confidence is going to pick up or housing will bottom or whatever, it’s getting a better understanding of the workings of the economy. I think of it a lot like HIT- once you better understand how strength and muscle is built, your approach to health and fitness is narrowed down into a much more productive range of options.

    I was interested to hear you take on MMT’s description of the economy, not suggesting that they held the key to investment riches (not that its main proponents suggest anything like that)- sorry for the sloppy wording!


  4. @Karl – One of my financial mentors is Karl Denninger. He loathes MMT.

    As someone with zero debt and personal savings, I am biased toward wanting a deflationary outcome. I want to see those that extended unbacked credit eat their losses. But what I want is irrelevant.

    I’m not an economics guy, so I’m not interested in debating economic theory. I’ve come to terms that the greatest thing I can do with my time is develop or improve a skill that is unrelated to investing.

  5. Hi MAS,

    It’s an interesting site, he makes a lot of sense going after the finance industry and the politicians for their role in the current mess as well as the fundamental problems with how our economy is set up to reward certain groups at the expense of others. I think he’s wrong about how banking works- his discussion on reserve banking and bank balance sheets doesn’t reflect reality and he really missed the boat on QE and has a strange way to calculate inflation and think about it’s effects.

    In any case, I don’t mean to drag you into an argument about economics and I don’t hold myself out as an expert by any means. I could certainly be wrong and as you point out- there are much better things for all of us to spend our time on!

    Speaking of which- I’ve been trying some of your suggestions about fermented foods and have really enjoyed them. Thanks!



  6. MAS,
    Always glad to read your posts.
    Personally as a person who normally has 50% in stocks and 50% in bonds. I have sold most bonds and paid off most of my mortgage.
    Call it an unintended consequence of QE. 2012 has been too kind too fast, so I decided to do a 100% hedge on all equity positions as of Thursday Feb 16th using SDS. I’d rather hold the 10% YTD gain then just see it disappear due to any number of uncontrollable variables.

    Thought you may be interested in comparing the Aug 2009 forecast for accuracy.

    Here’s how I would rank the predictions vs Aug 2009 as of Feb 18th, 2012
    Prediction 1. Residential housing: slow decline real terms: 1-2% average annual increase or 22% in 10 years

    Assessment: largely accurate, perhaps too optimistic, From ReMax: national housing report: “January 2012 represents the 17th month of year-to-year home price declines, although this is the smallest decline since October 2010”
    Updated Forecast: no reason to expect significant change. I.e. a home is something you live in.

    Prediction 2. Non energy commodities, more tied to economic cycle: agriculture/metals: light inflation 2-7%/year: up 48% in 10 years

    Assessment: already up 26% since Aug 2009. No break in trend expected

    Prediction 3. Gold: -10% to +15% swings, drop in physical demand offset by speculative holdings, up 100% over 10 years

    Assessment: went much faster than I expected, up 80% since Aug 2009
    Forecast: This may actually flat line for some odd reasons, consolidate for next two years, then back to 3-5% gains.

    Prediction 4. Wages: 22% higher in 10 years, 20% lower in real terms (9% higher vs CPI)

    Assessment: from BLS for 2011 “the year, compensation rose 2.0%, wages and salaries 1.4%, and benefits 3.2%”
    Forecast: no change in trend

    Prediction 5. Energy: oil 8% average inflation next ten years, potential 10-20% annual spikes offset occasionally by technology, without technology improvements, prices 80% higher in 10 years

    Assessment: Using oil as a proxy: up from $70 to $100 in two years. Some big technology changes may hold this down from the same rate of change for the next decade (as the past two years), but still see $150 a barrel in 2019 as realistic.

    Prediction 6. Interest rates: next 24 months, short term flat and low, afterwards driven by tax policy: a moderate tax rise with emphasis on spending cuts = mortgage rates in 6% range (short term in 3-4% range), moderate tax increases with no spending cuts = interest rates in 8-9% range (in a low wage inflation environment)

    Assessment: the fed has destroyed the yield curve. It will be near impossible for the Fed to stop doing QE. Once this view is more widespread, then the fate of the US economy may depend on things being “worse” everywhere else.
    So interest rates have still not risen but it is very difficult to get a loan.
    Still believe interest rates on the 10 year treasury have to go back to 10% in the next five years.
    That being said, owners of bonds had a great year last year, but now is the time to sell. Long term corporate bond funds had 20% returns last year.

    Prediction 7. Dollar value: annual loss of 2%, 18% loss over 10 years
    Assessment: dollar has been flat. Euro has been weaker than expected.
    Against basket expect continued downtrend. Euro is a wildcard. If they eject Greece it goes higher, otherwise, stays at current level. Long term Greece has to be thrown out, sooner the better.

    Prediction 8. Stocks from 8/25/2009: 8% average return over next 5 years: can hit 2007 high again in 2014: 12% better than inflation over 10 years: up 116% over ten years,

    Assessment: The S&P needs a pull-back NOW, 5-8%, then it could be up another 200 points over then next 2 years. It’s already been straight up for the past 200 points since Nov 25th.
    Most years, the S&P index will go below the years opening (1257) in the April/May timeframe. I would suggest to HEDGE 30-50% of all long positions using SDS gradually until the full top is formed over the next 3-5 weeks. The hedge can be pulled off in 3-4 stages as the anticipated 70-110 point drop is realized.

    Prediction 9. Inflation: real inflation over ten years 4.2%, CPI 2.9% : TIPS break even: govt CPI understates inflation by 1.5% year in most areas
    Assessment: QE2 forced up tips by 16% over last two years.

    Key message: expect some pullback in stocks in near term. Most trends otherwise intact. Yield curve distortions make bond investing very difficult now. Should avoid most fixed income except high yield (limit to 20% of portfolio). Use excess cash to pay down any debt. Be ready to hedge stocks at short notice but in small batches.

  7. @Derek – Nice to hear from you. You think the 10 year Treasury will yield 10% in 5 years and the stock market still goes up? Are you hedging your predictions, because I seriously doubt both can be true. Why would any investor push stocks higher for a much riskier and smaller return than a 10% guaranteed return?

    As for SDS, I will never touch a levered ETF again. The daily compounding will crush you unless you can time the movement.

    But what do I know? I clearly do not understand the current environment.

  8. MAS
    The 10% on the treasury yield was a typo, I meant to say 5%, still a big move up (vs 2% today) and I agree that it will impact stocks. But I see that happening in two stages.
    Through the next two years rates stay low and stocks rise, (albiet with some significant pullbacks). About 2-3 years from now, all bets are off, the total Debt will be close to 20 trillion and while it doesn’t end the game, it will be near impossible for the Fed to keep adding 1-2T a year to it’s balance sheet. At that time the US may try something akin to what’s going on in Greece now (austerity lite). That’s when all hell breaks loose and I’d then concur that stocks will get hit but with so much liquidity, it may only be a 20% hit given the number of multinationals.

  9. MAS,

    Side note, I closed the SDS position with a very small loss (4 cents a/share). If I had held to close, there would have been a small gain.
    Your point about the ETFs degrading is well taken, i.e you wouldn’t “buy and hold” it. Still given the risk over the weekend with Greece last weekend, I feel like it was a prudent course of action to have some short term hedge in place.

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