Volume III, Issue 7 / July 2009
Welcome Letter
Those of you paying close attention to the calendar will notice we pushed up our semi annual portfolio review by a couple of months. We did this because we have a nagging voice in the back of our head clamoring for caution and calling for crisis. And as long time readers know, we like crisis because within crisis lies opportunity if you are prepared. So as we often do during these portfolio review issues, we will first step back and offer you our perspective on the geopolitical landscape as we see it and then relate how we surmise it will play out in the markets. At the end of the letter we also include some housekeeping items and update you on more of the changes here at Without Borders. But first, on to more important matters.
The New Normal
One of the themes we consistently talk about around here is the fact that iterative changes can go unnoticed for a long time until one day the sum of those seemingly small changes is monumental. We refer to this as ten degrees off azimuth effect. Indulge us, if you will, with a bit of Airborne Ranger shop talk, as it will illustrate our point. One of the critical skills every good special operator must master is land navigation. This most often entails walking through rough terrain at night with a hundred pounds on your back. In order to get from point A to B in pitch darkness (not to mention quietly when behind enemy lines where people want to kill you) one must be able to use a compass and a map. For those of you who did not click through to the detailed explanation of land navigation, an azimuth is a compass heading where 0 is due north, 90 is due east, 180 is due south and 270 is due west. For example you are in the desert on a dry hilltop and you notice your canteens have enough water to last you another day. You see on the map that a day’s walk away there is a stream where you can replenish your water. So you draw a straight line between where you are and where you are going and you calculate that azimuth to be 95 degrees. Then you start walking on an azimuth of 95 confident you are going in the right direction. All is well until you hit a patch of dense brush and have to veer around, and then you hit a steep cliff and veer around that too. Without noticing you have been traveling on a 90-degree azimuth not the intended 95. But it is no big deal – only five degrees. If you are only walking half a mile or a mile then you will be able to find the water. However, over twenty miles those five degrees between 90 and 95 degrees could have you off target by several miles and you could die of thirst. We call this “drifting off azimuth”.
This is relevant today because most people don’t realize how far the western world has been drifting off azimuth politically, economically and socially over the past twenty years. There may not have been any big changes to the direction but over time the change in course has been monumental.
Western society has now wandered so far off its azimuth that there is no chance of getting back on the original path. Some will claim that this is the better way to go anyhow just like Chevy Chase in one of those family vacations movies. “We are not lost kids, this is a shortcut!” Others will cling to the premise that this is the correct course and that water is just over the next hill. The vast majority will remain oblivious to their error until they are ready to drink the sand. Regardless, we are nowhere near our original destination. Some realize this. Others do not or will not.
The fact is that western democracies have evolved (we might say devolved) over the last twenty years so rapidly that many simply refuse to accept that the premise for their arguments is no longer true. The left and the right both talk about the “free market” and “capitalism” as if either were still in existence today. They are not. The western democratic nation states all practice some form of blended socialism and fascism. We are basing our investment and to some extent personal decisions on this new reality.
You may remember that in March of 2008 we discussed the concept of an inflection point. Inflection points are perhaps the most overlooked and misunderstood market events. Perhaps this is because there is no way for the tweed jacket set to model inflection points with easily defined Greek letters. Nope. No chance of a Nobel Prize or even a major published work. Perhaps it is because there is no way for the government or mainstream economists to gain funding? Certainly the money management industry would never talk about inflection points because they would have to toss out all their asset allocation models, reduce their dollar cost averaging mindset and stop selling products designed to be average.
The reason we mention this again is because we believe we are in still in the midst of that inflection point. Our dual reversals: the capitulation of the individual and the end of levered profits is not recognized or accepted easily. Inflection points are not precise moments in time but rather they are periods when sentiment, attitude, and economic trends reverse. They are incremental changes in azimuth; two degrees here, three there, bailing out AIG would be considered a five degree shift after all the company is going to “pay back the government”. The government’s heavy-handed involvement in the Chrysler bankruptcy was probably another ten-degree variation. But we are now more than a little off course. Laws prohibiting foreclosure- 3 degrees socialized medicine- well we will see. We may not be looking at a full 180 but if we started in Rome headed heading for Vienna, we are going to get our feet wet before we hit the Alps.
This is important to highlight simply because many of the so called financial experts today are products of either the infotainment complex which needs to have a steady stream of “new developments” or government hacks who need to constantly spin their way to better poll numbers. The fact is the inflection point we highlighted back in March of 08 is still developing. It is consolidating, coalescing slowly and just starting to creep into the psyche of astute investors. It has not yet manifested itself in the business models of most companies or the spending habits of the populace at large.
Here is an indicator. We had a delightful lunch with two subscribers from Texas passing through our neck of the woods. Both are former Naval officers. He was a Navy surgeon and she an operating room nurse. Together they now operate a private clinic in Texas where he performs facial plastic surgery and she administers Botox and other “injectables.” We learned that while plastic surgery is way off its highs the Botox business is booming. They tell us that plastic surgery normally tracks the stock market pretty well and that there has been a slight increase in the amount of surgical procedures. However, at the moment we think we will wait for the Botox bottom before we take any solace. As we understand it much of the Botox demand is older workers trying to look younger so they can compete for the fewer jobs available.
Certainly most people under 40 have nothing to compare this environment to and they are going to expect things to go back to “normal” before they realize that there is a “new normal”. This is not only true in North America but throughout Europe where denial is not just prevalent, it is policy. Government bailouts and spin will slow the recognition and acceptance of the “new normal” but it will be accepted. Our gut tells us that when the first large wave of unemployed workers are no longer eligible for benefits starting this fall and the commercial real estate loans that are soon to be in default hit the news this fall we may see some reality set in.
Take a look at the following crude non-scientific diagram, which depicts where we are in the economic cycle and predicts what lies ahead.
This is not a graph of the stock market, or any single investment class, rather it is a crude representation of the economic climate, which includes purchasing power, attitude, sentiment, corporate earnings and spending. Our best estimate is that we are presently at B and there will be many false starts, head fakes and violent reversals between now and C. We don’t claim to know the exact movements but we are sure those fits and starts will provide great trading opportunities in the markets we cover. The inferences from the chart should be that the present inflection point is still ongoing and that while the major trend is absolutely down, there will be a great deal more volatility on the way down. This volatility is what we aim to take advantage of in our new FLASH CABLE service. It is also these violent swings which the so-called experts will claim is “the bottom” but do not be fooled. Most of these experts need it to be “the bottom” because their business or their time in power depends on it.
Our Model Portfolio
There is an old adage in the money management and the financial newsletter business: “My clients will forgive me if I loose half their money when the markets do the same but they will never forgive me if the markets go up 30% and their portfolio does not.” We do not subscribe to that adage and we figure you don’t either or you wouldn’t subscribe to Without Borders. In 2008 our portfolio was positive because we purposely avoided the mania in emerging markets and commodities. Doing nothing can be very hard but very smart. We are still of firm belief that now is not the time to “go all in”. Rather it is still the time to be nimble and be able to react. So you will see that our model portfolio is now poised to react to whatever the markets throw our way when they throw it our way and take advantage of short term opportunities while always keeping in mind that the situation is going to get worse before it gets better. There will be a time when we back up the truck on shares but the value today is not there en masse. Until then we will hop in and out of selected fast moving opportunities and continue to accumulate shares in companies we want to hold for the long haul when the price is right.
So for now keep:
30% in physical precious metals
30% in foreign productive real estate (rental property or agricultural/forestry land which can also be used as your escape destination if things get really bad at home)
20% in the securities we cover in Without Borders and others that will survive and thrive on the next leg down.
20% in a speculative trading account to capitalize on dislocations of the sort we will highlight in Flash Cable.
We feel compelled to reiterate that this is recommended for your investment/ speculation portfolio not all of your assets. In addition to the above it would be wise to have at least three months worth of living expenses on hand in cash where you can get at it. Not all in a savings account. As radical as it may seem and we hope it never comes to it, you should have enough bank notes handy to cover expenses should there be systemic failure of the banking system. Don’t be one of those people standing in line at the cash machine when it runs out of bills. It may not be necessary but it would be wise to make a habit of taking out a few hundred dollars a day from the bank on your way home and putting it in a safe place. If any of the potential scenarios we have talked about; civil unrest, bank holidays, currency controls, or worse a catastrophic attack, should occur you can quickly pack a bag and get out of Dodge. What do you have to lose by not doing it? Less than 1% in a savings account? We hope you know us well enough by now to understand we are not fear mongers or extremists. We just believe in being prepared. This will be part of the “New Normal”.
We always worry about sounding like Chicken Little or even worse “the black helicopter crowd”. Around here we joke about being the “rational wing of the lunatic fringe”. However, we’ve had the chance to meet more and more of our subscribers and we learn quite a bit from them. As we get to know each other, one theme emerges. Our subscribers are successful mainstream men and women who simply care about facts, think for themselves and worry about the deterioration of the world around them. They scratch their heads and wonder why their friends and neighbors just don’t recognize what is going on. Our subscribers don’t wear tin foil hats or camp out all night for Star Wars tickets. Rather they quietly go about their lives and prepare for what is likely to unfold.
One subscriber recently told us she had been back to the US after living overseas for a while and she struck up a conversation with someone who works for one of the largest manufacturers of Automatic Teller Machines. He told her he had to re program their machines in California to accept the new State IOUs that are being issued in lieu of payment to vendors. Her economic calamity instincts took hold and she shrewdly asked, “If there was going to be a bank holiday and all the ATMs disabled, would you know in advance?” Sadly but not surprisingly he answered, “What is a bank holiday?” When she told him his response was even more indicative of the state of denial even amongst educated professionals, “What? This is America we don’t do that! Our government couldn’t do that. People would be furious.” Well our government doesn’t nationalize banks, buy failed industrial companies, torture prisoners, or spy on its own people either. Right? Better check your compass Mr. ATM guy, you are programming machines to take IOUs!
This post is just an excerpt from a full issue of Without Borders. If you would like to read the full article and gain exclusive access to all of the actionable investment intelligence that our current subscribers are profiting from every month, then we invite you to try out or subscription, risk-free, for 30 days. So, try it out today and discover a new world of undervalued opportunities – and a fresh new world perspective.