Demographics as Destiny

If demographics is destiny, then America?s future looks bleak. I have long been a fan of demographic investing which creates opportunities for traders to execute on what I call ?intergenerational arbitrage?.? When the numbers of the middle aged are falling, risk markets plunge. Front run this data by two years, and you have a great predictor of stock market tops and bottoms that outperforms most investment industry strategists.

You can distill this even further by calculating the percentage of the population in the 45-49 age bracket. The reasons for this are quite simple. The last five years of child rearing are the most expensive. Think of all that pricey sports equipment, tutoring, braces, first cars, first car wrecks, and the higher insurance rates that go with it.

Older kids need more running room, which demands larger houses with more amenities. No wonder it seems that dad is writing a check or whipping out a credit card every five seconds. I know, because I have five kids of my own. As long as dad is in spending mode, stock and real estate prices rise handsomely.

As soon as kids flee the nest, this spending grinds to a juddering halt. Adults entering their fifties cut back spending dramatically and become prolific savers. Empty nesters also start downsizing their housing requirements, unwilling to pay for those empty bedrooms, which in effect, become expensive storage facilities. This is highly deflationary and causes a substantial slowdown in GDP growth.? That is why the stock and real estate markets began their slide in 2007, while it was off to the races for the Treasury bond market.

The data for the US is not looking so hot right now. Americans aged 45-49 peaked in 2009 at 23% of the population. According to US census data, this group then began a 13 year decline to only 19% by 2022. Using my two year ?front running? rule, the bear market in equities that started in 2007 will last all the way until 2020. This is a major reason why I am predicting a second ?lost decade? of sluggish 2% GDP growth for the US, and why our stock market could remain trapped in a broad range for much of this time.

You can take this strategy and apply it globally with terrific results. Not only do these spending patterns apply globally, they also back test with a high degree of accuracy. Simply determine when the 45-49 age bracket is peaking for every country and you can develop a highly reliable timetable for when and where to invest.

Instead of poring through gigabytes of government census data, my friends at HSBC Global Research, strategists Daniel Grosvenor and Gary Evans, have already done the work for you. They have developed a table ranking investable countries based on when the 34-54 age group peaks?a far larger set of parameters that captures generational changes. The numbers explain a lot of what is going on in the world today. I have reproduced it below. From it, I have drawn the following conclusions:

* The US (SPX) peaked in 2001 when our first ?lost decade? began.

*Japan (EWJ) peaked in 1990, heralding 20 years of falling asset prices, giving you a nice back test.

*Much of developed Europe, including Switzerland (EWL), the UK (EWU), and Germany (EWG), followed in the late 2,000?s and the current sovereign debt debacle started shortly thereafter.

*South Korea (EWY), an important G-20 ?emerged? market with the world?s lowest birth rate peaked in 2010.
*China (FXI) topped in 2011, explaining why we have seen three years of dreadful stock market performance despite torrid economic growth. It has been our consumers driving their GDP, not theirs.

*The ?PIIGS? countries of Portugal, Ireland (EIRL), Greece (GREK), and Spain (EWP) don?t peak until the end of this decade. That means you could see some ballistic stock market performances if the debt debacle is dealt with in the near future.

*The outlook for other emerging markets, like Russia (RSX), Indonesia (IDX), Poland (EPOL), Turkey (TUR), Brazil (EWZ), and India (PIN) is quite good, with spending by the middle age not peaking for 15-33 years.

*Which country will have the biggest demographic push for the next 38 years? Israel (EIS), which will not see consumer spending max out until 2050. Better start stocking up on things Israelis buy.

Like all models, this one is not perfect, as its predictions can get derailed by a number of extraneous factors. Rapidly lengthening life spans could redefine ?middle age?. Personally, I?m hoping 60 is the new 40. Immigration could starve some countries of young workers (like Japan), while adding them to others (like Australia). Foreign capital flows in a globalized world can accelerate or slow down demographic trends. The new ?RISK ON/RISK OFF? cycle can also have a clouding effect.

Still, it does present an intriguing framework for analyzing the international investment scene. In the meantime, I?m going to be checking out the shares of the matzo manufacturer down the street.

 

 

 

 

 

 

 

 

 

Watch Those Monetary Aggregates!

Call me a nerd, but instead of spending my Sundays watching the NFC playoffs, I pour over data analyzing the monetary aggregates. This is so I can gain insights into the future performance of assets classes. What I am seeing these days is not just unusual; it?s bizarre. Call it a double reverse, a Hail Mary, and a Statue of Liberty all combined into one.

You can clearly see the impact of QE2 at the end of 2010 on the chart below, which caused the monetary base to explode and triggered a six month love fest for all risk assets. Hard asset prices, like energy, commodities, the grains, and precious metals did especially well, leading to fears of resurging inflation. This prompted the European Central Bank to commit a massive policy blunder by raising interest rates twice. The US dollar (UUP) was weak for much of this time.

When quantitative easing ended in June, not only did the base stop growing, it started shrinking. Hard assets rolled over like the Bismarck, and gold peaked in August. No surprise that when you take away the fuel, the fire goes out. And guess what else happened? The dollar began an uptrend that continues unabated.

So what happens next? Given the continuing strength of the economic data, I think that the prospects of a QE3 have been greatly diminished. Not only has it been taken off the back burner, the flame has been extinguished and the pot put back into the cupboard.

Needless to say, if this trend continues it will have a deflationary impact on the global economy as a whole,? and ?RISK ON? assets specifically. This is great news for the dollar. It?s simply a question of supply and demand. Print fewer dollars and you create a supply shortage, forcing bidders to pay up. This augurs poorly for the non-dollar currencies, especially the Euro (EUO), which you should be heavily short. What! I?m already short the Euro? Fancy that!

 

 

 

Dad Was Always a Great Monetarist

The Flash Crash Risk is Rising

Those who lived through the cataclysmic ?flash crash? that occurred precisely at 2:45 pm EST on May 6, 2010, have been dreading a replay ever since. Their worst nightmares may soon be realized.

That is when the Dow Index (INDU) dropped a gob smacking 650 points in minutes, wiping out nearly $1 trillion in market capitalization. On that day, some ETF?s saw intraday declines of an eye popping 75% before recovering. A flurry of litigation ensued where many sought to break trades as much as 90% down from the last indication, some successfully.

The true reasons for the crash are still a matter of contentious debate. Many see a smoking gun in the hands of the high frequency traders who account for so much of the daily trading volume. But I happen to know that many of these guys pulled the plugs on their machines and went flat as soon as the big move started.

I think that it was the obvious result of too many people following similar models in markets with declining liquidity. The ease of instant execution through the Internet was another contributing factor. It also could be a symptom of no growth economies and lost decades in the stock market. The increasing short term orientation of many money managers also played a hand.

Mathematicians who follow chaos theory and ?long tail events? known as ?black swans? argue that the flash crash was not only inevitable, it was predictable. They are also saying that the next one could be far worse.

Since then we have suffered several mini flash crashes. These include the recent $200 collapse in gold, a $5 plunge in silver, a five cent gyration in the Euro, and a ten cent gap in the Swiss franc. Notice that these ?flash? events only happen on the downside, and that we don?t have flash melt ups.

In many respects, traders and portfolio managers dodged a bullet on that fateful day. What if it had happened going into the close? Then assets would have been marked to market less $1 trillion, and the Asian openings that followed hours later would have been horrific. This could have triggered a series of rolling flash crashes around the world from time zone to time zone that would have caused several trillion more in losses. Those losses eventually did happen, but they were spread over several more months at a liquidation rate that could be absorbed by the markets.

Regulators claim that they have reduced the risks of a flash crash through the enforcement of daily trading limits across a broader range of financial instruments. I am not so sure. During a real panic, preventing people from unloading risk is almost an impossible feat. I know because I have lived through many of them.

In the meantime, the S&P 500 continues its inexorable rise well above the exact point at which the last flash crash started, at 1,160. We are now 10% above that last flash point. Avoid, like the plague, shorting leveraged naked puts on anything.

 

 

 

 

 

Rubbing Shoulders With ?The 1%? at Incline Village

If you really want to get a read on how ?the 1%? are faring these days, take a ski vacation to the tony hamlet of Incline Village on the pristine shores of Nevada?s Lake Tahoe.

Each morning, I trekked to Starbucks, one of the few local sources for the Wall Street Journal and the New York Times. There, trophy wives line up to buy their chai tea lattes, all tall, thin, and blonde, wearing designer sunglasses and snow boots, as if produced from a Gucci cookie cutter. The parking lot is jammed with Range Rovers and Cadillac Escalades.

 

Keeping up with the Jones?s here on fabled Lakeshore Drive can be quite a task, especially when they are populated by such names as Oracle?s Larry Ellison, casino mogul, Steve Wynn, and Saudi arms dealer, Adnan Kashoggi. Ellison alone is thought to have poured $200 million into his mountain retreat. Some of these compounds offer private beach lodgings for bodyguards and dog groomers. Junk bond king, Michael Milken, springs for the cost of the town?s annual Fourth of July fireworks display as it coincides with his birthday.

In the ultimate feat of hubris one upsmanship, one billionaire is converting the profits from his check cashing business to build a $150 million, 36,000 square foot residence that looks like a convention center. He has ruffled the feathers of locals by chopping down every ancient pine and cedar tree on the property to max out the square footage, violating multiple town ordinances. Who knew that cashing checks was so profitable?

 

 

In fact, lakefront Incline boasts one of the few neighborhoods in the US that has held up reasonably well during the real estate crash, with six properties changing hands at $1,000 a square foot in the last year. I guess they?re just not making beachfront property any more. Current listings include a 3 bedroom, 2 bath bungalow for $49.9 million and a 8,694 square foot palace for $43 million. If you are looking for a real bargain, check out the five bedroom French castle at www.inclinecastle.com for $22.85 million. As with the large diamond shortage I have written about previously, this is further evidence that the rich are getting richer at an accelerating rate.

 

 

The land here was originally owned by one of the Comstock silver barons of the 1860?s. You may recall it as the location of the TV series ?Bonanza? and I?m sure that every female reader will remember ?Little Joe?. A development company subdivided the land during the 1950?s with the intention of creating a Palm Springs in the mountains, spurred on by the completion of Interstate 80 as part of the infrastructure demanded by the 1960 winter Olympics at nearby Squaw Valley.

Devoid by edict of the down market fast food chains that afflict most of America, Incline boasts two municipal golf courses, where at 6,300 feet, the air is so thin that your drive travels an extra 50 yards. If you want a Big Mac, you have to travel down the road to California-- if the road isn't blocked by snow.

Incline is also a Mecca for libertarian millionaires drawn by the absence of a state income tax. Unfortunately, they also possessed the financial sophistication to buy gorgeous mountainside homes, extract cash-out refi's all the way up, invest the proceeds in the stock market, and lose it all in the subsequent crash.

The result has been a meltdown of Biblical proportions in the housing market. Of the 8,000 homes in the village, 400 are for sale at distressed prices and another 400 or more discouraged sellers hang over the market. Brokers report a brisk business in bank owned short sales, foreclosures, and sales on the Washoe County Court House steps for homes worth less than $800,000 at prices down 60%-70% from the 2006 peak.

Jumbo financing is now an extinct species, unless you're happy to pay a 200 basis point premium over conventional loans. So the middle market, where homes are priced from $1 million to $4 million, has ceased to exist. Only cold, hard cash talks here. But high net worth individuals hate tying up capital in an illiquid asset when more attractive options abound. Precious metal coins are especially popular in the Silver State.

I am sad to report that antidepressant addiction among realtors in Incline Village is at epidemic proportions, since they don?t have anything to sell to the 1%. Some of their properties have been on the market so long that snow drifts have collapsed balconies, the local wildlife have moved in, and prospective buyers are scared away by offensive odors. Break-ins by black bears have become a serious problem, leaving basketball sized poops on the living room floor.

Abandoned homes see their pipes freeze and burst, causing irreparable damage. In Las Vegas, foreclosed homes can be easily spotted from the air by their dead lawns and green swimming pools. In Incline the 'tells' are the ten foot high mountains of frozen snow dumped there by snow plows, blocking entry. I guess all real estate markets really are local.

Owners used to be able to cover half their annual carrying costs by renting out their properties during Christmas and New Year's, and for a few weeks in the summer. Unfortunately, that market has collapsed also. There are not a lot of high rollers willing to fork out $10,000 a week for a vacation rental in a recession.

If you are one of the 99%, I?d think again before buying a vacation home any time soon. The only consolation is that conditions are much worse in Las Vegas. The optimists concede that prices could stay down for another decade. The pessimists can already be found at the bottom of the lake with the Godfather's Fredo Corleone, another former resident of Incline Village.

Hedge Funds Circling Over the European Wreckage

Have you ever wanted to spend your summers basking in the sunlight at your mountain top Tuscan villa, surveying the manicured vineyards which produce your own estate bottled wine? Are you drawn by the cachet of claiming George Clooney as a celebrity neighbor on the model strewn shores of Lake Como? How about a luxury apartment that is walking distance from the Vatican?

Hedge fund managers are salivating at the prospect of one of the greatest fire sales in history, as assets of every description are being dumped in anticipation of the hard times now hitting Europe. On the menu will be trillions of dollars of distressed loans hived off by desperately downsizing and deleveraging continental banks. Corporations are expected to dump money losing divisions and subsidiaries in a race to beat the coming recession, which is expected to be severe.

In many respects, these deals of the century represent the second shoe to fall after similar bargains were had in the US during the 2008 crash. Europe?s day of reckoning was postponed by four years, thanks to a recovery in the US, QE1, QE2, and Federal Reserve policies that kept interest rates at century lows.

The complacency in Europe since then has been staggering, with many turning their noses up, claiming it could never happen there. Some are predicting that the balance sheet scrub could take as long as a decade, similar to Japan?s tortuously long repair of its own banking system.

Some hedge funds are taking advantage of the wholesale withdrawal of European banks from the credit markets to beef up their own international lending?at much higher interest rates. The same funds, like Highbridge, similarly locked in enormous spreads in the US when conditions were dire. Several American private equity firms are said to be setting up new European distressed asset funds to peddle to pension funds and high net worth individuals. Those who made similar investments in the US four years ago, made fortunes.

For individual investors the easiest and ripest pickings may be among the European bond ETF?s that already trade in the market. Many of these have suffered gut churning declines in recent months as the European melt down unfolded, despite offering yields multiples of what can be found at home.

Below is a short hit list ranked in order of damage incurred from the recent peak to the trough:

PowerShares DB Italian Treasury Bond Fund (ITLY): -19%

Wisdom Tree Euro Debt Fund (EU): -13%

iShares S&P Citigroup International Treasury Bond Fund (IGOV): -11%

SPDR Barclays Capital International Treasury Bond ETF (BWX): -9.5%

Germany Bond Index (BUND):? -4%

Of course, the eternal question of when to buy is the open to debate. There have been enormous declines in European bond yields since the peak seen last week, with Italian ten year yields plunging from 8% to 6%, and Spanish yields plummeting from 7% to 5%. It was a simple shortage of paper, not any ECB intervention that drove yields down so rapidly.

Aggressive traders are already starting to scale in. Others say the worst is ahead of us and that these sovereigns could see 9% yields before the fat lady sings.

I think the safe play here is to use the major sell offs to start accumulating positions and count of the big cash flow to pay for it over time. You can hedge out your currency risk by taking out an equal dollar amount in short (FXE) positions. Triple ?A? French bonds were yielding 7% last week, while ?AAA-? US Treasuries paid a paltry 2.0%. Is something wrong with this picture? Guess how it will end.

 

 

 

 

 

Is the Fat Lady Singing for the European Bond Market?

Hey, Neighbor!

Austerity Hits Wall Street

This year, your bonus is that you get to keep your job. That is the bad news that will be dished out to many disappointed staff during annual reviews at the major Wall Street firms this year.

We all know that volumes have been trading at subterranean levels which have created a real drought of commission incomes. New regulations imposed by Dodd-Frank and the Volker rule mean that banks have to become boring, no longer able to juice earnings with trading revenues. For boring, read less profitable, leading to smaller budgets for compensation. This is the price of preventing banks from committing suicide with your money in hand.

Industry compensation experts are seeing bonus cuts of up to 30%. Equity divisions are seeing the greatest cuts, followed by bond departments, and investment banking. Senior staff are being nudged toward early retirement to further reduce overhead. Only private wealth managers are seeing pay increases, thanks to their ability to charge rich fees for enhanced customer service and place high margin products, like local municipal bonds.

The scary thing is that shrinking payouts is a trend that could continue for years, unless a new bull market suddenly appears out of nowhere. When I first started working on Wall Street nearly 40 years ago, one out of three taxi drivers were brokers rendered jobless by deregulated commissions. Be careful next time you cross the street. You might get hit with some free investment advice.

 

 

 

Did You Say ?Buy? or ?Sell??

Goodbye Steve Jobs, Hello Dividend?

Analysts continue to be stunned by the rate at which cash is rolling into Apple (AAPL). At current cash flows, the company?s hoard is expected to grow from $81 billion to $120 billion by next June, an increase of nearly $200 million a day!

So far, the company has resisted every entreaty to part with some of this dosh, either through a share buyback or a dividend. Now some are speculating that the passing of founder, Steve Jobs, and the succession of new CEO, Tim Cook, could lead to a loosening of the purse strings.

Let?s face it. Apple has had a great, decade long run. Hundreds of my readers, many of them Apple employees, are faced with the enviable problem that, having ridden the stock up from $4 to $400, they have too much of their wealth concentrated in a single asset. That is never a good idea from a risk control point of view. But every time I look for reasons to sell Apple, I find three more reasons to buy it. It?s a case of the grass being greener on my side of the fence.

Let me list just a few avenues for continued meteoric performance:

*As the Apple generation reaches the ranks of senior management, more Fortune 500 companies will begin to support their products. Thousands would love to quit carrying around a Blackberry for business and an incompatible IPhone for personal use, with the associated chargers. (note to self: short (RIMM) on the next rally).

*Despite this torrid growth, the stock trades at a discount to the S&P 500 at 12 times earnings.

*The Apple of today is essentially a spanking brand new, high growth company. The company?s only decrepit product is the IMac. The IPhone is only 5-6 years old, while the Ipad and Ap Store are only 1-2 years old and still in their infancy. The potential near term growth of these products is huge.

*IPhones only have a 5% penetration of the world market. Past market leaders like Nokia (NOK)? and Motorola (MOT) have reached market shares well into double digits.

*Apple is just scratched the surface in China, where it only has six official stores (but lots of fake imitators), and is already the premium product.? The growth opportunities there are massive. Everyone there wants an IPhone, and they are traveling to Hong Kong to get them.

*There was always a fear of what would happen to Apple stock after Steve Jobs was gone. That is now behind us. In the wine bars around the company?s futuristic Cupertino, California headquarters at One Infinite Loop, I am hearing that Steve left behind enough new product ideas, improvements, upgrades, and direction to keep Apple forging ahead for another five years. The vast, interlocking, synergistic ecosystem he envisioned is still maturing.

It all reinforces my view that Apple shares will reach my long term target of $1,000 sooner than anyone thinks. It is already trading places with Exxon (XOM) as the world?s largest company and most profitable company on an almost weekly basis. At $1,000, Apple would boast a market value of $930 billion, accounting for 7.5% of total US stock market capitalization, and 40% of NASDAQ.

What if multiples expand, as they should? Take Apple stock up to its past peak multiple of 36, and the company would be worth $2.8 trillion and rank 5th in the world in GDP, more than France, and just behind German. Wow!

 

 

Goodbye Steve Jobs, Hello Dividend?

Report From Australia

SPECIAL AUSTRALIAN ASSET CLASS REVIEW

 

 

I am writing this report on the ferry boat from Sydney to Manley, where I will attend a gathering of Australia based hedge fund managers to absorb their collective wisdom. I have deliberately taken the slow boat,? so I have the time to give this report the depth it deserves. The Australian swim suit model sitting next to me will just have to wait and enjoy the scenery.

 

 

 

When I first came here in 1976, women were not allowed into the pubs, and drinking was the national pastime. Today they still drink like fish, but the prime minister is a woman, Julia Gillard, although probably not for long. It?s proof that if you live long enough you get to see everything.

 

 

 

They call this the lucky country for very good reason. It is surfing the crest of a decade long resource boom to prosperity. Virtually everything it produces in size, including iron ore, coal, and gold, have seen enormous price increases over the past decade. The cities of Sydney and Brisbane are vibrant and bustling. The department stores were besieged with women buying hats for the upcoming Melbourne Cup, the country?s premier horse racing event. Talk to people and they are optimistic and upbeat about the future. It is all very refreshing. Only a people with Australian levels of self-confidence and brass will be told that construction of their bold new opera house in Sydney was beyond the reach of modern engineering, and then go ahead and build it anyway.

 

My Favorite Australian

In Brisbane, I saw a lot of kids racing hot new expensive imported cars. When I remarked to a local that there must be a lot of rich parents here, he replied ?It?s not the parents, it?s the kids who are making the money.? By working a ?21/9? schedule, which means working ten hours a day for 21 consecutive days at a distant mine, and then getting 9 days off, a 20 year old here can earn A$200,000 a year. Now, workers in other industries want a larger piece of the pie. Australia is one of the few countries in the world where you actually see strikes. Indeed, the antics of the Qantas union, the national airlines, made traveling to and from the country challenging at best.

Hey, Junior, Can I Borrow the Car?

 

The boom has fundamentally remade the Australian economy. Over the last 15 years, mining has jumped from 4% to 10% of GDP and management services from 10% to 15%. At the same time, manufacturing was pared back from 15% to 10%. That enabled the country to more easily absorb the blow when China took over the world?s low end manufacturing industry, which has caused so much damage in the US.

Today, services of all descriptions account for 69% of GDP, which gives it a crucial buffer against the extreme volatility in commodities prices. But it is not immune. During the 2008 crash, shares in mining and energy giant, BHP Billiton (BHP), the country?s largest company, and the third largest in the world, collapsed by 80%. Competitor, Rio Tinto (RIO), plunged by 90%. As much as Australians are complacent in their belief that they are immune from the world?s problems, that is anything but the case. A dependence on foreign oil imports of 80% presents another big risk.

Much of today?s prosperity can be traced to groundbreaking reforms of the financial and tax system in 1983. These enabled the country to replace colonial ties that were severed when Britain joined the European Community in 1973 with trade relations with neighboring Asia. It was a natural and inevitable geographic realignment. China now absorbs far and away the largest share of exports, followed by Japan and South Korea. Australia is also host to 120,000 foreign students, mostly from Asia, further adding to the newfound muscle in the service sector.

Although Australia has been running large current account deficits for 50 years, the shortfall has been more than made up of large foreign capital inflows. Most recently, China has attempted to take large minority stakes in several firms, especially in the resource area. This will accelerate in coming years to the extent that Australians permit it. A capital shortage in the country there is not.

 

Today, Australia ranks 10th in per capita GDP at $39,764, behind the US at $46,810 (7th), but well ahead of China at $7,544 (94th).? You can expect those numbers to converge in coming years, with America continuing its fall and the Land Down Under rising. A debt to GDP ratio at an enviable 22% has made Australia one of the few to maintain its triple ?A? credit rating. GDP growth has averaged a blistering 3.6% rate for the past 15 years.

Another Favorite Australian

If there is a dark cloud hanging over this economic miracle, it is a rampant property bubble. Prices have doubled or tripled since 2003, and homes now sell for a sky high seven times average annual earnings. The post-crash US is seeing homes selling at multiples of three to four. Houses can be bought for as little as 5% down, and many individuals have been pouring excess savings into multiple real estate purchases.

There are a whole host of tax subsidies that favor home ownership. Liberalization of real estate purchases by foreign investors has further thrown the fat on the fire, attracting massive Chinese buying. House prices are now rising at triple the inflation rate. These are all signs of coming trouble that can only end in tears. But point this out to newly enriched Australians, and I get the same chill I received from Americans in 2005.

 

Which leads us to the question, ?What to do about Australia?? If you are Australian, it is easy. Sell your home. Take the money and run. This is the easiest cash you have ever earned, and you are unlikely to experience such a windfall again. Rent, don?t buy. As Americans proved so amply, the home ATM doesn?t stay open forever.

A continuation of home price appreciation at these rates is a mathematical impossibility. Once prices stop going up, the hot money will exit post haste. And like real estate markets everywhere, there is a ton of liquidity on the upside and none on the downside. It is your classic ?Roach Motel? market. You can check in, but you can?t check out

Will this cause a subsequent crash in the Australian banking sector? That is unlikely. The industry received a firm rap on the knuckles during the 1998 Asian financial crisis. As a result, the country today has one of the most conservatively run banking systems in the world. Leverage is a miserly 10:1. It is highly concentrated, with just four majors, the Commonwealth Bank of Australia capitalized at A$80 billion, Westpac Bank (A$65 billion), Australia and New Zealand Banking Group (A$56 billion), and National Australia Bank (A$55 billion),? accounting for the bulk of transactions. By comparison, libertarian America has 14,000 banks. Still, they will get slapped around a bit. Going into the autumn swoon, Commonwealth?s shares were off 25% from their 2010 peak.

Commonwealth Bank of Australia (CBA)

For the rest of us who don?t own Sydney homes with spectacular Pacific views or enormous farms in the outback, the question becomes a little more complicated. Because of a heavy reliance on commodities, Australian financial assets of every description have become a call option on the growth of the global economy. When growth is healthy, Ausie assets outperform on the upside. Look no further than the Australian dollar (FXA), one of the world?s few remaining high yielders, which nearly doubled against the US dollar after financial assets bottomed in March, 2009.

This is why hedge funds have fallen in love with Australia, and why you hear me singing ?Waltzing Matilda? in the shower whenever global markets are in ?RISK ON? mode. Good times bring massive buying of Australian stocks, currency, and every kind of commodity. During bad times you want to throw all these things out the window. The dark side to this interest from hedge funds is much greater volatility in all things Australian, including the lady sitting next to me. Notice that when ?double dip? was on the table during the summer, the Ausie dollar cratered 15% in a few weeks.

Another consideration to keep in mind is the China card. During this trip, I have been constantly queried about the risks of a ?China crash.? Put those concerns out of your mind, China isn?t going to crash. Slow down, yes, crash, no. The Midde Kingdom growing at a more sustainable long term rate is a good thing for investors. I will go into the why?s and wherefores in a future country report.

Suffice to say that a China with a $5.5 trillion GDP growing at 7% in the future will generate far more GDP and final demand for Australian resources than one with a $1 trillion GDP growing at 10%? ten years ago. In fact the annual GDP increase today is almost as much as the country?s entire GDP a decade ago, and is also much larger than the $300 billion in new GDP the US will create this year at its own arthritic 2% growth rate.

 

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China Isn?t Going to Crash

Australia also has a tailwind behind it which others lack: immigration. This is why America consistently grows 1%-1.5% faster than Europe year in and year out. American fertility rates are close to the replacement rate at 2.1, while those in European countries have plunged to as low as 1.2. They are just not making Europeans anymore as fast as they used to.? Australian fertility rate are still up at 1.8 times, and they supplement that with large waves of inward immigration, primarily from Asia.

Having visited this country for 40 years, the change in the makeup of the population is very noticeable. There were no sushi restaurants in Brisbane in the early seventies. Today I am spoiled for choice. And as I constantly pound the table about in my demographic research pieces, higher fertility and immigration create young, faster growing economies, and make far better investments than old slower growing ones with a lot of benefits to pay out. Oz is a perfect example of this.

 

So what?s the play here? If you are an Australian there are some intriguing opportunities. They used to say that you should buy your age in bonds. Australia is one of the few countries in the world where this is still valid. If you are 70 years old, that means keeping 70% of you portfolio in local bonds and 30% in equities. That guarantees interest from fixed income instruments and reduces the volatility of your income stream as you go into retirement. If you are 30, it means putting 70% of your portfolio into growth equities, and 30% into more sedentary bonds. At your age you will outlive any of the momentary 50% declines that occasionally wrack these securities. Whatever your portfolio allocation, you are really in the sweet spot because most Australian stock and bond alternatives are offering relatively higher returns than elsewhere.

Foreign investors have the luxury of sitting back and waiting for those rare windows that open offering great investment opportunities. If we go into recession next year, as I expect, both the Australian stock markets and currency should see declines of 30% or more from current levels. That would be a great time to load up on long term positions in the resource, energy, and precious metal sectors. You can either index through an ETF like the (EWA) or going for the highest weighted resource stocks in the index, (BHP) and (RIO), which trade like water. You should be able to get great prices that will lead to multiyear gains when the ?RISK ON? trade returns. One thing is certain. When the music starts playing again, the same gorgeous girls keep getting invited to the ball, cycle after cycle.

Until then, a position in Australian government bonds, now yielding 4.54%, might be worth a shot. An economic slowdown will send prices for this paper through the roof. Just make sure you hedge out your Australian dollar exposure when you do so. You don?t want to be putting money into one pocket, only to take it out of the other.

As for the exact timing on all of this, when you need to be running a ?RISK ON? or ?RISK OFF? portfolio, I?m afraid you?ll just have to keep reading the Diary of a Mad Hedge Fund Trader.

Well, the ferry is just tying up now at the Manley dock, the stevedores tossing the heavy ropes on to the pier, and it is time to bring this missive to a close and give my Sheila the attention she so richly deserves.

 

 

 

Report From New Zealand

I am writing this report from the Duke of Marlborough Hotel and Pub in remote Russell, off the east coast of New Zealand?s North Island. One known as ?The Hell Hole of the Pacific?, in 1835, no less an authority than Charles Darwin claimed this 19th century whaling port was populated with ?the refuse of humanity.?

It has since been cleaned up, gentrified, and turned into a tourist mecca. It is much like Lahaina on Maui, Hawaii was in the early seventies, before the blighting high rise hotels and condos went up.

The Residents of Russell Were Most Welcoming

Others Had Different Opinions

The bar is packed to the gunwales with drunken and riotous rugby fans screaming their lungs out in support of their team in the world cup quarter finals. When Wales won, I bought a round of drinks for the house, but first had to arm wrestle a deeply tanned and craggy faced Welshman for the right to do so. I hope my credit card doesn?t get cancelled when the bill comes through for NZ$1,046.29. ?Thomas? is a Welsh name, isn?t it?

The trip started auspiciously at SFO when I found myself checking in behind a group of heavily tattooed, bulked up Maoris. First class was entirely occupied with older, but very large, white males all wearing an assortment of rugby juries. I arrived to find a country in the grip of rugby fever, every car and structure sporting the silver fern flags of the All Blacks home team, famous for their pregame ?hakka? war dance.

Perhaps a Distant Kiwi Cousin?

The rental company was out of cars, thanks to the games, but managed to come up with a battered old Toyota Camry with bald tires, breaks well past their prime, and leaking fluids from every orifice. In other words, it was a lot like me. I was OK with the left hand drive, having lived for 20 years in Japan and England.

But the stick shift certainly made things interesting. I can?t tell you how many times I turned on the windshield wipers instead of the right turn signal. I headed north from Auckland hoping to find better weather, picking up hitch hikers along the way to absorb the local lore.

My dad was here 70 years ago with the Marine Corps, training for the invasion of Guadalcanal, and always remarked how friendly approachable the women were. I found them friendly, yes, but not so approachable. Maybe this is because he was a combat ready 19 year old, and I am a combat ready, but aging 59 year old fart.

The countryside was incredibly lush and green, mountainous, and covered with massive ferns and kauri trees ensnarled by choking vines. Cleared grazing lands were dotted with sheep. The Maori are ever present, accounting for a substantial part of the rural population. Every town name seems to start with the letter ?W?, as in Whangaparaoa, Whangarei, and Waipu.

One of the most interesting conversations that I have had this year was with an aged Maori historian and Shaman at the Waitangi Treaty Grounds. When I told her I was part Cherokee, Sioux, and Delaware Indian, she opened right up and let loose for two hours. It turns out that tribal groups around the world are cooperating and coordinating legal attacks on establishment land ownership around the world. Everyone from the Maori?s to Hawaiians, Navajo?s, Australian, Aborigines, and Finish Laps are involved, and are getting legal aid from the United Nations.

The Maori?s have been especially successful, scoring a $170 million payoff from their government. The money went into community centers and education in the most Maori dominated parts of the country. It isn?t often that I get to discuss the global economic with a Neolithic tribal representative, and I relish the opportunity. I am always looking for the new view, and I?m sure there is much we can learn from 8,000 BC.

When I checked into the Pahia Beach Hotel and Spa, I did what I always do when I visit the Southern hemisphere. I flush the toilet, watching with satisfaction as the water disappears in a counterclockwise fashion, thanks to the Coriolis force. In the Northern hemisphere is goes down clockwise. If you don?t believe me, go try it. That night I found the Southern Cross, the only one of 88 constellations not visible at home.

We all thought New Zealand was toast when Great Britain cut the economic umbilical coat by joining the European Community in 1973, leaving the land of the kiwis out in the cold. A radical series of reforms saved the country in 1984. The financial system was deregulated and exchange rates were freed. Agricultural subsidies were cut, forcing farmers to become more efficient and globally price competitive.

Through a series of fortunate historical accidents, it then entered the sweet spot of the global economy. It was too small to have its own car industry, so it had nothing to lose when Japan took over that business. The same occurred with manufacturing, which China swallowed whole in the past decade. Today, services and tourism account for 70% of GDP. With a per capita GDP of $27,130, New Zealand ranks 33rd in the world, behind the US at $46.810 (7th), but well ahead of China at $7,544 (94th).

Kiwis Will Sell You Anything

Today, the World Bank ranks New Zealand as the most business friendly country on the planet. It has the lowest taxes in the developed world, and an unemployment rate at an enviable 6.6%. People are happy and the cities bustle. This makes all of the country?s assets long term buys, including the New Zealand dollar (BNZ), the stock market (ENZL) and a ten year government bond that yields a generous 4.65%. Use the big dips to take positions.

And Never Throw Anything Out

Well, I have to go now, or I?ll miss the last ferry back to Pahia on the mainland. Besides, that waitress across the room is starting to wink at me.

The Bull Market in Mustangs

The Western US has found a new wrinkle in the housing collapse, where homeowners are desperately struggling to cut living costs to meet the next doubling of their adjustable rate mortgage payments on their underwater houses.

Raising horses can cost more than children, so Nevadans are turning them loose to join herds of wild mustangs, to dodge the $30,000/year it costs to board and care for these voracious animals. Local populations are exploding, eating local ranchers out of house and home, who depend on public grazing lands to feed commercial livestock.

Recently, the Bureau of Land Management held hearings on where to place 25,000 excess animals. Mustangs are the feral descendants of horses which escaped the conquistadores, and there are now thought to be 30,000 running wild, down from a 19th century peak of 2 million. The BLM has another 30,000 in pens, and is making 10,000/year available for adoption at $125/each.
The problem is that many adopt ?pets? who then flip them to Canadian slaughterhouses, which cater to the odd French taste for horseflesh. To see how this works, watch Clark Gable, Marilyn Monroe, and James Dean?s last film, The Misfits.

Madeleine Pickens, the wife of famed oil trader T. Boone Pickens, has offered to take the BLM?s entire herd and put them out to pasture at an undisclosed million acre location. If there is anyone who could have an undisclosed million acres, it is Boone. I have frequently run into majestic and beautiful mustang herds over the years while camping in the remote desert (no, I don?t go to Burning Man). Reminding me that there is still some ?wild? in the ?West?, I will miss them when they are gone.