Where Are The Leaders In Europe?

The story unfolding in Europe in a nutshell:

“Undercapitalized banks are supporting over-indebted governments by holding their IOUs; over-indebted governments are supporting troubled banks; and there is insufficient equity in the European banking system to absorb the losses implicit in the solvency gap.  The outcome is that the European Central Bank ends up providing liquidity on an open-ended basis to the peripheral countries to keep their banking systems afloat at the cost of an ever weaker balance sheet.  The one surprise in all this is that more of the retail deposit base of southern Europe has not disappeared in capital flight.”

From John Plender, “Time for Eurozone Policymakers to Grasp the Nettle”: http://www.ft.com/intl/cms/s/0/207fb2a4-ac9d-11e0-a2f3-00144feabdc0.html#axzz1SZnxOYcr.

Almost everyone in Europe seems to have his or her head in a hole in the ground ignoring reality.

Anytime we hear anything from them it is always about who is to blame for the current crisis…the international banking community…greedy speculators…rating agencies…or the cheating being done in world class men’s soccer. 

Real leadership seems to be totally absent from the scene.

Few make such a blatant claim as the New York Times did this morning: “Greece is effectively insolvent.” (http://www.nytimes.com/2011/07/20/world/europe/20europe.html?_r=1&ref=todayspaper)

There, I wrote it!

Greece is effectively insolvent!

It is not the international banking community that is causing the problem.  It is not “greedy speculators” or the rating agencies causing the problem.

The problem exists because of what the Greek government has done.  (For another take on this see Thomas Freidman’s column in the New York Times this morning:  http://www.nytimes.com/2011/07/20/opinion/20friedman.html?ref=opinion.)

Countries…people and businesses…cannot live way beyond their means forever. 

Greece did this to itself, and now the debt is coming due.

Does the Greek debt need to be written done?  You betcha’!

Will the write down be around 50 percent of face value?  That is what the market seems to think.

Can the banks holding Greek sovereign debt weather such a hair cut?  Certainly the “cowardly” stress tests just administered by the eurozone officials give us no such information about this possibility. 

However, sufficient information has been made public about the balance sheets of eurozone banks to indicate that many banks (many more than the nine identified by the stress tests) might have a “hard go” if this amount of a write down did take place.

But, we are in “hard go” country…thanks to the leadership in this area of the world.

Leadership that postpones dealing with problems is not leadership at all. 

“If one says that the problem is ‘out there’…that is the problem!” One of my favorite quotes from Stephen Covey.

I have worked with many failed institutions and in every case when one reviews the records, previous management never assumed that the fault was their own…it was always someone else’s fault. (Are you listening Mr. Murdoch?) 

As a consequence, steps were never taken to correct the problems faced by the organization and, therefore, the problems just got bigger and bigger and bigger.

The same has been true with Greece.

But, the contagion issue arises.  Is this the “Lehman Brothers” moment for Europe?  Will Portugal, Italy, and Spain follow in the footsteps of Greece?

These countries are not immune from the criticism leveled at Greece…and the statement of Plender above.  They have exposed themselves to the fate of the debtor and the debt collector is at the door.  Interest rates now paid by these nations on their debt are exorbitant and unsustainable. 

The losses must be absorbed…they cannot continue to be postponed in the hope that further credit inflation can buy them out of their dilemma.

Read my lips: the debt levels are unsustainable and must be dealt with now!

I like the quote at the end of the New York Times article quoted above: “The market is far more intelligent and resilient than a lot of politicians realize,” said Lee C. Bucheit, a lawyer who has handled sovereign defaults. “Investors realize that sometimes you make money and sometimes you don’t.  But they can’t abide prolonged uncertainty.”

I would close with a slightly modified statement: “Investors can’t abide a prolonged absence of leadership.”

Are you listening America? 

Bring on the Debt Restructuring in Europe

Did you hear the latest one…94% of college professors in the United States believe that they are better teachers than the average college professor! Furthermore, the vast majority of college professors also believe that they are better researchers than the average college professor!

I just thought of this when a quote in the Financial Times this morning. The columnist Gideon Rachman writes of the European leaders: “European leaders do not know whether to be more frightened of the bond markets or of their own voters.” (http://www.ft.com/cms/s/0/38e83edc-4e70-11e0-98eb-00144feab49a.html#axzz1GaG5raM7)

In the first case, the European nations do not seem to be able to create any workable plan to bail out the sovereign nations whose debt is under attack by those nasty “speculators” in the bond markets. In the second case, more and more elected officials, like German chancellor Angela Merkel, French president Nicolas Sarkozy, and others, are under pressure from the voters in their countries to adopt “much harder-line policies on everything from immigration to European spending.”

There is a real possibility that Europe could move much more to the right, politically, than has been the case for a long time. Two countries provide vivid examples of this possibility: the Netherlands and England.

The reason I included the little bit of humor in the first paragraph above is that I needed an example of the fact that not everyone can be above average (except in Lake Wobegon). To be honest, there are a lot of horrible college teachers. And, there are a lot of horrible (peer reviewed) research papers written by college professors.

And, not every country (or business or individual) in the world can “pump up” its economy through fiscal deficits and create more and more and more debt.

Someone has to buy the debt and countries and businesses and individuals will not always be available to run fiscal surpluses so as to acquire this debt for their portfolios.

I know this sounds like heresy, but there ultimately comes a day of reckoning for those that issue excessive amounts of debt. I know that the meaning of the term “excessive” is in the eye of the beholder, but, how the financial markets decide what is “excessive” can be cumulative.

That is why we talk of a “debt deflation” and a “credit inflation.” In periods of “credit inflation” the taking on of risk accelerates during the buildup and leverage increases. In a “debt deflation” people cumulatively reduce their exposure to risk and they also de-leverage at such times.

We cannot “average” the amount of debt across nations and say that all these nations just have an average amount of debt outstanding: if we average the amount of sovereign debt in Greece and in Ireland with the sovereign debt of Germany and the Netherlands we cannot say that these countries combined will then have the “average” amount of debt outstanding.

Rachman provides the example of the current Franco-German relationship: “A senior EU official in Brussels says that this is not the old Franco-German relationship that was built on a basis of equality: ‘Germany needs France to disguise how strong it is. And France needs Germany to disguise how weak it is.’”

But, the people of Germany do not seem to be buying this and Ms. Merkel is in trouble. Because of this she has been taking stronger and stronger positions in the negotiations within the European Union. And, Sarkozy seems to be trailing the far right candidate in the buildup for next year’s presidential election and has, therefore, been more of a supporter of Ms. Merkel.

Within such an environment it seems almost impossible that a unified political settlement could be reached that would ultimately satisfy the bond markets in terms of a bail out financing package for EU countries. This would take a political union that I just don’t see happening in the present state of the world.

Some of the weak, like Ireland and Greece, do not appear to be willing to submit to the strong, Germany, in the ways the strong believes the weak must act. Thus, the bond markets will not be satisfied.

But, there seems to be a section of the voting public that are saying that they should not be paying for the undisciplined way others have acted in the past. This body of voters appears to be gaining ground as the coherence of their message grows and the confidence in their ability to succeed expands.

As I said yesterday, there seems to be only one path out of this dilemma: the sovereign debt of the fiscally troubled nations must be restructured. (See http://seekingalpha.com/article/258172-are-there-any-leaders-in-europe.)

Bring it on!

Where the Action Is

Commercial banks aren’t lending. That we know.

But, there is action elsewhere and, I believe, that this behavior tells us a lot about how the recovery is working itself out…although it is not a recovery like the ones of the recent past.

There is a lot of money in the financial markets…in the shadow banking system…and worldwide.

Where is the action taking place?

Well, for one, in the bond market. We have major companies issuing bonds at ridiculously low interest rates. For example, Microsoft just completed a new bond deal. On September 23, 2010, Microsoft Corp., the world’s biggest software maker, sold $4.75 billion of bonds, “at some of the lowest rates in history for corporate debt.” The offering information stated that “Proceeds may be used to fund working capital, capital expenditures, stock buybacks and acquisitions.”

This follows Microsoft’s “first ever” debt issue which came in May 2009. An analyst noted at the time, “Redmond, Wash.-based Microsoft is sitting on $25 billion in cash, so the company doesn’t need the bond proceeds ‘unless they have something big in mind.’”

And, Microsoft is not the only major company taking advantage of the AAA bond market.

Then there is the “Junk Bond” market. The New York Times trumpets “Junk Bonds Are Back on Top.” (http://www.nytimes.com/2010/10/08/business/08bond.html?scp=1&sq=junk%20bonds%20are%20back%20on%20top&st=cse)

Jim Casey, “one of today’s junk-bond kings” and who runs the junk-bond business at JPMorgan Chase claims that “even those heady days of the 1980s” when Michael Milken ruled Wall Street and who Mr. Casey worked for at Drexel Burnham Lambert, “seem a little tame.”

So far this year, it is reported, that in the first nine months of this year corporations have raised $275 billion in this market worldwide, up from $163 billion in 2009.

“In high-yield, it’s undeniable that these are the best years that anyone has seen in their career.”

Whew!

It is estimated that “about 75 percent of the deals are aimed at refinancing, rather than taking on additional debt.” The risk profile of the companies has gone up!

And, who are big players helping to underwrite these deals? Let’s see, JPMorgan, Bank of American and Merrill Lynch and Citigroup…the top four!

Further action?

Well check out the private equity interests. They are raising capital in the billions. To do what? “Many banks are looking to sell large portfolios of commitments to private equity funds that they made during the credit bubble.” Banks are doing this because these “assets” are underwater and also because new higher capital requirements will make their “ownership” very expensive.

This just points to a whole host of private equity interests moving into the area of distressed assets. And, they are moving in aggressively. We read the article in the New York Times this morning about short-seller David Einhorn, the founder of Greenlight Capital. (See “A Bear Roars”, http://www.nytimes.com/2010/10/14/business/14views.html?ref=todayspaper.) One of the interesting insights relating to the work of Mr. Einhorn is the detail that Greenlight Capital put into its “due diligence” of the target.

The attention being focused on “distressed assets” today is not just a casual thing. Fund managers are aware of the risks they are under taking, just as they are aware of the potential returns that are available. As some have said, they are “taking care.”

One analyst remarked on the condition of the market: “We are seeing a steady river of deals” and “we expect this stream to carry on for some time.”

This is all part of the movement I reported on in “Corporations are Hoarding Cash and Keeping Their Powder Dry,” (http://seekingalpha.com/article/228507-corporations-are-hoarding-cash-and-keeping-their-powder-dry).

There seems to be a tremendous re-structuring of the economy taking place. I now believe that the re-structuring that is going on is beyond the power of the government to reverse. I believe that a similar re-structuring took place in the 1930s and 1940s, a re-structuring that the government, at that time, could not reverse. The 1950s represented the start of a “new era”.

The structure of the industrial base of the United States is dis-located with American industry using only 20% to 25% of its capacity. The structure of the work force is dis-located as 20% to 25% of the age-eligible workers in the United States are under-employed. And, the income/wealth distribution in the United States has become more and more skewed over the past fifty years.

These “dis-locations” will not be resolved by what corporate America seems to be doing now. Large companies, large banks, private equity funds, hedge funds, and other money sources are building up their cash reserves. They are looking, I believe, to buy assets, to buy “distressed companies” and so forth.

Imagine that Microsoft, a company that had never issued any debt in its history, has raised over $8.5 billion in new cash over the past 18 months or so while it is sitting on $25 billion in cash. Can you picture this money going to fund working capital and capital expenditures? I can’t but I can certainly see it going to fund stock “buybacks” (which raises its ability to purchase other companies) and to fund acquisitions.

Actions like this, however, will not result in higher levels of employment or greater investment in capital that would spur the economy along. If anything, a re-structuring, like the one I am writing about will have exactly the opposite effect.

Yet, this may be how the economy goes about recovering!

As I said above, I now believe that the re-structuring that is going on is beyond the power of the government to reverse. If this is true, neither a further quantitative easing on the part of the Federal Reserve System nor additional fiscal stimulus on the part of the federal government will do much in the way of achieving a more rapid economic recovery. If I am correct, the economic re-structuring will take place at its own speed. But, this will require a different response on the part of the government.

The Bubble in the Bond Market

There is an op-ed piece in the Wall Street Journal that I believe everyone should read. It is written by Jeremy Siegel and Jeremy Schwartz and is titled “The Great American Bond Bubble.” (http://professional.wsj.com/article/SB10001424052748704407804575425384002846058.html?mod=WSJ_Opinion_LEADTop&mg=reno-wsj) I believe this article is important enough and should be read even if you don’t exactly agree with the argument, which I don’t.

Siegel and Schwartz contend that the current “bubble” in the bond market is comparable to the bubble that occurred in the United States stock market in the 1990s. The reason for this bubble: “Just as investors were too enthusiastic then about the growth prospects in the economy, many investors today are far too pessimistic.” In effect, they argue, investors are too concerned about the possibility of slow economic growth and price deflation.

In order to make these “bets” investors have moved money from the stock market into the bond market. “The Investment Company Institute reports that from January 2008 through June 2010, outflows from equity funds totaled $232 billion while bond funds have seen a massive $559 billion of inflows.”

My argument is slightly different. The Federal Reserve has held its target interest rate, the Federal Funds rate, in a range from zero percent to 0.25% since December 16, 2008 to the present. The yield on the 10-year constant maturity, United States Treasury issue has ranged over this time from about 4.00% to about 2.75% where it now stands at. The 3-year constant maturity has stayed in the 2.00% to 0.80% range.

Thus, investors could (and can) borrow money at close to zero interest and invest at a substantial spread...and THIS IS A RISK FREE TRANSACTION!

This is called the “carry trade”! Duh!

What about interest rate risk, the risk that interest rates will rise?

Well, the Federal Reserve, in its infinite wisdom, has taken care of that by promising the financial markets that it will maintain its low target interest rate for “an extended time.” Well, the “extended time” has lasted for twenty months so far and given the news coming out of the Open Market Committee meeting last week, it sounds like the “extended time” will last well into 2011.

The carry trade seems like it has a pretty safe bet for “an extended period of time.”

The Fed seems to be accomplishing two things in following such a policy. First, it is helping the Federal Deposit Insurance Corporation, the FDIC, resolve the problem of dealing with a massive amount of insolvent “smaller” banks in an orderly fashion. This work-out still has a long way to go by all accounts.

Second, the Fed is helping the federal government place massive amounts of debt. Never before has so much government debt been placed in the open market. And, given projections that the federal government will have to place $15 trillion or more of its debt in the next ten years, the Fed faces a daunting task of accommodating such a huge supply of Treasury securities.

The Federal Reserve has certainly accomplished some major things in helping the FDIC and the Treasury Department and in doing so has subsidized the large banks, major corporations, and other investment funds who could partake of the “carry trade” opportunities it created. Too bad if you are a smaller organization or don’t have the wealth to partake.

The Fed subsidy is lining the vaults of the large banks, the large corporations, and the large
investment pools. They are awash in cash!

And, we have a bubble in the bond markets!

This is the third financial market bubble in the last 15 years or so: the stock market bubble in the late 1990s; the bubble in the housing market in the 2000s; and now the bond market bubble. All of these are a product of the Federal Reserve.

I don’t disagree with Siegel and Schwartz in terms of the possible consequences of the current bubble.

“Those who are now crowding into bonds and bond funds are courting disaster.”

“Furthermore, the possibility of substantial capital losses on bonds looms large.”

“One hundred times earnings was the tipping point for the tech market a decade ago. We believe that the same is now true for government bonds.” (Siegel and Schwartz contend, for example, that “The interest rate on standard noninflation-adjusted Treasury bonds due in four years has fallen to 1% or 100 times its payout.”)

However, given my argument, these consequent outcomes and the timing of them depends upon the Fed. The “extended time” will end at some point in the future and the Fed will have to let rates rise. When it does there will be a whole bunch of new problems it will have to face.

The Fed seems to be careening from one serious problem to another and appears to be “out-of-control”. (http://seekingalpha.com/article/220224-does-the-fed-even-know-what-it-s-doing-anymore) Over the past 15 years or so, the Fed has created one bubble after another, one problem after another, and now finds itself in an almost untenable position. It has pumped an excessive amount of reserves into the banking system. It is subsidizing the cash pools of large banks, large corporations, and large money interests. It has been overly accommodative to the financing of the debt of the federal government. And, now its risks bankrupting a large number of people, as Siegel and Schwartz suggest, when it ever raises its interest rate target. What next?

The Supply Of and Demand For Loans at Commercial Banks

More and more stories are appearing that exhibit the reasons why the commercial banks below the behemoth size are not seeing their lending growing. And, the evidence appears to be that the slowdown in lending is being affected by the demand for loans from businesses and households as well as by the supply of loans coming from the banking sector.

Yesterday, I touched on the aggregate balance sheet figures published by the Federal Reserve. (See, http://seekingalpha.com/article/165994-commercial-real-estate-lending-problems-hitting-the-smaller-banks.) One can interpret the most current data as showing that the financial difficulties that larger commercial banks have been facing are migrating to the smaller banks and this is affecting bank lending activity.

This morning there were two articles in the New York Times on the front page of the business section that provide additional antidotes and analysis on what the “less-than-huge” commercial banks are facing. The first looks at the situation that some borrowers are facing in attempting to obtain loans from banks. This article, by Peter Goodman, “Clamps on Credit Tighten”, http://www.nytimes.com/2009/10/13/business/smallbusiness/13lending.html?_r=1&ref=business, emphasizes the difficulties small companies are having because they cannot obtain funds from the banking system at this time.

It becomes apparent within the article, however, that the shortfall of lending is not solely coming from the supply side. Raymond Davis, the chief executive of Umpqua Bank, in Portland, Oregon is quoted as saying, “Banks want to lend money. The problem is the effect that the recession is having on us. Some of these businesses are still trying to come out of it. For them to go to a bank, if they are showing weak performance, it is harder to borrow.” The Umpqua Bank is a regional lender.

In other words, businesses know that the banks have tightened their requirements when it comes to lending and they know that their balance sheets and income statements are not up to these new bank standards. Consequently, they are postponing even going to the bank until such time as they are in a position to get a favorable response on a loan application.

These business, of course, are ones that are not in such dire straits that they are desperate for funds and are trying to find any source they can for obtaining the funds that they need. Fortunately for them they can wait out the current state of affairs, at least for the near term. However, this delay means that people don’t get hired and inventories are not purchased and so economic recovery is pushed off longer into the future.

Also, these companies are restructuring in an effort to get their balance sheets in order: “Among small privately held companies, the amount of debt they carry as a portion of their equity has slipped by about 5 percent since 2007” the article reports. “The drop reflects not only how companies have cut their inventories and paid down debt, but also the tightened credit terms they face when they try to borrow.”

The intermediate term problem relates to the cumulative result that if firms can’t borrow, for whatever reason, they can’t conduct their business, they can’t hire people who then don’t have money to spend on things, and the firms can’t make profits to improve their balance sheets. The article contains several narrative stories on how this is playing out in various areas of the country.

Another article in the New York Times, deals with the “pace” of loan losses. See the article by Eric Dash, “Pace Slows on Losses for Banks”, http://www.nytimes.com/2009/10/13/business/economy/13bank.html?ref=business. The gist of the article is that although loan losses at commercial banks “are still expected to stay high through most of next year” the speed at which these losses are accumulating is lessening. Loan losses “haven’t peaked, but outside of mortgages, we are getting close,” according to Scott Hoyt. Again the evidence points to the differences in where the difficulties are coming. Larger banks are currently suffering more from delinquencies and defaults from consumers.

The “Less-than-large” banks are facing rising pressure from problems in the commercial real estate area. “Elbowed out of the credit card business and mortgage lending businesses by their larger rivals, (hundreds of small, community banks) began aggressively financing home construction projects as well as office, hotel, and retail development deals. Many of those borrowers are just starting to default, leading the banks to book giant write-offs and set aside more money to cushion future blows.”

That is, these charge offs are just starting to hit the books!

Some businesses are finding one possible source of funds that they have not tapped to any degree in the past. This is the bond market. As reported by Goodman, “As the financial crisis has largely eased in recent months, big companies have found credit increasingly abundant, with bond issues sharply higher.” This movement to bond financing seems to be occurring in companies that are smaller than big and it seems to be a worldwide phenomena. For information on this latter development see the article in the Financial Times, http://www.ft.com/cms/s/0/0abdb056-b78f-11de-9812-00144feab49a.html. These companies are using funds for the bond markets in ways that they formerly used bank lending for. Plus, they are not faced, in the bond markets, with some of the covenants and restrictions they faced with the banks.

This move by companies to obtain bond financing raises an interesting question. The question is this: What if this movement is part of the overall effort to “securitize” everything? That is, what if almost all funding occurs in “financial markets” and not in financial institutions as it mostly has been done in the past? Maybe this slowdown in bank lending will accelerate this movement to market-based financing. Then maybe the commercial banking industry will shrink as has the thrift industry (see my “Have Thrifts Outlived Their Usefulness”, http://seekingalpha.com/article/164533-have-thrifts-outlived-their-usefulness).

Certainly commercial lending is not the major part of the balance sheet of the commercial banking industry as it once was. Commercial and Industrial Loans at commercial banks, as of September 30, 2009, represent only about 12 percent of the total assets of the banking system. In January of 2000, this number was about 18 percent. In the 1980s, the number was substantially higher. The makeup of commercial banks is changing. Is the current move to greater use of the bond market just one more step along the path to the remaking of the whole financial system?

Just a thought.

Uncertainty: The King of the Market and what to do about it

This is a time that is particularly conducive to impulsive or instinctive behavior. It is a time that behavioral economists love because it proves their case about irrational human behavior. People react and they react on the basis of a gut feeling or a snap judgment.

These researchers tell us that this type of behavior is what has helped the human species survive. However, it is not necessarily the kind of behavior that leads to decisions or actions that are in our best interest when investing. “Relying only on intuition in finance can lead to very bad outcomes, not only for individuals but also for markets.” (This quote comes from David Adler’s new book “Snap Judgment”: see my post that reviews this book, http://seekingalpha.com/article/145660-book-review-snap-judgment-by-david-e-adler.) Yet we humans, individually and collectively continue to perform in this way.

Right now, the concern is whether or not the economy is bottoming out and starting to recover. We get “green shoots” here, but then some other indicator of economic activity comes in worse than expected. Alcoa puts up better than expected loss numbers but retail sales come in lower than expected. Sales of existing homes improve yet we get wind of another wave of subprime mortgage problems. (See “Subprime Returns as Housing Woe,” http://online.wsj.com/article/SB124709571378614945.html#mod=todays_us_money_and_investing.) And, what about the problems in commercial real estate, credit cards, and Alt A mortgages?

Then there is the question about whether or not there should be a second round stimulus bill. Paul Krugman has argued for a long time that the first stimulus bill was not enough. Yesterday Laura Tyson indicated that she thought that there needed to be a second round. Now the debate is all over the place. But, wouldn’t another stimulus bill add more to the government budget deficit going forward? And, there are questions about the possibility that the government has already committed to too much debt.

So the Dow Jones average goes up from 6500 and looks very strong approaching 9000 and then goes into a swoon. The price of crude oil was approaching $40 a barrel in February and then shot up to above $70 but now has returned to the $60 range. The yield on the 10-year treasury issue was nearing 2.00% in December 2008, jumped up to around 3.90% in the middle of June and traded at 3.30% yesterday. An index relating the value of the dollar against major currencies was around 70 in July 2008, popped up to the mid-80s in March 2009 and has since declined to about 77.

When the economic indicators seem strong the price of oil goes up as does the stock market and the price of bonds and the value of the dollar decline. When the economy seems weaker we get just the opposite movements. And, my bet is that it is going to continue this way for a while. So, uncertainty, and hence volatility, rule the marketplace.

This is the short run. Recently, however, I have been writing more upon the long run, what deficits do to long term interest rates and to the value of the dollar. Over the longer run, historically, some patterns repeat themselves over and over again. This, of course, brings to mind the statement made by John Maynard Keynes, “In the long run we are all dead!” Still, we need to take the long run into account.

This is where we need to take heed of what the behavioral economists advise. We, as investors, must not rely on intuition or gut reactions. We must not over react to the environment we now find ourselves in. Research has shown that acting in this way is not necessarily in our best interest.

The research also indicates that investing based on fundamental economic reasoning does work. Therefore, it seems as if now is a time for discipline and hard work. And, it is a time for patience.

But, this does not mean that one needs to totally ignore the short run. It is perhaps impossible to expect that most people will just sit out this stage of the economic cycle and invest their funds in safe, low-yielding assets. So, what kind of strategy might work here? My suggestion is that one needs to segment one’s portfolio, allocating some money to playing in the current market volatility, but allocating a larger share of the funds to potential future fundamental investment choices.

The smaller part of the portfolio can be allocated to playing both sides of various markets. Obviously, getting into the market near a “bottom” would be very profitable, but selling short near a “top” would also work. But, by all means consider any investments here as short term in nature because it is highly likely that the “bottom” may not turn out to be a “bottom” at all. Likewise for a “top.” So, one must be very agile in investing this way. Don’t hang onto losses, but let gains ride. Behavioral finance tells us that people tend to operate in the opposite way hanging onto losses hoping for the best and quickly selling gains to have something to show for their efforts. This is where discipline and focus are crucial.

Furthermore, remember that, on average, the expected returns on trading are zero: and there are still fees that need to be paid. But, using part of your funds in this way keeps you “playing the game” while still keeping the major part of your portfolio available for “value” investing to take advantage of longer run opportunities.

As research has shown, the fundamentals do apply over longer periods of time. Perhaps, however, it is not quite time to commit to some of these “value” propositions. People are worried about the potential inflation that may come about due to the large government budget deficits and the possibility that the Federal Reserve will have to monetize a substantial amount of the debt created. But, there are many people who think that deflation is going to be more of an issue in the near term. Hence, it is perhaps a little premature to put funds into investments that will prosper from a future period of high inflation. This part of the portfolio should be kept safe, but also should be able to be accessed when the time is right to commit to the longer run fundamentals. Research, however, has shown that it is alright to be a little early on these types of investments because the possible returns on such a commitment to fundamentals are substantial enough that being a little early is not harmful.

It is also important that an investor should stay in the areas of the market that they know best. If your skills lend themselves to the technology sector of the stock market then stay there. If your skills are in the government bond market then stay there. If your skills are in the foreign exchange market then stay there. Again, discipline and focus are all important.

Uncertainty is going to remain with us for quite some time in financial markets and commodity markets. The behavioral economists have warned us that this is a dangerous time to act in just an impulsive or instinctive manner. So, if being methodical is not your “cup of tea” then beware for the statistics are not with you. Chasing every “green shoot” or market reaction is not going to produce happy results. Acting in a focused and disciplined way may be very difficult for us to achieve but we need to try. That is what humans have learned they must do in activities like investing in financial or commodity markets.