Trends I'm Watching

Investing in the Shortsightness of Government Officials

Trend: Governments that have focused only on short-term problems are facing some grim realities as neglected long-term problems expand exponentially.

Below are some excerpts from a speech by David Einhorn, President of Greenlight Capital. He describes some of the trends that worry him and the events that got us into this situation. For the first time, he suggests holding gold to protect capital. He is renowned for shorting Lehman Brothers before the financial crisis after uncovering the problems that the ratings agencies ignored.

Link: John Mauldin's Outside the Box - InvestorsInsight.com

Presently, Ben Bernanke and Tim Geithner have become the quintessential short-term decision makers. They explicitly "do whatever it takes" to "solve one problem at a time" and deal with the unintended consequences later. It is too soon for history to evaluate their work, because there hasn't been time for the unintended consequences of the "do whatever it takes" decision-making to materialize.

In the context of the recent economic crisis, a highly motivated and organized banking lobby has demonstrated enormous influence. Bankers advance ideas like, "without banks, we would have no economy." Of course, there was a public interest in protecting the guts of the system, but the ATMs could have continued working, even with forced debt-to-equity conversions that would not have required any public funds. Instead, our leaders responded by handing over hundreds of billions of taxpayer dollars to protect the speculative investments of bank shareholders and creditors. This has been particularly remarkable, considering that most agree that these same banks had an enormous role in creating this mess which has thrown millions out of their homes and jobs.

...Americans understand that the Washington-Wall Street relationship has rewarded the least deserving people and institutions at the expense of the prudent. They don't know the particulars or how to argue against the "without banks, we have no economy" demagogues. So, they fight healthcare reform, where they have enough personal experience to equip them to argue with Congressmen at town hall meetings. As I see it, the revolt over healthcare isn't really about healthcare, but represents a broader upset at Washington. The lack of trust over the inability to deal seriously with the party goers feeds the lack of trust over healthcare.

Can We Survive Unsustainable Budget Deficits for a Decade?

Trend: The budget deficits caused by government overspending are growing larger and more damaging to the US economy, with no solution in sight.

John Mauldin first wrote about the Muddle Through Economy in 2002. In 2007 he wrote that we would indeed get back to a Muddle Through Economy after the end of the coming recession. Last week he expressed concern that the US is taking actions that could indeed "Kill the Goose" of our free-market economy. Now he is questioning how we can muddle through in the face of $1.5 trillion and larger deficits. Excerpts below.

Link: Thoughts from the Frontline - John Mauldin

I am not surprised about the response of the Fed to the current recession and credit crisis, whether it's the large monetization of debt or the low interest rates. Assuming they more or less remove the monetary easing in a reasonable manner, there is nothing that would make me think we do not eventually recover, albeit at a very slow Muddle Through pace, with a jobless recovery that lasts for several years. It will not be pleasant, but we'll survive.

The ECRI Weekly Leading Index Predicts Strong Recovery

Trend: The ECRI Weekly Leading Index predicts that the economy is poised for its strongest recovery in more than 30 years.

John Markman says, "...the ECRI weekly leading index is the only gauge of the economy that I have found to have real usefulness as a forecasting tool. Unlike the linear measures that most indexes use, it uses non-parametric measures to look around the corner and figure out what’s coming."

Excerpts below.

Link: Here's Why the U.S. Rebound Will Be Stronger Than You Think - Jon D. Markman

According to the latest data from the Economic Cycle Research Institute, the economy is poised for its strongest recovery in more than 30 years. The monthly growth rate of its Weekly Leading Index is now sitting at a level that has not been witnessed in at least four decades.

That’s big.

It was early in calling the recession two years ago, and caught a lot of heat; and it was early in calling the recovery early this year, and has caught a lot of heat. ECRI chief Lakshman Achuthan told Reuters that with the WLI at new record highs, “the economic recovery will prove to be far more resilient in coming months than most believe possible.”

Best Performing ETFs for the Past Week

Trend: Direxion Daily Energy Bull 3X Shares (ERX) led the one week performance (+24%). Ultra Silver ProShares (AGQ) and Direxion Daily Financial Bull 3X Shares (FAS) were the second and third best performers, respectively.

The 20 ETFs with the best one week performance through 10/9/2009 tracked by Morningstar are shown below.

Source: MSN Money Exchange Traded Funds (ETFs) Performance Tracker

Name	Ticker	Category	Holdings	Morningstar	Last Price*	1-Wk	4-Wks	13-Wks	YTD	52-Wks	3-Yrs	5-Yrs
Direxion Daily Energy Bull 3X Shares	ERX	Specialty - Natural Resources	holdings		$44.28	24.07	22.97	85.86	14.43	N/A	N/A	N/A
Ultra Silver ProShares	AGQ	Specialty - Precious Metals	holdings		$64.54	20.30	15.62	78.63	104.89	N/A	N/A	N/A
Direxion Daily Financial Bull 3X Shares	FAS	Specialty - Financial	holdings		$86.42	19.76	13.97	122.60	-31.73	N/A	N/A	N/A
Direxion Daily Small Cap Bull 3X Shares	TNA	Small Company	holdings		$47.53	18.18	15.10	105.10	39.94	N/A	N/A	N/A
Direxion Daily Mid Cap Bull 3X Shares	MWJ	Growth	holdings		$101.75	17.89	13.99	105.04	N/A	N/A	N/A	N/A
Ultra FTSE/Xinhua China 25 ProShares	XPP	Pacific Stock	holdings		$73.26	17.55	2.92	30.24	N/A	N/A	N/A	N/A
Direxion Daily Emrg Mkts Bull 3X Shares	EDC	Diversified Emerging Markets	holdings		$145.72	17.19	22.12	99.29	182.39	N/A	N/A	N/A
Rydex 2x S&P Select Sector Energy	REA	Specialty - Natural Resources	holdings		$20.04	17.19	15.18	52.78	24.89	3.44	N/A	N/A
Ultra Basic Materials ProShares	UYM	Specialty - Natural Resources	holdings		$28.91	17.09	13.81	87.40	103.11	21.02	N/A	N/A
Direxion Daily Real Estate Bull 3X Shrs	DRN	Specialty - Real Estate			$125.61	16.48	11.55	N/A	N/A	N/A	N/A	N/A
Ultra Oil & Gas ProShares	DIG	Specialty - Natural Resources	holdings		$34.43	15.54	12.64	48.90	20.24	2.17	N/A	N/A
Direxion Daily Dev Mkts Bull 3X Shrs	DZK	Foreign Stock	holdings		$86.86	14.73	5.39	87.16	51.60	N/A	N/A	N/A
Direxion Daily Large Cap Bull 3X Shares	BGU	Growth	holdings		$53.26	14.37	11.74	80.03	47.71	N/A	N/A	N/A
Rydex 2x S&P Select Sector Financial	RFL	Specialty - Financial	holdings		$14.20	14.24	10.33	79.75	-0.16	-37.66	N/A	N/A
Direxion Daily Technology Bull 3X Shares	TYH	Specialty - Technology	holdings		$143.21	14.21	11.61	81.19	162.56	N/A	N/A	N/A
UltraPro S&P500 ProShares	UPRO	Growth	holdings		$135.10	14.05	11.22	77.52	N/A	N/A	N/A	N/A
PowerShares DB Base Metals Dble Long ETN	BDD	Specialty - Natural Resources			$12.42	13.94	1.07	55.64	130.85	-3.12	N/A	N/A
Market Vectors Russia ETF	RSX	Foreign Stock	holdings		$30.25	13.08	20.52	61.42	131.45	91.81	N/A	N/A
Market Vectors Gold Miners ETF	GDX	Specialty - Precious Metals	holdings		$48.29	12.93	9.45	36.76	42.53	59.64	13.01	N/A
PowerShares Global Gold & Prec Metals	PSAU	Specialty - Precious Metals	holdings		$37.88	12.86	6.69	37.05	44.12	62.55	N/A	N/A

Disclosure: We may own any EFT above at any time.

Please verify the performance of any ETF before investing,

The Budget Deficit Tipping Point

Trend: According to the Congressional Budget Office, in FY 2009 40% of federal government spending was funded by debt, compared to 15% in 2008 and 6% in 2007.

Michael Panzner calls our attention to a disturbing benchmark. Let's hope that the US government can lower the budget deficit before the consequences undermine the financial system in this country. Excerpts below.

Link: Financial Armageddon: The Real Threat to Future Economic Stability.

According to research highlighted by Hayman Advisors in their October Letter, the fact that such a sizeable share of government spending is being financed with borrowed money has, historically at least, been a harbinger of trouble ahead:

There have been 28 episodes of hyperinflation of national economies in the 20th century, with 20 occurring after 1980. Peter Bernholz (Professor Emeritus of Economics in the Center for Economics and Business (WWZ) at the University of Basel, Switzerland) has spent his career examining the intertwined worlds of politics and economics with special attention given to money. In his most recent book, Monetary Regimes and Inflation: History, Economic and Political Relationships, Bernholz analyzes the 12 largest episodes of hyperinflations - all of which were caused by financing huge public budget deficits through money creation. His conclusion: the tipping point for hyperinflation occurs when the government's deficit exceed 40% of its expenditures.

Are Actively Managed ETFs a Good Investment?

Trend: ETFs are taking investors and funds from the mutual fund industry; the mutual fund industry is retaliating with actively managed ETFs.

Teeka Tiwari at The Tycoon Report sees managed ETFs as an attempt by the declining mutual fund industry to create stock-picking ETFs that are managed by their fund managers.

Link: The Tycoon Report - Teeka Tiwari - Sector ETFs: Still the Most-Profitable Way to Invest.

A recent article in The Wall Street Journal sang the praises of "managed" Exchange-Traded Funds (ETFs).

Don't be fooled by these "new" financial products. They are just old-fashioned mutual funds disguised as ETFs.

You see, the mutual fund boys have been hemorrhaging cash, as the ETF market has exploded in popularity. ETFs have just a fraction of the cost of a mutual fund and are infinitely more flexible.You can sell an ETF short, and you can also buy or sell options against it. Additionally, ETFs have immediate liquidity and utter transparency.

Currency Devaluation and Gold

Trend: Currency devaluation – the falling dollar – is a primary reason that gold is attracting smart money.

Alice Schroeder at Bloomberg.com describes why gold is a good investment before financial crises. Excerpts below.

Link: Gold Tells You U.S. Bubble Hasn’t Popped Yet: Alice Schroeder - Bloomberg.com

...the relationship between gold and financial crises goes back centuries. In the aftermath of the credit-bubble bust, we confront a Moby Dick-size pile of leverage and the question of whether this is inflationary or deflationary. So it’s worth considering what the price of gold may be telling us.

Leverage is a broad term that covers the complete history of finance, which all boils down essentially to the same structure: debt secured by assets. You give me a cow, I give you a piece of paper. Later innovations are simply variations of obligations secured by assets.

So a simple explanation of bubbles is that they form whenever someone creates a rationale to increase obligations too far beyond the level justified by the assets, regardless of the form of the asset or obligation.