Monday, April 21, 2014

A New SAT Question


From the L.A. Times this weekend; "Student Debt Holds Back Many Would Be Home Buyers"

Sarah Luna wants to buy a home in up-and-coming northeast Los Angeles before it's too late.
At 31, she has a master's degree and earns more than $70,000 as a court reporter and freelance editor. She daydreams about trading the Glendale apartment she shares for a little condo, maybe in Echo Park or Highland Park.

Just one thing holds her back: The $700 she's paid every month since 2008, after she graduated from the University of Southern California — with $75,000 in student debt. With about half that total left to pay, buying that condo seems a long way off.

"Honestly, I don't know if it'll ever happen," she said. "Barring some sort of awesome miracle, a down payment is hard to wrap my head around right now."

Of the many factors holding back young home buyers — rising prices, tougher lending standards, a still-shaky job market — none looms larger than the recent explosion of college debt.

The amount owed on student loans has tripled in a decade, to nearly $1.1 trillion, according to the Federal Reserve Bank of New York. People in their 20s and 30s — often the best-educated and highest-earning among them — owe most of that tab. That is keeping a crucial segment of home buyers on the sidelines, deferring one of the traditional markers of adult success.

It is fairly common sense. If students borrow $1.1 trillion to get through school today, that is $1.1 trillion (plus interest) less that they have in the future to purchase a home, invest, buy goods or start a business.

The unlimited money offered by the U.S. government to cover tuition, housing, books, food and "other expenses" (clothes, alcohol, phones, etc.), has been a short term back door boost to the economy that will have lasting negative impacts for years to come.

Will Japan's Pension Fund Rescue The Japanese Stock Market?

Thursday, April 17, 2014

Tectonic Shifts Under The Surface Of The International Monetary System

There was a major headline earlier this week from the Wall Street Journal, which has mostly gone unnoticed as the masses focus on earnings for overpriced U.S. stocks. It read:

"IMF Members Weigh Options To Sidestep U.S. Congress On Overhaul"

The IMF is the central bank that backstops all other central banks around the world. The United States currently has the majority voting rights within the IMF and most importantly they have the ability to veto any decision made (which no other country currently has).

A movement has begun within the growing powers of the emerging markets to increase their voting share and remove the U.S. veto ability. The United States, of course, is dragging their feet on moving forward with this proposal. The emerging nations are becoming upset with the U.S. political gridlock, and they are now moving forward to create their own IMF subset to handle future global issues.


The importance of these tectonic shifts on the future cannot be overstated. It would take an entire book to explain the significance of the IMF, how it will used during the next crisis and what will unfold following that period. Fortunately, that book has already been written and it was released earlier this month titled "The Death Of Money" by Jim Rickards. It is the absolute must read book of this year if you want to understand how the future will unfold.

The next crisis will be completely different from what we experienced in 2008 because the sovereign central banks have already destroyed their balance sheets. The IMF (International Monetary Fund) and the SDR (Special Drawing Right) currency they issue will soon become household names.

The following is an interview with Jim Rickards on some of the topics within his new book. If you would like to download the interview in mp3 format you can do so here.



Global Tax Rates Today & In The Future

Global tax rates are currently set at an artificially low level because thus far in the sovereign debt crisis governments have had the ability to borrow unlimited amounts of money to offset any size budget deficit. The secret to this? Central Banks have promised to purchase an unlimited amount of bonds in every major developed country to keep bond yields low.

This will change during the next phase of the sovereign debt crisis, most likely beginning with Japan as the world watches what happens when a central bank loses control.

When people connect the dots and extrapolate forward how Japan's disaster will unfold in their own country (see the United States, U.K. and members of the European Union), they will begin to look for better locations to earn their living, raise their children or grow their business. Government balance sheets will become an important part of that decision because they will allow people to forecast the potential loss of future wealth through currency devaluation or taxation (most likely both).

The U.S. is experiencing this on a state and local level as individuals and businesses in former bubble real estate markets (California, New Jersey, Florida) are now fleeing their area and heading for the excellent business climate found in Texas. Meredith Whitney's book Fate Of The States described how and why this process will unfold over the next decade. This movement will soon become a global phenomenon.

Taxes Around the World
Source: Online-Accounting-Degrees.net

Wednesday, April 16, 2014

Kyle Bass On Japan's Higher Inflation & Low Bond Yields



For more on Japan see: Japan Is A Powder Keg In Search Of A Match


Daring To Be Great

Sometimes I come across articles in the finance and business world that cause me to think about how they apply to my own personal life. I decided to share some of those thoughts here today after reading Howard Marks' most recent investment letter "Dare To Be Great: Part Two," which was a follow up to the original article he wrote back in 2006. It may be helpful to read the memo before reading the thoughts it triggered regarding my life.

The thought process behind "daring to be great" is an excellent way to sum up the investment world. If you invest in index and mutual finds that track the general market you will find yourself in the general herd that is on auto-pilot. Sometimes that is great (such as being heavily weighted in U.S. stock funds during 2012 through 2013). Over half my readers live outside the United States so it is probably unlikely they would find themselves in that category. The U.S. herd just happened to be in the right place at the right time (similar to the late 1990's). 

The same goes on the downside. When the markets crashed in 2008 it impacted almost everyone, even the rich. I have discussed this in the past, but studies show that this loss of wealth was easier for Americans to endure knowing that everyone around them was also in pain. The human mind is a herding machine, constantly looking to enter into or stay within a flock. While you could write a book extrapolating what that means for markets, in short, it is a large part of the reason behind the current boom and bust cycle markets have entered since about 1995. 

The idea of "daring to be great" can extend beyond the world of investing as well. The general herding system currently in place around the world goes something like this; go to school and get a good job with benefits. That sums it up. I don't mean for the word "herd" to be seen in a negative context. I will discuss in a moment why it is usually the healthiest and happiest place to exist.

I would describe my day to day business life as existing outside of the herd. My business time is focused on two relatively simple goals that when actually put in motion become more complex:

Goal 1. Become a better entrepreneur. Develop the skills needed to build a strong business.

Why?  I believe that sometimes in life there are rewards for moving in the opposite direction of everyone else. With 99% of people looking for jobs instead of starting their own companies, I believe the government will continue to provide incentives to business owners who create jobs in the future (specifically tax incentives). 

There are many additional reasons, including the ability to grow wealth exponentially vs. the potential ceiling involved with working for a company. I believe this will become more visibly relevant in the future as people realize they are battling central banks that are removing purchasing power from under their feet. 

I also enjoy the freedom to make my own hours vs. being told to work X:00 to X:00 no matter the circumstance. I usually work about 10 hours a day so it is not that I am lazy, I just want the ability to go for a run in the afternoon if I need a break. This keeps me at the highest state of productivity. I also like the ability to turn off in the afternoon if I've already put in a 12 hour day (I usually get started around 4:00 AM, including weekends). 

How am I working toward accomplishing goal number 1? I started my own company three years ago (a company I will discuss in detail in the future). As with everything in life, the best way to learn something is by doing it. See the learning pyramid below. The only better way is to teach someone. This cone is a large part of the reason I created this site (see "teach others" at the bottom). I probably take in over a hundred hours worth of information on the financial markets every month through audio and reading, and I found that by putting my thoughts down on this website it allowed me to retain the information at an exponentially greater level.


Goal 2. Become a better commercial real estate investor. Develop the skills needed to locate undervalued properties, obtain financing and successfully manage them. 

Why? I believe that at some point during the next 15 years we will experience another major real estate price decline, which will represent the greatest buying opportunity of our lifetimes. This will not only occur in the United States, but in major cities and countries around the world.

Real estate provides investors with leverage, tax incentives and control. It is the most difficult investment to master (stocks, bonds, commodities and currencies have little management), but the rewards are the greatest, by far. 

How I am working to accomplish goal number 2? I spent two years managing a large commercial real estate property. I spent over a year at one of the largest commercial real estate finance companies in the world to become fluent in that spectrum. I am currently working and learning in the acquisition part of the industry. As with the goal number 1, I am learning by doing. 

In Howard Marks' letter below he includes a quadrant with four possible outcomes. On the left side you have conventional behavior where the two possible outcomes are "average good results" and "average bad results." As discussed above, it makes people far more comfortable psychologically to exist within this sphere.

On the right side of the quadrant you have unconventional behavior where the two possible outcomes are "above average results" or "below average results." As Marks describes:

For years I’ve posed the following riddle: Suppose I hire you as a portfolio manager and we agree you will get no compensation next year if your return is in the bottom nine deciles of the investor universe but $10 million if you’re in the top decile. What’s the first thing you have to do – the absolute prerequisite – in order to have a chance at the big money? No one has ever answered it right.
The answer may not be obvious, but it’s imperative: you have to assemble a portfolio that’s different from those held by most other investors. If your portfolio looks like everyone else’s, you may do well, or you may do poorly, but you can’t do different. And being different is absolutely essential if you want a chance at being superior.

Sounds easy right? Just living your life on the right side of the quadrant provides you the opportunity for exceptional returns both in finance and in your business life. However, there are consequences to living this way, both in investing and working, which are just as important to discuss.

Below average returns means you may watch the stock market run away from you if you made what was the fundamentally correct choice by not participating in an overvalued market. This example is easy to demonstrate because it occurred with anyone who watched the U.S. stock market from the sidelines over the last two years. Those non-herd people then attended dinner parties where everyone discussed how magnificent their 401k's were performing. 

On the business side, if you spend 5 years building your own business and the business fails, not only have you lost the capital you put into the business, you have lost the capital you could have earned working at a company earning safe money. This is equally devastating to handle. 

Another drawback or warning I would give to someone who is thinking about moving outside the herd is that it is difficult to turn it off. When most people leave a job at 5:00 they are mentally finished working for the day.

My business/investing mind never turns off. When I finish working 12 hour days I often move on to a book on global finance. When I'm not working, my mind is thinking about ways to grow my business, the loan package for a 400 unit apartment community in Nashville, or how the yen is trading after hours. This is not easy for my wife, and it's a constant battle to try and turn off and be a somewhat normal person.

Why am I telling you all this?

If you are thinking about going out on a limb and leaving the herd in either your portfolio or business life, make sure you understand both the upside and downside to doing so. I would not change my lifestyle for anything in the world, and I am fortunate that I have an amazing wife who can put up with me. However, there are times when I look at my more normal friends and wish I could exist in their mindset for a week.

Mark Cuban describes the business and investing world as a 24 hour, 7 day a week sports arena which never turns off. I couldn't agree more. Unlike normal sports, the business world does not expire at a certain age. I completely understand why 75 year old multi-millionaires put in longer hours than 25 year old employees. It becomes a drug. You probably noticed that my goals above do not have a finishing point. That is because I hope to be just as excited about becoming a better entrepreneur and real estate investor when I am 70 as I am today (and writing about it here).

That being said, here is Howard Marks' perspective on "daring to be great." 

Sunday, April 13, 2014

Welcome To The Euphoria Stage Of The Junk Bond Bubble

The year 2013 tallied the largest issuance of junk bonds in history. It was the highest in gross issuance and the highest in percentage terms of all corporate debt issued. The average yield on junk bonds was the lowest in history (meaning investors paid the highest price for these bonds in history).

What has changed in 2014? Nothing. People love junk debt. Are junk bonds now the largest bubble in the United States? (this position was formally held by bitcoins; see Bitcoin Crashes 70% In Four Months)

The only thing more ridiculous than purchasing junk bonds (bonds that have a very high likelihood of defaulting) at very low rates of return, would be to remove the requirements of borrowers around actually pay the money back. Do they create junk bonds like this? Yes, they are called covenant lite bonds. Here is the definition from investopedia:

"A type of loan whereby financing is given with limited restrictions on the debt-service capabilities of the borrower. The issuance of covenant-lite loans means that debt is being issued, both personally and commercially, to borrowers with less restrictions on collateral, payment terms, and level of income."

Obviously this can only be a tiny sliver of the bond market because no one could be duped into buying such a bond after watching homeowners walk away from trillions of dollars worth of mortgage debt after it went bad. Right?

Unfortunately, wrong.

The chart below shows that covenant lite bonds now make up 50% of  bond issuance, making the 2007 toxic debt binge look mild in comparison.

So what happens when interest rates rise? Buckle up.

The Flash Boys Encore: Charlie Rose Interviews Michael Lewis

It's been two weeks of non-stop high frequency trading talk since the release of Michael Lewis' Flash Boys. I will continue to discuss the topic of high frequency trading moving forward, but the interview below will be the encore for the Flash Boys discussion here on this site. For those that missed the earlier Lewis pieces see:

60 Minutes: How The Stock Market Is Rigged
High Frequency Trading Conversation Goes Mainstream
More Discussion On High Frequency Trading



And as a reminder....The Best Book Released This Month Was Not Flash Boys

Six Years Into The U.S. Depression & The Echoes Of The 1930's

John Maynard Keynes defined a depression as "a chronic condition of sub-normal activity for a considerable period without any marked tendency either towards recovery or towards complete collapse."

People associate the period during the 1930's as a ten year "complete collapse" but the majority of the decline occurred during the initial 1929-1930 phase. The ten year period that followed was best described by Keynes' definition above.

Depressions tend to occur every 75 years throughout history, and the U.S. entered the most recent depression in December of 2007. We are now over six years in. There are differences between the 1930's depression and today's, the most obvious being the monetary policy response used by the Federal Reserve. In the 1930's the U.S. experienced severe deflation, where today the Fed has managed to keep inflation alive with over $3.5 trillion printed so far.

In the 1930's deflation stocks, bonds, real estate and wages all declined simultaneously. Banks failed and debtors had a more difficult time paying back debt.

On the opposite side of the coin, deflation provided a benefit to savers. The cost of living fell precipitously, which means if a wage earner experienced a reduction in their salary, their cost of living fell in tandem.

Governments hate deflation for many reasons, but one reason is that a decline in the cost of living is a raise to every person living in that country that cannot be taxed. What does that mean? If a person's salary increases by $5,000 in a year the government may take 40% of that raise through taxes. If the cost of living falls by $5,000 in a year the citizen keeps 100% of that benefit.

Those that saved their money instead of speculating in the bubblicious stock market of the late 1920's saw that they now received a far higher return on their savings when interest rates rose after the crash.


Unemployment during the 1930's reached a high water mark of 25% before slowly working its way lower through the remaining portion of the decade.

Calculating unemployment using the same methodology today shows that it crossed 20% after the current depression began in 2008 and has moved steadily higher since (blue line below).


The majority of U.S. jobs created since 2009 have been in the lower paying or temp job category.


Many stocks in the U.S. fell by over 80% from their 1929 peak to the low in 1932. They then rallied over 420% into 1937 before rolling over again. Most forget that one of the greatest cyclical rallies in stock market history occurred during a depression. 


Many stocks in the U.S. fell by over 50% from late 2007 into the 2009 low. They have since rallied over 170% into 2014.


Coming off a GDP decline in 2008, GDP growth has been anemic (reaching a high of 4 percent in the fourth quarter of 2009 and moving range bound around 1 to 2 percent since). GDP is not contracting, but it has been in "a chronic condition of sub-normal growth for a considerable period," as Keynes defined a depression in the quote above.

Why are we still lingering in a zombie-like state five years into this cyclical recovery? It is due to the actions taken since 2008 to "save the world." Removal of bank's mark to market accounting, the nationalization of the housing market, the new government induced student loan bubble (choking off potential growth of the younger generation drowning in debt), massive government spending programs and endless injections of the the QE monetary heroine are just a few of the toxic programs that have not allowed the system to cleanse.

If U.S. leaders had allowed the economy to enter into a much deeper and protracted downtown (cleanse) in 2009 and 2010, the country would be experiencing far higher levels of real growth today from a much stronger foundation. Cleansing would have involved allowing bank stocks to be wiped out, bond holders to take a hit, toxic loans nationalized and then sold off as they were during the 1990's savings a long crisis.

There is no need to go on and on about what should have happened because it didn't happen. However, knowing what should have happened will be important in understanding why the U.S. economy, which is a house of cards built on quicksand, will collapse again.

A recession is a cyclical decline, meaning that monetary stimulus and government spending have the ability to bring the economy back to life. Hypothetically, you can then tighten monetary and reduce the deficits during the next period of growth (this is the Keynesian textbook play).

A depression is a structural decline, meaning that monetary stimulus and government spending only add a layer of poison to a cancer that needs be cleansed. There are no economists today that have models going back to the last depression so they are continuously confused why their tools have only make the problem worse.

The next collapse will be larger than the last, and it will come at a time when the world economy around the United States is far weaker than it was when the depression began in late 2007. In the United States we have a stock bubble, bond bubble and a real estate bubble in some sectors of the market (farmland, apartments, bigger city office and retail, some residential markets). It will be interesting to see how the Federal Reserve handles the next decline when its chips are now already "all-in" the pot.

85 Percent Of Pension Plans Projected To Fail

The massive and incredibly successful hedge fund Bridgewater Associates have completed a stress test on U.S. pensions. They determined most pensions are likely to receive an average return of 4% (or below) return on their assets moving forward. This return would bring 85% of pensions to failure, which would be troublesome for the large percentage of Americans that are counting on this income to get them through retirement.

Instead of trying to cut current payouts (which would mean taking on unions) or raise income (raise taxes), pension plans have decided to go with the most illogical path available; allocating their assets toward higher yield (higher risk) investments. They are moving heavily into stocks and real estate, joining the herd rushing to "reach for yield."

It is important to remember that this study took place after a five year artificial reflation of paper asset prices, which are all on the precipice of the next major decline. Following the next collapse the number of pensions projected to fail should be closer to 100%.