From the Ash's

After a volatile month, it seems that everything's cooled down both in the oil sector and in the Middle East (aka, the oil sector), and Wall Street's psyched.  But hang on to your hats, boys and girls, because the rollercoaster ride is not over yet.  In fact, it's just starting.

Let's look at why our market fundamentals are indicating that this trend in volatility and increased oil prices isn't going away any time soon.

1. A loose Federal fiscal policy for the last two presidents (~14 years) means that our government debt has gone nowhere but up - financed not by the U.S. but rather by foreign central banks.
2. Investment in hedge funds and private equity has more than tripled in the past five years.
3. Investment in energy commodities, especially oil, has more than tripled in the past three years.
4. The ratio of P/E ratios between large and small-cap stocks in the S&P 500 is way off its mean and approaching an all-time, 30-year low (which correlates with negative future returns in the S&P 500).
5. The index of CEO performance expectations is below 0.50, contrasted to record profit margins across most of the U.S. market.

That's quite a laundry-list of items there... so, you might ask, what does it all mean?  Simply put: a high risk of stagflation!  But Ash, didn't we kick that back before you were born when Reagan and Volker threw out Keynesian economics?

NO!!!  We've been falling back into New Keynesian economics since the early '90s.  It seems that the allure of the "tools" offered by Keynesian economics, like the IS-LM model, were too much for economists to pass up, so they "reconciled" them with the monetarism that has proven so right in the last 25 years.  No wonder I dropped Macroeconomics...

New Keynesianism is just as wrong as Keynesianism was in the last century.  It proves great for a while - the Go-Go 60s or late 90s - but it doesn't last, and we're about to see that again.  Mid-East violence is resurgent, and the world's oil supply is stretched more thinly than it was in the 70s thanks to added consumption, not only in the U.S., but in Eastern Europe, India, and (the 800-pound Panda) China.  That means that smaller shocks have bigger ramifications in the world market.

Those shocks have been exacerbated by the entry of large quantities of hedge fund and private equity capital in these markets.  Thanks to a loose fiscal policy and too much money in the market, this extra capital has driven prices up beyond anything that OPEC or anyone else can control.  And despite what most of Wall Street currently believes, this capital is not a result of unparalleled prosperity... IT'S A RESULT OF POOR FISCAL DISCIPLINE!!!

That's a harbinger of inflation... in point of fact, it's the textbook definition of it: Too much money chasing too few goods.  The markets just haven't put two and two together yet.  Why?  Simply put, inflation is the hardest thing to get right.  People don't believe predictions about shifts in inflation until they perceive shifts in inflation (thanks Dad for that epiphany!).  That means that they don't expect it until too late.

So why am I so bearish if I'm not suppose to be believing in inflation yet?  Simple: I don't have a lot of money, and I remember just 6 years ago when gas in San Francisco, California - the most expensive region for gas in the country - was only $1.75.  I don't think you can tell me that the price of gasoline doubling in only 6 years is not going to create added inflationary pressure in the economy, especially not when the price of crude oil has not just doubled but tripled in that time.

What this means for the economy is a lot of pain.  We haven't been taking our medicine, we've been driving big cars, running up astronomical debt on our houses (according to The Economist, the housing bubble, as a percent of GDP, is half-again the size of the dot-com bubble), and purchasing everything in sight... all while that nasty cancer has been growing under the surface.

It's okay... that's just human nature.  However, it's coming time for the Chemo to start.  We might lose our hair for a while, maybe we'll pull it out, maybe it'll fall off, but it'll grow back eventually.  The question is now not if, but how long?  And that, my friends, nobody knows.

Posted by ash.dyer at 08:19 AM | Permalink | Comments (0) | TrackBacks (0)

Recently, my father sent me a Wall Street Journal article that I had been staunchly avoiding.  Feeling bad about deleting it outright, I briefly skimmed it before sending him a verbose reply explaining my rational for avoiding the piece.  In fact, my actions are likely to shock both my father and many of my friends.  I am an avid Journal reader and consume about as much information about personal finance as I possibly can.  Why then would I refuse to read a Journal article about personal finance?

The answer is simple: BECAUSE IT'S SO WRONG!

That's right.  Even the Journal's authors can be quite wrong when it comes to topics that they know little about.  They just fall into the same trap that most other media outlets fall into... annointing their columnists as so-called "experts" when they really have no business talking about that subject.

Take, for example, this author's comment that one should not begin "seriously saving for retirement" until after age 30.  They couldn't be more wrong.  Analysis has shown that someone who puts away a fixed amount every year from 20 to 30 and stops will have almost twice as much in the bank at 65 than someone who puts away the same fixed amount from 30 until 65.  That's the power of compound interest!

Good financial advice will tell you that.  In fact, it's one of many questions I use to triage whether or not somebody knows they're stuff about finance.

Here's another question: when are student loans good?  The answer is two-fold: 1) when you need them to finish school, and 2) when you can make a rate of return from investment that is significantly higher than your interest payments.  Student loans are somewhat unique because they tend to have more generous terms than most other loans, including lower interest rates.  That in turn makes it possible to use money from student loans for investments in securities, which enables you to reap the difference between the two rates (rate of return and interest rate).  The caveat: don't try this unless you know how to invest... you're taking on extra risk so you need to be confident that you're not going to actually lose the money (although, better to do it in your 20s than when you have a family to care for).

The first thing that you need to ask when you're getting financial advice, is whose advice are you getting?  In other words, why is this person qualified to give you advice?

Let's break it down: what types of professionals are qualified to offer advice?  Bankers?  Financial Advisors?  Columnists?  Economists?  Successful Businesspeople?  Successful Investors?

The correct answer is only the last two - successful businesspeople and successful investors.  People like Robert Kiyosaki and Warren Buffet, who have whethered all sorts of financial changes and crises, and made hundreds of millions or even billions over decades.  If you're not willing to go that course, than financial advisors may be right for you... they know what they're doing in terms of savings and helping you meet modest goals.  They won't generate millionaire returns, but they'll give your kids a college education and you a comfortable retirement.

So if you're keen to start getting advice from the right people, or at least test the water, what should you do?  First, take the advice of one of my best friend's fathers, a man whose made many millions in his lifetime, run down to your local bookstore, and buy yourself a copy of Rich Dad, Poor Dad by Robert Kiyosaki.

Now, I've noticed a lot of people have read this book without really reading it.  So, what I want you to do is read it once kind of quickly.  Then, pull out a pen, pencil, or highlighter and read it again slowly, chapter by chapter.  Highlight or underline key points and make notes in the margins.  Never read more than a chapter in a day, and if you want extra credit keep notes on a notepad.  Get a couple of your friends who share your interest to do this with you and discuss it regularly.  This method of studying will help you internalize those lessons.

When you're done, go out and buy another book from a real expert and start scouring the Internet for articles from real experts.  They're out there.  Robert Kiyosaki writes a column for Yahoo!Finance, Warren Buffet has produced a number of books, some successful mutual fund directors, like the Hussman Funds, regularly publish columns about investing on their websites.

The information's there.  GO GET IT!!!  And remember to always ask yourself: is this person really qualified to give me advice?

Posted by ash.dyer at 07:46 AM | Permalink | Comments (0) | TrackBacks (0)

As congress departs for its summer recess, one of the most prominent bills left on the table is the permanent change to the "estate tax".  Why is this such a contentious bill, and, more importantly, why are Republicans so wrong on this one?

Estate tax has evolved greatly since its inception in 1916.  However, right now it still retains its initial purpose: reducing the income divide between America's younger generations to prevent the emergence of entrenched socioeconomic classes that Europe has been plagued with for millenia.  To this end, the tax has been reasonably effective: America has the highest rate of transitions between socioeconomic classes of all developed nations.

On the other hand, as we have seen with the Rockefellers, Carnegies, Kennedys, Bushs, and the like, there is a growing entrenchment of an American upper class.  The Republicans current efforts to reduce and repeal the estate tax serve simply to increase this entrenchment - not to help the economy or any other purpose (look at Europe's stagnation!)

What's the difference?  By taxing estates valued at over one million dollars (fluctuating wildly over the next five years), we reduce the amount of money that upper middle and upper classes can inherit without negatively impacting the transfer of monies between generations of the lower, lower middle, and middle classes - as in, protecting the American Dream.  That means that we promote a meritocracy because each generation has to work anew to reach high socioeconomic stratum.

That's not to say that those children whose parents are already in high socioeconomic stratum will be even with those whose parents are not.  Quite the contrary, they have access to the education and networks critical to rapid success.  However, what it does mean is that these children must still work extremely hard to enjoy the same success as their parents because they are thrown into competition with more of their peers from other socioeconomic backgrounds.  This competition is particularly evident in schools - the profusion of scholarships in elite private high schools and universities, as well as the judicious use of standardized tests and the notorious "tell us how poor and disadvantaged you are" essay questions means that the students accepted to these institutions are rated on their merit as well as their parents' wealth.

What do merit and competition mean for society?  EVERYTHING!  Economies grow through competition, hard work, and the pursuit of riches.  While everyone laments the overinvestment in dot-com companies, the fallout is not as bad as everyone believes - in less than a decade, more well more than a decade's research and development was achieved and the productivity gains resulting from it will continue to propel the global economy for decades.

The evidence is all around us.  The 40 hour work week exists only for a very small portion of the population.  For example, I'm penning this essay on Sunday.  With many companies establishing offices across the globe, it is not uncommon for people to come into the office at odd hours of the morning or night to participate in teleconferences.  Work on most projects runs around the clock as offices pass off projects to each other based on their timezones.  The proliferation of modern communications tools means that people bring their work home, and continue it on the road as well.

This means that Americans must work both harder and smarter in order to maintain our preeminence in the global workplace.  In the face of more competition abroad, we must also make efforts to step up competition at home.  Thomas Jefferson is famous for saying "The tree of liberty must be refreshed from time to time with the blood of patriots and tyrants."  The truth of this saying has never faltered.  However, another, parallel, statement has emerged to be just as truthful: The tree of economic growth must be refreshed from time to time with the blood of the meritorious and the wealthy.

So what's the fallout from all of this?  Well, as part of a broader effort this alteration to the tax code risks killing something all (or almost all) Americans believe in: The American Dream.

Posted by ash.dyer at 01:00 PM | Permalink | Comments (0) | TrackBacks (0)

There is no doubt in my mind that we're entering a new energy market, and that our experience in the last oil shock in the 1970s does not apply to the new rise in energy prices.  This fact stems from the rapidly increasing demand in places like India and China - a demand that oil production cannot hope to meet with current energy prices - that did not exist in the 1970s.  This knowledge has led a lot of people, particularly investors, to seek opportunities in renewable energy technologies.  However, most of these are doomed to failure for the same reasons they were the first time, and - as noted by my friend Kurt Keville - it is important to realize that most of the old players from the 1970s renewable energy field have decided to pass on this opportunity.  If nothing else, that should tell you something.

Ethanol is the darling-child of renewable energy buffs everywhere.  However, it has a long way to go before it will ever be a serious force in the marketplace.  Here are some reasons why:

• Distribution of oil moves in a river-delta format - it starts with a fat pipe at an oil field, moves down the pipeline to a refinery, the refinery pipes to a distributor which then sends it down the tendrils to all of the gas stations... only at the end do the logistics leave serious arteries.  Bio fuel must first aggregate from a number of small sources then disseminate, roughly doubling the logistics involved.
• Ethanol is significantly more corrosive than gasoline, which means it is ill-suited for use in normal vehicles, even as more than a 10% additive.  Aside from the corrosion, when it's concentration in fuel is greater than 10%, toxic fumes from the ethanol will seep from the fuel system of most cars.
• Modern, non-flex-fuel cars are optimized for gasoline consumption.  Switching the fuel will significantly degrade both the performance and the fuel efficiency (not including ethanol's reduced power-per-gallon in the next point) of those vehicles.
• Ethanol has significantly less power-per-gallon, which means that you have to burn more of it to get the same performance - even in the best of conditions.  It also means that a full tank won't get you as far down the road, so there have to be more fueling stations and it will take more of people's (already dwindling) time.  Hybrid technologies may find a huge opportunity in improving the performance of ethanol vehicles, but this application is likely close to a decade away.
• There is a chicken and egg problem inherent in this industry.  In essence, the petroleum companies are asking the question: "If we build it, will they come?".  Note, this isn't the case for American car manufacturers because there has been a long standing tax break to encourage them to produce "flex-fuel" cars, which is a hold-over from the fallout of the oil shocks of the 1970s.
• There is not enough production capacity, nor even potential production capacity (ie. all arable land), in the world to produce the corn crops necessary to shift all vehicles to ethanol and other biofuels.  Hence, the "ethanol economy" is inherently a non-starter.
• Many non-vehicle technologies, such as plastics and fertilizers, require petroleum for production.  Ethanol won't be able to replace petroleum in fulfilling the needs of these industries.

These seven reasons are just some of the top ones for why ethanol is a non-starter.  However, other darling-children of the renewable energy crowd are also doomed to a supporting role.  Solar power, which relies heavily on metals and silicon for the production of solar panels (not to mention, extremely toxic chemicals), has too low a power density to replace lots of energy generation systems.  Also, throw in the fact that you have to extract the silicon and metals needed for its production from mines, which requires petroleum. 

Likewise, wind power has a limited role, since the average windspeeds required for consistent power production make only a small percentage of available land well-suited to wind production.  Used in concert, all of these technologies will help ease the stress on current energy supplies; however, they're not going to solve the issue.  Ever.

So where does the path lie?  Well, in the short term it's simple: conservation.  There is incredible inefficiency everywhere in the world, borne of oversupply of power for so many years.  That means that we can reap a lot of value out of getting better at keeping what we have.

What else?  This is going to make me pretty unpopular: nuclear.  There are new nuclear technologies, pioneered in part by my alma mater, MIT, that are completely safe and very efficient.  Such technologies offer the energy densities necessary for practical use in a macroscopic application.  I predict that China, and maybe India, will be front-runners in exploring the use of new nuclear technologies... Why?  Simply because they need it for growth, and they have to be more pragmatic about their situation than the populations of developed nations.

I also predict that the new oil - the new driver of our economy - is something we haven't seen yet, or have relegated to the back of our minds.  It's obvious with just a few BOTEs that current renewable energy technologies are not going to meet our energy needs, so it's time for savvy investors to look farther out into the fog to see what's really going to save the day.

Posted by ash.dyer at 08:34 AM | Permalink | Comments (0) | TrackBacks (0)