Cosmic Laws in Finance?

A friend of mine has a blog called The Economics of Cosmic Law. He discusses how things are deeper than the media would have you believe - that if you cared to open your eyes, you'd 'find out how far the rabit hole really goes...'

http://financialdiscussion.blogspot.com/

Turn on the headlines today and you will hear about Euro federalisation, Quantitative Easing, CDOs, ABSs, MBSs, ETFs, ECNs, the VIX... and on and on. Yet this is the surface. You have to go deeper. Whereas most things become more complex the further you go, finance becomes easier. The complexity is a shield for the industry. If everyone knew Quantitative Easing meant 'devaluing YOUR money to balance MY checkbook,' people might not be so complacent.

Which brings me to Law #1: The market is a zero-sum game.

Somebody wins and somebody loses. All financial transactions must obey this law:

    Media Hype                                  Winner(s)                                              Loser(s)
Euro Federalisation         Lazy, Indebted Nations' Taxpayers                German & French Taxpayers
                                                     German Exporters                    General Sovereignty - (UKIP!)
                                                     Euro Bureaucracy 
             
Quantitative Easing                             Central Banks                                           Savers
                                                          Governments                                              

Whilst the Zero-Sum Game is fairly well-known, another economic law which doesn't get enough credence is that of proportionality - specifically, the proportionality of booms and busts in the business cycle.

Boom/Bust Ratio


Regardless of political plans or economic forecasts, Booms seem to last in proportion to busts. The Dow Jones Industrial Averages show this in detail:

The Average Phase in the Business Cycle is 18 years. 2017 is wishful thinking!

1929 - 1949: 20 years (Great Depression, WWII)
1949 - 1966: 17 years (Recovery, Economic 'Miracles')
1966 - 1982: 16 years (Stagflation, Vietnam)
1982 - 2000: 18 years (Internet Boom, Cold War drives Innovation)
2000 - ????: ~12 years (Terrorism, Mismanaged Wars, Subprime Crisis, Sovereign Debt)

You might be thinking to yourself: 'The bust years seem to be OK for the stock market (Forgetting the Great  Depression) - they look like straight lines!' This is because heavy inflation has manipulated the chart: check this out:


     A New Perspective: The 70s look a lot worse now, don't they! (Fred's Intelligent Bear Site)

This blog is not intended to scare you, just to inform you, to offer a different view. The government would never produce the forecast '2017 will be the beginning of a new growth era!' It's always next year, provided you vote for them.

That's it for this week's blog. My next blog will answer the question: 'What do bees, flowers and fingers have to do with financial markets?'

Be Prepared

(www.warren-buffett.org)

In a recent conference, Warren Buffett made this joke about the US/Obama:

"I like to invest in companies which are so profitable that any idiot could run them. The US is such a good country that any idiot can run it!"

Buffett had the luxury of growing up in the Post-War era. (Born 1930, he would have started forming concrete views of the US during WWII). At that time, America accounted for over half of the world's economic output and was a creditor of nations. The 'Almighty Dollar' was a statement of fact - not a punchline. Regardless if the nation were run by warmongers, Watergate nutjobs or even peanut farmers, the nation remained the world's gold standard. For this reason, Berkshire Hathaway has invested primarily in American businesses, buying and holding shares in sound companies.

However, with a Debt to GDP ratio of 99%, deficits topping 10% annually and a Federal Reserve printing money like its going out of style, Buffett's patriotic buy-and-hold investing needs serious revision. Recently, 'Independent Trader' Alessio Rastani ranted on the BBC that the savings of millions would be wiped out in less that a year. I will go out on a limb here and predict that there will be no mass liquidation, no hyperinflation and no catastrophic alien invasion; however Rastani's warning is to be heeded.

Investors are gamblers - whether they invest for 20 years or high-frequency trade for 20 milliseconds - they play the odds. Most people would agree that the odds of making money in today's market are very poor following the Buffett model. In fact, Berkshire Hathaway, the bastion of American Capitalism, has returned a paltry 10% over the past 8 years. After inflation, the Oracle of Omaha has lost investors money. 

Berkshire Hathaway Class A Shares. 8 years, no growth! (www.finance.yahoo.com)

So the question becomes how can we put the odds in our favour, taking for granted that the future could be rife with hyperinflation, low or negative growth or even an unforseen boom?

Inflation

Investors can easily hedge against inflation through two major market instruments: precious metals (gold, silver, etc.) and TIPS (Treasury Inflation Protected Securities). An ounce of gold in 1920 could buy you a well-tailoured suit for $30. An ounce of gold can still buy you that suit today for $1000, with plenty left over. Precious metals can be bought in bullion, or in ETFs (Exchange-Traded Funds). TIPS give the holder a rate of return equal to the CPI index (Consumer Price Index).



Quant fund DUNN Capital made 52% in 2008
 and has seriously outperformed the S&P
(http://www.trendfollowing.com/perf.html)



Bull or Bear Market?

Who cares? Trying to figure that out has caused the majority of fund managers to underperform key indices like the Dow and the FTSE. The only class of funds that beat the market consistently are quantitative hedge funds. These funds build trading robots which automatically buy and sell instruments ranging from gold to the Swiss Franc to Pork Belly Futures, based on mathematical formulas known as algorithms. Typically, investors pay 2% in management fees and give the managers 20% of the profits. All these fees are often worth it though, since quant funds can make money in both bull and bear markets, whereas most other funds are long-only (can only buy). Unfortunately, UK and US governments only allow high-net worth (rich) investors to invest in quant funds, because the government believes the wealthier you are the more informed/educated you are. Under that logic, both governments should have negative IQs as they have each been in perpetual bankruptcy for 50 years, but I digress. If you don't have the cash, you can try to build your own quant system using NinjaTrader, MetaTrader or TradeStation, although it will take a month or so to learn the computer code.

World Bond Funds

If the market scares you, but you want to earn more than the .1% that the banks give you, consider a world bond fund. Bond funds typically invest in government debt that is secure but giving a fair yield. German Bunds and US Treasuries are often well represented. Typical returns are 6% per year, enough to almost double your money each decade at a low risk.

Bottom Line: Don't buy and hold like Warren Buffett, don't run for the hills and please don't keep your money at the bank - be prepared!