Joined: 28 Dec 2005
|Posted: Fri Jul 10, 2009 2:57 pm Post subject: How to Prosper in the 2010s
|Section [I] is a background of the U.S. macroeconomy. Section [II] explains how to profit through economic change.
I] The Real U.S. Economy:
There are many misperceptions about the U.S. economy. The U.S. had a "superbubble" from 1995-00, at the tail end of a spectacular structural bull market, where U.S. actual output generally exceeded potential output. The U.S. had another superbubble, in a structural bear market that began in 2000, where there was a strong expansion of the real goods market, real asset booms, and a steeper rise in U.S. living standards than 1995-00, along with the greatest global economic boom in history.
It's important to note that U.S. actual output has generally been below potential output throughout the 2000s. Export-led economies have been absorbing U.S. dollars to maintain acceptable levels of employment and output. Just like the volume of output in itself will cause declining prices and induce demand, the volume of capital will in itself cause interest rates to fall and induce demand. The gains of U.S. assets increased faster than the gains of U.S. liabilities. Similarly, the increases in U.S. output exceeded the rises in U.S. inflation, which induced demand and raised living standards. Export-led economies needed to accept small gains of trade to spur export growth (which imply the U.S accepts large gains of trade). Also, while the U.S. dollar depreciated, export-led economies were required to accept even smaller gains of trade to maintain export-led growth. The U.S. had abundant capital from foreign capital inflows and capital creation of U.S. firms. Much of that capital flowed into the U.S. housing market creating an oversupply of houses.
The U.S. created 17.6 million jobs between 1993-98, and created only 3.7 million jobs between 2001-06. However, U.S. real GDP growth was only slightly higher from 1993-98 than from 2001-06. So, the U.S. became much more productive in the 2000s, i.e. using fewer inputs to produce more output.
The quick and massive U.S. Creative-Destruction process, generally between 2000-02, freed-up resources, e.g. labor, capital, raw materials, energy, etc. Freed-up capital was redeployed into firms that generated even more capital, including U.S. Agricultural and Industrial Revolution firms. Older U.S. firms gained greater market power, since they focused on higher quality "core" products, while offshoring less profitable goods to Third World countries for larger profits (rather than discontinue operations of those products), and imported those goods at lower prices. Consequently, U.S. corporations generated double-digit profit growth for a record 20 consecutive quarters in the 2000s, which resulted in strong balance sheets. Much of the redeployed capital flowed into business start-ups, which helped keep the U.S. unemployment rate low. U.S. Information and Biotech Revolution firms continued to lead the rest of the world combined (in both revenues and profits) after the Creative-Destruction process. The only way to move from one economic revolution into the next is through efficiencies, which free-up limited resources. Excess capital was distributed to the masses, which raised actual output towards potential output (e.g. through the housing boom and related goods). It's all interrelated, and inevitable, which is why the U.S. leads the world in the Agricultural-Industrial-Information-Biotech Revolutions.
It's not understood, global imbalances were created by foreign governments. So, the U.S. government needed to respond appropriately. One imbalance was U.S. firms and households exchanged dollars for foreign goods, and then foreigners exchanged those dollars for mostly U.S. Treasury bonds. Consequently, although the world is flooded with dollars, they were drained from the U.S. economy, and those dollars needed to flow back to U.S. firms and households.
In 2008, the U.S. had an oil shock that was twice as big [in real dollars] than in the 1970s. Yet, unlike the '70s, the U.S. didn't fall into a severe recession, until the credit market froze after Lehman failed [in Sep '08]. Iraq, which is now a democracy, has the potential to quadruple its oil production, and increase its oil revenue substantially. Iraq has up to 25% of the world's oil reserves and it's very cheap to extract.
Export-led economies are the big losers in this recession, which is a correction to reduce global consumption. The U.S. already captured enormous real assets and goods, in the global economy, while export-led economies continue to hold worth less U.S. paper assets.
The U.S. had a virtuous cycle of consumption and investment. Export-led economies sold their goods too cheaply and lent their dollars too cheaply. Consequently, the U.S. overconsumed and underproduced, while export-led economies overproduced and underconsumed. The U.S. housing boom (and related goods) helped raise U.S. actual output towards potential output, which caused export-dependent economies to overproduce even more. The U.S. consumption-investment cycle turned into a boom, which was unsustainable.
The correction was inevitable. The question was would it correct slowly or suddenly. There was diminishing U.S. marginal utility, since Americans bought too many goods, and would buy more goods only if prices fell further. Export-led economies had production strains, while lending their dollars to the U.S. more cheaply. They exchanged their goods for U.S. dollars instead of U.S. goods, and received increasingly smaller gains-of-trade through inflation (e.g. postponing or never buying U.S. goods), received negative real interest rates (e.g. low long-term and short-term bond yields), and lost in the foreign exchange market (receiving fewer units of their currencies per dollar). Export-led economies lost up to 10% a year either holding worth less U.S. paper assets, or through importing U.S. inputs (e.g. capital goods rather than consumer goods) for their output.
This is the first severe recession, since 1981-82. However, not all recessions are the same. In the 1981-82 recession, there was too much money chasing too few assets and goods. In the 2008-09 recession (based on two consecutive quarters of contraction), there's too little money chasing too many assets and goods. Rather than clear the market of excess private assets and goods, through a large tax cut, the U.S. government has chosen to destroy, rather than allow households to consume, the excesses, while creating public assets and goods through massive government spending. There was a strong expansion after the 1981-82 recession. However, the U.S. government may prevent a strong expansion, because of capital and output destruction, while creating inefficiencies in production. After the market clears of excess capital and goods, there will be rising interest rates, accelerating inflation, and greater taxes, or the illusion of prosperity, e.g. through the creation of inefficient jobs. The cost of living will rise substantially, and living standards will fall.
Chart of key economic indicators 1980-82 and 2008-09 below:
The U.S. is heading towards lower living standards, and it's completely unnecessary. The U.S. government is massively increasing costs of production, crowding-out the private sector, and will squander trillions of dollars. It will likely achieve what it's attempting to avoid, i.e. a long-term L-shaped recovery, similar to Japan's Lost Decade. There are four ways to balance the budget; expand the economy, raise taxes, cut spending, or sell government assets. The Federal Reserve will be in the impossible position of preempting inflation and maintaining economic growth, while the U.S. government squanders trillions of dollars. Americans will work harder and longer for fewer and smaller assets and goods. There won't be a third superbubble, from 2009-14, similar to 1995-00 or 2002-07.
Chart of projected U.S. budget deficits:
II] How to prosper in the 2010s
It'll take some time for the market to clear of excess assets and goods, while the government destroys more than enough excess capital to generate accelerating inflation and rising interest rates. Consequently, in the 2010s, gold should continue to rise, and Treasury bonds should fall. So, buying GLD and selling TLT should outperform most other investments. Moreover, the U.S. consumer will be a weaker engine of global growth. So, a precipitous fall of the dollar is possible. Furthermore, it's likely the stock market will trade in a lower range, and not make a new high, unless the dollar collapses, which will make the dollar almost worthless, and cause the stock market to rise substantially.
George Soros and Bill Rogers use a remarkably simple trading methodology in their Quantum Fund. They trade on long-wave business cycles. For example, from 1965-82, the U.S. was in a structural bear market, and from 1982-00, the U.S. was in a structural bull market. In the 1970s, the Quantum Fund gained 4200% while the S&P 500 advanced about 47%.
There are ways to earn even greater returns more quickly using the leverage of stock options. It should be noted, there are hundreds of pitfalls trading with stock options, and avoiding those traps is most important. Using the GLD long and TLT short examples, from above, long-term GLD calls can be bought on pullbacks, and long-term TLT puts can be bought on bounces. Options that expire in several years are best, which have more leverage than stocks and more safety than shorter-term options. Some options can be sold when they rise to lower average costs, build-up cash, and buy more if the options pullback. After a few trades, the investment may become risk-free, since enough gains were made on the original investment. Also, a portfolio stop-loss can be used to minimize losses or preserve capital.
However, there are ways to make huge returns quickly. This is similar to investing in an oil well or gold mine, except the risk is much smaller. It's important to wait for an excellent opportunity, which eventually always shows up, and then make a bold move. It's necessary to accurately estimate the probablity the options will make money, and when there's a 75% to 90% chance of making money, then a bold trade should be taken. It should also be noted what the potential losses are if the trade goes the other way. Consequently, there will be very few stocks chosen for potential trades, typically less than five per year. It may be best to explain some real trading examples I made for myself and others.
RMBS was my top pick. It was trading around 80 [before the stock split]. I bought Mar 80 calls two or three weeks before it began to rise towards 470, which it reached in three weeks. I bailed-out completely with a huge return when it rose to about 140. However, if I bought the Mar 140 calls when at 80, and sold at the top, when at 470, I would have turned each $6 into $33,000 in three weeks. I didn't expect RMBS to rise from 80 to 470 in three weeks. RMBS eventually completed a big "M." So, even larger gains could have been made.
IMCL was another top pick. Over a six month period, in a friend's account, I bought IMCL calls on pullbacks and sold some on bounces, etc., I made a 43 times return. At that point, I didn't believe there would be much further gains, and told my friend to close the account.
DNA was one of my top picks. I recall buying $0.50 calls and selling them at $2.00 within a few days. However, I traded DNA before it made a big move, and completely missed out on huge gains.
A friend was leaving the country and wanted me to find three small stocks for him to buy before he left. He picked one EISQ, and bought at $0.20. Six or eight months later, I noticed it was over $7, and sent him an email congratulating him on making over a 35 times return. He sent me an email back basically saying, you know, I held that stock for over six months, and forgot about it, and then noticed it didn't do anything, so I sold it [at roughly the same price he paid, before it went way up].
IP was my top pick days before it reported earnings. Normally, it's too risky to trade a stock before earnings, but IP was too cheap and the calls were also too cheap. After earnings were reported, the calls rose from $0.80, the prior day, to $4.00, at the open.
SQNM and XOMA were my top biotech picks. However, I didn't make money on them, because I was a year too early. Eventually, they both rose by huge margins. Years later, I had two other top biotech picks CTIC and DNDN. It turned out I was also about a year too early before they went way up.
Most recently, over a several month period, I had only three picks. YHOO and SNDK calls, and SPY puts [only to hedge]. YHOO was my top pick. However, I traded only YHOO calls and SPY puts. When YHOO fell towards 10, I started buying calls, and bought more calls while YHOO fell lower. YHOO rose to 17, and made big gains buying on pullbacks and selling some on bounces. I had a net loss on the SPY puts. However, it was a relatively small loss, which was more than offset by the gains on YHOO. SNDK also performed well, since it doubled [rising from 8 to 16].
For more information or to answer your questions, my email is email@example.com