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Alan Schram
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Alan Schram is the managing partner of Wellcap Partners, an investment partnership based in Los Angeles. He founded Wellcap Partners in 2000 and has been managing investment portfolios for private and institutional investors since 1997. Prior to that he co-founded Sitestar Corporation, a... More
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  • Two Investing Ideas for Japan's Crisis

    Japan is an incredible civilization in many ways. It was reduced to rubble after WWII, yet became an extraordinarily rich country and the second largest economy within only a generation.

    Today, however, it is hard to feel optimistic about their prospects. Despite what some Keynesian economists still believe, destruction is not beneficial for the country, spending does not create prosperity and tsunamis won’t stimulate the economy.

    Economics at its core describes choices made in a world of scarcity. The resources required for rebuilding Japan could have gone into other endeavors, and the money will now likely come from new government borrowing. This will exacerbate the deficit for what is already the most indebted developed nation (with a debt-to-GDP ratio of 200%), and should slow growth and hurt equity prices. Indeed, in 18 years of Keynesian experiments (1992 to 2010), Japan had an average of 0.85% annual GDP growth. Over the same period, the Nikkei 225 declined 55%.

    More critically, last year Japan passed an important turning point, with negative implications: pension plans began selling assets to fund pension obligations. They had to, because Japan has the oldest population in the world: a median age of 45, almost a quarter of the population 65 years old or more, and a fertility rate of 1.27 children per woman, which is below zero population growth. For perspective, in 1960, when Japan was on its way to becoming an economic power, 49% of Japanese were under 25 years old and less than 8% were over 60.

    Debt and demography will therefore limit their ability to fight back, and thus it is hard to be cheerful about Japan’s future.

    Yet there are intelligent ways to take advantage of the confusion in financial markets. There are plenty of solid US and European companies on fire sale right now, and whose business will not be impacted in a significant way. Others will suffer losses but will clearly survive. Toyota Motors, to name one prominent example, is one of the most respected brands on earth. In the long run, the disastrous events in Japan are no more than a speed bump for them. And Toyota’s stock price has been slashed more than enough to reflect the damage suffered by the company.

    Another good example is Munich RE, one of the largest re-insurance companies in the world. With a balance sheet of over $200 billion, Munich RE will easily survive their exposure to Japan. The shares are down 15% over the past week and are trading below their book value and at a P/E of 8.5, paying a dividend of 5.7%.

    Reinsurance of nuclear facilities does not generally extend to “Force Majeure”, and in Japan the government, not private companies, will provide most of the compensation for earthquake and tsunami damage. In addition, large claims from Japan will drive catastrophe reinsurance prices higher, and insurance companies will be able to raise premiums.

    After most disasters people panic and puke out shares of insurance companies without thinking. The solid ones come back in a big way. In 2005, hurricanes Katrina, Rita and Wilma caused losses of $100 billion. Yet the shares of most insurance companies made new highs in 2006. In fact, according to Citigroup, reinsurance stocks outperformed the S&P 500 for up to a year following the 16 largest global catastrophes.

    The knee-jerk reaction to disaster is to panic and move to cash. Yet it rarely pays to act without thinking. Investing is about staying rational and having a low cost basis. As the old saying goes, you buy when there's blood in the streets, or in 21st century parlance, when there is nuclear meltdown in the streets. You buy uncertainty because you have to pay a high price when uncertainty recedes.

    And as far as general US equity markets are concerned, printing money has historically been good for stock prices. That was true when Nixon devalued the Dollar in the early 1970’s, and it was true when the Federal Reserve printed money to bail out Latin America in 1982. And of course it has been true throughout these quantitative easings.

    In the first quarter of 2011 we had, so far, revolutions in Tunisia and Egypt, civil war in Libya, riots in several other Arab countries, and a huge earthquake, tsunami and nuclear meltdown in Japan. Yet the S&P 500 is still up for the year. What better sign for the market’s underlying strength?



    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Tags: TM, Japan
    Mar 20 11:41 PM | Link | Comment!
  • Municipal Bond Mess
     

    Yields on top rated 10-year U.S. Municipal debt rose steeply today, as investors were dumping municipal bonds and a flood of states and municipalities were seeking to raise money.  California alone is planning $14 billion of debt sales before Thanksgiving.

    Historically, the US experienced very few municipal defaults---around a tenth of 1% over the last 40 years, and hence has been thought of as a safe place to invest.  But that $2.8 trillion market is becoming more and more vulnerable.

    A recent Northwestern University study found the funding gap for city pensions is $574 billion, on top of the much larger gap at the state level.  A few weeks ago, the state of Pennsylvania gave an emergency cash allowance to stave Harrisburg, the state capital, from default.  Jefferson County, Alabama may file for the biggest municipal bankruptcy ever.  New Jersey, Philadelphia and Los Angeles are in similar distress, and many more fare only a little better.

    Lavish pensions and liberal healthcare plans created huge unfunded liabilities and a sense of entitlement.  89 California Highway Patrol officers earned over $200K in 2009.  That is just one example of the obligations California has taken on, thanks to the devastating collaboration between elected officials and unionized state and local workers.

    With declining tax revenues, many municipalities can no longer afford those obligations.  Politicians, long accustomed to freely spending taxpayers’ money to win the affections of the electorate, will soon be facing a choice---either default on the municipalities’ obligations (and stick anonymous debt holders with the bill), or face their constituents, cut back essential services and raise taxes.  What course do you think a typical politician will follow?

    Based on the historical record, many municipalities still enjoy high debt ratings.  But recall that some Lehman CMBS were still rated AAA the morning Lehman filed for bankruptcy.  So was the case for AIG bonds, to name just two of many prominent examples.

    The last time munis got in trouble was the Great Depression: 851 cities and 359 counties were in default in 1935. Yet in 1929, half of the defaulting issues carried a AAA credit rating.

    Today, municipal bond yields are still near record lows.  Investors like to extrapolate the recent past into the near future.  But the potential for disaster is enormous, and it does not come close to being compensated for by the puny existing yields.

     

    Alan Schram is the Managing Partner of Wellcap Partners, a Los Angeles based investment firm. Email at aschram@wellcappartners.com.

     
     


    Disclosure: None
    Tags: Muni's
    Nov 15 8:08 PM | Link | Comment!
  • The Next Thing to Go Wrong
     

    Gold prices just hit a new all time (nominal) high of $1,257 an ounce. The Dollar lost more than 70% of its gold value since the beginning of the decade (an ounce of gold was $273 in January 2001).

    Because most people take note of the dollar in reference to foreign currencies, they overlook the significance of this. The European Union has bigger problems than America, and so their currency has been even weaker, making the dollar's decline easy to ignore. But since gold prices are quoted in dollars, the meaning of gold going up is that the dollar is falling.

    A look at energy prices leads to a similar conclusion. For decades the prices of gold and oil closely paralleled one another. In 2003 an ounce of gold would have bought you 12 barrels of oil. Today that ounce will buy you about 16 barrels, even though the price of oil is now more than twice what it was in 2003. Thus the increase in oil prices is really a result of inflation, not energy markets' supply and demand. Energy prices are simply not keeping pace with the rising price of gold.

    This erosion in the value of the dollar is effectively inflation, even if it does not yet show up in the CPI. And it is tantamount to a tax more devastating than anything Congress can come up with. Inflation consumes capital. If you receive 5% interest on your savings and pay 100% capital gains tax during a year of zero inflation, you are no worse off than a person who pays no income taxes at all during a year of 5% inflation. Either one is left with no real income.

    People would riot in the streets if capital gain tax of 120% was enacted, but don't seem to mind collecting 5% interest rate on their municipal bonds with 6% inflation, even though that is exactly the same as 120% capital gains tax.

    So far, both inflation and long term interest rates have remained surprisingly low, despite the flagitious promiscuity in which the U.S. has increased its federal debt, from $5.5 trillion to $8.6 trillion in just 18 months. But Gold has historically been a reliable harbinger of both inflation and rising interest rates.

    Rising interest rates obviously reduce the value of all fixed income investments. And when the value of the dollar deteriorates, fixed income instruments with principal payments denominated in dollars are not going to do well. Thus, the erosion of the dollar is a threat to our economic stability.

    Every empire in history has shirked its liabilities by debasing the currency. Aggressive spending plans, especially in a time of war, escalate these inherent tendencies. And the further the dollar declines, the more dire the consequences. Yet investors who should be looking for safe haven are, oddly, confident in our currency and convinced that Washington will honor its long term fiscal obligations.

    That false sense of security is dangerous, because we are vulnerable to a crisis of confidence in the dollar. And the resulting sudden spike in interest rates will have such large impact on the economy that it will dwarf any other factor.

    The second Murphy law says that what actually goes wrong is not that we anticipated going wrong. But this scenario is at the top of my worry list.



     


    Disclosure: No Positions
     
    Jun 21 1:10 PM | Link | Comment!
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