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Random Idea (pseudonym) is a manager of an investment fund focusing on absolute returns through equities and commodities. Previously he worked in finacial risk management for a $10+ billion hedge fund and on the sell side covering commodities and commodity based equities. He holds the CFA... More
  • Flying toward a black hole 0 comments
    Jun 2, 2009 1:26 PM | about stocks: UDN, TIP, XLE

     

    Below is a letter I wrote to my Congresswoman, Senators and the President.  As a Republican, I’m embarrassed that it has been our party that has over the past thirty years been largely responsible for the expansion of the federal deficit.  What happened to limited government?  I don’t write to argue politically…only to admit my party’s failure and admit that we need to do something about it.  The debt is everybody’s problem and if some serious changes do not occur we will be in big trouble. 

     

     

     

    As a student of economics, I have watched as history has been made over the past year.  We stood on the precipous of collapse after Treasury allowed Lehman to go under.  TARP allowed the system to stabilize.  I understand the need for drastic measures in desperate times.

     

    However, I fear that these desperate times have caused a shift beyond what is reasonable.  We must realize that there are externalities of decisions and that what may benefit us in the short-run could hurt us in the long run. 

     

    John Taylor (professor at Stanford) wrote a great piece in FT last week about the direction we are headed for (www.ft.com/cms/s/0/715...).  In it, he describes the debt levels we are headed to and as I hope you are aware, there is a limit to the amount we can borrow in the treasury market.  THE SCARIEST PART ABOUT IT IS THAT WE PROBABLY WILL NOT KNOW WHAT THAT LEVEL IS UNTIL WE REACH IT--WHICH BY DEFINITION WILL BE TOO LATE.

     

    Yesterday we saw the bankruptcy of a great American icon.  GM's failure demonstrates what can happen to world-leading organizations that fail to stay competitive, are insulated from competition, gradually become redistributive in their finances, and make assumptions about the future (by taking on too much debt).  The funny thing is that America has competitive car manufacturers.  Honda and Toyota build more cars here than the big three combined.  It is not the American car industry that has failed.  It is Detroit that has failed.  And yet I fear Detroit is a foreshadowing of what will happen to America.

     

    James Carville was quoted as saying "I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody."  Leadership of this Country has a choice.  They can proactively choose measures that lead this Country toward prosperity, or they can wait and let the bond market force their hand.  The latter will be exponentially more painful--maybe fatal yet I fear that while it is in everyone's collective interest to avoid this outcome it is in no one's personal interest (the prisoner's dilemma)-- therefore incentives suggest that this will be the medicine we will take.

     

    As investors, how do we invest in such an environment?  If we continue to see the government not address the issues above I would offer a couple of things will do really well in an inflationary world: 1) borrow at fixed rates (your payments will remain the same in dollar amount and actually decrease as inflation eats away at actual cost), 2) invest in real assets (include real estate, commodities, companies with inflation-resistant revenues), 3) save at short-term rates or in inflation-indexed bonds.

     

    Disclaimer: No position in three ETF's listed but long energy positions.

     

     

    Stocks: UDN, TIP, XLE
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