Wednesday, November 28, 2007

The Gathering Storm

The storm is gathering. However, I do not expect economic collapse, but the trouble will be large and widespread – as it was in the last major cyclical downturn.

Every cycle has this type of problem to varying degrees. The details change but the theme is the same. 20 years ago it was the failure of more than 1,000 savings and loan associations. 10 years ago it was the Asian financial crisis and the Russian bond defaults. This time it will be hedge funds and SIVs.

These are the financial symptoms and manifestations of the economic cycles. The world will not end – though many will think so and dump their assets at fire sale prices (God bless them, every one).

The geniuses at the hedge funds bet the farm and make huge fortunes as long as things go well. They blend their sophisticated instruments into packages of “uncorrelated” risks.

However, it turns out that the uncorrelated risk becomes correlated because everyone bought the same stuff, and will try to sell their uncorrelated assets at the same time – with disastrous results.

I have been expecting financial turmoil and cyclical decline. Back in 2005 when I thought the real estate market was peaking and about to slide, it was actually a bit more over-priced than I thought. The decline will likely be worse than I predicted at that time. I had expected a price decline of over 20% in places like San Diego and Los Angeles - I now think it will go deeper.

In late 2006 I forecast that the 10 yr treasury would decline to around 4% by the end of 2007 (it has), and that it would go lower during 2008 as the economy becomes sluggish into 2008. I bought 5yr and 10yr treasury bonds when the yield was around 5% - with the yield now under 4% they have gained in price. I did a similar strategy during the bear market from 2000 through the end of 2002 – a time when I lost no money on stock because I had sold it all before the decline.

During the last year I have sold about 70% of my stock – selling into the rallies this year. My average selling price was about 15% higher than the current market prices. My last sale was in late September. I will soon sell a little more (into rallies), and then I will wait for the bottom to come. There will be great bargains to be had.

The shit is hitting the fan and will likely get much worse for stocks and real estate for another two years. The party is long gone for real estate, and I believe it recently ended for stocks.

Batten down the hatches for the big storm, and keep your cash dry.


At December 18, 2007 12:03 AM, Anonymous Anonymous said...

I would have to agree, though I must admit to being surprised by the magnitude of the recent broad market sell off.


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