Euro Crisis or Catastrophe?

This graphic from Stratfor just about sums up Europe's dilemma. Or should that read Germany's dilemma. As a student of German history I've long believed Germany was the key to the course of European history. But who would have imagined that to unfold to this extent? And who will exploit this crisis most? China? Russia?

KAM Approved for Firehouse 8

We were approved to day by the San Antonio city council on a purchase for historic firehouse 8 at 2323 Buena Vista. This is a win for us, the city and the westside community as we bring a nice infill redevelopment project to an up and coming part of San Antonio. Stay tuned for more details!

Warning: Insanity in the Air

This from John Mauldin: "According to Bloomberg and The Hill, Barney Frank plans to submit a bill that would remove the votes of the five regional Federal Reserve presidents from the 12-member Federal Open Markets Committee (FOMC), which sets interest rates, and replace them with five appointees that would be nominated by the President and confirmed by the Senate.

Frank says "he is concerned that the process is undemocratic because the regional Fed presidents are not elected or appointed by elected representatives, and he believes that regional Fed presidents are overly likely to focus on guarding against inflation at the expense of more adequately tackling the country's unemployment crisis." (US News and World Report)

Basically, he wants the Fed to be subservient to the politicians. Under his proposal, the FOMC could lose what independence it has in a short time. This is part of a strain of thought that suggests that the decisions that affect all of us should be made by a few elite people who purport to understand what is going on, which coincidentally are government insiders and the academics who foster their agendas.

How did Weimar and other hyperinflation incidents occur? When power was in the hands of a few well-intentioned elites who did not understand the long-term consequences, or were acting in self-interest without transparency or any check on their decisions. The Fed is designed to be a system of checks and balances, with no one president getting to appoint all the governors (they have 14-year terms), in order to try to remove the process as much as possible from political interference. That does not mean they will make the right decisions, but in this I agree with the alarmists: history suggests that without some constraint (gold standards as an example) hyperinflations may occur."

Students of history will understand that we Americans make a lot of our economic decisions with a great sensitivity to the trauma of the Great Depression. Germans, on the other hand, have a a tremendous sensitivity to unemployment and hyperinflation. Governments are historically fond of inflating their way out of debt problems. This also amounts to a confiscation of wealth from private citizens! Citizens....resurrectio!

Debt and Financial Repression

The debt levels seen throughout the world, both sovereign and personal balance sheets, while in some ways unprecedented,  is not something that hasn't been seen before. However, these debt levels are typically associated with major wars.

So how have economies historical "righted" themselves from debt levels of this magnitude? There have been three primary elements:

1. High Growth

2. High Inflation

3. Financial Repression

High growth is, I think, self-explanatory. And while that is true, policy makers seem befuddled as to precisely what steps to take in order to achieve such growth. In the U.S., we appear to be in a tug of war between "government does it best" advocates and "the private sector does it best" advocates. I suspect that means a blend of the two is what is needed.

High inflation is also self-explanatory. The U.S. government tells us we don't have meaningful inflation in our economy. Can I see a show of hands of those who think otherwise? I thought so!

Financial repression is, I believe, the least understood of the three paths to debt salvation. Wikipedia defines financial repression as "a term used to describe several measures which governments employ to channel funds to themselves which in a deregulated market would go elsewhere." I highly recommend a quick read of the Wikipedia entry as financial repression is certainly underway as defined there.

On a more basic level, financial repression will punish savers. Case in point, if you've been fiscally responsible and saved over the years, what are your fixed income options today? What rates are being offered? Are the real rates a positive return after taxes and inflation? One of the key tools of financial repression is explicit capping of interest rates on government debt. Didn't the Federal Reserve announce just last week that they would be keeping rates low for the next two years? That certainly sounds like interest rate control to me.

Financial repression is simply another form of taxation without the political heat. I fear this will be a feature of our economy for many years to come and investors should prepare themselves for this. I believe a cornerstone strategy for any portfolio should be to seek higher interest rates in private debt markets with instruments backed by real assets as an inflation hedge.

Getting Back to Even

Last week's wild market ride sparked more than one conversation about not only recent market action, but the markets and returns since this bear market cycle began in 2000. Watching gut-wrenching declines, punctuated by seemingly strong rebounds, only to be followed by more steep declines, prompted me to visit one of my favorite risk management topics: the importance of minimizing losses when investing.

"In order to make money, you must first not lose money" George Soros

No matter your investment style or approach, being mindful of what's referred to as "drawdowns from peak" is very important That's a fancy way of saying losing money relative to how much your portfolio has grown to over time. 

Say your portfolio started at $100,000, grew to $500,000 then subsequently declined to $300,000. Are you up $200,000 or down $200,000? When examined from the perspective of drawdown from peak, you're down $200,000. I prefer this method of determing progress in wealth management.

"You cannot get ahead while you are getting even." Dick Armey

After steep market declines, investors often underestimate what it takes just to get back to even. The following chart illustrates how advances required to get back to even grow geometrically as it relates to losses:

% Loss of Capital	% of Gain Required to Recover
10%	11.11%
20%	25.00%
30%	42.85%
40%	66.66%
50%	100%
60%	150%
70%	233%
80%	400%
90%	900%
100%	broke

The periodic deep declines in the S&P 500 since the beginning of this secular bear market, which I believe began in 2000, have challenged investors to stay the course and certainly required iron nerves to give their portfolios the opportunity to get to "even." So how has that worked out?

From January 1, 2000 through today, it's been quite a harrowing ride to be invested in the S&P 500. The statistics below show just how frustrating the experience has been. Choose your method for risk management and stick to your discipline!

Start date	Jan-03-00
Start price	$119.60
End date	Aug-12-11
End price	$118.12
Number prices	2922
Total gain or loss (Start date to End date)	-1.24%
Annualized gain or loss (Start date to End date)	-0.11%
Total dollar value for $1,000 purchase made on Start Date	$987.63
Total gain or loss for all possible returns	9.67%
Number returns	4,267,581
Number profitable returns	2,693,479
Percent profitable returns	63.11%
Number unprofitable returns	1,574,102
Percent unprofitable returns	36.89%