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Wednesday January 21, 2009 - 16:02:18 GMT
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A Little Rant on Coronation Day 2!

Key News
• European Union finance ministers warned that they are running out of room to spend money to boost their economies, as Germany predicted its economy would shrink at least 2% this year and Hungary's currency fell to a record low despite recent efforts to prop it up. (WSJ)
 7:00 a.m. MBA Mortgage Application Refinance Index For Jan 16: Previous: 7414.1.
7:45 a.m. ICSC Chain Store Sales Index For Jan 17: Previous: -2.3%.
8:55 a.m. Redbook Retail Sales Index For Jan 17: Previous: -2.3%.
1:00 p.m. Jan NAHB Housing Index: Previous: 9.

 “It is not whether you are right or wrong that's important, but how much money you make when you're right and how much you lose when you're wrong.”

- Stanley Druckenmiller

FX Trading – A Little Rant on Coronation Day 2!
Not being a fan of mass hysteria myself, and always nervous when Kings are fabricated for a so-called democracy, I chose to watch dollar rally yesterday instead of the coronation.  That was good!

What we continue to find extremely interesting is the ongoing idea that the dollar will “soon collapse” or be “devalued” ... don’t you know??!! (Conspiracy abound.) But then again most all newsletter scribblers do love conspiracies.  No matter it is all BS, it sells newsletters and that’s “the important thing,” don’t you know??!!

But after reading the ridiculous comments made by many at yesterday’s coronation, it’s no surprise to see why newsletter conspiracy BS sells so well; there are millions who want to lap up stuff that validates their view—logic and independent thinking be damned! 

Who is John Galt?

I once read a very interesting book, in fact I continue to re-read it as it’s a bit dense (and likely I am too).  The book is titled, “Why Stock Markets Crash: Critical Events in Complex Financial Systems,” and the author is Didier Sornette.  Mr. Sornette lays out a mathematical/scientific/behavioral finance framework covering such things as herding, agents, hierarchies, power laws, and even fractals—most of which was way over my head.  But, the takeaway is social creatures aren’t rational and these subtle, and often not-so-subtle, irrationalities play out along all levels of the social/institutional hierarchy whereby the upper level influences the bottom and bottom influences the top in a constant self-reinforcing feedback loop.  This interaction builds what is believed to be solid “rationales” that may have little to do with reality.  Yet, otherwise seeming intelligent and logical people accept these “rationales” built by irrational social beings, as the gospel. 

Thus we end up with crowd behavior—consensus thinking and mass hysteria which leads to things like financial and political bubbles.  And the reality is that all of us, at least those who are social beings (my wife is not quite sure I fit into that category; with good reason) are caught up in this in one way or another.  After all, that is why they call it a “belief” system and not a “reality” system.  So, I plead guilty to having a “belief” system that may not be “rational.”  It is a never ending box when we think of things that way.  Which is why it is really funny watching analysts being trotted out on TV or in seminars (guilty as charged) spout with such serious and weightiness why xyz either happened or will happen—“That’s right, I am rational and I have a forecast based on my rational analysis don’t you know??!!,” goes the mantra of our analysts.  Really, it is to laugh if you really think about it. 

It is why I have told John Ross that “we don’t do forecasts, we only make guesses about the future based on irrational varying degrees of confidence.” 

Imagine a big time XYZ fund manager is in front of an investment committee.  Said esteemed committee is deciding whether or not they should allocate $100 million to XYZ fund.  Mr. Fund manager says, “Well, ladies and gentlemen of the esteemed committee, first, thank you for considering me, and secondly, I’d like to say that I will do the best I can in formulating my probability bets with your $100 million and see how reality plays out against my guesses.”  I would venture there is a low probability our esteemed committee will be sending $100 million anywhere near XYZ fund. 

Why?  Most people, and especially “important” people, want their consensus views validated because they think their views are rational.  It is to laugh and it is what usually sells newsletters and conspiracy theories. 

This is not to suggest there are not rational views.  And it is not to deny rationality.  Having been in enough “altercations” shall we say, I am all too aware of physical laws and reality—the place where real science is conducted.  Thus sheds some light on why economic or political “science,” as our esteemed universities label it, is an oxymoron.  But the word “science” is thrown in front of economics and politics to give it an air of respectability and “rationality.”  There we go again. 

Our guess is a couple bubbles of rationality are in the process of popping:

1) China is a great place to invest, and
2) The euro will challenge the dollar’s world reserve currency status

As Chinese growth tumbles and social unrest rises, even Jimmy Rogers, Mr. Chinese Cheerleader who couldn’t quite believe his own BS and make it all the way to China to set up his domicile, has to admit his much beloved investment destination isn’t holding up to his previous and numerous pontifications. I just hope Jimmy was true to his word and got all his money dominated outside the dollar last year just in time for a massive dollar rally. 

Jimmy is one of those agents high up on the hierarchy that people listen to—a big driver of that self-reinforcing investment feedback loop.  Wonder how all those commodities fund buyers’ are loving Jimmy now?  Heck, commodities “must” go higher! Yeah, okay Jim!

“The Chinese economy suffered a hard landing in 4Q08. We estimate that China’s GDP growth may have registered negative quarter-on-quarter growth of -1.7% in 4Q08 after a flat quarter in 3Q08 (on a seasonally adjusted, annualized basis). Specifically, while the growth rates of industrial production (value-added) and external trade (both exports and imports) plunged, inflation rates also declined sharply.

When discussing China’s economic outlook for 2009 in early December 2008, we argued that three factors had caused the sharp slowdown in the economy. These were (in order of importance): 1) the cooling in real estate investment; 2) a massive de-stocking of raw material inputs in the immediate aftermath of the collapse of international commodity prices; and 3) the slowdown in external demand,” says Morgan Stanley economists Qing Wang and Denise Yam.

Our guess is that China, Russia, Brazil, and India, affectionately known as the BRICs are change-agents for the rest of the emerging market (EM) world.  And our next guess is that banks with the most lending to the EMs could some under some serious pressure given the seeming drought of liquidity flowing their way.  And by extension of these guesses, we guess there will be multiple EM defaults sometime in the future.  And by use of real logic, one would expect those holding most of the paper that may be defaulted upon would feel some pain. 

Thus, the fact (or statistic we saw) that European banking holds (incredibly) an estimated $4.4 trillion of the $4.8 trillion in loans to EMs suggests to us that more SUBSTANTIAL pain could be heaped on the Eurozone banking system adding to the already tremendous stresses we know are in the system.  Thus, the idea that the euro will challenge the US dollar for world reserve currency is a “rational” thought bubble that could pop in a very big way.

 (Chart unavailable in text format.)

“In physics you are playing against God, who does not change his mind very often.  In finance, you are playing against God’s creatures, whose feelings are ephemeral, at best unstable, and the news on which they are based keeps streaming in.”

       E. Derman

In short, that’s what makes markets—stay tuned.

Jack Crooks
Black Swan Capital LLC


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