I used Apple’s Keynote presentation software from their iWork package to create a video that goes along with the IFA Quote of the Week Issue #44. The episode talks about the rise and fall of fund manager Bill Miller. Have a look and give me suggestions for improvement. Get these videos delivered to your iPod or iPhone automatically by subscribing through iTunes.

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Check this out. NYTimes, with its unlimited budget (ha) has gone and done my pitiful "Table of What it Takes to Get Back to Even " several times better. Theirs is an interactive graphic (in Flash no less) where you can enter what you once HAD, what you now HAVE, and your expected return rate (ha again!). It will tell you how long you’ll have to wait to see that same amount of money again.

http://www.nytimes.com/interactive/2009/01/06/business/20090106-comeback-graphic.html

What’s neat is that if you put in a negative inflation rate, say -3%, you can get your money back in a few years even at 0% Annual return!

I was talking with Mark Hebner today about this idea of Black Swan investing. As I mentioned in show 141, I read an article entitled “Is There Such a Thing as Austrian Investing?” by  Sterling T. Terrell. He talks about the differences between passive and active investing. But then he talks about their similarity: they both realize small gains most of the time and large gains very rarely. He says an Austrian approach would embrace the fact that the future is unknowable. He says the way to invest in the unknowable is to do Taleb’s approach of putting most of one’s net worth in low risk assets, perhaps money markets or short term bonds, and then with a small amount invest in options. The idea is that most of the time one would lose a little amount of money but on rare occasions, when there is a shock to the market, the strategy would make a large amount of money.

My comment upon his article is that it needs to be fleshed out more. Simply saying that one would follow this approach because the future is uncertain leaves a lot of arguments untouched. For instance, the article does not show how one would implement it, how it would have performed in the past, and what mathematical basis it has upon reality. Show me how such a strategy would have performed over the last 10 years. 20 years. Rolling periods. What amount of one’s investment would be eaten by fees and bid/ask spreads on these options? Can an individual actually implement such a plan or must one be a hedge fund with millions rolling around?

Wouldn’t investing in capitalism be closer to the Austrian ideal rather than speculating in financial derivatives? And particularly investing in ALL of capitalism and taking out the “controlling” decisions of some fund manager to select which companies may do better than others. This means investing in index funds. This means buying baskets of as many companies as possible, with some rational due diligence hopefully embedded in the process. By this I mean, if a company comes out and says, “We intend to close our business in the next couple of years” then by all means the index manager could have leeway to pull out of that stock.

Perhaps an important aspect of Austrian Investing was something else Terrell mentioned, 

To further explore Austrian investing, one might look at the nature of Austrian Business Cycle Theory: how can the role of the Federal Reserve in setting interest rates, causing shortages and surpluses in the market for loanable funds, the nature of malinvestment, and the inevitable boom and bust that follow, be formulated into a successful investment process?

That’s definitely something to take into consideration. Peter Schiff, Nouriel Roubini, Ron Paul, James Grant, Jim Rogers and many, many others are trying to do this too. Still, applying it to investing is akin to licking one’s finger and sticking it up to the wind. I need something more scientific, more measurable, more definitive so that I can take the belief factor out of the equation and instead invest rationally. In fact, maybe rationality is the real key to Austrian Investing after all.

By now you’ve heard about the alleged multi-billion, multi-year Ponzi scheme by Bernard Madoff and how so many other hedge funds were invested with him and how they lost money. Here’s the question: Are we sure those hedge funds lost their money by investing with Madoff? Maybe they did lose some money but maybe they are inflating their losses. Were they running a Ponzi scheme of their own and simply used the Madoff scandal as a scapegoat? Sounds like good cover to me.  How many other cockroaches will come out of the woodwork claiming their losses were due to Madoff? Hat tip to my wife for the idea.

This is funny. If he hadn’t already done this, I would have liked to have done a similar sarcastic “fix of the economy” on my show.

 Here’s a handy table (for your printing pleasure) that shows what percentage gain you need to get on your investments to get back to where you were before a certain percentage loss. So for example, the S&P 500 index is down about 40% year to date. Looking down the table, you’ll see that we’d need a gain of 66.7% to get back to where it was at the start of the year.

For Fannie Mae (FNM) you’d need a gain of 7839%. It closed at 39.98 on 31 Dec and now trades at about 0.51.

[An observant reader pointed out my mathmatical flaw in the article below. I have corrected it now. I had a feeling as I was adding percentages that I was doing something stupid. Doing the math properly makes a difference, but turns out it is not a major change to the result.]

The good folks at Index Funds Advisors have studied statistics about the stock market going back many years. One of my favorite statistics is the Monthly Rolling Period Analysis of, for example, IFA Index portfolio 100. (You can click on any of the other numbered portfolios from that page to get their Monthly Rolling Period Analysis.)  When you examine that table, you will see on the 4th row down is the 12-month rolling returns. Starting in January 1958 until December 2007 there were 589 such 12-month periods. Note we’re not just going from January to January but also February to February and March to March and so on. 

In columns six and seven you see that the worst 12-month period for the index portfolio 100 was from 10/73 until 9/74 when the portfolio experienced a loss at -35.73%. It now appears that the chart will have a new entry for lowest rolling period. According to information I have pieced together from the Benchmark Your Portfolio Tool and the Year To Date Returns of IFA Portfolios and Indexes as of Market Close 10/31/08, both available at IFA.com, the period from 11/07 thru 10/08 has just experienced a loss at -42.53% [corrected]. To arrive at this number, combine the -8% loss from 11/07 thru 12/07 with the -37.53% loss YTD in 2008. [This was the source of my math mistake: I added the percentages together.  Instead, I should take the percentage of the percentage. For example: $1000 with 8% loss is $920. $920 with 37.53% loss is $574.72. From the original $1000, that is a 42.53% loss.]

This will have a significant impact on the statistics and on the assumptions of risk going forward as the Monthly Rolling Period Analysis table gave an impression that the worst loss one might reasonably expect in a 12 month period was -35%. When the table is updated to show a maximum expected loss of 45%, it might cause investors to choose a portfolio with lower risk. Note that I have singled out 12-month rolling period. I suspect we have also set records in many other rolling periods as well. A quick check of the 2 year shows it was -23.86% and is now -29.57%. [The 2-year return is annualized, not total.] A more detailed check of the 2 year shows it was -23.86% but the most recent was only a -17.86% loss annualized.

Also using IFA data, I calculate that the S&P 500 12 month return just ended was (-4.81%) and  (-32.71%) resulting in -35.95%. If you examine the tables carefully, you will see that the S&P 500 has slightly more risk (measured by monthly standard deviation) than a portfolio 85, but with lower annualized returns. 

To create the Rolling 12-Month Analysis for any of the other 19 IFA Index Portfolios, use the Benchmark Your Portfolio Tool and select the portfolio of interest and choose the range from 1 November 2007 through 31 December 2007. Add Combine [properly] the total return (which is probably negative) to one of of the following 2008 Year-to-date returns through 31 October 2008:

But just to be fair, we should also examine the Highest Rolling Period Return and ask if we might someday overstretch its limits. It currently sits at 66.72% for the period 4/03 thru 3/04, a time after a recent recession. I wonder if after this recession we will bounce back higher? Note I’m not predicting that it will happen, just kinda wishing. Maybe after the 10% gain of the past few days, we’re on the right track?

I liked this explaination of how CDOs work and why they helped cause a financial crisis…

hat tip drop.io/dailysourcecode

Remember my show called "Surviving the Tsunami ?" I thought tsunami was a pretty good metaphor for what I thought would happen when the current deflation (wave going out) is followed by hyperinflation (giant wave crashing to shore).

I was delighted to see someone else use the same metaphor today. This is James Howard Kunstler (hey another guy with three names!) in an article entitled Deflationary Pullback Precedes Hyperinflationary Tsunami:

To switch metaphors, let’s say that we are witnessing the two stages of a tsunami. The current disappearance of wealth in the form of debts repudiated, bets welshed on, contracts cancelled, and Lehman Brothers-style sob stories played out is like the withdrawal of the sea. The poor curious little monkey-humans stand on the beach transfixed by the strangeness of the event as the water recedes and the sea floor is exposed and all kinds of exotic creatures are seen thrashing in the mud, while the skeletons of historic wrecks are exposed to view, and a great stench of organic decay wafts toward the strand. Then comes the second stage, the tidal wave itself — which in this case will be horrific monetary inflation — roaring back over the mud flats toward the land mass, crashing over the beach, and ripping apart all the hotels and houses and infrastructure there while it drowns the poor curious monkey-humans who were too enthralled by the weird spectacle to make for higher ground. The killer tidal wave washes away all the things they have labored to build for decades, all their poignant little effects and chattels, and the survivors are left keening amidst the wreckage as the sea once again returns to normal in its eternal cradle.

Go read the whole article for yourself. I love the term "monkey-humans!"

This is a follow-up to my posting from last May called “Technical Analysis and Trend Following” where I compared the S&P 500′s decline from 2001-2003 to the movement from April 2006 to May 2008.  It was a thinly-veiled jab at those who were predicting a resumption of the bull market based upon a recent uptick in the market. I showed that there was an uptick in April 2001:

and anyone who bought at that time lost big as the index went from about 1300 in April 2001 down to 850 in 2003:

Then I showed a chart that looked similar to the first chart, but this time one that was of the recent market from April 2006 to May 2008:

This was a time when stock market pundits like Cramer and most of the talking heads on CNBC were saying the market was set to go much higher. Others who didn’t get mass media attention like Nouriel Roubini, Peter Schiff, Gary North, and Ron Paul were saying we were in big trouble.

Amazing how it worked out. Chart #2 above took two years to drop from 1300 to 850. This next chart took only five months, from May 2008 to October 2008, to drop the same amount. And yes, there was an intra-day low of 839.8 on October 10th.

If I were to show a chart from February 2003 to October 2007, it will look like the north slope of Mt. Everest. Oh heck, why don’t I go ahead and show it…

Is that what the S&P 500 will look like from October 2007 to 2011? Or will it be condensed into a space of five months like the recent deline was? Or will it be different this time?

I do not know where the market will bottom out. My sense of it is that the market will trade violently around the current level for the next few months, bouncing along this bottom. As earnings report come in lower, the P/E ratio of the market will adjust accordingly. I think there is more widespread bearishness today compared to May. But I think there are still a lot of bulls trying to buy the bottom. There is an epic battle between the bulls and bears which will continue until we see the light at the end of the economic crisis tunnel.

Meanwhile, I’m taking a look at dividend focused funds and will report on show 133.

Mark Hebner of Index Funds Advisors gives some sound advice for the current market: