Watson shows 59 is new 30 - By Thomas Friedman

A story about Tom Watson at the British Open that I enjoyed.

A wonderful but cruel game

Also, as Watson himself appreciates, the way he lost the tournament underscored why golf is the sport most like life. He hit two perfect shots on the 18th hole in the final round, and the second one bounced just a little too hard and ran through the green, leaving him a difficult chip back, which he was unable to get up and down. Had his ball stopped a foot shorter, he would have had an easy two-putt and a win.

That's the point. Baseball, basketball and football are played on flat surfaces designed to give true bounces. Golf is played on an uneven terrain designed to surprise. Good and bad bounces are built into the essence of the game. And the reason golf is so much like life is that the game – like life – is all about how you react to those good and bad bounces. Do you blame your caddy? Do you cheat? Do you throw your clubs? Or do you accept it all with dignity and grace and move on, as Watson always has. Hence the saying: Play one round of golf with someone and you will learn everything you need to know about his character.

Golf is all about individual character. The ball is fixed. No one throws it to you. You initiate the swing, and you alone have to live with the results. There are no teammates to blame or commiserate with. Also, pro golfers, unlike baseball, football or basketball players, have no fixed salaries. They eat what they kill. If they score well, they make money. If they don't, they don't make money. I wonder what the average NBA player's free-throw shooting percentage would be if he had to make free throws to get paid the way golfers have to make three-foot putts?

This wonderful but cruel game never stops testing or teaching you. “The only comment I can make,” Watson told me after, “is one that the immortal Bobby Jones related: ‘One learns from defeat, not from victory.' I may never have the chance again to beat the kids, but I took one thing from the last hole: hitting both the tee shot and the approach shots exactly the way I meant to wasn't good enough…. I had to finish.”

THE MAN NOBODY WANTED TO HEAR

Thanks to Matt for the find.

William White predicted the approaching financial crisis years before 2007's subprime meltdown. But central bankers preferred to listen to his great rival Alan Greenspan instead, with devastating consequences for the global economy.

William White had a pretty clear idea of what he wanted to do with his life after shedding his pinstriped suit and entering retirement.

White, a Canadian, worked for various central banks for 39 years, most recently serving as chief economist for the central bank for all central bankers, the Bank for International Settlements (BIS), headquartered in Basel, Switzerland.

Then, after 15 years in the world's most secretive gentlemen's club, White decided it was time to step down. The 66-year-old approached retirement in his adopted country the way a true Swiss national would. He took his money to the local bank, bought a piece of property in the Bernese Highlands and began building a chalet. There, in the mountains between cow pastures and ski resorts, he and his wife planned to relax and enjoy their retirement, and to live a peaceful existence punctuated only by the occasional vacation trip. That was the plan in June 2008.

And now this.

White is wearing his pinstriped suits again. He has just returned from California, where he gave a talk at a large mutual fund company. Then he packed his bags again and jetted to London, where he consulted with the Treasury. After that, he returned to Switzerland to speak at the University of Basel, and then went on to Frankfurt to present a paper at the Center for Financial Studies. From there, White traveled to Paris to attend a meeting at the Organization for Economic Cooperation and Development (OECD). Finally, he flew back across the Atlantic to Canada. White is clearly in demand, including in North America.

Since the economy went up in flames, the wiry retiree has been jetting around the globe like a paramedic for the world of high finance. He shows no signs of exhaustion, despite his rigorous schedule. In fact, White, with his gray head of hair, is literally beaming with energy, so much so that he seems to glow.

Perhaps it is because someone, finally, is listening to him.

Listening to him, that is, and not to his rival of many years, the once-powerful former chairman of the US Federal Reserve Bank, Alan Greenspan. Greenspan, who was reverentially known as "The Maestro," was celebrated as the greatest central banker of all time -- until the US real estate bubble burst and the crash began.

Before then, no one in the world of central banks would have dared to openly criticize Greenspan's successful policy of cheap money. No one except White, that is.

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Related paper: William White: Is price stability enough? – April 2006

Jeremy Grantham's 2Q 2009 letter: Boring Fair Price!; Running Out of Resources

Waiting for Markets to be Silly Again

A year is certainly a long time in markets, and so is a quarter. A year ago, equities globally – and everything else for that matter – were very overpriced, particularly if they were risky. A quarter ago, in mid March, prices everywhere were cheap. Now they have all – or almost all – converged for a few unusual moments at fair value. A year ago, it was very easy to know what to be: a risk avoider. It was not so easy reinvesting when terrified, but most of us knew that we should have been doing more. But today? It’s difficult to be inspired at fair value.

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What we specialize in at GMO, not surprisingly perhaps, is doing the easy job: we wait for extreme situations and predict that they will become normal once again. When markets sell at normal prices, life for us becomes much harder, perhaps 10 times harder. Predicting movements away from rational prices in an irrational world should not be easy, and indeed it is not. Our one and only effort at predicting a bubble – in emerging markets – is likely to stay just that. Only U.S. quality feels (and measures) to us like a real outlier. As for the rest, if you feel yourself becoming overconfident about anything, take a cold shower and start again. Just be patient. In our strange markets, you usually don’t have to wait too long for something really bizarre to show up.

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Behind these two issues, however, lurks another longer-term and more important factor affecting future growth, and that is the increasing limitations on resources: we are simply running out of everything at a dangerous rate. We apparently have trouble processing numeric issues of this kind, and this missing faculty will cause considerable grief. We do not understand the implications of exponential or compound growth rates: the main implication being that they are impossible to sustain.

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It should be obvious from simple arithmetic that population growth is on a direct collision course with increasingly scarce resources.

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This transition away from carbon-based fuels could have been relatively painless on paper, but in real life our species has such a modest ability to deal with distant outcomes or to defer gratification that a bad ending is probably inevitable. We need, it seems, the shock of a Pearl Harbor to really gear up and make sacrifices.

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Well, dear readers, happy thoughts and wishful thinking do not make it so; 30 precious years have passed, and there is now no safety margin. We must prepare ourselves for waves of higher resource prices and periods of shortages unlike anything we have faced outside of wartime conditions. In fact, I believe we are already several years into this painful transition but are still mostly invested in denying it. Everything within the investment business will be affected as well as everything outside of the business.

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Reading and Listening List [from end of Grantham’s letter]

Hardin, Garrett. Living within Limits: Ecology, Economics, and Population Taboos, Oxford University Press, 1993.

Bartlett, Albert A. The Most Important Video You’ll Ever See, Arithmetic, Population, and Energy. 2009 .

Martenson, Chris. The Crash Course. 2009 .

Jean-Marie Eveillard on King World News

Part I - July 17, 2009

Part II - July 24, 2009

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Related previous post: First Eagle Conference Presentations from Mathew McLennan and Jean-Marie Eveillard

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It’s the real economy, stupid

Sprott Asset Management's July Comment, via Simoleon Sense: HERE

Related links:

Eric Sprott on King World News - July 17, 2009

Eric Sprott on King World News Part II - July 24, 2009

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Warren Starring on the Web

Chris Anderson on Charlie Rose

Graham and Doddsville Newsletter - Summer 2009

Columbia Business School's Graham and Doddsville Newsletter - Summer 2009

Featuring Paul Sonkin and Steve Moyer, among others

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Hussman Weekly Market Comment: Tending Seeds - Reacting, Responding, Planting, and Watering

If you'll forgive the discourse (and at the risk of wandering a bit afield), over the years I've found thinking about the world from the standpoint of seeds to be enormously helpful. My friend Thich Nhat Hanh puts it this way:

“Consciousness is said to be a field; a plot of land in which every kind of seed has been planted – seeds of suffering, happiness, joy, sorrow, fear, anger, and hope. The quality of our life depends on which of these seeds we water. The practice of mindfulness is to recognize each seed as it sprouts, and to water the most wholesome seeds whenever possible.”

The basic idea is that, confronted with a whole host of seeds in our daily lives, the ones that we water will generally (though not always) be the ones that grow. So if we tend and water the negative seeds; worry, anger, disappointment, fear, and so on, the energy we put toward those seeds will tend to make them grow and become very big in our daily lives. If instead we tend and water the positive seeds; friendship, gratitude, discipline, peace, and happiness, then those are the seeds that will grow. That doesn't mean walking around like a Polyanna (which is unlikely for a crusty skeptic like me), but it does mean that there is some tendency, however imperfect, to reap what we sow, even just by what we choose to habitually think about. As the Buddha said, “with our thoughts, we create our world.”

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Seeds not planted or tended by choice tend to be weeds, so at least for me, it's very helpful to consciously and periodically choose which seeds I want to water, and to think through what I expect to happen from that watering. Investors can spend a lot of time and energy reacting to the latest bits of news and trying to predict the next surprise, rather than choosing a consistent set of daily actions that they can carry out as things develop, regardless of how they develop.

COCKSURE: Banks, battles, and the psychology of overconfidence – by Malcolm Gladwell

Since the beginning of the financial crisis, there have been two principal explanations for why so many banks made such disastrous decisions. The first is structural. Regulators did not regulate. Institutions failed to function as they should. Rules and guidelines were either inadequate or ignored. The second explanation is that Wall Street was incompetent, that the traders and investors didn’t know enough, that they made extravagant bets without understanding the consequences. But the first wave of postmortems on the crash suggests a third possibility: that the roots of Wall Street’s crisis were not structural or cognitive so much as they were psychological.

In “Military Misfortunes,” the historians Eliot Cohen and John Gooch offer, as a textbook example of this kind of failure, the British-led invasion of Gallipoli, in 1915. Gallipoli is a peninsula in southern Turkey, jutting out into the Aegean. The British hoped that by landing an army there they could make an end run around the stalemate on the Western Front, and give themselves a clear shot at the soft underbelly of Germany. It was a brilliant and daring strategy. “In my judgment, it would have produced a far greater effect upon the whole conduct of the war than anything [else],” the British Prime Minister H. H. Asquith later concluded. But the invasion ended in disaster, and Cohen and Gooch find the roots of that disaster in the curious complacency displayed by the British.

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Cohen and Gooch ascribe the disaster at Gallipoli to a failure to adapt—a failure to take into account how reality did not conform to their expectations. And behind that failure to adapt was a deeply psychological problem: the British simply couldn’t wrap their heads around the fact that they might have to adapt. “Let me bring my lads face to face with Turks in the open field,” Hamilton wrote in his diary before the attack. “We must beat them every time because British volunteer soldiers are superior individuals to Anatolians, Syrians or Arabs and are animated with a superior ideal and an equal joy in battle.”

Hamilton was not a fool. Cohen and Gooch call him an experienced and “brilliant commander who was also a firstrate trainer of men and a good organizer.” Nor was he entirely wrong in his assessments. The British probably were a superior fighting force. Certainly they were more numerous, especially when they held that ten-to-one advantage at Sulva Bay. Hamilton, it seems clear, was simply overconfident—and one of the things that happen to us when we become overconfident is that we start to blur the line between the kinds of things that we can control and the kinds of things that we can’t. The psychologist Ellen Langer once had subjects engage in a betting game against either a self-assured, well-dressed opponent or a shy and badly dressed opponent (in Langer’s delightful phrasing, the “dapper” or the “schnook” condition), and she found that her subjects bet far more aggressively when they played against the schnook. They looked at their awkward opponent and thought, I’m better than he is. Yet the game was pure chance: all the players did was draw cards at random from a deck, and see who had the high hand. This is called the “illusion of control”: confidence spills over from areas where it may be warranted (“I’m savvier than that schnook”) to areas where it isn’t warranted at all (“and that means I’m going to draw higher cards”).

At Gallipoli, the British acted as if their avowed superiority over the Turks gave them superiority over all aspects of the contest. They neglected to take into account the fact that the morning sun would be directly in the eyes of the troops as they stormed ashore. They didn’t bring enough water. They didn’t factor in the harsh terrain. “The attack was based on two assumptions,” Cohen and Gooch write, “both of which turned out to be unwise: that the only really difficult part of the operation would be getting ashore, after which the Turks could easily be pushed off the peninsula; and that the main obstacles to a happy landing would be provided by the enemy.”

Most people are inclined to use moral terms to describe overconfidence—terms like “arrogance” or “hubris.” But psychologists tend to regard overconfidence as a state as much as a trait. The British at Gallipoli were victims of a situation that promoted overconfidence. Langer didn’t say that it was only arrogant gamblers who upped their bets in the presence of the schnook. She argues that this is what competition does to all of us; because ability makes a difference in competitions of skill, we make the mistake of thinking that it must also make a difference in competitions of pure chance. Other studies have reached similar conclusions. As novices, we don’t trust our judgment. Then we have some success, and begin to feel a little surer of ourselves. Finally, we get to the top of our game and succumb to the trap of thinking that there’s nothing we can’t master. As we get older and more experienced, we overestimate the accuracy of our judgments, especially when the task before us is difficult and when we’re involved with something of great personal importance. The British were overconfident at Gallipoli not because Gallipoli didn’t matter but, paradoxically, because it did; it was a high-stakes contest, of daunting complexity, and it is often in those circumstances that overconfidence takes root.

Several years ago, a team headed by the psychologist Mark Fenton-O’Creevy created a computer program that mimicked the ups and downs of an index like the Dow, and recruited, as subjects, members of a highly paid profession. As the line moved across the screen, Fenton-O’Creevy asked his subjects to press a series of buttons, which, they were told, might or might not affect the course of the line. At the end of the session, they were asked to rate their effectiveness in moving the line upward. The buttons had no effect at all on the line. But many of the players were convinced that their manipulation of the buttons made the index go up and up. The world these people inhabited was competitive and stressful and complex. They had been given every reason to be confident in their own judgments. If they sat down next to you, with a tape recorder, it wouldn’t take much for them to believe that they had you in the palm of their hand. They were traders at an investment bank.

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It makes sense that there should be an affinity between bridge and the business of Wall Street. Bridge is a contest between teams, each of which competes over a “contract”—how many tricks they think they can win in a given hand. Winning requires knowledge of the cards, an accurate sense of probabilities, steely nerves, and the ability to assess an opponent’s psychology. Bridge is Wall Street in miniature, and the reason the light bulb went on when Greenberg looked at Cayne, and Cayne looked at Spector, is surely that they assumed that bridge skills could be transferred to the trading floor—that being good at the game version of Wall Street was a reasonable proxy for being good at the real-life version of Wall Street.

It isn’t, however. In bridge, there is such a thing as expertise unencumbered by bias. That’s because, as the psychologist Gideon Keren points out, bridge involves “related items with continuous feedback.” It has rules and boundaries and situations that repeat themselves and clear patterns that develop—and when a player makes a mistake of overconfidence he or she learns of the consequences of that mistake almost immediately. In other words, it’s a game. But running an investment bank is not, in this sense, a game: it is not a closed world with a limited set of possibilities. It is an open world where one day a calamity can happen that no one had dreamed could happen, and where you can make a mistake of overconfidence and not personally feel the consequences for years and years—if at all. Perhaps this is part of why we play games: there is something intoxicating about pure expertise, and the real mastery we can attain around a card table or behind the wheel of a racecar emboldens us when we move into the more complex realms. “I’m good at that. I must be good at this, too,” we tell ourselves, forgetting that in wars and on Wall Street there is no such thing as absolute expertise, that every step taken toward mastery brings with it an increased risk of mastery’s curse.

Greenlight Capital Q2 Letter

Link: Greenlight Capital Q2 Letter

It ends with a great quote: “The pessimist complains about the wind; the optimist expects it to change; the realist adjust the sails.” –William Arthur Ward

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That quote reminded me of the way Bill Miller opened his Q2 2008 Letter:

A group of us were standing around a few weeks ago when Warren Buffett wandered over. Chris Davis had dubbed us the Value Support Group, as we all adhered to that approach to investing. We were commiserating over how badly we had done in this market, how valuation appeared not to matter and had not for the past couple of years, how it was all about momentum and trend, and how we were all losing clients and assets over and above our losses in the market. It seemed like we needed a 12-step program to cure us of our addiction to buying beaten-up stocks trading at large discounts to our assessment of their intrinsic value.

Mason Hawkins said, "Warren, I'm an optimist. I think this whole thing can turn quickly, and surprise people. Are you an optimist?" "I'm a realist, Mason," the sage replied.

Bill Gates offers the world a physics lesson

Thanks to Steve Friedman and Simoleon Sense for finding and posting this.

In between trying to eradicate polio, tame malaria, and fix the broken U.S. education system, Gates has managed to fulfill a dream of taking some classic physics lectures and making them available free over the Web. The lectures, done in 1964 by noted scientist (and Manhattan Project collaborator) Richard Feynman, take notions such as gravity and explains how they work and the broad implications they have in understanding the ways of the universe.

Gates first saw the series of lectures 20 years ago on vacation and dreamed of being able to make them broadly available. After spending years tracking down the rights--and spending some of his personal fortune--Gates has done just that. Tapping his colleagues in Redmond to create interactive software to accompany the videos, Gates is making the collection available free from the Microsoft Research Web site.

Gates said that he hoped his action would serve as a model for taking great educational content and making it broadly available for free.

Time to tackle the real evil: too much debt - By Nassim Nicholas Taleb and Mark Spitznagel

The core of the problem, the unavoidable truth, is that our economic system is laden with debt, about triple the amount relative to gross domestic product that we had in the 1980s. This does not sit well with globalisation. Our view is that government policies worldwide are causing more instability rather than curing the trouble in the system. The only solution is the immediate, forcible and systematic conversion of debt to equity. There is no other option.

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Our ability to forecast suffers due to this complexity and the occurrence of the occasional extreme event, or “black swan”. Such degradation in predictability should have made companies more conservative in their capital structure, not more aggressive – yet private equity, homeowners and others have been recklessly amassing debt. Such non-linearity makes the mathematics used by economists rather useless. Our research shows that economic papers that rely on mathematics are not scientifically valid. Not only do they underestimate the possibility of “black swans” but they are unaware that we do not have any ability to deal with the mathematics of extreme events. The same flaw found in risk models that helped cause the financial meltdown is present in economic models invoked by “experts”. Anyone relying on these models for conclusions is deluded.

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We believe that stimulus packages, in all their forms, make the same mistakes that got us here. They will lead to extreme overshooting or extreme undershooting. They lead to more borrowing, by socialising private debt. But running a government deficit is dangerous, as it is vulnerable to errors in projections of economic growth. These errors will be larger in the future, so central bank money creation will lead not to inflation but to hyper-inflation, as the system is set for bigger deviations than ever before.

Relying on standard models to build policies makes us all fragile and overconfident. Asking the economics establishment for guidance (particularly after its failure to see the risk in the economy) is akin to asking to be led by the blind – instead we need to rebuild the world to make it resistant to the economist’s mystifications.

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Related book: The Black Swan: The Impact of the Highly Improbable

Robert Rodriguez on WealthTrack

Robert Rodriguez was a guest on last week's Consuelo Mack WealthTrack: Video - 7/10/09

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Related previous post: Bob Rodriguez - Morningstar Keynote Speech: Reflections and Outrage

Monday Interview: Man on the money with Buffett

Thanks Linc!

Over the years, generations of investors, chief executives and journalists have wondered why Mr Munger has stayed happily in the background for almost half a century as Mr Buffett forged a reputation as the world's greatest stock-picker.

"Warren is peculiar, and I'm peculiar," says Mr Munger, who is also Berkshire's vice-chairman. "We've got our own peculiar operating model. Nobody else operates the same way or stays in the game in a major corporation as long as we have, so we've got a different model. And we like it that way."

Working 1,500 miles apart – Mr Buffett remains in his hometown of Omaha, Nebraska – the two "intellectual pals" have built up a stellar record by sticking to the basic principles of value investing: they buy companies in industries they understand, with managers they trust, at cut-rate prices. "We think all intelligent investing is value investing," he says. "What the hell could it be if it wasn't value?"

While Mr Buffett's mentor, the economist Benjamin Graham, is considered the father of value investing, it is Mr Munger who is credited with helping Mr Buffett evolve beyond buying stocks for no other reason than that they were cheap.

"That worked fine in the period after the 1930s," Mr Munger says. "I don't think it works nearly as well now. Too many people are doing it."

Many of Berkshire's holdings, from longtime investments such as Coca-Cola and Wells Fargo to last year's purchase of General Electric's preferred shares, are blue-chip companies considered the best at what they do.

The strategy sounds simple enough, but Mr Munger says few investors practise it. "You can't believe the way that conventional wisdom invests money," he explains. "They tend to rush into whatever fad has worked lately. In my opinion, a lot of them are going to get creamed."

There are no regular meetings at Berkshire, no corporate-speak or standard management memorandums that help define the cultures of so many companies.

"The legally required meetings for corporate governance, we do those," Mr Munger says. "Everything else is ad hoc."

The Wisdom of the Stoics: Selections from Seneca, Epictetus, and Marcus Aurelius

Frances and Henry Hazlitt (yes, the author of the great Economics in One Lesson) put together this wonderful compilation of wisdom from three great Stoics. I found this a little while back and Miguel's post from earlier today inspired me to finally get around to putting it up.

Link: The Wisdom of the Stoics:

Selections from Seneca, Epictetus, and Marcus Aurelius

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Related books (the main works by the three Stoics are available for free online in various places as well):

Seneca: Letters from a Stoic

Enchiridion

Discourses and Selected Writings 

Marcus Aurelius: Meditations

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Warren Buffett on CNBC

Howard Marks Memo: So Much That’s False and Nutty

As reported in The New York Times of May 5, Warren Buffett told the crowd at this year’s Berkshire Hathaway annual meeting:

There is so much that’s false and nutty in modern investing practice and modern investment banking. If you just reduced the nonsense, that’s a goal you should reasonably hope for.

As we look back at the causes of the crisis approaching its second anniversary – and ahead to how investors might conduct themselves better in the future – Buffett’s simple, homespun advice holds the key, as usual. I agree that investing practice went off the rails in several fundamental ways. Perhaps this memo can help get it back on.

Warren Buffett on Good Morning America

The interviewer also mentioned (at the end of the video) that she asked Mr. Buffett which one index he follows the most. She said his response was the freight train index because it really shows the movement of raw materials throughout the country. (Will, thanks for passing the video along!)

As debate grows about a possible second stimulus package for the flagging American economy, at least one legendary investor is giving the idea his guarded approval.

"I think that a second one may well be called for," Warren Buffett, the CEO of Berkshire Hathaway, told "Good Morning America" today. But, he added, "you hope it doesn't get watered down in many ways."

Buffett cautioned that a second stimulus package, like the first, won't be "a panacea," because stimulus packages take time to work. He criticized lawmakers' work on the first stimulus package, which contained $787 billion in spending.

"Our first stimulus bill ... was sort of like taking half a tablet of Viagra and having also a bunch of candy mixed in ... as if everybody was putting in enough for their own constituents," he said.

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Related link (Thanks Barry!): Railfax Report

Nassim Taleb talks about the book “Dance With Chance”

Great find from Miguel at Simoleon Sense. Link to Miguel's post and video: HERE

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Related books:

Dance with Chance

The Black Swan

Fooled by Randomness

The Drunkard's Walk

Apollo Asia Fund: the manager's report for 2Q2009

During the first quarter we repositioned the portfolio significantly; during the second we made only modest changes. Three months ago we reported an abundance of quality/growth options at attractive prices. Many of the more promising participated fully in the market's surge. By end-June, we had net gains of 36%, 99% and 164% on the three stocks which we added in 1Q. Several leading companies report that they see no signs of green shoots, but have anyway doubled in price. Valuations are now much less compelling. We are back to carefully weighing the relative resilience and prospects of businesses for the long haul, against a backdrop of economic turbulence which we expect to continue, and possibly to intensify.

Governments, disappointingly, have 'wasted a good crisis'. Not only have they thrown away unimaginable amounts of taxpayers' money, postponing necessary adjustments, and impoverishing future generations. Not only have they missed opportunities for intelligent reform and appeared to be victims of 'regulatory capture'. Not only have they flouted the established hierarchy of creditors, imposing unwarranted losses on the prudent, and distorted the allocation of capital. They have also failed to seize the opportunity to reexamine market fundamentalism, to lead intelligent debate on the appropriate goals of societies, and to forge a new consensus on effective moves towards a more sustainable future.

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We mentioned that the economic crisis may intensify. Papering over cracks serves only to obscure the necessity of remedial action while the problem gets worse. The patchwork of quick fixes will have unintended consequences. Crises in pensions, insurance, government finances, housing foreclosures, etc, may be visible long after their worsening becomes inevitable, long after they become impossible to avert - but long before they reach bottom. The same will at some stage prove true of energy resources, and environmental damage. The timetable for these is less forecastable: they could be decades away, but the possibility that they may intensify suddenly should be borne in mind. Planetary and bureaucratic overload, like military blowback, lend themselves to the models of catastrophe theory, and may reach tipping points with little warning.

How to plan for energy and environmental contingencies, we are not at all sure. Fortunately, it seems likely that there will be better times to act. The stampede for inflation hedges may be premature (forced and voluntary deleveraging may outpace the printing presses for a while). Exchange-traded funds have made the establishment of long positions in commodities more convenient for many, and more investors now seem to be viewing commodities as appropriate for large asset allocations, changing historic price relationships. In John Hussman's phrase, it may be 'hard for investors to sustain a durable sense of doom about inflation risk', if we have a period of subdued prices or deflation meanwhile. Likewise for resource shortages: some 1970s analysis still reads well, but many market participants would regard three decades 'too early' (even if intended as a warning) as tantamount to being wrong. However, early warnings are valuable. Investor views on appropriate long-term strategies would be welcome.

Meanwhile, the attempt to recreate the market economy of 2007 seems both doomed and foolhardy. Many industries will not quickly return to 2007 levels: some will never be the same again. We are wary of future predictions for most 'luxury', several types of retail and consumer goods (spending patterns may change for decades), the auto industry, many types of capital machinery, and construction equipment... among others. We nevertheless hold some shares in these sectors, if the risk-reward proposition remains reasonable, but many of our holdings are in other sectors where business is relatively predictable - supermarkets, fast food, consumer finance, aircraft maintenance, basic telecommunications - and life, for the time being, goes on.

Hussman Weekly Market Comment: Brief Holiday Update

Given current household leverage from mortgage and consumer debt, coupled with the inability to access mortgage equity withdrawals (that largely fed spending increases during the most recent economic expansion), my concern continues to be that unemployment will behave as a leading indicator rather than a lagging one. During typical economic downturns, there is always some feedback from employment losses to credit losses, but that effect has been more contained because debt burdens have not been nearly as high, and homeowners have not been saddled with negative home equity. The dynamic of this downturn is different, so investors should be slow to accept the “employment is a lagging indicator” argument under present conditions.

On the inflation front, I continue to believe that any persistent inflation pressure is most probably several years out. The primary inflation risk is not simply that the Treasury and Federal Reserve have dramatically expanded the volume of government liabilities. To the extent that these agencies have taken assets in – commercial mortgage securities or preferred stock of banks – these transactions could theoretically be reversed without leaving a persistent increase of government liabilities in their wake. The real problem is that avoiding inflation here requires that these transactions can be undone, and that will prove impossible if mortgage defaults do not actually stop. There is no reason to believe that they will, particularly given the enormous overhang of second-wave mortgage resets that will begin later this year. So the real problem is not just that we've issued more government liabilities, but that the assets that we've taken in return will turn out to be worth less than the liabilities we created. The difference, of course, will represent pure money creation, and that's what will feed inflationary pressures over time.