The Collapse of Leverage
By Paul Lamont
May 11, 2011
Since the late nineties, many
people have lost a significant portion of their net worth speculating on one
asset class after another (especially when using leverage).
The remedy for this is very
simple. A very large portion of your funds should be watching from the
sidelines in U.S. Treasury Bills (until bargains are irresistible in
traditional asset classes).
Commodities Sell-Off
In March, with inflation fears in a
frenzy, we argued that the only way to “inflation proof” your
investment portfolio was to take the hype as a warning for a sell-off.
"Whenever you find yourself on the
side of the majority, it is time to stop and reflect." - Mark
Twain
Commodities broke hard last
week. According to Reuters: “Never before had
crude oil plummeted so deeply during the course of a day...The rare moves of
$10 a barrel usually are set off by dramatic events -- the outbreak of the
first Gulf War in 1991, or the collapse in 2008 of Lehman Bros bank, which both
led to recessions.”
In March, we reminded investors that
the oil rise “helped break the financial system in 2008. We look for it
to happen again in 2011.” Our conclusion was to “urge investors to
use this time to reduce risk, get liquid and secure your investment portfolio” (if they
haven’t already done so).
Interestingly enough, as the
chart below shows, there is more leverage in the stock market now than before the collapse of Lehman Brothers.
“When
you combine ignorance and leverage, you get some pretty interesting
results.” – Warren Buffett
During the recent oil sell-off, which encompassed all markets to some
degree, “‘’Funds were likely to take profits before June when
the direct (Fed) bond purchases stop. All were eyeballing each other to see who
would take profits first,’ said a London-based oil trader.”
When valuations are high,
this game of chicken ends up convincing investors to stay past the peak. The smartest investors sell when regular investors are piling in and the mania is at fever pitch. While George Soros was selling according to the WSJ,
“day traders were going crazy.” If a trend ever gets
to this level of excitement, cross it off your list if you are a buyer or sell
if you already own, i.e. do what Soros does.
QE2 Was Just Speculation
Russell Napier, author of Anatomy
of a Bear: Lessons From Wall Street’s Four Great Bottoms (and who we
quoted extensively in early March), followed us with a similar
report published on March 18th 2011. It was titled QE2 fails, Sell U.S. Equities. He concludes: “QE2
has boosted reserves but banks continue to reduce credit, while broad money has
contracted. There is material downside risk to equity valuations.”
Which
means in everyday language: The banks are using all the printed money to back
losses in the housing market. Speculation that the money would get out into the
economy is completely wrong...Get ready for a major sell off in stocks.
“Pay
attention to what everyone else neglects.” – Jim Rogers. A Gift to
My Children. 2009.
Words of Wisdom from GMO And
An Ancient Stonecutter
James Montier (GMO, LLC) describes his Seven Immutable Laws of Investing :
1. Always
insist on a margin of safety.
2. This
time is never different.
3. Be
patient and wait for the fat pitch.
4. Be
contrarian.
5. Risk
is the permanent loss of capital, never a number.
6. Be
leery of leverage.
7. Never
invest in something you don’t understand.
"High dwellings are the
peace and harmony of our descendants." - Ancient Stone Tsunami Marker in unscathed Aneyoshi, Japan
Professionals Go To Cash
If you haven’t already liquidated
your portfolio of stocks, bonds and money market fund shares and moved to cash you are
already late. Bill Gross, who runs the world’s largest bond fund and
co-founder of PIMCO, is now 31% in cash - the most ever for the BOND fund. Jeremy Grantham, co-founder
of GMO LLC (which serves institutional investors), wrote in his Quarterly Report published May 11, 2011:
“the environment has simply become too risky to justify prudent investors
hanging around, hoping to get lucky. So now is not the time to float along with
the Fed, but to fight it.” His advice to investors is to have “extra cash reserves and patience.” Another sage, Jim Grant, author of the Grant’s
Interest Rate Observer, has spent pretty much all of his entire career since
1983 railing against the weak dollar (and rightly so). In an
April interview however, he believes that after a sharp burst of inflation a
“terrific chaos in investment markets” will occur where
“liquidity would come into its own very suddenly.” He is even
forced to admit that U.S. dollars would become “precious and
valuable”, while recognizing that he is in the “habit of
disparaging them...because they are paper.” These paper dollars are
needed by banks to hold against paper losses and for investors to pay down
debts used in speculation.
Since February, the 3-month
T-Bill yield has moved back down to almost zero. We’ve already had our
bout of inflation; the rush into cash is already on. We should expect a
collapse of leverage.
Full Disclosure: Paul J.
Lamont holds a small S&P500 put option position.
At Lamont Trading Advisors, we provide wealth preservation strategies for our clients. For more information, feel free to contact us. Our monthly Investment Analysis Report requires a subscription fee of $40 a month. Current subscribers are allowed to freely distribute this report with proper attribution.
***No graph, chart, formula or other device offered can in and of itself be used to make trading decisions. This newsletter should not be construed as personal investment advice. It is for informational purposes only.
Copyright ©2011 Lamont Trading Advisors, Inc. Paul J. Lamont is President of Lamont Trading Advisors, Inc., a registered investment advisor in the State of Alabama. Persons in states outside of Alabama should be aware that we are relying on de minimis contact rules within their respective home state. For more information about our firm visit www.LTAdvisors.net, or to receive a copy of our disclosure form ADV, please email us at advrequest@ltadvisors.net, or call (256) 850-4161.