Thursday, December 4, 2008

Nassim Taleb on Charlie Rose; Credit Default Swaps on US Jumping

Black chips win today, market down 2.5% from 3 PM to 4 PM. Need to adjust strategy it appears for the 3 PM Long-Short Hedge fund: whatever direction the market is going at 3 PM it will go 2-4x that direction in the last hour. I'd love to see a list of which hedgies are running and gunning these ETFs post 3 PM but apparently the SEC is not quite so intellectually curious.

So tomorrow is the end all be all on the thesis of "it's all priced in" for the near term - the equity market has shrugged off bad news Tue, Wed, and all of today up to 3 PM. (the bond market has never left its course of fear and the past year the bond market has always been right) And the morning headlines each day have been awful. We said they would be, and will continue to be for a long time. Everyone knows tomorrow will be a disaster on the employment report - after the initial knee jerk reaction we want to see what the market does around noon to 1 PM. That should be telling - but there has been a lot of shrugging off of bad news most of this week. Bulls will cling to that and if it continues one has to respect it. The faith in government to "save us all" which was so prevalent in latter 2007 and parts of 1st half of 2008 (in retrospect it was very misplaced) seems to have re-emerged with the Obama honeymoon factor. That is all based on sentiment which is impossible to game - you just have to watch the stock price action and if the equity market "believes" we go up. (even if the debt markets disagree).

But what is clear now is we are going to be going down 1 of 2 very distinct paths in the next 6-18 months. Either the "reinflation" by government shall work, and we'll move from deflationary fears to inflationary fears and a new subdued version of the US in 2004-2007 (and that's the good outcome), or we go into a Japanese deflationary spiral as government efforts fail - that leads us to fun outcomes such as social acrimony, crime waves, desperation by the populace, 2nd wave unemployment effects, food hoarding, intra country trade protectionism, disenfranchisement, and the like. A bipolar outcome - too soon to tell which way we end up.

If this latter scenario sounds outrageous consider that to fund all our bailouts we need to either have other countries continue to buy our debt (which they've been thrilled to do so far as a flight to safety!), or print it out of thin air like a banana republic. And the credit default swaps (insurance against the risk of default) on our nation have increased 68% in a month, and are up 650% year over year. The kindness of strangers remains paramount for this game to continue. (i.e. no US debt default) "That could never happen to us" has not been a great credo the past 18 months. The mini US (U.K.) is faring even worse.

What I am working on now mentally is the eventual recovery - what will it look like, what will be the catalysts. If you sit at home and think what we have left to exploit (we've used up the stock market in early part of decade and real estate in middle part of decade, the middle class' savings have been destroyed repeatedly the entire decade, and "shopping" probably won't be on the front burner as a catalyst for a long while) it is very hard to find what our drivers will be. There are only so many wind turbines we can build, and only so many roads we can rebuild. I know what we will TRY to do - reinflate the housing bubble and get people to spend over their heads again - I just don't know after the unemployment levels we will reach by this time next year, along with housing values 30-50% below peak levels, if people will be in the mood for that in 2010-2012. So as troubling as this downturn are finding the drivers for a true recovery for a country that has moved most of its production capability to cheaper locales and was relying on a 'finance based, service' economy for the new age. The finance part of this economy is not going back to 2005-2006 levels for a very long time (I think the peak of 27 year olds in investment banks making $850K was probably 2006), and the service part ties into that whole over consumption thing. I suppose 20% of us can return to be farmers - we still dominate the world in food production... hopefully some kid is in some garage somewhere thinking of the next Microsoft (or 5 of them) since we need a lot of innovation and I don't think "green energy" is going to create 10M jobs in the next few years. Remember, not only do we need a roaring economy to pay off all our coming entitlements but also to pay for all the bailouts we are doing and will continue to do well into 2009. A lot of bills come due.


This is a 20 minute video but worth the listen if you are into these things; if you are unfamiliar with my references to Black Swans, here is the Wikipedia entry and Taleb is the originator of the theory.

The Black Swan theory (in Nassim Nicholas Taleb 's version) refers to a large-impact, hard-to-predict, and rare event beyond the realm of normal expectations. Unlike the philosophical "black swan problem", the "Black Swan" theory (capitalized) refers only to events of large consequence and their dominant role in history.

I use it mockingly a lot on posts because now you see everyone using it as an excuse, back in the old days they used to say "how could we see this once in a 100 year event" (that now happens once every 5-7 years) but now it's more fashionable to say "we were a victim of a Black Swan event" (which by it's nature should be so rare that it makes no sense that everyone points to their circumstance as a Black Swan) Much of what Taleb says has been covered on the website, but most likely when he says it, it has more authority. What people should be asking is why these emergency situations that should be happening once in 100 years, now seem to happen every half decade. That's a structural problem that people are avoiding talking about. Bottom line - our system of executive adoration/compensation who live in "tails we win, heads we win" abundance .... now followed up with the "too big to fail" government assistance program creates massive risk bearing situations where entire institutions can be risked so that a few individuals can profit, and the average populace is continuously taking the pain (socialism of losses) for the blowups, while the privatization of gains go to the very few. The system is corrupted, and I am not sure how many breakdowns it takes before people understand it. Or if you don't belive that, I guess Black Swans are now as common as Pigeons.

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