• Financial & Investment Management Group
  • Tuesday, January 06, 2009

CHANGE, It Is A Comin?

by Paul Sutherland
Posted June 10, 2008
FIM Group

Current Observations

June Edition
PDF Version

A few weeks ago, we had our quarterly Utopia Funds (marathon) all-day quarterly meeting. Our fund attorney, David, had just returned from a conference where the SEC listed out their "four worries." As David began to review, I turned to a fresh page on my yellow legal pad and wrote quickly:

  1. 1) Correlation … all on the same side of a trade (Lemming)
  2. 2) Liquidity
  3. 3) Valuation
  4. 4) Policies and procedures/risk systems

    5. We went to break, and I stared out over the Chicago skyline from the 28th floor conference room's ceiling-to-floor windows to reflect on the four worries. What struck me initially was that, to me, the four worries could have been boiled down to one worry, which I'd call the "what if" risk. What if we have a recession? What if real estate goes down in value?

    Most risks are manageable. The Phoenix Mars Lander that touched town on May 25 could have had critical systems go haywire, something break, landing jets fail, a collision with a giant meteor or any other potential failure risks. The scientists and managers at NASA planned every phase of the 422-million-mile journey from Earth to Mars. Those who created the mission plan were doing what we humans have done since our creation – managing risks as part of planning for success.

    Humans are wired to be "risk systems." When I hear even the slightest noise at night, I wake up and analyze the noise. Is it our Daisy Dog, Chloe, barking at a raccoon, the wind or a burglar who promises he won't take too much?

    I remember standing on a busy street corner waiting for a light when this young boy came running through the crowd and headed into the street's oncoming traffic! About a dozen hands grabbed the boy and pulled him to the curb, safe from harm's way. His panic-stricken mother showed up before the light changed and just looked into our faces with gratitude as she strapped the four-year-old back into his "big boy" stroller.

    With personal safety, and the safety of hurried naïve boys, our don't-be-dumb, common-sense system is well-developed. However, when it comes to money, many seem to take their responsibility to its stewardship quite casually with a "so far, so good" attitude.

    The two charts on the next page clearly illustrate the landscape of perils and opportunities at hand for America. America is a country that today has allowed years of complacency to sink into its financial system. And rather than fix the problem, it appears we will put off the day of reckoning to future generations. Our government's response to the financial disaster of the day (namely, debts) appears to simply allow democratic capitalistic systems to work when it comes to profits, while allowing socialistic forces and "taxpayers – society at large" to take hold when it comes to losses. Life is always about the tension in the middle. So are politics, raising four-year-olds, landing stuff on Mars and running a business. The SEC's worries are really not about small investors losing, they're about a giant, disruptive "everyone is doin' it, so we may as well, too" bubble-creating behavior - the Internet bubble of the '90s, our real estate bubble of today, our developing bubble of consequence of what I'll call the "GDP paradigm." (I will talk about this GDP paradigm and its consequences in our next newsletter.)

    When a society privatizes its profits and socializes its losses (e.g., the bailout of consumers, which bails out the banks, which bails out Wall Street, which bails out the institutional investors who should have known better – or at least better than the consumer that doesn't know the difference between a basis point and a ball point), it creates risks and opportunities. Alas, this disconnect of economic reality and the causes of and solutions to our energy-food-debt-employment-deficit problem/opportunities are being solved in a way analogous to a person who believes that the way to keep a drunk from having a hangover is to keep him drunk. We need to have a real energy policy, a realistic agriculture policy. I sound political in these statements, and that is not my desire. The point is that the economy and, thus, investing is unsympathetically dispassionate in who benefits or loses from its forces. The economy doesn't care – people do. And they act and adapt when things get bad enough.

    We have brains that are wired to adapt to new information. We can learn, but we as a society seem to hate to learn. We avoid change, and we tend toward a natural state of complacency – until it gets so bad that we need to do something. Our attitude is to "keep the drunk drunk!" – it's his life after all – until it affects us personally. Democracies are reactive systems, so maybe this fall we will elect leadership that accepts the realities of today, says what is best for our future, fights, argues, cooperates and engages all sides for the benefit of our 300 million citizens, and acts.

    So change, with or without political response to help or hurt, it is a comin'. Will we honestly ask ourselves the big and little questions? Will we give up on the antique definition of "recession"? Should we subsidize agriculture? Are taxes in the USA causing investment capital to go overseas? Are income taxes fair, or should we move toward a flat tax or something simpler? We are big investors in H&R Block, so you know our thoughts on the "Will taxes get simpler?" debate. What about the war? What about the military industrial complex? Should we be the world's policeman? (We patrol 93 percent of the world's shipping lanes.) Should we allow drilling in Alaska and off-shore windmills in Nantucket and San Francisco Bay? Does GDP matter? Do deficits matter? (We think so. See charts showing our $48 trillion debt and our nominal GDP 10-year percentage change – quite a dramatic picture.)

    The consequences of those decisions affect investing and create opportunities. Inflation, deflation, high energy costs and unemployment are beneficial to some and cause sleepless nights to others. So I am struck by the SEC's four worries, that they can be distilled down to:

    1. 1) Use common sense
    2. 2) Things change
    3. 3) Don't be dumb
    4. 4) Be flexible
    5. 5) Pursue virtue and wisdom
    6. 6) Be responsible
    7. 7) Think long-term
    8. 8) Take action
    9. 9) Plan

    America is a great, rich, smart country. Our history shows that we will do what it takes to become stronger, usually after challenges. But the bottom line – change, it is a comin' – and it means investors will need a global, flexible approach to managing their portfolios, which is exactly what we do. While I have opinions on solutions, as do most reading this column, I know that what is important is to not let political hope or bias influence investing. I also know that realistic optimism is the best course – because as the Chinese character for "crisis" teaches us – "opportunity" is imbedded in its symbol (The symbols for "crisis" and "opportunity" are identical in Chinese). NASA's website is really great and will lead you to Mars, or even Pluto (www.nasa.gov). The SEC's website is also very informative, and all you need to do is click on their site map to see the complexity and breadth of their services (www.sec.gov). I would love to hear your thoughts on the economy, politics or investing, and a healthy critique of the points I make in this article. Snail mail works, too, and so does e-mail – psutherland@fimg.net.

 
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