Featured Trades: (PCY), (LQD)

3) Sovereign Debt is a Great Place to Hide. I am constantly asked where to find safe places to park cash by investors understandably unhappy with the risk/reward currently offered by the markets. Any reach for yield now carries substantial principal risk, the kind we saw, oh say, in the summer of 2007.

I have had great luck steering people into the Invesco PowerShares Emerging Market Sovereign Debt ETF (PCY) for the last nine months, which is invested primarily in the debt of Asian and Latin American government entities, and sports a generous 6.44% yield. This beats the daylights out of the one basis point you currently earn for cash, the 3.86% yield on 10 year Treasuries, and still exceeds the 4.70% yield on the iShares Investment Grade Bond ETN (LQD), which buys predominantly single 'BBB', or better, US corporates.

The big difference here is that PCY has a much rosier future of credit upgrades to look forward to than other alternatives. It turns out that many emerging markets have little or no debt, because until recently, investors thought their credit quality went down like a bad fish taco. No doubt a history of defaults in the region going back to 1820 is in the backs of their minds.

You would think that a sovereign debt fund would be the last place to safely park your money in the middle of a debt crisis, but you'd be wrong. PCY has minimal holdings in the Land of Socrates and Plato, and very little in the other European PIIGS. In fact, the crisis has accelerated the differentiation of credit qualities, separating the wheat from the chaff, and sending bonds issues by financially responsible countries to decent premiums, while punishing the bad boys with huge discounts.?? It seems this fund has a decent set of managers at the helm.

With US government bond issuance going through the roof, the shoe is now on the other foot. Even my cleaning lady, Cecelia, knows that US Treasury issuance is rocketing to unsustainable levels (she reads my letter to practice her English). Moody's has been rattling its saber about a downgrade of US debt on an almost daily basis, and it is just a matter of time before this once unimaginable event transpires. When it does, there could be a stampede into the debt of other healthier countries, potentially sending the price of PCY through the roof.

A price appreciation by PCY of 170% to $26.19 a share in the past year tells you this is not exactly an undiscovered concept. Since my initial recommendation, money has been pouring into PCY, taking it up to a record $500 million in assets. Still, it is something to keep on your 'buy on dips' list.

I lived through the Latin American debt crisis of the seventies. You know, the one that almost took Citibank down? Never in my wildest, Jack Daniels fueled dreams did I think that I'd see the day when Brazilian debt ratings might surpass American ones. Who knew I'd be trading in Marilyn Monroe for Carmen Miranda? But that day is coming.

Featured Trades: (THE US EDUCATION SURPLUS)

3) The Huge US Balance of Payments Surplus in Education. I spent the weekend attending? a graduation in? Washington state, a stone?s throw from where the 2010 Winter Olympics were recently held. While sitting through the tedious reading of 550 names, and listening to the wailing bagpipes, I did several calculations on the back of the commencement program. I came to some startling conclusions. Higher education has grown into a gigantic industry, with a massively positive impact on America?s balance of payments, generating an impact on the world far beyond the dollar amounts involved. There are 671,616 foreign students in the US (90,000 from China alone) paying an average out-of-state tuition of $25,000 each, creating a staggering $16.8 billion of payments a year. On a pro rata basis, that amounts to a serious part of our total receipts in services in Q4 2009 of $131.6 billion, not far behind financial services (click here for the Bureau of Economic Analysis site ) . A fortunate few, backed by endowed chairs and buildings built by wealthy and eager parents, land places at prestigious Universities like Harvard, Princeton, Yale, and UC Berkeley. The overwhelming majority, however, enroll in the provinces in a thousand rural state universities and junior colleges that most of us have never heard of. The windfall has enabled once sleepy little schools to build themselves into world class institutions of higher learning with 30,000 or more students, boasting state of the art facilities, much to the joy of local residents and state education officials. Furthermore, this dominance of education industry is steadily Americanizing the global establishment. I can?t tell you how many times over the decades I have run into the Persian Gulf sovereign fund manager who went to Florida State, the Asian CEO who attended Cal State Hayward, or the African finance minister who fondly recalled rooting for the Kansas State Wildcats. Those who constantly bemoan the impending fall of the Great American Empire can take heart by merely looking inland at these impressive degree factories. It also might give them an explanation of why the dollar is so strong in the face of absolute gigantic and perennial trade deficits.

Global Market Comments
March 23, 2010

1) Son of Texas and financial seer, John Mauldin, believes the stock market could shed 40% in the near future (SPX). John is the president of Millennium Wave Advisors, LLC, a Dallas, Texas based investment advisor, with $600 million in assets under management. John worries that the velocity of money, an indicator of how many times a dollar is reused in the economy, is collapsing. This ratio, which is defined by the GDP divided by the money supply, bottomed at 1.15 in 1946. It peaked at a breathtaking 2.2 times in 1997, near the top of the Dotcom bubble. The ratio has been retreating ever since, has recently accelerated down to the 100 year mean, but still has much farther to fall to get to the bottom of the 100 year range. The collapse of velocity signals the end of a 50 year super cycle in lending. For you and I, this means lower economic growth for perhaps another decade. It is partly the result of banks getting generous funding from the Treasury, and then sitting on it. The bucks simply stop there. It suggests that no matter how much money the government pumps into the economy, it might as well be pushing on a wet noodle. The gold bugs have got it all wrong, simply focusing on money supply growth and expecting hyperinflation. A lot of money can sit and go nowhere. The inflation will come back with a vengeance when the economy revives and banks finally resume lending. With so much new money being created in the last two years, the chances of the Fed being able to head this off are close to nil. Similarly, the bond vigilantes may have to wait a couple of years for their big move down in the 30 year Treasury bond (TBT). When the bond markets call ?times up,? the US will be forced to embark on some highly deflationary spending cuts. If this happens during a recession, it could be a disaster. John thinks there will be a substantial slowdown in growth in Q3 and Q4. With anticipated federal tax increases of 2% of GDP in 2011 added to a further 1% in state tax hikes, the recovery will be strangled in its crib. That?s when the risk of a double dip recession explodes. Over 3-4 years higher taxes could add up to a burdensome 9% drag on GDP. John says that emerging markets (EEM) will decouple from the US and keep powering up, as this is where the real economic growth is (EEM). He has been a gold bull since 2002 (GLD), when it was below $300/ounce, and isn?t backing off from that position, but prefers to own it against Euros at this point. He thinks the entire premise for the existence of the European currency (XEU) is questionable, and sees it eventually moving to parity against the dollar. John doesn?t manage money directly himself, but outsources assets with market timers employing a number of different models. One firm he has particular success with is CMG in Philadelphia (CMGTX). He really only selects individual stocks in the biotech area, which he thinks have the potential to develop into a bubble, and has a variety of small cap and microcap holdings. Not pulling any punches, John said that the Republican leadership of the last congress was ?criminally incompetent? in the way they unnecessarily squandered surpluses and spent their way into oblivion, leaving us without dry powder to fight the current crisis. John has an incredibly diverse past, which includes a degree from Rice University, a stint at divinity school, and time spent running a check printing company which led him into newsletters. Today, his two letters, Outside the Box and Thoughts From the Frontline, go out on the Internet to 1.5 million readers a week. John is the publisher of three investment books, The Millennium Wave, Just One Thing, and Bulls Eye Investing. To learn more about John?s many activities in the markets, please visit his website at http://johnmauldin.com/ . To catch my entire insightful interview with John Mauldin on Hedge Fund Radio, please go to www.madhedgefundtrader.com/ and click on the ?Today?s Radio Show? menu tab on the left.

2) ?We have 3,500 nuclear weapons left over from the cold war we don?t need, they take 20 seconds to re-aim, we?re not afraid to use them, and by the way, they?re already aimed at you.? That is the approach James Baker III thinks America should take with Iran, Ronald Reagan?s Chief of Staff and Secretary of the Treasury and George H.W. Bush?s Secretary of State. At the same time we should be talking to the regime in Tehran, while doing everything we can to support the reformers, tighten sanctions, and enlist Europe?s help. Baker does not see a military solution in Iran, even though their potential to create instability in the region is enormous. This was one of dozens of amazing insights I gained spending an evening chatting with the wily Texas lawyer during an evening in San Francisco. Baker is happy to take on the ?America Bashers?, pointing out that the US still plays a dominant role in the UN, NATO, the IMF, and the World Bank. It still accounts for 25% of GDP, and its military is unmatched. The US spread globalization, and the spectacular growth of China and India is largely the result of open American trade policies, raising standards of living globally.? But the US can?t take its leadership role for granted. The biggest threats to American dominance are the runaway borrowing and entitlements. US debt to GDP will soar from 93% to 100% in three years, the highest level since WWII. This is unsustainable, is certain to bring a return of inflation, and unless dealt with, will lead to a long term American decline on the world stage. Massive trade and capital flow imbalances also have to be addressed. The 80 year old ex-Marine, who confesses to being the only Treasury Secretary in history who never took an economics class, believes that the advantageous rates that the government now borrows at are not set in stone. Baker is the man who engineered an end to the cold war with a whimper, and not a bang. He thinks that ?even our power has its limits,? and that there is a risk of strategic overreach.?? While conditions in Iraq still look dicey, there is a good chance that we can pull out combat troops by August, and all troops by 2011, and leave a stable country. With the US politically evenly divided, Congress has degenerated from debating teams into execution squads, and consensus is impossible. The media are partly to blame, especially bloggers who propagate wild conspiracy theories, as confrontation sells better than accommodation. Regarding the financial crisis, we need to end ?too big to fail? and embark on re-regulation, not strangulation. All in all, it was a fascinating few hours spent with a piece of living history who still maintains his excellent contacts in the diplomatic and intelligence communities.

QUOTE OF THE DAY

Early in the political career of James Baker, III, when he was campaigning in the Texas panhandle, a voter approached him with a question. ?Does anyone ever tell you that you look a lot like James Baker, III?? he asked. Baker answered, yes, I get that a lot.? The man responded, ?that must really piss you off.?

Global Market Comments
March 17, 2010

1) It?s time for my annual review of the residential real estate market in the High Sierra mountain hamlet of Incline Village, Nevada, and I am sad to report that antidepressant addiction among realtors there is still at epidemic proportions. This is the town on the shores of sparkling Lake Tahoe that is the home to the Godfather III, former junk bond king Mike Milliken, the mythic arms dealer Adnan Khashoggi, and a high school with one of the worst drug problems in the Silver State. Devoid by edict of the down market fast food restaurants that afflict most of America, Incline boasts two municipal golf courses where, at 6,300 feet, the air is so thin that your drive travels an extra 50 yards because the air is so thin. Incline is also a Mecca for libertarian millionaires drawn by the absence of a state income tax. Unfortunately, they also possessed the financial sophistication to buy trophy waterfront homes, extract cash-out refi?s all the way up, invest the proceeds in the stock market, and lose it all in the subsequent crash. The result has been a meltdown of Biblical proportions in the housing market. Of the 8,000 homes in the village, 400 are for sale at distressed prices and another 400 or more discouraged sellers hang over the market. Brokers report a brisk business in short sales, foreclosures, and sales on the Washoe County court house steps at prices down 60%-70% from the 2006 peak. With jumbo financing now an extinct species, the high end market has ceased to exist. One fabulous property on tony Lakeshore Drive, with every imaginable upgrade (a heated driveway?), originally listed at $14 million and sold for $4 million. Only cold, hard cash talks here. The only consolation is that conditions are much worse in Las Vegas. The optimists concede that prices could stay down for another decade. The pessimists can already be found at the bottom of the lake with the Godfather?s Fredo Corleone.

 

2) A few years ago, I went to a charity fund raiser at San Francisco?s priciest jewelry store, Shreve & Co., where the well heeled men bid for dinner with the local high society beauties, dripping in diamonds and Channel No. 5. Well fueled with champagne, I jumped into a spirited bidding war over one of the Bay Area?s premier hotties, who shall remain nameless. Suffice to say, she has a sports stadium named after her. The bids soared to $6,000, $7,000, $8,000. After all, it was for a good cause. But when it hit $10,000, I suddenly developed lockjaw. Later, the sheepish winner with a severe case of buyer?s remorse came to me and offered his new date back to me for $9,000.? I said ?no thanks.? $8,000, $7,000, $6,000? I passed. It was embarrassing. The current altitude of the stock market reminds me of that evening. If you rode gold from $800 to $1,220, oil from $35 to $80, and the FXI from $20 to $40, why sweat trying to eke out a few more basis points, especially when the risk/reward ratio sucks so badly, as it does now? I realize that many of you are not hedge fund managers, and that running a prop desk, mutual fund, 401k, pension fund, or day trading account has its own demands. But let me quote what my favorite Chinese general, Deng Xiaoping, once told me: ?There is a time to fish, and a time to hang your nets out to dry.? At least then I?ll have plenty of dry powder for when the window of opportunity reopens for business. One of the headaches in writing a letter like this is that while I publish 1,500 words a day for 250 days a year, generating about half the length of War and Peace annually, you really need to tinker with your portfolio on only a dozen or so of those days. So while I?m mending my nets, I?ll be building new lists of trades for you to strap on when the sun, moon, and stars align once again. And no, I never did find out what happened to that date.

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3) Until now, the country?s power grid has been divided into three unconnected chunks, making transnational transmission impossible, leading to huge regional mispricing. While California and New York suffered from brown outs and sky high prices, electricity was given away virtually for free in Texas. A group of power companies is now proposing to build the $1 billion Tres Amigas superstation in Clovis, New Mexico that would connect all three grids. The plant would use advanced superconducting technology that will send five gigawatts of power down cables cooled at 300 degrees below zero. The facility would solve a major headache of alternative energy planners, and will no doubt accelerate development. It would allow the enormous wind farms on the drawing board in the Midwest to ship energy to the power hungry coasts. Ditto for the mega solar projects proposed in the Southwest deserts, and the big geothermal plants being built in Nevada. With Obama sending tidal waves of government cash towards the sector, the timing couldn?t be better. It is also great news for major alternative suppliers like First Solar (FSLR). Some of these projects might now actually make some sense.

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4) If you want to impress your friends with your vast knowledge of financial matters, then here are the Latin translations of the script on the backside of a US dollar bill. ?ANNUIT COEPTIS? means ?God has favored our undertaking.? ?NOVUS ORDO SECLORUM? translates into ?A new order has begun.? The Roman numerals at the base of the pyramid are ?1776.? The better known ?E PLURIBUS UNUM? is ?One nation from many people.? The basic design for the cotton and linen currency with red and blue silk fibers, which has been in circulation since 1957, carries enough symbolism to drive conspiracy theorists to distraction. An all seeing eye? The darkened Western face of the pyramid? And of course, the number ?13? abounds. Thank freemason Benjamin Franklin for these cryptic symbols, and watch Nicholas Cage?s historical adventure movie National Treasure. The balanced scales in the seal are certainly wishful thinking and a bit quaint. Study the buck closely, because there are going to be a lot more of them around.

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QUOTE OF THE DAY

?When it? raining gold, reach for a bucket, not a thimble,? said Oracle of Omaha Warren Buffet.