Perhaps the Fed should include food and energy prices in inflation?

Since the late 90’s, oil prices have rocketed over 1000%. Riots are occurring around the world because of shortages of such staples as rice and wheat. Even Costco and Sam’s Club are rationing rice consumption here in the U.S.!

If the cost of such fundamental necessities as food and energy are going up so much, why do economists and the Fed believe that inflation is stable and at acceptable levels?

Quite simply, they don’t include food and energy prices in their calculation of “core” inflation (that sounds like the same game as reporting “operating” and “pro forma” earnings that companies were criticized for 8 years ago).

You see, food and energy prices are very volatile, and most of the time their movements make inflation look uncomfortably unstable.

But, what happens if food and energy prices are rising because of real, no kidding inflation? The Fed and most economists have no way to adjust for this. Don’t be surprised, though, if they finally get around to adjusting long after we’ve all been beaten down by “non-core” inflation.

I’m no economist, but I think I understand what makes for a stable currency.

The central banks of the world run the printing presses, and they can print dollars (euros, yen, bahts, pesos, reals, etc.) at almost no cost. This doesn’t create value, mind you. What it creates, when dollars are printed faster than underlying growth, is inflation.

In my humble opinion, that’s what we’ve been experiencing at a faster and faster pace over the last 10 years.

The central banks of the world reacted to the Asian contagion by printing more money. Then, they reacted to the fall of Long Term Capital Management with more money printing. Y2k (remember that “crisis”?), more money printing. Telecom, technology and dot-bomb crash, print more money. Housing crash and credit crisis…you get the idea.

I don’t think energy and food prices are running up temporarily, I think this is the slow bubbling up of inflation created by the world’s central banks over the last 10 years. You can see it bubbling up through the economy from energy to metals to transportation to food.

The easiest place to see this is in the price of gold, which bottomed at around $250 and ounce in the late 90’s and is now 360% higher (after peaking 400% higher). Or, look at shipping rates. Or, look at base metals prices. Or, look at iron ore and coke used in making steel. Or, look at wheat, rice, etc. Do you suppose chicken, beef and pork could be next?

Think what you’d like about government bailouts and stable currency, I believe we’re getting more and more inflation.

Could this all be the result of higher demand, especially from China and India? In the short term, yes. In the long term, no. That’s where the rubber meets the road from a forecasting standpoint. If demand is the cause, then profits and innovation will eventually drag prices back down, as most economists are betting will happen. But, if part or all of the price rise is due to inflation, then expect prices in general to stay higher.

How long before central banks and economists start adjusting inflation for food and energy costs? Don’t hold your breath.

I’m expecting prices to go up long term, even if they take a breather as the U.S. and global economies slow down. In time, though, we’ll all have to recognize that prices are probably permanently higher, and the it’s the result of inflation caused by our central banks. When people start to more generally recognize this, higher interest rates will be another thing to deal with.

Investing in such an environment can be difficult, but also very profitable. I’m glad I prepared myself and my clients for just such a possibility years ago.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Snake oil salesmen

Flipping through the TV channels last weekend, I stumbled upon an info-mercial for training people to make money trading stocks.

The advertisement was designed to get people to sign up for a free seminar being held at 5 Colorado conference centers for 2 days each.

I couldn’t believe the stuff these people were saying.

They were guanteeing results.

They were showing people in huge houses, driving exotic cars, hanging out on their yacht, walking away from their private airplane.

Nowhere did I see any warnings about past results not being a guarantee of future performance.

Nowhere did I see any kind of disclosure.

My wife and I couldn’t believe it! It was the biggest pile of horse-pucky I’ve ever seen in my life!

There’s no reason for you to know this, but as a professional, I’m not allowed to advertise in any of the ways these charlatans were.

I can’t guarantee results. I can’t show people living the good life without warning them about the risks. I can’t show how much money people made on one trade without disclosing all the other investments made.

So, how do these people get away with this? I have no idea.

I thought it was the most irresponsible advertising I’ve ever seen. The regulators would kick me out of the business for saying anything these buffoons were saying. Where are the regulators on this one? I have no idea. Perhaps the snake oil salesmen can afford better lawyers than I can.

You know what the worst part is? Trading stocks based on a sales-pitch seminar is probably one of the most sure-fire ways to lose your money. Anyone signing up for such a seminar would have an infinitely better chance of reaching their goals by investing with someone like me instead.

I could never morally or legally advertise the way these yahoos were, and yet they will fill up 5 conference centers over 10 days ripping people off.

No wonder this business has such a bad reputation.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Concentration versus diversification

The academics will tell you to diversify, and they will probably tell you that there’s no such thing as too much diversification.

I beg to differ.

It all depends on your objective. If your objective is to match market performance, which, by the way, will beat 80-90% of individual and profession investors, then by all means diversify to your heart’s content.

In diversifying, make sure you have all asset classes, including stocks, bonds, real estate, commodities, etc. And, make sure you have subclasses within in those asset classes, like small and large stocks, foreign and domestic stocks, etc. Finally, make sure you keep your costs as low as possible.

But, if you want to out-perform the market, you have to concentrate your investments.

By definition, investing in all the stocks in the S&P 500 will, after fees, never significantly beat a low priced S&P 500 index fund. That seems obvious.

The only way to out-perform the index is to invest heavily in a few stocks that you believe can out-perform the index. Once again, that’s definitional.

It makes intuitive sense, too. Is it even possible to keep track–really understand and accurately assess the value–of 500 stocks? Not in this world.

It doesn’t seem reasonable to expect your 21st, 51st, 101st, or 501st idea to be as good as your top 5, 10 or 20, either.

It makes as much sense empirically as it does intuitively.

The folks who out-perform the market–really out-perform after fees by a worthwhile margin–are always concentrated on less than 50 or, more likely than not, 20 stocks.

And, they probably size their positions to correspond to the return and probability characteristics of the investments they make. By that, I mean they buy more of the stocks they believe have a high probability of getting outstanding returns and buy less of the stocks they believe have a lower probability of achieving merely good returns.

If you don’t believe me, look at Warren Buffett, or Bob Rodriguez, or Wally Weitz, or Bruce Berkowitz, or Glenn Greenberg.

Warren Buffet recently said that if he were managing $50 – $200 million right now, he’d have 80% in the top 5 stocks and 25% positions in the top few. If you aren’t as good as Warren Buffet, you probably don’t want to be that concentrated, but you get the idea.

Do you have to have conviction to invest this way? You betcha!! And nothing hones your investing focus like putting a lot of your money into a few stocks.

I’ve been investing this way for over 12 years now, and I’ve been quite happy with the results. I’ve beaten the market by a significant margin (past results are no guarantee of future performance), and this has allowed me to grow my net worth quite quickly.

If you want to match the market, diversify broadly and do it with the lowest fees possible.

But, if you want to beat the market, you should concentrate.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Manhattan

On a lighter note, I made my first trip to New York City, and Manhattan in particular, last weekend.

Considering I grew up in Washington, D.C., and love investing and history, it’s startling that I made my first trip as a 37 year old.

Wow. Wow! WOW!!! I had an absolute blast (although flying with a 7 month old was a challenge)!

What an amazing place. I did touristy things, like Times Square, Empire State Building, Grand Central Station, Statue of Liberty, Ellis Island, the Metropolitan Museum of Art, Central Park, but I also enjoyed some outstanding dining and just hanging out.

Of course, I made the obligatory pilgrimage to Wall Street. I was awestruck standing in front of the House of Morgan, the NYSE and just being in the financial district of the financial capital of the world.

It’s a wonderful place and I’m already looking forward to going back.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.