Connecting the Dots - February 2012

Bloomberg Businessweek recently ran an entire issue dedicated to the life of Steve Jobs. Early in the article there is a reference to some statements by Jobs and a quote; “Jobs would claim that he never invented these things (mobile and iPhone, iPad); he discovered them; they were always there, someone just needed to “connect the dots, to put the parts together into a whole no one else seemed to see.”

Jobs was highly successful and created more millionaires than anyone else through the growth of Apple stock. But Apple is a company with tangible assets, patents and concrete value. Late last year, experts were talking about Facebook’s pending IPO being valued at more than $100 billion. It is interesting, because Facebook has few tangible assets.

Connecting the dots in investing seems more and more difficult as time goes on. In investing, the most important dots to connect are the dots to the different asset classes. Asset allocation is the most important decision an investor needs to make. Sectors are good one year, excellent another year, and bad the next. Having investments in multiple investment sectors allows the investor to minimize volatility and create more opportunity.

UNITED STATES DEBT

Current United States national debt is over $15 trillion and will be $16 trillion before the end of the year. The total US debt is over $56 trillion. Indeed, these are staggering numbers. The US Government has three choices with regards to the debt as follows:

1. Pay it off
2. Default on it
3. Print money

The first option, paying off the debt, is painful because it bleeds economic growth and directs the national productive output into the hands of creditors. This would mean an enormous increase in taxes. It could also lead to higher unemployment, fewer goods and services and an unhappy population.

The second option, default, is unthinkable. It would cause the country to be thought of as a poor or negative credit risk. All goods and services would need to be paid for in cash; with a collapsing currency that is almost impossible to do. As an example, imagine if the dollar was not viable and we still needed to import the majority of our daily petroleum needs. The dollar would lose its international value, oil priced in dollars would increase substantially and the U.S. economy could be permanently damaged.

The third option is really the only viable alternative. Money printing, or its electronic alternative, is the preferred choice. The problem is that it is also the most dangerous path to take because of the destruction of the currency and destruction of wealth. However, it pushes the results so far out to the future that the day of reckoning will probably be someone else’s problem. What happens is that inflation rises and the value of the dollar decreases, allowing the debt to be paid back with depreciated or less valuable dollars.

THE DOLLAR VS. OTHER CURRENCIES

In 2010, the dollar rallied against most other currencies (especially the Euro) because it was considered a safe haven. The problem comes when the money printing policies deflate the value of the dollar (which almost has to happen) and the people who fled to the safety of the dollar are left “holding the bag.” When government admits that we have higher inflation is really anyone’s guess. There is no timetable and no one can predict how long the Fed can continue low interest policies. According to John Williams of Shadowstats.com, without government manipulation of statistics, inflation was running at over 8% during 2011. The Bureau of Labor Statistics has inflation at 2.8% for the same period. Anyone investing in Treasuries has a nice safe 2% yield with a negative real return (return – inflation) of -6%. Safety is fine, but losing money to purchasing power can cause real problems with lifestyle and necessities.

WHAT TO EXPECT IN 2012

We believe that we are going to experience more of the same type of markets as we have had the past two or three years. We will get market increases with periods of low volatility and then periods of high volatility which will cause fluctuations in the markets. Diversification into many different sectors, many of which are non-correlated with the markets, would seem to provide for some growth, limited volatility and safety.

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