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Fleck Rap



Note: Professor Fleckenstein provides his commentary for educational purposes - his insights are not intended as investment advice. You can find his daily comments at

It's OK. I'm in It for the Long Term

Not much transpired overnight, either in foreign markets or our stock-index futures. Preopening saw a big collapse in the Empire State Manufacturing survey, which came in at 12.6, vs. expectations of 32.3. I don't make too much out of that junior economic data point, as I think it's more or less worthless. (But folks seemed to make a big deal out of that survey when it was going up).

Mr. Market Soaks in Rejuvenating Oil

Once the casino opened for business, buyers poured in, having presumably decided that oil just had to come down. A couple hours into the day, oil was in fact down a massive 11 cents, and that was good enough to ignite a rally of 1% in the S&P/Dow and about 1.5% in the Nasdaq. I guess you could call housing stocks the leader to the upside, but the Sox was also trying to bounce, as were financials. In essence, nearly everything was green.

After the initial surge to the upside, the market basically flopped and chopped near the top end of its range for the rest of the day, with the exception of the Nasdaq, which saw a little selling late in the day. In essence, the early leaders got stronger all day, minus the chip stocks, which had a very labored and heavy rally, as demonstrated by the fact that Intel (INTC:NASD) actually closed down on the day.

Away from stocks, we saw a mixed bag. The euro was lower, but other currencies were higher. Gold was up 1% and silver was up almost 2%. Fixed income was slightly lower. Oil closed at $45.69, down 34 cents.

Warning: Deconstruction Zone. Hardhats Required

I'd like to take a minute to deconstruct a popular myth that was quite prevalent in the mania and is still, I believe, prevalent today, and that is: "I don't really have to worry about what stocks do in the short run because I'm in it for the long haul." That thought was half of the great rationalization during the mania. The other half was the belief that stocks just had to go up, because where else were people going to put their money?

Do you remember that? People thought stocks couldn't go down because they were the only game in town. Whenever you hear folks making that statement, you know you're deep into the process. That rationalization is always destined for failure because people can put their money anywhere, and it's usually a rationalization used by novice investors to justify doing something in a larger size than they should.

Similarly, "I invest for the long term" is often a rationalization for sticking with a losing idea. When I (personally) invest "for the long term," I'm thinking three years, maybe five years. You can have a reasonable opinion about what might happen over the next three years to five years, and maybe make some decent guestimates, but thinking that you know what's going to happen in 10 or 20 years and buying stocks on that basis is really just a rationalization, in my opinion.

Competition Is Not Child's Play

A couple of articles last week brought this home to me. In the Wall Street Journal on Thursday, they ran a story titled "Toys 'Were' Us?" It talked about the demise of Toys "R" Us (TOY:NYSE) from a toy retailers' standpoint. When I first got into the investment business 25 years ago, Toys "R" Us was a juggernaut, and of course it was a juggernaut for much of this time. But a quote from the article illustrated a very critical point that "long-term investors" need to keep in mind. Burt Flickinger, managing director, Strategic Marketing Group in New York, said: "It's a sad day in retailing when Toys 'R' Us declares victory, runs all the competition off the cliff and then Wal-Mart (WMT:NYSE) kills off the only surviving toy retailer."

The moral of that story: Folks need to think about businesses they own from a competitive standpoint. In other words, what is the barrier to entry in this business? Very, very few businesses have barriers to entry, though some do. Not having a barrier to entry means that if you have a decent profit margin, you are going to be subjected to intense competition.

One of the dirty little details that's never discussed on Bubblevision, or by many of the perma-bulls, is the fact that a lot of businesses don't have barriers to entry, and paying historically high valuations for them is basically a recipe for disaster.

The Shortsightedness of a Long-Term View

Another point I tried to make in the mania -- when people would say, well, I am in this for the long term -- was to point out that the problem with investing for the long term (meaning the next 10 or 20 years) is that from time to time, life issues its margin calls, and oftentimes does so at an inconvenient moment. Often when you lose your job or experience a similar loss, that's the same time that house prices or stock prices decline.

This nugget was brought home to me by a story in Friday's New York Times about United Air Lines, titled "Asset Mix Took Toll on United's Pension Fund." It talks about some of the less than conservative investments that United made, which of course it points out are actually quite common these days. But the moral of the article was contained in this quote:

"While United's investment results were not far out of step with other pension funds, the losses had a far more devastating effect on the fund because they coincided with United's own business troubles [the emphasis is mine]." That being an example of life issuing its margin call at a most inappropriate time. (In fact, I would make an argument that if you were running a particularly dangerous business, as the airline business is, you should have an even more conservative mix in your pension plan than a less conservative one, but that is another issue.)

All Hail the Bailout

Of course, all of corporate America doesn't really worry about this because they know they've got the Pension Benefit Guaranty Corporation as a backstop, which encourages them to swing for the fences because if it works, it lowers the company's pension costs and if it doesn't, the tax payers pick up the tab. It's a heads-they-win-tails-we-lose problem.

This is exacerbated because of the insane way that pension gains can be used to bolster profits. The article very succinctly explained it this way: "The accounting rules for pension funds help, by allowing companies to project the long-term gains they expect from their pension investments, then factor that projection into their bottom lines -- even in years when the projections are dead wrong."

So there you go. Place money in risky assets, assume that they're going to grow at some rate of return, and then the fact that that rate of return is higher than the assumed rate you need to match off your liabilities, ergo, you have a profit. This whole pension mess is just another lurking time bomb out there for the bulls, and folks need to be aware of that.

The Writing on the Wall, Etched in Gold

Turning lastly to the subject of gold, Richard Russell wrote a very concise explanation on the subject of why folks should own gold. I know that most Rap readers probably subscribe to his service. I have certainly recommended it often enough. I thought that just in case, I would like to share his thoughts right here:

"I wrote a lot about the gold situation yesterday. And I want subscribers to remember that when we hold gold or gold shares, we're playing 'the waiting game.' The U.S. and its overseas friends are also playing a game. Americans have a secret name of this game. It's called -- 'We pretend to pay you with our worthless paper dollars, and you send us your goods and pretend that you're being paid.'

"So why do China and the Asians continue this basically idiotic, losing game -- are they just stupid? No, they're not stupid. They simply want to continue selling their goods to the U.S. You see, the leaders of China and Asia have a problem. It's called keeping the masses employed. The Asian leaders' problem is to see that hundreds of millions of their people have jobs. China, for instance, has TEN million people coming into the work-force every year. If these people can't get jobs, well, there's always the possibility of revolution.

"So the game goes on. It will go on until the U.S. sinks under an ocean of liabilities and debts and our foreign 'partners' will no longer accept dollars. But no one knows exactly when that time will come. Next month, next year, three years from now? The signal for the fall could be a collapsing dollar. Or maybe we're getting the first hints of the fall now -- with the stock market heading down along with the dollar (the dollar got whacked big time today).

"The smart boys like Warren Buffett see the writing on the wall, and they have taken a multibillion-dollar position in foreign currencies. But foreign currencies are still junk paper. They're just better-quality junk than dollar. In the end, the only time-tested intrinsic money is gold. But as I said, when you hold gold or gold shares, you're going to be right in the end -- but you're also playing 'the waiting game.' And waiting can be difficult, it can on occasion be scary, and it can certainly try your patience.

"This is what the central banking system has done to us. This is what the Federal Reserve is all about. This is the potential disaster that the paper money system has inflicted on all of us. My wise old father used to tell me during the Great Depression, 'Dick,' he'd say, 'the only thing you can depend on in this world is a good education and what's between your ears.' I've told my own kids the same thing. It's the God's honest truth."

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