3 THINGS I THINK I THINK – BUTTERFLIES AND RAINBOWS DON’T RUIN YOUR DAY

1) Milton Friedman famously opined that the Euro would not survive its first major financial crisis.   I just can’t help but wonder if Friedman was correct about the Euro being “flawed”.  As we see the debt crisis in Europe unfolding it’s been interesting to see just how unified Europe actually is.  Germany has effectively given Greece a nice big middle finger in what can only be described as a frustrating situation for all countries involved.  Thousands of years of bad blood are suddenly trying to be papered over by “currency unity” and the first time the you-know-what hits the fan it looks like everyone is fending for their own….As it should be.  After all, this is not the United States.  These are not unified states.  They never have been and they never will be.

Interestingly, what is occurring in Greece is what occurs to a nation that is revenue constrained under a convertible or commodity linked currency system.  In times of peril, you can’t properly defend (or spend) for your own people.  You have to beggar thy neighbor.  Does that make any sense at all?  What if Greece were attacked by a neighboring country?  Could they financially defend themselves?  Could they print money without creating massively destructive inflation?  Would Europe truly unite around Greece and defend them?   Or would they be forced to leave the Euro system just so they could print their own currency and spend it as they please?  The Euro, much like the gold standard or convertible currency systems of old, are terribly flawed.  I understand that there is some good that comes out of austerity, but the Greeks are helpless and entirely by their own choosing….The Greeks are discovering the flaws of the Euro currency system and they’re not the last country that will discover why such a currency system favors those with strong surplus driven economies and hurts those with weaker deficit driven economies.  Pure common sense tells me the Euro is not here to stay….At least in its current form.  There will be defections.  In fact, there almost must be defections.  When that will occur is anyone’s guess, but the problems in Greece are just the beginning of bigger problems within the Eurozone.

2) A big part of me is beginning to wonder if we’re entering one of those confusing periods where good news is actually bad news.  Last week, investors celebrated the lower than expected jobless claims before dramatically selling the news.  Friday’s jobs number could be north of 200K according to estimates (and don’t let anyone tell you these March jobs aren’t real because of the Census hiring – these are real working & spending citizens even if they only have these jobs for a few months).  What are the real ramifications of a big jobs turnaround?

Most analyst’s and investors knows this recovery has been largely due to government spending and accommodative Fed policy.  A job’s turnaround brings us that much closer to higher interest rates and no further government stimulus.  The uncertainty regarding such an environment strikes me as being extremely high.  We are still Japanese to anyone who takes a look under the hood and sees how disastrous the consumer balance sheet remains.  And without government stimulus and continued aid we all know what happened to Japan….

A much stronger economy might not be what the equity market most needs right now (with the consumer balance sheet in shambles)….In fact, the real Goldilocks for this market is the one that is just perfectly weak.  Strong enough to keep the government pouring the kool-aid, but not strong enough to force them to remove the bowl….If we remove the bowl before the consumer balance sheet is fully repaired (two years away by my estimates) we seriously risk a double dip….

3) I received a friendly email from a regular reader who asked:

“You are obviously level headed so why do the majority of your articles tend to be bearish?”

I replied:

“Because butterflies and rainbows don’t ruin your day.”

I’m not pessimistic by nature.  In fact, I am quite the optimist (I was very optimistic about the U.S. stock market even at the beginning of 2009).  But I view the trek up to the top of the investment mountain as being full of risks.  Seeing butterflies and rainbows sure make the trek more enjoyable, but won’t guarantee that you ever get there (just ask the millions of baby boomers who have been fooled by the myths of buy, hold & hope!).  Anyone can get caught up in the beauty and wonder of a butterfly or a rainbow (or a bull market!), but it’s the cautious observant who steers you clear of the loose rocks and the avalanche attached.   If you don’t watch out for potential pitfalls I guarantee that you’ll never get to the top of the mountain.

This website is a reflection of that approach.  Of course, I’d be lying to you if I said that I spend most of my time reading articles about butterflies, rainbows and v-shaped recoveries.  As a risk manager I spend most of my time finding risks and fending them off before they blow me up.  I still consider my move to cash in August 2008 and my October crash call as the single greatest investing achievement of my career even though it was followed by underperformance in 2009….I hope readers understand this risk management focused approach and find my (sometimes) negative bias helpful in avoiding their own potential portfolio debacles….

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Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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