Here are several investment related questions that burn in my mind every day, I would love to develop conviction regarding the answer to one or more of them:
 
1. Is it possible to have the sovereign debt of the United States continue to grow relative to the current or even prospective GDP of our economy without eventually having to pay higher and higher interest rates on its re-funding?

2. Are the actions of the Federal Reserve (or inaction) likely to result in a devaluation of the U.S. Dollar and cause prices to rise faster than any increased productivity in labor’s output generated as a result of managerial action or improved technology?

3. Some respected money managers predict that the U.S. and other developed economies are moving into what they call a “New Normal”. When asked what does that mean they respond: slower growth rates in domestic industrial production and even a greater shift of emphasis to services requiring intellectual as opposed to physical skills. Asked to give an average growth rate for normal, their response is 1-2% per annum. Can the U.S. maintain its contracted entitlements and pay interest and principal on the projected debt they will cause with this growth rate?

4. We are in a massive rationalization of individual and corporate balance sheets, primarily due to continuing real estate devaluation. At the same time the chaos in Europe and fears elsewhere in the world are contributing to inflows supporting demand for the U.S. Dollar and pushing the U.S. Treasury security bubble ever upward. This apparent circumstance is contributing to the Fed’s ability to keep its low interest rate policies in place without increasing its security purchases. Question, is the risk of this reversing such that interest rates could explode if and when management and individuals decide to invest their huge cash horde? 

5. How can we invest comfortably in China, Southeast Asia and Eastern Europe, the emerging and dynamic growth areas, with some degree of confidence that these countries are protecting investor rights and assuring transparency in shareholder financial information?  

6. The basic question I think about is: “How do we protect the purchasing power of our wealth without losing reasonable,or at least comfortable, levels of liquidity and convertibility?” I have written on the subject of Gold, but are the other investment vehicles, stocks, bonds, notes, CD’s, Money Market Funds, Commodity ETF, Foreign Currency, Real Estate, Annuities, etc.,more likely to preserve wealth? I don’t know! But I feel less uncomfortable with one or the other and so I have tried to diversify among those with good marketability and liquidity until I am able to develop greater conviction for just where we are going.

7. Of course here is the most important question: “Are Obama, Reid, and Pelosi leading this country down the path of becoming more of a social egalitarian society at the expense of its freedoms and individual’s liberty? I think you know my opinion on that. What bothers me the most about it is that there doesn’t appear to be a real leader in the conservative camp who is strong enough to turn those misguided beneficiaries of redistribution around in their understanding and conviction of which system is best for them in the long run- Free market capitalism (with all its potential exploitive risks) requiring individual responsibilities or a state controlled, highly regulated beauracratic social capitalist system with its loss of freedom and liberty to pursue and benefit from individual aspirations.

These questions keep me awake at night (or rising early in the morning) and motivate my watching and learning from “Squawk Box”.

One Man’s Opinion–Bud Brewer

June 3,2010: Good investment strategies always call for some cash reserves. In todays real estate markets, those who have cash reserves and are willing to take some unusual risk, the “short sale” offerings in more modest priced neighborhoods could make it possible for those who are looking to buy a home to live in or for investment to make a good relative value purchase. A short sale is a real estate transaction in which the price for a property is below the total amount of morgage loans that exist on it. It is a process by which the lender takes control of the property in cooperation with the legal owner to sell it, usuallly well below the value of the mortgage(s). In some regions, short sales are by far the majority of transactions that are being done in the current real estate market. This is much like 1994-5 when it was common to find properties “under water” due to the recession and the fact that many homeowners had loans taken out during the super high interest period of the early “Eighties”. One case in point was Budor’s purchase of a condominium in Newport Beach in 1995. The property was purchased on a “short sale” for $435k using a personal guaranteed $180k mortgage loan. The existing loans on the Condo totaled $575k so the property must have cost the prior owner $650k or thereabouts. After a $100k remodel and 12 years of net lease income of $24,000+ per year Budor sold the property for $1.3M at the peak of the bubble. Of course we didn’t know it was the top but the demand for Newport real estate was causing some pretty high prices so we elected to take advantage of it. The result was that Budor experienced a solid return on equity over the eleven years of ownership. The key was that the property fit the location, location, location pre-requisite and was purchased for a reasonable replacement cost or 60% of its last sale price. When this criteria fits a real estate property (or stock prices for that matter), it is always worth while having some cash reserve in order to be able to take advantage of any investment selling at a distressed price or where the current fair market value has strayed significantly away from its mean price trend. You want to stick your toe in the water when someone is forced to take big discounts on what they want to sell. In this market nobody is anxious to buy because they are not confident where this Administration is leading the economy. There is plenty to be concerned about regarding the future consequences from fiscal policies of this government, but mortgage rates are artificially low and if the offering prices of a property fit the rental value providing 6-8% cash flow on market value then with a 50% mortgage (reasonable but conservative leverage) an investor could expect to experience an annual cash return of 8-10% on equity even after property taxes and Association fees if any. I wouldn’t speculate that we will have sharp price appreciation soon especially given the probability of high debt caused inflation or currency devaluation in the foreseeable future. Housing prices may even go down in the future discounting higher interest rates, but rental values should hold pretty well, notwithstanding.

Applying the same point of view to the stock market

As I said, the same potential risk investment in stocks would be to buy British Petroleum on the theory that even after paying all the adjudicated damages for the oil spill, the residual value of BP would be worth more than the current market price. Prior to the spill, BP was priced at $60 per share paying a dividend of $3.36 for a cash yield of slightly over 5%. The company has 3.6 billion shares and earned $38.7 Billion EBIDTA in 2009. It currently is $36-7 per share and the decline since April is over $75 billion in market value. That is a pretty big loss in anticipation of damages, law suit awards, clean ups costs, etc. Last year, the company had $265 Billion revenue and a book value per share of $33.00. Now if you believe that the cost and damages attributed to the spill will severely hamper the company’s future profits of $38 billion from producing, refining and distributing oil and oil products, then the company may see its stock price continue to erode, but given their cash position of $6.8 billion, it is hard to conclude that the ability of this company to survive and recover isn’t more likely than not. I think, although clearly a risk given the politics operating, this company will not only recover but in several years will be benefitting from higher oil prices and, strangely, benefitting also from the likely restriction upon deep water drilling by our all knowing government since it will cause the company to stop exploration in this area which is currently causing negative cash flow to the company. BP is doing deep water drilling now even though they are losing money with the oil price at $70 per barrel. Like all oil companies that are successful, they continue a business plan expecting the trend for oil prices to increase to levels where current investment in deep water exploration will enable profitable production in the future.

The risks are that our populace government policies cause Congress to enact higher corporate tax rates, penalty taxes, and some sort of insurance reserve charge or fees for potential spills on all future oil revenue. Our government and most consumers don’t like the oil companies anyway so they may support some pretty drastic(stupid) legislation regarding them especially since the average person thinks oil companies profits are obscene. All these negative risks still don’t seem to justify the severe decline in the price of British Petroleum. But what do I know “I’m only the 200 pound gorilla in the room.

One Man’s Opinion -Bud Brewer

I read an article by Arthur C. Brooks in the Washington Post, Sunday, May 23, 2010 and thought the words so profound and illustrative of my personal fears for the future, I wanted to have them read by every reader of this blog. America is facing a new type culture proposed by a minority of its citizens. This narrative is long but every word is important.

“This is not the culture war of the 1990s. It is not a fight over guns, gays or abortion. Those old battles have been eclipsed by a new struggle between two competing visions of the country’s future. In one, America will continue to be an exceptional nation organized around the principles of free enterprise — limited government, a reliance on entrepreneurship and rewards determined by market forces. In the other, America will move toward European-style statism grounded in expanding bureaucracies, a managed economy and large-scale income redistribution. These visions are not reconcilable. We must choose.

It is not at all clear which side will prevail. The forces of big government are entrenched and enjoy the full arsenal of the administration’s money and influence. Our leaders in Washington, aided by the unprecedented economic crisis of recent years and the panic it induced, have seized the moment to introduce breathtaking expansions of state power in huge swaths of the economy, from the health-care takeover to the financial regulatory bill that the Senate approved on May 20th. If these forces continue to prevail, America will cease to be a free enterprise nation.

I call this a culture war because free enterprise has been integral to American culture from the beginning, and it still lies at the core of our history and character. “A wise and frugal government,” Thomas Jefferson declared in his first inaugural address in 1801, “which shall restrain men from injuring one another, shall leave them otherwise free to regulate their own pursuits of industry and improvement, and shall not take from the mouth of labor the bread it has earned. This is the sum of good government.” He later warned: “To take from one, because it is thought that his own industry and that of his fathers has acquired too much, in order to spare to others, who, or whose fathers, have not exercised equal industry and skill, is to violate arbitrarily the first principle of association, the guarantee to every one of a free exercise of his industry and the fruits acquired by it.” In other words, beware government’s economic control, and “woe betide” the redistributors.

Now, as then, entrepreneurship can flourish only in a culture where individuals are willing to innovate and exert leadership; where people enjoy the rewards and face the consequences of their decisions; and where we can gamble the security of the status quo for a chance of future success. Yet, in his commencement address at Arizona State University on May 13, 2009, President Obama warned against precisely such impulses: “You’re taught to chase after all the usual brass rings; you try to be on this “who’s who” list or that Top 100 list; you chase after the big money and you figure out how big your corner office is; you worry about whether you have a fancy enough title or a fancy enough car. That’s the message that’s sent each and every day, or has been in our culture for far too long — that through material possessions, through a ruthless competition pursued only on your own behalf — that’s how you will measure success.” Such ambition, he cautioned, “may lead you to compromise your values and your principles.” I appreciate the sentiment that money does not buy happiness. But for the president of the United States to actively warn young adults away from economic ambition is remarkable. And he makes clear that he seeks to change our culture.

The irony is that, by wide margins, Americans support free enterprise. A Gallup poll in January found that 86 percent of Americans have a positive image of “free enterprise,” with only 10 percent viewing it negatively. Similarly, in March 2009, the Pew Research Center asked individuals from a broad range of demographic groups: “Generally, do you think people are better off in a free-market economy, even though there may be severe ups and downs from time to time, or don’t you think so?” Almost 70 percent of respondents agreed that they are better off in a free-market economy, while only 20 percent disagreed. In fact, no matter how the issue is posed, not more than 30 percent of Americans say they believe we would fare better without free markets at the core of our system. When it comes to support for free enterprise, we are essentially a 70-30 nation.

So here’s a puzzle: If we love free enterprise so much, why are the 30 percent who want to change that culture in charge? It’s not simply because of the election of Obama. As much as Republicans may dislike hearing it, statism had effectively taken hold in Washington long before that. The George W. Bush administration began the huge Wall Street and Detroit bailouts, and for years before the economic crisis, the GOP talked about free enterprise while simultaneously expanding the government with borrowed money and increasing the percentage of citizens with no income tax liability. The 30 percent coalition did not start governing this country with the advent of Obama, Nancy Pelosi and Harry Reid. It has been in charge for years. But the real tipping point was the financial crisis, which began in 2008.

The meltdown presented a golden opportunity for the 30 percent coalition to attack free enterprise openly and remake America in its own image. While Republicans had no convincing explanation for the crisis, seemed responsible for it and had no obvious plans to fix it, the statists offered a full and compelling narrative. Ordinary Americans were not to blame for the financial collapse, nor was government. The real culprits were Wall Street and the Bush administration, which had gutted the regulatory system that was supposed to keep banks in line. The solution was obvious: Vote for a new order to expand the powers of government to rein in the dangerous excesses of capitalism.

It was a convincing story. For a lot of panicky Americans, the prospect of a paternalistic government rescuing the nation from crisis seemed appealing as stock markets and home prices spiraled downward. According to this narrative, government was at fault in just one way: It wasn’t big enough. If only there had been more regulators watching the banks more closely, the case went, the economy wouldn’t have collapsed. Yet in truth, it was government housing policy that was at the root of the crisis. Moreover, the financial sector — where the crisis began and where it has had the most serious impact — is already one of the most regulated parts of our economy. The chaos happened despite an extensive, intrusive regulatory framework, not because such a framework didn’t exist. More government — including a super-empowered Federal Reserve, a consumer protection watchdog and greater state powers to wind down financial firms and police market risks — does not mean we will be safe. On the contrary, such changes would give us a false sense of security, especially when Washington, a primary culprit in the crisis, is creating and implementing the new rules.

The statist narrative also held that only massive deficit spending could restore economic growth. “If nothing is done, this recession could linger for years,” Obama warned a few days before taking office. “Only government can provide the short-term boost necessary to lift us from a recession this deep and severe. Only government can break the cycle that is crippling our economy.” This proposition is as expensive as it is false. Recessions can and do end without the kind of stimulus we experienced, and attempts to shore up the economy with huge public spending often do little to improve matters and instead chain future generations with debt. In fact, all the evidence so far tells us that the current $787 billion stimulus package has overpromised and under delivered, especially when it comes to creating jobs.

If we reject the administration’s narrative, the 70-30 nation will remain strong. If we accept it, and base our nation’s policies on it, we will be well on our way to a European-style social democracy. Punitive taxes and regulations will make it harder to be an entrepreneur, and the rewards of success will be expropriated for the sake of greater income equality. The new statism in America, made possible by years of drift and accelerated by the panic over the economic crisis, threatens to make us permanently poorer. But that is not the greatest danger. The real risk is that in the new culture war, we will forsake the third unalienable right set out in our Declaration of Independence: the pursuit of happiness.

Free enterprise brings happiness; redistribution does not. The reason is that only free enterprise brings earned success. Earned success involves the ability to create value honestly — not by inheriting a fortune, not by picking up a welfare check. It doesn’t mean making money in and of itself. Earned success is the creation of value in our lives or in the lives of others. Earned success is the stuff of entrepreneurs who seek value through innovation, hard work and passion. Earned success is what parents feel when their children do wonderful things, what social innovators feel when they change lives, what artists feel when they create something of beauty.

Print this out or save it to permanent files. When you begin to think that a Government managed economy is not too bad, take it out and read it again!

One Man’s Opinion-Bud Brewer