Black Friday Boom

Could this coming Friday be our economy's Black Friday? No, not Thanksgiving's Black Friday when all companies finally make a profit for the year. 

S&P Index Futures show a peak being formed

Instead, is this Friday going to become the top of the equities and bond bubbles artificially created by the Federal Reserve?
Surely I am not talking about bubbles that made things better for all of us. The recent highs in the equities market have demonstrated that while Wall Street can be joyfully celebrating, 'main street' can continue to suffer all along from a post-recessionary hangover.
During Obama's term, the cost of money for large organizations went so low that many CEO's decided to mortgage their company's future by padding their own bank accounts with lots of options on shares bought back from the market on borrowed money.

Stock Buybacks

This was a clear misallocation of resources; of the kind that central governments often incentivize. The cheap money allowed CEO's to buy back shares, thus improving the per share profit performance. This in turn made CEO's look so good that their job-well-done was rewarded with stock options. In a way, cheap Fed money allowed a transfer of wealth from investors to CEO's. Let's also remember that in a few years, all the current CEO's will be gone and not held to account any more. Yet, all company loans will have to be repaid with the future profits that would otherwise go to investors. You got to love the way the game is played. The stock market's optimistic booming picture disproportionally benefits company leaders more than any other stakeholder group.
Meanwhile, Obama also brought us a drying of the otherwise available capital that was needed for small business growth. For eight years, the cost of borrowing sky rocketed for small businesses regardless of where the Fed set their rates. But how could this happen? Well, it all resulted of the so-called economic stimulus by the Fed.
When the government bought so many of their own bonds, through transactions between the Fed and Treasury, most low risk assets were drained out of the market. This pressed low risk-tolerance lenders to compete for higher risk corporate bonds. The greater number of lenders competing for the same number of bonds pushed prices (interests) down. At the same time, this left lender portfolios with a higher risk profile than would normally be preferred. So, they then had to increase the price (interest) for small business loans to bring their risk profile back into shape. In a nutshell, next time the government tells you they are trying to help you, the small business owner, run for the exits. No matter how many PhD's work at our central bank, their actions will continue to result in big failures similar to those from Mao Tse Tung's great leap forward where 45 million people died after their government tried to help them.

Corporate Bond Cycle

For thirty years, the Fed has pushed interests lower and lower. Always with the goal of 'helping' the economy. Today, we are at the very end of one of those cycles that reverses about every 30 years. But whether the Fed actually prices interest rates higher or not, let's remember that bond prices are no more than a gauge of trust. If capital holders trust the environment, money flows into markets. When trust is lost, prices of bonds go sky high and capital drains out of markets. Interestingly, the same trust is what holds the price of stocks high. So, it is not unreasonable to think that we could face a pivotal change in the cost of money and a pivotal change on the cost of stocks, both at the same time. While bond charts show no more signs of peaking other than their cycle's maturity, equity markets are screaming 'top" like never before.

Elliot Wave Analysis of S&P 500

First, there is the fact that most large traders set price levels using the same technical analysis that shows that we are at a point where several longterm Fibonacci studies converge as tops.
Second, many more large traders look at what is called 'Elliot Wave' which is now calling for an end of an eight year move.
Finally, it's October. You know, all bad things in the stock market happen in October.
So, whether the bond and equity tops happen this Friday or the next, it seems clear that the difference is academic at best. The end of the current run seems upon us.
But, is it possible that I could be wrong; after all, there have been many calls for the top in recent years? Well, yes. I could be wrong.
Still, this week's relentless push upwards has the characteristic price action of a top. This week's price movement seems to be creating a Doji, a well known top formation used by 'Japanese Candle Sticks' chart readers. Yes, I know it all sounds funny and surreal. Still, these people make millions of dollars every year from looking at these studies that go back centuries.

In any case, I believe that, as a leader, one must be aware of any potential change in market sentiment. If a recession starts this month, it would last at least a year and a half. During such time, loans would be called back everywhere as lenders will try to reduce their risk profile. Capital will probably dry up. In extreme cases even trust between banks could create international commerce seizures due to an absence of international letters of credit. For a single day during the last recession, this same picture became a reality and all global commerce almost came to a halt. The risks are simply too high to ignore.
You have been forewarned. Let's hope I am wrong.

A Positive Solution to Frivolous Litigation

—For our purpose here, it makes no difference
if your company was exposed to other risks through
medical, legal or any other services or products.—

Here's a business owner's nightmare scenario. Let's say that your company uses hazardous materials in its daily operations.
Let's also say that despite doing everything right to protect your workers, an employee finds a complaint and gets a hold of an attorney.
But this happens to be more than just an attorney.
This guy is good... I mean, bad; depending on whether he's on your side or is playing against you. This attorney has an astute modus operandi that diverges from the norm and which is quite effective. This guy sues you and your company.
But he has no interest in winning the court-battle. No!
Judicial Harassment is more like torture. Pain is the main factor driving results. The more intense and personal the pain he can exert on you, the better his chances at getting what he wants.
After proving that there was damage to his client, he will ask that the court safeguard the money that could be used to pay his client's compensation. He will ask that your accounts be frozen.
He knows that most small business owners pay personal expenses through their company in an attempting to reduce tax liabilities. Many businesses follow the advice of their CPA's. They create pass-through companies and show no income at the end of the year.
It is therefore easy for this lawyer to show that you have previously taken money out of the company for non-business related expenses. He will next argue that you will certainly be tempted to doing it again; thus putting at risk his ability to properly gain indemnity for his client.
Depending on the case, this hassle will even disrupt normal cash operations in the business. Thus, the risk of crippling the company is very real. Remember that his chances of winning increase as he cranks up the pain.

The net result is always the same. You won't be able to pay your mortgage, your cars or a number of important expenses. Under the circumstances, you won't be able to get an income increase to compensate for your now strained cash position. If you did, the judge would probably respond with strong punitive measures; never a good thing. 

In a nutshell, you could easily lose your property; which is the essential part of the Harassment. Just think of the fact that it always takes a long time for a case to go through the courts. How long could you hold your breath underwater? It may be over a year before you can prove your innocence to the judge.
Inevitably, you will probably give up and settle. He wins!
Yes, you and every small business are just one bad-attorney away from a scenario like this. Perhaps more depressing is the fact that more successful companies make better targets as the bounty collected by the pirates could be much greater. And for those who pay the price once, the chances for a repeat are greater yet, once the word spreads.
Companies may go for decades without experiencing a single frivolous law suit. But this is a case where past experience does not offer a certain view at what the future will bring. Moreover, I find questioning the probabilities that you could experience Judicial Harassment to be misguided.
If a solution was costlier that the problem, I could see why ignore the issue. But since the cure is simple, valuable to you and your family, and may be used for other purposes, the real question should be why not?
You see, this is no ordinary protection. It isn't like liability or car insurance, which expire worthless every year and which serve no other purpose.
Section 7702 of the IRS code allows for the creation of an impenetrable fund where money is protected from dirty attorneys and other predators. They just can't claw their way into the money.
These funds are completely under your control and could be structured to have a high degree of liquidity for these or many other emergencies. They can be structured to benefit from tax deferred growth. Tax free access to the money is even possible when well designed. And perhaps the best part is that in case that you are never under threat of Judicial Harassment, the money continues to grow under your control and available for your retirement or gifting needs down the line. Despite mentioning it before, it is worth writing it again: Unlike derivative options or other types of hedging mechanisms, which lose value every day, these solutions continue to grow their worth over time.
Intrigued? Ask your professional advisers about how to use 7702 for this and other business risks.

Español

Para leer este articulo en Español, haga clic aquí

Finding a Buyer; An Owner's Dilemma

Retirement Planning?

You’ve poured a lifetime of sweat, time, and capital into building your business. You’ve begun thinking about retirement. Your strategy is to sell your company for a good price, settle back, and enjoy a financially secure retirement. But, like many business owners, you’ve made the mistake of assuming this scenario will happen, and you haven’t bothered to make any other retirement plans. 

My advice to you? Be realistic. What are the odds there will be a person showing up at your doors at the right time, with cash in hand and willing to buy your business for a fair price? For thousands of small business owners each year, no buyers ever ring the bell.
Perhaps your business is too specialized or is tied too closely to the owner’s unique personality and skills. Then there is the chance that potential buyers may equate a retirement sale with a distressed opportunity; subsequently making only low-ball offers. Whatever the reasons, many owners find that their company has suddenly become a white elephant that nobody wants.
But here is a thought: select and develop a successor. Prime a replacement; someone who will buy your company when you’re ready to retire. You could even look at your current co-owner. Just be careful if she is about the same age as you. Retirement plans may coincide for the two of you.
The, how about your son or daughter? Are they active in the business? Could you look at a younger key employee? Business owners who successfully groom their own replacements leave nothing to chance. They realize that there’s no room for error at the point of retirement.
Be cautious nonetheless; make sure your heir apparent is the right person in terms of temperament, personality, competence, and personal goals.

Nurture a buyer, write a buy-sell agreement
and fund the deal with insurance. That simple!

But don't look for yourself. Being compatible does not mean being identical. You are not looking for a twin but for a potential leader who can do things as well as you, but differently.
Set up a probation period so you can terminate the relationship if you find that this person will not work out. During that period, keep everything as informal as possible; strictly verbal. Even when you go to a formal agreement, make sure it contains a termination provision. It's important to reduce your risk's profile while you engage the search.
Offer incentives to ensure that your replacement stays until the baton is passed. An ambitious successor needs and deserves gradually increasing authority and benefits. Options should include deferred compensation or the opportunity to acquire partial ownership prior to your retirement. This provides both parties with something to win by sticking to the agreement, and something to lose if it falls apart.
Create a buy-sell agreement. With the help of your attorney, lock in who does and gets what, spelling out all details and caveats, including how to establish the final valuation of the business. This formal agreement protects everybody.
Build in a funding mechanism. This is of crucial as funding is why most deals fall through despite even the best buy-sell agreement terms. Any plan is worthless without the money.
Under one option, the successor may be able to purchase the company from ongoing profits. Other options include setting up a sinking fund or allowing the successor to simply borrow the money. These options may work but they leave much to chance.

Life insurance is a flexible financial
instrument available to any business owner

Instead, consider a funding vehicle that also protects your family in the event of your disability or premature death, such as life and disability income insurance. You would be surprised what can be done with a properly structured life insurance policy. Your insurance professional or your independent professional advisers can work with you to help you develop a sound business strategy.
Alternatively, have a Plan B. As a business owner, you know that very few things go exactly as planned. What if your business hits tough times or your successor dies, becomes disabled, or leaves because of a personality conflict? Or what if there simply is no heir apparent waiting in the wings? Sometimes, your only alternative may be to dissolve the business. Be ready. It is after all the route most often taken.
Now that, if you dislike the idea of fading your business away, then you have no alternative but to begin mapping out your retirement strategy today. What are you waiting for?

Stocks and Bonds: Where Cash is King

I probably made a fool out of myself on May 22 when I suggested that stocks were probably topping. In any case, I will not know how wrong I was until much later. For now, it is time for an update on what I am seeing in the markets.

S&P Futures

Since my post, things have turned a little scary. The S&P is sitting at about a 3% loss after recovering from losses as big as 6%. Incredible swings are literally shaking money managers out of their convictions. Everybody who says that things are fine is having to think twice. The price chart to the right shows the trading activity on Wednesday the 12th and Thursday the 13th of August when viewed through the S&P Futures window. Yes, despite happening at the end of an already sharp drop, the curve depicts a wild roller coaster between the two days.
It is believed that the large Thursday's rise was strongly supported by the fact that there were many traders closing short positions to collect their profits. To close short positions, which are designed to make money when assets go down, traders need to buy the asset; adding to the upward pressure from others who felt that prices dropped far enough to make them cheap to buy again.
There is also the fact that the Federal Reserve has an announcement scheduled for next week. From reading my post, you would already know that stocks topped during Federal Reserve Chairman Ben Bernanke's testimony to congress. So, everybody will be paying attention to his words attempting to anticipate how much will the Fed continue to distort markets through their monetary intervention.

Boom and Bust Cycle's Reversion to the Mean

Finally, next week will be quadruple expiration week. Also known as Quadruple Witching, options and futures will expire forcing many funds to re-valance their portfolios. This means that there will be a drop in price volatility, which will surely be welcomed by those still shocked by the gyrations of the last two weeks. The insurance needed for portfolio protection comes down in cost during this period. There will also be a natural push higher on asset prices due to portfolio re-balancing; also a welcomed fact.
After the recent drop in prices, the Efficient Markets Theory would suggest that the risk is to the upside. Recall that no market moves in a straight line. All markets tend to push high further than they should, resulting in bubbles. Markets then correct lower than equilibrium, creating crashes. So for now, there is the chance that markets have temporarily pushed too far to the downside.
In general, there are plenty of factors which will probably push market prices higher in the near term. This means that those who feel that the economic strength is not what it seems will take any price increase as an opportunity to raise cash.
While equity and bonds markets do not directly impact our "real" economy, our "real' economy impacts these markets as well as our businesses and our lives in general. To me, asset markets are therefore great indicators of what is happening to the real economy, if not the creator of such changes.
We are now in an economy where the white house is on an business witch-hunt, bonds are vulnerable, housing is sitting on poor foundations, equities are valued by jittery capital and where there is no fundamental full-time employment growth or long term capital investment. Whenever the market decides to price these factors, asset prices will go down, perhaps by quite a bit, thus making cash the king of the market.

Face-off with Risk - Stock and Bond markets respond

After a decade of trading equities, options and futures, I could recognize yesterday's morning reversal as something important. Today, we face further downdraft as market participants adjust their risk profile to the level where they will be comfortable next Tuesday, when markets reopen after the holiday weekend.

Sell in May and go away

Next, we face the issue of seasonality. The whole sell in May and go away is real. Much of Wall Street takes longer vacation breaks during the summer. As a result, liquidity drops and intraday volatility increases. In general, except for something big unexpectedly happening, money managers are not willing to add money to rising positions during the summer. Valuation growth usually waits for a few months.
I am sure that you have experienced a time when your company grew nonstop. The feeling among your team was that momentum would carry sales higher, but instead sales dropped. Why? It was simply that all possible buyers of your products made purchases during the momentum buildup until there was no one else to buy. In market terms this is referred to as a lack of marginal buyers. With not one additional willing buyer, sales abruptly stop and momentum turns negative instead.
As I saw the futures go negative in real time during Bernanke's speech yesterday, it looked as if marginal buyers were pushing for the last time. An absence of sellers gave the last buyers the chance to quickly drive prices very high. Then a flood of new sellers came in; overwhelming buyers. At the end of the day, the large reversal and the massive volume confirmed suspicions that the market was ready to exit risk.
It is important to understand that US equities have been rising due to a lack of good alternatives. It is not abnormal for money managers to drink their own Kool-Aid and wax poetic about the great logic behind their purchases of ballooning assets. I saw this exact same phenomenon during the last recession. Despite seeing construction spending collapse after April, 2006, buyers of real estate assets continued to binge for over a year more.
We now need to keep an eye on the end of the month. If the S&P 500 ends the month around 1,600 or lower, be ready for the fall to continue.

Treasury Bonds

For bonds, on the other hand, things are not so simple any more. Summer is usually the time when bonds go up in price. This time, though, there are doubts looming over the historic bubble that, after thirty years, is now finally ending. When bonds start to move, they will drop in value so much faster than equities that your head will spin. Incredibly, bond assets that are usually associated with safety now carry disproportionate risk
As long as our political leaders continue to promote ideas of wealth confiscation, or as Obama calls it wealth redistribution, market risk will not change. Businesses everywhere will continue to refuse to make long term investments.

Nobel Prize

There are a few economists who believe that people do not actually think rationally about what they do. As a result, they assume that businesses do not respond to risk with the same predictability as perfectly rational players. To them, I offer that large companies do in fact plan based of sound risk assessments. Medium and small companies, those lacking the expertise to process such information, depend instead on banks to determine when the right time to make investments is. Yes, the bond vigilantes are back. Everybody knows that the bond market is much smarter than the equities market. Bond holders are lenders; bankers are lenders; there must be something in the water they both drink. As market risk increases, bankers increase borrowing hurtles. This serves as an effective mechanism that forces small and medium businesses to operate as if they too were perfectly rational about risk. There you have it, cake all over the face of those Nobel winning economists. They should get out more often.
If we want to see a better economic future, a new era when markets reflect real values and not distortions created by governments, we need to stop allowing our leaders to continue to make business the bad guy of the movie.

End of stocks' bull run?

10:32 AM. As I write this, we may be seeing the end to the stock market's bull run. No, I am not too eager to look foolish by making a call that would be both wrong and memorable. Nonetheless, I am witnessing a momentous occasion and simply had to write about it.
Federal Reserve Chairman, Ben Bernanke, is at this moment testifying in front of the Joint Economics Committee of Congress about the state of the Federal Reserve accommodations and the economic outlook. This is something that has gathered great expectations from market participants even when the general public is probably oblivious to it. At stake is the continued stimulus support by the Fed. If they decided to end Quantitative Easing or any component of it, the market would have no more reasons to continue to climb.

There are major risks hidden behind the recent rise on equity prices. Most dividend paying companies, those that are going up in value most, have gargantuan shortfalls in their pension funds due to ballooning entitlements an unusually long low-interest environment. For example, Delta, a company that has gathered momentum as the whole airline industry has seen renewed appreciation for their stock shares, has pension liabilities equal the whole value of the company. In order to solve the problem, they are hoping for an increase in interest rates. But even substantial increases in interest will not be enough. They will have to use cash from future earnings to moderate their pension shortfall. This will not affect their future profits but will destroy their cash position; and we are talking about a lot of cash.
Because other companies are in the same position as Delta, we should expect for dividends to come dramatically down. Since present stock prices take into consideration dividends, it is almost certain that these valuations will come down as dividends suffer. The question here is not whether this will affect stock prices but when.
In order for prices to stay the same, corporate profits or the premium that investors are willing to pay for them would have to rise. Because most of the money chasing stocks higher today is risk-adverse, the probability of the higher premium is almost not possible. This leaves us with profits going up. Here, remember that much of present corporate profit performance has been due to two factors. First, companies have been taking advantage of low interest rates to borrow to buyback shares of their stock. This increases the per share profit performance. These companies have bought at a rate of about $1 trillion worth of their shares per year. The stock market is about $18 trillion in size. My gut feeling is that they would not be able to continue this for long.
The other thing that has helped improve profit performance is directly related to the massive decrease in payroll that has taken place over the last five years. But how far can you cut payroll? At some point companies have to begin hiring; making this technique least sustainable.
If the stock market ends at near the opening price for today, we might have seen the top. That this would coincide with Bernanke's presentation is not abnormal. The Fed's tactics have pushed risk-adverse money into riskier assets. These funds are looking for the smallest indication of change to exit the market.
They say that no one rings a bell at the top. So, I can not say that I heard any bells. Nonetheless, the day seems like a reversal kind of day.
What does the market mean to average people? Nothing directly; everything indirectly. The White House has continued to press regulations and fear onto business at such furious rate that corporations have refused to commit to long term investments. This means that the country will lose the ability to sustain a strong middle class every day more. Not only are we seeing lousy economic performance, but we can expect to see more of the same. I have written extensively about the economic subject recently; most of it has not been optimistic. Witnessing the Federal Reserve consider an exit and seeing the market react does not help. The Fed has been the only good thing going for the country. Now, we may have to face the music. Keep today marked on your calendar. I hope to be wrong.

Stocks push higher not on dividends; traces of risk aversion

Did you miss it? The stock market has been stretching higher and higher each day. Now that if your investment portfolio has not participated on the current push through historic highs, you are not be alone. There is definitely something driving stock prices higher, but it does not seem to be money from the average investor. Who is behind all the buying is more important than the fact that new records are getting destroyed almost daily.
The media argues that the floods of capital landing on our shores are seeking yield. They claim that, since Treasuries do not pay investors enough, these funds are goblin dividend paying stocks.
Low interest rates set by the Federal Reserve and their Quantitative Easing program are no doubt creating an environment where bond buyers are getting pushed away from Treasuries and towards other assets. But is yield what these bond holders are looking for? I argue that it isn't; at least not exclusively.

Normal behavior (2009 to present)

Under normal circumstances, stocks or sectors experiencing greater economic expansions would command a higher price than those with inferior potential growth performance. To see this normal behavior, look at the comparison chart of the FTSE Colombia 20 Index, with ticker symbol GXG, and the US Utilities Sector SPDR, with ticker symbol XLU. Because Colombia is going through the economic renaissance that's witnessing the formation of strong balance sheets by former debtor nations in Latin American, it has enjoyed great price appreciation since 2009. On the other hand, the US Utilities Sector's price performance during the same period has been as expected: boring. Normally, not one investor would brag to his mates about owning Utilities. It is like watching paint dry; there is no excitement at all.

Similar Dividends, Diverging Performance (2013 YTD)

But the story has reversed since the beginning of the year. Normal market rules have not applied. Economic success stories Peru (EPU) and Colombia (GXG) have lost about 10% of their value despite their great fundamentals. Contrasting this performance, US Utilities (XLU) and US Consumer Staples (XLP), sectors that would other wise stay flat, have gained between 17% and 20% in value in just four and a half months. These are incredible gains. The gap between exciting and boring assets has grown to about 27% in favor of the boring. Incredible!
Looking at the unusual divergence in pricing, one would be tempted to believe that the push for dividend income is what's creating the gap. The problem here is that all four assets in the chart offer great dividends. In fact, Peru's ETF (EPU) pays 3.63% while the US consumer staples SPDR pays only 2.71%. The other two fall in between. With similar dividend levels, there has to be a different reason behind the difference in price performance.
Risk seems to be the culprit. Money that would otherwise be invested in Treasuries, is now pushing boring sectors higher because these sectors normally experience lower levels of volatility. While dividends matter, perceived safety carries a much larger premium at this time of economic uncertainty. It should be clear that markets are thus pricing risk as if there was a great probability of trouble ahead.
Now that for all those not in the market, there are potential repercussion within the real economy. We have already experienced one economic slow down with all its associated problems in the ability to borrow or to find willing customers. A second swing lower would be most destructive for many businesses now residing at the margin.
I believe that the money that has driven the stock market higher has the characteristics of risk intolerant capital. I therefore think that a correction larger than three to four percent, the dividend being paid, would create a rush for the exits; leaving us all wondering what happened.

Wealth Redistribution House

I think that the present administration and its misguided ideals of wealth redistribution have created an air of uncertainty within the businesses environment. The result has been a complete unwillingness to invest in long term projects and of hiring new employees on the part of business owners. As a result, the economy has not improved despite a massive Federal Reserve intervention. This has created large pools of capital that have been looking for where to get some kind of return while keeping risk low. These funds demands a high degree of liquidity from their investments; a liquidity that would allow them to immediately exit positions in the event of drops in value. Not a great thing during jittery markets.
I certainly would prefer to see a robust recovery, but the signs do not support beliefs of a sound come back. If things were well, money would chase growth potential rather than safety. But as discussed, risk aversion is the call of the day.

Hoax offers taste of nearing capital rush from risk

A hacked Associated Press Tweet drove jittery capital back to Asia

Without warning, all financial market prices crashed precipitously. Within two minutes, the Dow Jones Industrial Average collapsed close to 150 points. Then, just as quickly, the Dow erased most of the losses. Was this a sign of what may yet come? That all financial markets are interconnected became clearly evident on Tuesday the 23rd. At 1:08 PM.

Launch AP Twitter

Apparently, a hoax by hackers commandeering the Associated Press' official Twitter account had spooked the markets. The fake Tweet alerted of two explosions inside the White House and that the President had been hurt. In an instant, every financial instrument crashed. Futures, Options, Equities and Bonds delivered pain to their investors; all markets but one. Interestingly, currencies responded in a distinctive and insightful way.

When capital moves between two countries, currency prices show the flow's intensity and direction. After the Euro remained absolutely stable during the crash while the Japanese Yen skyrocketed, there was no doubt of the unusually large capital flows escaping our market. The US Dollar chart graphs price fluctuations from the instant US markets were crashing. As capital exited towards Japan, demand for the Yen increased and Yen prices moved higher. The relative difference between the Yen and all other currencies was not subtle, highlighting the impact of this currency. A second chart of the Japanese Yen further shows the strong gravitational force that this currency exerted over many global currencies. Flows back to Japan were just huge.

After the crash, the media debated the impact that black boxes had on price swings. High frequency traders had left their finger prints all over the now familiar flash-crash. But perhaps the question shouldn't be who was behind the trading but what were they trading with? I am referring to the type of capital being deployed. Where does it come from? Is it patient or risk intolerant?

In his fantastic book Unintended Consequences, Edward Conard makes a compelling argument about the difference between two types of capital. There is risk-tolerant equity that does a great job underwriting risk. Then there is risk-adverse capital which demands instant liquidity at the first sign of risk.

Edward Conard

If Mr. Conard is right, intolerant capital entering US markets would first inflate low-risk asset prices. Johnson and Johnson's stock would move higher, for example. Finally, any sign of risk would trigger rapid liquidation as intolerant capital flees the US. Yes, the coincidences are eerie.

Treasury Bills would see unusual demand, no matter how dysfunctional our government may be. Then, as the Federal Reserve crowds out bond buyers through quantitative easing, intolerant capital would be forced to migrate to riskier assets. There would be robust demand for high-dividend stable company stocks;

To prevent such capital flights, the Fed needs to reconsider quantitative easing. The cost/benefit analysis of the situation seems asymmetrical. There is close to a trillion dollars of unused money parked at the Federal Reserve. Long term capital investment has never recovered from the recession's collapse. Quantitative easing is simply not doing too well. On the other hand, it is forcing intolerant capital to underwrite risk; driving stock and bond prices higher without a corresponding increase in patient equity. This is unsustainable.

I may not be into debating haute économie with the scholars at the Fed. Nonetheless, I can easily see that there is jittery capital being deployed. I agree with Mr. Conard that in order to ensure full economic potential, we need to create the equity that can underwrite the risk that intolerant capital can't.
This is at the core of the transformation that will make us a great nation for the next hundred years. Government as well as the whole nation need to unite once again behind entrepreneurs and those willing to take risks. We have gone too far with our drive to force people to contribute their "fair share". It is coming across as punishment for success and it is hurting our future. 

Strangle Options: gaining from success, protecting from failures

What will you do with your investment in a company that soon could face failure as easily as it could soar? What if it's structured as a tax pass-through entity and it continues to borrow to fund operations?
Whether you are an Angel investor or just someone who helped a friend fund her company, you need to be aware that a business failure while holding unpaid debt will create a tax liability to its share holders if structured as a tax pass through.
I recently gave advise to a friend who faced such scenario. Excited for its potential, he had decided to invest in a company. In exchange, he received 25% of the shares. He originally found the opportunity as the company's landlord. When the business failed to make an on-time rent payment, the business founder explained the fact that he had to bootstrap operations to keep the company and its great potential alive. The business was part of an industry with a growing trend, so the upside was great. Furthermore, the founder was a highly enthusiastic and all around great guy who had the deep technological knowledge needed to succeed in its industry. The investment seemed both emotionally and fundamentally warranted.
When the company continued to have poor cash flows, evidenced by the repeated failures to pay rent, my friend turned down a requests to provide additional funding out of fear of ending up too deeply invested in a potential failure. While not ideal, he was somewhat fine losing his initial investment but did not want to risk any more. Nonetheless, he felt that the upside potential demanded that he help the business find individual lenders to help keep the momentum going. Without much to show in the form of success, the company had to pay a premium for borrowed money. Unfortunately, paying such premium made it more difficult to make the company break out of its base. The outcome potential became purely binary. Either things would eventually make everybody lots of money or the business would soon collapse due to the weight of its business debt.
The obvious problem for my friend was that he was stuck with an investment that made it difficult to sleep at night. On the one hand, a failure would result in an unexpected tax bill for any unpaid loans, due to the business' pass through status. If a $100K loan went unpaid, for example, he could suddenly owe around $8K in taxes. On the other hand, if the business flourished, he would not be able to participate beyond his 25% stake despite having given the business free rent on multiple occasions. He needed to find a way to manage his position. So I suggested what is called an Option Strangle. Yes, this is a real financial solution despite it sounding more like a bad horror movie.

Launch the Options Industry Council's website

An Option Strangle has two parts: a Long Put Option and a Long Call Option. Long is geek speak for bought, as in having to buy instead of selling the two Options in order to set up the strategy. A Strangle is designed to profit when prices of an underlying investment move outside of the present range. An Option Strangle is designed to protect against downside risks while increasing exposure to upside gains. It is a great strategy when there are increasing probabilities of an asset moving either down or up within a given period of time. If the asset value does not change within such time, the premiums paid for the two Options would be lost. In my opinion, the cost of the insurance is very much worth the protection; especially considering the circumstances.
To buy a Put Option, my friend simply had to pay the premium price to the company's founder. Of course that there is the need for a Put Option contract to record the transaction and make everyone's responsibilities clear. There are many Put Option contract samples online. A Put Option grants my friend the right, but not the obligation, to sell his 25% of the company to the founder at a pre-agreed price before the Option's expiration date. To make sure the deal happened, I suggested that the pre-agreed price, also known as the strike price, be low; perhaps a dollar. The goal was not to sell the shares at a value higher than their market price right before collapse. Instead, the intention was to accumulate capital losses from his bad investment to reduce other tax liabilities while eliminating the ownership share that could end up creating a surprise tax bill because of any unpaid debt. Remember that a Put gave him the right to sell, which means that the company founder had the obligation to buy the shares.
The rights from owning an Option can be exercised at any time before the Option's expiration date; a date that could be as far into the future as necessary. In any case, it is also possible to close one Option and then buy another one to extend the protection period if the expiration date ends up happening too soon. Think of the fact that car insurance expires at the end of one year and must be bought again and again every year. In fact, Options are insurance devices where the price paid is in essence the premium of the insurance policy.

The second part of the Option Strangle requires the purchase of a Call Option from a company stock owner. In my friend's case, he needed to write an Call Option contract with the founder. A Call Option gives the right, but not the obligation, to buy additional shares at a pre-agreed price. Here, the founder would have to sell the shares to my friend upon my friend's request. If, on the other hand, my friend did not want any more shares, he could simply let the Option expire without exercising his right. The reason behind the Call Option was to convert unpaid rent into company equity in the future if things improved. I suggested that the pre-agreed price, the strike price, be defined by the present share price minus the amount of the free rent. Consider the fact that the Call Option contract must specify how many shares are available and at what strike price. 

I further suggested that my friend use part of the free rent he already gave the company as payment for both Option premiums. This would allow him to protect his position against a downturn while gaining from any upside at no additional cost. 

Remember that you must first check with your CPA on all tax related matters. I am not a tax specialist nor am I offering tax advice. I am also not legal counsel. My goal is to simply highlight the fact that there is the need to be better informed about these issues and that there are powerful solutions that could help you in case you find yourself in the same position.

I know well that the strategies I cover here are much more sophisticated than what is the norm for most business people. But you should learn them nonetheless. These are instruments that have wide use throughout the financial markets. I find that there are great possibilities for investors who are willing to break out of the proverbial box. To me, success in business is all about an open mind and an insatiable desire to solve challenges. Feel free to share your challenges with me. Together we may come up with solutions that will surely help many business owners and investors.

Launch LinkedIn

Secret double-life - Warren Buffet spices things up with leverage

Launch Forbes

What does this book tittle tell you: Warren Buffett and the Art of Stock Arbitrage: Proven Strategies for Arbitrage and Other Special Investment Situations?
Another book about the Oracle of Omaha? More close your eyes and buy advice? How about the Arbitrage word? Why such long title and subtitle?
Let me tell you, what the book does contain are awesomely and incredibly interesting insights! None of the boring buy-Coca-Cola Buffett stuff. This book is certainly not about buying something and not worrying about the market closing for five years. No sir; Warren Buffett is sort of coming out of the closet here. It turns out that he does use leverage after all. Moreover, he uses it with gusto! So much so that his otherwise lower performance is super charged thanks to his being a naughty boy.

Warren Buffett and the Art of Stock Arbitrage

That these facts came as a surprise to me is an understatement. Who knows what else we will learn next. Maybe we will uncover his disdain for taxes on a future book about him. We will have to wait and see.
For now, the Warren Buffett and the art of arbitrage book is easy to read and short; yet it comes packed with everything from Graham math to various arbitrage techniques for outstanding returns. If you dare to self-direct your investments and are comfortable with looking deeper than the surface, I strongly suggest this book; not because it is about Warren, but because the content is racy in an investment-geek sort of way.







Book Title: Warren Buffett and the Art of Stock Arbitrage
Book Subtitle: Proven Strategies for Arbitrage and Other Special Investment Situations
Author: Mary Buffett
Author: David Clark
ISBN: B004UBL79S

Think independently - legendary investor advice

A Gift to My Children

Legendary Investor Jim Rogers found so much success in the financial markets that he retired at 37. He even partnered with sage George Soros to create the Quantum Fund.
Many stock market prognosticators have their fair share of detractors; but I just can't see Jim Rogers having any. After all, it is difficult to argue with real-life success. Once he made enough money as to never have to worry about it again, he traveled all around the world, once on a bike and another time on a modified Mercedes Benz in the company of his second wife.
With nothing else to achieve, he focused on what is the most important aspect of life: the creation of a loving and closely knit family. Yes, Mr. Rogers made it to fatherhood a little past the time when most other men do it.
His latest book, A gift to my children, was written by the man who has seen it all (literally), as advice to his daughters. The book is short and easy to read.
I had previously read another one of his books, A Bull in China, which exclusively dealt with economics and markets. Mr. Rogers has also authored four more books: Investment Biker, Adventure Capitalist, Hot Commodities, and Street Smarts.

Launch Video Site

A gift to my children, different to his other economics books, barely covers any of his trading experience. What the book does is to drive concepts such as perseverance  thinking independently, doing extensive research (learning), speaking at least another language, not trusting boys and keeping an open mind. That he cares deeply for his daughters is evident from the book. It left me wishing that one day my daughters will too read this book.



Book Title: A Gift to My Children
Book Subtitle: A Father's Lessons for Life and Investing
Author: Jim Rogers
Publisher: Random House
ISBN: 978-1400067541

Is a Futures Hedging Specialist a must for your business?

The business environment has changed in just a couple of decades. While business success used to depend only on the skills of the early-eighties owner or manager, today businesses must attract and synergistically coordinate the efforts of many knowledge workers. Knowledge workers are those whose main job is to make sound decisions. Engineers, analysts and specialists, among others, carry the responsibility of making decisions beyond the ability of most, if not all, of the workers at the company. Often, these experts will demonstrate deeper subject knowledge than that of even company leaders.

Knowledge Worker Performance - Peter Drucker

Thus, companies should develop guidelines for all decision making processes that are based on a sound risk/reward balance. The goal is to enter into situations where the balance is asymmetric; where the downside risk is low or limited while the upside reward potential is high or unlimited. This will result in the best deployment of all knowledge workers.
With this in mind, let's start by considering a topic of great importance for manufacturers: the cost of raw materials. The seemingly uncontrolled volatility of important materials like copper or oil turn business planning into a little more than a wild guess. Thankfully, there are ways to solve this problem. There are well established, liquid and transparent derivatives markets that can help a business hedge against raw material volatility. I am talking about Futures and Options markets. Both offer alternatives that can help insure against the kind of market gyrations that could put a company out of business. From these, the Futures market is the simplest to understand. Options are much more flexible. Unfortunately, such flexibility comes with a high price in complexity.
Like with other insurance policies, a business manager must understand that there is a cost associated with an insurance policy that protects profitability against large swings in cost of goods. The cost of such insurance is the limited downside. The fact that a business will not have to suffer the same fate as all other businesses in the same industry when raw materials go up is the great upside.
But chances are that the manager or owner has no idea on how to even start hedging through Futures contracts. It is therefore essential to employ a qualified knowledge worker who could help set up a basic insurance program for the company. As I mentioned above, there are many areas where specialists bring value to a company way beyond the leader's capability.
To help a manager get a beginning understanding of what Futures are, I found this great video from the UK's Money Week magazine.

Launch MoneyWeek.com

While this video does not show how to hedge, it does describe how Futures operate. Hedging, should be individually addressed by a specialist in the field. Because all companies have different needs and due to the fact that improper hedging techniques could kill the company, I do not suggest for an old-fashioned manager to go it alone. Saving on the expert could prove to be very costly indeed.