January 2011

2010 Review & The Great Retrenching

In last year's annual letter I broke tradition and wrote a piece full of predictions.  Of the predictions, most of which were longer term in nature, some have come true already, others will take more time, a few will not come true.  So, as time sorts out of what I said a year ago, we will take some time to review what went on in 2010 and how that will impact us the next few years.  But first, take a second to reread my January 2008 letter where I warned "I believe that the problems at Bear Stearns are the tip of the iceberg regarding problems that are likely to emerge in the financial sector."  If you never read that letter, now would be a good time because some of the things I am going to say will be very challenging and that letter will help you understand my perspective.

In this annual letter I will unload quite a bit of information, with links supporting my opinions.  This letter will read long, so grab a refreshment and get comfortable.

Financial Reform

In 2010 President Obama and the Democratic Congress with help from three Republican Senators passed much needed, although lightweight, financial reforms despite shrill cries from corners of the financial industry, their political shills and anti-regulation zealots.  The core of the Dodd-Frank bill is designed to reduce the risk of "too big to fail" and contains provisions dealing with changes in securities laws, capital markets, banking and consumer finance.

While much of the financial reforms are still works in progress, they are a step in the right direction at controlling crony capitalism (which Michal Lewis foreshadowed in his book, Liar's Poker, and chronicled 23 years later in his book The Big Short: Inside the Doomsday Machine).  Such controls are necessary after the destruction and underfunding of the regulatory framework from 2000 to 2004, which was clearly a major reason why the economy spiked and collapsed the past decade.  Simply put, the lack of regulation allowed an unprecedented amount of cheating.  The type of skimming and stripping of the economy that occurred was the type that we in the U.S. accuse the Russians of.

Presuming the rule making process for these reforms is sensible, no small presumption, we might again find ourselves with the stability that Glass-Stegal, the post great depression rules, helped give us for three generations.

For more on the Dodd-Frank financial reforms visit:



Support for Small and Medium Sized Business

2010 marked a notable change in government support of small business.  Over the past few decades, big business had gradually steered rules, regulations and tax policies in their favor through their massive lobbying efforts.  The result, in my opinion, has been the gradual loss of opportunity for those who wanted to start their own business or expand an existing one, ceding effective control of the economy to a very small group of people in the executive levels of the biggest corporations.  That situation has had dramatic effects on employment, wages and the fabric of our democracy.

In 2010, two bills potentially helped move the playing field back to a little closer to level between large businesses and small to medium sized businesses, or for those willing to consider the notion, from corporate elites slightly back to everyday Americans.

The first provision of the law that has changed is the much maligned Healthcare Reform Act.  While I am the first to admit this is an imperfect law, it does accomplish several things immediately, such as, coverage for sick children, closing the donut hole on prescriptions for the elderly and expanding preventive care.  The bill also importantly creates a potential framework for holding costs down for healthcare in the future by reducing expensive emergency room care expenses of the uninsured and the effects of cost shifting from the uninsured to the insured.  It is important to understand the magnitude of getting people out of the ER and to primary care via guaranteed coverage options, just doing that can offset the aggregate cost of national healthcare by 10-15% alone.

The relief to small business under the healthcare reform is substantial.  For 2010, small businesses that provide healthcare coverage will receive a tax credit to offset their costs.  Beginning in 2014, small businesses will be able to purchase coverage through exchanges which increase competition for their insurance business, and theoretically reduce costs, an idea from previous Republican proposals.

It appears that insurance companies are getting in their last swipes at steep premium increases now, knowing that they will have to commit more premium dollars to paying claims and less to executive compensation per the coming new rules.  I would expect premiums to become much more levelized after 2014 when all the provisions of the law become effective, which will help small businesses plan their budgets much more effectively and become even more competitive.

For more on the healthcare reform impact begin reading here:



The Small Business Jobs Act further improved the outlook for small business inline with proclamations from both parties that small business is the backbone of America.  There are eight key provisions to the act which include various tax incentives and loan facilitation which are detailed in the links below.

Read here for more details:



Debt, Debt Still Everywhere

Household debt in the United States remained high in 2010 according to Federal Reserve statistics.  However, the trend has been for debt to be declining, which is a positive step.  Mortgage debt remains a major problem though as debt to value ratios are still out of whack and promise to be for years to come.


With the extension of tax cuts now official, many households will be tempted to spend that money, which for most of the middle class will exceed $1000 for the year and for those with incomes around $100,000 approach $3000.  My best advice: do not spend your tax cut, save it or pay down debt further.  The reduction of your taxes is a direct hit on the federal budget, someday that money will have to be made up, which means that sometime in the future money will get tight again.  Save for a rainier day today, it is probably coming.


Over the past two years I have argued that the U.S. government needed to spend to keep us out of the type of depression that could undermine the basic stability of the nation as a whole.  Largely due to government spending to keep public sector employees employed and thus retain services, and due to tax cuts, we have avoided that type of depression- barely.  I am still in the camp that we are in a type of depression, but that it is demographic in nature, which there is really no cure for other than time.  That being the case, it is in fact time that the federal government started pulling in on spending.

It is necessary to address debt at a national level now because the United States debt is finally approaching the point of becoming dangerous.  Historically, the economy's of developed nations can carry about 100% of debt versus the nation's gross domestic product (GDP).  The United States, really being the richest nation on earth in terms of absolute assets, can probably get to about 120% or so of debt to GDP without major problems, so long as the trend is reversed from increasing debt to GDP to decreasing debt to GDP.  This can happen with a combination of two things, slowing the rate of spending so that we get close to balancing the national budget near the end of the decade and with growth of GDP.


That Crazy Federal Reserve

2010 was the year to bash the Federal Reserve.  Much of that criticism is not quite right.  Here is the Federal Reserve's Mission right off of their website:

The Federal Reserve System is the central bank of the United States. It was founded by Congress in 1913 to provide the nation with a safer, more flexible, and more stable monetary and financial system. Over the years, its role in banking and the economy has expanded.

Today, the Federal Reserve's duties fall into four general areas:

-Conducting the nation's monetary policy by influencing the monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates.

-Supervising and regulating banking institutions to ensure the safety and soundness of the nation's banking and financial system and to protect the credit rights of consumers.

-Maintaining the stability of the financial system and containing systemic risk that may arise in financial markets.

-Providing financial services to depository institutions, the U.S. government, and foreign official institutions, including playing a major role in operating the nation's payments system.

While the "Fed" has clearly struggled in regulating bank institutions from about 1997 to 2008 and containing systematic risk, the criticism is usually regarding its monetary policy by politicians and pundits.  Of all the things the Fed does, it seems to handle monetary policy best, along with providing financial services to depository institutions.  Critics fail to understand that the Fed is largely responsible for the expansion of the 1980s through middle 2000s by maintaining credit and financial conditions that allowed a historic long term boom that only collapsed after Congressional and Presidential led deregulation which allowed rampant stealing by the broad financial sector.

So yes, the Fed is imperfect, and clearly Alan Greenspan kept monetary policy too loose for too long following 9-11, which I think was forgivable and understandable given the circumstances following 9-11.  The criticism from some corners of government is laughable due to the extreme hypocrisy given their considerable role in collapsing the financial system.  They ought to look in the mirror, especially those who voted to repeal Glass-Steagall and enact the Commodities Futures Modernization Act of 2000.

The Continued Rise of China (and Russia, India and Brazil...)

While the rise of global economic powers is a diverse group, none garners the attention of Americans more than the rise of China.  I addressed this issue a bit in my March 2010 letter and will touch a bit on it again here as the Chinese continue to follow a self-interested path, as we do.

One of the most interesting developments in my opinion recently was the Chinese response to inflation in China.  Rather than letting their currency appreciate, they simply tightened lending standards, raised interest rates and raised the minimum wage by a whopping 21%.  Frankly, this was brilliant strategy on their part.  They simultaneously maintained much of their competitive advantage while helping their citizens live more affordable lives.

Now, I know this does not jump off the page at a lot of people, and I really can not make this exciting (not even to most financial people or economists), but this course of action is a big deal. By making their economy more cash based (the tightening of credit) and raising wages at the low end, the Chinese have preemptively dealt with a problem we had to learn the very hard way.  They pricked their bubbles instead of waiting for a collapse.  They did so without accelerating a loss of competitiveness, which will happen gradually anyway as we reach wage parity over the next generation, that a sharp rise in their currency might have brought.  If you are a Chinese citizen, then you like what they did, and that is really what the Chinese government cares about as Chinese citizens gain more freedom and assertiveness.

The Great Retrenching

Winston Churchill once said that, "Americans always try to do the right thing after they've tried everything else." I believe that is actually a knock off of an even older quote from the 1800s, but regardless, I think that America, after having done a number of unintelligent things the past few decades, particularly the last decade, is about to do things right.  I can not have any other view and still be an optimist about the country mind you, but I am in fact optimistic longer term.  What people need to realize is just how bad we have stepped in it since the 1980s, and especially since 2000, and that the time to get out of this mess will not be easy nor swift.

For the United States, China's approach is a blunt reminder that we are largely on our own in dealing with our problems.  It should also be a reminder that although many of us are blinded to our own missteps recently, most of the rest of the world is not.  Note the criticism from Germany, among others, recently.  America must redirect her energies to her own productive capacity and refocus on growing the economic pie for all, not just the very rich.  And let me define that a bit so I do not sound partisan (I am not).  The top 1% of Americans control over 50% of all assets in the United States. To put it frankly, that is not capitalist, nor American. So while I do believe that America is the greatest country on earth and in American exceptionalism, my analysis is that we have wounded ourselves of our own accord and now must heal ourselves.

I call this period the Great Retrenching.  I am certain that this is not an original phrase, as Google has demonstrated, but I like it and will use it since I thought of it before I read it.  It seems to me that the nation, despite being beaten up and down by political extremists, media hucksters and various screamers is at a point of making decisions that either will support the populace of the nation, and thus the nation, or tear it down so far as to incite violence and the type of rebuilding that our founding fathers suggested might happen if we are not diligent in protecting the foundations of the country.

I hope that last sentence had the correct impact.  We are approaching some very dangerous territory, not only with national debt, but also with extreme long term unemployment.  Real unemployment is hovering, adjusted for those who have exceeded the time period of being counted as unemployed, above 20%.   Over half of all unemployed have been unemployed for over a year- and the reason is not that most of them do not what a job.  Almost 3/4 of families are struggling to bring in enough income to get past living check to check.  We must improve this situation, soon.  We can not go on with ideas or policies that brought us to this point.  More specifically, we must incentivice domestic employment and disincentivize the outsourcing of jobs for our retrenching to occur or will potentially see a greater national collapse. It is up the silent centrist majority in this country to speak up and make certain that what needs to get done gets done.

I do not have all of the answers for improving the economy of the nation, but I can see validity in many ideas that hopefully gain traction.  Regardless of what I would like to see (a much better energy policy is high on my list), there is plenty of middle ground and a foundation for creating another multigenerational period of prosperity in America.  We not so simply need to focus on reason and reality, while staying away from rhetoric and ideological distractions.  We need to make sure we are not the subject of this parable.  So, although I think we have begun down a better path, I am not certain.

Financial Planning and Investing

I do not repeat myself as often as I could, but probably more than I should, so you can skip this if you have read it before.

In short, our strategy is to be very selective and cautious in our investing.  We do not care about short term (1 to 2 years) index movements.  Let me repeat, we do not care about short term index movements.  We believe that we can take less risk than the markets and make an inflation beating return.  We believe that where appropriate, we can take the market risk, such as after a substantial correction, and see significant gains in capital.

“Wide diversification, which necessarily includes investment in mediocre businesses, only guarantees ordinary results.”  Charlie Munger, Berkshire Hathaway, billionaire money manager

In general, we like global investments, we like private equity, we like commodity linked investments, we like some bio-tech and a handful of other high growth areas, and we like short term bonds and cash (among a few other assets).  We do not like too many mutual funds or highly diversified investments that tie us to the emotional swings of the markets.  We further do not like being tied too closely to the broader markets because if our macro analysis is wrong, or even if it is right and some influence, say government, war or financial shenanigans, changes the landscape, we want to be fluid enough and protected enough so as to avoid equivalent large losses when crashes occur (losses that we largely avoided in 2008). We like to be buyers when prices have fallen to levels lower than a reasonable person would buy a business intact.  We like to be sellers when we know prices are high, or as more often happens, when we are not sure what an appropriate price level should be today.

Looking at the short term, the weak consensus in the financial industry is that the first quarter in the U.S. markets should be very good and that things might go bad after that.  If that consensus becomes stronger, it is almost surely to be wrong, or hindsight by the time it is adopted.  I don't care about the consensus, although there are a handful of very smart people worth listening to in my opinion.  I am fairly certain that the United States is still in a secular bear market, regardless of the cyclical bull market or just a longer than normal rebound rally that we are seeing.  While I can see a continued rally for weeks, months or quarters, I do not see it lasting for years.  So, for most investors, as the fire gets hotter, it is more likely that we should pull away.  It is also apparent to me that the biggest opportunities are in international and commodity related markets, although there are also substantial risks there as well.

We are investing in ideas we understand and can analyze first hand or at least read the first hand analysis of people we trust very much.  In most accounts, we are also maintaining a trading position which will invest with the momentum or trend of a few chosen sectors.  We will use this trend trading strategy as a way to hedge our other bets and if a major correction (I try to avoid saying crash) occurs, attempt to not lose money during such an event.  We are also investing in a re-emergence of volatility which has actually reached very low levels again that I do not believe can stay low long.

Long term, as I described above, we will come out this retrenching period eventually.  I have suggested in print and in public, as well as in meetings, that I believe the sustained expansion will begin later in the decade largely based upon international growth.  Until then, we can expect another significant drop in the American investment markets at least one more time before a sustained secular bull market emerges.  We hold the cash and short term bonds waiting for expected, but unpredictable volatility, so that we can accumulate certain long term assets when they become cheap, such as real estate or more commodity linked assets.

A bit of advice regarding employer sponsored retirement plans, such as 401k plans, be very careful.  Rollover IRAs or Roth IRAs are more ideal places for aggressive investing because you have greater control of your asset choices.  If a 401k (or something similar) is your only asset then you must be diligent about managing it, including a few trades per year.  Contact me if you would like to have your retirement assets managed on an hourly basis, my fees are very low.

In Summary

The world continues to plod along with all of the same longer term trends that were in place before the financial collapse.  That is the big picture we must see.  However, volatility can rear its ugly head at any time and take from your hard earned nest egg- it is that monster we must always diligently protect against.  Remember the quote on the front of my page:

"Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it." Warren Buffett, Berkshire Hathaway, billionaire money manager

It is that premise which guides us to be cautious and patient.

Happy New Year from your long winded, cautiously optimistic about the long term advisor.


Kirk Spano


This newsletter contains forward looking statements that may not come true.  Past performance does not guarantee future results.  This letter is intended for informational purposes only, and reflects only my thoughts and opinions in general, and do not constitute individual advice.  Opinions expressed may change without prior notice.