My Current Perplexions

I realize that I have a dangerous bias--one that gravitates toward the calamitous. I'll credit my work experience with that as I have largely had to envision the worst and prepare for it. While a useful skill in doing turnaround work, I'm not sure how helpful it is in investing.

That the market climbs a wall of worry is something that I understand more fully now than I did as much as a year ago. I admit that I have this absolute dread of being caught fully invested in the next downturn. Though a distinctively unsuccessful strategy for me was to bet on the much anticipated decline as opposed to being hedged against it.

I cannot help wondering if my increased understanding (though still bumbling and nascent) of macro issues has done anything more than render me incapable of making prudent investment decisions. Nevertheless, I'm going to continue to process information as well as I can, and be devoted to my continuing tutelage. And I firmly believe that this is an important time to try to figure out how the winds are blowing, as it is my belief that there is some shifting of gears regarding the economy.

I was listening to Jim Puplova, and there were a few things discussed that I found interesting.

• Volatility: increased volatility will cause credit contraction.
• Dollar is mostly tied to whether or not foreigners want to hold USD's. Why would foreigners want to continue to invest in a slowing economy? Also, to affect the dollar, they will only need to make changes at the margin.
• We've not had a consumer led recession in more than 10 years.
• Central Banks have lost control over money supply (I also note that Don Coxe said this as well 05.29.06). Hedge funds are their own bank--anyone can borrow @ Fed funds rate.
• Fed will counter contraction that affects consumer (through lower rates).

I still do not believe that housing issues have shown up in the employment numbers--and I continue to believe that is due to undocumented workers. That would result in an understatement in unemployment claims as currently reported.

I do not believe that loan loss reserves have yet been hit with any credit degradation in their loan portfolios. I still find this odd, but I don't think my worry is wrong, it is just early! I have a very small position in Firstfed Financial Corp (FED). Here's a recent release:

"Amortization, which results when unpaid interest earned by the Bank is added to borrowers' loan balances, totaled $215.8 million at December 31, 2006, and was $62.6 million at December 31, 2005. Negative amortization increased by $38.0 million during the fourth quarter of 2006 and $153.2 million for the year ended December 31, 2006. Negative amortization has increased over the last two years due to an increase in short-term interest rates.

A $3.0 million loan loss provision was recorded during the fourth quarter of 2006, the same as the third quarter of 2006 and less than the $4.0 million recorded during the fourth quarter of 2005. A loan loss provision of $12.4 million was recorded for the year of 2006 compared with $19.8 million for the prior year. Net loan charge-offs totaled $90 thousand and $190 thousand for the fourth quarter and year of 2006. This compares with net loan charge-offs of $36 thousand and $1.4 million recorded during the comparable periods in 2005. The ratio of non-performing assets to total assets was 0.21% at the end of 2006 compared with 0.05% at the end of 2005."

I truly found the loan loss reserve decline surprising. However, note that the ratio of non-performing assets to total assets increased 4 fold (though these rates are still historically low). So either the worst is behind us or there is more to come. I'm in the more to come camp.

I'm keenly aware that I may be letting my bias interfere with the processing of the evidential matter before me. I was right regarding interest rates all of last year, so I'm holding that one insight (but an essential one that much smarter people were taking the other side of) out that I'm not a complete dunce.

Roger Nusbaum had a nice segment on patience. (And Nona, I pulled out my 18th Century Lit book with a section on S. Johnson and one of his Rambler quotes on patience--it's unintelligible to modern readers, so I'm not even going to quote it!) . I was inspired by Roger's counsel on patience. Accordingly, my goal is to cultivate greater confidence in my thinking. I have undermined my confidence through my failing to be patient in allowing what I expect to unfold happen in its due time. The snippet from FED is not yet showing (except for the non-performing assets ratio) any stress fractures. And even though the non-performing asset ratio is increasing, for all financial institutions, this ratio is at historic lows. You'll remember that I posted a graph from FRED here that shows this ratio. We'll continue to watch this. And by June 30, I will expect to engage in either a minor gloat or a confessional on my continuing foolish thinking.