I am not suggesting that PIMCO hasn’t earned its size or that it is unstable - note that I did not say “Too Big to Fail” in my title despite the Fannie / Freddie bailout.  I would have no desire to evaluate that and I am not qualified as I don’t do much with the fixed income world other than analyzing the broad implications of debt instruments on the general economy and what that means for stocks.   My title has more to do with them being too big for their britches.  I am just more than a little concerned about a weird feeling I have every time Bill Gross, Mohamed El-Erian, Paul McCulley or William Thompson appear on CNBC, Bloomberg or any other media outlet that have annointed PIMCO as the leading authority on the credit markets.  It’s more than just their blatant book talking or their ass-kissing of politicians and especially their constant endorsements of government bailouts and interventions.   I just get this strange feeling that PIMCO is way too involved in politics.  I know they are the biggest (and supposedly the best) fixed income guys and their understanding of these markets in a time of extreme confusion with global credit markets might be something that clueless politicians would want to hear.  But there comes a point were advice conflicts with influence and coordination.   No one elected these guys.  No one appointed them to a regulatory role.  Does anyone dare wonder how many times PIMCO has met with politicians during the past year and what was said and then what was done?

Assuming a Democratic President and Congress, increased taxes on investments via capital gains and dividends seem like a given. When dividends and capital gains were reduced in 2003, the media hyped how dividend stocks would get more investor interest and that the reduction in capital gains tax would increase stock prices in general. Academics and politicians and Buffett have debated how much of an impact these specific changes actually would have or did have.   No matter what the real impacts are…this has largely just become a political economics issue of supplysiders vs. the tax and spend crowd or rich vs. poor or progressive vs. regressive or Republican vs. Democrat.  I am not interested in that.  The fact is that the S&P 500 closed at 950.12 on May 28, 2003(the day President Bush signed it) and now it’s 1279.  If you believe in discounting and pricing things in before they happen, then given that its passage in Congress took a few months, it almost looks like the dividend and tax cut changes set the bottom in the market at the end of the last bear.   From reading my stuff over the past few years, you know I don’t assign one thing as a singular cause for longer term market movements and I am not impressed by the claims that the market is as great of a forward discounting mechanism as smarties will tell you and I don’t believe that taxation should be your sole reason for making investment decisions and I am sick and tired of having economics/capitalism confused with politics.  Regardless of the causation, taxes were lowered and stocks increased.   The Dems are likely to win in November.  It will be interesting to evaluate taxation causation in the other direction.

“We didn’t want to do this but we had no other alternative.”

“We had to do something.”

“We couldn’t do nothing.”

“If you have a better idea, let’s hear it.”

“I would rather not be asking for this, but I am playing the hand I was dealt.”

The politicians and regulators keep making statements like this and none of them indicates that what we are doing is anything more than an attempt to avoid blame.

I reflect upon this past year in finance and American life in general with great sadness. Much of my emotions are coming from taking a hard look at myself. I take great pride in not being naive and understanding how the whole finance game and politics are played. The events that have unfolded have shown me just how naive I am. I never imagined some of the things that have happened with both finance and politics (as much as those two can be separated these days!) I’ve tried to use this blog to help expose some of the truths and realities that I felt were hidden behind the lies, spin and fantasies. I’ve warned about things that I thought were going to happen in the future …not to be prophetic, but just on the hopes that someone else may benefit from the caution. And while I’ve gotten more than a few of those things right, it’s humbling to realize how only partially right they were. It’s like predicting in May that NY City would have snow falling in July…only to be right but have the snow turn into a blizzard with two feet of icy powder. In light of this introspection, I’ve decided to hold back on my desire to constantly flash warning signals. It makes no sense to me to do that. To be successful, I’d have to take my normal concerns and then to try and be right, I’d have to take them to extreme levels that I would never expect to be possible.  Our situation and certain “leaders” have proven that things I thought were impossible have become realities.  One of the key motivations for me to write this blog was the desire to protect against the dangers of being naive, that is no longer achievable.

Which makes you feel worse?

Having a gain on your portfolio that is worse than the gain on the index.

OR

Having a loss on your portfolio that is worse than the loss on the index.

Which makes you feel better?

Having a gain on your portfolio that is better than the gain on the index.

OR

Having a loss on your portfolio that is better than the loss on the index.

How does the joy of making 10% feel compared to the pain of losing 10%?

Asking questions like this and answering them with extreme honesty will help you identify some key elements of your portfolio management style, how you handle risk and how performance affects your desire to modify your portfolio.

I was going to write a new post about how pathetic it is that Merrill raised capital again under desperate terms despite all the previous claims that it didn’t need more than it already had. Then I realized I had written stuff like that already…several times. So to avoid wasting my time trying to write an original post about a story that it seems most investors love to ignore or only see the “positive side”… here is a bunch of snippets from related posts in chronological order.

From March 12, 2007 about the Subprime Ripples that I was expecting:

But it really doesn’t stop there, subprime divisions became popular at quite a few companies when the housing bubble was throwing off huge returns. Morgan Stanley’s acquisition of Saxon last August might not turn out so great and Merrill Lynch’s $1.3 billion purchase of First Franklin Financial looks like it will be a charge to 2007 earnings compared to the original accretive claim. In addition to direct operating units, Wall Street firms have benefitted greatly from the securitization of these loans and from lending to them directly. So, I am looking forward to the earnings reports coming from Wall Street in the next week and will be paying a lot of attention to guidance from the impacts of subprime.

And then in closing….

But despite what you might hear elsewhere - subprime is not a small problem and it has ripple effects thoughout our economy and markets.

From June 21, 2007 about being Afraid Of What We Do Not Understand and how Merrill Lynch’s pressure on the Bear Stearns hedge funds over a few billion dollars would create a cascade of problems for the markets.

As I expected, Bear Stearns and Merrill found a way to temporarily avoid a huge meltdown from the marking to market of these products. But what has been exposed in the process is extremely threatening to almost every aspect of the markets and now that the genie is out of the bottle, it will be tough to shove CDOs back into the junk drawer or under the rug. CDOs are too complex for people that are not investing in them and the majority of investors don’t play in this game. So when they hear that CDOs are a threat to their assets, it’s a dangerous situation.

Did Bear Stearns draw the short straw? That’s what a group does to pick the unlucky guy that needs to sacrifice himself for the good of the team. I keep looking at this BSC hedge funds / CDO / subprime fiasco and feel like they either were the only ones to make a mistake or they drew a short one.What’s curious to me is the odd way this got exposed. I seriously doubt that Merrill didn’t contemplate the consequences of their actions before telling the market of their plans to pressure BSC and more importantly, the entire CDO market. Wednesday’s afternoon drop gave a very quick measure of letting this Pandora all the way out of the box. It should surprise no one that Merrill backed off. It was much better for the team when “CDO” were just three letters that other investors heard and tried to use in a sentence at cocktail parties.When no one ever really liquidates an asset and all we see is a product category that has expanded past $1 trillion, it’s easy to just assume lofty pricing that will only head higher. Now that we had this little episode, the players in this crowd and anyone who is giving this some thought will know the risk of trying to sell it. And that is a scary point - if a small group is getting nervous about products that they can only sell to each other, what do you do? Somehow a CDO ETF doesn’t sound so good. So it looks like the guys that created these products will have to find a way to deal with them on their own.If the CDO market is entirely stable other than this one problem at BSC and with subprime mortgage risk, everything is okay. If not, I’d hate to have to draw straws and be the next member of the team to take a hit.

I have a new suggestion for solving the Subprime problems and the housing market price declines. You ready? I bet each of those houses has at least two sinks(bathroom and kitchen) and depending on whether they were jumbo mortgages with lots of bathrooms the foreclosure fortresses might even have 5 or more. So each troubled homeowner should remove their sink(s) preferably with the help of a plumber but if you are a do-it-yourselfer you could click here for some instructions. Once removed, the homeowner should promptly throw it in the front yard and then make a public announcement to all the neighbors that the worst is behind them. This strategy seems to be working exceedingly well with financial stocks like C, UBS, MER, and WM so I thought it might do the same to make troubled homeowners feel better and increase the value of their home. Of course, I am joking and I don’t want to see sinks in the front yards of America. However, I have a sinking feeling that the tactics of our financial sector is a big joke as well.

Politicians love Sarbanes-Oxley. It showed their prior inaction action reaction to Enron, Worldcom, Adelphia et al. In July of 2002, they were decisive with votes of 423-3 in the House of Representatives(Note that Ron Paul was one of the 3 Nays) and 99-0 in the Senate and a very rapid non-veto from President Bush.

Since then, there’s been a lot of talk about how expensive certain provisions are (Section 404) and how it makes it tough to be a public company…blah blah blah. Those complaints are all a big distraction really and that’s all that we seem to hear about the bill - complaints about complying and all the stock listings we’ve lost. And here I thought SarbOx was supposed to be all about punishing bad corporate executives, bad accounting firms and bad corporate attorneys for misleading investors and in so doing, creating confidence in the financial markets. The act even created a whole new part of the Federal government to supervise this whole mess, the PCAOB (we need bigger government I guess.)

Please take a few moments and think about all the Sarbanes-Oxley violations that have occured since 2002. HMMMMMM!?!?! Tough right? How many execs do you remember taking the “perp walk” for financial statements that were fraudulent? You cannot include Enron, Worldcom, Adelphia or any other company that encourage Congress to protect investors. Try to only name companies or execs that were naughty after SarbOx was put into place. Good luck. Here is a help…check with the SEC and see how many SarbOx violations they have enforced or with the PCAOB and see how many of the companies / execs / accountants that have been punished are familiar to you.

Since it is so difficult to come up with a few(or any) names, you might think that SarbOx is a huge success. Draft a law, pass it almost unanimously(always watch out for unanimous legislation), and then tadaaaaaa … no meaningful enforcement actions must mean that everyone was so afraid of being naughty they just cleaned up their act. Well, that might be what the supporters of the legislation want you to believe. But do you believe that? Really?

With all the goofy financial statements coming from the finance industry over the past few years…do you have confidence that the statements were 100% accurate?

Remember when Blackstone went public? The S&P 500 opened at 1520.92. Blackstone traded a high of $38 per share that day (it’s $17 per share now.) Remember all that hype - protectionists hating the Chinese investment in Blackstone, Congress vowing to change tax laws to target Blackstone, Private Equity premiums pumping up the market, CNBC constantly updating their annoying orange DOW RECORD HIGH ticker, and most ridiculous of all…the claim that the Blackstone IPO would be a market topping signal.

Now that 13 months have gone by and the S&P 500 has declined about 18%, you might think that I would believe that I was wrong about the “market topping signal” concept - I don’t.

It wasn’t coincident (the market high was 4 months later) and the last time we hit 1520.92 was during December 11, 2007 (about 6 months after the BX IPO.) And it wasn’t causative, Blackstone wasn’t responsible for the housing market or many of the other plagues that have beaten down stocks.

But for all the people who believe the BX topping signal, I wonder how many would dare say that KKR’s IPO will also signal that we are heading lower from here.

In December, I let everyone know that I intended to shut down the blog and database during 2008 in order to apply what I have done with HEDGEfolios and get back into serious money management via a hedge fund of my own or by working with someone else. Click here if you want to read that notice.

Since then, I have taken additional steps to open up access to the database with or without registration so that any interested parties can evaluate the consistency and quality of the signals at HEDGEfolios.

Regarding the blog….in March, I promised that I would finish up a bunch of old post ideas and then give everyone a week to send topics they’d like me to discuss before I stop or slow down my commentaries. I’ll explain more of the reasons next week, but the time has come for me to focus on other activities with time I now spend on this blog. During next week and by no later than July 31, 2008, I will complete the backlog of things I still want to discuss.

From now until August 7th at midnight, I will entertain your ideas…all you need to do is send me an email to notifications (at) hedgefolios (dot) com. I do not expect to start writing my responses until I finish my own stuff.

As I wrote before:

I will only write about topics that you readers want me to discuss. If there are no requests at that time, there will be no posts from me. If I don’t like the ideas people send in…I won’t write about them.

To clarify…if I don’t like the comment or request because it doesn’t fit with the objectives I have tried to exhibit at HEDGEfolios…I will just delete the email without explanation. I will not publicize anyone’s email address or complete name in any way during this process. Once we are past that August 7th deadline, I make no commitment to respond to requests.

I’ve been told how I would be more popular if I allowed comments. I am not sure about that or just how popular or unpopular I am, but being a popular blogger is not something I set out to become or something that I value. I appreciate the sentiments that many of you have expressed via email and I recognize that I have not made it easy to communicate with me. This effort (and if it goes well, one more that I am considering) will attempt to compensate for a few years worth of being somewhat out of touch.

Today was tough for anyone that had been betting that this rally would continue. I am one of those people - it was tough on me too. I went from being hugely hedged to the downside a week ago to making the biggest reversal to the long direction I have ever done.

Whenever something like this happens, I inevitably get some comments that either attempt to ridicule me for being a “moron” or ask me whether I regret what I did or wonder whether I still feel the way I did when I made the changes. As to whether I am a “moron”, I am comfortable with your assessment. The very short answers to those other questions are “No” and “Yes”. No, I do not regret making the changes (yet) and yes, I still feel more bullish than bearish in the short term. It was one day. I measure things in weeks, not days. If I spent my days like many people in this business getting in and out, I guess I’d feel like I got caught with my pants down by leaning in the wrong direction at the wrong time. As it is, I will wait until this weekend to evaluate things the way I do them.

I know it hurts to take a position that looks like it is solidly heading in one direction and then having that fall apart in the next 3 minutes after getting filled. It happens all the time. Sometimes, it takes longer than 3 minutes…maybe 3 hours…maybe 3 days. The emotions you go through are not much different regardless how long it takes to materialize. You start questioning yourself. And in my opinion (contrary to many trading psychology gurus) you should question yourself. You should always question yourself. And if in that process, you feel like a “moron”…you probably need to evaluate how you made your initial decision. What was it based upon that could possibly change so quickly? If you made a decision without adequate due diligence, you should not be surprised when you start questioning whether you did the right thing. And that realization will lead you to a desire to improve your investment decision process. The more you go through this exercise, your work becomes more disciplined, deeper, broader and more robust. As a result, your performance improves and the next time you question whether you got caught with your pants down, the less likely you are to shake your confidence.

For me, it’s largely about consistency. My analytical techniques are the result of a lot of practice and they are based upon a broad set of fundamental and technical factors. That consistency provides enough confidence to look at days like today as very small factors in the bigger scheme of things. For me to admit I was a moron, I have to convince myself that everything I used to make the decision was wrong. Because I look at factors that take a while to develop, it is only natural that it will take a while to fall apart. That rarely happens in one day, even if it is a day like today.

If investors make a decision based upon short term moves, then it is reasonable that they will second guess very quickly after something goes against them. If you are a day-trader that holds for a few hours on average, you should expect that you will question yourself and your trading methodology several times during those few hours. It’s a common and natural occurrence and nothing to be ashamed of. If you are a swing-trader, you should expect to question yourself a few times during the week or two you typically hold a position. It’s nothing to be ashamed of. And if you are embarrassed…get over it…use it to make yourself better. Each type of trader has their own emotional challenges that need to fit with their portfolio management. It’s just a part of the business. But if you plan to hold for a week and consistently find yourself stressing every few minutes or hours, you are not a match with the investment style you are practicing.

Feeling like you got caught with your pants down is not a problem if you are comfortable with what is underneath. Know who you are as a trader or investor. Know that things are going to go against you when they were going the right way just a few minutes, hours or days ago. If you can honestly say that your investing decision was wrong, then adjust accordingly. If the result of questioning yourself improves your confidence or your portfolio management, day’s like today will be kept in the right perspective.