CB Capital Research’s Reading List

Success entails hard work, tenacity, integrity, self-awareness, and being an open-minded and independent thinker. There is no Holy Grail when it comes to being a successful investor. Garnering the investment experience–and learning from one’s and others’ investment mistakes–certainly help; getting an MBA or CFA typically do not, and in my experience, may detract from one’s long-term investment performance.

Reading books alone doesn’t help either, but they do speed up the learning process. Reading books provides a solid foundation for a successful investment/finance career. They are also key to leading a successful life, which should be the #1 priority of every human being. Having or staying in a broken marriage; or having no friends, is miserable and certainly do not lead to a successful investment career in the long-run. Without further ado…

1) The Art of Living and Being

The Tao Te Ching (Stephen Mitchell’s translation) by Chinese Philosopher Laozi, Letters from a Stoic by Seneca, and A New Earth by Eckhart Tolle are my all-time favorites. They are widely accessible and are great signposts for the attainment of higher self-awareness and enlightenment, as well as one’s higher purpose. These books shatter the illusion of the importance of everyday’s trivialities–allowing one to be present and to focus on the big-picture. Reading these books is an important step to being a successful investor for two reasons: 1) For most purported investors, reading these will guide them to a different career path–one they truly enjoy and where they possess innate talent; 2) A person that lives in the present has more energy to focus on one’s present tasks. Anxiety and worry only sabotages one’s life, and those around you. Yes, there is a practical application to these works. Some may even leave long-term relationships or switch careers after reading these, and they will be for the better. Reading these books also allow us to be more connected with our fellow human beings, what Carl Jung would describe as the “Collective Unconscious.” Being in tune with the psychology of the masses (their hopes, fears, and what they are invested in) allowed me to catch the final “exhaustion” tech rally in late 1999; and to have the good sense to sell and short the market during January to March 2000.

For our more scientific-minded or technical readers, I highly recommend String Theorist Brian Greene’s The Hidden Reality: Parallel Universes and the Deep Laws of the Cosmos. Similar to the above three books, The Hidden Reality strives to answer the age-old question: “What is Truth?” and conjures a reality that is alien to everyday experiences, as well as a world-view that has been solidly in place since the Age of Enlightenment. Newton’s Laws and our limited 3-D perception no longer provide an adequate explanation of how our universe and lives truly work. To this point, CERN’s next goal is to explore the existence of other dimensions after verifying the existence of the Higgs Boson earlier this year,

Why is this important? Because these books give you better perspective; and challenges the (arrogant) notion that we could model the economy or even value stocks (the notion of “value investing”–i.e. pretending that you understand a company’s valuation better than that of the market–is hubris) using classical models. By definition, stock returns cannot be modeled using classical models. Only simulations created by a quantum computer could achieve this. e.g. We know that a 300-qubit quantum computer can model the behavior of every atom in our universe; but if String Theory is correct, we will need an even more powerful quantum computer. Right now, we are not even close to having such a quantum computer, so we should stop pretending we have the right tools.

2) The Art of Leadership

A successful investor needs to build a successful institution. At the very least, such a successful investor needs to build a trustworthy network capable of supporting him or her in difficult times. Let’s say you have made great investment decisions in the past and have accumulated a large portfolio of securities. One day, you have a stroke. How do you make sure your portfolio will continue to make decent returns and support your standard of living in the future?

Or let’s say you were a great trader and have made a substantial portion of capital for a French-Jewish bank before and in the midst of WWII. The Nazis take over. You may have great investment or market timing skills. Hopefully, these timing skills translated to real life, and you were able to flee the Nazis in time. André Meyer, partner at Lazard, found himself in such a predicament. Utilizing his network, he was able to flee the Nazis just in time. Called “the most creative financial genius of our time in the investment banking world” by David Rockefeller, he eventually became co-head of Lazard’s American operations, and would lead Lazard to become the top U.S. M&A firm in the 1960s, and act as a close adviser to Jackie Onassis and LBJ.

Of course, one cannot lead or build a network of close confidants by reading books. But I have found that reading books on leadership have made me conscious of what I was doing correctly or otherwise. e.g. Few people in power roles have good listening skills. In today’s social media driven and globalized world (where cross-cultural investing and understanding are becoming more important), good listening skills are a must. A book I highly recommend for personal development is “Co-Active Coaching: Changing Business, Transforming Lives.” Co-authored by the founders of The Coaches Training Institute, the book digs into the essentials of effective communication, mentoring, and coaching skills. It calls for understanding, curiosity, and compassion for your clients and fellow human beings–traits that are essential for the 21st century leader. I used this book as my blueprint during my coaching classes at CTI, and it has paid off in both my business and personal relationships. Perhaps most importantly, reading the book also helped me discover my own unique leadership and communication styles. Other books I include in this category are the Jim Collins’ classics Built to Last and Good to Great. You can learn about what makes for a bad company or management, and vice versa–allowing you to avoid bad investments or find good shorting candidates. I hesitate to recommend more books in this category simply because the most effective way to learn leadership or business-building skills is to go and just do it.

And finally, some actual investment-related books!

3)  Timeless Works on Investing

There is no book that is as timeless or better captures the individual and mass psychology of investing than Reminiscences of a Stock Operator. Rumored to be ghost-written in the early 1920s by Jesse Livermore, this book is the culmination of all of Livermore’s investing and trading wisdom since he began trading full-time at the age of 14. Filled with anecdotes and historical events (such as Livermore’s personal experience in the Northern Pacific Corner of 1901), this book comes alive and is at its most effective at capturing the action and psychology during important market events. You feel as if you were living and breathing these events–and making the same mistakes as those made by Livermore–while you’re reading it. Livermore’s signature trade was a massive short position ahead of the 1929 crash. He came out of the crash in November 1929 with $100 million in cash ($15 billion today on a US-nominal-GDP adjusted basis). I have read this book cover-to-cover at least a dozen times over the years.

Unfortunately, Livermore’s streak did not last. He protected his assets by putting some of it into trust funds; but he eventually filed for bankruptcy and committed suicide in 1940. The 1930s just wasn’t a good time to trade–either on the long or short side–there just wasn’t much activity or liquidity. Livermore did not build an institution (see 2) above), and on top of that, was likely bipolar. This leads us to the next book.

Co-authored by Bethany McLean and Peter Elkind, The Smartest Guys in the Room is an incisive biography of Enron and its collapse in 2001. The Smartest Guys in the Room is a textbook study of the failures of leadership and enterprise risk management, along with their sad consequences for both employees and society-at-large. The study of the rise and fall of Enron is almost an anti-thesis to the perfect case study in 2). Ironically, The Reminiscences of a Stock Operator was required reading on Enron’s trading floor.

Another required reading on the Enron trading floor was When Genius Failed: The Rise and Fall of Long-Term Capital Management. One story stuck in my mind during LTCM’s long string of losing days was a quote from Vinny Mattone, Meriwether’s long-time friend, who saw the markets as chaotic and unpredictable. Vinny Mattone was everything that LTCM’s professors were not. When he learned that LTCM’s portfolio was down by half, he flatly told Meriwether “You’re finished … When you’re down by half, people figure you can go down all the way. They’re going to push the market against you. They’re not going to roll your trades. You’re finished.”

LTCM was a study in the common occurrence of the self-fulfilling prophecy, which George Soros popularized as his Theory of Reflexivity in his book The Alchemy of Finance. Quoting Soros: “In his books [Karl] Popper [his tutor] argued that the empirical truth cannot be known with absolute certainty [see 1) above, namely the book The Hidden Reality and quantum mechanical behavior]. Even scientific laws can’t be verified beyond a shadow of a doubt: they can only be falsified by testing … Ideologies which claim to be in possession of the ultimate truth are making a false claim; therefore, they can be imposed on society only by force. This applies to Communism, Fascism and National Socialism alike.”

From an investment standpoint, the implication is significant: Fundamental valuations are constantly evolving and reflect the sentiment of the times, including technicals. That is why so-called fundamental analysts who are slaves to their valuation models always fail and under perform. Firstly, it is hubris to think you know more than the market. In my opinion, valuation models are only useful for scenario analyses. Secondly, as we mentioned in 1), classical models cannot, by definition, be reflective of the real world. Consider that only a 300-qubit quantum computer is capable of modeling all the atoms in our universe. Also consider that humankind only understands, at most, 5% of the universe–the latter of which excludes other potential dimensions. Thirdly, we know empirically that the momentum factor is the most predictive of all factors in terms of future stock returns.  The valuation factor has failed for extended periods, including the 1930s, the late 1990s, and late 2007 to early 2009.

Soros’ Theory of Reflexivity dictates that prices affect fundamentals, and vice versa. When IndyMac fell below $3 a share in 2008, I (impolitely) told a friend who worked there that the firm was finished. He disagreed for obvious reasons, and stated that it was “undervalued.” But he did not understand that IndyMac’s cost of equity just went through the roof, and it had become impossible for the company to borrow or to raise equity (this was even before Hank Paulson put Fannie and Freddie into conservatorship). This is not dissimilar to J.C. Penney’s (JCP) situation today. As JCP’s stock price continues to fall, it becomes harder for the company to raise much-needed equity. At some point, JCP’s vendors will pull their financing, which is especially important ahead of the Thanksgiving and Christmas shopping season. I expect JCP to file for bankruptcy by Christmas 2014, unless U.S. real GDP growth comes in at 3.5%+ in 2014.

William O’Neil’s How to Make Money in Stocks synthesizes the common factors of the best-performing stocks over the last 110 years. Philip Fisher’s Common Stocks and Uncommon Profits and Other Writings (Philip Fisher has as much influence on Warren Buffett’s investing style as did Benjamin Graham) attempts (and achieves) the same feat on a more qualitative basis. Both investors can claim actual, real-world performance as evidence for the validity of their systems and writings. Unlike what business schools teach (such as the highly theoretical and unusable “Porter’s Five Forces”), these are real-world tools available to most investors.

A reading list on investing isn’t complete without biographies, some history, and of course, some technical reading…

4) Financial Biographies

These works are self-explanatory. Reading the biographies of great financiers allows one to find the common traits that lead to success; or other traits that may have been just right for the times they lived in. It is up to you to decide what they are and how they fit into our times, and your way of life. Such books include:

5) Financial History

Those that do not know history are doomed to repeat it. It is through the meticulous study of the 1929 crash (where I holed myself in a library for ten straight weeks; this was in early 2000, before all the historical archives were available on the internet) that I became convinced the timing was ripe for a similar crash in technology stocks in early 2000 (note: I was >100% long in tech stocks as late as January 2000). I sent a series of three emails from February 14 to April 2, 2000 detailing my reasoning–email me for copies.

6) Final Reads

This list would not be complete without a mention of the required curricula in our MBA finance classes, as well as the CFA, CAIA, FRM reading materials (all of which I had to go through, but which I enjoyed). Most are useless for real-world applications, but interesting anyway. They are required reading not for hazing purposes; but because other investors have read them and are using these tools. In a zero-sum world of investing where true alpha is nearly impossible in the long-run, one needs to know and understand what one’s fellow investors are doing. For example, some fundamental managers shorted value stocks during August 2007 knowing that their quant counterparts were heavily, leveraged long these same stocks and thus vulnerable to a mass exit. This strategy–which had nothing to do with valuation or excel modeling–paid off. Books that I highly recommend among these areas include:

Please email me if you feel I have left any off the list. I’d be happy to post a mention of you as well as an updated list in the future.

A Technological Revolution in the Making – The U.S. Giant Awakens

Note 1: We asserted in our June 18th commentary that WTI crude oil will definitively rise above $100 a barrel this summer, driven by the ongoing U.S. economic recovery, steady oil demand from China (the country’s short-term credit crunch is over), and pockets of strength in the Euro Zone. WTI crude oil is at $103 as I am writing this. And no, it is not due to unrest in Egypt, as Brent crude did not rise much on a proportionate basis. The narrowing of the spread between the price of Brent and WTI crude is also the best evidence of a U.S. economic recovery.

Note 2: In our late January newsletter, we asserted that gold was due for a major correction. We advocated a short position in gold. With gold at $1,660 an ounce at the time, we argued for a 12- to 18-month price target of $1,100 to $1,300 an ounce. Today, the price of gold sits at $1,220 an ounce. In just five months, the price of gold has hit our price target. Bottom line: We are revising our price target for gold. Our new position calls for a 6- to 12-month price target of $1,000 to $1,200 an ounce. The two most reliable psychological indicators for a tradeable bottom in any asset class are: 1) Panic, or 2) Indifference. The best time to invest in any asset class is after years of investors’ indifference. That–along with other screaming buy indicators–was the reason why I invested in physical gold and unhedged gold miners at under $275 an ounce in late 2000. Of course–unless the U.S. mints a new currency–the price of gold will never see $275 an ounce again. So far, we haven’t witnessed much investors’ panic; nor indifference towards gold. With U.S. real interest rates (the ECRI Future Inflation Gauge just hit a 7-month low, even as long-term Treasury rates are spiking up) hitting new cyclical highs, we believe there is at least one more major sell-off in gold before there could be a tradeable bottom. The Dow-to-Gold ratio today sits at 12.4. I would only consider investing if the Dow-to-Gold ratio rises to 15, or above.  Avoid gold, for now.

Now, let’s get on with our main commentary. About 400 years ago, Descartes famously remarked “I think, therefore I am.” Descartes tried to prove his own existence by linking his thoughts to his consciousness. In other words, Descartes argued that because he cannot be separated from his thoughts–and because thoughts exist–therefore, he exists.

But Descartes was wrong. Equating one’s consciousness with one’s thoughts is mere identification with one’s ego–a path to endless pain and suffering. We are at our most enlightened state when we live in the present. A glimpse of a beautiful object, attending a concert, or seeing your loved one for the first time in a long time–these could all quiet our minds for just enough time to witness the beauty and truth in our own existence.  Unfortunately, human beings–just like Descartes–have equated our identities with our own, rigid set of thought/belief systems for thousands of  years. Such unconsciousness on a global scale has led to mass intolerance, discrimination and hatred, directly resulting in mass genocide, global wars, and witch-burnings–down to petty arguments over politics and household chores. It is sheer madness. A madness that many societies (e.g. the Middle East) still have not awaken from.

On a more practical level, an individual cannot invest successfully unless he awakens from such unconsciousness. Just like the natural laws of the universe, there are certain axioms any investor needs to follow; however, these axioms only provide the larger framework, and as of today, are not yet complete. Sir Isaac Newton explored the meaning of gravity, but lost his entire fortune in the aftermath of the Great South Sea Bubble. Investors are taught from an early age to follow benchmarks ranging from valuation ratios, cash flows, inflation, and GDP growth, to central bank policy, energy policy, technological breakthroughs, and finally to more esoteric indicators such as the VIX, various investment surveys (useful from a contrarian perspective), and sentiment data via Twitter feeds and Google Trends. An investor who is unconscious–i.e. one who follows a rigid set of thoughts and belief systems–cannot make outsized returns, since most investors follow such rigid thoughts, and by definition, most investors cannot beat the market. Sir Isaac Newton tried to follow such physical laws whilst speculating in South Sea stock. Both the final run-up and the subsequent collapse would catch him completely off-guard. Later on, he would remark “I can calculate the movement of stars, but not the madness of men.” The final exponential run-up in technology stock prices in early 2000 offered yet another example. Investors who failed to acknowledge this “New Era” missed the bull market in 1996, 1997, 1998, and 1999; many blue-chip funds under performed and numerous money managers lost their jobs because their rigid set of belief systems prevented them from owning technology stocks (at the peak in March 2000, the NASDAQ Composite traded at a P/E of 260). Of course, they were eventually proven right. But being “early” in the financial markets is just a nicer way of saying one was wrong. Similarly, many investors who were caught in the 2001 to 2002 bear market did not realize the rules have changed yet again.

I made this same mistake when I began investing in college. I tried to predict stock prices with factor models using linear regression analysis. I studied modern portfolio theory and was fascinated by real options valuation models. I thought the bull market in technology stocks would go on forever. I was unconscious. Thankfully, I did not remain unconscious for long. I managed to catch the tail-end of the technology boom; sold all my technology stocks in early 2000 (and warned others to do the same), and was 100% short the NASDAQ by late March 2000. The lesson I learned: Regimes come and go; belief systems are overturned (even thousand year-old systems such as the Chinese dynastic system in 1911); and something faster, crazier and more unbelievable will always come along.

A study of human history yields an endless chronicle of conflicts, wars, famines, mass slaughters, rape & pillage, and general misery. For sure, such a dismal record has been punctuated by glimpses of human goodness and progress in mass consciousness. e.g. The unprecedented prosperity and the promotion of peace during the “New Kingdom” period in Ancient Egypt, the export of Greek culture during the Hellenistic period, the harnessing and control of new technologies during the Han Dynasty in China, and of course, the European Renaissance and the Enlightenment. But it was not until the adoption of the United States Declaration of Independence–inspired by the writings of John Locke, and documents such as the Magna Carta, the Petition of Right, and the English Bill of Rights–did a major society finally begin to embrace the concept of human equality, freedom, and other basic, “inalienable,” rights.

In my opinion, the 56 delegates who debated and signed the Declaration of Independence as part of the Second Continental Congress represented the gathering of the most talented, progressive, and yet pragmatic, men in all of history. The Declaration of Independence–riding on concepts clarified by Enlightenment philosophers such as John Locke, Voltaire, and Rousseau–is the definitive document which defines the United States of America to this day. Yes, the U.S. falls short in many places; that is to be expected as the U.S. represents an ideal–an ideal that all of us should continue to strive for. It is thus no accident that the U.S. remains the most attractive center for entrepreneurs, hard-working immigrants, innovators, and the world’s best and most creative minds–despite our shortcomings.

In the wake of the Pearl Harbor Attack by the Empire of Japan, Admiral Yamamoto is alleged to have remarked: “I fear all we have done is to awaken a sleeping giant and fill him with terrible resolve.” Ever since the collapse of the technology boom and subsequently, the events of September 11th, the U.S. has been rudderless. Over the last 12 years, both the U.S. political and corporate leadership have failed the world, and reneged on too many broken promises. However, not all was lost. There have also been flashes of brilliance. e.g. the completion of the Human Genome Project in 2003, D-Wave’s progress in the development of a quantum computer, the advent of 3-D printing (a trend which I have tracked since 2007), shale fracking and horizontal drilling in the energy industry, and nanomedicine and nanotechnology in general–leading to advances in targeted cancer treatments, more efficient conductors, and stronger/lighter-weight materials.

As we have covered in our newsletters and commentaries, we are confident that the U.S. is on the cusp of a new technological revolution. It takes strong leadership, a functional financial industry, the right markets, and a bit of luck to commercialize the many, revolutionary technologies that we have written about. The U.S. is already undergoing an energy revolution–the rise in domestic crude oil production over the next several years will surpass the last domestic oil boom in the 1950s and 1960s. The 1950s/1960s domestic oil boom drove U.S. manufacturing and industry to unprecedented heights–and led to the creation of the U.S. middle class. The rise of 3-D printing, along with advances in 3-D scanning technology, means we could create our own tailored t-shirts in our own homes. I envision a timeline of just five years. Eventually, we will be able to “print” more complex objects with more differentiated parts. Together with cheap natural gas prices, the U.S. is already experiencing a renaissance in “in-shoring” and “in-sourcing,” beginning with low-labor content goods.

Slowly but surely, the U.S. giant is awakening. The economic recovery since 2009 is merely a precursor–a big, giant yawn. Our expertise and networks in healthcare, technology, and energy has placed CB Capital right in the center of the next technological boom, driven by American ingenuity, focus, and honest hard work. We are looking forward to the ride.

Developed Equities Overbought

Since the publication of our 2013 outlook on January 7, the MSCI World has rallied by 3.7%, the MSCI EAFE by 4.1%, the Dow Industrials by 4.7%, and the S&P 500 by 3.5%. Our constructive outlook on developed equities relative to emerging markets equities was prescient, as Emerging Markets remained flat during the period. Meanwhile, Frontier Markets rallied by 5.0%. Based on our technical and sentiment indicators, both developed and U.S. equities are now overbought. For example, last week’s survey of 40 NAAIM (National Association of Active Investment Managers) member firms shows an equity exposure of 104.25%, the highest level since early 2007!  This survey (courtesy Decisionpoint.com) contains data from leveraged and long-short strategies, and thus responses can vary widely. The results are then averaged every week. Inception of this poll is 2006. The latest result shows active money managers to hold a net leveraged long position, which has only occurred the second time since inception of this poll. From a contrarian standpoint, U.S. (and developed equities) are now highly overbought.


We are still constructive on developed equities, given ongoing central bank easing (the BOJ has vowed to adopt a more aggressive easing policy by actively underwriting more government spending), decent valuations, and the elimination of certain tail risks as discussed in the inaugural issue of our monthly newsletter (please email us for a sample). However, we cannot ignore the market’s overbought conditions. As such, we are revising our 12-month outlook on developed equities. Our 12-month return outlook for developed equities is revised down from a rating of 7 to 5, while our risk rating is revised from 6 to 7. Our outlook on developed equities is now on par with that for EM equities Our ratings for other major asset classes remain the same, although we are keeping a close eye on U.S. Treasuries, gold, and WTI crude oil.

12-month outlook February

The Superclass: A Rational (Investor’s) Perspective

It’s that time of the election cycle again. Many frequent musings I overhear include:

“This is one of the most important Presidential elections.”

“The market is going to sink by 30% and the U.S. is entering a recession.”

“The Fed shouldn’t be doing this or that, and the Fed should be abolished.”

This is all random noise, and ultimately a waste of time. It doesn’t matter what you or I think. It only matters what Fed Chairman Bernanke, the ECB, IMF, Angela Merkel, and the new Chinese government think. Unless you are Bill Gross or Larry Fink and have a direct line to Treasury, I won’t care about what you have to say unless you are better at getting inside their heads–as well as the heads of large institutional investors–than I am. If you failed to time the last two major peaks of the global stock market (i.e. early 2000 and late 2007), then you have failed your clients–and should get and stay out of the investment industry.

To quote French dramatist, Jean Anouilh:

“God is on everyone’s side … and in the last analysis, he is on the side with plenty of money and large armies.”

To gauge the sentiment of global policy makers and large financial institutions, you need to at least read Bernanke’s two major publications (“Inflation Targeting” and “Essays on the Great Depression”) and to get inside his head regarding what the Fed will do today. If you had read both books before the late 2007 to early 2009 crisis (which we did), you’d have had a much better idea on Bernanke’s next steps on a real-time basis during and after the financial crisis. It is unacceptable to be learning and reading about things after the fact.

It is also unacceptable to write a long commentary when one could be brief. So here goes.

Today, we know that:

1) US Treasury rates remain at historic lows; therefore, the US government will not cut Federal spending
2) Using the same logic, neither would they increase US taxes
3) And yes, the Fed will inflate–the Fed is already doing this through QE3 with $40 billion of MBS purchases on a monthly basis

A currency regime is only sustainable if the underlying currency is allowed to be debased on a small and consistent basis. It is laughable to hear young Americans advocating for the return of the Gold Standard, when these same Americans (especially the so-called Jeffersonian “yeomen farmers”) were advocating for a bimetallic standard and rallying behind William Jennings Bryan’s “Cross of Gold” speech in 1896. It also did not occur to these same individuals that a true gold standard never existed in the United States. Chaos reigned after President Andrew Jackson killed the Second Bank of the United States. Banks issued their own bank notes and inflated the economy through the normal credit cycle, in spite of the so-called gold standard. The “gold standard” subsequently became a strait jacket on credit creation once the down cycle hits–thus accentuating the busts. For example, at the peak of the Panic of 1873, the NYSE closed for 10 days, and 36% of all corporate bonds defaulted from 1873 to 1876. The latest financial crisis pales in comparison.

With regards to U.S. interest/Treasury rates, we also know that there exists a shortage of global risk-free assets. According to numerous studies, there will at least be a shortage of $9 trillion worth of risk-free assets in the next five years due to the destruction of risk-free assets during the European sovereign debt crisis; as well as the implementation of Base III requiring higher capital standards of global banks.

That means there will be a rush to purchase more US Treasuries, no matter where US domestic inflation lies. By the way, there is no hard rule that nominal interest rates have to track inflation; nor any hard rule that nominal interest rates have to be positive. In fact, my base case scenario is for the U.S. Treasury Bill rate to decline below 0% sometime in the next several years.

Besides, we also know that inflation is nowhere near as “sticky” as it was in the last inflationary cycle during the late 1970s (culiminating in the peak of the gold price at $850 in January 1980). A comparison to the late 1970s to 1980 is thus erroneous. Inflation was very sticky in the 1970s given the rigidity of wage increases due to the power of unions and the fact that US labor was mostly domestic in nature. Today, unions no longer hold any power; and US labor wages are tied to global wages due to outsourcing.

So in a nutshell, yes, the Fed will continue to ease. And no, the government will not spend less; nor will it increase taxes. And yes, interest rates will remain low until at least the next Presidential election. And yes, what you say does not really concern me, unless you happened to be in a “Top 50 list” of global policymakers or a fund manager with >$100 billion in AUM. And at the end of the day, it doesn’t matter whether you agree or disagree with these global policies. As an investor, my concern is only about making money for my clients. And outside of that, my time could be better spent with family and friends rather than discussing the questionable virtues of a “sound currency” or “sound policy”–whatever that means.

John Pierpont Morgan on Trust

In the aftermath of the Panic of 1907 and its powerful impact on the national economy, a special U.S. congressional subcommittee was formed in 1912 to investigate the “money trust.” Headed by lead attorney Samuel Untermyer, the Pujo Committee seek to reveal the true power and network vested among Wall Street bankers, especially within the House of Morgan.

Known as America’s de facto central banker, it is no accident that J.P. Morgan was born in 1837, the year after the “hard money” Andrew Jackson famously killed the Second Bank of the United States. It is also no accident that Morgan died in 1913, the year the Federal Reserve was born. From his brilliant feats of concentration (Morgan worked only a few hours a day) to his coolness under fire (Morgan had to obtain an 11th hour anti-trust waiver from Teddy Roosevelt to acquire Tennessee Iron & Coal in order to halt the Panic of 1907), Morgan relied on his reputation and trust network to get things done. The Pujo Report ultimately revealed the extent of Morgan’s influence: the House of Morgan controlled over $22 billion in resources and capitalization through 341 directorships in 112 corporations (equivalent to 60% of U.S. GDP in 1912, or nearly $9 trillion in today’s dollars). The following exchange between Samuel Untermyer and John Pierpont Morgan is now forever immortalized in the financial annals.

Mr. Untermyer. Is not commercial credit based primarily upon money or property?

Mr. Morgan. No, sir; the first thing is character.

Mr. Untermyer. Before money or property?

Mr. Morgan. Before money or anything else. Money cannot buy it … Because a man I do not trust could not get money from me on all the bonds in Christendom.

Today, trust is a commodity that has been lost in the financial industry. Beginning in the early 1980s and culminating in the birth of the junk bond market, the derivatives market, and now algorithmic trading, the Rothschilds and Lazards days of personal relationships have degenerated into a series of empty transactions. We are pushed into a multitude of products by banks and funds alike for the sake of higher fees; and we no longer know our personal banker.

The Panic of 1907 began as a liquidity crisis among trust companies, ultimately morphing into a crisis of confidence. Similar to the late 2007 to early 2009 financial crisis, the Panic of 1907 traced its roots to the explosion of a “shadow banking system” (i.e. the trust companies) outside the purview and protection of the New York Clearing House. By early 1907, New York trust companies held almost as much assets as New York banks (source: Atlanta Fed), with much of it “invested” in illiquid real estate or as margin loans for speculative purposes. During a typical bank run, the New York Clearing House would step in and issue “Clearing House Certificates” to panicky depositors. This was not the case with trust companies. Once a run developed, here was no effective system to stop its spread. Only the reputation and resources of J.P. Morgan were able to bail out the trust companies and the New York Stock Exchange.

We continue to believe that the U.S. financial system (and society) overall is evolving into one where personal trust and relationships are of paramount importance. At CB Capital, trust has always been of paramount importance–but going forward, power will no longer be derived from financial capital or intelligence, but from trust alone. Or as J.P. Morgan would put it: Character.

The Next Secular Bull Market

As Newton’s and Einstein’s scientific ideas became mainstream in the 20th century—and with the fall of the Berlin Wall in 1989—the world, while prosperous, became a little boring. The Cold War era of secret government agents, spy planes, and a common enemy lost its allure among the American populace. Gone also were the myths—those of ancient Egypt, Greece, and Rome as students became more “practical” and studied finance, economics, engineering, and business. The Space Race no longer mattered. While the liberalization and civil rights movements allowed women and minorities to explore more life and career options, many of us could no longer find any “outlet” to channel our energies and passion, with the exception of work and family life. The advent of the internet and social networking meant we could now find out what our neighbors and friends are up to at any moment—thus eliminating any remaining intrigue and mystique in our lives. Suddenly, that trip to Spain, Thailand, Fiji, New Zealand or even the North Pole doesn’t sound so exotic and exciting, especially when holiday photos are posted real-time on Facebook.

In today’s age of rationality, material comfort and political correctness, many of us crave for excitement, or even seduction. This urge is especially powerful for the repressed (by the church, family heritage, significant other, etc.); or those who never quite satisfied those childhood dreams. Louis XV, having the misfortune to immediately succeed the “Sun King,” is a prime example. Jeanne Antoinette Poisson–a highly ambitious woman–sensed his powerful inferiority complex and yearn for excitement/seduction immediately upon meeting him. Madame de Pompadour would go on to become one of the most influential figures in the life of Louis XV and the French court until her death.

The late 1990s in many ways provided the perfect environment for the stock market to seduce the masses, namely the seduction to invest in technology and internet stocks. Americans needed an outlet—not just for their savings (which were at record highs)—but also for their repressed desires and yearn for excitement. The bull market also provided an intellectual and spiritual touch, as every upswing in semiconductor or biotechnology stocks further reinforced investors’ self-confidence. The market was proving them correct—surely they were more intelligent than what college professors (whose meager salaries could not compare to their stock market gains) told them 10 or 20 years ago? And given the potential for these companies to change the world—in essence shifting from an information to a biotechnology era—surely investing in these stocks were a patriotic and a spiritual endeavor? Many of these investors also realized the ideal of a Jesse Livermore, Bernard Baruch, or even JP Morgan in them in the late 1990s. Like virtually all seductions, though, this was not to last.

The greatest danger in a seduction lies not in hate, repulsion, or resentment—but simply indifference. Extending this analogy, it is not the lack of earnings, high interest rates or even financial dislocation that characterizes major bear market lows (July 1932, April 1949, and April 1982). It is the genuine lack of interest or resources to invest in stocks. By 1932 (with the U.S. dividend yield at 14%), families were more concerned with feeding and clothing themselves than investing in the stock market; and whatever funds they had invested needed to be spent on food and clothing. By 1949, investors haven’t witnessed a major bull market in 20 years; and no respectable college graduate went to work for Wall Street. Ditto for April 1982. Valuations did not matter at those times (although they were good entry points, in retrospect).

Today, with the recent bull market still etched into people’s memories (especially in emerging markets), and with the clever invention of automatic 401(k) deductions, we cannot imagine a revisit to the March 2009 lows anytime soon. While we understand there needs to be a revolutionary change in much of the developed world’s social welfare programs, many major countries are coming to this realization (with the exception of Japan). Italy has no imminent solvency problem as long as its 10-year yield remains below 6.75%. Combined with the ECB’s promise to purchase more Italian and Spanish sovereign debt (along with the possible implementation of QE3), our outlook for U.S. stock prices is relatively benign.

That said, there needs to be a confluence of events in order for the masses to be “seduced” into stocks again. There needs to be a theme or a series of technological innovations (and commercialization) that could change the global economy in a revolutionary way and capture the imagination of investors, such as the commercialization of the quantum computer, second-generation biofuels (which would replace gasoline as a transportation fuel almost overnight), carbon nanotubes, nanotech-based drug delivery systems, etc. As such, we are not looking for a resumption of a secular/1990s style bull market. Rather, over the next five years, we expect U.S. stocks to return at an annualized rate of 5% to 7%.