That Which Cannot Continue  . . . .

One of the multitude of investment pages I get is the Gartman Letter.  If you are not familiar with it, it is great if you are into really granular investment information.  On top of currency analytics and commodity flows, there is usually a pearl of wisdom in each days dump.

Today's message, which I borrowed for the working title of the blog, is provided originally from the economist Herb Stein who actually said "That Which Cannot Continue, Won't."

Garnet used some pretty scary research from Nicholas Eberstadt a political economist who holds the Henry Wendt Chair in Political Economy at the American Enterprise Institute (AEI). He is also a Senior Adviser to the National Bureau of Asian Research (NBR), a member of the visiting committee at the Harvard School of Public Health, and a member of the Global Leadership Council at the World Economic Forum. Eberstadt has written many books and articles on political and economic issues, including demographics and the political situation of North Korea.[1][2][3] He has consulted for governmental and international organizations, the U.S. Census Bureau, U.S. State Department, USAID, and World Bank, and has often been invited to offer expert testimony before Congress.  (Thank you Wikipedia.) 

Eberstadt's research indicates the number of people being supported by the government has grown to a very uncomfortable level "In 1960, roughly 134 Americans were engaged in gainful employment for every officially disabled worker; by December 2010 there were just over 16."  He goes on to mention more than 8 million "disabled" people are so labeled because their mood swings or severe back pain. 

Needless to say trending is not good and it is clearly evident the system we have in place cannot support the weight of all those currently being supported by government programs.  Something has to give.  Hopefully our leaders will realize it has to be a combination of tax increases and entitlement program adjustments.

I like answering questions.

One of our reader asked a great question and it is one that probably impacts a bunch of folks.  Eve S. had asked about my opinion on the idea of moving money to bonds or bond funds until after the election.  (OMG a week away?)

At face value, who gets elected should not have an immediate impact on the bond market.  The Fed and its policies is shooting for low interest rates for the next 2 years.  In theory that should keep the bond market stable.

In reality, you want to keep a close eye on inflation.  If we see inflation make any serious moves above 3%, Treasuries will get nailed first and folk enjoying the false confidence of the safe haven of the under 2% money.  Values of money market type bonds should fall and fall quickly, followed by corporate bonds values and then of course junk bonds.

Currently, because of recent investment activity, we are highly invested in municipal bonds and high quality (relatively low yielding) corporate bonds. 

The election might have more of an impact on the equity market, but most assumed scenarios are built into the market price.  The current drop in the market is more a result of the lackluster earnings than political worries.

So to answer Eve's question, if you have no bonds, you should do your homework and have a portion of your holdings in bonds.  The type of bonds should be determined by your risk tolerance, so spend some time with a qualified financial advisor (WHICH I AM NOT) and determine how much risk you can sleep with.

Keep in mind that there are certain characteristics of bonds that mimic stocks.  You have a face value, then you have the current value and you have an interest rate and you have a yield.  If you pay 100 dollars for a bond and you are getting a 2% yield and suddenly you see inflation head up to 3-4%, you will see the current value of that bond drop down.

Thanks to a tip from one of our readers Doyle, many years ago we bought a buch of depressed GM Financing Smart Notes at a discount of 43%.  In other words we were paying 57.00 for a 100 dollar bond.  The bond drove a 6% yield, so our yield to maturity was about 9%.  I am glad to say those bonds are near their Par value of 100.00.

I hope that answers your question.  If you really want to understand bonds, there is a book that belong on every investors book shelf.  It is called Bonds;The Unbeatable Path to Secure Investment Growth by Hildy and Stan Richelson.

We also had kind of a question from Doug B.  He is intrigued about Selling PUT Contracts.  He was wondering if there is a Dummies Book about how to do it.  There probably is and there is a lot of information out there on how to do it.  Schwab has some great info and so does the CBOE and there are a ton of videos on Youtube explaining how to do it.

We spent a small fortune and whole bunch of time in 2010 and 2011 learning about options.  We read and read and read until I knew everything I could, but really did not learn anything until I actually did it.

We would suggest you do some basic reading on your brokers website and then (assuming your account is marginable and you have option writing priveldges-talk to your broker) write one contract to see how it works.

Let me use this analogy for writing (selling) a put option.  Let's say you see a sweater that you really really like.  It costs 100.00.  You like it, but you really want to pay 85.00 for it.  Nordtrom says we will give you $5.00 today if you promise to buy the sweater at $85.00 if we lower the price to 85 dollars or lower by January 15, 2013.  They also say, if we don't lower the price or if we raise the price, you get to keep the $5.00.

That is basically what you are doing when you sell a put.  Don't get me wrong because you only want to sell a put on a stock you REALLY want to own.

For example, lets say you like AAPL at $600 a share and its trading for $650.  You just sell one put for say 23 dollars for a January purchase.  If the stock drops below 600, you are on the hook for $60,000 dollars but you own AAPL at 600.  If it does not come down to $600, you get to keep 2300 dollars just for playing.

Again, DO YOUR HOME WORK.  Only use this strategy on stocks you would buy any way.  This strategy has made me more money this year than most of my long trades.

Call me if you have any specific trades you want to play and I might play a long with you.