Why No ECB QE?

While fire in the Euro zone blasts investor confidence in the area, the question why the European Central Bank doesn't do the same thing as the U.S., Japan, and others to have qualitative easing, to be specific, buying government bonds makes sense. So what are the reasons ECB holding back?

ECB indeed has a fire hose --- buying constituent country bonds to put out borrowing costs in Greece, Italy, and Portugal. There are two main reasons why ECB doesn't want to or can't do that.

First, ECB considers itself is not the sovereign lender that can substitute government's fiscal responsibilities. Their mandate is preserve price stability. Their charter forbid them from using bank resources to finance governments. If there is a deflation, ECB would feel necessary to response. Now the Euro zone inflation is at 3%, higher than 2% ECB threshold. In other words, ECB concerns their integrity would be breached if they buy any bond purchasing. But ECB has consistently been expressing their intend to help if governments approve. That brings in the second reason.

ECB needs EU countries, especially Germany, approval to act. Without government's green light, they will violate the law doing so. Meetings go to the direction that governments have gradually come to understand they must come to consensus first then ECB will come to help readily. Reports say that Germany has realized this.

If ECB's QE action is approved, the market will turn around.

Revision to the question of Why not 100% stocks

Casual holiday picking drew this question to mind: Why not 100% stocks? The question was raised in "The Intelligent Investor", 2003 Edition. The answer was given in the book.

For a tiny minority of investors, a 100%-stock portfolio may make sense. You are one of them if you:

• have set aside enough cash to support your family for at least one year
• will be investing steadily for at least 20 years to come
• survived the bear market that began in 2000
• did not sell stocks during the bear market that began in 2000
• bought more stocks during the bear market that began in 2000
• have implemented a formal plan to control your own behavior

Unless you can honestly pas all these tests, you have no business putting all your money in stocks. Anyone who panicked in the last bear market is going to panic in the next one --- and will regret having no cushion of cash and bonds.

As the author expected, the next one did come in 2008, with much stronger damaging power. So is the same question still viable? I think yes with some revision. The following is my version. I believe everyone who has ever thought about thi

• have survived the 2008 crisis and understand why you survived not from luck
• learned what to sell and what to buy in 2008
• developed a trading philosophy to weather storms at this magnitude
• Started accumulating strong stocks since 2008
• Learned how to self-protect, or how to stop loss
  
• Know how to control risk
• Know how to win big in 2009
  

Thanksgiving Talk

Barely before I picked up the phone and started holiday season's greeting, the other end of the phone came with such barrage, “there will be no solutions to European crisis. Absolutely no solution. Even the German Heaven had problem selling debts. If Europe down, China will be down, India will be down, everything will be down. Not even gold isn't safe. We should keep a lot of cash.” I put myself together and realized this is one of the most pessimistic opinions that floating around. We then skipped the greeting part.

I go with one seemingly unrelated report on airline fare first. Nowadays long distance first class flights are more and more like private jet. The reclined seats are spacey. One airline even goes to the extreme: it puts a normal bed next to the seat. All the clients want is comfortable sleep during these long-distance flight. The benefits of these gadgets are obvious: the first class fare normally generate 50% of total revenue. The prices of first class are usually 5x to 10x to economy tickets. That means the 10% to 20% people generate half of the revenue. Airlines do their best to allure high class customers. In other words, quality is more important than quantity.

Now pull back from that topic at the start. I don't think the situation is that dismal, although it is serious. The Big Three in Europe, Germany, France, and Italy, as well as ECB just had a meeting to discuss the Euro zone problems. They tried to keep budget down so that they can meet capital requirements. This is truly uncertain time because of the complexity in European political web. When the big guys collaborate, just like the airline business, it is easier to stabilize. The 3 out of total 27 EU countries realized that they must ally. That is the most important message. In addition to that, recent bond yield hikes didn't come to consensus: some fund managers think the countries can meet their responsibilities even with 7% yield for short period of time so they are attractive. Even the worst of the worse happens, EU collapses, some still think individual country have their own currency. The Fed has been printing money to tolerate higher level of debt, why can't they do that?

Some more clear positive news in the U.S. side.

- Last quarter customer spending is up;

-Thanksgiving holiday spending is estimated to be up 2.8%, before official numbers;

- After adjustment, GDP is at 2%, within expectation;

- Unemployment rate is down (some say it is hard to find clear economy direction out of unemployment rate. I don't know what is more important than employment);

- Companies hold hundreds of billions cash;

- Warren Buffet has been in buying spree in the last quarter;

- Larry Fink thinks that bond yield can't make long term investment sense. The only way to go is equity, with high quality dividend;

- Although it is slow, consensus shows that economic recovery is expected to grow over time.

So the situation isn't that dire.

Lesson from Bill Miller

Bill Miller completed his role at Legg Mason's Value Trust fund. His Value Trust fund now has $2.8B under management, dropped from $19.7B in 2005. Even this year, it has been down 5.5%, behind S&P 500, according to a WSJ report. The big hits came from names such as AIG, Bear Sterns in 2008 and Kodak recently (bought at $40 and sold less than $2 per share).

Miller adopted value investing philosophies and being contrarians. Like Warren Buffet, he believes in long term investment in undervalued companies. The strategy worked well for him: under his management, the Legg Mason Value Trust outperformed the Standard & Poor’s 500-stock index for 15 consecutive years, from 1991 to 2005, one of the longest winning streaks in mutual fund history. By comparison, Fidelity’s star manager, Peter Lynch, beat the market for 11 years, from 1977 to 1990, during his tenure as the manager of the giant Magellan Fund. However, the same method lost its lust in 2008/2009 crisis. He confessed that, “The crisis was the biggest mistake we made — not understanding the systemic nature of what was happening,”. I am surprised that he said "not understanding the systemic nature", from one that had been with market pulse for 3 decades. So he continued in his interview with NYT: his instincts in those months, based on decades of experience, were that “you tend to go in, on a contrarian basis, and buy what everyone else is selling,” he said, before rattling off a long list of crises since 1987 in which that strategy had worked like a charm. “But what’s different this time, over my 30 years of investing, is that contrarian value-based investing just isn’t working anymore,” he continued. “Stocks go down further than the historic metrics would indicate — and they stay down.”

Is this a happy ending? I personally don't see this way. But Bill himself looked differently, “An old guy I met in the market when I was young once told me, ‘Kid, you want some advice? Survival equals success.’ And he didn’t survive,” Mr. Miller said. “So the people I admire in the market are people who have been able to survive. Surviving for 30 years is plenty.” Such calmness and self-satisfaction may explain his long success.

Miller's successor, Sam Peters, would use the same approach but employ more quantitative measures. In other words, not purely from personal subjective experience but objective metrics. The fund put heavy
weight on giants AAPL, MSFT, and GE so that it will be less volatile in the coming quarters, as mostly believe. I believe so too also because now the fund is much smaller and easier to manage. In this business, size really matters.

Not a coincidence, John Paulson had experienced worst performance in hi
s entire career in last quarter. According to a report, he is looking for products that not require to report his holdings regularly.