Annual Retrospective 2006

Looking back and looking ahead

Eric Janszen

Weekly Commentary - May 12, 2006

Candide: "But for what purpose was the earth formed?"
Martin: "To drive us mad."
- Candide, Voltaire

The world is unpredictable, maddeningly so.  The future of the economy and financial markets are notoriously difficult to foresee.  Anyone bold or foolish enough to claim to make economic and market predictions needs to occasionally look back to assess those predictions.  If not correct more than 50% of the time, it's time to get out of the prediction business. Unless you're in show business like James Cramer.  In that case accuracy doesn't matter.  What matters is how well you are performing while you are misinforming your audience.

If you are in the prediction business and make the cut above 50% accuracy, the most common question you're going to get from readers is, "What should I do?"  Not only is it inappropriate for me to tell anyone what to do -- I'm not a certified financial advisor -- but giving financial advice to anyone without knowing anything about them doesn't work.  The only thing worse is giving advice to people you know really well, your friends.  Worse than selling them your old car.  That's why professional financial planners exist.

Unfortunately, most professional financial planners are doctrinaire.  In the new world of Bubble Cycles that means many, but not all, give advice that worked well in the era of Graham, Dodd and Cottle, authors of the famous bible of finance Security Analysis, or Burton Malkiel, author of the bible of beginner's investing, Random Walk Down Wall Street.  But it's a brave new world, where at least for a while the rules of chance do not apply, where the rule of men in matters of money is greater than the rule of law.  Now that's a conundrum.  But maybe there's a solution, and I'll get to that at the conclusion of this commentary.

I'm going to rip through six years of, hitting on the highlights, to give you the background you need before we dig into the detail of a theory that's at the heart of a framework for's predictions, what I call Ka-Poom Theory.  Here goes.


As Managing Director of Osborn Capital, my partner Jeff Osborn and I invested in 20 start-ups.  More precisely, when we formed Osborn Capital, Jeff had already made most of the investments that turned out well for us, including Arrowpoint (a 200 bagger) and Compatible Systems, both companies acquired by Cisco.  We had seven positive liquidity events between 1999 and 2003 with acquisitions by Microsoft, Nortel, EMC and two by Cisco, and two IPOs. 

I started in 1998 to warn readers not to put their retirement savings into Internet stocks.  With a front row seat at the Internet bubble show I could see the market had clearly morphed into a casino.  After doing a lot of reasearch, I wrote to explain how market bubbles form in Causes of the Internet Bubble.  Research included meeting
Charles P. Kindleberger who wrote Manias, Panics, and Crashes: A History of Financial Crises.  He happened to live in the same town I live in, Lexington, MA.  Hard of hearing and, in his nineties, understandably more interested in friends and family than the stock market, he did confirm that a historically significant market bubble was underway. He died in 2003.  While best known for the book on manias, he was a leading architect of the Marshall Plan. Everyone liked that America.


Soon I was also writing for Ken Kurson's Green Magazine, later acquired by  In 1999 I explained how the Internet bubble was going to end in What will pop the Internet bubble? 

Also in 1999, I took a shot at predicting the economic consequences, calling for a period of deflation followed by period of severe inflation, what I termed Ka-Poom Theory: How the Asset Bubble Ends.


In March 2000, I wrote 
Janszen Crying Wolf?  Not so fast (not my choice of title) for Green Magazine that warned that the end was approaching, the month before the NASDAQ tanked.

The next month, in April 2000, with
A Bear Market is Born I warned readers a long bear market had started.  Don't wait for the NASDAQ to "come back."  The market was a bubble.  It isn't coming back.  It's over. 

Following this advice, my partner Jeff and I sold our stock from Cisco and other portfolio company deals between March 2000 and June 2000.  At the time I was pointing readers to Treasury Direct.  I went 50/50 U.S. treasury bonds and cash back when a 10 year treasury bond was paying 6.10%.  That was in anticipation of the deflation cycle spelled out in Ka-Poom Theory.  

The "Poom" inflationary part of the cycle assumed two stages, inflation then severe inflation.  Inflation was expected to result from inevitable post-bubble reflation policies: rate cuts, tax cuts and currency depreciation.  In 2000, I had lunch with Dudley Fishburn III, then the managing editor of The Economist magazine.  After teasing him about the magazine's March 1999 prediction of $5 oil, I told him I was thinking of buying gold, silver and platinum when gold hit bottom at the end of the deflation cycle.  He thought it was a pretty good idea.


In 2001, before I expected the deflationary part of the cycle to end, I took a lot of the cash and bought precious metals and some gold stocks.  In 
Questioning Fashionable Financial Advice made the case to readers in the one and only piece I ever wrote about gold, by coincidence near the 20 year bottom of the market.  Gold was trading at $270, 13% of its inflation adjusted peak price.

I didn't write much after that for either Green or  I was busy running VC backed start-up Bluesocket starting in April 2001 until January 2004.  During the worst depression in the history of IT.  For that I cannot claim to have a very good sense of timing.  Aside from writing one article on gold, the only advice I gave on the stuff was to give members of my management team gold coins as Christmas presents in 2001.  These were intended not only to express appreciation for hard work, but also had a dual role as advice.  As CEO of a company you can't go around telling your management team or anyone else in your company what to invest in, but I hoped they'd get the message in the unconventional gift. (Guys, if you're reading this,
I also hope you didn't sell them.)


In August 2002, in 
Yes. It's a housing bubble. I made one update to to point out that the housing market was turning into a bunch of regional bubbles.  Coincidentally, that was the start of the speculative phase of the real estate market.

That piece left it up to the reader to decide whether to play the speculative housing market or not.  As in the case of the Internet Bubble, there was no reason not to speculate in housing as long as you know that's what you're doing and you're not buying into the latest "prices only go up" bullshit and are not over-leveraged.  However, the problem with speculating in real estate is that when a real estate market turns it becomes illiquid. Over-confident speculators get stuck and can go bankrupt.  It's like buying tons of stocks on margin.  In fact, you can think of what's going on in many housing markets around the world today as a giant global margin call on real estate.


After Bluesocket while working for venture capital firm Trident Capital, in a piece
Housing Bubbles Are Not Like Stock Bubbles originally published by Always-On Network in January 2004, I explained how housing bubbles end, with a collapse in transactions followed by a slow decline in prices versus a sudden collapse in prices as in the case of stock market bubbles.


I wrote a piece 
Housing Bubble Correction, Fifteeen Years to Revert to the Mean in January 2005 outlining a 15 year downturn in real estate.

A year later, Yale Professor Robert Shiller published a second edition of Irrational Exuberance
that predicts more or less the same 15 year timeframe for a downturn in real estate.  The first edition came out in March 2000 and predicted the end of the stock market bubble.


Bill Gross at PIMCO has been down on the U.S. economy for a while and likes to say that what's bad for the economy is good for bonds.  But his latest missive  As GM Goes, So Goes the Nation sounds distinctly circa 1999: "Higher inflation, higher personal and corporate taxes, and a lower dollar point U.S. and global investors away from U.S. assets and toward more competitive economies less burdened by health and pension liabilities – those personified by higher savings rates and investment as a percentage of GDP.  Need I say more than to sell U.S. assets and buy Asian ones denominated in their local currencies; or if necessary to hire a global asset manager with sufficient flexibility and proper foresight to thrive in an increasing difficult investment environment?"

This leads us to the present and full circle back to Ka-Poom Theory.  Let's compare the original 1999 prediction to how events have evolved so far.  Below is the original chart and description from 1999.  

KaPoom 1999
Original 1999 Ka-Poom Theory

  • National currencies are primarily valued by the relative economic strength of trading partners with floating currencies, except for the U.S. dollar.
  • A major component of dollar strength is the unique demand for dollars due to the dollar's reserve currency status.
  • Dollar demand and thus price is supported by all nations trading with the U.S. and among each other as all need dollars for international exchange, especially for oil.
  • If dollar reserve currency status declines, either gradually via euro diversification or suddenly due to an event that causes a loss in confidence in the future purchasing power of the dollar, dollar demand and value declines in kind.
  • U.S. interest rates are low mostly due to demand for U.S. debt from foreign central banks of nations, especially Asian, that seek to keep U.S. consumers borrowing at low interest rates to purchase their exports using strong dollars, e.g., Asian "vendor financing."
  • Ka: A random exogenous event (e.g., a stock market crash predicted in 1999 for year 2000 and recession predicted for 2001) intensifies disinflation created by Asian vendor financing, causing the Fed to shift from bubble fighting to anti-deflation polices.
  • Fed responds with an excessive cheap money policy, targeting Fed funds rate below the inflation rate.
  • The Fed keeps interest rates too low for too long, creating a new asset bubble.  But in what?  We did not know in 1999.  The answer: real estate and other credit sensitive assets.
  • Poom: A random or not so random exogenous event that has not yet happened (the stock market crash we predicted for 2000 did not have the impact we expected but a collapsing housing bubble may do it) exposes the true level of risk to lenders that is inherent in this unbalanced system, causing lenders to loose confidence in the future purchasing power of the dollar and seek alternative reserve assets.
  • Interest rates and inflation rise rapidly as dollar demand and value falls, import prices rise, and the Fed moves to raise rates to stem the tide or dollar repatriation.
  • The first foreign central banks to move will be those with the least exposure to losses in national income from sales of exports to the U.S. or depreciation in the value of the dollars they are holding as reserve assets (e.g., France).

Here's the grade on Ka-Poom 1999 based on what happened since then with a revised Ka-Poom prediction below.

On predicting the timing, length and extent of the deflationary or "Ka" part of the cycle, I'll give myself an "A."  It started from the middle of 2000 and ended in the middle of 2002, as predicted.  Inflation during 2001 averaged 1.6% for the year as shown in the updated 2006 graph below and it hit bottom at -3.3% in October 2001 as shown in the 1999 original above. 

Here's where reality and the prediction diverged.  Reflation policies had the intended result of preventing a collapse of the economy into a deep recession, as expected.  We had the first stage "Poom" inflation that sent gold up from $270 in 2001 to around $450 in 2005.  Still earning a good grade on the prediction.  But we did not see the loss in confidence in the dollar that would have sent foreign creditors running for the exits, dollars coming home, and interest rates and inflation spiking in 2006 as shown in the original original graph.  Is that a "C" or an "I" for "Incomplete"?

That may be starting to happen now, driving gold from $450 in 2005 to over $700 today.  These prices are leading indicators of rising interest rates and inflation.  If that's the case, I'd simply phase shift the original Ka-Poom prediction out by six months to a year.  But there's more to it than that.  

The primary reason for the delay in the predicted semi hyper-inflationary "Poom" cycle is cooperative devaluation of currencies over the last year.  This has delayed the "Poom" but there's a fine line between 
cooperative devaluation and competitive devaluation.

KaPoom Revised 2006
Revised 2006 Ka-Poom Thoery

This is the essential paradox of current global imbalances that Ka-Poom Theory attempts to model and forecast.

The Fed does not need to go on a printing binge to produce the kind of inflation that the theory predicts.  All the dollars that are needed to produce the inflationary "Poom" have already been printed and reside outside the U.S. as dollar denominated assets owned by individuals, institutions and central banks.  In fact, if the Fed were to completely stop issuing new money -- stop the printing presses tomorrow -- the U.S. economy would fall into crushing recession, foreign investors would flee and the dollar money supply and inflation in the U.S. would rapidly rise.  Why?  Because every time a foreign holder of dollar denominated assets sells, they have to sell dollars and buy their own currency.  If the Chinese, Japanese and Brits were to panic and all do so at once, suddenly demand for yuan, yen and pounds increases and demand for dollars falls; the price of the former rises and the price of the latter declines.  If this happens in an uncontrolled fashion, you get "Poom," a
cycle of a declining dollar, rising interest rates, a slowing U.S. economy, a declining dollar, and so on, until a free market valuation of U.S. interest rates and the dollar valuation is restored.  

Even though the process appears to have started,
if you are heavily hedged against dollar depreciation, such as with precious metals, you need to be prepared for a last stand that supports the dollar and forestalls the "Poom" event.  For this reason you see a second deflationary and inflationary period added in the updated version of the Ka-Poom model.  Doesn't mean it's going to happen, we may have entered into the Poom cycle that will in fits and starts run through to completion.  The added dis-inflation cycle is a bit of optimistm that assumes it's possible for central banks to cooperate to stall the "Poom."  It's useful to keep in mind that there is very likely to be a period during when the dollar is rising again and the crisis will appear to have passed.  

If you are hedging inflation risk with PMs, get ready for a wild ride.  The chart below shows U.S. Global Investors Gold Fund USERX from 1986 to May 2006.  Considering USERX in this chart peaked on the dead cat bounce of the last gold bubble that peaked in 1980, at not even 1/3 of that peak it appears we are no where near a cycle top.  Also, note that USERX has outperformed gold EFT GLD.  


The key value of Ka-Poom theory is that it has given us a framework within which to interpret the Reports from the Front from our readers, Interviews with noted professionals in the investment community
such as James Rogers, Guest Columns and the AntiSpin in the Daily News.


A lot of ideas that appeared in six years ago are starting to become mainstream.  Yesterday the Wall Street Journal runs an article that claims that gold is due to keep rising due to pressures on the dollar and U.S. economy.  Today, MSNBC reports
US dollar takes a pounding over deficit: "The US dollar suffered a severe sell-off on Friday, taking it to its weakest level against a trade-weighted basket of currencies since October 1997, as fears about the US current account deficit crossed world markets.  Marc Chandler, economist at Brown Brothers & Harriman in New York, said: "Precisely what officials feared would happen from the large global imbalances is now taking place in reaction to their clumsy attempt to 'fix the problem'. Volatility in the capital markets is rising. Global equities are tumbling."

Go to and enter "Bubble Cycle."  Up pops a piece I wrote for Always On in January 2005.  The thesis is that the only way to make money in the markets is to play the cycle of bubbles that the Fed has been managing since the U.S. went off the gold standard. 

This month, nearly a year and a half after the AO piece introducing the concept of The Bubble Cycle, the equity research team of Francois Trahan, Kurt Walters and Caroline Portny from Bear Stearns issued a report titled Approaching an Inflection Point in the Bubble Cycle (pdf) where they say, "The end of one bubble often triggers the beginning of another.  A bubble-induced economic slowdown oftentimes leads the Fed to once again inject liquidity into the economy.  This phenomenon typically acts as a trigger that paves the way for the beginning of a new asset bubble."

Normally, imitation is the sincerest form of flattery, but plays at the semi-lunatic fringe of future possibilities curve while striving for well informed and carefully conceived fringe prognostications.  When investment bank analysts, the guy running the world's largest bond fund and mainstream financial media outlets like MSNBC start to sound like did five years ago, you know the economy and financial markets are in deep yogurt.

I am not a certified financial advisor.  I'm not going to tell you what to do with your money.  I will from time to time tell you what I'm doing with mine and you can decide to do as you wish with the information.  

To sum up three decades, my observation is that to optimally play inflation and interest rate cycles of the Bubble Cycle economy since the start of the Bubble Cycle system, only four major asset allocation shifts were needed in 30 years:
  • Stocks to commodities in the early 1970s
  • Commodities to stocks in the early 1980s
  • Stocks to cash and treasuries in 2000
  • Cash to commodities 2001
If you want certified financial planning advice, will soon be advertising a few that I feel meet's standard of intellectual honesty.  If you generally agree with the arguments made here, you're probably going to agree with the investment philosophy of the financial planning firms advertised. 

Still, maddeningly, like Voltaire's Candide, you'll still have to wrestle with the ambiguities of the world and your own ambivalence to decide among them for yourself.

Discuss this...     
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