THE DENALI VIEW
DENALI CAPITAL
MANAGEMENT, LLC
4TH QUARTER 2012
VOLUME 9, ISSUE
4
Scott’s Thoughts — 2012 in Review
DECEMBER 2012
INSIDE:
SCOTT’S THOUGHTS
1& 2
GOOD YEAR?
TIDBITS...
3&4
4
THE FISH SEZ
4
Over four years have gone by since we experienced the collapse in housing
prices that generated so much collateral damage. Stocks bottomed in March
of 2009, the economy slowed, inflation and demand declined, and optimism
for the future was about as low as low can be. PIMCO coined this as the
“New Normal”. The years of progressively increasing leverage and the belief
that housing was always an appreciating asset, and one’s trusted retirement
ATM, were behind us. We know things have changed; borrowers are forgiven of their debt and allowed to borrow anew at near zero interest rates,
Scott Husband
while savers earn slightly more than nothing. It is a good time to be a borrower and not a lender. But what do we call this? We hear terms like inflation, stagflation,
disinflation and deflation with none satisfactorily explaining this chapter of economic history.
I went to Investopedia (not the best place to go, but good for simple definitions) and found the
following definitions for the four terms mentioned above. As background, in 2012 the US
economy GREW somewhere in the 2% range, and stated inflation was just about the same.
For now, I will ignore how the changes in the weighting of varying components of inflation
has lessened the CPI number but not necessarily the cost of living. Housing prices have recently risen slightly, fuel prices are much higher, and almost every item I see when shopping
for food and discretionary items costs more than 2% higher than last year. Importantly, in
2013 the world’s central banks will print enough new money to purchase 20% of all the gold
ever mined.
From the Investopedia explanation of 'Disinflation':
“Disinflation is commonly used by the Federal Reserve to describe situations of slowing inflation.
Instances of disinflation are not uncommon and are viewed as normal during healthy economic
times. Although sometimes confused with deflation, disinflation is not considered to be as problematic because prices do not actually drop and disinflation does not usually signal the onset of a
slowing economy.”
Explanation of 'Inflation':
“As inflation rises, every dollar will buy a smaller percentage of a good. For example, if the inflation rate is 2%, then a $1 pack of gum will cost $1.02 in a year.”
Explanation of 'Deflation':
“Declining prices, if they persist, generally create a vicious spiral of negatives such as falling profits, closing factories, shrinking employment and incomes, and increasing defaults on loans by
companies and individuals. To counter deflation, the Federal Reserve (the Fed) can use monetary
policy to increase the money supply and deliberately induce rising prices, causing inflation. Rising
prices provide an essential lubricant for any sustained recovery because businesses increase profits
and take some of the depressive pressures off wages and debtors of every kind. Deflationary periods can be both short or long, relatively speaking. Japan, for example, had a period of deflation
lasting decades starting in the early 1990's. The Japanese government lowered interest rates to try
and stimulate inflation, to no avail. Zero interest rate policy was ended in July of 2006.”
Explanation of 'Stagflation':
“Stagflation occurs when the economy isn't growing but prices are, which is not a good situation
for a country to be in. This happened to a great extent during the 1970s, when world oil prices rose
dramatically, fueling sharp inflation in developed countries. For these countries, including the
U.S., stagnation increased the inflationary effects.”
THE DENALI VIEW
Page 2
Scott’s Thoughts (continued)
Deflation would seem to fit the current situation , except that food and energy prices are not declining. Inflation is
apparent, but the much slower growing cost of housing holds this measurement back significantly. The case for
stagflation may yet be made, but for now the economy is growing and inflation is not high enough to be deemed a
problem. Disinflation does not seem to accurately explain what is happening in our economy but, at the surface, it
appears to be the closest of the four definitions.
The “New Normal” might be the most accurate description. Individuals are deleveraging, companies have borrowed
at the lowest rates ever (and called for redemption their older, higher coupon debt), and countries are borrowing like
never before. We have written before as to how the debt trouble started with the consumer, went to the banks, then
the agencies, and is now resting solidly with the government.
I will no longer try to place a word on the economic environment we are experiencing. The reality is it does not
matter what it is termed. What does matter is you, your family, your business, and how we prosper through this.
We must maintain sufficient cash flow to be able to move with fresh, fully valued dollars to areas that offer increased value. In other words, we do not want to have to sell an asset for less than our cost so we can go buy something we perceive has greater value. We want enough cash or cash flow to take advantage of opportunities. I do
not believe that longer-dated bonds have sufficient value to entice us into ownership; the principal risk is simply too
large compared to the negligible income. Thus we own very short term IOUs. Housing could offer an attractive
opportunity because I expect inflation to become a growing reality, however, demographics will not support everincreasing housing demand. The stock market, even with all these uncertainties, appears to offer the most opportunity at the current time. Despite their volatility, stocks have not increased in value since 2000. Thirteen years of no
appreciation is a compelling reason to own stocks. Stocks tend to like inflation because it makes their assets worth
more and their quarterly growth comparisons look great (though the value of the increase is over-stated). Our bias
going forward is to own stocks (preferably dividend paying), short term quality bonds, and some metals.
2013 is going to be an exciting year. We have the ongoing fiscal cliff debates, a still unbalanced budget, a wanting
and entitled citizen, huge debt, and no political consensus for long term fixes. What better “wall of worry” is there
for stock markets to climb?
We at Denali Capital wish you a very enjoyable and prosperous New Year. Thank you for your trust, it makes for a
wonderful motivator.
Source: http://www.investopedia.com/terms/
It is time to apply for your
Alaska Permanent Fund
Dividend (PFD) for 2013.
The deadline to apply is
March 31, 2013. Filing can
be done online at:
https://www.pfd.state.ak.us
Oregon…
Where is your DCM bag?
Baby Dodson’s ETA is March 3!
THE DENALI VIEW
Page 3
It was a very good year...wasn't it?
Looking back at the year through our Denali Capital glasses, I tend to see swirling waves of financial turmoil
interspaced with eddies of inexplicable calm. It would be ever so easy to view this year (and the coming one)
in a pessimistic way for a few reasons I’ll outline up front, but if you stick with me through the article I promise to share plenty of reasons to be optimistic about our future.
The European Community managed to kick their financial crisis down the road for another year by providing a
Spanish bank rescue, some open market government bond buying, and a last minute Greek infusion that allowed that beleaguered country’s government to buy back some of its bonds for about 30 cents on the dollar.
Next on their plate is convincing the Germans to pay for it all, and a possible Spanish internal secession movement.
Mark Simpson
The Chinese economy continued to cool off to a measly 7% or so which put economic pressure on the rest of the Asia-Pacific
region. In its continuing attempt to fire up its deflationary economy with spending, Japan’s government drove its sovereign
debt past the 200% of GDP mark.
Meanwhile, on these shores, in its continuing attempt to fire up our sluggish economy (wait, didn’t I just write that…?) the
Federal Reserve announced an ongoing program of Quantitative Easing that was quickly dubbed Q-E-Ternity by Wall Street.
This will require additional monthly purchases of treasuries and mortgage-backed securities, and a promise to keep interest
rates low (ZIRP, or Zero Interest Rate Policy) until 2016 at least. This will continue to punish savers, and provide less income
for those living off of their retirement investments.
Speaking of bonds, in February, Warren Buffett, the “Oracle of Omaha” said that “they are among the most dangerous of assets”. In his annual letter to Berkshire Hathaway shareholders, he said “Current rates, however, do not come close to offsetting the purchasing-power risk that investors assume. Right now bonds should come with a warning label.”
Stocks are attractive currently, even if it is only because all of the alternatives are not. Yet among the investing public, disgust
has been building to exasperation at how the markets are increasingly driven by hyper-fast computer algorithms fighting each
other over fractions of a cent at the rate of thousands of trades per minute. This year, we witnessed three high profile market
failures: High Frequency Trading exchange BATS Trading cancelled its IPO after failing to process trades for its own stock,
Facebook’s widely anticipated offering was marred both by NASDAQ’s unpreparedness for the resulting volume and reports
that certain large institutions received information that was not in the prospectus, and long-time market maker Knight Capital
Group was driven to within hours of bankruptcy when a rogue software upgrade started executing orders of its own volition.
The New York Society of Security Analysts, in a recent paper, went so far as to say that “public confidence in the integrity of
equity trading markets appears to be at a once-in-a-generation low”. This could be a reason for the almost $300 Billion that
small investors have pulled out of stock mutual funds since 2009. This feeling, that “the stock market is rigged”, is not helped
by headlines about the continuous round-up of insider trading conspirators from within our major investment firms.
So where is all the good news, Mark? For that, you need to take a step back and look at some of the free-market driven innovations and efficiencies that individuals and companies are using to make our country, and the world a better place.
All in all, in terms of global prosperity, 2012 has been a banner year. There is less disease, less hunger, and less war than ever
before. Around the world, standards of living show continued improvement. The Millennium Development Goals adopted by
the UN in 1990 called for halving, by 2015, the number of people in extreme poverty. It was only announced this year that
the goal was met back in 2008. The credit for achieving this lies with the spread of global capitalism, not the actions of any
government or supranational program. But what about the 1%? These same figures show that the increased income is being
distributed more equally than ever before. Globalization is leading to a richer and fairer world.
Some advances, like in technology and medicine, can be readily seen in life expectancy. AIDS deaths have been dropping for
the last 8 years. Malaria fatalities are down by 20% in the last 5 years. Africa’s life expectancy hit 55 this year, up from 50 a
decade ago.
You might not realize it from the headlines generated by an industry that believes “if it bleeds, it leads”, but according to
Oslo’s Peace Research Institute, this decade has seen fewer war deaths than any time in the last hundred years. There are generations alive that have no real knowledge of war at all. Just because we always seem to be teetering on the edge of another
conflict does not mean we should not take time to celebrate our success in avoiding major ones. The increased capabilities of
telecommunications and data sharing play a large part in leading to a more peaceful world.
These same technological innovations and efficiencies are manifesting themselves on another important front – energy. Hydraulic fracturing has allowed the production of previously uneconomical deposits of oil and, more importantly, natural gas.
THE DENALI VIEW
Page 4
DENALI CAPITAL
MANAGEMENT
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Good Year?
REFERRALS
A successful business grows
through personal recommendations
from satisfied clients. If you have a
friend or associate who may benefit
from our services, please ask them
to give us a call. Thank you to
those of you who have already referred clients.
The Fish Sez…
Don’t call me Waldo.
Continued...
In the U.S., our total fossil fuel usage is declining, and so are our carbon emissions. Whether this trend will slow the threat of
global climate change is an unanswered question, but it is undoubtedly a welcome development.
In the investment world, I am watching some areas that excite me a great deal. On the healthcare front, we should soon see advances in biotechnology and nanotechnology that hold the promise to curing long-dreaded afflictions. The new technology of
three-dimensional printing may completely alter the way the world manufactures its products – it is already in use by companies
that run the gamut from mom-and-pop websites to global aerospace giants. Advancements in these sectors could truly become
global game changers.
So 2012 was the proverbial half glass of water, with the pessimist seeing half-empty, and the optimist seeing half-full,
(according to my son’s T-shirt, engineers see it as twice the size it needs to be). We will continue to invest with rational optimism in the continuation of free markets and human ingenuity, and we invite you to look forward through the same prism.
Happy New Year!
Some comparisons have been drawn from “Parametric Estimations of the World Distribution of Income” from the National Bureau of Economic Research, 2009.
Humor From Dave Barry’s Year In Review…
In Spain and Greece, hundreds of thousands of people take to the streets in protest against government-imposed austerity measures
necessitated by the fact that for the past five years pretty much nobody in Spain or Greece has done anything except take to the
streets in protest.
In labor news, Chicago teachers go on strike over controversial proposed contract changes that would allow the school board to
terminate teachers who have passed away. Meanwhile the NFL comes under increasing pressure to settle the referee strike following a game between the San Francisco 49ers and the Tennessee Titans in which the replacement refs call four balks and three traveling violations, and ultimately declare that the winner is the Green Bay Packers. At the end of the month the strike is settled, and
the replacement refs move on to their new role as Florida elections officials.
There is much fiscal-cliff drama in Washington as Congress and the White House — after months of engaging in cynical posturing
and political gamesmanship while putting off hard decisions about a dangerous crisis that everyone knew was coming — finally
get serious about working together to come up with a way to appear to take decisive action without actually solving anything.
Read more here: http://www.miamiherald.com/2012/12/29/v-print/3160638/dave-barrys-year-in-review.html#storylink=cpy
ANNUAL REMINDERS
You may request Denali Capital Management's Privacy Notice, Form ADV Part II and Schedule F. If you would like to go paperless and receive
Charles Schwab statements, the Denali View and DCM quarterly reports via e-mail, please contact Heather. If you do not file an extension, April 15,
2013 is the deadline to contribute to your IRA for 2012. Please contact Heather if you need deposit envelopes. Also, please remember to check your
credit report at www.annualcreditreport.com.
This newsletter is for informational purposes only. It is not an offer to buy or sell securities or advisory services. This information does not purport to be complete. Opinions may change without notice.