In the last few months, Jason has had some big name guests on the Creating Wealth Show. Some of Jason’s recent guests of note are Pat Buchannan, Robert Kiyosaki, and Catherine Austin Fitts.

Pat Buchannan is well known in the United States as an outspoken conservative voice in favor of limited government, and less globalization. In his Jason’s interview with Pat, they discussed the prospect for large amounts of inflation in the near future. Pat commented that the US debt would be floated away on a sea of inflation. At the Financial Freedom Report, we couldn’t agree more with this sentiment, and advocate that investors defend their financial wellbeing with income producing assets that are financed with fixed-rate debt.

Robert Kiyosaki is the author of the noted “Rich Dad” series of books, games, and videos. In his interview with Jason, he discussed the importance of financial education in achieving success. They also discussed the importance of passive income to financial success, and the impact of dynamic investment strategies. Robert rightly pointed out that it is possible to make money in any kind of investment, and also possible to lose your shirt in any kind of investment. The key is always to become educated. At the Financial Freedom Report, we couldn’t agree more with this sentiment.

Catherine Austin Fitts is the founder of the Solari report, and is a renowned thinker in the financial world. She advocates for a decoupling from the centralized banking model that channels influence toward the dominant industry players and government. Put another way, she is an advocate of free markets but the current system is nothing even remotely resembling a free market. We advocate direct ownership of investment property as a way to help circumvent the systemic bias toward institutional players.

The Creating Wealth show will continue to seek cutting-edge thinkers that help provide insight into investing and the economy. We firmly believe in the importance of becoming educated, and the best source of education is frequently to seek advice from experts. This does not necessarily mean that we agree with everything that all of our guests say . . . what it means is that we believe there is always something that can be learned.

Jason Hartman’s Creating wealth show has had a wide variety of notable guests over the last few months. One of Jason’s recent guests was Gillian Tett, a British journalist, whose recent book Fool’s Gold confronts the current banking and financial crisis. In March 2009, Dr. Tett was named the Journalist of the year at the British Press Awards. During her interview with Jason, she spoke at length about the systemic problems of the current system, and potential solutions.

The principal problem inherent in the current banking system is that free market forces are not allowed to prevail, as demonstrated by the government efforts to bail out failing banks. The problem created by this system is that when financial institutions are protected from failure by the government, it incentivizes them to take extremely large business risks since their upside is vast, and their downside is covered by the government. In response to this upside-down set of incentives, many have called for increased regulation of banks. One of the difficulties discussed was the fact that some of the problems that precipitated the credit collapse were the direct result of regulations imposed on the banks by public authorities.

Ultimately, the principal source of the problems for financial institutions is the fallacious notion that risk can be eliminated. By perpetually shifting risks onto counterparties, the financial world devolves into a large game of ‘hot potato’ where everybody tries to toss the hot potato to somebody else before the timer expires and the ticking bomb explodes. An example of this phenomenon is the practice of securitizing mortgage products into collateralized debt obligations. As these products were combined with one another, it became more and more difficult to ascertain the risk profile of a given security. When the credit crisis emerged, these became ‘hot potato’s’ as investors tried to offload the securities onto one another before the values collapsed.

The Creating Wealth Show #105:

Propelling investment success using econometrics and

competitive analytics

In the one hundred and fifth episode of Jason’s extremely popular Creating Wealth show, he interviews David Savlowitz, the head of Competitive Analytics (CA), a niche full-service market intelligence firm. In this show, David explains the way that his firm uses a multiplicity of data to generate more robust information for their clients than can be obtained by the simplistic scorecards that are employed by most of the financial media. The methods that CA employs analyze supply and demand by using statistics, econometrics, predictive modeling, comprehensive research, and applied mathematics.

In this show, Jason talks with David about the ways that Competitive Analytics uses comprehensive data analysis to drive prediction models for their clients. One of the methods that they frequently employ is an economic composite score that is based on a multiplicity of weighted indicators. When applying this methodology to the general economy, David’s model is predicting the bottom of the economic cycle in Q4, 2009 with a return to equilibrium by Q4, 2011. Furthermore, David’s models are forecasting a U-shaped recovery that will have an extended trough. This stands in sharp contrast to previous V-shaped recoveries that experienced an immediate “bounce back” from the market lows. The reason for this extended trough is because a significant adjustment needs to be made in order to equalize the debt-financed over-consumption that fueled the recent asset bubbles.

The unique part of David’s methodology is the fact that his team uses a very wide variety of input variables in an attempt to capture future items that may become big swing factors. He rightly understands the implicit danger that can be present within quantitative economics for people that do not fully understand the analysis. This danger stems from the fact that econometric analysis uses trends in the past to predict the future, and thus cannot anticipate the impact of events that have never happened before. The importance of this insight comes from the fact that rare events like September 11th, 2001, the Russian Financial Crisis, and the collapse of credit default swaps were never incorporated into any prediction models because they had never happened before.

Each of these events had an unfathomable impact on the marketplace that left people who were blindly following technical trends of the past absorbing unbelievable losses (or pushing those losses onto the taxpayer in the form of a government bailout). As a point of reference; the hedge fund “Long Term Capital Management” was the brainchild of Robert Merton and Myron Scholes. It made heavy use of econometrics to undertake highly leveraged arbitrage trades in the bond market, but nearly collapsed the financial markets after the Russian Financial Crisis in September of 1998. This became the first iteration of a “too big to fail” argument, and is being used as the precedent for the government bailouts of financial institutions that are currently being pushed on the marketplace.

This is not to say that quantitative analysis and econometrics are implicitly dangerous. It is simply to say that it is a tool . . . a very powerful tool that needs to be understood before it is used. When applied by knowledgeable professionals, it can generate valuable insights. When given over to pseudo-intellectual or short-sighted agents, it can become a tool of mass financial destruction as the algorithms become an item of blind faith that drives insane investment decisions. As with all tools, the result depends largely on how it is used. Thankfully, David keeps the scope and limits of his analytics in perspective. A strong dose of this perspective is highly advised for anybody that seeks to incorporate econometric analysis into investment decisions.

The recent stock market rally has inspired a rising tide of hope and optimism within the investor community.  Evidence of this is seen in the gentle step-up in market values from the floor of their recent decline.

This optimism seems to be discounted into the Price to Earnings ratio of the S&P 500 Index as well, since the current price of $921.23 represents a P/E ratio of 31.2 times the next four quarters of forecasted earnings per share for the index.  Since the historical valuation for this index is significantly below the current level, it stands to reason that the investor community collectively believes that the government initiatives will create a market recovery in the near term.

At the Financial Freedom Report, we are not yet convinced that the fundamentals of the market justify such an optimistic valuation.

The market is currently in a period of great uncertainty and volatility.  Some believe that there is a budding stock market rally developing, while others believe that the recent economic problems are merely the first of many disruptions that will shake the foundations of America over the coming years and possibly for decades.  Our belief is that there are many forces pushing against a return to the rapid economic expansion that many have come to expect over the past 25 years.

The first force is the dramatic government spending obligations that are being financed by inflating the US Dollar.  This will indirectly ‘tax’ economic output by eroding the purchasing power of the currency.  The second major force is the inevitable increase of interest rates and tightening of credit standards.  This will increase the cost of capital for business activities in the midst of rapid price inflation.  The most likely result of these two forces will be a dramatic slowdown in the growth rate for the US Economy.

This will create tremendous opportunities for investors that position themselves to take advantage of the upcoming demographic shift of people out of the homeowner pool, moving into the rental pool.  As millions of Americans adjust their expectations for the standard of living that they can reasonably afford, they will be paying rent while this transition takes place.  Prudent investors should place themselves in a situation to take advantage of this shift.

Direct investment in rental real estate continues to represent the best way to take advantage of this trend by allowing investors to collect regular cash flow and ‘outsource’ their fixed-rate debt to the renters.  Over time, inflation will push up the rents and values of properties while the mortgage payments stay flat.  This will generate tremendous wealth for astute investors who place themselves in a position to realize gains from the coming shifts and disruptions.