Showing posts with label Investing. Show all posts
Showing posts with label Investing. Show all posts

Friday, January 4, 2013

Getting Back to Reality



The extraordinary increase (as a percentage move) in the 10 Year T Note yield shows the artificiality and the fragility of market values, everything being propped up by the Federal Reserve in the absence of any sound fiscal policy.  The recent Fed minutes merely hinted at the possibility of reducing asset purchases before the end of this year, and bond investors were left without their bungee cord:



Bill Gross, the "bond king," persuasively writes about the problem in his January letter, a long discourse on why "helicopter money" rained down by the Fed to save the financial system has to end badly in some way.

The artificiality of it all hasn't escaped the notice of corporations, many of which have loaded up their balance sheets with cheap debt, while holding mounds of cash, even to the point of paying massive dividends to their shareholders with borrowed funds.  The poster child for this is Costco which paid its shareholders $3 billion and borrowing the funds to do it.  Of course that was before the laughable fiscal cliff deal, which raised taxes on dividends to 20% from its present 15% but only for high income taxpayers.  They were talking about taxing dividends as regular income which must have freaked out the five largest shareholders who are corporate officers or directors, their take on the special dividend with borrowed funds being almost $12 million.  What a country! Borrow the money to pay your top people a huge bonus that is taxed at only 15%.  It truly is the microcosm for the contrived and completely unpredictable financial landscape of today.

A few days ago Barry Ritholz suggested a positive way of using today's manipulated market -- that is to upgrade and repair our aging infrastructure. Many of our roads are atrociously maintained and bridges are crumbling, not to mention aging water systems, power plants, and a railroad transportation system which is truly 3rd world quality.  As Ritholz says: At some point in the future, your kids are going to ask — “Wait, you could have upgraded _______ and it only would have cost you 2.5% in borrowing costs?!?”
 
Isn't that where we should be putting borrowed money to work, creating jobs?

Friday, June 8, 2012

Some Good News?


To offset the abundant  "bad news" of the last entry, here is an interesting article from Marketwatch on the deleveraging progress: U.S. debt load falling at fastest pace since1950s; Despite surge in federal deficit, America is deleveraging

Some salient points:

* Little by little, our economy is reducing its debt burden, slowly repairing the damage caused by 10, 20 or 30 years of excess.

* Total domestic — public and private — debt as a share of the economy has declined for 12 quarters in a row after surging over the previous decade.

* The level of public debt is indeed worrisome, but it’s not as big a worry as the economy’s total level of debt — public and private.

* As much as we hear politicians, pundits, tea-party patriots and the Congressional Budget Office obsessing about government debt, it was excessive private debt — not public debt — that caused the 2008 financial meltdown. And it was private debt — some of it since transferred to the public — that lies behind the current European debt crisis. (

* The U.S. is actually doing much better than you’d think if you just listened to the conventional fears about how we’re rushing headlong into a debt Armageddon.

* In fact, since the recession ended in June 2009, total U.S. debt has risen at the slowest pace since they began keeping records in the early 1950s. While Washington has taken on a lot of debt since then, the private sector has paid off, written off or dumped on the government almost as much.

* Economists who have studied the impact of indebtedness have found that low levels of debt are essential to growth, but that high levels of total outstanding debt can hurt an economy. Beyond a tipping point, adding on more debt will reduce growth over the long run, even if it inflates a bubble in the short run.

*According to a study by McKinsey published earlier this year, U.S. households may have two more years of deleveraging left before their debts are sustainable again. If McKinsey is right, the U.S. economy may have to endure a couple more years of slow growth.

Another little mentioned factor is that while the public debt has surged during the past few years, maturing debt is being replaced by new debt with coupons (interest rate) of one half or even one fifth the maturing ones. For instance, the US Treasury 30 year bond issued in 1982 had coupons of some 15% while the most recently issued US Treasury 30 Year bond was issued at 3.06%.  Ten year yields are now less than two percent, replacing US Treasury Notes in the 4 - 5% range.  Servicing the debt is actually getting cheaper, although these savings are probably offset due to the expansion of borrowing that has been needed to fend off a depression.. The low rates also leave investors with a continuing dilemma.
   

Tuesday, August 16, 2011

What To Do?

If I were a Tweeter I'd be retweeting these two links. I've mentioned Barry Ritholtz's The Big Picture blog before. He has a measured view of the markets, and politics, not a raving bull or bear. And I've also mentioned John Hussman's Monday morning entries published in The Hussman Funds site. He has been criticized as a "Permabear" which is unfair as he looks at long economic cycles and he has been spot on long-term. His analysis can be technical and hard to follow for us lacking a PhD in economics, but well worth reading.

The recent gyrations of the market, Dow up 400, down 500, up 200, down whatever seems to signal that we are in uncharted economic and investing waters. The Fed's zero interest rates feed the fire of uncertainty. No longer is there the opportunity of having a "balanced" investment portfolio of stocks and bonds as the latter yields nothing. In fact the zero yield is adding fuel to the gold market as there is no longer an alternative cost (loss of interest) holding the yellow metal.

Hussman's recent write up makes two interesting points and then his very long piece elaborates: The reason we are facing a renewed economic downturn is that our policy makers never addressed the essential economic problem, which was, and remains, the need for debt restructuring. There are two one-way lanes on the road to ruin, and these - in endless variation - are unfortunately the only ones on the present policy map:

1) Policies aimed at distorting the financial markets by suffocating the yield on lower-risk investments, in an attempt to drive investors to accept risks that they would otherwise shun;

2) Policies aimed at defending bondholders and lenders who made bad loans, which they now seek to have bailed out at public expense.

Ritzholz writes a "slightly" lighter piece, with a list, A Decade of Punditocracy, Pathetic Edition. It shows how some policy makers and prognosticators drive with a rosy rear view mirror. I love the first on the list, George W. Bush, June 17, 2002: “Now, we’ve got a problem here in America that we have to address. Too many American families, too many minorities do not own a home. [...] Freddie Mac will launch 25 initiatives to eliminate homeownership barriers.”

So what is one to do? I still believe that well chosen dividend stocks held through thick and thin is part of the answer. This week's Barron's gives some valuable information on this topic, citing S&P's Howard Silverblatt's screen: Silverblatt has provided a substantial list of companies as a starting point for dividend investing. It's not a buy list but a screened set of stocks meeting certain criteria. It's available at www.marketattributes.standardandpoors.com. At the site, click S&P 500 Monthly Performance Data and then Dividend Starting File, at the bottom of the menu. Again, it's merely an interesting place to start.

Chances are that AAA firms such as Johnson & Johnson, Exxon, and Microsoft will survive, no matter what the economy might do, and one is paid to wait. Balance that with some Treasury Inflation Protected securities, and perhaps gold, and even cash, and wait out the market turmoil (it may be a very long wait). The key is to buy any of these on weakness and make the mix appropriate for one's own investment needs and risk tolerance.

Tuesday, August 9, 2011

Fed Speaks

The Federal Reserve’s press release covering its recent meeting begins “Information received since the Federal Open Market Committee met in June indicates that economic growth so far this year has been considerably slower than the Committee had expected. Indicators suggest a deterioration in overall labor market conditions in recent months, and the unemployment rate has moved up.” Later, it continues, “the Committee now expects a somewhat slower pace of recovery over coming quarters than it did at the time of the previous meeting and anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate. Moreover, downside risks to the economic outlook have increased.”

Its main action point is that the nation’s economy is “likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.” Talk about telegraphing what it probably already knows: the economy seems to be slipping into recession once again and the Fed is helpless, meaning continued high unemployment, no remedies for the real estate market and homeowners with mortgages under water, and continued low returns on any savings. And these conditions are not temporary: they are expected to last two years (and unless Congress ever learns to function again, they will last much longer). Imagine, three year Treasury notes (no longer AAA which is another farce from S&P, the folks who brought us triple A-rated collateralized debt obligations) now yield less than a half a percent!

Where this is all likely to end is anyone’s guess, including the learned economists at the Fed. The volatile markets are reflecting that uncertainty. Buying dividend paying stocks may the best option for income, but any severe recession could leave those stocks vulnerable, jeopardizing the return of capital. That seems where the Fed is leading the individual investor.



Friday, March 25, 2011

Drip Your Way to Retirement

Give yourself the gift of a DRIP (dividend reinvestment plan). This advice was made more acutely real to me by a recent visit of my wife's cousins and their 43 year old son, Michael (and his fiancée). I haven't seen Michael in some time and he reminded me that when he turned thirteen I had given him a birthday gift of a few shares of Exxon, with some sound advice of something along these lines: cherish these shares and enroll them in Exxon's DRIP (reinvesting the dividends for more shares), and review their Annual Reports for an education regarding how a large, resource-rich, multinational corporation functions and grows. Now, I'm not sure whether he took the latter part of the advice, but he did enroll those initial shares in Exxon's DRIP and, now, after numerous stock splits and dividend increases along the way, Michael said he now has about 600 shares worth about $49,000! By the time he retires, shares and value should continue to grow, a mighty oak tree from a mere acorn.

I fail to remember why I choose Exxon at the time rather than other dividend paying stocks. Perhaps it was because Exxon was much in the news during the 1970s energy crisis and as that crisis turned to an oil glut in the early 1980s, when the shares were purchased, Exxon's stock price was in limbo. It must have seemed like a good opportunity to buy, but no matter when one does the math, almost any time would have been fine given a thirty-year time horizon. During such a long period DRIPs are subject to a number of compounding events, the reinvestment of dividends, capital appreciation, and the growth of dividends themselves (Exxon's dividend payments to shareholders have grown at an average annual rate of almost six percent during the period).

While always having been partial to dividend paying stocks, especially in this economic environment, I admittedly failed to heed my own advice when it came to DRIPs. I am glad Michael did.
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Tuesday, March 1, 2011

Inflation Takes a Haircut

Jon Hilsenrath, normally a straight forward journalist who is the chief economics correspondent for The Wall Street Journal covering the Federal Reserve, made an argument on CNBC today essentially basing the real inflation rate on the price of his haircut. He was interviewed by Joe Kernen, who is enamored by his hair as well, in regard to today's testimony before Congress by Ben Bernanke.

According to Hilsenrath, the Commodity Research Bureau's (CRB) indexes "do not hit American households...we do a lot of other things with our money, like haircuts, which is one of the benchmarks I use, and [they] are not rising....The people who look at food and energy ignore those other things."

While the CRB puts commodity inflation well into the double digits, the CPI reports nearly no inflation (1%) excluding food and energy. Surely, between the two is the REAL inflation rate that is taking its toll on most Americans, particularly retirees.


Jon (and Joe), instead of preening your haircuts as anecdotal evidence of there being little inflation, you should walk in the shoes of a balding retiree. I just happened to have reconciled our 2010 expenses, and have accurate data going back eight years. Comparing that data our income was up only marginally as, even though social security kicked in during the period, investment income declined substantially due mostly to bonds and CDs maturing and having to be replaced by lower yielding investments (the Fed's attempt to force investors into riskier investments, the very issue that almost started a depression). Indeed, fuel and groceries were among the most significant inflationary items over the eight year period, up almost an identical 68% in our case. But what I found interesting there were also large increases in items that are not only essentially non-discretionary, but they are nearly monopolies as well, the consumer having only marginal choices, such as health care, insurance (car, home and health), water and sewage, communications (cable, telephones, Internet), and, most lately, real estate taxes. These take their toll on retirees.

But as I now generally buzz cut my remaining locks, haircut expenses were de minimis so there must be little inflation. Thanks for the fine journalism, Jon and Joe.
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Sunday, January 2, 2011

We're On a Crazy Carousel

The passage of still another year reminds me of Jacquel Brel's brilliant waltz from the late 1960's musical review: Jacques Brel Is Alive and Well and Living in Paris. It is a song that begins slowly, sanely, gathering tempo as it culminates breathlessly at the end. I was playing that song during the anticlimax of Y2K.

We're on a carousel / A crazy carousel / And now we go around / Again we go around / And now we spin around / We're high above the ground / And down again around / And up again around / So high above the ground / We feel we've got to yell / We're on a carousel / A crazy carousel

My "blogger friend" Mark over at Fund My Mutual Fund, whom I've referenced before in these virtual pages, has been writing, strategizing, constantly working towards the goal of starting his own mutual fund. He is pursuing the golden ring on this carousel of life, following his dream, and this year he will finally realize it. His New Year's message revealed many of the details that led to this culminating moment and I applaud him for his tenacity.

Decades earlier, like Mark, I followed my own dream, carving out a niche in the publishing world, one that fascinates me to this day, but at one time in my life I had considered a career change and perhaps if the Internet existed then, I might have followed a different path. It wasn't that I had a falling out with my interest in publishing, but I too had become enamored by "the markets" and fancied myself an "investor."

My interest started out by investing in some of the Nifty Fifty ( many of which crashed and burned under their own overvalued weight in the poor economic, high inflationary years of the 1970's), and then with the help of VisiCalc (the precursor of Lotus 1-2-3, in turn the precursor of Excel) and my first computer (an Apple II), came up with what I thought was a "bullet proof" system of investing in convertible debentures. I even marketed a VisiCalc template ("Converticalc") to analyze them. Well, as we all sooner or later recognize, there is no infallible system, and making investing an avocation can be as dangerous as being your own surgeon, so now I rely on people like Mark and, I am not ashamed to admit (in this era of "fast money"), I'm also a buy-and-holder, investing in selected dividend aristocrats selling at reasonable price/earnings to growth ratios. But Mark's New Year's message reminds me that things might have turned out differently if I followed my other dream to its logical conclusion.

The program drew interest at the time and there was even some discussion with a major brokerage house about starting a mutual fund based on it. By today's computer standards the program is laughable, but mind you this was nearly thirty years ago. A new publication, Financial & Investment Software Review, which was dedicated to "microcomputerized investing" carried my article on investing in "converts" in its Summer, 1983 issue. I wish I could just give a link to the article, but I have to paste it below in its entity as it doesn't exist anywhere on the Web. Actually, the concepts haven't changed that much -- as far as straight investing in Convertibles is concerned -- but the nature of these instruments have changed with the advent of computer driven arbitrage. They are not for the faint of heart.

So, this is now water under the proverbial bridge for me, but things could have turned out differently if my interest in investing finally outweighed my passion for the publishing business. Follow your dream in 2011 and watch for the launch of Mark's "Paladin Long-Short Fund."

Evaluating Convertible Debentures by Robert Hagelstein (Financial & Investment Software Review, Summer, 1983, Volume 1, No. 3)

Convertible debentures are an unusual investment opportunity but largely have been overlooked because of the complexities in evaluating them and because of the relative illiquidity of the marketplace. During the last several years, however, convertible debentures have been issued by a growing number of companies and in larger numbers, significantly improving their liquidity. This factor, in combination with the widespread availability of the microcomputer for analysis, makes convertible debentures suitable for most portfolios. Much of the following discussion of convertibles has been adapted from the manual that accompanies CONVERTICALC , a VISICALC® template that was developed for the evaluation of convertible debentures.

Convertible debentures are debt instruments that are convertible into common stock. They share the most attractive aspects of both kinds of investments, the appreciation prospects of equity with the high current income of a bond. In addition, the debt characteristic of the convertible creates an investment floor, a point at which the convertible will not decline, even if, theoretically, the common declines to nearly no value (assuming bankruptcy is not the cause of the decline).

Despite the focus on convertible debentures in this article, there are also convertible preferred issues that may be of interest to the investor. A drawback to this convertible security is preferred stock has no maturity date at which time one can expect to receive par value for the investment. Nonetheless, many of the evaluation techniques discussed below can be applied to these convertibles should the investor wish to include such issues in an investment portfolio.

Corporations issue convertible bonds as an inexpensive means of raising capital. In effect, a convertible offering is an equity offering in the future, allowing the corporation to issue a debt instrument with a coupon rate much lower than prevailing rates. Until recently, convertibles were mostly the exclusive province of corporations with lower debt ratings. Persistent high interest rates have changed this; even Kodak and IBM have issued or filed to issue convertible securities.

There are several publications that follow convertible debentures, each providing essential information needed to evaluate them: the number of shares into which each debenture is convertible (the "conversion ratio"), the coupon and maturity date, the quality rating as a debt issue, the amount of debentures outstanding, and the identification of the issuer and the issue into which it is convertible (some are convertible into the common stock of companies other that that of the issuer). These publications include Standard & Poor's Bond Guide, Moody's Bond Record, and the Value Line Convertibles Service. They also provide some of the computations used to analyze convertibles, particularly Value Line.

SOFTWARE PROGRAM
CONVERTICALC not only gives the critical formulas for evaluating convertibles, but it also provides the data on approximately one-hundred of the most actively traded issues on the NYSE and AMEX exchanges. The user can add or substitute other issues, replicating the evaluation formulas.

Nevertheless, there is no computer program that can forecast the direction of security prices. There are a host of intangibles affecting investors' perceptions of value, many of these relating to investor psychology rather than to fundamental values. CONVERTICALC is intended to be an investment aid and does not offer any prescribed buy/sell decisions, It endeavors to supply information to evaluate convertible debentures in relation to one another and in relation to the underlying common stock.

As convertible debentures can be exchanged into the underlying common stock, at the option of the holder, the appreciation prospects of the common is crucial to evaluating its corresponding convertible, Traders convinced that the common will move substantially higher within a short period of time, are normally better off buying the common than the convertible. Longer term investors, particularly conservative ones to whom current income is important, may find the convertible to be the better choice. In both cases, however, the first step in making a buy decision is determining whether the common stock is desirable.

Convertibles selling at a large discount from par may be especially attractive to long-term investors. Such issues enable one to "lock" into a virtually guaranteed capital gain, even if the underlying common stock should fail to appreciate during the period. Another consideration is the convertible's bid and asked price. This spread will normally be small for issues actively traded on the NYSE or AMEX. It can be considerable for issues with a relatively small float and for those traded over-the-counter.

Most convertible are "callable" by the issuer, requiring the holder to either sell at the call price or convert into common stock. It is not unusual for convertibles to be called once the issue is selling at substantially more than par. Usually, convertibles are callable at prices higher than par during the first few years after issuance, declining to par as the date of maturity approaches. Many are callable at par long before maturity. For this reason Moody's Bond Record is an invaluable companion for investors considering buying convertibles: current call terms are specified.

CONVERSION PREMIUM
A key element in evaluating convertibles is the issue's "conversion premium." This premium represents the percentage at which the convertible is selling over its "conversion value" (the number of shares into which one debenture is convertible multiplied by the current price of the common stock). The lower the premium, the more likely the convertible will move in relation to the underlying common stock while the higher the premium the more likely the convertible will move in relation to interest rates. Convertibles with low premiums, having relatively high yields and fast "payback" periods (see below), are generally the best buys (if, of course, the common stock merits a buy). Such convertibles will appreciate with the common stock and provide greater yields than the common stock, giving the investor the best of two worlds: capital gains and lower downside risk.

As the conversion premium is intrinsic to evaluating convertible values, the CONVERTICALC disk includes a section sorted by conversion premium. Generally, those convertibles carrying premiums of less than 5% will follow nearly all of the underlying common stock's rise. However, some of these same issues may be equally vulnerable to a substantial decline of the common while others may follow only half the common's decline. The potential magnitude of a convertible's downside risk relates to its yield in relation to those paid by non-convertibles of similar quality. Obviously, convertibles with yields to maturity approaching those prevailing for straight debt issues that would decline the least even if the underlying common stock should decline (see the discussion of the "investment premium" below).

It is possible to quantify the potential price relationship between an underlying common stock and a convertible debenture, plotting what is known as the "convertible curve" on a x/y axis graph. An awareness, however, of a convertible's conversion and investment premiums generally obviates the need to maintain such graphs.
Then, there is the concept of "payback period," the amount of time it will take to recover the conversion premium from the additional yield provided by the convertible over the common stock, This is important when considering whether one buys the convertible or the underlying common, When a convertible has a relatively long payback period and the premium is not excessive the common stock yields nearly the same as the convertible. If the dividend is relatively secure, the common stock may be a better value than the convertible,

INVESTMENT PREMIUM
The concept of "investment premium" can be as important to one's investment decision as the conversion premium, The former represents the percentage a convertible debenture is selling above its investment value (as if it is devoid of its convertibility feature). In order to ascertain this percentage, it is necessary to identify the debt quality of the convertible being considered. Access to Moody's or Standard & Poor's bond publications will provide a bond rating for the issue, For this reason, it is necessary for the investor to know the yield to maturity of the convertible being considered. Even if the investor is not looking for high current yield, yield to maturity is the basis for comparing convertible to straight bonds, CONVERTICALC provides an approximate yield to maturity calculation.

Quantifying the investment premium is a method of judging the potential "floor" for the price of a convertible, a means of establishing the magnitude of the investment risk, A convertible with virtually no investment premium is selling at its investment value. Such issues are more likely to be more sensitive to changes in interest rates than movement of the underlying common stock This is also a characteristic of convertibles with high conversion premiums. Therefore, generally, the investment premium and the conversion premium will tend to be the reciprocal of the other, high investment premiums following low conversion premiums and vice versa, Sometimes one can find convertibles with relatively low investment AND conversion premiums, These are the undervalued issues that should be sought by the investor; they have nearly the same upside potential as the common stock with very little downside risk if the common stock should decline (assuming static interest rates).

The investment premium may be quantified by using a hand-held calculator or the remaining memory available on the VISICALC matrix. After the bond rating for the convertible issue being evaluated has been ascertained, and the prevailing yield for equivalent non-convertible debt issues has been established, a bond table would reveal at what price the convertible would have to sell to yield the prevailing rate. Then, by subtracting the current price from the price at which it would have to sell to yield the prevailing rate and dividing the remainder by the current price, the investment premium can be calculated. Common sense can generally substitute for an actual calculation. In comparing a number of convertibles chosen on the basis of relatively low conversion premiums, ones of roughly the same investment grade, those with the highest yields to maturity have the lowest investment premiums.

Convertibles should not only be analyzed against one another and against the underlying common stock; they should also be evaluated against themselves over a period of time. Maintaining a file on a regular basis and recording changes in the key convertible evaluation components - conversion premium, yield, and payback period - enables the investor to "plot" bands of values. Market volatility, earnings growth, interest rate movements will profoundly affect these statistics. By observing these movements as computed by CONVERTICALC, the investor can decide when the common is overpriced in relation to the convertible or vice versa. One may want to sell a convertible whose conversion and investment premiums have become too excessive and switch into one with lower premiums and/or a higher yield. By observing diligent portfolio management the investor can maximize return and minimize risk.
"Evaluating Convertible Debentures" © 1983 by Robert Hagelstein. CONVERTICALC, is a VISICALC® template formatted for 64 K APPLE II® DOS 3.3. APPLE® is a registered trademark of Apple Computer, Inc. VISICALC® is a registered trademark of VISICORP''.

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Wednesday, August 11, 2010

Inflation or Deflation?

I remember watching Wall Street Week with the late Louis Rukeyser in the late 1970s and early 1980s during another alarming economic period, with talk of South American style inflation reaching the U.S. and the mindset that goes along with that fear, people buying gold, eschewing long term US Treasuries which were yielding around 15%. It seemed each and every week investors were waiting for reports on the “money supply” with any large increase reinforcing the then prevailing view. In retrospect, how much simpler and more benign economic matters seemed then.

Now money supply measurements are not even discussed. Instead, we wait with baited breath for the Fed’s latest interest rate decision, endeavoring to parse the Federal Open Market Committee’s statements, comparing them with prior statements for clues as to what the future holds.

Today seems to be the inverse of those days with US Treasuries yielding nearly nothing, and the fear of deflation driving investor psychology, leaving few alternatives to us average folk not of CNBC’s fast money crowd. By the Fed’s decision to reinvest its portfolio of maturing mortgages in U.S. Treasury debt, rather than shrinking its balance sheet, it has embarked on a method of monetizing debt. Normally this would ring the inflation bells but not in this economic environment where spending is a higher priority than reducing debt or saving. Deflation is a state of mind that once it takes hold becomes a self fulfilling prophecy, particularly in the wake of the economic turmoil and bailouts of the financial sector of the last few years, with high unemployment and state and local government fiscal problems, leaving the Fed with few remaining options. And, unlike inflation, we have little experience with it other than the 1930s and Japan’s ongoing battle with it since the early 1990’s.

As reflected by CD rates of nearly zero, it is an investment environment where one has two choices, take risk (which is being encouraged by the government’s actions) or put your savings under a mattress (which, in a deflationary environment produces a positive return without risk). Inflation or deflation? One has to wonder what the Fed knows that we don’t. It is a conundrum for the saver. Bring back the good old days of Wall Street Week!


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Tuesday, June 29, 2010

Market Report

The S&P was down 3.1% today as the market reacted to slowing growth in China, continuing high unemployment, and signs that deflation, not inflation, is the problem de jour. The 10-year Treasury Note now yields less than 3% reflecting that belief. New York Times’ Paul Krugman characterizes this as The Third Depression. John Hussman, the economist turned mutual fund manager, more mildly states that this is a resumption of the recession. Pain management stocks were up 2.4% in today’s down market.

Friday, April 9, 2010

Anecdotal Headlines

I haven’t done this in awhile, in fact not since December 2008 as the Dow was rushing towards its low during this recession – that is to highlight some of the headlines from the Wall Street Journal, anecdotal evidence of where the economy and the market might be heading. Back then we were in the thick of it, virtually every headline pointing to fraud, bailouts, bankruptcies, and rising unemployment.

Today, while the Dow basks in the glow of massive liquidity injections in a low interest rate environment, approaching 11,000 as I write this, and investment bankers are rewarding themselves with record bonuses, the economy swims on against the tide of high unemployment (much higher than reported), kicking the state/municipal finance crisis down the road, and rising foreclosures. (We still wait on the consequences of future resets of adjustable rate mortgages.) No one really has an idea of how this will resolve. The CNBC cheerleaders are on the side of a continuing rising market, while there is no shortage of Armageddon forecasters who advise buying gold and farmland and head for cover. No forecaster I, but we seem to be moving from headlining the symptoms, and are getting more to the heart of the matter. It’s interesting that “Fed Chiefs Hint at Low Rates Possibly Into 2011” can be juxtaposed to “Mortgage Rates Hit 8-Month High of 5.21%,” perhaps an indication that the government has less control over the outcome than it did when this crisis began. From today’s Wall Street Journal:

Foreclosures Hit Rich and Famous
Houses with loans of $5 million or more will likely see a sharp rise in foreclosures this year, according to a RealtyTrac study.

Greek Bond Crisis Spreads
Concern over a potential liquidity shortage at Greece's private-sector banks fueled a sharp selloff in Greek debt and equity markets

States Skip Pension Payments, Delay Day of Reckoning
The deferrals come as pension experts say the funds need the money more than ever

Jobless Claims Rise Unexpectedly

Cash Crunch Will Force Governments to Do Less

Fed Chiefs Hint at Low Rates Possibly Into 2011

Los Angeles Faces Threat of Insolvency
Dispute Between Municipal Utility and City Council Over Electricity Rates Deepens Fiscal Crisis; Bond Rating Cut

Big Banks Move to Mask Risk Levels
Quarter-End Loan Figures Sit 42% Below Peak, Then Rise as New Period Progresses; SEC Review

Mortgage Rates Hit 8-Month High of 5.21%




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Tuesday, October 27, 2009

Awash in Liquidity

Again (see last post) I defer to another insightful analysis about the economy and why we might be at an investment inflection point, this time turning to the world’s leading bond manager, Bill Gross at PIMCO. His monthly investment outlook, Midnight Candles, details why the investment “bubble” is a long standing one, that as a nation which once relied on the production of real things, we became focused on “paper asset” appreciation by the 1980’s. Governments have artificially influenced those prices since then. Gross distills this in an interesting observation: “How many TV shots have you seen of people on the Times Square Jumbotron applauding the announcement of the latest GDP growth numbers or job creation? None, of course, but we see daily opening and closing market crescendos of jubilant capitalists on the NYSE and NASDAQ cheering the movement of markets – either up or down.”

That sets the macro economic scene, which has been compound with the crisis of the last couple years. More recently investors have flocked to riskier assets as the Fed has flooded the markets with liquidity and driven interest rates to nothing. Unless the real economy grows substantially, this has to end badly when the Fed reverses course. For this reason, Gross believes asset prices might be peaking.

Gross is certainly one of the more literate, philosophical money managers around, and his prefatory remarks set the stage in that venue. As one who is about Gross’ age, I identify with his feelings about being “Everyman.” I suspect he has read Philip Roth’s novel of the same title, but that’s another matter.


On a lighter side from my photo archives….


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Wednesday, October 21, 2009

Einhorn’s Speech and Bubble Du Jour

Sometimes you come across a point of view on our economic crisis that provides such clarity you want to share it. Such is the case with David Einhorn’s recent speech at the Helbrunn Center for Graham & Dodd Investing. Einhorn is President and founder of Greenlight Capital, a money management firm that specializes in long-short value oriented investments, and he is the author of Fooling Some of the People All of the Time, the story of Greenlight’s short sales of Allied Capital and the subsequent controversy that became highly publicized. I learned of this speech from a blogger colleague over at Fund My Mutual Fund but undoubtedly it has been widely circulated by others as well.

I have selected some salient points from the speech and post them here. If you read these, go to the entire speech, as quotes out of context cannot convey the full measure of Einhorn’s well-reasoned arguments. While his value oriented investing style will remain his approach, the current crisis has convinced him to include gold in his portfolio, something most value investors find antithetical.

I wonder what he thinks about the rise of the Dow to more than 10,000, a sixty percent “recovery” from its earlier lows. Late last year I had posted a summary of the Wall Street Journal’s headlines all of which were decidedly negative, the perfect contrarian indicator. Now, the market is being bid up with talk of green shoots and improving earnings. An anecdotal observation regarding the latter is the recently announced “improved” earnings (that is, a positive comparison to expected earnings, not normalized ones) of many of the Dow’s major components seem to be accompanied by a shortfall in revenue, in other words earnings that come as a result of cost cutting, particularly layoffs and hiring freezes. Corporations cannot sustain earnings growth without revenue growth and the latter cannot happen while real unemployment rates stubbornly remain in double digits leaving the consumer on the ropes.

The illogical exuberance of the market lately is in lock step with the dollar’s decline as interest rates have also disappeared into a black hole. Stocks have just become another commodity, with a more limited supply than the government’s ability to manufacture dollars. As the headlines of almost a year ago signaled a bottom, perhaps the recent introduction of the Porsche Panamera, a $133,000 four door sedan with a 500 horsepower twin turbo V8 that can reach 60 mph in a mere 4 seconds – the perfect car for the bailed-out gang on Wall Street in this energy-challenged age – foreshadows a new bubble.

Here are some salient points from David Einhorn’s speech (Value Investing Congress David Einhorn, Greenlight Capital, “Liquor before Beer… In the Clear” October 19, 2009) which should be read in its entirety here:

* As I see it, there are two basic problems in how we have designed our government. The first is that officials favor policies with short-term impact over those in our long-term interest because they need to be popular while they are in office and they want to be reelected. …. Paul Volcker was an unusual public official because he was willing to make unpopular decisions in the early ’80s and was disliked at the time. History, though, judges him kindly for the era of prosperity that followed. Presently, Ben Bernanke and Tim Geithner have become the quintessential short-term decision makers. They explicitly “do whatever it takes” to “solve one problem at a time” and deal with the unintended consequences later.

* The second weakness in our government is “concentrated benefit versus diffuse harm” also known as the problem of special interests. Decision makers help small groups who care about narrow issues and whose “special interests” invest substantial resources to be better heard through lobbying, public relations and campaign support…. [A]t some level, Americans understand that the Washington-Wall Street relationship has rewarded the least deserving people and institutions at the expense of the prudent. They don’t know the particulars or how to argue against the “without banks, we have no economy” demagogues. So, they fight healthcare reform, where they have enough personal experience to equip them to argue with Congressmen at town hall meetings. As I see it, the revolt over healthcare isn’t really about healthcare, but represents a broader upset at Washington.

* The financial reform on the table is analogous to our response to airline terrorism by frisking grandma and taking away everyone’s shampoo, in that it gives the appearance of officially “doing something” and adds to our bureaucracy without really making anything safer. With the ensuing government bailout, we have now institutionalized the idea of too big-to-fail and insulated investors from risk. The proper way to deal with too-big-to-fail, or too inter-connected to fail, is to make sure that no institution is too big or inter-connected to fail. The test ought to be that no institution should ever be of individual importance such that if we were faced with its demise the government would be forced to intervene. The real solution is to break up anything that fails that test.

(As a follow up to this last point, see today’s New York Times article: “Volcker’s Voice Fails to Sell a Bank Strategy: The former Fed chief said the giant banks must be broken apart and separated from risky trading on Wall Street, a view not shared by many in the White House”)

* Rather than deal with these simple problems with simple, obvious solutions, the official reform plans are complicated, convoluted and designed to only have the veneer of reform while mostly serving the special interests. The complications serve to reduce transparency, preventing the public at large from really seeing the overwhelming influence of the banks in shaping the new regulation. In dealing with the continued weak economy, our leaders are so determined not to repeat the perceived mistakes of the 1930s that they are risking policies with possibly far worse consequences designed by the same people at the Fed who ran policy with the short term view that asset bubbles don’t matter because the fallout can be managed after they pop.

* Over the next decade the welfare states will come to face severe demographic problems. Baby Boomers have driven the U.S. economy since they were born. It is no coincidence that we experienced an economic boom between 1980 and 2000, as the Boomers reached their peak productive years. The Boomers are now reaching retirement. The Social Security and Medicare commitments to them are astronomical. When the government calculates its debt and deficit it does so on a cash basis. This means that deficit accounting does not take into account the cost of future promises until the money goes out the door.

* [T]he Federal Reserve is propping up the bond market, buying long-dated assets with printed money. It cannot turn around and sell what it has just bought. ….Further, the Federal Open Market Committee members may not recognize inflation when they see it, as looking at inflation solely through the prices of goods and services, while ignoring asset inflation, can lead to a repeat of the last policy error of holding rates too low for too long.

* I subscribed to Warren Buffett’s old criticism that gold just sits there with no yield and viewed gold’s long-term value as difficult to assess. However, the recent crisis has changed my view. The question can be flipped: how does one know what the dollar is worth given that dollars can be created out of thin air or dropped from helicopters? Just because something hasn’t happened, doesn’t mean it won’t. Yes, we should continue to buy stocks in great companies, but there is room for [another] view as well. I have seen many people debate whether gold is a bet on inflation or deflation. As I see it, it is neither. Gold does well when monetary and fiscal policies are poor and does poorly when they appear sensible. Gold did very well during the Great Depression when FDR debased the currency. It did well again in the money printing 1970s, but collapsed in response to Paul Volcker’s austerity. It ultimately made a bottom around 2001 when the excitement about our future budget surpluses peaked. Prospectively, gold should do fine unless our leaders implement much greater fiscal and monetary restraint than appears likely. Of course, gold should do very well if there is a sovereign debt default or currency crisis.

* For years, the discussion has been that our deficit spending will pass the costs onto “our grandchildren.” I believe that this is no longer the case and that the consequences will be seen during the lifetime of the leaders who have pursued short-term popularity over our solvency.

On the lighter side of things, here is something I caught at Westport Now, the online newspaper that covers Westport, Connecticut, where I worked for so many years. Our first office was built on the site of an old New England lumber yard, on the Saugatuck River at 51 Riverside Avenue, and I recognized the building, the one on the left, in Westport Now’s recent photograph, the same fall colors ablaze as I remember them nearly forty years ago…

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Monday, August 3, 2009

Headline Tedium

Bailouts, bonuses and Madoff. Are we getting tired yet of the endless litany of related headlines such as the Wall Street Journal’s recent “Bank Bonus Tab: $33 Billion; Nine Lenders That Got U.S. Aid Paid at Least $1 Million Each to 5,000 Employees”?

The rock star of these “fab” financial “leaders” is Andrew Hall who makes a bundle for himself trading energy contracts for Citigroup's energy-trading unit Phibro LLC, with compensation approaching $100 million for 2008. It is interesting to read Sunday’s New York Time’s front page article on his activities and compensation. No doubt he is a talented individual and I suppose if Citigroup didn’t want his operation’s expertise in “taking advantage of unusual spreads between the spot price of oil and the price of an oil futures contract,” other firms would be lining up to pay his price. That is the American way. We know how to lavish money on our superstars, whether from the media or sports, or in this case, dice-rolling trading moguls.

The Times refers to his compensation as “his cut of profits from a characteristically aggressive year of bets in the oil market.” It also says “the company, for example, often wagers that the price of oil will rise so fast during a particular period, say six months, that it can make money by storing oil in supertankers and floating it until the price goes up. “ Finally, “right before the first Gulf War, Phibro placed an elaborate bet that the price of oil would spike and then go down faster than others were anticipating. The company earned more than $300 million from the gamble.” I emphasize bets, wagers, and gamble, as these words cut to the heart of the matter. Arbitrage and hedging can be a means of controlling risk or it can magnify risk to the point of endangering the entire financial system. Is this what our banks should be doing: betting, gambling and waging? Heads they win, tails the taxpayer loses? I have to wonder what the consequences would have been if Mr. Hall’s trades had gone disastrously against Citigroup. Would he have been personally at risk for the same $100 million he “earned” being on the right side? Do we want our banks, the bedrock of our financial system engaging in such activities – aren’t these the domain of the individual entrepreneur and private capital? To what extent does such “trading” create spikes such as $147 for a barrel of crude oil while there is a glut of the commodity?

Then there is the continuing rhetoric about having to reward the financial superstars that got us into this mess in the first place, or they will “walk.” I like Warren Buffet’s homey comments on this topic so I quote from his 2006 letter to his Berkshire Hathaway shareholders. Although this is aimed at CEO pay in general, which is also absurdly high in many (but not all) corporations, it applies to our banks and other financial service firms as well:

“CEO perks at one company are quickly copied elsewhere. ‘All the other kids have one’ may seem a thought too juvenile to use as a rationale in the boardroom. But consultants employ precisely this argument, phrased more elegantly of course, when they make recommendations to comp committees. Irrational and excessive comp practices will not be materially changed by disclosure or by ‘independent’ comp committee members….Compensation reform will only occur if the largest institutional shareholders – it would only take a few – demand a fresh look at the whole system. The consultants’ present drill of deftly selecting ‘peer’ companies to compare with their clients will only perpetuate present excesses.”

Another mind-boggling headline “Picowers Rebut Suit Tied to Madoff Fraud” is from Saturday’s Wall Street Journal. and The New York Times version of the same “Big Investor Counters Charges in Madoff Case.” According to the Madoff bankruptcy trustee, Irving Picard, Picower’s accounts posted gains of more than 100 percent a dozen times between 1996 and 2007, with one gaining 950 percent, but this counter suit contends the latter was “only” 37.6 percent and none of his accounts earned more than 100 percent “in any single year.” But the $5.1 billion Picower withdrew over the years may have represented a return greatly exceeding any reasonable return during the same period. How a knowledgeable investor (presumably Picower qualifies) could believe that Madoff can “guarantee” steady returns of 10 to 12 percent a year and be satisfied by the statements received from Madoff to bear out those returns is beyond me. I still think the “idea” of creating a new reality TV show, something we seem to be better at than regulating financial Ponzi schemes (either private or government sponsored) might be just the ticket to fund the innocent victims of Madoff.

On the eve of President Obama’s inauguration, I had written the following: “The winners in this economy were not only the capitalists, the real creators of jobs due to hard work and innovation, but the even bigger winners: the financial masters of the universe who learned to leverage financial instruments with the blessings of a government that nurtured the thievery of the public good through deregulation, ineptitude, and political amorality. This gave rise to a whole generation of pseudo capitalists, people who “cashed in” on the system, bankers and brokers and “financial engineers” who dreamt up lethal structures based on leverage and then selling those instruments to an unsuspecting public, a public that entrusted the government to be vigilant so the likes of a Bernie Madoff could not prosper for untold years. Until we revere the real innovators of capitalism, the entrepreneurs who actually create things, ideas, jobs, and our financial system will continue to seize up. That is the challenge for the Obama administration – a new economic morality.”

I haven’t changed my view and I fear that while we bail out banks, insurance companies and their like, leaving present compensation practices in place, we just continue to perpetuate financial risk taking, swinging for the fences, making “bets and wagers” that will just dig us into a deeper future hole. As the headlines attest, the “challenge” remains. A true recovery requires jobs, jobs, jobs – and how are they going to be created – by banks trading energy futures? What happened to the commitment to the infrastructure? Our roads, utilities, and public transportation are falling apart. Alternative energy seems DOA. Aren’t these the areas our financial recourses should be focused on, ones that will create jobs, in construction, technology, and finance, and can lead a true economic recovery we can pass on with pride to future generations?