Saturday, December 3, 2011

Tom Russo Lecture At Columbia Business School/Greenwald (2009)



This is a 1.5-hour Columbia Business School lecture by Tom Russo from Spring 2009 (unconfirmed, my estimate).

Staying the course is important and hard to do in bear markets: Buffett visited his Stanford bschool class in 1980 and gave the following principles.
(1) The IRS does not tax unrealized gains so try to find things you can hold forever, the long term matters
(2) In a lifetime, you might have 20 great ideas so buy and hold
(3) Define your circle of competence (for Russo, consumer product and media companies)
(4) Choose management well. There is no deal to be made with corrupt people. It is an agency cost.

Long-term holding/stay the course has worked for his partnership. In 1999, they were down while the markets were up 27%. The story at time was that the internet will change everything, including grocery shopping and media. Traditional businesses were sold off, and the investors were bidding up the glamorous internet. Then in 2000, the market was down, while they were up 17%.

Also thinking long-term, stocks do reflect underlying cashflows. Since they hold a lot of basic consumer companies, these cashflows have been generally stable and growing over time. Also brand owners are able to match inflation well.

In addition, consumer companies are very shareholder-friendly: less agency costs. They do keep shareholders in mind when making capital allocations. He likes family-controlled businesses (unlike many who are wary of it) provided that, upon inspection, there is no self-dealing. Gives Adelphia vs. Comcast example. The families do not need to get bigger, and are less likely to do accounting manipulations.

Since they invest in global companies they also get some currency tailwinds. While admittedly not statistically significant, their experience has been that during years in which the US markets are weak, the US dollar has been weak. So an investor holding 40-65% international portfolio gets some boost from currency gains. For example, in 2002 they ere barely down (with 6% gain in currency) vs. S%P down ~25%.

Now the downside, they hold PM: they expect 80c decline EPS decline on $3.40 solely due to currency. Also holds other brand companies, Nestle, SAB, Heineken, Pernod Ricard, and likes the products, as it makes the research more fun.

There are few new ideas. A professor had an investment: an undervalued champagne company with no earnings, lots of inventory and acreage. Then at Sequoia Fund, he researched Brown Forman. BF then expanded into the flavored alcohol/coolers business. The stock shot up on the acquisition, but then the business fell off the cliff and the stock tanked. The shares plunged, and Sequoia researched them. So he's been investing in alcohol for a while. In 1987 the partnership was up 35% vs. market down 7% largely because of an alcohol company they had (Beefeater-brand owner) that was acquired. Great single brand companies do not survive for too long on their own: usually no distribution clout. Overtime they owned Corby, BF, Diageo, Allied Domeq. The point is you can figure out things, you will have multiple times to participate in the industry you know.

He also invested in newspapers, straight from Berkshire, so he started following them ("no new ideas"). Now that industry has hit a wall.

Now owns global liquor businesses: huge reinvestment opportunities. The brands have very small shares in the most interesting markets (China, India). So the cash flows from the mature business go to build in the new markets. So the real return to value investors is not only from the discount but also growth because of good reinvestment prospects. The market sometimes gets it wrong when the emerging market investments create short-term financial reporting disappointments. But these are often fixed cost investments, then they scale very well. So "reported" profits may be understated. This is true across many businesses they have with EM operations. They first bought BF in 1989, doing at 5 mm cases of Jack Daniels, mostly in the US. The multiple was low. The entire return since that time has come from growth abroad. They do 10 mm cases now. The shares have compounded at 15% per year. It has never been very exciting, largely a forgotten company. And now the future prospects are even higher as they hit the breakevens on the various international markets. Same with Pernod.

Pernod case: management has a good record. They started with a small cashflowing business in France, then started acquiring abroad. Irish Distillers, then Seagrams. With Seagrams, they got a good China business, Chivas and Martell. Then the 1997/98 crisis happened in Asia, and many Western businesses shut down. Back then, the crisis led currency collapses adn lack of buying power. Importers found it very hard to import, so foreign companies left. Pernod did not leave, and ended up "owning" the market once the recovery came. Many portfolio companies have the ability to endure losses like these. Then Pernod bought Allied Domecq and became a global. The business is decentralized. They own their distribution channels whenever possible. Now Pernod bought Absolut, the shares tanked due to the leverage, so Russo is buying Pernod. Pernod understands branding: in China, they just increased Absolut prices 50%, it was not aspirational enough. They will quickly make up the volume with dollars margin. Also very good at localizing products to taste or complimentary products. Price is suppressed: fear of emerging markets, fear of downtrading in OECD, the Absolut acquisition put 5 bn euros of debt/future credit access, share repurchases have stopped and the price paid for the acquisition. Position sized at about 5%, have 25% in alcohol. Across the board at single P/Es but all have good prospects for growth.

Q&A:
Q: Formula for financials' assessment?
A: the core business of Pernod is strong, Absolut is transformative in our view. We cannot put a precise number on that.

Q: Do you have an intrisic value for Pernod?
A: No

Q: On currencies/EMs in the turmoil?
A: Currencies and foreign markets are unknowable. Met with PM CEO, and he thinks the crisis is a US crisis. So (EM example) Russia, will be better vs. 1998: stronger country, local expenses, local production, several pricepoints. Russo has exposure in E Europe: the currencies look wobbly but no view on the future.

Q: How do you assess total addressable market in EM?
A: You will know it when you see it, no real approach. You know an elephant when you see it. He's investing in the conversion of rising GDP to branded consumer products. Often this displaces an indigenous product, like baiju in China, with a global brand. In India, beer is at 0.7L per person vs. 17 in china and 100+ in US. PG and disposable diapers: started at 3 mm cases few years ago, 2008 70 mm cases. But this is 2 cents per capita vs. few dollars/capita in the US. PG has tiered the product. New diaper plants come pre-assembled and can put it up in a week.

Q:How do you measure management alignment of interest with shareholders?
A: Have to pick the family right. No litmus tests, spend time with the family.

Q: Direct EM investments?
A: Often have the multinationals that deal in EMs, so they get more control over local management, more audit certainty, etc. Had a direct investment in a Slovakian chocolate company. The information flow burdens and the risk were too high to bear. Also the valuations have been much higher in EM for locally listed subsidiaries (ie Unilever Hindustan).

Q: Sell discipline
A: Now more prepared to take a critical look after 2008. But now harder to want business at lower prices.

Q: ??
A: Good discussion of how Richemont expanded in Russia (carefully, no partners, spent more for real estate they control).

Q: Tech?
A: Can't see Dell's future so no investment there. Ultimate commodity, and threatened by technology. Can't model it after consumer company process.

Q: ??
A: Sarbox is helping them with more controlled entities. Comfort varies from family to family, it is qualitative. With Berkshire's new independent board, succession is centerstage, and this is helping them as outside holders.

Q: Brand impairments?
A: Try not to get involved with impaired brands. Absolut might have been underutilized, and Pernod has the capacity to revitalize. Cadbury Schweppes: their great growth came when Mars went to sleep. Mars is now back, bought Wrigley, and this might hurt C-S company.

Q: Sell at what multiples?
A: At very high multiples, he'd sell no matter what; at high multiples, they reduce if it is a higher percent of the portfolio (i.e. grown from 5% to 8%). Often uses the cash to add to undervalued/underrepresented positions.

Thursday, October 6, 2011

Notes from Bloomberg's "One Hour with Bill Ackman"



This is a very recent interview with Bill Ackman (BA) in which he discusses several of his past and present investments, and shares thoughts on Hewlett-Packard, Fannie/Freddie, and the overall US economic policies. About half the questions are from the Bloomberg interviewer, and about half are from the admittedly friendly and well-heeled audience. I use Bill Ackman ("BA") when he uses "we" to refer to his fund, Pershing Square. The headlines focused on the HPQ "brain damage" line but the interview has a lot more interesting bits.

Q: What is activism to Bill Ackman?

Lots of capital is managed passively: we are more concentrated. Look for undervalued companies and understandable reasons, and then work with management ("come up with irrefutable answers to problems").

Recent examples:
JCP: "iconic" retailer, moved from NYC to Plano, TX, in 1992. Stock was at $38, BA bought it at $21. JCP also sold its Manhattan building (today worth probably $2.5 bn) and built HQ in Plano. JCP spends $1.3 bn/year on marketing. Old CEO made two changes, but they needed to do more. CEO was near retirement, and BA was invited on the board.

New CEO: HBS, went to Mervyn's, then AAPL eleven years ago to build AAPL retail from scratch. BA worked hard to recruit him.
New CMO: just hired out of TGT

They will work with great assets: the brand, owns most RE or leases it for free, and it will be transformational over time.

JCP is an example of their longer-term, operationally focused approach. A different example is Fortune Brands (BC: formerly FO). FO owned three disparate businesses: Titleist golf, Moet faucets and the parent company for Jim Beam, Sauza and other alcoholic beverages. FO was trading at a substantial discount, BA built a 12% stake at $41, met with management, laid out a case, and the businesses were separated. Today they trade at $57 on an equivalent basis.

GGP: took a 25% stake in Nov 2008. Market cap was $23 bn in 2007, to $10 bn before the Lehman weekend, to $100 mm market cap in November. Founding Bucksbaum (sp?) family stake went from $4 bn to $25 mm. BA bought 80 mm shares for less than $1/share, joined the board (adviser Goldman Sachs did not want him; family member cast the deciding vote), BA led the restructuring. Now BA chairs HHC (Howard Hughes assets from the GGP Rouse acquisition).

Q: Why is JCP going to be successful where you [failed] at TGT?

TGT: it was already successful. We had two ideas for them, sell the credit card business (uses up capital, subscale, no advantage) and separate the owned real estate they own into a very safe REIT with NNN leases (ground rents). The land was worth $40/share with TGT at $50/share.

Went to management, management was very receptive and asked them to be quiet. Management was slow and really missed the market to sell, our loss was 50%, BA was upset, led a proxy contest, management agreed to some changes, little profits after four years. Now JCP hired their top marketing guy that led the designer strategy and now JCP will make it easy to buy Missoni and others.

Beauty of the retail business: JCP has 1,100 boxes, selling an unimpressive $150/sq ft of product. With retailers, next year you can be selling something very different so with the right marketing, merchandising and customer service, the number can improve a lot.

Q: People think that a proxy contest is needed at HPQ. They have hired GS preemptively to defend even though there is no activists around. Why do you think people think that an activist is needed?

Over the last few months, BA has gotten calls from the 5-6 top shareholders of HPQ begging him to take a stake and be proactive. BA focuses on predictability, and HPQ is a number of businesses that are difficult to predict even on a five-year basis. the PC business might be irreparably damaged after the spin announcement.  So it looks cheap but it is a "big complicated mess".

BA learned early in his career to do "return on brain damage" for investment decisions: there would be too much brain damage at HPQ without the potential profit to justify it. GGP justified it, HPQ is a big mess. HPQ is also very large, BA likes 10% stakes.

Q: You recently bet on the reevaluation of the HKD: you gravitate towards retail, real estate, etc. Is it out of your comfort zone?

BA are known for our large stakes but also do small "mispriced probabilistic investments" like CDS on MBIA, bought for $30 mm, ended up at $1.1 bn. Small position; investors "would not notice if we lost it"/asymmetric payouts. Also likes to hedge the big stakes against market declines. Used to do it with CDS but now corporate America has recapitalized and is in good shape. So this is how he came across the HKD.

HKD was pegged to silver, then to GBP, then floating but in the early 1980s, the UK/China handover negotiations were not going well (Thatcher broke her leg, bad sign), the HKD started to depreciate rapidly, people panicked and started stocking up supplies. The government was forced to peg to the USD. However, since then, the GDP has grown by leaps and bounds, HK gained AAA rating while the US lost it, housing market is overheating, inflation is high, but their monetary policy is identical to the US. So ZIRP with 6% GDP growth, heavy imports, heavy asset inflation. The currency is artificially held. Eventually it will break.

Because it has been pegged for so long, the volatility of the options is zero. The bet is $100 mm in calls so a small move will yield enormous profit. It is also a hedge against a USD collapse- we might be headed in that direction. You're earning zero on your money market, buy some HKD, better yield, and may be you'll make out well if the peg is removed and the HKD appreciates.

Q: How do you keep your LPs from getting "squirrly"? Your strategies take time, people redeem.

Benefit of good record over eight years, low 20% compounded net of fees. We've made people money. But more importantly, BA is the opposite of a black box strategy: most investments end up being public and people just know what BA tries to do. They also understand that it is a concentrated strategy. BA does not offer smooth returns and investors understand this. BA communicates quarterly and annual dinner.

Q: Loeb and Einhorn have created reinsurance funds for permanent capital. Will you do this?

Buffett has the best permanent capital because he does not have to worry about redemptions. In BAs case, even though they had good 2008, in 2009, they lost 27% to redemptions from investors who had outside liquidity needs. This means being defensive when it is the best time to be offensive.

BA does not like mixing reinsurance risk (with no expertise, small scale) with investment risk. The world is too uncertain; can't really feel confident in the maintenance of the 30-year old reactors like Fukushima. BA plans to issue a closed-end vehicle to investors some time in 2012 for permanent capital.

Audience questions:

Q: Auto industry?


Might be cheap now, post-restructuring GM is competitive cost-wise, but does not/never did love it. It is too volatile (likes "annuities"-type businesses), too capital-intensive, labor unions always ask for more when times are good. Better opportunities elsewhere.

Q: Newspapers?

Learned a valuable lesson 5-6 years ago with Borders investment. NYT is relatively better now (become more national) as the smaller competitors have blown up. The iPad gives some hope, people are paying for it. The NYT might be a vanity investment, like the WSJ/Murdoch. NYT is now more like artwork, not for me. Also controlled.

Q: Human capital/marketing/etc/ investment in JCP that is required?

JCP is a $18 bn "Start-up", $1bn+ EBITDA to do whatever he wants to. Big advantage. Replacement cost of the real estate is $12-15 bn. You get all that for about $6 bn market cap. The business is cheap, good place to start. Now has to attract talent, new CMO is a coup: now people want to come work for them. With the asset base, attract people and go from there.

Q: Financials?

Likes the big banking franchises, likes C the most, at these prices: there is a lot baked in the prices. The government bailed out the banks, converted to common, sold it, and now sues the banks. FRE/FNM lawsuit is absurd that they did not know. Now best thing, the government should take a face-saving litigation, and let them focus. Regulation also a problem, reporting to too many agencies: hurts small/medium business access to capital. Current stock prices factor a lot, C is still at 6x current bad earnings, and may be 4x core earnings after the noise which will take time. Interesting risk/reward but don't put half your assets.

Q: Why did you not wait to buy financials until now?

By the time the dust settles, the stock is up 50%; you have to do it when it is cloudy. BA bought GGP 11/16/2008, on the brink of bankruptcy, no securitization market, BA has to predict the future but the odds have to be good.

Q: Occupy Wall Street consequences?

Not sure what they are protesting but it should not be ignored. Governments can be overthrown without leaders now. Unemployment and disparity is a problem, especially for non-college educated. Cost of healthcare, housing, commodities increasing. It is critical to have leadership in DC.

The president is the CEO of the US as a business, we can have real problems. Obama began as anti-business, and it cost us. Legislation has made it more difficult, tax policy does not incentivize investment.

Whoever is the next president will have to make the country succeed as a business.

Q: Russia and China/rule of law?

(Goes on to talk about US legal system instead of the international investing question). Our legal system is still pretty good. Some expections to that. Recent proposals are hurting the markets. For example, Wachtell Lipton is in the busienss of protecting entrenched management to get M&A deals. WL invented the poison pill. WL is now trying to speed up activist disclosures and impose cooling off purchasing periods post-5% acquisitions which would effectively mean that BA will not be able to accumulate the target 10% stake. The passive and small retail investors rely on activists for helping but we have to buy a big enough stake.

No outstanding CEO worries who the shareholders are, only the weak ones do.

Q: Yahoo is putting up a fight with Loeb; is corporate America getting better at "defending"?

Usually the entrenched CEO is defending himself. HPQ is very unfortunate story: Hurd had an incident, got fired (is the Board held by the same standards), then hired CEO with no core business expetise. He said he's not acquiring anything then overpays. Then the stock tanks, the Board fires him, does no search, hires Whitman with no core expertise. Morale is low.

Boards are to blame, and the election process is Stalin-esque: there are no alternatives on the ballot, plurality voting, etc. BA ran the TGT slate: it cost BA $10 mm to put up alternatives for shareholders. Last year SEC put up a new rule to help this but it was defeated. The directors are typically selected by other directors or the CEO. TGT board had no retailers, no real estate, no credit card execs.

Q (from Ackman's father): Congress is a disgrace; we cannot get qualified people to run; what can we do to get qualified people to run for office?

Likes the Bloomberg model: business oriented, rich, and can do what is right. Country is ready for a candidate who says what he thinks, this is why people were excited about Chris Christie because he does not care what people think. If BA were Obama right now, he'd come up with a few pro-business policies:

(1) To change both the spirit and the confidence of business, get rid of all tax loopholes. Do a flat rate with no exemptions. Do something similar with personal tax code (incl. HF manager taxation). But now 49% of people pay ZERO taxes: so if you don't pay for the country, you don't care about it. Everyone should have some ownership in the country. Two-page form, couple of rates. BA's personal tax form is an absurdity, has not read it, has no idea if it is right.

Repatriation should be easy/low tax: no sense to have HPQ overpay because it will be taxed at home and subsidize UK employment. Obama has to respect the business community, the corporate aircraft industry is great, don't pick on Las Vegas, people there need jobs, too.

(2) Merge Fannie and Freddie, stop dumping foreclosed houses, turn them into REITs for single homes. In most markets you can make high single digits unlevered. This will dry up the supply in the market. Now FNM FRE are subsidizing apartment construction, their competition. Better off having local renters/maintenance, may be tweak the tax on home capital gains, too.

/end/

Sunday, September 25, 2011

Is High-Frequency Trading (HFT) Harming Progress?



In part, yes. My thoughts below.

There are many definitions of progress, but I am going to skip over the more politically convenient ones. I view progress as truly novel ways to do old things (i.e. cell phones, internet, alternative energy), getting rid of widespread diseases (i.e. polio), order of magnitude cost reductions (i.e. chips for calculations), and the like. One can include things we can't imagine yet (past examples include plastics, telephony, flight). Twist-off beer caps, heated car seats or seaweed yoga pants do not count as progress.

For thousands of years, individuals have been able to make various important discoveries and inventions by and large on their own, or with relatively modest capital investments. These days are gone, for the most part: no one truly expects to mix up a cure for AIDS in a basement or to sequence the human genome on the kitchen table over yesterday's NY Post. The next large steps in progress will- in all likelihood- require that the person is a part of a large organization such as a university or a corporation. The next large steps would also likely require deep specialization in a certain field: after all, most- if not all- of the low-hanging fruit is gone, and the new generation has to step on the shoulders of the giants of yesterday.

Progress is in some aspects also a product of luck: you need lots of people doing lots of things, and some will be successful. These people nowadays are usually hard science PhD-level individuals- and, while I am mindful of individual choice and preferences, it seems that society (and progress) would be advancing faster if the high level of specialization was put to work in the proper conditions.

The problem is that less and less of this is happening. Big Pharma has been shrinking for years. The old tech giants seem more interested in behaving like patent trolls rather than funding R&D (for example, what used to be a highly innovative company, Hewlett-Packard, has cut its R&D from 6% of sales to almost 2% of sales in about a decade). R&D is viewed as a cost and is high on the list for outsourcing, creating even less incentives for people to take risks by working on what might be career and scientific dead-ends for a disloyal employer. Who is picking up the talent?

One industry is high-frequency trading. The low-to-negative societal value of co-location, quote/cancellation tricks in nano-seconds, order sniffers and the like is established beyond doubt, in my view. But these companies are dangling $300k++ packages to physics and engineering PhD's straight out of school to come up with even more innovative ways to milk fractions of pennies from your orders. This effectively removes talent from what might be the "unimaginable" developments and puts them to addictively lucrative work that one might argue contributes to regress, not progress, by undermining the faith in and the integrity of the capital markets (the flash crash last May being a recent popular example). So, it does seem to me that HFT is impeding human progress.

Sunday, September 4, 2011

Andrew Redleaf Lecture at Yale Fall 2008

This is a lecture by Andrew Redleaf, co-founder of Deephaven and Whitebox Advisors. It was given in Fall 2008 to Prof. Robert Shiller's class at Yale (Shiller of the Case-Shiller index and Irrational Exuberance fame). Redleaf is not a natural public speaker ("graduated from Yale University in three years with a BA and MA in Mathematics and was recognized as the top mathematics student of his graduating year in 1978"), and there are no slides, so here are my notes. I have bolded what I found interesting.
Efficient market theory: two camps, yes/no.
A theory has to be predictive, and EMH is not: dual class stock, CEFs discount/premium to NAV, stubs, less volatile outperformance, certain outperformers, bubbles all refute EMH
Once the hardcore academic believers die, it will not even be an open question whether markets are efficient

But doing better than the markets is non-trivial (not impossible but hard)

Challenges
For individuals, should stay within area of information advantage but they will not be diversified; also individuals have more limited access to products and information; less assets

For institutions, there is the constraints: liquidity requirements by outside investors (i.e. 30-day notice); institutional biases stemming  from individual biases; problems with decision making in the areas that have a mix of randomness and skill; understandable areas are fully random are easy; poker is similar to markets because of the randomness/skills mix; often someone who plays will admit to not being that much into it, why would they do tell you? Pet theory: setting up in advance to lose and easier to deal with internally . Other individual biases are causality just because one thing happened after another, recency, anchoring

What they try to do:
3 principles
(1) The investment world divides b/n coupon-clippers (cash flow-oriented investors) vs. re-sellers (owning to re-sell to someone at a higher price). There are successful people in both areas, and they make their money off the less successful people in the group. They are about the coupons: focus on cash flow. VCs are re-sellers: find an idea, sex it up, and get a good valuation from the public.
(2) Risk is primarily about what is the worst thing that can happen. Typical Wall Str risk management is about VAR: how wide is the range of probable outcomes. The VAR approach is fundamentally wrong but it done because statisticians are good at it, and it is hard to imagine the worst that can happen.
(3) Most at odds with the academics/general perception: you don't get paid for taking risk, you get paid for eliminating it. In the history of the planet, very few people have been paid for taking risk. A tightrope walker in the circus is an example: it is paid very well but you have to look at lifetime income, it is not that great if they fall. They are paid well because they have been working on training not to fall (=eliminating risk). Pharma drug development is uncertain risky business. Are they paid for the risk? No, they are paid for applying intelligence and eliminating certain compounds and combinations in advance. Insurance companies: if they are doing their job right, they should be avoiding risk. A casino does not have the risk that they will lose money because the law of large numbers takes care of it (the risk is in traffic/visits).

So we look at what is the coupon, what is the worst outcome, and how can we eliminate it? Sometimes it is diversification (independent positions; or sometimes offsetting positions, such as long a high yield bond and short the common in proportion is a simplistic example of clipping a coupon and reducing risk.

The next part is a discussion of events happening around the time of the lecture (November 2008) and Q&A.

Q: Are markets less efficient if prices are going up vs down?
A: No systematic view, but in recent years, more examples of overpricing but not clear if this is due to money creation.

Q: ??
A: An individual's default position should be cash; should invest only in compelling cases. Equities get cheap periodically by most standards. Recommends buying stocks now (Nov 2008). With the housing bubble taking off a few years ago, apartment REITs were interesting (below replacement cost) with compelling comparative yields (5-9%). Municipal bonds now yield more than equivalent treasurys, that's compelling. Has not happened since the fears of them losing their tax exempt status.

Q:??
A: The long term argument for stocks in the US has strong survivor bias and has benefited from the US switching from agrarian to industrial. It is not clear at all whether the next 100 years will be like this.

Q:??
A: Swensen of Yale Endowment has strong preference for equity; Redleaf likes fixed income securities a bit more because they are more analyzable inherently. Stocks have to be really cheap because they don't pay out earnings and in the future, they might do something stupid. Buying stocks at mid-single digit multiple for a good reason, you will get paid twice: multiple expansion and earnings growth. The market is telling you though that the earning are going down if the P/E is mid-single digit. RIMM is risky: very high multiple, it might not matter if they double earnings, and they'll never pay any dividends.

Q:??
A: Involved investors are good (activists or direct owners). Executive comp is not the result of arms-length negotiations unlike hedge fund comp which is market-negotiated.

Final Q:??
A: Lengthy discussion of special situations where there is an event of default for delayed financials filing, and how they are active in it. They co-owned Sun Country Airlines with Petters Group (now a known massive ponzi scheme)

Thursday, September 1, 2011

Why ZIRP is Bad for the Middle Class


The Fed announced recently that they will continue with their zero interest rate policy (ZIRP) at least until 2013. May be they want to see a wholesale flight out of paper dollars like we saw last fall. Regardless of the market implications, I think that ZIRP is bad for the middle class in many ways, including some that are less quantifiable. As Charlie Munger says, not everything that counts can be counted.

A fundamental tenet of "middle class-hood" is future orientation (vs. present orientation). People with present orientation like to do things without regard to future consequences (driving drunk, having unprotected sex, skipping class, buy now/pay later, etc.) A core middle class value is future orientation: decision-making that takes into account future consequences. This has meant staying in school, not fathering children left and right, and, the focus here, saving: saving for a downpayment on a house, saving for a car, saving for college, saving for retirement. ZIRP discourages saving by stealing the interest earned on savings and encouraging present consumption. This leads to both overconsumption (relative to incomes) and to lower retirement savings (and, in part, to defined benefit plan underfunding).

ZIRP is also bad for middle class jobs. In many businesses there is an optimal choice between capital and labor (sometimes not direct, make something manually internally vs. buy machine-made from outside). A factory owner would love to fire all workers if robots were cheap enough: I know I would prefer to deal with machines than people who stay home when their kid is sick or walk in the office with an offer letter, asking for a raise. ZIRP (and Obama's accelerated depreciation stimulus) heavily favor machines vs. labor. I am all for progress/mechanization but I think that the relationship has gotten a bit distorted.

ZIRP leads to malinvestments: we had a housing bubble a few years ago. We not only ended up with too much (and highly energy-inefficient) housing but also we ended up with a large % of the workforce in the bubble-fueled real estate economy, from the slick jumbo mortgage broker to the gruff plaster guy. Some of these were formerly middle class jobs, especially in smaller communities, and now the sheer decline in business volume has hurt them. The decline in housing prices post-bubble has also cost the middle class dearly in equity.

ZIRP speeds up job exports. Large international companies, like MCD or WMT, can borrow at very low rates here in the US and invest these money at much higher returns in emerging markets. These create not only MCD or WMT front-line jobs: with every expansion come the accountants, the marketing personnel, the buyers, the logistics, the IT, the management, and, perhaps most importantly, the R&D. GE just moved their X-ray R&D work in China. This probably would not have happened so quickly (if at all) if they could not borrow so cheaply to build or acquire abroad.

ZIRP is an implicit policy of dollar devaluation. People argue about the mechanics but the message is that the dollar will be weaker. This means inflation as the US is an oil importer. The middle class is already already struggling the points above (unemployment, reduced wealth, no interest on savings), this hurts even more, be it at the pump, the heating oil delivery, the airline fuel surcharge or the consumer-level price increases due to higher energy costs. The winners here (exporters such farmers and miners) are a small percentage of the workforce. The middle class is not a winner from $120 oil.

ZIRP discourages real capital formation. This is a off-shoot of the savings and employment point: capital formation for small businesses comes from savings- we are talking about rentals, restaurants, car washes, chips delivery routes, hair salons, food trucks, small shops, etc. Most everyday people are not into social media start-ups. A potential entrepreneur (and his/her family) actually loses money after taxes and inflation while trying to save up for the business. This hurts both entrepreneurship and, consequentially, hiring (oft cited stat is that most jobs come from small businesses). There is an argument that loans are cheaper, too, but the contra here is that higher equity businesses are more robust.

ZIRP needs to end. To give you an idea of where the rates "should" be, for a 1-year CD to earn a meager 1% in real after-tax return, the 1-year CD rate should be at about 5.75% (simplified calculation: 1% real return + 3.6% LTM inflation =4.6% after-tax, at 20% total tax rate-Fed/State/Local- this implies 5.75% pre-tax). The average one-year CD is at 0.84% today per  Yahoo Finance. Who benefits from this? Three administrations have worked to double the size of the government in 10 years via cheap deficit spending, while the banks are getting nicely recapitalized.

A Better Way to Hire?



The labor market has been a challenge for years. A part of the problem is that the market one of the least efficient markets out there. Many transaction opportunities are not advertised, limiting the flow to a small network. And even the more widely advertised positions often have a gatekeeper: HR or recruiter whose short attention span (and, often, lack of ability to discern quality) means that only the "best-branded" resumes get a priority. Like in the supermarket, going for the brand makes the buyer feel more secure and reduces time spent on making decisions. This is a part of the larger credentialism problem that we have as a society.

So is there a better, more meritocratic way to hire? There is a good recent example of that. A NYC-based hedge fund manager, Aram Fuchs, was looking for a junior and a senior analysts to work for him. Instead of playing the "resume game," as he calls it, he managed an open forum, the Capitalist Collective, where anyone, regardless of background, could submit stock ideas, discuss others' ideas or engage in general discussions. Mr. Fuchs recently announced four "finalists", and the process will culminate in a day-long investing conference on September 9th, 2011, featuring speakers, stock speed-dating, and, of course, the grand finale. Along the way, Mr. Fuchs hosted a couple of socials and had calls with some of the participants.

While obviously longer and more involved than the traditional route, the process draws from a much larger audience and the hiring person can observe and interact with the applicants over weeks, thereby developing substantially more valid views on suitability and other important factors. The forum format also allows a lot more contact points with people who are currently working elsewhere. There are unlimited opportunities to show and defend ideas rather than the regular 1-2 stock pitch approach. Finally, the participants know that the opportunities advertised are "real", unlike the phony "openings" that collect stock ideas without any intention to interview or hire.

Let's hope that this approach becomes more widespread with time.

Saturday, August 6, 2011

Teacher Cheating, Banking Self-regulation, LIBOR, and Ethiopia's Population: How Incentives Matter



There is widespread mandated standardized student testing in the US that is supposed to measure the learning outcomes of cohorts of children. These are high stakes tests: teachers and school administrators have a lot to lose (depending on the locality) if the tests show no progress, or even regress. However, there is one flaw with the system: the teachers administer the tests to their own pupils (!). So, much to the surprise of people with low real world IQ, turns out that there is widespread cheating by teachers across states, cities and districts (some teachers tell students what some of the answers are, others manually correct wrong answers prior to submitting the tests for official grading).

The teacher situation is similar to banking (or any other industry) self-"regulation". I won't belabor the point as there is plenty that has been written on dejure and defacto (regulatory capture) self-reg. Though one of the more memorable moments from the credit crisis was the probe into LIBOR manipulation (LIBOR is probably the widest-use reference rate globally): it is still on-going. LIBOR is a self-reported rate by the banking industry, and, needless to say, there is a strong suspicion that individual banks might have "mis-reported" their numbers during the peak of the crisis to make it lower than it actually was.

There is a horrible famine (pics link) going on right now in East Africa (which most Americans associate with the movie Blackhawk Down). Hundreds of thousands might die. Back in the 1980's there was a similar situation there- in Ethiopia: the world came together and brought food in. But there was a message about incentives that got lost: Ethiopia's population in 1983 was 33 million, now it is...75 million (Update: 91 mm per 2011 CIA esitmate). If the US had grown at that rate since 1983, we'd be north of 500 600 million people now.

People do what you incentivize them to do: if you pay them to report improved scores, they will report improved scores. If you pay them to report low borrowing costs, they will report low borrowing costs. If you pay them to lack foresight, they'll surely not have any.

Thursday, August 4, 2011

Case-Shiller in Gold

So what happens when you put together one of the most beloved assets and one of the most maligned? I pulled the Case-Shiller Q1 US Composite (since 1987, first year available), and compared it to the average gold price in USD/oz from the World Gold Council (and eyeballed $1,500 for YTD). The chart shows Case-Shiller divided by 1 oz of gold in USD.

On a relative basis, housing in gold was most expensive in 2000. By 2005-06, the peak of the housing boom, gold prices have already appreciate substantially. The mean, median and harmonic mean for the period are 24.6%, 20.8%, and 20.9% respectively.

Based on the most recent Q1 C-S read, and $1,500 average gold for 2011, we are at 8%, the lowest value for the last 25 or so years.

More importantly, what are the implications? I wish I knew for sure but it appears to me that housing, in certain areas, might have gotten "de-risked" enough (read, cheap) where it is a better relative value vs. gold, which has been both unstoppable and a very one-sided trade for a long time.

Wednesday, July 27, 2011

Book Review: 40 Actionable Trade Setups From Real Market Pros- The StockTwits Edge



This is an unusual book: in a true Twitter spirit, it is crowdsourced from various Twitter/StockTwits members. This "portfolio" approach is both a strength and a weakness: while there is a good variety of approaches described, some of the authors are not natural writers. On the positive side, the chapters are relatively short and any one that is a drag can be skipped over.

After reading the intro, I thought that the book would be a bit more balanced between various investing methods: it is not. Various momentum trading strategies (broadly speaking) are over-represented (probably more than half of the book) while others (options trading, value) get some space but it is pretty far from even. The final part of the book, The Art of Trading, is a catch-all for a few non-specific essays, some of which I found very interesting. Also of note, some chapters are parsimonious with their insights but very generous with pushing certain subscription products; other authors spent a bit too much time discussing their personal backgrounds. Finally, I was very surprised to see that Joe Fahmy was not in the book.

The sections within the book are: trend following, value, day trading, swing trading (longest), options, forex (shortest) and "the art of". I think an "average" investors would benefit from how various market participants think and act, while an "average" trader would find a good number (less than the promised 40) of set-ups for different markets and timeframes.

My favorite chapters- without giving away the store- were:
Value: Michael Bigger looking at CROX/fallen angels; Eddy Elfenbein looking at Aflac/quality
Swing: "ChessNWine" on trading break-outs from bases; Ivanhoff/Stocktwits50 has a thoughtful chapter on momentum
Options: Joe Kunkle has a good multi-factor approach (market sentiment, technicals, fundamentals) combined with spotting unusual options activity
The Art Of: well-known bloggers Greg McDonald and Josh Brown have good pieces, while Charles Kirk has three pages on insights from years of mentoring traders (might well be extended to "long term" investors, many similar issues pop up).

Net-net, there is something for everyone in this book but the slant is towards momentum traders. This is a natural offshoot of Twitter (and the smaller group, StockTwits, which sourced the book) being very trading oriented. May be the next book can be targeted towards "long form" investors.

Full disclosure: I received a free copy of the book from Ivanhoff, one of the editors and authors

Saturday, July 9, 2011

Coffee Stocks: Don't Burn Your Fingers



Anything related to coffee has been hot recently. There are some fundamental reasons for this: bean prices have been dropping, people are drinking more specialty coffee, the k-cup business is becoming big. However, it seems to me that there is a lot of speculative moves: be careful.
GMCR has been one of the best performers of the decade. Their meteoric rise has fueled the search for the next great coffee stock.

Several coffee-centric restaurant stocks have done well over the last year: SBUX, THI and CBOU. Even "fallen angel" KKD is rising nicely.




Things start to get a bit strange when we hit the bean roaster side of the business. Here's PEET, the company that locked horns with GMCR over the legendary DDRX acquisition (DDRX was a fortunate k-cup license holder and was acquired at $35/share after trading in the sub $1-level less than a year prior to that).

And now we are deep in bizarro world. JVA sells coffee to GMCR (as they have been for a while). Somehow this became explosive news recently.

But they are not alone: heavily promoted JAMN and under-the-radar JCOF have also had spectacular runs recently:


Which leads to today, when a small water distributor with a coffee operation just blew up:

Don't burn your fingers.

Sunday, July 3, 2011

Too Long for Twitter, Too Short for Separate Posts, 2nd Edition



"The Recovery", regardless of various statistics, has been a disappointment. One part of the issue is the anemic economic and employment growth (GDP at 2%ish). The big problem that I see is that we no longer have a normal market economy across many sectors, therefore we should not be expecting recovery patterns that are consistent with market economies. As we move closer to North Korea and Cuba via central planners/bailout managers in DC, we are going to be seeing slower and slower growth across the cycle. Until the powergrab reverses (both sides are guilty, as are their fossilized corporate and union patrons), we will have to learn that we are in a recovery because the Treasury Secretary said so in an op-ed called "Welcome to the Recovery". Turbotax Tim misses the subtlety of the principle "if you have to say it..."

Soon we'll reach the 4th anniversary of the first shot in the credit crisis: on August 9th, 2007, BNP Paribas halted withdrawals from three subprime funds. This begs question: was the crisis wasted? Absolutely: the too-big-to-fail banks have gotten bigger and none of the top-level perpetrators are in jail. I am not a lawyer but sure seems plausible to me that the DOJ can and should use RICO to go after the control fraud leaders. There is ample evidence, in my view, of organizations engaged in various types of frauds going back a fair number of years. If this means the closure of the TBTFs then so be it: ring-fence the essential operations and manage the rest. Instead we get a few showtrials of insider traders: not that these are not needed but the failure of Obama's DOJ and its leader, AG Eric Holder, has been stunning.

"The way to crush the bourgeoisie is on the grindstone of taxation and inflation"- Lenin. The Comrade had been targeting the capital owner class but these might also be two possible reasons for the decline in the middle class in the US. There are many others, of course, and the debate is still very much ongoing. However, the middle class has proportionately borne the brunt of taxation (holistic view of taxation here: % of income going to income, SS, medical, sales, property, tolls, excise taxes) and inflation (think of inflation in non-discretionary spending: energy, food, medical care and education). What do we have in DC now? Continuation of taxation (via deficit spending=future taxation) and inflation (explicit inflationary policies). So our reps should really look in the mirror while searching for the culprits.

"Taxing the rich" is a grossly misleading marketing soundbite. Obama makes no difference between stock and flow. Steve Jobs is "rich": billions (stock) in Apple equity (that pays no dividend) and $1 in salary (flow). XYZ MD just finished her residency, started working at $150k (flow) and has a negative net worth of $250k (stock) due to med school loans. Who's rich here? Who's paying higher taxes? Does it confirm that taxing income = taxing the "rich"?

The majority of babies in the US are now non-white. While this is bad news for some people, I think that it will add another angle to the debate regarding the inter-generational wealth confiscation going on from the non-voting minors to the voting seniors. This, of course, presumes that the system has not blown up by then.

Eggs. Yes, eggs. Eggs have been unfairly maligned for a long time. Here are a couple of things. One, the USDA recently reduced the cholesterol estimates by 14% (215 mg to 185 mg per egg), and increased the Vitamin D estimates by 64%. Second, and more interesting, there is a phospholipid in the yolks that prevents cholesterol absorption: some scientists were actually granted a patent on that, so I'd think the evidence is strong.

Saturday, July 2, 2011

Understanding Sovereign Credit Risk

One of the phenomena in sovereign credit is that the spread that certain countries and regions have to pay over the benchmark (such as US Treasurys or German Bunds) persists for many, many years. Surely some of it is factors such as intertia and liquidity. Some of it is simply credit risk: who is a more credit-worhty borrower? Since I like looking for new perspectives, here's a couple of brass music videos, one is from the Balkans (Greece, fmr Yugoslavia, Albania, Bulgaria, etc.), one is from Germany. Whom would you rather lend to? (based on some feedback, I should point out that these are extreme, caricature examples not to be taken literally)

Sunday, June 19, 2011

Howard Marks Is Selling: Should You Be Buying?



Surely it was all coincidental: Howard Marks, probably a top three favorite manager of mine, recently released a book ("The Most Important Thing: Uncommon Sense for the Thoughtful Investor"). A chapter from the book was the front page story in last month's Institutional Investor magazine. In March there was a lengthy Fortune/CNNMoney feature on him. Then on Friday 6/17/11, Bloomberg Markets ran a long profile with details all the way to his diet and parental occupation, casually mentioning that Oaktree is... going public. The Bberg article was time-stamped at 17:43, while the S-1 filing was stamped at 16:25. A marketing professional might call this "generating buzz around the brand": turns out, the sudden burst of publicity had a reason.

Mr. Marks is a true legend: according to the S-1, his distressed debt funds have averaged a gross IRR of almost 24% since 1986 with Sharpes above the benchmarks. This is nothing short of phenomenal: remember that we are talking about credit here! Very few equity equity managers can claim a record like his, let alone managers in the fixed income space. Interestingly, Oaktree was an early investor in Jeffery Gundlach's DoubleLine, a new but already stellar fixed income fund family, despite Mr. Gundlach's "difficult" separation from TCW.

Unlike many other investors, Mr. Marks has been very generous with his insights. His "Memos From Our Chairman" are available on Oaktree's site, and I strongly recommend that people read them all. There was also a 700-page pdf collection floating around with many of the letters combined: between Mr.Marks and his colleagues, we are talking about hundreds of years of investing experience all distilled for you. He really drives a few points: the primary job is to control risk. An investment cannot be viewed as more risky or less risky without discussing the price: at the right low price, nothing is too risky. Mr. Marks is known for returning capital to investors when the opportunities are not there, and for putting money to work when the window is open ($6 bn late 2008, just like Warren Buffett, except that you never read about Howard Marks riding on a white horse in the GS boardroom and asking for usurious preferred stock). There are a few other insights in the letters that you should discover on your own, including a few from an "earlier" version of Michael Milken.

So here is a guy who was buying during the biggest liquidation in a generation, and now he is selling a piece of his management business (not in the funds themselves): should you be buying? In a word, no. Here's why:

(1) Just common sense: don't be seduced by explanations such as "liquidity needs", "permanent capital", "estate planning" and the like. Another professional seller partnership, called Goldman Sachs, went public in 1999: you all know what happened to the market soon after.

(2) Are we at the end of the bull market for credit? The economics of the fund management business are driven by the fund results and the AUM. The two are inter-connected: good results beget higher AUMs. We have had a 30-year bull market in credit, and the phenomenal results we have seen might not be repeated by anyone at any time when the credit cycle reverses upwards. If you look at the 10-year yield chart since 1980, you are seeing a series of lower highs and lower lows. This means that a high yield loan might be at 10% initially, 25% in distress (when Oaktree buys it), and then at 8% when things stabilize ("lower low"). The IRRs would not be there if the credit cycle were going the other way, i.e. 10% new/25% distress/15% stabilized.

(3) Unfavorable structuring for the investors: the units do not have voting control, lose some of the tax benefits, generate peculiar income tax liabilites, and a few other things that make them differ substanitally from a "normal" stock

(4) Generally poor performance by investment manager LP units in the market. Oaktree is not the first partnership to go public. AllianceBernstein has been public for a number of years. In more recent history, Blackstone, Ochs-Ziff and Fortress all marked the top with IPOs in 2007, and proceeded to tank 85-95% off the IPO price (!) in 2008, and they are still at 50-85% off. AB, too, was $92+ in 2007, and is at $19 now. In recent months, we've had the IPOs of PE titans KKR and Apollo, and a recent bake-off by The Carlyle Group: again, remember that these are professional sellers. This, and the record of unit performance post IPOs, make me unenthusiastic about the offering. That said, to channel my inner Howard Marks, if the price is low enough...

Friday, June 17, 2011

M&A Activity This Week Indicative of Peak Cycle



Back at the end of April of this year I wrote an article asking where are we in the current economic cycle. I looked at several "real time" indicators such as profitability of cyclical companies and the IPO pipeline, and I thought that there is evidence suggesting that we are at the "peak". The stock market has certainly been unhealthy since then with several recent IPOs burning their investors, and the collapse in commodity and China stocks.

We also had a lull in merger announcements recently (one of the other factors I had looked at), until this week. While by no means a predictive factor, I like keeping an eye on what is happening in the space as it captures several factors at once: management's views of the future, management's view of the value of cash vs. own stock, equity and debt financing conditions, industry consolidation drives, even mood.

So here are a few noteworthy deals, events related to deals or rumors that happened just this past week. While the S&P500 might have been down 6-7 weeks in a row, it does not seem that the M&A cycle has slowed.

-CapitalOne possibly acquiring ING Direct for $9 bn: this is one of the largest deals this year and will make CapitalOne big enough to be TBTF (7th largest by assets) and enjoy the unfair funding advantage that comes with it
-Energy Transfer buying Southern Union for $4bn+/~$8 bn EV: this is a gas pipeline consolidation, everyone knows the US natural gas story
-Allied World/Transatlatic $3bn+ reinsurance deal: I don't have the details/views on this one
-Avis car rental buys back into Europe for $1 bn: high-beta company expansions are peak cycle material
-Graham Packaging going with Reynolds/Rank instead of Silgan: this is after another unsolicited deal on the paper side, with International Paper going after Temple Inland
-BJ's Wholesale Club being acquired by Leonard Green Partners and CVC. BJs had been on the block for a while, and LGP is a PE firm well known for its expertise in retail.
-Wendy's selling Arby's for a paltry sum upfront: while it does not look good on WEN, the fact that there was a buyer (Roark, big investor in restaurants) is a positive sign
-Unusually high profile hostile deal with the Toronto Stock Exchange means that people are braver
-Boyd Gaming making a small Gulf resort purchase: this is a regional destination resort, would be interesting to see the traffic numbers trends there vs. slow/no-recovery markets like LV or AC
-HCA is buying out JV partner in 7 Denver hospitals for $1.45bn: while most financial media attention has been focused on the big pharma decline, it is interesting to see what hospital operators are doing in light of the greatest industry uncertainty in many years
-Dish Network offers $1.4 bn for TerreStar out of Chapter 11
-Air Products buys a semiconductor industry suppliers: this is peak cycle material

Rumors:
-The two Russian fertilizer behemoths Uralkali and Belaruskali are denying talks: when there is smoke and industry consolidation, there's fire
-Blackstone in exclusive talks with Jack Wolfskin: interest in discretionary brands is usually a topping signal (also of note, the Samsonite and Prada IPOs in Hong Kong were not blockbusters)
-GM might be selling Opel again, this time from a position of relative strength
-Glencore denies interest in a large Kazakhstan commodity company

What is the conclusion? We are seeing more of the typical signs of peak-cycle merger activity. There are deals across many sectors. Some of the deals are very substantially sized. Some of the deals are hostile. What we are not seeing is high equity vs. cash usage: part of this might be that there is a lot of cash sitting around earning nothing. While not indicative of where the market will be next week or month, we are seeing that the corporate titans are still optimistic and willing to take on high-risk moves.

Monday, June 6, 2011

An Accidental Victory Against Credentialism: When A Nobel Prize Isn't Enough



President Obama's Federal Reserve Board nominee, Mr. Peter Diamond, just joined tens of thousands of recent college graduates who discovered that having their degrees and awards is insufficient in getting hired. Unlike Mr. Diamond, however, the generation saddled by student loans and tasked by Obama himself with "Winning The Future" do not have the option of going back to their "congenial professional existence as a professor at MIT."

Mr. Diamond penned a widely-read op-ed in the New York Times on June 5th, 2011 ("When a Nobel Prize Isn't Enough"), in which he laments his inability to get hired despite his expertise in the labor market. It is fairly ironic that a labor market "expert" cannot get himself hired but this speaks to the wider disconnect between high-rent academics (as well portrayed in the Oscar documentary "Inside Job") and the real world.

Here's the news, Mr. Diamond: what you offered to the people who have to approve your nomination does not meet the market needs. You may view this as unfair, as an affront to your lifetime achievements, as idiotic, as politically-motivated, and so on, and, no doubt, these are all true statements, but may be you should just accept that the trebuchet of reality has demolished your self-congratulatory ivory tower. The process has been political circus of the lowest order but don't hate the player (Senator Shelby), hate the game. And stop with the sense of entitlement: clearly your Nobel is not enough for the market. Markets are forward-looking and the market has clearly communicated that it would like to see people who do not rubberstamp every decision, as has been the case all along.

I have been on both sides of the "credentialism" wars and I am an active proponent in demolishing academic and professional "branding" through initiatives such as Khan Academy and the Thiel Fellowships. An Eight Schools Association boarding school, followed by a legacy admission to an Ivy League and a fencing championship, followed Goldman prop desk easily leads to hundreds of millions for a "start-up" fund: but what percentage of this success is linked to parental zipcode and the access/socialization associated with it, rather than merit?

Thursday, June 2, 2011

Too Long for Twitter, Too Short for Separate Posts

 I am crossposting here and on Davian, the technology and marketing partner for my inflation-oriented autotraded product.

Spain, just like China, has its own set of empty towns. Whenever you see these satellite pictures, you can be sure that there is a bank somewhere holding the bag (or keys, if you'd prefer). Long periods of mispriced credit look great on the income statements but, as they say, the balance sheet is the future.
*****
Currency devaluation chart from the Roman Empire: tracking the decrease in silver content in the coins over the years. Persistent currency devaluations seem to cause a lot more problems than they solve. Since it is difficult to imagine life without money, I wonder if there are two future scenarios possible: a "stable" global currency (many countries do not have own currencies now as it is) and/or a group of competing or complementary private currencies without governmental control. Private currencies would need major network effects to be successful, so, dare I say it, hello facebook dollar!
*****
Speaking of countries that need a new currency, look at Belarus. After its currency devaluation, the government decided to freeze food prices until July 1st of this year. These attempts never really work and lead to shortages. Other Eastern European countries learned the hard way and have been operating with currency boards for many years quite successfully as a stable currency is major factor in predictability, and, hence, economic development. In general, countries that are not that great at self-governance are not that great in managing their currencies, either, and the populace knows this so most contracts are denominated in the "USD equivalent of..."
*****
Energy is a precious resource that should be used judiciously. I wonder if some emerging markets are making a major mistake by encouraging the rapid automobilization of their countries. The single-driver daily commute is very energy intensive, often stressful, and a noticeable waste of time for highly specialized labor. No easy solutions exist for the US but some markets might be making the mistake of copying the US model.
*****
The ore barons in Australia and Canadian homeowners might not have a full idea what is coming to them if/when there is a slow-down (or worse) in China.
*****
Three quotes I posted on Twitter recently that got "mileage":
Coco Chanel: "Some people think luxury is the opposite of poverty. It is not. It is the opposite of vulgarity."
Leon Trotsky: "You may not be interested in war, but war is interested in you"
George Orwell: "If liberty means anything at all, it means the right to tell people what they do not want to hear."
*****
On the topic of liberties, the gradual erosion of liberty is in full bloom. Recent court decisions have rolled back rights going back to the Magna Carta (that's 1215 AD), including the right to due process. We're not at the EU stage of targeting free speech as thoughtcrime but we are getting there (“one sees the sun slowly set, yet one is surprised when it suddenly becomes dark.”)

Thursday, May 26, 2011

Is There A Lemming Trade? The Ira Sohn Conference Effect

 I am crossposting here and on Davian, the technology and marketing partner for my inflation-focused product for retail investors.

The Ira Sohn charitable conference took place in NYC today, and a large number of well-known and successful fund managers presented their best idea/s in rapid succession (each has ~15 minutes). The effect on the stocks in questions only confirms that stocks can be "branded" by being associated with the right manager on the right platform. It was fascinating to see the jumps in prices in real time during the afternoon. Did people do it just for a trade? Is this a buy first, think next situation? I don't know and I stayed out: no one is infallible, including these very smart guys who were actively talking their book.

Here are a few charts:









Tuesday, May 10, 2011

Real Median Incomes vs. Supermarket Stocks?

I am crossposting here and on Davian, the technology and marketing partner for my inflation-focused product for retail investors.

I had a very interesting conversation yesterday with a top-ranked analyst at a financial institution. Among the topics we discussed was the state of the average/middle-class consumer. My views, expressed here and on twitter, have been that healthcare costs are a significant and growing tax on the middle class (both directly and indirectly, by making US labor more expensive), and that US median incomes in real terms will trend towards global median incomes due to globalization. Structurally weak labor market keeps the growth nominal down, while inflation reduces the real growth.

The analyst's insight was regarding supermarkets. Supermarkets have been a challenging area to invest in over the last decade (some high-profile bankruptcies there are Winn-Dixie and the A&P parent). He overlaid a real median income chart over the stock charts of some of the big names, and the charts look very similar. I am including WMT here as the argument has been that the supercenters are responsible in part.
I find this very interesting because I have the sense that the migration to new formats (i.e. COST) cannot be wholly responsible for the stagnation in the stocks: with flat real incomes, price has become a bigger factor, and the traditional supermarket channel might not be the most competitive.

Charts via Safeheaven and Big Charts.




Wednesday, April 27, 2011

Are We At The Peak?

 I am crossposting here and on Davian, the technology and marketing partners for my inflation-focused product for retail investors.

Forecasting is difficult, especially when it is about the future, someone quipped. So instead of pretending that I can look through the windshield, I am looking through the side windows at the scenery passing by. From what I am seeing, there are signs that we are either at peak or post-peak economic expansion.

Here are a few signs:
- Big earnings by a lot of the cyclical names: Ford, Whirlpool, Cummins, Electrolux, VW, Volvo, etc.
- Inflation acceleration (surely there are many reasons here but at least some of it is bonafide demand growth)
- Big resource mergers: there was a bidding war over an iron ore producer, lots of consolidation in fertilizers, large gold miner buying into copper
- Other marquee volume deals happening: JNJ doing a $20bn buy, T + T-Mobile, etc.
- PE is back in the game buying riskier companies: retail, chip makers, software.
- We have not seen the balance sheet impact of Japan and euro-peripherals restructuring
- Actual and planned IPOs of weak companies (as in "never profitable/does not expect to be in the near future")
- Very speculative mood in certain equity sectors (i.e. China and India internet companies)
- Very speculative mood in private markets for "social media" companies
- Emerging markets trying to confiscate (vs. attract) foreign capital (Bolivia, Venezuela's new windfall tax)
- Pronounced recent strength in defensive sectors (XLP, XLV)
- US residential rents have been strong for a year
- Modern Chinese art hitting record prices, Ferrari introducing its first 4-seat model, law school applications down
- No discoveries of massive NEW frauds (the prior set of whales beached a while back, some are in jail already, others- Mozilo, Fuld, Raines, etc.- are roaming around free)
- Pretty much everyone who could have written a book about the crisis has already done so

What we are not seeing/non-confirmation of my opinion:
- Actual improvements in total employment (not rate but number of people working)
- Rates marching higher in developed markets (not yet at least)
- Single-family housing not recovering (though there is a case here that mean reversion + weak labor are the primary forces)
- Retail stocks (XRT) closed at all-time highs yesterday: not indicative of a peak

What are you guys seeing real-time? Missing anything major pro/con from the list?

Thursday, April 14, 2011

Can Corporates Trade Through Sovereigns?

I am cross-posting here and on Davian, the technology and marketing partner for my autotraded inflation product for retail investors.

There has been some discussion regarding the spread of corporate bonds over treasurys, and, more widely, can corporates trade “through” sovereigns, that is, can corporate bonds yield less than the government bonds of their domicile?

For starters, it is already happening in the periphery of the eurozone.

Greece’s 5-year is at over 15% as I write this, while Coca-Cola Hellenic, a Greece-based bottler, is paying 4.xx% for their 5-years. This is a full 1,100 bps under the Greek sovereign. (Of course, CCH is international and backed by KO's credit implicitly)

Can it happen here? At this stage, no. The US is not Greece as the US can both borrow and print in its own currency. Greece has not had the drachma for years and its borrowing is in euros. There is no reason for the US to default on obligations in its own currency: most holders are domestic, and defaulting would mean the near-certain end of pensions plans, numerous financial institutions and insurance companies who are legally required to hold a lot of US credit instruments. The other option is to pay back in nominal, but not in real terms: this is the path we are on.

However, what would happen if the US cannot issue dollar-based debt? This is a possibility, few countries in the world have the luxury of borrowing in their own currency, and we have certainly abused this privilege (along with the privilege of having the main reserve currency).

If the US has to borrow in SDRs or in currency X, I do think that high quality corporates in the same currency will be trading substantially lower than the US debt. Why?

Let’s review the 5 C’s of credit: character, capacity, capital, conditions, collateral. I will focus on three: character, capital and collateral. Compare the US government to a large corporation on these three counts: the corporation has its books done properly with adequate disclosures of future obligations. The US is not even putting GSE debt on its balance sheet, let alone unfunded promises. A large corporation is run, generally, by rational decision makers. Can we say the same about Congress? A large corporation has global, relatively predictable earnings stream from which to pay back debt. The US government is wholly reliant on its taxation power, something that is not nearly as predictable. Of course, the government can pledge or sell federally-owned land and other assets but I hope we won’t get there. A large corporation has well-established audit/security procedures. The US government is rife with waste.

It is clear that a well-run global corporation should be a lower credit risk than any one sovereign risk provided that the borrowing is done in a currency that neither party controls. There is no reason why JNJ or WMT or MCD have to pay a spread over Geithner & Co. It will be a major paradigm shift when it happens in the US.

Friday, March 25, 2011

2-for-1 Book Reviews: "Lay the Favorite" and "Gaming the Game"

 I am cross-posting here and on Davian, the technology and marketing partner for my inflation-focused autotraded product

Of the two, "Lay the Favorite" is by far superior in the literary sense, while "Gaming the Game" is poorly written but has a lot of details on actual booking and betting operations.

"Lay the Favorite" by Beth Raymer is an autobiographical book, chronicling her entry and work in the world of high-stakes sports betting.

Raymer stumbles into working for "Dinky," a professional bettor in Vegas while working as a waitress. Dink is a Jewish guy from Queens who ended up moving to Vegas to work professionally. He teaches Raymer the ins and out of the job: lines, runners, various contacts around the country. Dink bets his own money exclusively and does not do bookmaking. He comes across as a very smart and genuinely nice guy. They do go down to the Caribbean during the offshore gambling boom: Raymer describes a non-stop Spring Break scene with money flowing in at incredible rates, though few of the bookies who set up shop there were able to build a serious, professional enterprise.

Raymer moves to NYC for boxing, and ends up working for another major gambling figure, and a friend of Dink's, on Long Island. "Bernard Rose"'s character is also intricately chiseled: a sharp, gregarious glutton who, like Dink and Battista (from below) works long hours across many markets. She does a stint in Curacao with Bernard, too, while the boom still lasts. Raymer eventually leaves this world for a new life and a new boyfriend.

Overall, the book is very enjoyable and can even be classified as "chick lit" while a guy might read it for the underworld detail. The writing is crisp, the stories flow and connect well, while the characters are unforgettable. 

"Gaming the Game" by Sean Griffin is the story of the alleged mastermind behind the NBA referee betting scandal, James "Sheep" Battista.

The books seems to have been edited only for spelling, and not for style. The result, outside of the direct interview quotes that take up about half the volume, is a tedious, tortured narrative, often clearly taking Battista's street-talk and putting it in the storyline. There is also quite a bit of minutiae on local bookmaker "legends" and a drawn-out appendix that make the book sound like a rushed term paper stretching for the required length. This is ironic considering that the author is a professor (criminal justice) at Penn State- Abington. There are other fillers, such as pictures of the airport Marriott where the characters met or the front doors (really) of the high school the characters attended. The final style quibble is the gratuitous use of "consequential" (28 times), "legendary" (10 times) and "seminal" (5 times).

That said, the book is a must-read for fans of true crime and sport bettors. Through a series of interviews, Griffin chronicles Battista's rise to the top echelon of professional bettors and his subsequent downfall, driven by opioid addiction and his involvement with the NBA ref scandal. The book also works to correct the wrongful impressions that the media had created about Sheep: he does not seem to have been involved with organized crime, and he had not been a threatening figure in the "industry" that forced the ref to participate in the scheme.

Battista comes from a hard-working lower middle class family from a Philadelphia suburb. He gets by in school and eventually enrolls in a university, but drops out shortly thereafter. He had been around drug dealers, and starts using his shoe salesman job for this purpose. He then moves on to an electronics store, where he organizes an embezzlement scheme but gets caught. Eventually he winds up working in the bar/restaurant scene, and starts picking up bookmaking skills. He learns the trade with a couple of local bosses before forming up his own group, The Animals (based on the guys' nicknames). They work very hard and do well, hide from the local mafia, move to Vegas, spend some time in the Caribbean running a sportsbook, and then break-up. Battista eventually moves up and becomes a helper to four or five of the really large professional bettors, helping them place bets (one of these is "The Computer," who was, my guess, profiled on 60 Minutes recently).

To use the finance terminology, the sharps are portfolio managers: they have analysts (handicappers) working for them to find value: a discrepancy between the actual line and what the line should be. Then the PMs make the capital allocation, and traders, people like Battista, would have to place the order in the market without moving it (or moving it in the other direction prior to placing the real money).

Tangentially, Battista gets involved with Donaghy, an NBA ref, through a small-time drug dealer with a Napoleonic complex who is a mutual acquaintance/friend from high school. It appears that Donaghy had been betting, quite successfully, on games he reffed for years. He ends up being paid for his "picks" by Battista, who himself places sizable bets on the inside information. Donaghy is portrayed in the book as a greedy, aggressive, misanthropic and socially maladjusted man. 

Of course, the word gets out, and the FBI is eventually on the case. Battista is the only one who does not cooperate, and all three end up with similar sentences. Battista is now free and trying to rebuild his life outside of the underworld, reconnecting with his five children and repaying the restitution he was ordered to pay.

The book is interesting in several other ways. It offers an inside glimpse into the world of high-stakes betting and the hoops these guys go through in order to place bets (hopefully the system will change, and the US will get Betfair, a true peer-to-peer exchange, where anyone can bet or lay). The other significant new piece for me is the entire shadow banking system that exists to support the bookmakers who currently operate on the ground in the US: this is a network of guarantors, deposit-keepers and cash runners, spread around the country, settling accounts once per week, collecting or forgiving debts, transferring cash, etc. Unlike lotteries or casinos, it appears that most illicit sports bets are done on credit, with periodic settlements. Finally, there are the market dynamics of how lines move based on money flows, rumors and news.

Thursday, March 17, 2011

Linkfest of Linkfests



Linkfests are great. They are a very efficient way of gathering information and analysis. People who share links consistently deserve admiration as they greatly improve the ecosystem.

Here are the linkfests I follow in my RSS feeds. I link to recent editions so you can go and check them out for yourself. There is no particular order of importance as many are not directly comparable.

Barry Ritholtz/The Big Picture: One of the most influential bloggers shares Afternoon Reads quite often. Generally finance-focused.

Yves Smith/Naked Capitalism: Published author and voice of integrity does an extensive list daily, always with a picture of cute animals at the end as an "antidote".

Bess Levin/Dealbreaker: Dealbreaker is well known for its proprietary flow of information and rowdy commentariat, but wonder-editor Bess also has opening and closing links with nice summaries.


David Merkel/Aleph Blog: Merkel shares interesting reads with commentary on twitter, no linkfest per se on the blog itself.

Josh Brown/Reformed Broker: one of my favorite bloggers and emerging media mega-personality does not one but two linkfests, one on the blog and one for RIAs on the WSJ

Clusterstock: There are a few daily things there that can loosely qualify as a linkfest but I always go for the main morning one and Wall Street Gossip in 60 Seconds in the afternoon.


Felix Salmon/Reuters: Famous corporate blogger shares a few links nightly.

John Carney/CNBC: Former Dealbreaker and Clusterstock guy, now at CNBC, does a headline roundup. Unfortunately, he does not have a full RSS feed which means that I visit about 5% of the time.

Miguel Barbosa/Simolean Sense: This is the Renaissance Man linkfest. Miguel painstakingly puts together a long collection of cerebral articles on a wide variety of topics every Sunday. You can feel smarter just by reading the summaries. He shares links continuously throughout the week but the Sunday effort is true feast.

Crosshairs Trader Blog: trading-focused links

Calculated Risk: another titan blogger shares his finds periodically. CR also has very high quality weekly summaries and graphs.

Tadas Viskanta/Abnormal Returns: the only full-time links "curator" in finance that I know of. He does an early edition and a full edition of carefully categorized links, along with interesting periodic interviews. Daily read even just to pick up what people talk about.

MaoXian: MaoXian's shared links are easily the most eclectic bunch that "the Chairman" collects as he surfs: homemade nutella recipes to Beijing air quality to stocks making new lows, it is all there.


Pakiya Funds: weekly links on various topics of interest to value investors

Jay/Market Folly: Many people know MF as the pre-eminent hedge fund tracking service, but he also has a periodic, high quality reading list.

George/Fat Pitch Financials "Festival of Stocks": weekly links primarily on value topics

Some Assembly Required: this is a bit of a left-leaning, alarmist daily links list that I keep an eye on for topics I rarely encounter otherwise

Ed Harrison/Credit Writedowns on delicious: CW links primarily to news articles

Tim Iacono/TimIacono: Daily news links, well sorted

James Altucher/Daily Finance: yes, that Altucher does links periodically

iShares blog: the mothership of ETFs has a blog, and a relatively new weekly links effort, I hope it stays

Marginal Revolution: slightly more econ-focus here, more or less daily

Insider Monkey: a relatively new blog focused on insider moves and hedge funds that shares good finds periodically

Tom Brakke/Research Puzzle/RP Pix: underfollowed but very thoughtful blog and separate "pix" with links

Surly Trader: sorted news links weekly