Monday, December 05, 2011

MF Global, Corzine & Gensler

The lead staff editorial in Thursday's Wall Street Journal provides a nice overview of what's wrong with federal regulation of the banking and securities sector.

The piece details how, once Jon Corzine became CEO of MF Global, the Fed reconsidered and reversed its earlier decision to deny the firm its request to become a primary dealer.

The Journal notes that MF Global had posted six losses in the past seven quarters, but drew no extra regulatory scrutiny. It was more than halfway through that period when the Fed granted MF Global its primary dealer status.

What the editorial explains, correctly, I believe, is that it's not quite correct to simply say that Dodd-Frank and the overall federal regulatory scheme worked, because MF Global failed without larger consequences or incidence. But the apparent misuse of customer funds, and outsized position risks taken by the firm, were completely overlooked by regulators.

Isn't that what the system is supposed to prevent? The actual illegal and overly risky types of actions which MF Global is suspected to have taken?

Gensler recused himself from the case, which tells you how much this is all about crony capitalism, which the Journal contends. Either Gensler shouldn't have had to recuse himself, or he should have admitted the cronyism back when Corzine took the helm of MF Global.

It's tempting to write off the MF Global collapse as a one-off, smallish, successful proof of Dodd-Frank. But, in reality, it's proof that our federal financial system regulations don't seem to have clear-cut objectives, or, quite likely, if they do, are not capable of actually implementing them and protecting anyone or anything- not customers, shareholders or the larger US financial system.

Friday, December 02, 2011

Regarding Facebook's Valuation

The Wall Street Journal has published several page one articles recently concerning Facebook's putative $100B market value. I had to go to the Journal's site to confirm Tuesday's edition's lead which contained that number, it seemed so staggering. Facebook is looking to sell just 10% of that value in its IPO scheduled for early next year.

Much is being written regarding the appropriateness of that valuation. I'm not in that business, so I'm not going to argue over billions.

What I am, though, is a strategist who has learned to apply that type of critical thinking to business and equity management.

Among online ventures, I would agree that Facebook should be at the upper end of the valuation scale. Here's why.

Zuckerberg's- and his famous twin collaborators- big idea was initially simply replacing the once-popular college paper 'picbooks' or 'facebooks,' which I first encountered as a graduate business school student at the University of Pennsylvania, with an online version. From there, the rest is history.

Like Google's Brin and Paige, Zuckerberg and his colleagues invented one thing, which just happened to be a popular 'app' for which, in time, advertising was a natural fit. For Google, the search results were just begging for nearby ad placement. And the best part was that, unlike passive television, active searches allowed Google to sell literal terms to advertisers, thus making specific buyers much more valuable.

Facebook has the same characteristic. By developing an application which induces people to spill their guts about their lives onto a webpage, it's tailor made for associating advertising with these pages. And because of its communal nature, it multiplies that value through the various platinum-plated, self-organized, genuine communities of great and frequent interest.

For a marketer, it's a dream come true. Instead of searching for, say, early adopters, you have the ability to link to the close friends of one by virtue of the site's very nature.

How can that not be valuable? Or, as the late Steve Jobs might say, 'insanely' great and valuable?

And because Facebook is simply a generic self-expression tool, it's potentially usable by every living person on the planet, and maybe, in the future, the dead, as well, in absentia. So the accessible market is literally the entire global population that has web access.

Search engines have come and gone. Who even recalls Webcrawler or Lycos anymore? But, like telephony or the mail, social networking technologies become more valuable and monopolistic by their very nature. That's why MySpace became such a money sink and, ultimately, loss for NewsCorp. Second place in social networking is nowhere. Especially when the market share leader is so far ahead as Facebook is.

Thus, while Linked-In is, by comparison, relatively narrow, with its business- and skills-focus, and Groupon is deal-specific, Facebook is perhaps the most common of social networking applications. It probably does belong, if not now, then eventually, in Google's league, which is now about $200B.

Stunningly, that's only twice what Facebook's IPO-imputed valuation. Barring gross mismanagement, I think that sort of valuation range is quite reasonable and appropriate. In the future, who knows by how much that could increase?

From an equity management perspective, of course, that doesn't mean my portfolios would include Facebook in the future. Google never made it into the portfolio. In the early years, its valuation was simply too rich, relative to its growth rate. By the time the valuation had become reasonable, according to my selection criteria, its growth, too, had moderated. Perhaps Facebook will undergo the same dynamics. It will be interesting to see.

About Angela Merkel's Prussian Values

I wrote this post last week, in which I provided a disclaimer relating to my views on how Germany views the profligacy of many of its fellow EU members,

"As a disclaimer, let me mention that my own heritage is Germanic. So the Teutonic insistence on the profligate Europeans paying for their sins is not foreign to me."

By the way, I'm not just of German extraction, but Prussian. Both sides- one from the permanently-German states, the other side from borderlands between Poland and Germany.
Thus, I was amused to read this in Wednesday's lead Wall Street Journal staff editorial,
"In opposing that option, the Germans are said to be imposing their Prussian morality on everyone else. But without reforms, the countries of southern Europe will never pull out of their downward debt spiral. The Germans are at least telling the truth."
I highlighted the two words in the passage which I found so amusing. It's not just me who sees this long-evolving crisis as a morality tale now relying on Prussian values and discipline to resolve it.

Thursday, December 01, 2011

Monetary Cocaine From Six Central Banks

What can you say about yesterday's equity index responses to the announcement that six large-country central banks, and the ECB, provided coordinated dollar funding support to European financial concerns? This news, along with a optimistic ADP payroll forecast, drove the S&P500 Index up 4.3%.

But if you listened to various pundits on CNBC and Bloomberg television, the news wasn't actually so good. It gradually dribbled out that un unnamed European bank was set to go bankrupt over this coming weekend from insolvency due to an inability to replace lost dollar funding. The credible pundits, people like El Erian of PIMCO and Alan Meltzer, for example, were relieved with the immediate move, but remain concerned that the longer-term problems in the Euro zone remain unresolved. Meltzer advocated a two-track Euro, effectively saying he believes the currency, as we now know it, is finished.

But let's be blunt, if seemingly cynical.

What you heard from the asset management community was a gigantic sigh of relief that these six central banks have put their taxpayers' incomes behind promises to dollar-fund failing European banks, thus providing a free floor under the values of those managers' portfolios.

This is the sort of hyper-global crony capitalism against which Occupy Wall Street rails, only most of them aren't actually sufficiently knowledgeable to understand that.

Does anyone who is informed about the history of markets actually believe that a handful of central banks, several of which, I believe, aren't exactly all that significant (Canada, Switzerland), can outgun the world's hedge funds? Recall how George Soros gained a huge leg up in his net worth by betting against the British pound, allegedly on an inside tip, and won?

What about the Baker Plaza Accords of the 1980s? When central banks go to war in the markets with fund managers, the managers typically bring more assets to bear. Yes, the banks can 'create' money, but, in doing so, depreciate the value of the currency they are printing. There's a relevant range of effective expansionary monetary policy, i.e., printing or borrowing money, with respect to time, quantity and fiscal context. Right now, the Euro nations don't have much range, the US a bit more, but, in total, global economies are phenomenally over-leveraged already.

So how is it that a Euro-zone crisis caused by over-borrowing will be solved by central banks....borrowing or printing more money to magically produce dollar funding for near-insolvent European banks?

That said, I hope you enjoyed yesterday's landmark US equities rally. I'm sure the hedge fund managers whose asset values have been saved, provided they weren't naked short Euros, or can wait out the short-term pop in the currency's value, are very pleased. Everybody who was in the market got a nice 4% or so boost in value before selling the top in the coming months.

But as Rick Santelli said on CNBC this morning, the Fed is now 'all in' backing the Euro-zone and ECB. Helicopter Ben has linked the US economy and dollar to a bunch of entitlement-loving Euro nations and their failed fiscal policies.

Wednesday, November 30, 2011

Tom Keene's Housing-Related Program Yesterday On Bloomberg

Bloomberg's Tom Keene continues to slip in my estimation with almost every program of his that I view. His guests are of uneven quality, and Keene tends to project this naivete that makes you wonder if he's really up to cross-examining his guests. I'm guessing not.

Yesterday he had two women guests discussing the US housing situation. First was, I believe, Laurie Goodman, a principal with an asset manager.

Goodman declined to attribute responsibility for how we came to have 20% of all mortgages in existence five years ago now delinquent, and 23% of all US mortgages underwater.

Keene was totally in love with a trend chart purporting to illustrate that job growth was dependent upon housing, so without housing growth, the US economy is dead. He never questioned whether perhaps this had been a short-term (only a decade or so, I believe) and artificial correlation that is, in fact, unhealthy for the US economy.

Goodman sensibly said that thing will get better as new construction stops, thus forcing the huge foreclosure overhang to be worked off. And that two other events need to occur.

One, which Lew Ranieri explained over six months ago on CNBC, is the appearance of a government program allowing local investors to buy foreclosed properties and rent them. The second is to process as many foreclosures as possible in order to eliminate the old, high costs bases and allow new owners to buy at market prices.

She added that lending for these new mortgages is stalled, presenting a stumbling block.

The second guest, Stephanie Meyer, now with BofA Merrill Lynch, echoed Goodman's sentiments. She was clear about the need for foreclosures to move along and allow repricing of housing stock.

Interestingly, and another incident of Keene's failure to adequately question his guests, neither woman, nor Keene touched on the political issue of dumping so many existing delinquent homeowners out of their homes. That the current administration is trying to prevent this by threatening 'cramdowns' and such forcible taking of investor value to reward delinquent homeowners.

Disappointing, too, was Keene's failure to challenge whether the housing sector should ever have become so central to the US economy, and whether its removal of mobility for homeowners was a mistake in our modern economy?

Still, the raw information from these two guests concerning what would move the housing sector forward was refreshing.

Tuesday, November 29, 2011

Black Friday & Yesterday's Equity Market Pop

Positive news about Black Friday's sales numbers propelled equity indices up sharply yesterday. The S&P500 Index rose 2.92% on the strength of the information.

However, as a Wall Street Journal article explained, there's actually little correlation between Black Friday sales and sales for the entire holiday season. It mentioned the 2008 holiday season, when Black Friday sales were up 3%, leading estimates for the entire season to be increased to 7.2%, only to see the actual data come in at -4.9% for holiday season spending.

Moreover, as I watched CNBC's coverage of the unfolding Friday shopping, guest hosted by well-regarded retail analyst Dana Telsey, it was clear that people were out shopping because of the large discounts being offered. Telsey admitted that this season's sales would be low-margin in nature but that, due to falling commodity prices, hopefully 2012 would be 'the year of the margin.'

Meaning that Black Friday's sales were robust because many people were out taking advantage of sales. And this is good news? This is going to fuel a long-lived US economic expansion?

I doubt it.

Another reason for yesterday's equity index performance was reported to be, as one analyst coined the term, 'hope-ium' that Euro governments discussing coordinated, tougher and enforceable fiscal policies would eventually resolve that trading bloc's sovereign debt woes.

If that isn't a pipe dream, what is? Looking at the reactions of the populace in Greece and Italy to austerity measures, what do you think will occur if/when the same is applied to Spain and France?

As I write this, the S&P futures are up to 1194, presumably on the news that Cyber Monday sales were 15% higher than last year.

Again, fine for a passing S&P500 rise, but suspect as the source of lasting US economic expansion. As a friend of mine opined last night regarding the holiday sales reports, and his own experience at a crowded restaurant over the weekend,

'It seems like if you have a job, you're spending. But if you don't, it's a different story.'

Just so. And with broadly-defined, actual US unemployment between 15 and 16%, and real median income for the past decade flat, that doesn't seem to be an improving underpinning for the US economy going forward.

US equity indices reflect global economic activity, so they may outpace US economic growth. But Europe's slide into recession should concern investors looking at the global GDP outlook.

Monday, November 28, 2011

The Economist's Denial Concerning The Euro & Europe's Entitlements Crisis

The current issue of The Economist entitled it's lead staff editorial "Is This Really The End?" Of the Euro, of course.

The piece then goes on to examine various ways Euros may be printed or borrowed, or back yet another instrument in hopes of fooling investors into overlooking the EU's real problem.

While usually on target, the Economist is hopelessly in denial on this issue. They concentrate mostly on the topic of Germany and Merkel simply bailing out Europe, about which I wrote recently. But that's almost a sideshow.

What the editorial never mentions is that this isn't simply a financial or sovereign debt crisis, per se.

It's a European entitlements crisis.

The Economist can blather on all it wants about the ECB, the EFSF, the Euro, and various means to move the same old monetary pieces around the same board, sometimes with new labels on them. But none of that will solve the problem.

The United States and Europe's nations all share a common, heretofore not experienced problem. Their lush government defined-benefit obligations have finally outstripped their abilities to fund said obligations. They are all gigantic Ponzi schemes, in which 1.5-2 generations have legislated extravagant benefits for themselves, to be paid by borrowing now and taxing later generations, or simply taxing later generations. Thus, there's no possibility of resolving the loss of confidence by global investors, because the money to solve the problems doesn't exist yet.

And with the suffocating tax and regulatory burdens besetting all these nations, it's looking like economic growth won't be helping anytime soon.

Face it, the developed nations are in for a rough economic ride for probably at least one decade- maybe more. Since WWII, governments have voted their older citizens benefits never before enjoyed in the history of civilization. And clearly won't be again, either. It's been a massive acceleration of spending fueled by wealth borrowed from future generations. Thus, GDPs since the war have also probably been artificially pumped up on this monetary equivalent of steroids.

Only a return by all large economies and nations to defined-contribution social welfare and corporate pensions and health care schemes will bring this unsustainable financial joy ride to an end.

And forget what you hear about any of these oldsters having "earned" their promised benefits. That's a lie. Those benefits were legislated without a clear explanation of their funding, while economists stood by and remained silent on the senselessness of promising such large-scale fixed and escalating benefits to be funded by dynamic, competing, uncertain economies throughout the world.

In America, beneficiaries of Ponzi schemes are forced to return their payouts by virtue of the scheme being a fraud and, thus, no real gains being available for anyone to realize. As an example, witness the ongoing recoveries of the Madoff fraud's payouts.

Why should the payouts of similar government-run Ponzi schemes for retirement and medical care be any different? Nobody 'earned' those benefits. They were never really affordable in the first place.

It may take years, but eventually, voters will have to accept that they elected governments which promised benefits many voters knew weren't really affordable. And they'll all have to take haircuts on those benefits.

Which brings me back to my starting point.

Germany can't fix the Euro problems because they aren't, strictly speaking, just about sovereign debt, the Euro and defaults. They are about totally unsustainable government benefit programs which can't be financially finessed back into solvency.

It's not a liquidity or currency issue. It's a social welfare state issue around the globe.

The Economist should know better than to go into denial about this truth.

Saturday, November 26, 2011

Great Expectations

If you want to understand how America has corrupted itself while amassing $15T in debt, with even more in still-unborrowed, unearned entitlement liabilities, consider this thought experiment.

It is 1925. WWI is behind us, and the Roaring '20s are in full swing. GDP growth is torrid, new products and innovations abound. Incomes are rising, as are standards of living. Electricity, telephones and the car have revolutionized American life.

Income tax must be paid in one lump sum, while medical expenses and retirement are self-funded. People are still self-reliant.

Ten years later, global economic conditions, bad, constrictive monetary policy and too-liberal borrowing to buy equities have resulted in a market crash and simultaneous global recession which becomes the Great Depression in the United States. FDR's response is to print money to fund various government giveaway programs, while pushing Congress to pass the act that creates the greatest social welfare mistake, Social Security, which will inexorably change peoples' savings behaviors and the social structure of families.

Over the next few decades, young and old alike begin to rely on government promises of defined, ever-increasing benefits, and spend more, instead of saving for old age. Three decades later, Medicare and Medicaid are similarly mistakenly designed on the same lines as the original error, Social Security. Dependence on government for near-total pension and medical care funding are complete.

Now the experiment.

Imagine an America that never created Social Security, Medicare or Medicaid. Imagine that, like in 1925, future decades saw an America without government promises of retirement income and medical expense funding.

Instead, Americans remained self-reliant on themselves or their employers for retirement and medical care funding.

Since, ultimately, Americans were going to pay for these expenses themselves in some way, whether privately-funded, through taxes, or government borrowing financed by taxes on later generations, the real question is: how would their interim spending and savings behaviors have been affected?

What did Americans do before the government-promised benefit schemes of the 1930s and 1960s? I believe they spent more prudently, saved more, and expected to work longer. So if we'd never had the badly-designed Social Security, Medicare and Medicaid programs, it's likely people would have continued to do the same- spend less and save more for their own retirement and medical needs.

See, whether government provides it, or individuals save for it, the money for post-work living expenses and medical care come from the same place- wages earned while people work.

You can call it taxes, government borrowing or you can call it forced individual savings, but, either way, money for people's old age living and health care can only come from wages they, and/or future generations, don't spend.

If government had begun to mandate savings for both needs, kept in individual accounts, the effect would have been the same as if everyone behaved prudently and saved enough of their incomes to fund those needs.

However, the major difference would have been that there would have been no looming unfunded government-suppled defined-benefit pension liability or medical care funding, including generational shifts in the liabilities for them, because no such benefits would have been promised. Instead, savings would have gone to accounts meant to fund individuals' old age and medical care.

Of course, one other major difference is how these schemes affect the financial behaviors of individuals. When told government is supplying benefits, people spend more. Even though the money for the 'guaranteed' benefits has to come from taxes now and borrowing which is repaid with taxes on future generations. And it's a safe bet that cycling money through taxes, Washington and and back again adds to the cost of the benefits which are being funded by taxes on individuals' wages anyway.

There's one more difference. When benefits, instead of contributions, are promised, then timing can become mismatched. And one generation can enjoy benefits which leave debts for the next generation to pay.

Which is where we are now. But reasonable people realize that the defined-benefit schemes of the 1930s and 1960s have over-promised and won't be affordable for another generation. So, in reality, one generation promised itself lush benefits and left the bill to following generations.

That's why defined contribution schemes are inherently more fair and moral. They leave the cost of old age and medical care with the generation incurring them.

I find it fascinating to consider how families in the 1920s considered funding for the retirement of the adults in, say, the 1960s. Or their medical care. Without government programs promising those benefits, or company-supplied medical insurance, didn't they just save more and spend less, budgeting those costs into their existing lifestyles?

Why couldn't the same behaviors return for Americans, once we abolish unsustainable group defined-benefit programs? The money comes from the same place.

The real difference, in the end, affecting behaviors, is the expectations set by either self-funding or government promises of defined benefits. And the past 80 years have demonstrated that inappropriately-raised expectations by government's unaffordable and unsustainable promises have raised expectations to unaffordable levels for our entire society.

Friday, November 25, 2011

Germany, Merkel, EuroBonds, The ECB & The Euro-Crisis

It's almost funny now to hear pundits and reporters on CNBC and Bloomberg gush over how the only solution left that will placate investors is for German PM Angela Merkel to agree to either ECB issuance of bonds/printing of Euros, or EuroBond issuances.

Anything else, one European correspondent solemnly intoned, and the world will plunge into financial chaos and ruin. Did the Germans really want this?

Or will they step up to the plate and save the global financial system all by themselves? C'mon, he implied, why can't Germany just open its checkbook to bail out everyone else?

As a disclaimer, let me mention that my own heritage is Germanic. So the Teutonic insistence on the profligate Europeans paying for their sins is not foreign to me.

But I do, honestly, see the Germans' viewpoint. Why should they mortgage their economy to bail out those of France, Greece, Italy, Spain, etc.? Where will it all end?

The foreign correspondent who tut-tutted Germany for playing chicken with global ruin also confessed that, sure, in such a scenario, Germany comes out best among the ruined financial world.

It has become borderline-hilarious to me how media pundits and analysts desperately hope that Germany will ruin itself financially in an insufficient attempt to rescue the entire rest of Europe and, by implication, the world financial system. And why? Because it's the last apparently large, solvent European nation, and a fairly comparatively conservatively-managed one, as well.

As I wrote in a prior piece, echoed in a humorous piece by a Harvard economic historian in last weekend's edition of the Wall Street Journal, what the Germans couldn't accomplish with their 88mm guns in WWII, they may well achieve simply by being patient as the rest of Europe offers more and more financial and political control to the Germans, in exchange for a gigantic bailout.

In the meantime, regardless of the global consequences, I can't but respect and agree with the German reticence to be sucked into financially rescuing the rest of Europe.

S&P500 Index Performance vs. US Economy- Now You Know Why They've Diverged

Finally, a really good, solid datapoint!

Tuesday's Wall Street Journal featured an article on the front place, top, of its Marketplace section with the headline,

"U.S. Firms Eager to Add Foreign Jobs"

The first paragraph said it all,

"U.S.-based multinational corporations added 1.5 million workers to their payrolls in Asia and the Pacific region during the 2000s, and 477,500 workers in Latin America, while cutting payrolls at home by 864,000, the Commerce Department reported."

Further, regarding the other important business input, capital, the article stated,

"The multinational companies, for instance, reduced capital-investment spending in the U.S. at an annual rate of 0.2% in the 2000s and increased it at a 4.0% annual rate abroad. Still, they allocated $2.40 in capital spending in the U.S. for every $1 spent abroad."

In summary, US-based multinational companies cut 864,000 workers in the US and added 2.9 million workers overseas from 1999 to 2009.

If this doesn't explain why the US economy and GDP growth are slowing, with stubborn unemployment, while S&P500 company profits continue to rise, what else do you need?

It also explains why business investment spending, while remaining robust, isn't helping US employment. It's reasonable to expect that much of that new investment spending is being serviced by overseas units and, thus, workers, of US-based companies.

No surprise to me. This is pretty much what I would have expected to see. This is simply the first solid piece of data on the phenomenon which I've seen.

If you heard interviews with the author of Steve Jobs' authorized biography, you may have heard him recount Jobs' frustration with US immigration policy. The story involved Jobs and Google chairman Eric Schmidt, at a White House dinner with its current occupant, explaining that a lack of US engineering talent forced Apple to build a facility in Southeast Asia, where the engineers were available. In addition to the hundreds of engineers, Jobs told the president, Apple also hired thousands of local workers for the production facility.

That, writ large, is what these recent Commerce numbers capture.

Shareholders of these companies should rejoice that the firms are doing what is economically best for them. That includes...ahem.....union members whose pension funds own shares of the S&P500 Index or companies therein.

I wouldn't go pillorying the executives or boards of these companies. They are simply reacting to global demand, costs, tax rates and regulatory environments.

The US Congress and administration should take note. This report illustrates Ricardian comparative advantage economics in action. And that clearly portrays a US labor market that has become overly-regulated, too expensive and difficult to accommodate in exchange for the presumed benefits. Thus, these multinationals find it more cost-effective to service overseas demand with overseas labor, capital equipment and facilities.

Wednesday, November 23, 2011

Larry Fink On Warren Buffett

I had the opportunity yesterday to watch the hour-long Bloomberg program I had recorded on Monday evening which featured an interview at UCLA's Anderson School of Business with graduates Bill Gross of PIMCO and Larry Fink of BlackRock. It's well worth some 40 minutes of your time- sans commercials- to view. Two of the smartest asset allocators in the world answer some pretty direct, potentially embarrassing questions. I learned a lot, if only, in many cases, that my own views are pretty close to those of these two asset management titans.

Of particular interest to me, after both veteran asset managers' generalized asset allocations for the near term future, were Larry Fink's remarks about Warren Buffett. They illustrate, for me, the continuing perception of Buffett that is so at odds with reality.

Fink told a story of meeting with Buffett on a day on which equity markets were plunging. He spoke admiringly of Buffett getting up several times during their meeting- apparently in his office- to 'buy more stocks.'

Then Fink reinforced his point by saying that 'everyone should behave more like Buffett,' lauding the Omahan's tactics of 'ignoring quarterly results and investing for the long cycle.'

Fink went on to say more glowing words concerning Buffett's track record.

Only here's the point. We don't know what Buffett's actual equity selection performance record is. We only know what Berkshire Hathaway's total returns have been. And those haven't been exactly consistently stellar in recent years. Moreover, Fink was stressing buying dividend-paying classic industrial or consumer goods stocks, while Buffett has been crowing about technology and banks. The latter, by the way, I believe both Gross and Fink said they wouldn't go near.

It seemed to me that Larry Fink was more repeating what he'd read in the fawning press regarding Buffett's long-ago equity selection results, rather than commenting on what's observable recently.

He also skipped over the part about Warren not needing to worry about short term performance. In that recent linked post, I wrote,

"I contend that if Berkshire's price charts were labeled Fund X and compared to other funds, Buffett's company would be judged inadequate, inconsistent and, at best, mediocre."

What Gross and Fink, termed by the Bloomberg host as the two men with more assets under management than anyone else in the world, both glossed over is how different management of institutional money by very large, now-reputable firms is than what individuals can accommodate.

It's simply not possible for the average retail investor of a few tens of thousands, perhaps hundreds of thousands of dollars, to emulate Buffett. Nor should they. They don't have the risk profile that Berkshire/Buffett does, nor access to the same risk management analyses, nor tools to manage risk. Buffett's corporate billions can withstand losses that individuals cannot. Individuals facing retirement and worried about market downdrafts don't have Buffett's luxury of riding out Fink's "long cycles."

Further, they can't get an inside track to lend BofA money at preferred rates, plus warrants. Or get an otherwise-illegal inside track to make a tender offer for Burlington Northern while excluding any competing bids.

I have tremendous respect for Larry Fink. He's built one of the two largest money management businesses in the world, from scratch. He clearly does good work for his clients.

But I don't think that makes him either objective or an expert about Warren Buffett's equity management style or its utility and applicability for average retail investors. And his comments illustrated how widely-accepted, without evidence, Buffett's reputation remains.

Tuesday, November 22, 2011

Examining The Context of Market Timing

Yesterday I wrote this post, in which I noted how the S&P has been around the 1180-1190 level several times in the past few months and, in fact, a year ago this week. Thus suggesting that overly-active management has pitfalls. Because in some market conditions, if you wait long enough, you'll see the market return to a level.

However, while discussing the post with a friend, I articulated a key facet of overly-active management, or timing, that makes it so dangerous and prone to overestimation of success.

Consider the following datapoints pairing dates and closing values of the S&P500 Index.

6/24/2011 1268.45

6/27/2011 1280.1
6/28/2011 1296.67
6/29/2011 1307.41
6/30/2011 1320.64
7/1/2011   1339.67
7/5/2011   1337.88
7/6/2011   1339.22
7/7/2011   1353.22

10/19/2011 1209.88

10/20/2011 1215.39
10/21/2011 1238.25
10/24/2011 1254.19
10/25/2011 1229.05
10/26/2011 1242
10/27/2011 1284.59
10/28/2011 1285.09

11/1/2011 1218.28

11/2/2011 1237.9
11/3/2011 1261.15
11/4/2011 1253.23
11/7/2011 1261.12
11/8/2011 1275.92

In each case, the last datapoint is the local maximum, from which the S&P fell. Yesterday's close was 1192.98.

When index gains seem to be part of a monotonic upward series, there's nothing magical about the peak closing value. A priori, amidst the justifications of many pundits who suddenly appear on cable networks, an investor is prone to be concerned that if he sells now, he'll miss a big move in an obviously upward-trending market.

This is where discipline makes a difference. Investing discipline is particular in its meaning to the style of the investor. It may involve adhering to signals and rules, rather than letting contemporaneous market conditions affect sentiment which overrides those signals or rules. Or it may involve some target rate of return, after the attainment of which positions are closed to cash or some fixed income instruments.

On one extreme, one might be a dollar-averaging, long term buy-and-hold index investor. In which case trends are moot. Or one might engage in some hyper-active style which buys upon a certain percentage downward index movement and sells upon a corresponding move upward. These are, of course, simplistic examples meant to mark the poles of market timing.

But rest assured, local equity index maxima don't come with identification tags or warnings. Attempting active timing without some well-founded, researched approach invites disaster.

Google Speeds Cable Disintermediation Via YouTube Celebrity Channels

After reading a piece in the Wall Street Journal yesterday concerning Google's $100MM bet on celebrity channels on YouTube. It reminded me of my old mentor, Gerry Weiss' insights into competition and colliding arenas.

Gerry and his colleagues developed the concept as strategic planners at GE under Jack McKittrick. Essentially, a technology that is at the core of one entity in one 'arena,' or business area, uses said technology to expand into a new business. The entity's technological and/or other business model attributes strike at a vulnerability of existing occupants of the new business, causing a radical upheaval.

That's what seems to be about to occur at Google/YouTube.

I've been writing about the disintermediation of cable television for a few years. Now I realize that Google's recent staking of various media celebrities to $100MM worth of channels for their own creative usage will only speed that disintermediation. The Journal article cites several actors having broken into work on cable television programs via viral YouTube videos.

I've contended for several years that a writer/producer like Larry David would be foolish to bother putting his next series on cable. He could easily go right to streaming video from a website.

Then Glenn Beck departed Fox News for his own website-based media empire.

The Journal piece ended on a cautionary tone, noting that Google isn't likely to be earning revenues from any of this YouTube effort anytime soon. But offered a silver lining that in just three years, its Android cell phone alternative has grown to take half of the smart phone market.

My own sense of Google and YouTube is that, in the simplest case, they get eyeballs on which to earn advertising revenues. Then, over time, as viewers are trained to watch streaming web videos as their natural way of viewing heretofore broadcast- and cable-only frequently-aired (i.e., weekly programs) content, the step to paying for new content from a bankable talent like David or some other writer will be simple.

At that point, it wouldn't be a stretch for Google to be straying into signing and backing new talent, would it?

Even if not, just by migrating more and more viewers to their streaming video, they'll drain the last drops of life from broadcast network television, while accelerating the problems at cable providers.

That's one of the hallmarks of arena competition. Whether it's smart or not, the new entrant can afford to subsidize its intrusion into the new business with profits from its existing businesses. In Google's case, they aren't unconnected. But its targets don't really have multiple revenue sources on which to rely in the coming video content sourcing battle.

Monday, November 21, 2011

What Did I Miss? Evidently Nothing.

As I write this post at 11:15AM today, the S&P500 Index is at 1187. My proprietary vvolatility measure, which more or less tracks the VIX, has been above a critical threshold since early August.

Interestingly, you could have been gone for the past two months and missed nothing in terms of S&P level. Or three months, since mid-August, for that matter, if you're a buy-and-hold kind of guy.

Or a year, for that matter! The S&P was at today's levels a year ago this week.

Of course, if you were invested for the past year, but rebalanced gains or were incredibly lucky with your market-timing, perhaps you sold above 1300, realizing a 10%+ gain.

But the point is, volatility has been above my threshold more than not since early 2008, or three and a half years! The interval between the US equity market turnaround in March of 2009, and the initial Greek debt crisis was only about 13 months. The highs of 1400+ on the S&P of early 2008 have never been revisited.

At present, November's S&P monthly return is below -5%.

Which is why market-timing on relatively small gains and losses in the indices is such a dangerous practice. Especially now.

This Morning's Stupid Remark on CNBC

Howard Ward, a growth portfolio manager at GAMCO, made a rather naive and stupid pair of remarks this morning, and it's not even 8AM.

First he asserted that there have been 'five or six weeks of good economic news' in the US, so "we're doing okay."

Really? 9% unemployment and 2%+ GDP growth is okay Howard? Wow, I'd hate to see bad.

Ward then proceeded to declare that even as Europe slips into a recession,

'The rest of the world can keep on growing and Europe can have its recession separately.'

Where has Ward been for the past two decades? Global interconnection of supply chains and US companies' dependencies, especially recently, for growth overseas has resulted in a much more correlated global economic picture than ever before.

Europe is a huge economic trading bloc. Growth in one of its larger member countries, Italy, is projected to be negative next year.

I guess CNBC is desperate for guests if they're getting this caliber of pundit on their morning program.

Friday, November 18, 2011

More Housing Missteps By Congress

Yesterday's Wall Street Journal's lead staff editorial reported the disappointing news that, with so much public attention focused on Fannie Mae and Freddie Mac, the FHA is being granted a rise of about $100K in value, to almost three quarters of a million dollars, in the size of mortgages it can guarantee.

Various data detailing the FHA's precarious capital position (about .25%, rather than the mandated 2.5% or so) and enormous, though underestimated future defaults on its portfolio.

FHA was supposed to be the original low-income government-assisted housing loan program. I recall selling my first home some twenty years ago to a veteran who received special treatment under the FHA loan for which he applied. Incredibly, as the seller, I had to pay his points. Imagine my surprise at the closing when I learned the couple had therefore gone and borrowed significantly more than they had initially represented in their purchase offer, sticking me with higher fees for selling my house.

The FHA program was designed long ago as a vehicle to assist the emerging middle class in what was then viewed as a laudable goal- home ownership.

It's hard to see how even in the New York Metro area, at this time, a $725K home can be considered either a starter, or deserving of any sort of special government assistance.

No doubt those defending this increase in FHA mortgage size will claim it is to boost housing demand in order to rescue the housing sector, create sales and, somehow, magically, ignite housing starts.

How many times have you heard pundits and, of course, National Association of Realtors officers blather on about how a US recovery must begin with housing? How we have to get housing fixed to fix the economy? How much the US economy relies on the construction sector which is sustained by housing?

What happened to letting the US economy, with its hundreds of millions of actors, determine sector activity through their genuine demand for various goods and services?

From my youth, to now, I can cite three industries which were supposed to be the backbone of the US economy in their day- steel, autos and, now, housing.

Each had a parasitic union which ultimately sapped its host nearly to death. Each sector had its productivity peak, the bulk of its value-added fall victim to lower-wage, and thus, higher-productivity foreign competitors. Which led to the exit of US producers as the products became more commoditized and the US lost competitive advantage in those products.

Housing, being a locally-produced and -consumed good, didn't get sent offshore. We killed this one by over-subsidizing it.

I've been very impressed by the studies I've read that demonstrate home ownership to be the enemy of the once-vaunted mobility of the US labor market. And never moreso the low end of the income distribution. The absolute worst thing you can do for the lower income worker is to chain her/him to a home, so that when their semi-skilled job vanishes, they can't pick up and move immediately. Oh, and by the way, when that job does vanish, probably with hundreds or thousands of others like it, local property values will plummet, causing them to lose what little savings they had, as the home goes upside down with respect to its mortgage.

Maybe it's time we finally just stop subsidizing any sectors out of an arrogance which assumes a few legislators, with the 'help' of lobbyists for a sector, know what's best for American consumers and the US economy.

As of 2011, we've reaped a moribund housing industry from too many years of subsidizing the consumption of ever-larger houses by ever-more Americans. We've binged on housing, and now the value of that housing stock has fallen.

Market economics would lead us to let housing prices go where supply and demand take them. In this case, falling to a point where a newly-enabled tranche of buyers can afford that which was previously beyond their means, and at realistic interest rates and by appropriately careful lending standards.

No other path will resolve the housing sector's ills, nor cause it to have a positive effect on the US economy.

Rather than listen to politicians and pundits who declare we need this or that special program to incent consumers or business owners to behave in a certain way, to 'jump start' the US economy, perhaps, now, after several years of lackluster growth and a subsidized-housing-sector financial crash, we might just let market forces, in their own time, produce a real, sustained recovery driven by genuine market demand and, consequently, supply.

Thursday, November 17, 2011

Non-Breaking News On Tom Keene's Bloomberg Program

Sometimes I think Tom Keene purposely acts stupidly in order to make his guests feel smart. Other times, I think he really is as clueless as he periodically makes out.

Take this afternoon's closing segment on Keene's noontime program.

Keene's guest used the UBS announcement that it is simplifying its business model by shedding a few thousand investment banking employees. After a few minutes of discussion, Keene had his 'gee whiz, I'm surprised' moment regarding the rise of privately-held financial services boutiques. Then he let on that he knew Blackstone has a very healthy and large M&A advisory business.

Subsequently, the term 'brain drain' was used to describe the movement of talent from publicly-held formerly investment banks, now commercial banks (Goldman Sachs, Morgan Stanley & the IB divisions of legitimate commercial banks such as Chase, Citi and BofA/Merrill Lynch).

Except this isn't news. It's been going on for over a decade.

Ever here of a little outfit called Long Term Capital Management, Tom? That was 1998 when it imploded.

I've written a handful of posts dating back over several years observing the history of Wall Street- the real Wall Street, not the commercial money center banks outsiders incorrectly call by that term.

Hutton, Shearson, Lehman Brothers, Kidder Peabody, First Boston, Salomon, Morgan Stanley, Bear Stearns,, rushed to go public in the first big hoodwink of investors back in the 1970s and '80s. I've argued that since then, investment bankers discovered how to get a one-time huge windfall for dumping risk onto public shareholders at a premium.

Some former partners hung around for the lush paychecks and options. Others quickly moved back into private partnerships. That's how Blackstone, BlackRock and other private shops were founded. Add in hedge funds for the veterans of the formerly-private firms' trading desks, and you pretty much have the recreation of the old, old Wall Street of the partnership era.

Then there's Dillon Read, which has sold itself at a market top, then gone private at the bottom, so many times that it makes your head spin.

Schwarzman's Blackstone has even initiated round two of the big bilk, selling a slice of the private equity firm a few years ago, at what astutely proved to be a market top. You gotta love these equity mavens- convincing investors to buy shares of their own firm, while forgetting they were putting themselves on the other side of the trade from the sharpest equity valuation guys around.

What passes for the public face of it has been run by mediocre talent for some time. Even Goldman let itself get tangled up in seamy, public messes rising from originating, then betting against mortgage-backed structured instruments.

Meanwhile, the new barons of the financial sector are people like BlackRock's Larry Fink, Wilbur Ross, and Blackstone's Stephen Schwarzman, along with hedge fund titans like Steve Cohen and James Simons.

How this has escaped Keene for over a decade is beyond me.

Even in commercial banking, two of the nation's largest, old money centers Citi and BofA, are headed up by inexperienced, inept seat-warmers Vik Pandit and Brian Moynihan. A failed hedge fund manager and a lawyer. Some talent, eh?

As nearly the entire publicly-held US financial sector had to be rescued in 2008, thanks to poor risk management, it should tell you where the real brains of finance were- in private practice. Where they've been moving since the first wave of mergers after the original going-public wave of the '70s and '80s.

Phil Angelides on Bloomberg TV Last Week

Former FCIC chairman Phil Angelides appeared on Bloomberg TV last week one afternoon for a fawning interview during which he was asked to dispense his wisdom on a variety of topics.

What stuck with me was his insistence that the recent nearly-trillion dollar stimulus bill wasn't enough, and more must be spent to create jobs.

There were several other topics on which he was asked to opine. So many that I reasonably thought he must have some broad, long career in business, prior to his California political career. To ascertain that, I found and read Angelides' biography on a Stanford FCIC webpage.

To my disappointment, but, frankly, not surprise, he has a degree from Harvard in 'government' and absolutely no private sector experience. The Wikipedia page offers more detail on Angelides' political life. Suffice to say, he plunged into California Democratic politics upon graduation. Becoming Treasurer opened many more doors, including leading to his stint at CALPERS.

I suppose that career path, coupled with a Democratic Congress in 2008, with a Speaker from California, led to Angelides' chairing the FCIC.

What's curious is that there's nothing in his background to suggest he would actually comprehend all of the complex nuances of the events and actions by many players, including those in government, GSE and the private sector, which led to the boiling over of the crisis three years ago this fall.

Yet, having served on the FCIC, I guess Angelides is viewed as an expert on all things governmentally financial.

Nevermind that California's finances are a mess, and CALPERS has had its share of serious missteps, as well. Both of which you'd like to think would disqualify Angelides from being considered an expert on anything.

Which brings me to Bloomberg's producers. They must know that Angelides is essentially an empty suit. Like many other career politicians having no business experience, he would seem to have no basis on which to answer many of the questions a business cable television channel would ask of him.

But that doesn't stop Bloomberg from interviewing him on topics far afield from Angelides' experience, or the former FCIC chair from launching into lectures on such topics.

It seems to me telling that Bloomberg- and CNBC- focus so much on guests with essentially no business background but, rather, experience as government officials dabbling in business.

As they used to say in Hollywood.....that's entertainment!

Wednesday, November 16, 2011

Puzzling Economic News

This passage appeared yesterday evening in a daily email from a financial services provider which attempts to explain the drivers of US equity and fixed income market performance,

"Retail sales in the US were stronger than anticipated and prices at the wholesale level cooled markedly from the levels seen the month prior, while the first read on manufacturing activity for November coming from the New York region unexpectedly moved back to a level depicting expansion and business inventories were flat."

Yet we know that the real median consumer income has declined in the last decade, and unemployment remains high- in the 9% neighborhood on the narrowest definition, probably 16% on the widest one.

If there wasn't a large and high-profile environmental variable, i.e., the European sovereign debt/banking crisis, currently causing uncertainty, these slightly positive economic data reports might be seen as harbingers of economic recovery.

However, as I wrote yesterday, in retrospect, the signs of mounting trouble in 2007 didn't prevent hope and cheerleading by the financial community through much of 2008.

I believe it was Larry Fink, in his CNBC appearance yesterday, who proclaimed that when an economic and financial market recovery occurred, it would be a surprise which moved faster than investors might expect. Isn't that always how it is?

The overall macroeconomic picture today seems very cloudy. Even Fink agreed that while current economic signals appear weakly positive, the environment is gloomy. By that he apparently meant the political climate of excessive, intrusive governmental policy, weak employment picture, and low GDP growth.

It's been written that during the Great Depression, things were tight but bearable if you had a job. Those who were employed at larger companies tended to weather the period pretty much intact. But new job growth was absent, so the unemployed remained so for a long time.

Our current economic situation is beginning to resemble that scenario. There were brief periods of equity market rises and seeming economic expansion during the 1930s, but none of them lasted for long.

With that example in mind, I wonder whether profits from US companies, by themselves, are sufficient to trickle through to shareowners and drive a US economic recovery in the face of stagnant employment. It wouldn't seem that's a likely recipe for a robust US economic expansion.

Selective Memory In The Economist

I've subscribed to The Economist for over two decades now. I can't recall when the magazine's editorial pages didn't insist American tax rates had to be higher.

You'd think, given the publication's pedigree, that this would not be so. But, it is.

Yet, there's more to it than simply a stance on taxes that favors making the US more like, well, European welfare states. You know, like Britain.

There's also selective reporting to slant events.

For example, in an editorial regarding the Congressional supercommittee in the magazine's November 12th edition, you would read,

"Mr Obama and the House Speaker, John Boehner, discussed just such a grand bargain back in July, before the anti-tax wing of the Republican Party took fright."

Implying, of course, that Boehner succumbed to pressure from his more conservative House members. But that's not what happened at all.

Rather, as Boehner explained, he and Obama had a deal, then Obama succumbed to pressure from his base and added one more tax demand. Boehner walked on both principle and the particular tax issue.

But you'd never know it from reading that editorial.

It's tough to evaluate business and economic information when the reporting sources don't even get their facts straight.

Tuesday, November 15, 2011

Europe's Crisis & US Equities

Two asset managers appeared on CNBC this morning- Mario Gabelli and Larry Fink.

Of course, these days every manager is asked about Europe. I didn't pay enormous attention to Gabelli's comments, but recall him pushing industrial sector equities, which probably means that's where his book is.

Fink, however, was more interesting for several reasons. First, his firm, BlackRock, runs much more money than Gabelli. And Fink tends to be more thoughtful and expansive in his comments.

Listening to Fink, I was struck by two aspects of his remarks.

First, like many pundits and observers, he continues to see the prospect of countries leaving the Euro to return to their own currencies strictly in economic terms. This morning, Fink sort of threw up his hands and contended that it would be unmanageable for a country to have Euro-denominated liabilities while leaving the currency. But that's not really true. The country would simply have to manage its positions with the Euro like any other foreign currency. It's liabilities in Euro terms would require FX transactions to settle payments, just like dollar-denominated obligations.

Second, Fink began to describe the US economic condition as not getting worse, but a terrible surrounding environment. Then he generally recommended dividend-paying equities, as if to suggest that it would be unwise to expect price-based total returns going forward for the next several years.

When someone like Larry Fink, who controls the allocation of billions of dollars of investments, makes remarks like the ones he did this morning, I think you have to read between the lines. Fink knows that blunt remarks from the likes of him will move markets. That's not the type of book-talking he can afford to do. It might even make him, and BlackRock, liable for damages resulting from such gloomy public remarks which would negatively affect returns in the portfolios which the firm manages.

In that vein, Fink asserted that the current situation is not at all like that of 2008-09.

Yet, I can't help thinking that it actually is, in several respects.

Back in 2007, there was already a lot of discussion about commercial bank-sourced SIVs. Remember when those off-balance sheet holders of mortgage-backed instruments began to run into problems? Then in late 2007, several large US financial firms began to scour the globe for additional equity investments as they wrote off large losses on mortgage-related assets. By the spring of 2008, Bear Stearns was pushed into bankruptcy as counterparties withdrew funds and short term lending lines dried up.

My own proprietary equity allocation signal moved from long to short by the summer of 2008. In retrospect, the signs of a building problem with US equity valuations could have been said to have been building for nearly a year before the collapse of equity prices in the fall of 2008.

In the current situation, we've seen the European debt crisis begin in earnest in the spring of 2010. Things haven't really gotten better since then. Granted, the Greek and Italian governments have changed, but the realities of outstanding debts haven't.

Meanwhile, some fancy footwork avoided an outright default on Greek debt which would have triggered credit default swaps to pay off. But now, as Fink acknowledged, Europe is entering a recession. His comments about the US economy and equity strategies are tepid, at best.

Will we look back, from a year or so from now, and wonder how anyone could have missed the building signs of problems with global equity values which began to be apparent in the spring of 2010?

Perhaps in that sense, the current developing global financial strains do resemble the period of 2007-2009. A series of unresolved, connected and deepening financial problems that can't be magically resolved by climbing equity values.

It's one thing for equity prices to climb 'a wall of worry' about environmental variables which are missed or misread. But it's an entirely different matter for equities to rise amidst a large scale environmental variable such as global deleveraging in the wake of the 2007-09 financial crisis and its impact on Europe's large economies and nations. That's more like climbing in the face of real problems, not simply worries about whether problems exist.

Government-Sanctioned Ponzi Schemes Come Under Pressure- Here & Abroad

This past week's changes of government in Greece and Italy brought forth the following headline in the weekend edition of the Wall Street Journal: Europe Pulls Back from Brink.

Indeed, the last two days of the week saw a rise in the S&P500 of a combined nearly 4%. Hooray! All is well!

Ah.....not quite.

I've had discussions with several people over the past week on this topic. A few were kindred business persons, while several others were not. It's very good practice to explain these matters to economic neophytes, because one's reasoning has to be tight and sensible.

Simply put, since 1971, when the US dollar was decoupled from gold and became a fiat currency, inflation has raged. The Euro, too, is a totally fiat currency. As such, both have have been debauched by the governments which control them, promising ever-larger benefits and engaging in larger budget deficits so that politicians could buy re-elections.

When was the last time you heard a genuine discussion in the US Congress about cutting one or more programs in order to afford spending elsewhere? No, it's just spend more and print or borrow the money.

But the Ponzi scheme hasn't been confined to only government-provided defined benefit schemes.

In the November 7, 2011 edition of the Wall Street Journal, the Marketplace section's headline screamed Pension Trusts Strapped. It seems that the UAW and USW are finding their VEBAs- Voluntary Employee Beneficiary Associations- running out of money to satisfy the pension and health care obligations they were created to serve. VEBA's were conceived so that otherwise-bankrupt companies could off-load their legacy pension and health care obligations to the unions whose members were owed the benefits. In effect, for the unions and their members, it was take some money and manage the mess themselves, or see it all vanish in bankruptcy.

The UAW's VEBAs cover 820,000 employees and is said to be short some $20B for meeting its obligations.

Now, union officials are the ones telling recipients to expect higher premiums, larger contributions by retirees, or perhaps further benefit cuts. It seems that, once in union hands, the UAW VEBAs quickly cut some of the lusher medical benefits, such as prescription Viagra. Returns for the funds under custody of the unions aren't clearing hurdles of 9% per annum, thus squeezing the VEBAs from that side, as well.

Everywhere you turn, somebody's pie-in-the-sky, group defined benefit plan is being threatened by economic reality. Whether Greek public sector unions, Italy's generous social spending, US Social Security or the remaining private sector union defined-benefit pension and health care plans, they are all under pressure as a generation of retirees has pushed these legal Ponzi schemes to the breaking point.

You think any of this is going to be fixed in the next year or so? Or right after the 2012 election in America, if either party runs the table at the federal level to hold the White House and both chambers of Congress?

Think again.

Slowly, people in Western democracies are waking up to the reality that, whether public or private sector in nature, many retirement and medical benefit promises simply won't ever be kept. They can't be because they were never realistic in the first place.

If someone informs you that you will only collect, for argument's sake, half of the benefits you were promised, what would you do? The people with whom I discussed this all automatically said the same thing:

"spend less, save more."

Guess what will happen to OECD nation GDP growth rates for the next decade or more?

Forget any more "stimulus" spending by the major economies' governments. Who will be be lending to meet such borrowing? Which countries, while cutting entitlements, will simultaneously be splurging on other debt-fueled spending?

Due to a confluence of several factors, we're probably on the threshold of a phenomenon nobody's ever seen before- the vaporization of expected benefits for hundreds of millions of people which will affect spending and saving behavior, causing unexpected consequences at the macroeconomic level on a global scale.

I don't think it necessarily means equity market crashes. But I do think it means we are entering a period of heretofore unexperienced changes in the factors which will drive those markets.

Monday, November 14, 2011

More Warren Buffett Cornpone On CNBC This Morning

Warren Buffett appeared on CNBC this morning with plenty of his trademark cornpone and increasingly annoying guffaws.

This time he was spewing socialistic comments on taxing the rich, plus issuing ridiculous calls for higher taxes in general. Put Warren down as a limousine liberal. Would he have thought the same twenty years ago? More?

Absent on Buffett's part were such important aspects of the consequences of his views as the fact that taxing all of the income of the top 1% won't fund the government for even a year, if I recall Kyle Bass' analysis correctly. And there's the dangerously slippery slope which Buffett, having billions to give to charity, won't have to endure, i.e., how much 'more' is enough, and who judges that?

A young entrepreneur looking at confiscatorily high rates at the upper income ranges will likely behave differently than an old 'fat cat' like Buffett who has already amassed his fortune. Buffett's lifestyle won't be affected by almost anything the federal government does with tax policy, but that's not true for the younger, upcoming millionaires and billionaires of tomorrow. The more the chance to keep one's own earned money is reduced, the more the entire idea of the American Dream is subjected to socialism.

What's more sickening is that CNBC can't even dare to question Buffett's views, airing them with absolutely no critical challenges whatsoever. How about having Kyle Bass on the phone available to engage Buffett in defending his rank socialist views?

On the professional front, Buffett's big announcement was that he's accumulated about 5.5% of IBM's equity. Then he went on to babble about 11% of the firm's equity changing ownership in a year, and that turnover is so high these days. Of apparent note was that IBM is considered a technology company, which is a sector Buffett has historically shunned out of lack of understanding.

It was a charming throwback to antiquity when Buffett told how he actually read the recent annual report and, gosh darn it, liked what he read, so he bought 5.5% of the firm. And encouraged other investors to read that report, too!

Unfortunately, real investing is a bit more complicated than reading annual reports. At least it is if you plan on owning equities that constitute a portfolio which consistently outperforms the S&P500.

What Buffett doesn't seem to acknowledge, regarding the share turnover question, is that, in the decades since the Big Bang on the NYSE which cut brokerage fees, and the subsequent explosion of volume and mutual funds, people have access to cheaper professional management of their money. Especially via 401Ks invested with mutual funds. Buy and hold a la Graham and Dodd was conceived in an era of a 14% round trip charge on trades, versus flat dollar fees today.

The volatility and erratic performance that individuals might have to live with when investing on their own is probably less tolerable from a paid manager. Thus, more trading occurs in the quest for better returns all the time.

Now consider what Buffett reiterated this morning regarding his own holdings- Wells Fargo and BofA. They are erratic. Buffett no longer behaves like a typical manager, in that he doesn't even attempt to mitigate inconsistencies in his company's returns. While IBM has been moving toward being a consistently superior equity for years, BofA and Wells Fargo are not. BofA is a disaster, and Wells has tracked the S&P, meaning you'd be exposed to similar returns for far less risk by owning the index, rather than WFC. These price series are illustrated in the first nearby chart.

 I contend that if Berkshire's price charts were labeled Fund X and compared to other funds, Buffett's company would be judged inadequate, inconsistent and, at best, mediocre.

But being Buffett, people forgive performance lapses because they buy into a now decades-old performance that no longer exists.

A firm Buffett said he can't and won't buy- Microsoft- tells you something about his judgement.

Microsoft, as my prior posts have illustrated, has had a lost decade of flat returns. It's been a disaster. Yet Buffett claimed he won't invest because, as a friend of Bill- Gates, that is- he would be accused of having inside information. He didn't just bust out laughing at the prospect of throwing his investors' money away on a moribund has-been technology company if he bought shares of MSFT.

 To illustrate the inconsistency of Buffett's firm's performance, consider the next three price series charts. They compare BerkshireA with the S&P500 Index for the past 1, 2 and 5 years.

For the past year, the S&P has outperformed Buffett by 10 percentage points. For the past 24 months, they are even. For the past five years, Berkshire outperforms the S&P by 20 percentage points.
Berkshire has become something of a timing stock, at best. At worst, whether due to size of the portfolio, or Buffett's outdated selection strategy, it's simply seen its returned attenuating toward the index.

For what its worth, IBM has been near qualifying as an equity in my portfolios because of its increasingly-consistent relative performance on several key criteria. But, unlike Buffett, my strategy doesn't blindly hold for years. It continually assesses consistency of performance.

Of course, I'm not Buffett. As I noted earlier in the post, investors have long since given up measuring him by the same standard as they would other managers. Thus my point that if Berkshire were included as a choice among funds to choose, with its name changed, I doubt it would get the investment it does because it's affiliated with Buffett.

Frankly, anyone who would seriously consider investing in Microsoft would, on that basis alone, scare me off.

But that's the world according to Buffett. It's a different investing world with different rules. Performance doesn't matter as much as it does for lesser-publicized investment managers. 

Is There Really US Income Inequality & What Exactly Would Be Its Impacts?

Some months ago, I had a discussion with a friend regarding income inequality. Being a systems engineering consultant primarily working with he military and its suppliers, he cited an author who claimed that significant income inequality had presaged the fall of great powers in the past.

Currently, the Occupy Wall Street crowd focus on income inequality, screaming about the "1%" versus the "99%."

Income inequality is often measured via some variant of the Herfindahl Index, described in that linked source as it applies to its original subject, market share concentration,

"It is defined as the sum of the squares of the market shares of the 50 largest firms (or summed over all the firms if there are fewer than 50) within the industry, where the market shares are expressed as fractions. The result is proportional to the average market share, weighted by market share. As such, it can range from 0 to 1.0, moving from a huge number of very small firms to a single monopolistic producer. Increases in the Herfindahl index generally indicate a decrease in competition and an increase of market power, whereas decreases indicate the opposite."

As applied to incomes, one simply substitutes that variable for market shares. The principle is the same.

However, regardless of how one measures income concentration, the question is the same: what exactly are the impacts of various levels of income equality or inequality?

I can't answer those questions, because I don't have primary research data to support any specific response. But the constant harping by many liberals on this question causes me to ask three more related ones:

1. What would be the empirical relationship, were we to have the data to assess it, between income concentration and periods of human innovation and growth in average standards of living?

2. What were US income concentrations in past eras? Particularly, for example, after the Revolutionary War, during the pre-Civil War era, then 1880s-1890s, and the early 20th century?

3. What are the percentages of various income levels that change to higher or lower levels through time?

Let's take the first question. What I'm attempting to get at is the phenomenon of capital accumulation and its effect on civilization. Whether it involves infrastructure such as roads, dams, water provision, sewage or art, such non-subsistence-level human activities require capital. And capital comes from savings, which is, definitionally, the positive difference between production and consumption.

If a society doesn't have capital accumulating, it's not going to advance on any significant dimension. Historically, unless you sign up for hereditary monarchies or feudalism, capitalism is the economic system which has done the best job combining merit-based wealth accumulation and the ability of a society to accumulate capital for which allow investments that, over time, improve general standards of living.

Specifically, in the US, I'd love to know the answer to the second question. Has the US experienced major changes in income concentrations over these eras? What do you think income concentration was like before the middle class ushered in by the Industrial Revolution?

Further, what does it say about US income concentration that Steve Jobs, Bill Gates and Mark Zuckerberg, none of whom apparently completed a four-year college degree, all became billionaires within the past two decades? And Larry Page and Sergey Brin, the co-founders of Google, did so within the past several years, though they finished college.

It appears that the potential for Americans to create wealth for themselves still exists. Perhaps not all are created equal and, thus, incomes won't ever be equal. Or perhaps some of the now-vocal 99% are simply lazy, or have made poor career choices.

Thirdly, from years in business, and my own proprietary equity research, I'm rather distrustful of simple static analyses. Simple static pictures of US income concentrations aren't as useful, informative or actionable as would be quintile-quintile migration tables for US incomes. Or any of several other ways of depicting the dynamics of US income concentration among specific groups of Americans.

What percent of the current top 5% of US income earners are children of similar income earners? How many years, on average, do people remain in a particular income strata?

The existence of Jobs, Gates, Zuckerberg, Page and Brin tell us that it's still quite possible in America to vault from median income to substantial wealth, even to the level of the top 1% of American incomes, in just a few short years.

So we know that US income mobility is still alive and well. And, really, that was one of the fundamental purposes of our nation's founding. You know, that old line,

", liberty and the pursuit of happiness...."

If, as I hypothesize, the early days or our Republic were marked by greater income concentration than that over which people currently Occupy parks in various US cities, perhaps they weren't all that discouraged. After all, having liberty was not a trivial thing. And still isn't.

And the pursuit of happiness was, for many homesteaders both before and after the Civil War, the ability to have and work their own farm or business, regardless of its economic prosperity.

It seems to me that we have far too little evidence of a problem with the dynamics of US income concentration at this time. There will always be a lower echelon of income earners. And, if I'm correct in my hypothesis about the early years of our nation, income disparities didn't prevent people from immigrating to America- it spurred it. As it has until very recently, when the economic growth of the nation began to slow.

How people got to an income level, and for how long, on average, people stay there, and how many rise, is of more interest in determining both if there is a problem in the US with income concentration, and what to do about it.