Friday, July 22, 2011

The iPad, The Laptop & Schumpeterian Dynamics

This week has seen some interesting fireworks between Intel and various analysts concerning the future of personal computers and laptops.

Specifically, upon learning of Apple's blowout quarter and torrid pace of iPad2 sales, many pundits have pronounced he laptop effectively dead. With a generally-acknowledged 2% p.a. growth rate, the former desktop killer has been itself eclipsed by X-pads of several varieties.

I had the occasion recently to assist a friend in buying an iPad2. What I saw caused me, prior to the flurry of this week's analyst and pundit remarks, to conclude that the laptop as a home device has seen its best days.

It began with a visit to Barnes & Noble. My friend picked up a Nook, sneered and asked why she'd ever want to read books like that? A few minutes later, she wanted to buy one! When I saw the $249 price of a color screen Nook, I told her to wait and visit the nearby Apple store to check out an iPad.

Specifically, per my prior posts, I suggested that she buy a pad made by the firm selling it, and that she choose one with more applications than simply ebook reading. I had in mind that she could replace a laptop's functionality at a fraction of the price, with much greater ease of use.

How right I was.

She asked me to accompany her to the local Apple store a few days later. After steering the Apple rep to some specific topics of interest for my friend, we left the store and discussed what we'd heard. We returned about an hour later and she bought an iPad2 without the cellular modem.

As expected, the post-sale support to configure her iPad was superb. She left the store with iTunes, a web browser, text writing and ebook apps on her device, plus a few books to start. It took no effort for the iPad to recognize my friend's home wireless network and connect.

Since then, she's been attached to the device whenever possible.

And, just as I expected, she no longer needs to use a laptop, with its long bootup time, operating system and hard drive. Instead, the solid state, unbelievably small and thin iPad does everything she needs as a casual user who does not run a business on a laptop. Whatever questions she has can be answered during the store's afternoon workshops held, for free, just for that purpose.

It's no surprise to me that Apple is selling all the iPads it can assemble. And why laptop sales have faltered.

I doubt I'd buy another laptop, except for business purposes. For home use, traveling and general non-business daily use, it would be difficult to see why an expensive laptop would be necessary.

Despite Intel's attempts to rebut the analysts' 'death of the laptop' theme this week, I believe the latter are correct. Schumpeterian dynamics are hitting laptops with a vengeance.

Just as lighter, cheaper and better laptops eventually made consumer desktop computers obsolete, so, too, are the many X-pads, particularly the iPad, rapidly cannibalizing laptop sales growth.

Yet another reason not to sell Apple short, literally, just yet. But I wouldn't want to be caught holding equity in HP or Dell.

Thursday, July 21, 2011

Goldman Sachs' Earnings

It's beginning to get positively humorous listening to various bank sector analysts and fund managers discuss recent earnings and hoped-for future performances of six large US financial institutions: large commercial banks Citigroup, Chase, WellsFargo, BofA, and the one-time investment banks MorganStanley and Goldman Sachs.

Nearby is a price chart for the six, plus the S&P500 Index, for the past two years. Some results surprised me, while others did not.

The S&P outperformed all six banks, which I expected. That Citi was next best was a shock. I suppose it's because of a rebound effect of coming out of government ownership. Careful examination reveals that the formerly-insolvent bank has headed downward in terms of shareholder value since the beginning of the year.

The next pair of banks tracked each other closely- Wells and Chase. Neither one was close to failing, but, then again, neither was ever really a stellar bank, either. Solid middling finishes below the Index.

Last come BofA, MorganStanley and Goldman.

BofA I would have expected, as well as MS. Goldman has been declining all year, along with the other two.

Yesterday, I listened to some pundit on CNBC declare that he confused Goldman's results with MorganStanley's, so mediocre were they. Much was made of Goldman's pullback from risk, thus causing a precipitous drop in trading earnings. That the firm is not diversified and balanced, like Chase or Wells, so it's suffering from the misfortunes of only one business. The Wall Street Journal carried a prominent piece critiquing the firm's quarterly performance, as well.

Noises are being made about Goldman tightening its belt for a lean year, cutting staff and riding out the near term markets.

However, stepping back a bit to study the price chart above, I think something else is finally occurring.

The most significant feature of the chart, for me, is that the S&P500 has outperformed all six banks over the two years. Further, all six are generally in decline since January, while the Index has flattened or been slightly positive.

Here we are, two years after the recent global market lows, and the largest US financial firms haven't been able to outperform the broad market.

One-time thoroughbreds MorganStanley and Goldman Sachs are slumping, likely the victims of intended consequences of the Dodd-Frank regulations. Ordinarily, I'd say bet on monoline financial service firms. But given the punitive nature of Dodd-Frank, and the reasonable effort to separate risky trading activities from government-insured businesses, that probably no longer holds for these two firms.

As for the other banks, well, I think it boils down to this. Sector analysts like Tom Brown and Dick Bove have to make a living, so they'll be calling an eternal horse race among the four. But BofA remains poorly-run and generally expected to splinter at some point in the near future. Citi remains a wreck, too. Once the various capital market effects of its brush with death fade, it can return to being a large, poorly-run, badly-designed large bank. Perhaps, like BofA, it, too, will finally shed some of the more cumbersome businesses in its portfolio.

Which leaves the two mediocre leviathans, WellsFargo and Chase. Neither is anything to write home about. They will likely remain timing plays for the analysts to use as fodder for their cable television appearances as the banks rise and fall over the ongoing quarters. If BofA and Citi become less horrific, they can rejoin that short list.

Whether Goldman or MorganStanley return to private partnerships is unclear. With the former's downward vector, it would be a classically bold, yet sensible move for the firm to buy itself when others see little value in owning it.

But what's pretty clear is that we are witnessing the last stages of consolidation and stagnation of publicly-held private financial sector firms in the US. Conventional commercial banking among the large players has become predictable, overly-regulated, costly and uninteresting. Investment banking looks to be suffering as intended under Dodd-Frank.

The US banking sector, at the large end, is nearly at the point of being appropriately uninteresting as a home for long term, consistently superior total return performers.

Wednesday, July 20, 2011

No Inflation, Huh?

So there's no consumer price (for want of a better word, because this isn't the technically correct one) inflation, huh?

Last night I dropped by a Starbucks location on my way home to buy a pound of espresso beans. For as long as I can recall, it's been a $10.95 purchase.

Except last night. It suddenly jumped to $12.95.

An 18.3% price increase!

To be honest, I'd read over a month ago that the chain was going to be raising prices soon. I'd expected it last time I bought my espresso beans.

I rarely buy coffee drinks at Starbucks, preferring, instead, to brew my own espresso for cappuccinos and iced lattes at home. A pound of beans probably lasts about a month. So you'd think that $24/year more for coffee shouldn't matter.

And maybe, to me, it won't, very much. Perhaps two fewer inexpensive dinners out in a year will cover the cost.

But what about the poor schmucks who are addicted to their daily Starbucks fix? Are they going to head to Dunkin Donuts or McDonalds now? Or just spend less on something else each day?

Either way, I call this a definite food price increase. If I had a word that didn't mean debauching the value of our money (inflation), that's what I'd call this.

Taxes, Economics, Rawls & Nozick

In the current fight between Democrats and Republicans concerning the debt limit increase, one hears the former primarily focus on the notion of 'fairness' of taxation.
That is, the president and his party's members of Congress will take a few favorite elements of the existing tax code, such as existing rates for higher-income earners, reduced under President Bush in his first term, and grudgingly extended last year, or special provisions for private business aircraft, and hold them up as 'unfair' to lower-income earners.

Of course, from a purely objective perspective, the reason for taxes is to raise money to fund governmental operations. As these posts on taxes that I've written discuss, tax policy has consequences on taxpayer behavior, regardless of whether politicians believe it to be so, or the CBO models such affected behavior.

It's common knowledge that the CBO uses what is known as 'static scoring,' wherein simple arithmetic changes are modeled for tax policy changes. That is, an hypothetical change is modeled as ex post on pre-existing incomes, spending, investing, etc., with no assumption that such a change may have, in reality, changed prior behavior.

Along with this myopic scoring goes the misguided concept of 'paying for tax cuts.' This peculiar view assumes that some tax revenue level is due to the government, so any change in tax law that results in the static scoring showing lower total tax revenues must be 'paid for' by either new taxes or higher rates elsewhere.

Of course, any fool who reads that second sentence instantly realizes its idiocy. You get less of what you tax, so trying to raise more tax revenues through higher rates or new taxes is, overall, self-defeating.

This is why, among the 22 tax-related posts I've written, you will find a couple detailing economic research leading to Hauser's Law, wherein, over time, a fairly consistent 18% of US GDP is collected via taxes, regardless of tax rate structures.

Once you understand and accept that relationship, it becomes obvious that the way to increase gross federal tax receipts is to set rates at levels that maximize GDP.

But this assumes one uses tax policy primarily as a means to fund government. And it distinguishes between tax rates, and tax receipts, which may be inversely related.

But many liberal elected federal government officials in Congress and the White House choose to discuss tax policy primarily as a tool to enforce "fairness."

Unfortunately, when you attempt to make a single policy, such as tax policy, serve two objectives, such as raising maximal or sufficient government funding, and enforcing some undefined notion of "fairness," you get, well, a mess. Especially when measures of fairness are not obvious.

Yes, there are various indices of differences between high and low incomes or taxes paid. As with the subject of concentration of market share in sectors, one can design various measures purported to indicate relative uniform distribution or distortions of any variable.

However, the basic notion that there is some "fair" amount of tax receipts, or their income, which "the rich" should pay, doesn't seem to be any sort of bedrock, fundamental Constitutional principle.

In fact, if you read the Constitution, as I did this morning, it was originally written rather vaguely and imprecisely on the subject of taxes. The only thing that was fairly clear about taxes in the original, pre-1912 Constitution, was that taxes were levied on business activity, not people.

Even today, one could choose to replace the income tax with a spending tax, if one so chose. There isn't really anything special, per se, about income-based taxes, except that it appears to penalize those who earn more.

By the way, which should be the subject of fairness- tax rates, or tax revenues, or percentage of toal taxes paid? Or is it subjective, i.e., whichever soaks the rich more is "fairer?"

On that subject, and this one, it so happened that I stumbled upon a discussion of this topic yesterday morning on CNBC. Due to the loss of Erin Burnett to CNN, and Mark Haines to death, the network has switched its co-anchor lineups, replacing Carlos Whathisname in the 6-9AM slot with Andrew Ross Sorkin, a NY Times liberal media darling.

At issue, with Michele Caruso-Cabrera defending the conservative viewpoint, was whether high-income taxpayers are "giving back" to the nation by paying a lot of gross dollars in taxes. Apparently the president recently called out Apple's Steve Jobs, by name, for failing to "give back" sufficiently to America via charity, as his rival, Bill Gates, has done.

This is an excellent example of why it is dangerous to allow government to begin to use concepts such as "fairness" in taxation policy.

Who is to be our arbiter of what is "fair" for anyone to pay in taxes, or charity, to the nation? Why is it necessary that tax rates even rise with income level? Surely, if there were one flat rate of, say, 10%, then a person earning $1MM would already be paying 10 times the amount paid by someone earning only $100K.

Isn't that "fair?"

The Constitution is notably silent through most of its original language on the topic of citizens having direct relationships with the federal government. One surely does not get the idea, when reading it, that the Constitution had as any of its purposes to enshrine a climate of punishing those Americans who either earned high incomes or amassed large amounts of assets.

How odd, now, to hear one party continually beat a drum for all conversations involving government debt, deficits and spending, to immediately become about "the rich" paying "their fair (meaning higher) share" of taxes.

I find it helpful to step back and recall studying, as a graduate student, two well-known Harvard philosophy professors- John Rawls and Robert Nozick.

At the time, being young, I was enamored of Rawls' concepts as stated in A Theory of Justice. Being a good social liberal, Rawls was big on equity of distribution. I thought this was important at the time.

In contrast, Nozick, a libertarian, concentrated on minimalist states which provided the barest necessary levels and tools of government, in order to leave individuals with maximal liberty and responsibility for their own destinies, as he wrote about in Anarchy, State and Utopia.

I suspect because it's easier for most people to grasp the notion of dividing up an existing pie of resources, or tax obligations, they do not pay as much attention to the notion that some tax and government schemes create substantially larger pies of resources, such that either smaller assessments raise as much tax revenues, or equal assessments raise even more.

It seems that our current Democratic office-holders can't grasp the notion that the US economy would grow faster with simpler, lower tax rates, thus providing even more tax revenues than much higher rates which distort economic resource allocation and retard economic growth.

Besides the purely subjective nature of class-warfare style polemics characterizing whatever "the rich" pay in taxes as "insufficient" or "unfair," such approaches ignore the more basic, pressing function of tax policy, i.e., to fund our government.

And nowhere in the Constitution is there any language concerning what is "fair" about treating high income earners or the wealthy differently than anybody else.

Tuesday, July 19, 2011

Tom Brown At It Again

Just last week I wrote this post discussing Tom Brown's gung ho, self-serving talking of his bank sector equity portfolio book on Bloomberg.

Unbelievably, he was back at it again this morning on the same network. This time it was to bemoan Goldman Sachs' disappointing earnings announcement, specifically its trading revenues.

Facing obviously uneven results in the banking sector, Brown had to act fast on air to try to convey why investors should remain interested in banks with such earnings problems.

What came next was something for which I was unprepared- old fashioned Wall Street sell-side hucksterism.

Brown harked back over 20 years to when, he so modestly disclosed, he had coined a now-famous meaning for BofA's ticker, BAC- "Buy All you Can."

Wow. I mean, how much more distilled can Brown's brilliance get? And it's so long-lived, too! Over twenty years!

I first heard this sort of nonsense years ago when I briefly dated a stock broker. She repeated the apocryphal phone patter for me by rote, in her thick Brooklyn accent,

"If you liked it at 60, you'll love it at 50 and you marry it at 40."

In short, declines are always and only opportunities to buy before the equity swings ever-upward again. Colossal management mistakes which led to current losses are surely one-time gaffes. These same managers, or their successors, will never- never- make another mistake of similar size. Really. Trust him. It's safe now. This time, it'll be different.

This morning, Brown went on to forecast, somewhat murkily, that in six quarters, BofA would be doing just fine, so load up on it now.

Funny thing about those pesky investors- they actually don't like to be told to wait six quarters for a return. They prefer constant, positive returns, when possible. And when you're counseling investors to buy and wait for a stock in a sector that cratered so badly in 2008 that it had to receive a federal bailout of unprecedented proportions, it is not a comforting recommendation. A lot can happen in six quarters.

But consider Tom Brown's dilemma.

If he tells the truth- that the large-bank sector is moribund, populated by slow-moving, heavily-regulated financial leviathans which are only good as very risky timing plays, retail investors will leave his fund.

If he tells the truth that right now just isn't the best time to buy large-bank stocks, retail investors will leave his fund.

Brown's objective is to say things, preferably on air, appearing as an objective analyst, rather than an interested portfolio manager, which keep his investors in his bank stock portfolio fund.

Once investors sell out of his fund, they may never return, captured by some other manager's line about some other sector. Perhaps technology, or cloud investing, or even gold and other commodities.

So Brown must act quickly to prevent such redemptions and departures.

In this light, BofA's recent large losses become an opportunity to buy low. Goldman's lower trading revenues? You should love it even more at its new low price!

Witch hunts on Wall Street come and go. New regulations, like Dodd-Frank, come and go.

But basic, unvarnished sell-side Wall Street hucksterism of Tom Brown's variety never, it seems, goes out of style.

Monday, July 18, 2011

Pity Poor Citi?

The weekend edition Wall Street Journal's Heard on the Street column was actually laughable.

David Reilly argued that Citigroup's market/tangible book value is too low. Specifically, it's below that of BofA. Thus the title of Reilly's piece, Let Citi Out of Doghouse.

Let's see.....a bank run by a guy who's never done commercial banking, nor run anything large, which operated itself into insolvency under the guy's predecessor, a lawyer, should now be treated as a brand new bank?

I don't think so.

Mediocre as it is, BofA at least didn't technically need to be rescued by the Fed, while Citi would have been in Chapter 11 without the government's stay of execution.

As an example of corporate cronyism, poor board performance and overall ineptitude, it would be difficult to find a better one than Citigroup during and after the Weill-Rubin years.

Meanwhile, novice CEO Vik Pandit has done nothing appreciably significant but ride out the resulting storm and manage to cling to his job. The government and financial markets did the rest.

And this is reason to suddenly improve its valuation?

Hardly. Look at the nearby price chart of the four large US commercial banks and the S&P500 Index for the past five years. Performances since the financial crisis are, to me, expectedly similar. A few minor differences, with BofA recently diving. But, for the most part, all four are pretty much flat since the beginning of 2009, as is the S&P.

Like all four of the largest US commercial banks, Citi is simply a government-backed financial utility that wouldn't even actually need a CEO to run it anymore. Any investments in the equity of Wells, Citi, Chase or BofA is, at best, a timing play. Nothing more.

Their total return performances are all, to varying degrees, depending upon their specific business mixes, more vulnerable and dependent upon market conditions, rather than the micro-management of the banks themselves.

More Economic Nonsense from Alan Blinder

Only last month Princeton's Alan Blinder was in the Wall Street Journal espousing discredited economic theory. On the subject of his views, and Alan Meltzer's comments thereon, I wrote,

"Specifically, Meltzer discussed more recent economic work showing that investors and consumers take note of government actions and develop expectations as a result which then affect their behavior.

These reactions involve several of the points I made in yesterday's post, i.e., expectations by consumers and investors regarding future tax and interest rates affect their behavior in a very dynamic and sensible manner. Some of that effect can result in a sort of palsy, in which both spending and investment await less government intervention and more predictable behaviors.

Meltzer's comments added an interesting dimension to the exchange because, without appearing mean-spirited, he basically characterized Blinder, Krugman and their kindred economists as rather backward and primitive, clinging to a discredited, eighty-year-old theory which has been eclipsed by new theory based upon empirical research."

Blinder was at it again last week in the same paper. This time Blinder was castigating businesspeople for not hiring, and advancing his own personal remedy involving some sort of payroll tax credit.

Sadly, he demonstrated the same, well, to use a pun, blindness to how business managers react to uncertainty. Specifically, in the face of slack or uncertain demand, they don't rush out to hire more people. Blinder couldn't seem to fathom that his model of cost-push hiring isn't how the real world operates.

Yes, for non-perishable end-use products in a grocery store, lowering the final cost will spur demand, according to conventional microeconomics.

But hiring workers to produce goods or services isn't the same thing at all. When revenue growth is in doubt, making incremental workers cheaper isn't relevant and won't affect hiring decisions.

It's more evidence of how far removed from the realities of business many economists are. And Blinder is clearly one of them.

Sunday, July 17, 2011

Is A US Default Is A Good Thing?

Over on my political blog, I've been writing in partisan terms about the current standoff between the GOP-controlled House and the president regarding the soon-to-be-reached US debt limit.

In this post, I'm going to attempt to be non-partisan, and, instead, engage in a thought experiment concerning the US debt limit and default.

Everyone seems to believe that a real US default would be bad. Two months ago, I wrote this post discussing Stanley Druckenmiller's weekend interview in the Wall Street Journal. He contended,

"A financial crisis is surely going to happen as big or bigger than the one we had in 2008 if we continue to behave the way we're behaving," says Stanley Druckenmiller, the legendary investor and onetime fund manager for George Soros. Is this another warning from Wall Street that Congress must immediately raise the federal debt limit to prevent the end of civilization?

No—Mr. Druckenmiller has heard enough of such "clamor and hyperbole." The grave danger he sees is that politicians might give the government authority to borrow beyond the current limit of $14.3 trillion without any conditions to control spending.

"I think technical default would be horrible," he says from the 24th floor of his midtown Manhattan office, "but I don't think it's going to be the end of the world. It's not going to be catastrophic. What's going to be catastrophic is if we don't solve the real problem," meaning Washington's spending addiction.

"Here are your two options: piece of paper number one—let's just call it a 10-year Treasury. So I own this piece of paper. I get an income stream obviously over 10 years . . . and one of my interest payments is going to be delayed, I don't know, six days, eight days, 15 days, but I know I'm going to get it. There's not a doubt in my mind that it's not going to pay, but it's going to be delayed. But in exchange for that, let's suppose I know I'm going to get massive cuts in entitlements and the government is going to get their house in order so my payments seven, eight, nine, 10 years out are much more assured," he says.

Then there's "piece of paper number two," he says, under a scenario in which the debt limit is quickly raised to avoid any possible disruption in payments. "I don't have to wait six, eight, or 10 days for one of my many payments over 10 years. I get it on time. But we're going to continue to pile up trillions of dollars of debt and I may have a Greek situation on my hands in six or seven years. Now as an owner, which piece of paper do I want to own? To me it's a no-brainer. It's piece of paper number one." "

I think Druckenmiller is correct, and generally on the right track.

Suppose the GOP has dug in its heels and will only raise the debt limit with associated, larger spending cuts, and the Senate won't pass such a bill. Or, if it does, Obama won't sign it, daring Congress to allow a government shutdown.

We've all had the last week's worth of presidential press conferences to digest, let's take Obama at his word- that he will tell Geithner to stop writing any checks whatsoever if the debt limit isn't raised.

I think this would actually be a good thing. But to believe it, you have to also believe, as Druckenmiller does, that US fiscal policy for the past few decades has been seriously wrong. That running chronic large deficits since the 1930s has become a habit that cannot be sustained for more than the next few years.
Druckenmiller contends that no serious change at all in federal spending and disposition regarding its habits would be the worst outcome. And if the GOP rushes to capitulate after a government shutdown, there won't be such change. Obama will declare political victory, many Tea Party voters will be disgusted with the GOP.
But if Obama faces a GOP House whose members are willing to force a shutdown and, then, after it is clear there won't be capitulation, an ordered payment of federal obligations, while some functions are shuttered, everyone- global investors, voters, onlookers- will understand that things have changed.
In the meantime, the US would have lost its AAA rating. No matter which party gained relatively greater power among Congress and the White House in 2012, a return to borrowing and spending for new programs would no longer be an option. Interest rates would be too high on Treasuries to borrow much more money, if investors would even lend it. Slow economic growth and joblessness would make higher taxes on anyone a non-starter.

In short, a default now will bring forward what I believe would be the eventual outcome of political business as usual in Washington, which will continue without a default.

The United States is currently governed, for the most part, by a Democratic control of the executive branch, with its veto, and the Senate. Like it or not, the House can really only frustrate Democratic attempts to pass legislation, but it cannot, on its own, make policy.

Whether it's this group of Republicans, or another, after a brief return to Democratic control of the House, Senate, and Oval Office, and the final orgy of unaffordable deficit spending, it will likely now take some catastrophic event such as a credit rating downgrade and default to wake up Washington politicians to what is understood by many American voters and most global investors, to wit, no small change in American federal government fiscal policy will suffice any longer.

There must be wholesale changes in entitlement spending, the tax code and routine spending. Even leaving Social Security and Medicare untouched for the generation that concocted those Ponzi schemes won't suffice anymore, either. To truly fix what ails America, the coming fiscal pain must be shared by all, not only those victimized by the Porkiest Generation's self-interested entitlement scams.

Thus, I welcome a government shutdown, default and even a credit rating downgrade sooner, rather than later. Because it's coming, and later simply means more borrowed trillions for all of us to repay, with much higher interest. I don't believe most federal elected officials, nor Americans, truly comprehend the scope of the fiscal hole into which we've allowed our Congress and presidents to dig us since 1935. But it will probably require the economic equivalent of wartime belt-tightening for at least a decade to rectify it. By that I mean a near-total shift to defined contribution entitlements, retroactively changing Social Security, Medicare and Medicaid to such bases, large-scale elimination of federal spending on non-essential, non-common-good services, lower, globally-competitive tax rates, tax-preference item eliminations, and overal federal spending at or below 18% of GDP. Period. No more deficits.

To do otherwise, in my opinion, is like giving a self-confessed alcoholic more to drink, agreeing that he can always stop drinking tomorrow. Well, tomorrow will never come in that scenario.

And it won't in Obama's current fiscal scenario of off-limit programs for cutting, higher taxes, and modest, future spending cuts in exchange for the debt limit increase.

I know this seems to be a gloomy, dark scenario. But after decades of warnings of the insolvency of Social Security and Medicare, the continued unsustainable deficits spent by both parties, and a lack of awareness that there simply isn't time to avoid sharp spending cuts, I'd rather have external, uncontrollable fiscal consequences shut the door on liberal, big-spending American government starting in August, than rely on conventional, internal-to-America political swings to do it later.