Friday, October 14, 2011

Great by Accident?- More Flawed Research by Jim Collins

Several years ago, after seeing multiple references to it, I bought a used copy of Jim Collins' Good To Great, published originally in 2001. I wrote this brief review in 2005 and, judging by the lack of subsequent pieces on the topic, didn't really find more of interest in the book to bother critiquing. Some of my key observations were captured in these passages from that post,

"Much of my work for the last decade has involved measuring the performance of publicly-held U.S. corporations. There is really only one body of work of which I am aware that sounds remotely similar to mine.

What I found upon reading Collins’ methodology was an odd mixture of quantitative and qualitative bases of analyses. There are a variety of problems with his methods, which I will ......."

I must admit, I was rather shocked that such slipshod and simplistic quantitative definitions of “good” and “great” performances would exist in a book so seemingly well-regarded in the business community. Perhaps it is yet another case of the broad class of mediocre managers and leaders being unable to distinguish “great” work when they see it.

Between his use of market value, rather than total return, and a simple point-to-point measurement, Collins' metrics in his original book left a lot to be desired. As did his mixing in of qualitative measures which tend to be so judgemental as to be nearly useless for interpretation or application in other contexts.

Unless, of course, you were using the book as a marketing tool for your consulting efforts. Which Collins does.

Thus, I was interested to read in this past Tuesday's edition of the Wall Street Journal a review, by longtime Journal executive Alan Murray, of Collins' recently-published book, Great by Choice. The review's title was Turbulent Times, Steady Success, which I found a bit of a reach, for reasons I'll explain later in this post. The highlight, or subheadline for the review read How certain companies achieved shareholder returns at least 10 times greater than their industry.

To start with, Collins uses cumulative returns over long periods of time to judge a company as “good” and/or “great.”

However, my own research on large U.S. publicly-held companies reveals that among companies which outperform the S&P 500 average total return over a period of years, firms which consistently outperform the S&P index, on average, create shareholder wealth at a much higher rate than companies which earn most of their total returns with a few years of outstanding performance.

Just reading those few lines told me a few things about problems with Collins' latest work. In fact, Murray's review contains enough information for me to find significant problems with Collins' latest work without having to actually waste time reading the whole thing.

First, I'm suspicious of published work of this type because no sane, intelligent person in the business world has published complete information on any market-beating strategies for decades. Whether a business school professor, consultant or equity portfolio manager, it doesn't pay to tell all. You always save something so that your published work can't be totally replicated or reverse-engineered, and prospective customers have to engage your services professionally to really benefit from your research findings.

One thing I discovered in my own proprietary research on US corporate performance over many years is that there is a limited timeframe within which most companies can demonstrate superior performance. And it's not a sufficient length of time to typically exhibit "steady success" during "turbulent times."

But, let me get to Murray's review. He begins with this telling paragraph,

 'Great by Choice" is a sequel to Jim Collins's best-selling "Good to Great" (2001), which identified seven characteristics that enabled companies to become truly great over an extended period of time. Never mind that one of the 11 featured companies is now bankrupt (Circuit City) and another is in government receivership (Fannie Mae). Mr. Collins has a knack for analysis that business readers find compelling."

Murray may have written that with his tongue in his cheek, but it lays bare a serious weakness with that type of approach. One I mentioned in an email to Murray after reading his review. I likened Collins' work to that of long-ago consulting guru Tom Peters, of "In Search of Excellence" fame. As I explained to Murray in my note,

"But the other aspect of his work which I noticed, having the benefit now of being aware of two of his works, is how much it reminds me of the Tom Peters' old type of 'great companies' books. Being, like me, of that certain age, I'm sure you recall the book which launched Peters out of McKinsey. Sadly, only a few years later, his great companies were no longer so.

I'd expect Collins' companies are likely to experience similar fates, because both authors use fixed timeframes of specific companies to construct their measures of greatness, rather than observe statistically-valid large samples that include many different time periods.

Peters wrote before the era of cheap desktop computing and inexpensive, exhaustive corporate data. But Collins hasn't. Yet his work still smacks of that 'hit parade' style of spotlighting a few companies for specific time periods, then extrapolating their idiosyncracies into strategic wisdom, rather than the other way around."

Suffice to say, starting with Peters, and now continued by Collins, this type of misleadingly shallow analysis provides business execs with easily-consumable 'best practices' candy, without actually being rigorous or deep in its methodology.

Murray describes the book's objective next,

"Mr. Collins's new book tackles the question of how to steer a company to lasting success in an environment characterized by change, uncertainty and even chaos."

Unfortunately, the objective is a chimera. I'm not going to divulge my own proprietary findings, because, among other uses, they help drive my own equity portfolio management process. Let me just assure readers that 'lasting success' is a good deal shorter time period than you'd ever believe. If more boards knew this, they'd be radically restructuring CEO compensation over time.

But, to provide a little more insight, all truly exceptionally-performing companies fall victim, within a definable number of years, to one or more of three forces: adjusted investor expectations; competition, and/or; regulatory scrutiny and action. Between the three, no company succeeds for too long. Here's a brief list of the once-great, now-fallen: Home Depot, Microsoft, Dell, Compaq, and Wal-Mart.

Murray then provides the reader with some information on the data which drove Collins' latest book,

"The data set that Messrs. Collins and Hansen examine so carefully ends in 2002, well ahead of the change, uncertainty and chaos of the 2008 financial meltdown. The intervening years were spent conducting their research. Still, the lessons of "Great by Choice" are not meant to apply to a particular moment of economic turbulence but to a continuous condition—a business world "full of rapid change and dramatic disruption."

For their study, the authors chose a set of major companies that achieved spectacular results over 15 or more years while operating in unstable environments; Messrs. Collins and Hansen call them "10Xers" for providing shareholder returns at least 10 times greater than their industry. Then the authors compared those companies—Amgen, Biomet, Intel, Microsoft, Progressive Insurance, Southwest Airlines, Stryker—to similar, but less successful, "control" companies: Genentech, Kirschner, AMD, Apple, Safeco, PSA and United States Surgical. It is an indication of the volatile nature of today's business success that, using 2002 numbers, Microsoft came out as a "10Xer" while Apple was its less successful "control" company, a ranking now reversed. More on that below."

Right away, I find serious flaws with Collins' approach.

First, no company posts "spectacular results" for 15 years. Yes, perhaps "over" 15 years, i.e., from point to point, over 15 years, there were some spectacular periods. But consistency has a value beyond a mere endpoint to endpoint total return value.

I've seen this sort of simplistic apparent performance phenomenon many times. Consider the nearby price chart for Dell, Microsoft, Apple, Home Depot and Google. Taken over the right timeframe, early years of stratospheric performance can offset a full decade of subsequent flatlining, as Microsoft's curve demonstrates.

Further, Collins' industry-specific metric renders his whole enterprise useless- except for, well, someone who wants to consult with his results to rather mediocre senior managers who read his book.

Here's why.

Investors can choose from among all public companies in which to invest. Even among private companies, in some cases. So to be truly exceptional, a manager should perform at a level among the best of, say, a broad equity market average. Not just his own industry.

By the way, just what defines an industry, anyway? Some companies don't have directly-comparable industry competitors. Others do, but only a very few. Consider auto makers. Do you count three- Ford, GM and Chrysler? Or two, when Chrysler was privately-held? Do you count Mercedes, Toyota, Honda, BMW,, although their parents and sizable operations are located outside the US?

And who believes Microsoft's badly-performing look-alike was ever Apple? Historically, Apple's integrated software and hardware competed with the Wintel combine of Intel and early PC makers IBM, Compaq or Gateway. Microsoft's Bill Gates was actually a guest at one of Steve Jobs' early Apple product debuts, as an example of a collaborative software publisher who appreciated having two platforms for which to create their products. Apple didn't do application software- just its proprietary operating system.

But that would make Collins' simplistic approach nearly impossible to use. So, instead, he opted for a comparison that has no credibility.

Having a point-to-point 15 year total return that is "10X" that of the average of three other firms in a poorly-performing sector like autos is hardly laudable. But if you plan to consult to Ford or GM, well, you could probably hoodwink those CEOs into at least listening to your sales pitch.

It's amazing how often people form impressions, a priori, on what constitutes a high-growth company. I've had some companies in my equity portfolios which few people would have thought would qualify if they knew the criteria for inclusion. Trust me, growth companies aren't just in technology sectors of the US economy.

Murray then provides his meatier treatment of the newly-published book,

"Messrs. Collins and Hansen draw some interesting and counterintuitive conclusions from their research. First, the successful leaders were not the most "visionary" or the biggest risk-takers; instead, they tended to be more empirical and disciplined, relying on evidence over gut instinct and preferring consistent gains to blow-out winners. The successful companies were not more innovative than the control companies; indeed, they were in some cases less innovative. Rather, they managed to "scale innovation"—introducing changes gradually, then moving quickly to capitalize on those that showed promise. The successful companies weren't necessarily the most likely to adopt internal changes as a response to a changing environment. "The 10X companies changed less in reaction to their changing world than the comparison cases," the authors conclude.

The book's organizing metaphor is built around the story of Roald Amundsen and Robert Falcon Scott, the two men who set out separately, in October 1911, to become the first explorers to reach the South Pole. Amundsen won the race by setting ambitious goals for each day's progress but also by being careful not to overshoot on good days or undershoot on bad ones, a disciplined approach shared by the 10Xers, according to Messrs. Collins and Hansen. Scott, by contrast, overreached on the good days and fell apart on the bad, mirroring the control companies in "Great by Choice."

If "Great by Choice" shares the qualities that made "Good to Great" so popular, it also shares some that drew criticism. The authors' conclusions sometimes feel like the claims of a well-written horoscope—so broadly stated that they are hard to disprove. Their 10X leaders are both "disciplined" and "creative," "prudent" and "bold"; they go fast when they must but slow when they can; they are consistent but open to change. This encompassing approach allows the authors to fit pretty much any leader who achieves 10X performance into their analysis. Would it ever be possible, one wonders, to find a leader whose success contradicted their thesis?"

Not content to critique the book generally, Murray fortunately, and shrewdly, provides an accidental example to which he referred earlier in his review,

"Which brings us back to Apple. Messrs. Collins and Hansen had no way of knowing, when they began sifting through their data in 2002, that Apple would become one of the most stunning turnaround stories in business history, soaring past Microsoft in market value. The late Steve Jobs accomplished that turnaround with a run of boldness, innovation, visionary thinking and egotism that might seem counter to the studied conclusions of "Great by Choice" as well as those of "Good to Great," in which Mr. Collins found that one of the leading attributes of the best business leaders was "humility." Steve Jobs?"

All of which satisfies me that Collins hasn't changed his approach much at all. He's still mixing hard-to-define qualitative assessments with quantitative ones. And applying them with, as Murray notes, considerably less than the precision one would wish.

Mr. Murray is not in the business of offending either an author who may advertise his book in the Journal, nor his readers. So he isn't about to land hard punches in his review by concluding that Collins' work is so vague and flawed as to be practically meaningless.

But I don't share Murray's constraints.

As I noted earlier, Collins' recent effort is perfect if what you hope to do is sell a book, for profits, that becomes a resident sales tool in many C-suites. And it even has an impressively-titled co-author from an equally-impressive university. But that doesn't make it valid or profound.

On that note, here's anecdote I learned years ago when I worked for Accenture's predecessor, Andersen Consulting. I had been chatting with Bob Gach, then a partner in the financial service group whose clients included Morgan Stanley and a few other investment banks. Since then, Bob has risen to become a very senior global partner in Accenture's financial services practice.

Back then, Bob was fretting because of the difficulty he was having closing a consulting contract with a Morgan Stanley executive.

As we discussed the firm's, and executive's behavior, Bob enunciated a principle which I've found to be pretty much universally true ever since. To paraphrase his remarks,

'This guy at Morgan Stanley really frustrates me. He's smart enough to force me to keep giving him enough examples of our work in his area, and to sign small pieces of work, that he keeps me from selling him the larger, more profitable interpretative and application modules.

When you think about it, the worst consulting customers are executives who are either really smart or really stupid. The smart ones know how to cherry pick a consultant's work and do the high value-added application of results to the rest of his businesses or operations.

The stupid ones are so thick they don't even understand why they need the consultant.

A consultant's best prospects are in the middle. Smart enough to know they need help. Dumb enough not to be able to get ahead of you in the thought process and rein in the scope of the project.'

Collins' work strikes me as designed to hit that middle group. It's too simplistic and flawed to sell to really intelligent business leaders. And the really slow ones will just never realize where to start to fix their problems.

But I can imagine quite a few middling companies with average executives jumping on Collins' rather shallow analyses as the answer to their prayers for some path out of mediocre performance.

And the beauty of Collins' approach, as Murray so deftly illustrates, is that there's always some other qualitative variable to blame when a CEO pays Collins for a lengthy engagement, follows his advice, and his business still doesn't outperform his peers.

I actually thought through all these issues when I was actively marketing the consulting application of my proprietary research on corporate performance. I even sold an engagement to the current chairman of the NYSE when he ran State Street Bank. Suffice to say, my consulting approach, as well as the research methods underpinning it, remains proprietary. But I will divulge that it is all quantitative, with no qualitative wiggle room.

Taxing Wealth, High Income, or....What?

The Wall Street Journal published an interesting editorial recently discussing the tax consequences of someone who realizes a large gain in the last year of his moderately-high income working life. The writer's point was that a one-time, larger-than-$250K income makes an otherwise-middle income person look 'rich' by the standards of today's arguments over tax rates and income levels.

This caused me to think of the larger picture, i.e., income versus net asset wealth.

To hear politicians from both parties these days, there seems to be confusion over what constitutes 'wealthy' or 'rich' people. Is it a net asset value, or an AGI level?

It matters. And causes me to wonder if this confusion affects taxation policy.

Currently, one's wealth is taxed when it was income. If earned, it's taxed each year it has been earned. If inherited, it is the detritus of the rather sizable haircut given by a dead benefactor's death taxes.

The current tax code has many provisions which reduce notional rates. If a person who, in the past, earned a lot of money, and has become an owner of substantial assets, uses tax code provisions to reduce his/her current income tax liability and rate, s/he is viewed as doing something immoral, if not illegal.

You have people like Warren Buffett and Jim Chanos publicly declaring their willingness to pay more tax on their income. Chanos went even further, claiming that, contrary to what economists predict, he would change nothing about his work life, work just as hard, even if he knew that the federal government would take a larger share of each year's income.

I thought about those two very wealthy businessmen, and what would motivate them to so publicly endorse the idea that they should pay more in taxes.

Aside from purely political persuasion, one is pretty much forced to believe that only people who had amassed so much wealth that current income really doesn't matter anymore would say things like they say.

Particularly Chanos. I'm not intimately familiar with any large windfall income years from his hedge fund management, but I have the general sense that he's worth hundreds of millions of dollars, or more.

I've written in prior posts about GE's Jeff Immelt, who has, as a matter of public record, already earned in excess of $20MM in cash during the past decade that he has been that firm's CEO. I contended that, once someone has been paid that much money, and hasn't simply pissed the bulk of it away, they are no longer motivated by future earnings. So when Immelt makes it a point to publicly claim that his current or future incentive payments will be more difficult to earn, I pay no attention. At this point, it's unlikely his lifestyle would change much if he earned those bonuses, or became a dollar a year man, like the late Steve Jobs, the recently-deceased CEO of Apple.

How do you suppose people like Chanos and Buffett would react if Congress announced that it was considering amending the tax code to require payment of, say, 2% of net worth from any tax filer with a net worth over $1MM?

Perhaps the law would simply change the basis of tax once one amasses a net worth of $1MM, including real estate. That would certainly address the issue of "the rich" paying "their fair share," wouldn't it? In effect, for wealthy Americans, federal tax would become a property tax, not an income tax.

Perhaps it would be scaled, like the income tax, so that above certain net worth levels, one paid multiples of the 2% of net worth.

After all, if it's just simple class warfare that the masses want the tax code to address, isn't a federal property tax on the very wealthy simpler to understand and apply?

Isn't net worth what most people mean when they say someone is "rich?" I don't really think that someone who, for one or two years, earns a lot of money, is seen, per se, as "wealthy." Unless perhaps it's a trader whose compensation for a few years is in the tens of millions, like Howie Hubler at Morgan Stanley, or Wing Chau at Harding Advisory. But, in those cases, someone's one or two year income pushes them right into the very wealthy group that would be subject to the federal property tax.

I don't really have firm answers for these questions. Rather, it simply occurred to me that if people are really out to "soak the rich" with taxes, shouldn't they be more clear about what they mean by "rich?"

And if they mean high net worth, then why not just tax that directly, rather than the income of people with high net worth?

Of course, it's quite possible that many so-called limousine liberals might change their mind about endorsing higher taxes on the wealthy if it applied to their net worth, rather than their annual incomes, isn't it?

Thursday, October 13, 2011

Regarding $2Trillion of Cash On Corporate Balance Sheets

Last week's Wednesday edition of the Wall Street Journal carried an article discussing the $2 trillion of cash on US non-financial corporate balance sheets.

It's an eye-popping number, to be sure. According to the article, the level of corporate cash was $1.4 trillion in 2008.

Thus, a nearly 50% increase in cash levels on those balance sheets in 3 years is one of the costs of the continuing turbulence in financial markets and global economies.

After seeing firms go bankrupt as a consequence of relying on short term funding during the financial crisis of 2008, it appears that many US non-financial corporations simply have ceased to trust or depend on their commercial banks and financial markets for operating funds.

Some view this large amount of cash as an impediment to a US expansion, as companies conserve those resources, rather than spend or invest them. And that's true.

But it's a consequence, rather than a first cause. That is, its CFOs' distrust of their prior, typical funding sources that caused them to essentially shift to self-funding. So it really identifies a heretofore hidden, lingering cost of the financial problems of three years ago. And the continuing global economic weakness.

Determined not to be caught out by unreliable funding sources again, US corporations have adapted to current circumstances. And that adaptation does seem to be resulting in a lack of expansive spending and investment.

Yet another source of uncertainty, along with tax and regulatory uncertainties, which drives US business behavior to be more prudent than it otherwise might be. With real consequences for the US economy.

Sales vs. Income Taxes- Why The Panic?

I'm writing this post on this blog, rather than my companion political one, because it's a non-partisan, economic topic of interest to me.

Ever since Herman Cain announced his 9-9-9 tax plan, there have been objections from those who are also adamantly against an American VAT tax, as well.

The most commonly-heard criticism of Cain's plan is that the sales tax portion is set at 9%, but can be raised in the future. So therefore, it's a bad idea.

Why is the fact that our income tax, initiated by a Constitutional amendment, has been raised and radically modified many times, not relevant in this regard? Clearly, whatever federal tax is proposed and levied on individuals, Congress will seek to modify it, effectively, or not, when they spend more than they collect in taxes.

A sales tax, or a VAT, is no different in this respect than an income tax. Congress will attempt to raise any of them when it suits their purpose, and voters let them get away with it.

Cain's sales tax is simpler to understand and operate than a VAT. Or that other odd tax that Huckabee was pushing in 2008 when he ran for president. And it does two valuable things which many critics miss.

First, it is actually less regressive, as Cain maintains, because a 9% sales tax is less onerous to the poor than a 15% payroll tax. Second, it hits the 50% of Americans who currently pay no federal income tax.

Taken in the context of eliminating all other taxes, a 9% sales tax isn't such a bad idea. It taxes spending, not savings. It is imposed as the double-taxation of dividends is eliminated, as is the separate taxation of capital gains.

Though many criticize Cain's tax plan as too simplistic, I don't really think it is. It is, instead, an Alexandrian type of solution to a tax code which is the equivalent of the famous Gordian knot.

Wednesday, October 12, 2011

Regarding Bloomberg's GOP Candidates' Event Last Night from Dartmouth College

To read my reactions to Bloomberg's two-hour GOP presidential candidate event- I won't misuse the term debate- held last night, go here.

Why Is Leo Hindery Seen So Frequently On Business Cable News Channels?

What is it about former TCI and ATT executive Leo Hindrey that merits his being seen so frequently on CNBC and Bloomberg? As I wrote in this post yesterday, be critical and sceptical of the pundits you see on those networks.

To my knowledge, the guy's biggest break was being one of John Malone's lieutenants at TCI when the latter sold it to Mike Armstrong's ATT. Hindery made a bundle on the deal, briefly became an ATT senior executive, then moved on to help destroy value by running a unit of Global Crossing.

Aside from Malone, a PhD and former Bell Labs techie, the bulk of the managerial so-called talent in those days dragged their knuckles when they walked. I know a bit about this because my mentor at Chase Manhattan, Gerry Weiss, made a lot of money personally from his cable investments. He was an early enthusiast, thanks to work he did at GE as chief planner there. He was an early advocate of the Kagan cable newsletter and, from that, learned to stay invested with Malone. Besides him, Gerry was dismissive of most of the industry, as was Kagan.

In case I'd missed something about Hindery, such as a PhD in finance or economics, or a Nobel prize in something, I searched for his bio. The best I could do was  this bio on Wiki. It confirms that Hindery went to Stanford and that, otherwise, he was lucky to be in Malone's organization at the right time.

Yesterday morning, Hindery was on Bloomberg pontificating about how the GOP candidates are weak on job creation policies. How the federal government just has to get involved. Then he derisively snorted at Herman Cain's 9-9-9 plan and judged it too simple.

Doesn't anyone at Bloomberg do any background checking? Hindery is a long time Democratic party backer. So much so that he was considered at one point to head the DNC. He's the guy who caused Tom Daschle his post in this administration's health care cabal by lending Tom a chauffeur and car, which Tom neglected to declare as income to the IRS.

Asking Hindery to handicap GOP presidential contenders is like asking the Koch brothers or Ken Langone to moderate a Democratic candidate debate.

Moreover, what's Hindery actually done since working for Malone and fortuitously cashing in on TCI options from the ATT deal? Nothing I can see. Sure, he's on boards and involved in philanthropy. Heads up his own activist foundation. But basically Leo is a cable guy who hit it big because of his boss' prescience. No track record in consulting, or creating his own business. No history of shrewd corporate strategy work. Nothing like that. Nothing which would cause you to suspect he's a business statesman and savant behind that unassuming visage.

Why he belongs on CNBC and Bloomberg so often to broadcast his personal views is beyond me.

As I noted yesterday and at the beginning of this post, just because someone is on a major cable network program doesn't mean you should accept their comments uncritically.

Tuesday, October 11, 2011

Disappointment About Bloomberg's GOP Presidential Debate Tonight

I must say that I'm profoundly disappointed by what I've heard- on Bloomberg TV- concerning the network's GOP candidate debate this evening from Dartmouth College in New Hampshire.

The questioner/moderator is apparently going to be Charlie Rose.

Charlie Rose??????

You have to be kidding.

On a network featuring Margaret Brennan and the very knowledgeable pair of anchors on the pre-market-open program, not to mention Tom Keene, Rose is the best they can do?

Rose doesn't know anything about economics or business. He's an idiot with a southern drawl who, from the times I've seen his boring interview program over the years, specializes in behaving and looking stunned and awed by anything any guest says.

I'll probably tune in for the first few minutes of the, well, debate isn't really the right word for these spectacles. I wrote recently on my political blog about a format I'd prefer. And, again, more recently, concerning Fox News' nod in that direction.

But having someone as clueless as Charlie Rose asking questions will likely have me channel surfing within five minutes, and probably, as usual, looking to various news programs tomorrow for a more concise reprise of what occurs this evening in Hanover.

Don't Believe Everything You See On Cable Business Channels

Neil Cavuto hosts a 4PM weekday program on Fox News which he tries to make into a blend of political and business news, typically beginning the hour by discussing the US equity market performance of the day.

Last week, I caught a few minutes of a misleading and, frankly, just wrong-headed segment in which a guest contended that Costco will be losing business by raising its membership fee.

I forget the woman's name, but she had an axe to grind against the warehouse discount store chain. All the woman could talk about was that Costco was raising its annual membership fee by about 10%, so she alleged, to around or just below $55. For the record, I know Costco has raised my annual fee once since I joined over four years ago. It was $50 when I joined, and I just wrote them a check for $53.50 last month.

In the past year, I realized that there is almost nothing which I used to buy at my former usual grocers, Kings and Stop 'n Shop, that I cannot also buy at Costco for roughly half the price. The biggest surprise was how much I save on staples- milk, juice, lettuce, chicken breasts, cereal, salad dressings and fruit. I now buy a package of six romaine lettuce heads for about $5, or what two heads cost at Kings.

I probably visit Costco once per week, since it's located within a couple of miles from my fitness club. My actual visits per week probably average 1.3.

While there, usually after playing squash and working out, I usually eat a light dinner for a laughably small sum. It's hard to spend more than $3.50 to eat dinner there, and the choices include a surprisingly healthy array of choices.

While having dinner and reading the editorials in the Wall Street Journal, I also watch the parade of shoppers checking out and leaving the store. I'd say roughly half are families or a couple with a very full shopping cart. Just from my experience behind people buying large amounts of food, and my own bills, I'd estimate that a full cart can easily represent $200-300 worth of groceries. Multiply that by 50 weeks, and you have at least $12,500 annual sales for a family that shops at Costco. I'm reasonably sure that's a low estimate.

On that base, a $5 annual fee increase is 4 hundredths of a percent! Even for me, it would be only about a tenth of a percentage point.

Yet the woman whom Cavuto had as a guest railed against Costco needlessly increasing its fee, insisting that many families would bolt the warehouse chain to return to their local grocery stores.

To use a phrase, 'in a pig's eye!'

Has this woman ever seen families carting out a 40" flat panel plasma TV? A workbench, chair or bicycle? You can't believe the bargains to be had on high-end electronics- camera, TVs, gaming accessories, laptops and tablets. Microwave ovens, office furniture, and medium-sized appliances. All half-price.

You can't seriously believe anyone who uses Costco frequently would change stores over much less than a doubling of the membership fee. The economics are simply too compelling.

Yet Cavuto himself was unable to do this math on air and challenge the woman's assertions. It was really pathetic. She was a moron clinging to a totally indefensible viewpoint, while Cavuto just sat there and expressed dumbfounded surprise, without asking the woman why such a small fee increase would matter to people spending thousands of dollars per year at Costco.

Taxing Billionaires To Fund The US Government- More Liberal CNBC Bias

In this recent post I discussed comments on Europe's troubles by Kyle Bass from his Barefoot Economic Summit 3 in Texas.

Bass was interviewed as part of David Faber's noontime CNBC program. Faber proclaims that he and Bass are 'old friends.' Probably from Faber's days as a regular morning SquawkBox co-anchor, when he cultivated sources like Bass, then a debt trader at Bear Stearns.

However, it's clear the two part company on politics. Consider the exchange between Bass and Faber when the latter asked the former for his take on US sovereign debt and the economy.

Bass pointedly noted that the fortunes of Bill Gates and Warren Buffett would only fund a month's federal government spending.

"So who pays for November," Bass challenged Faber?

Then Bass observed that confiscating all of the wealth of the Forbes 400 only funds the US government through the end of the year.

'So who will pay for 2012,' asked Bass rhetorically?

Faber grew increasingly uncomfortable with Bass' aggressive challenges on 'tax the rich' policies, replying rather meekly,

'But nobody's actually suggesting that the government do anything like that.'

It was a weasel-like comment for Faber to make, because he, like every viewer, knew that Bass was not suggesting that any Congressman or the president wanted this. Bass' point, which even Faber understood, is that you can confiscate all the wealth from the so-called wealthiest 400, probably even 2,000 Americans and you still can't fund the US government for a full year.

Thus the emptiness of calls to 'tax the rich,' or claim that they 'don't pay their fair share.'

Faber's dumbfounded reaction and, then, silence, once more illustrated CNBC's latent liberal bias. The liberal on-air reporters and anchors can never back up their liberal bias with facts. When confronted with facts they don't like, they just sort of stare at the offending guest, then change the subject.

In this case, Faber couldn't think of a comeback to refute the obvious point that no amount of 'more' and 'their fair share' of taxes from the wealthy which are designed to be above-average will ever actually close any federal funding gap.

It's an appeal to class warfare, pure and simple.

The obvious conclusion to be drawn from Bass' anecdotal statistics is that only by allowing the wealthy to invest their capital to allow business creation and expansion can new jobs be created in the US, thus aiding economic growth, from which the government can collect taxes on new economic activity.

Merely soaking the rich for more of their current wealth will do nothing serious nor sustainable to make a dent in America's horrific debt levels.

Monday, October 10, 2011

The Perils of Predicting Equity Market Moves

Last Thursday I published this post discussing US equity market levels and volatility. Among other observations, I wrote,

"Now, on any given day, the S&P can easily close in territory that moves the signal to 'short' for next month. Specifically, if the S&P return for this month is much worse than -2%, the signal will go 'out/short.'

Thus, I moved the bulk of my funds which were in equities into cash yesterday. Because the signal wasn't 100% solid, but only an intra-day low, I didn't move 100% of the assets.

For what it's worth, more than a few pundits and fund managers appearing on CNBC and Bloomberg have said they are doing the same in the past week.

For perspective, I took a look at the S&P levels and volatility since then. Beginning with that first Greek crisis in the markets, the S&P was at roughly 1110 to 1130. My proprietary options volatility signal rose to 'put' levels by early April, and stayed there for the next six months.

In the intervening months, the S&P has climbed as high as 1363 on 29 April 2011. Now it's back to where it was, more or less, at the start of the Greek crisis last year. Holding long equity portfolios generated by my proprietary strategy in the interim would have allowed an investor to realize gains for most of that period. Gains which would be rebalanced as portfolios rolled on and off. A sort of slightly more sophisticated variant of dollar-averaging, if you will.

But now, volatilities, and, thus, risk, in both my proprietary options and equities signaling systems have risen to critical levels amidst equity market levels which aren't providing concomitant returns.

As I write this post at about 1PM on Wednesday afternoon, the day before it will publish, the S&P is at 1131. A slight gain from yesterday. But in times like these, any one day's equity market performance isn't the point. It's the overall trend, or lack of one, coupled with instantaneous and recent volatility that guides my quantitative long/short signals. The qualitative economic and financial information I process provides context.

And now, the context and the signals are flashing to be mostly out of US equities."
The S&P finished Wednesday at 1144, then 1165 the next day, when the post was actually published. Today, Monday, at 1:50PM, it's at 1189.

Yes, making public statements about the direction of equity markets surely can be painful- at least in the short term. Or longer, I suppose, if you're Byron Wien and predicted an equity market collapse for about, what, three straight years? Until finally, like a broken watch, his prediction coincided with reality?

However, volatility is actually greater today than it was last Wednesday, when I wrote that post. The S& closed at 1210 three weeks ago. Meaning that the movement in the index continues to be violent. The pattern of the S&P daily closes, resembles, graphically, a distinctive saw-toothed pattern of generally range-bound values with rapid, sharp changes vertically over the past three months. Thus the abrupt rise in volatility at the beginning of August which has continued, only moderately abated.

Today's rally is based upon investors' hearing that Germany's and France's leaders claim to have a plan to resolve the European debt crisis. On Friday morning, US equities were up on what some believed were good jobless numbers. So why did the S&P close down -.8% that day?

What will happen in a few days, when the Euro-bears like Kyle Bass reiterate their fairly sensible, sane observations that there isn't enough money in the European Union to rescue all of the endangered sovereign credit, now including downgraded Spain and Italy? That there will be defaults and corresponding declining economic activity which will have effects on the US economy? I wrote in that post,

"Bass discussed how ludicrous it is to expect some nations, like Spain and Italy, to be guarantors of bad Greek debt today, then turn around and become receivers of further Euro help tomorrow. Bass referred, again, to his firm's original market research among Germans regarding their attitudes toward bailing out the rest of Europe, and added, this time, a reference to private conversations with senior German government officials. This smacks of the legwork Bass was known for, ex post, in the 2007-2008 mortgage crisis, as displayed on Faber's House of Cards documentary."

While CNBC, Bloomberg and the Wall Street Journal all strive to make an entertaining, must-watch or -read day out of every day the equity markets are open for trading, the truth is that to an equity portfolio manager of other people's money, such daily moves don't affect most of the portfolio. In my case, my call that it's time to be out of US equities won't really be clearly right or wrong for at least another month. Back in 2008, my equity signal was triggered in mid-summer. The equity market cratered first, rapidly, in October, with Lehman's bankruptcy, then again in March of the next year. The signal didn't recommend re-entry until after that.

So for the meanwhile, I'll continue to monitor S&P daily closes and associated volatility. It's not clear to me yet that it's safe to remain fully invested in equities. A month's S&P gains can be made up by a portfolio manager with a consistently superior-performing strategy. But a month's losses of, say, 7% is quite different. In the former case, the assets are still there, and the S&P has a slight incremental lead. In the latter case, it's likely that more than 7% of your assets are gone in one month, meaning you must earn the losses back from a smaller base.

Thus the asymmetrical risk, if you wish to call it that, of sitting out a positive S&P month amidst excessive turbulence, versus actually losing money as the market disintegrates, when your signaling system warned you to be cautious as the equity market neared a precipice.

Conflicting Opinions on China's Economic Collapse

There's an interesting contradiction regarding China's potential economic woes in the Economist and the Wall Street Journal this week.

Over the weekend, I read the current edition of the Economist, including an article lauding noted hedge fund bear Jim Chanos' longtime short on China. He's reputed to be traveling to Hong Kong this month, his first trip ever, apparently, so close to China. In his piece, the Economist reporter cited several pundits who feel it's now rather risky to short Chinese investments, so heavy have been losses in some of their values. Apparently as much as 30%, with P/E ratios down to only 8 for some equities. According to the piece, anyone rushing to short Chinese assets now is rather late to the party.

Meanwhile, in this morning's edition of the Journal, the back page of the Money & Finance section cautions that it's much too early to short China!

That reporter cites the continuing movement of people from country to cities, and China's national balance sheet's ability to absorb all manner of defaulted municipal projects while still maintaining a debt/GDP ratios of well under 100%.

I have no idea who is more correct. But it's clear somebody's going to be wrong.

To me, the fascinating aspect to this story is that two major, respected business publications have taken very public, contrary stands on an economic story of substantial global import.