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.