GM's Union Negotiations

According to Thursday's Wall Street Journal, GM is once again in negotiations with the UAW to try to solve its profitability problems on the backs of its blue-collar labor force.


I know, it sounds like I'm some sort of Debsian liberal. But I'm not. I actually happen to believe that the responsibility for Detroit's auto makers' mess is management's, not union's.


As I wrote in one of my first posts on this blog, here,


"Why did unions ever begin taking future pension contributions from the companies for which their members worked, instead of cash compensation?


When you think about it, some of those company CEOs of yesteryear were deceptively brilliant. They managed to get unsecured loans, in the form of future pension “obligations,” from the unions representing their workers. No bank would have lent the same sums on the same terms for the same prices. That’s because, ultimately, companies have much more latitude with which to discharge or change their pension obligations in bankruptcy than they have to escape a group of angry, unified, legally-empowered financial creditors in the same situation


In hindsight, “defined benefit” plans of any type or name, public or private, are a clever way for a public corporation or a government to fund operations with implicit loans. For big steel, autos and airlines, as well as other labor-intensive sectors in the ‘50s, ‘60s and later, this amounted to labor union members lending, via unsecured future compensation and fringe benefit promises from their employers, sums of money for which they had no collateral. Financial engineering which puts modern investment bankers to shame.


Where is the expose on the union leaders who foolishly negotiated, on behalf of their members, to accept unsecured IOUs from companies on terms that the companies’ banks would never have lent them the money?"


As I read the Journal article, what I see is further futility in the actions of all parties. Management attempting to close its cost gap with competitors mainly through cutting its employees' compensations. Union leaders breaking their organization into tiers, so that older members get higher compensation, while sacrificing newer workers, to preserve union membership and jobs. A very French-style, Faustian bargain.


Don't get me wrong. I think the union wage scale has remained stuck at an unsustainably high lever, with respect to the value now added in the manufacture of Detroit products. It's just a little sad to watch even the union leaders sacrifice their own members for the leaders' political aspirations of remaining head of a large union, when the number of members should be declining, with the value of output, and the number of employees necessary to create that output.


Looks like business as usual in Detroit this summer, all the way 'round.

GE To Become A Public/Private Equity Shop

In an attempt to justify GE's existence as a conglomerate, its CEO, Jeff Immelt, announced today that, henceforth, he would transform GE into a public/private equity enterprise.

"If Steve Schwarzman (Blackstone CEO) can go public with its portfolio of operating businesses, then I can take GE into the private equity game," Immelt was quoted as saying.

Tiring of getting "no respect," and feeling like "the Rodney Dangerfield of CEOs," Immelt has decided to spin off his entire business portfolio, while buying ailing units of other firms.

"We're going to show the world, and our investors, that GE's vaunted management system is the best in the world. We can take a corporate sow's ear and make it into the proverbial business silk purse, then spin it back to the public, just like Blackstone, KKR, and TPG," Immelt declared.

Regarded for decades as one of the two most influential incubators of US corporate management talent, along with Proctor & Gamble, GE has been known for training generations of financially-oriented managers who have gone on to lead other American corporations. Not, mind you, always to consistently superior total returns. But lead, nonetheless, complete with comfortable compensation packages.

As such, Immelt intends to convert GE into a sort of managerial competence "pure play." According to pundits and analysts, Immelt intends to put every manager in GE's new acquisitions through its storied Crotonville 're-education' center, in order to remake them as fully-trained, GE-style managers.

Immelt, tired of the heckling of numerous analysts and bloggers, declared,

"We're going to prove to investors, analysts, bloggers, and the public, that GE managers can manage anything well. If private equity shops can buy on the cheap and fix businesses, so can we. And to prove it, I'm starting with a clean slate of operating businesses."

To be sure, it's a novel approach. But, then, nothing else Immelt has done has delivered consistently superior returns for his shareholders. They would have been far better off selling their GE stock upon Immelt's elevation to CEO, and simply buying and holding the S&P500.

In a related story, GE's board was reportedly raising Immelt's compensation for 2008 to approximately $800MM. A spokesperson for the board noted that Blackstone's Schwarzman had received some $700MM from his company's IPO, and, thus, the CEO of a public 'private equity' shop, as GE's Immelt has reclassified his company, ought to be worth the same, if not a little more.

CNBC said it would not be interviewing Immelt on this latest compensation-related development. Not, at least, until NBC/Universal has been spun off to shareholders.

(The preceding piece is intended as humor. None of the quotes are factual. However, given Immelt's insistence on running a conglomerate, it may well be that the only way he can avoid penalizing GE shareholders with a discount to net asset values is to transform GE into the only type of successful conglomerates on the American business scene today- private equity firms.)

Blackstone's IPO Underwriting Strategy: Silence The Street

"Bribe" is an ugly word. So I'm not going to use it again in this post.

I read yesterday that Blackstone has employed 17 Wall Street investment banking houses in its IPO process. Even, according to the Wall Street Journal article by 'breakingviews.com,' Goldman Sachs. The latter was originally snubbed for having worked on another private equity shop's IPO.

Additionally, it is alleged that Chase was allowed in, despite its having backed a competing bidder for Equity Office Properties, a recent Blackstone purchase.

To quote the Journal article,

"But perhaps Blackstone has another motive. By bringing everyone on board, it may keep criticism of its trumpeted $33 billion-plus valuation at a minimum. This is particularly important for, say, Goldman, whose own stock trades at a whopping price-to-earnings discount to Blackstone's implied valuation.

Yet, behind closed doors, it's widely believed that those who publicly criticize Blackstone's value won't be invited to sell its IPO. Looks like Wall Street opted to keep its collective mouth shut."

You think?

This is unquestionably the motive for Blackstone's hoovering up any party whose credible scepticism about its IPO valuation might cause investors to balk. The effect is to mute all sell-side criticism. Then you have the unstated silence of anybody else with a trading desk, who hopes to broker any of Blackstone's order volume in this lifetime.

You can search my blog for posts on Blackstone's IPO. For starters, however, read this one, from April.

In this post, I wrote,

"What I find amazing, however, is that investors are lining up to buy shares of an entity in which they can't even measure risk levels. Essentially, they are buying income 'participation shares,' much like I advocated last year in this post regarding corporate governance and takeovers. But, rather than retaining interest in a previously-public firm, they are buying the equivalent of a blind pool.

In a very real sense, Schwarzman has created the best of both worlds- retaining total control and privacy of operations, while establishing a value for the firm, and cashing out while doing it.

Honestly, I have even more respect for him now than I did before. Not that I would be on the other end of an equity transaction from him. And, correspondingly, I have less respect for the investors who buy the Blackstone IPO shares."

I can only reiterate my earlier sentiments. As I said to my partner over lunch yesterday,

"Who would be foolish enough to be on the other side of an equity deal from Goldman or Blackstone?"

I own Goldman in my equity portfolio now. But I only bought it in January, not as an IPO. As such, it is market-valued now, not seller-valued.

With all the hoopla on Capitol Hill this week regarding new taxes for carried interest income in private equity deals, and Schwarzman's $700+MM payday, and $7B interest in Blackstone, the real danger is overlooked.

I contend it is this pervasive, collaborative silence on Wall Street, as it collectively abets Blackstone in valuing its IPO.

Alas, no amount of legislation will ever remedy this. No, for this, we have to trust people to use their common sense. To think.

And that brings me to an old story about the former Governor and Senator from my home state of Illinois, Adlai Stevenson.

When running in one of his campaigns for President against Eisenhower, it is said that Stevenson was approached by a woman who gushed,

"Governor, you have the vote of every thinking American."

Stevenson, perhaps apocryphally, is said to have replied,

"Oh, Madam, I'll need many more votes that that to win the election."

Caveat Emptor, indeed!

Private Equity Meets The MBA

Yesterday's Wall Street Journal carried a piece about private equity and MBA schools in its Career Journal section.

Where to begin? Perhaps with the question,

"Have these already questionable educational programs absolutely no shame?"

As I have written recently, here, and less recently, here, here, and here, the once-vaunted MBA is already, in my opinion, a shadow of its former self. Between more mediocre talent pools, teaching ranks stretched more thinly as more schools offer the degree, and a shift in focus to 'soft skills,' it's become a mere trade school certificate.

However, today's Journal article shocked even me. The gist of the piece is that MBA schools are angling to get more of their new grads into the lucrative private equity firms. They are trying to set up co-taught courses, using retired private equity partners. Trying to make contacts for mainlining their grads into the firms.

At this point, let's have a brief reality check. Private equity firms are, by and large, composed of very experienced, once-senior executives in publicly-held companies, who realized they could do better managing and fixing some businesses without the glare of shareholders and required SEC filings. They hire, for the most part, similarly-seasoned managers to actually work on and improve the businesses they buy. Then they spin them back out for the profit.

Where, in the model, besides ordering take-out for delivery late at night, or perhaps scheduling car services for the late-night workers on the various acquisitions, is there room for newly-minted, inexperienced young MBAs?

Didn't we all learn from the consulting sector that, ultimately, customers wise up to being read rehashed B-school platitudes from fresh-faced young things with MBAs? Last I looked, McKinsey, Booz Allen, and most of their ilk had much reduced circumstances and reputations, as their customers began to catch on.

So, now, the MBA mills are training their sights on private equity firms?

This is either about to be comical, or tragic. Comical, because PE firms are the real McCoys of smart, no-nonsense capitalists. Tragic, if some of those firms actually buy this line, and begin hiring novices to ply their ultra-profitable trade.

Not to mention, again, as in this post, that so much of what private equity does is simply better, faster implementation of the classic lessons of old-style, non-soft skill MBA and BS in BA programs. It's not so much the insights, as it is the experience of knowing just what to do, when, in which situations.

At some point, there actually are jobs that require experience, not simply a newly-minted degree from the right school.

It should be interesting to see if this story has legs, and we learn, in a year or so, that there is, indeed, an influx of newly-graduated MBAs into the sector. And what effect they are having on their employers.

On that note, one last word of warning. Back in the day, when I was a young MBA myself, a little outfit called Atari ruled the newly-digitizing world. I don't recall the exact number, but one year, something like 25% of the Harvard Business School's graduates went to work there. The next year, 1984, Atari, then a unit of Warner Brothers, and a victim of overheated expansion and loss of control over the company's strategic direction, was, in large part, sold to Jack Trarmiel. Upon this ignominious event, one wag commented that it should be a signal to the market that anytime a company begins hiring that large a portion of HBS's graduating class, it's time to dump the company's shares.

Last year, 11% of the HBS class went to work in private equity companies.

The Market, She Be Confused

Roughly a year ago, in one of the earlier pieces on this blog, , "The Market, She Be Angry...," I commented on how analysts so often, mistakenly, anthropomorphize capital markets.

In part, I wrote,

"Despite the signs of investors waffling on the economy's health, Brian Wesbury commented that average mortgage interest rates are still a full point lower than they were during the last expansion. And the Fed is moving to ensure low, long-term inflation. Thus, there's no reason to expect the economy to suddenly sieze up and slide into a recession."

And that paragraph roughly fits today's market, too. This time, the S&P500 Index is down recently due to investor worries about inflation.

In the past week and a half, inflation worries have trimmed roughly 3 percentage points from the Index's year-to-date return, driving down to about 5.3%.

But, wait. Weren't investors worried only two months ago about global economic growth and weak earnings? Wasn't the last earnings announcement season a big surprise, accounting for the Index's more than 8 percentage points of gain in April and May?

So, in the space of something like 60 days, we apparently have investors moving from worries about too little growth, to worries about too much growth, too little liquidity, and rising inflation.

Which is it? Or is it even either one? Is it simply the usual case of many inept pundits and analysts misleading equally-naive investors?

That would be my bet. More heat than light, again. In fact, in each of the past three years, pundits have called a near-recession for later in the year, only to see investors push the index up by November, as low-inflation growth was confirmed by the fourth quarter.

What is disconcerting is how much of this misinterpretation of economic signals is repetitive, and, yet, goes unreported as such. The much heralded recessions have not materialized. Now, the much heralded inverted yield curve is normal, rather than inverted.

So, where's the celebration, now that the non-inverted yield curve should be signaling no recession? Instead, the pundits frown, note the possibility of a Fed rate hike, or less global liquidity with higher rates, and, thus, slowing growth.....and a recession.

I think we're seeing more confusion on the part of most market watchers, pundits, analysts, talking heads, etc. And even retired Fed Chairmen, albeit one who has a spotty record on forecasting equity prices.

When I see this amount of baseless, rapid change of thinking in the equity investor base, I pay it little heed for long term equity market trends.

The New York Times Gives Jeff Immelt A Pass

New York Times writer Joe Nocera penned a long, fawning piece about Jeff Immelt, GE's CEO, in the paper's Saturday edition. My partner had mentioned it to me on Sunday morning, and sent me the article, knowing of my prior posts on GE and Immelt (search on either term, and/or click on the two labels on the side of the main page).

I wrote most recently on this topic here, and here. For the record, let me state my unequivocal belief that Immelt has failed in his richly-compensated role as GE's CEO for nearly six years. I believe that Immelt should go, as the company is spun into its constituent parts as standalone businesses. The firm no longer has an economic reason for being.

That said, let me quote some of the more outrageous passages from Mr. Nocera's Times piece,

“When you put your foot on the gas in this company,” Jeffrey R. Immelt said a few weeks ago, with just the slightest trace of a satisfied smile, “the car goes forward.”

Oh, and one other thing: the entire time he’s been chief executive, the stock hasn’t budged. (It closed yesterday at $37.32.) In April, Jeffrey T. Sprague, the Citigroup analyst, called for “a partial breakup” of G.E., arguing that the company’s “size and complexity is working against investor interest in the stock.” During Mr. Welch’s 20 years at the helm, G.E.’s stock had a staggering 7,000 percent total return, including dividends. If the company’s share price doesn’t start to rise soon, Wall Street is going to be agitating for more than a breakup.

Mr. Immelt seems pretty much at ease about that, too.

Mr. Immelt also felt that G.E. needed to do a better job at what is called “organic growth,” that is, growth that is not a result of acquisitions. So he had G.E. study companies that excelled at internal growth, like Apple and Toyota, quantified the qualities that those companies had in common, and began teaching them at General Electric. Now, Mr. Immelt has told Wall Street that he wants the company’s organic growth rate to be 8 percent a year, twice what it used to be.

Most C.E.O.s whose stock hasn’t moved in five years would be in a world of trouble, of course. And Mr. Immelt is not going to get his 20-year run if he can’t get the stock to move. But he’s still got plenty of time to show that his repositioning is working; Wall Street may be antsy, but no investor is crazy enough to call for his ouster. And he’s adamant that the solution is to wait for the market to catch up with the company’s changing nature, rather than to execute a partial breakup just to please the Street.

“Investors go through cycles where they don’t like conglomerates,” Mr. Immelt said. “But if you want to be a lasting company, you have to know how to be a multibusiness structure. If Google is going to be a 100-year-old company someday, it is going to have to learn to do more than search.”

Let me make a few points, by way of rebuttal.

First, my proprietary research has concluded that, in order to have a significantly above-average probability of earning consistently superior total returns, companies need to post real rates of revenue growth in excess of Immelt's goal of 8% per annum. Less than the rate I discovered, and the company will not be considered a consistently high-revenue growth firm. Earnings growth, by the way, is statistically unrelated to consistently superior total return performance.

So much for Jeff's foot on the accelerator helping shareholders enjoy consistently superior returns by holding GE stock.

Second, as I wrote in one of the linked posts recently,

"Few today realize how Jones, of whom I have heard it said, "once a beanie (accountant), always a beanie,' stripped much of the strategic vision from GE that Borch had instilled through his business unit investments. Jones retooled the company to be a cash machine because, well, he was an accountant. He liked cash.

Welch, upon taking the helm from Jones, faced an unprecedented period of high inflation and a wide array of non-strategic businesses at GE. He rapidly cut and pruned the company's businesses, earning the now-forgotten moniker "neutron Jack."

What's ironic is how everyone seems to have forgotten GE's heritage of being subjected to wrenching change with each new CEO of the prior forty years, except for Immelt. He's the only one not to have actually made a big change in the firm, and it has stalled."

Thus, Immelt has actually broken the pattern of GE leadership through the ages by essentially changing virtually nothing. The firm has adapted to past eras, that is true. And this era is one of the continued de-conglomeration of American business. His sarcastic shots about Google to the contrary, Immelt's firm is too diversified to provide consistently superior returns to shareholders, because it's taxing them to feed an overgrown bureaucracy presided over by....none other than Chairman Jeff the First.

What Immelt fails to understand, in suggesting Google can't continue growing in its natural niches, is that every business undergoes a Schumpeterian life- and death- cycle. My guess is, Immelt is going to preside over GE's death.

Third, regarding Immelt's observation about investors "going through cycled where they don't like conglomerates" is a bit disingenuous. As I wrote in one of the linked posts above,

"Simply put, corporate diversification for cash flow smoothing has been a discredited management approach for creating consistently superior total returns for some time. My own proprietary research, which drives my equity portfolio selection of consistently superior large-cap companies, confirms this. Back some thirty or forty years ago, when trading equities was expensive and information and innovation were in shorter supply, it may have made sense for investors to hold shares of conglomerates. And, in the day, they existed- Gulf&Western, ITT, and Litton, to name just a few. But they are gone now. ITT still exists, but in nothing like the shape it had under Harold Geneen."

The era of growing, permanent corporate conglomerates is over, thanks to very efficient, large and deeply liquid capital markets. Markets so liquid that private equity firms can borrow to buy ailing business units of conglomerates, fix them, and spin them back out to the public. The only apparently consistently profitable "conglomerates" these days appear to be the large, multi-operating-unit private equity shops. But they don't seem to want to hold their businesses- just increase their value and flip them back to the public.

I question Nocera's trust that Immelt has 20 years to eventually re-ignite GE's total return performance. In Welch's day, the large private equity pools now common did not exist, and investors were far more patient.

Typically, it's been my experience that corporations, and their CEOs, cite 'soft' values and concepts when they simply can't earn consistently superior total returns for their shareholders. Even today, as Yahoo's Terry Semel came under assault for that company's abysmal performance under his tenure, Yahoo's corporate spokesperson recited a long list of non-quantitative 'accomplishments' under Semel's reign, carefully avoiding the clear record of financial failure.

Immelt is no different, nor are his supporters, such as Mr. Nocera.

Distorted Market Signals On Insurance In The Hurricane Belt

Yesterday's Wall Street Journal featured an excellent piece on the shifting burden of homeowner's insurance for those who build and live in the known or highly-probable path of hurricanes.

As I explained to my 11-year old daughter over breakfast, while we looked at the headline, when governments attempt to control the price of risk for insuring things like building vacation, or even primary, homes in the likely path of destructive weather, the tendency is for private capital to flee, and government, meaning, all of us who don't enjoy that ocean view, to subsidize those who have so built.

As the article clearly describes, the recent trend has been for states to attempt to cap insurance rates, companies to leave states, then the same states organize their own 'insurance funds,' which are, logically, inadequate to the task at hand. The ultimate guarantor, since the people in these states see fit to guarantee coverage to their coastal-dwelling denizens, is going to be Uncle Sam.

Let's review the history. The year after I was born, there was a decade-long hiatus in killer hurricanes along the Gulf and Atlantic coasts. The resulting rush to build in these hurricane alleys resulted in today's dilemma. People have been allowed to expect that they will always be given coverage, at affordable rates, for their dubious choice of location for a vacation home. Or, in some cases, primary residence.

Now that nature has returned, as it were, to the field, there's been millions of tons of toothpicks created since Hugo set down in North Carolina those many years ago. Most recently, Katrina and Rita wrecked the New Orleans and parts of the Texas, Mississippi and Louisiana coasts.

Someone must pay!

But why? Back when I began this blog, in September of 2005, I quickly wrote about who really bore the cost of location decisions in the Gulf Coast areas. Leaving aside industry, it is pretty clear that, through distorted market signals on the price of risk for homeowner insurance, too many people have built too much housing which they cannot personally afford to insure at market rates, or rebuild from their personal fortunes, in the likely path of hurricanes.

A reasonable person will see in a hot minute that the most effective solution is to reduce insurance regulation, not involve more state and Federal price signal distortion.

On a related matter, what do you think is really happening every time some Gulf Coast location is declared a "Federal disaster area?" The local residents get to rely on every other US citizen to bail them out of their choice of living in an area which may be too risky for their own wallets.

The net effect of today's mess of homeowners insurance in hurricane areas is to make all Americans ultimately pay the tab for the difference between what local politicians feel they can ask their ocean-front-dwelling homeowners to pay for insurance, and what private insurers would actually demand for those risks. So you and I, if you don't have a beachfront home somewhere between North Carolina and Texas, pay a form of rent to those who do, but we never get to enjoy their view.

Common sense says that if it's too expensive for a person to afford privately-offered insurance to replace the value of a home built so near the ocean in hurricane territory, then the home shouldn't be built. Not that 'someone else' should step in and pay to make it affordable. How long can we, as a nation, afford this sort of economic idiocy?

When I read in the Journal article that,

"lawmakers in some states are also facing deep public anger about the rising cost of insurance on the coast,"

I was dumbfounded. Who's fault is this? The 'rising cost' reflects reality peeking in on an otherwise state of denial.

Something's very wrong. The incentives for rational decision-making with respect to economic development is distorted. Back in the post-Katrina era, I wrote a post quoting a Holman Jenkins WSJ editorial in which he revealed that southern Senators demanded the removal of a provision in Federal flood insurance laws that put a limit on the number of times a homeowner could file claims under the insurance. They explicitly admitted that the insurance guaranteed 'economic development' by way of assuring the rebuilding of the initially dubiously-sited homes.

This sort of market price signal distortion, on such a grand scale, is bound to come a cropper at some point. It's a good argument for simplifying the insurance market to become a national one, rather than 50 local ones, each hostage to local political appointees who try to beggar their neighbors by capping risk prices in their own states, and attempting to force the insurers to recover the true risk premiums 'somewhere else.'

The way things are looking, this would seem to cast doubt on the wisdom of investing in property and casualty firms anytime soon, if one expects consistently superior total returns.

Hedge Fund Leverage Risks

Today's Wall Street Journal carried a piece on the back page of the Money & Investing Section, describing the state of credit derivative hedge fund investments.

According to the article, over $300B is currently invested in these funds, on a leveraged basis, 6-1, for roughly $1.8T of controlled assets. One of the eye-opening pieces of arithmetic the authors did was to point out that a credit derivative fund with only 4x leverage, experiencing a decline of just 5% in the value of its portfolio, would be required to liquidate as much as 25% of its total assets to meet a 20% margin requirement. Multiply this by many hedge funds engaged in similar investing, with similar exposures, and you understand a fundamental underpinning of my partner's and my own options strategy.

We have a static options strategy in place which works automatically, without any recourse to a change in positions, in the event of severe market declines.

During a lunch meeting today with some associates in the financial sector, to explain in more detail our recent options-based implementation of our equity portfolio strategy, we discussed precisely this aspect of risk management. Ranging in ages from the 60s through 40s, we had enough cumulative and historical experience in the markets to all agree on one thing- the time at which you need to deploy a dynamic risk management strategy is precisely when it will be unable to be deployed, due to unforeseen market conditions involving illiquidity. This illiquidity could take the form of a failure for markets to be made in the instruments in question, or their quotes and prices to be impractical to take, due to an overall shortage of liquidity at affordable prices.

Thus, reading this recent piece on the implicit current risk of rapid and dysfunctional declines in prices and liquidity in the credit derivative markets, I am pleased that we are putting in place a 'no moving parts' risk management approach which relies on the simple attribute of a call or put option to allow for, but not necessitate, a trade, in order to limit downside risk to value.

Prudential's Withdrawal From Equity Research

Today's early morning program on CNBC provided breaking coverage of the announcement of Prudential's dissolution of its equity group. According to the story, some 400 people are being dismissed, including institutional equity trading, analysis, and, one supposes, underwriting.

As Becky Quick and Joe Kernen discussed the new development, nobody seemed to acknowledge the elephant in the room on this issue. Rather, they were musing about whether this means most research shops are not able to pay their way. One would think this was a foregone conclusion after the heavy use of 'research' to market underwriting and trading during the technology bubble of the late 1990s and early 2000s.

Conventional institutional equity trading of highly liquid, large- or mid-cap issues is simply unprofitable. Prudential is an also-ran player, behind the major investment and commercial banks. What hope could a second-rate securities unit, at an insurance firm, have to add unique value for institutional investors in the area of vanilla equities?

Personally, I'm happy to read of this development. It is yet another good example of Schumpeterian dynamics at work, weeding out the mediocre players in mature product/markets.

It's unlikely that anyone will notice, six months from now, that Pru's equity operation is even missing. The next two or three smallest shops could also shut down, with similar lack of impact on the markets. With so much free information available online now, why is anyone surprised at the shrinking market for providing conventional research and related equity services to institutional investors?

Of more value in today's market is the shifting volumes of transactions in specific issues, and sources of upward or downward pressure on demand for them among fund managers. That is a far cry from the old-style, conventional paper-based equity research provided by firms like Pru.

Implementing an Equity Strategy Through Options: More On Nassim Taleb

My recent post on the review of Nassim Taleb's book, "The Black Swan," has led to some insights which have radically transformed the alternatives for implementing our equity portfolio strategy.

In that prior post, I discussed Taleb's concerns regarding the inappropriate use of statistical distributions for various financial event forecasting and/or simulation.

Following on that book review, in a circuitous fashion, my partner and I were given a fairly lengthy article about Taleb, which appeared in the New Yorker magazine several years ago.

In that piece, buried toward the end, amidst considerable qualitative reasoning by Taleb on the subject of 'once in a lifetime' events, were a few jewels of investment insight. One was, a la Taleb's book, to eschew the use of normal distributions when assessing the likelihood of extreme market events, such as outsized negative or positive returns. The other was his avoidance of any equities, in favor of only purchasing puts or calls.

After considerable reflection, and the integration of the very timely comments of Professor Stephen Ross, discussed in this post, I realized that, strictly from a catastrophic event perspective, there is no scenario in which holding equities would be preferable to holding out-of-the-money call options on the same portfolio.

The only limiting factor to implementing an equity strategy in this fashion is one familiar to those who frequent casinos. Can we be fairly certain that our portfolios of call options will rise in value, above the cost of the premium, which is lost (unlike the investment in the underlying equity) each period, sufficiently frequently to avoid going bankrupt from a run of mediocre or negative portfolio performances?

After more reflection and some fairly involved quantitative Monte Carlo simulations, my partner and I have found the answer to be, "yes."

Further, once we determined that the risk of this bankruptcy is acceptable, we turned to a fairly simple, but incredibly effective strategy familiar to any casino player- banking your winnings. That is, we developed a simple approach to sweeping the positive returns back into the investment base, and making the size of each investment portfolio dependent upon various multiples of the original investment having been 'banked.' Thus, within a few periods of investing in the equity strategy via call options, we are playing with house, or the market's, money. This rapidly builds over time. The greatest risk for the strategy, as expressed through options, is a losing streak during the first 18 months. After that, the probabilities are that virtually any dry period can be weathered without losing the entire investment.

Along with the safety of implementing our equity strategy via call and put options, we realized two other transforming aspects of the new approach. By using options, rather than equities, we are able to reduce the investment required for holding a given dollar-value portfolio by roughly a factor of 20. And by more frequently investing in the strategy, using each month's selections, rather than simply running two, six-month duration equity portfolios each year, we were able to increase the expected returns by a roughly a factor of 6.

Together, the effect of using less-capital-intensive options, more frequently, have allowed us to increase the expected returns of the original equity portfolio strategy by something in the neighborhood of more than 100-fold, on a gross basis. And this assumes delta neutrality for long-dated, out-of-the-money options. In reality, our assumptions are very conservative with respect to the expected returns of such options, vis a vis those of their underlying equities. Since the original equity strategy had an expected annual return of roughly 20%, this yields a much more potent, yet safer, approach to exploiting the consistency of our large-cap equity selection process.

As a result of these recent new, and transformational, developments in our equity portfolio strategy, through the use of call and put options instead of underlying equities, we believe we will be able to forego the search for a large, institutional investor for the near term, and turn, instead, to our own capital, and that of selected high net worth individuals.

HP's Resurgence: The Details

Today's Wall Street Journal features an article purporting to describe, in detail, the reasons for H-P's resurgence under Mark Hurd. According to the piece, it all comes down to Hurd's first new hire, Todd Bradley, late of Palm.

What Mr. Bradley did, upon arriving at H-P, was essentially three basic things:

-reviewed consumer purchase behavior research

-concommitantly focused H-P's PC marketing on retailers

-identified, tackled and solved various operational issues involving distribution to said retailers>

What ought to concern any reader, and does me, is that none of what Mr. Bradley did was all that unusual. As I wrote about Burberry's recent CEO change here, so often, the solutions are not all that novel.

Why is it so hard to find people who can do the mundane and obvious? Where was H-P's board all the while when Carly Fiorina bumbled this one, via her 'management team,' such as it was? Why wasn't that board grilling Carly & Co. as to the reasons for whatever PC strategy they had, and why it wasn't working?

As I look at Mr. Bradley's actions, they are classically excellent. Clearly, this guy is worth whatever they pay him, as is Hurd, for finding him. But why did it take just Bradley? Why wasn't there some underling in the marketing or product management ranks at H-P who has or had sufficient talent to do this?

Let's review Mr. Bradley's program for rescuing the PC business.

First, he went to the data. He learned that Dell was weak in retail.... duh! That most consumers were now moving to buy laptops and notebooks and, consequently, wanted to see, touch and feel them, then walk out of the store with them. As I wrote here last fall, one benefit of selling notebook computers is that there isn't a whole lot to customize, so a vendor can realistically cover several price points at retail, without the time and expense of custom building the products for each order.

Next, Mr. Bradley focused on channel management issues. He improved communications and service to his downstream partners, listened to their problems and ideas, forged stronger relationships with them. Now he was in a leadership position in the channel of choice for notebooks and laptops.

Finally, he went about hunting down and fixing the various logistical stumbling blocks inside H-P that threatened the successful execution of the retail strategy. Through painstaking homework to identify bottlenecks, hold frequent meetings and establish performance metrics, he brought the logistical performance up to grade, and completed the overhaul of the unit's product and marketing strategy.

What about any of this was magic? Bradley did not apparently bring a team with him, or, if he did, the article omitted this. He simply used basic, traditional marketing strategy and tactics, common sense, and good management skills.

Are these so lacking in most American businesses, and H-P, as to require an infusion of this type of skill from another company?

Honestly, I think this speaks very poorly for the continuing state of American management education, the MBA as a useful degree, and middle-to-upper management in the average large US corporation.

H-P prior to Hurd seems to have simply been allowed to become mediocre. Even the board seemed to take a long time to show Fiorina the door and usher in a more competent CEO, Mark Hurd.

How many more US corporations underperform, consistently underperform the S&P500 total return, due simply to inept management of decent products in attractive markets?

GE's NBC Universal Unit: Is It Fixed Yet?

Last week, I wrote this post regarding GE's status as a discounted, closed-ended fund.

Within it, I referred to CEO Jeff Immelt's remarks last week on the turnaround at NBC Universal. He assured the CNBC audience that he personally approved of the new slate of television programs and films. That everything was fixed, and good times were at hand for the media unit of the ailing conglomerate he oversees.

Then came an article in the Wall Street Journal this past Tuesday. It announced the firing of programming chief Kevin Reilly, "as ratings slide."

Wow! That was quick! And I thought Jeff had it all under control. Buttoned down. In the bag.

Guess not.

According to the article,

"NBC Universal's timing indicates it doesn't have much faith Mr. Reilly's new slate contains the type of hit that could lift the network out of the ratings basement.....Mr. Reilly's successor will need to move quickly to put his stamp on the shows for fall, build morale at the network and learn GE's corporate culture."

According to Nielsen ratings, NBC "ranks a distant fourth behind Fox, CBS and ABC."

Maybe Jeff should hope to get a call from Rupert Murdoch, offering to take the struggling GE media property off his hands while it still has some value.

In any case, it sure makes you wonder what kind of conglomerate Immelt is running. Last week, he assures investors that his network unit is in great shape, and the progamming lineup is fixed. This week, they fire the chief programmer, amid word that the slate is in trouble.

Is this why GE, and its shareholders, 'enjoy' continued mediocre performance?

Apple, Microsoft & Schumpter- Steve and Bill Onstage Together

This morning's CNBC programming was heavy with clips of last night's Wall Street Journal-arranged hour and forty minute joint appearance by Steve Jobs and Bill Gates, hosted by two of the paper's columnists, Kara Swisher and Walt Mossberg.

Throughout this morning, I've seen the various clips of the two complimenting each other, discussing Apple's "PC Man" advertisements, and commenting about current technological trends.

As I listened to guests, on-air anchors, pundits, etc., all comment on the event, one thing was clear to me. These two people don't compete with each other anymore. One doesn't even really work now.

The fact that this event could even be staged tells you all you need to know. Active, competitive rivals don't typically sit around in plush leather chairs and exchange jokes and pleasantries about the "old days." Steve Jobs and Bill Gates, as software and/or hardware company CEOs, are now irrelevant. So was most of what they said last night.

Jobs has morphed Apple into a multi-pronged, digital entertainment and communications device manufacturer. Gates retired from his now-moribund software giant. Neither is changing the world with his company's work on PC-related efforts now.

Of course, CNBC's anchors stoked the fires, breathlessly asking,

'So, what does this mean for you as an investor?'

Fortunately, a few of their guests correctly replied, "nothing."

One CNBC anchor even opined on the two old rivals teaming their companies to "take on" Google.

As if.

Apple's taking advantage of the internet-oriented consumer base that Google has fostered. Microsoft is hopelessly behind. The two together have nothing that could possibly threaten Google now. They just compete in totally different product spaces.

This joint appearance by Jobs and Gates is a validation of Schumpeterian dynamics. In the 1983 clip of the two of them the last time they shared a venue, one can feel a bit of the old excitement of the nascent personal computer age. IBM's PC was just a few years old, and Jobs needed Gates & Co. to design software for the Macintosh.

That world is long, long gone. Apple PCs can run Windows operating systems, and the iTunes store was built to connect to a Windows world.

What this event demonstrated is that companies are a lot like athletes. They have a prime, then they age and die. CNBC commentators notwithstanding, neither Apple, nor Microsoft, is likely to be an investment in anyone's portfolio for their personal computer-related activities anymore.

The technological action has moved on, bypassing both companies' computer system-related efforts, as Schumpeter predicted.

The Economy, Liquidity Sources, and The S&P's New High

Friday's Wall Street Journal featured a fascinating editorial by David Ranson and Penny Russell of H.C. Wainwright & Co. Economics.


Their contention summarizes thoughts I've had since my first year in graduate business school nearly twenty years ago. That is, private monetization has evolved, since the early 1960s, to the point where it's reasonable to question how much impact the Federal Reserve's decisions and actions now have on our economy.


As the S&P500 flirts with a new closing all-time high, it's prudent and natural to wonder if this is a spike, or simply a stop on the continued road upward, as the index mirrors a healthy, growing economy.

Back when the index hit its previous high, in March, 2000, just over seven years ago, its P/E was in the low 30s. I don't know the precise current P/E for the S&P500, but I've heard something in the neighborhood of 15-18 bandied about by various pundits on CNBC in the past few days. Thus, the value of the S&P has returned to its seven-year prior level, but on much healthier revenue and earnings, and growth thereon. As opposed to a quick runup in the index, based upon internet startup valuations, it's now a function of a broader, slower growth in real revenues and earnings.

What does this have to do with the Journal article? Plenty.

Some pundits believe that most of the reasons for this recent rise in the index, and equity markets in general, is merger and acquisition activity. Personally, I think it is more a case of gradual, grudging recognition by mediocre analysts and money managers that the US and global economies are, in fact, growing in a low-inflation, healthy manner, thank you very much. Now, as a result of the under-appreciation of this, some smart capitalists have been buying other companies. But I would say the M&A activity is a result of growth expectations on the part of the better investors, frequently at private equity firms. Not the cause of the market advances.

What is private equity, if not private monetization of value and liquidity?

Back to the article in the Journal. The authors contend that the effects on "real consumption" of a 100-basis point increase in short-term interest rates, driven by the Fed Fund rate, has decreased from 1.84% in the period 1945-59, to -0.01% in the period 1990-2004. They contend that, as recently as 1975-89, the effect was as high as 1.35%.

Back in my graduate business school days, we studied the Treasury's "Operation Twist," its attempt to manipulate the term structure of interest rates, in the face of the nascent Euro-dollar market. This began due to, as is so typical, unintended consequences of a tax policy. The Treasury levied a withholding tax on the purchase of debt securities, in an attempt to control monetization. The result was the development of an off-shore issuance market in dollar-denominated debt, free of the tax. Voila, the leaks in US monetary base control had begun.

Coupled with the gradual liberalization of the old (again, things we were still taught in graduate school in 1979) regulations (R and Q come to mind) governing installment credit and bank deposit creation, the US monetary base began to undergo a transformation from a tightly-controlled quantity to a more easily expanded one enhanced by private credit extension.

With the arrival of more general-purpose credit cards, ATMs, cash-management sweep accounts at brokerages, and more expansion of public-company debt, monetization went wild.

I've always thought that most people gave far too little credit, if you'll pardon the pun, to the ability in our society for the private, which is to say, non-government, sector, to issue large amounts of debt in ever-easier to use packaging.

If you recall your old classical theory of money, M=Q*V, the V, or velocity, has been revved up by devices such as credit and debit cards. Additionally, the Q, or quantity, has been changed in character, as, now, immense pools of private equity capital invest small equity stakes in acquisitions, and simply issue debt through the public markets to complete the financing.

Ranson and Russell believe that this marginalization of the Fed is a good thing, as its "medicine" typically consisted of either starving the economy of funding, or flooding it with the same. Feast or famine, unemployment or inflation.

Now, we have the entire financial sector engaged in the role of money creation. Think about that.

Which would you prefer, if you had to choose just one method of money creation? A somewhat closeted group of unelected, but very intelligent and educated people who divine the market via their analyses, and set an interest rate? Or dozens of private entrepreneurs, large and small, who issue debt and monetize value, hoping to guess correctly on the profitable uses of the value they have monetized with their own currencies- resold mortgages, corporate debt, LBO debt, credit card receivables, etc.

It's a testament to our economic system that, slowly, without much notice, the private sources of monetization have come to limit, if not eliminate, much of the long-term effects of Fed policy, while shouldering the risks associated with the management of the quantity of "money" in our economy.

To quote from the economists' editorial,

"Ready access to both equity and debt capital from a proliferating number of sources means that businesses are no longer forced to curtail their activities when the Fed impeded the banking system's ability to provide credit. And since businesses thus no longer needed to lay off employees, employees no longer needed to cut back on their spending."

The passage which I have bolded is crucial. Essentially, after a 46-year management of US value monetization by the Fed (1914-1960), private sources began to flourish as means to fine-tune and adaptively finance business liquidity needs.

Right now, we see a situation in which the old quote, "this time, it's different," is actually true. Instead of the Fed's blunderbuss firing at a sector such as subprime real estate lending, and taking out the entire economy, we have private credit creation selectively expanding and contracting, according to the risks and losses experienced in each sector.

Congress, with its witch hunt for culprits in the subprime meltdown, is years away from comprehending this. Ben Bernanke is not. I think he actually realizes the truth, as synopsized in Ranson's and Russell's insightful editorial.

The benefit of risk-bearing, private-capital-providing credit creation is now, a la Adam Smith, a sort of invisible hand, evolving without design, which is allowing our economy to weather various sectoral peaks and valleys with the risks spread, and no need for the entire economy to tank over one sector's collapse.

Thus, with this broader, risk-aware monetization of the US economy by private, as well as governmental sources, economic growth seems to be steadier, and the sources of the S&P500's recent gains more enduring.

Amazon's Music Store vs. iTunes

The Wall Street Journal reported recently on Amazon's entry into online music purchasing for digital players. Apparently, their major innovation is selling DRM-free tunes.

As the article noted, however,

"...it is unclear whether typical consumers even think about the kind of problems the Amazon service is trying to address. That's because Apple's tightly integrated iTunes Store and iPod so thoroughly dominate their respective markets that most people may not even be aware that there are restrictions on what they can do with their downloads."

If I recall correctly, Steve Jobs' recent memo arguing for the cessation of DRM systems cited a surprisingly low percentage of iPod capacity being filled by iTunes Store purchases. Most of the capacity, he contends, is ripped by users from their own collections of CDs, and stored onto an iPod.

If so, this suggests that Amazon is targeting an extremely small 'problem,' indeed. And, by being so late to the game, it's essentially paying up to enter a commoditizing market. There are several other MP3-compatible online music selling or renting services, so premium pricing would not seem to be possible.

This new initiative by Amazon causes me to wonder if this is the best they can do for growth now. Looking at the nearby Yahoo-sourced price chart, it's clear that Amazon has been essentially in neutral for nearly four years. It has outperformed the S&P500 for the period, but largely all in 2003. Since then, it's drifted lower, then slowly picked up again in the last year.

However, it doesn't seem to demonstrate the sort of investor confidence, by driving its price steadily higher, that one associates with a profitably growing, technology- or retail-oriented company. I'm guessing that this new digital music sales effort won't do much to change this picture.

Business Media & Schumpeterian Dynamics

Today's "Financial Insight" column on the back page of the Wall Street Journal's Money & Investing section discussed Dell's recent foray back into retail, via Wal-Mart.

Essentially, the computer maker has deigned to sell some desktop units through the giant discount chain. Notably absent, however, are its notebook products. I wrote this post last fall, discussing how mistaken I believe Dell's strategy is in this respect.

At the end of the short piece, the authors wrote,

Dell has tried this strategy before, and it failed. In 1993, it began selling PCs at Sam's Clubs, a division of Wal-Mart. One year later, it pulled out. The reason: "This is a no- or low-return business," said Michael Dell. "We like to be in businesses where we can make money, and we know how to do that in the direct business. He must be hoping history doesn't repeat itself"

Guys, it never does.

What puzzles me is why much ink is even spent on this sort of Dell action anymore. History assuredly won't 'repeat' itself, in the larger sense, in that Dell is history. Its phenomenal total return and sales growth run is history. It has become just another datapoint sustaining Joseph Schumpeter's keen observations, early in the last century, on the nature of the rise and fall of businesses in a technologically-based, fast-moving capitalistic economy.

Home Depot is essentially the same. It, too, is now a market-saturating, mature company. The salad days of rapid, profitable growth and consistently-superior total returns are over.

Why can't the people in the business media see this? Companies are born, some develop strongly, they mature, then they age and go gently into that good night.

From an industrial structure point of view, aging sectors tend to consolidate, in order to preserve some vestiges of profit margin, amidst slowing or declining sales volumes and revenues. Very rarely, if ever, do leaders in a non-cyclical sector rise again, without drastically changing their business focus.

Dell and Home Depot are now, hopefully, just interesting, Schumpeterian footnotes in business history. I wish I could write that we won't hear a lot about them anymore, but that's probably not true. Because business writers and reporters don't seem to know all that much about business theory and reality over time. At bottom, business "news" and reporting seems to be more about entertainment than providing useful insights and information.

Burberry's New CEO and New Focus

Today's Wall Street Journal featured an article on Burberry's new CEO, Angela Ahrendts, and her retrenchment strategy at the famous brand's company.

I think Ms. Ahrendts is a very bright and decisive CEO. Her corporate pedigree suggests she's ideal for the job.

What really puzzles me, however, is that her predecessor was unable to effect the same strategy, even though it is more than 50 years old.

According to the article, when

"Walking through the Burberry showroom here after becoming chief executive last July, Angela Ahrendts looked at the wealth of apparel and accessories and thought, she recalls, "Way too much stuff."

....On her third day as CEO at Burberry Group PLC, Ms. Ahrendts asked Burberry Chief Financial Officer Stacey Cartwright for a report on what each product contributed to the business. Its findings: 80% of Burberry's sales came from 20% of its wares."

This simple, yet magnificently effective analytical approach was pioneered by Russell Ackoff in the 1950s among America's steel mills.

My manager and mentor at Chase Manhattan Bank, Gerry Weiss, used to say,

"There are hundreds of business aphorisms which we all know. The question is, which three or four apply in this particular instance?"

Few CEOs, it appears, know enough of the business strategy playbook to be able to shift gears and handle different situations, well, differently. So many seem, in effect to be one-trick ponies. Perhaps growth, or cost-cutting, or simply 'steady as she goes.'

Thus, Ms. Ahrendt's predecessor, Rose Marie Bravo, pursued rapid growth at Burberry's, although it eventually plateaued after almost a decade.

What I think this suggests is that boards of directors need to be more sensitive to how a CEO continues to perform over time. Initial successes are fine, and should be compensated. But that does not guarantee an endless honeymoon.

The reality of business seems to be that most CEOs cannot easily transition between environments, such as turnarounds, cost-cutting, or growth.

So at Burberry's, as Ms. Ahrendt reins in the product line, improving profitability, it will probably be worth watching in a few years to see how she does re-igniting profitable growth, when the pruning is finished.

On Derivative For Risk Management: Richard Bookstaber's Views

Last Friday's Wall Street Journal featured a long article which constituted, more or less, a review of Richard Bookstaber's new book, "A Demon of Our Own Design: Markets, Hedge Funds and the Perils of Financial Innovation."

The review sketches out Bookstaber's informed opinion that the dynamic use of various financial innovations, specifically derivatives, has contributed greatly to market meltdowns- the 1987 crash and 1998 LTCM, to name two.

Later that day, I saw a corresponding interview with Bookstaber, by the hapless Maria Bartiromo, on CNBC. Bookstaber reiterated most of the points covered in the Journal article. His response to her question concerning why Ben Bernanke would express confidence in derivatives as helping to spread risk more manageably throughout financial institutions, as evidenced by reduced market volatility, while Bookstaber is sounding a warning regarding the potential for increased, dysfunctional volatility, was quite interesting.

Bookstaber said, in effect,

"Yes, it's quiet right now, and things are working. But once they don't, watch out! That's when all hell will break loose."

Without a doubt, he's right, as is Bernanke. I discussed this with my current, and a former business partner at lunch that day. I hadn't yet heard Bookstaber's interview, but the same point was implied in the Journal piece.

The key to understanding the situation is to examine whether derivatives are used statically to guard against an unexpected, sudden market meltdown, or are planned to be used to offset a sudden and unexpected market meltdown. If you are using derivatives for the latter purposes, then, per Bernanke's view, they are beneficial. If, however, you are expecting to use derivatives dynamically amidst a market crisis, then Bookstaber's warning is correct, and, if anything, and understatement.

My partners and I all agreed, from twenty years of observing modern financial market meltdowns and crises, that the one thing of which you can absolutely be sure during a market crisis is that you cannot be certain of being able to trade any position.

Thus, there is a major difference between, say, using derivatives, such as options, as outlined in this prior post about Nassim Taleb's book, The Black Swan, and employing them in mind-numbingly complex combinations which are only underpinned by probabilistic distributional expectations, rather than straightforward, certain relationships. The use of call options to gain exposure to equity price appreciation, while removing the corresponding full exposure of price depreciation, is an example of the former. LTCM's complicated straddles and linked, cross-instrument and -market bets is an example of the latter.

When multiple derivative positions involving different instruments and markets are employed, many more assumptions regarding underlying distributions of occurrences of various price movements, and the probabilistic bets taken thereon, are often made than are realized.

Personally, I think this relates in some sense to the quality of talent going into financial engineering disciplines. Too often, less attention than necessary is paid to assumed underlying price distributions and various probabilistic assumptions on which, ultimately, so much of the value of presumed portfolio 'insurance' rests.

So, in this respect, I believe Bookstaber is right. Getting overly complicated in the use of derivatives invites failure of an investment strategy in the midst of a market meltdown that precludes any certain ability to dynamically reposition a portfolio.

Thus, as we consider options implementation of my basic equity portfolio strategy, I am mindful that it would be a static one, rather than an options approach that assumed any ability to trade in the midst of the type of rapidly-moving, unexpected market conditions. The key to successfully using derivatives is to allow them to function just by being in place, rather than hoping that a string of them move as predicted, according to 'typical' market conditions, or, if not, that they can be traded during such a market maelstrom to try to repair the damage of any incorrect assumptions.

Jeff's GE: Discounted Closed End Fund

Exactly one week ago, my partner and I attended a talk given by MIT Franco Modigliani Professor of Finance and Economics, Stephen Ross. I wrote about it here.

One of Professor Ross' topics was the anomaly of closed-ended funds selling at discounts to their net asset value. Specifically, approximately 7.5% for financial funds. I wrote that Ross discovered,

It turns out that simply quantifying and modeling the effects of management fees on the value of income and asset value to a closed-end fund-holder explained the difference between the market price and NAV of such funds.

What, you may ask, does this have to do with Jeff Immelt's GE? Plenty.

Today's Wall Street Journal carries a short article on page C14, by the paper's guest columnist, the online website breakingviews.com. Usually, these pieces are pithy, regurgitating what's already been in current discussion in the business media.

This morning, however, it raises the question of what GE's plastics division sale says about the rest of the conglomerate's valuation. To quote from the article,

"GE's vaunted premium to the sum of its parts, as estimated by analysts, has pretty much disappeared. Moreover, the plastics sale suggests many of GE's assets may have more value than investors and analysts are giving the company credit for in their models.....Companies that trade at a discount to their parts are prime targets for activist investors. Mr. Immelt should consider spinning off businesses such as GE Money and NBC Universal, before uppity investors dictate a more-Draconian corporate strategy for him."

I couldn't have said it much better, although I wrote it first. Here. Last August. Only it's not about spinning units off, but simply breaking the whole company into its constituent, standalone, unrelated businesses.

You see, Jeff Immelt is, in reality, simply an overpaid closed-ended fund manager. GE's shares are, well, shares of a closed-ended fund. The fund has invested in, actually acquired, a collection of unrelated businesses- finance, power systems, plastics (now gone), entertainment, etc.

As Stephen Ross illustrated, closed-ended funds trade at a discount due to management fees. In financial funds, those fees are typically one percent of assets, plus some expenses. You may ask why closed-ended funds exist. I did. Perhaps they are holdovers from the days when brokerage fees were high, liquidity was in shorter supply, as was information, and the best way for many investors to diversify was to buy a diversified fund.

None of those conditions are true today. That's why GE is an anachronism, as currently structured. It has no current reason for being.

To drive this home, let me relate what I heard yesterday morning on CNBC, Jeff's private (GE-owned) network. While discussing the plastics unit sale, he took the opportunity to once more attempt to fend off calls for splitting up GE. In particular, he argued that NBC/Universal was now turning around, and that they had a great slate of network programming and films on the way.

This was just hilarious. Jeff Immelt, corporate titan, is also a seasoned entertainment exec, with a sure eye for the next big hits on both the small and large screens of the world.

If you believe that, I have a bridge in Brooklyn to sell you.

As I contended in this recent post, Immelt is actually the only GE CEO in modern times not to have put his own stamp on the company. In this post, I explained why that doesn't matter to Immelt. He's already received a stupendous payday for nearly six years of abject failure.

Now, putting together today's Journal piece with Professor Ross' findings on closed-ended funds, it's much easier to see why GE should be dismantled into its standalone pieces, exchanging one share of GE for shares in each of its units. The discounted value as a whole conglomerate won't go away. But the plastics unit sale will now signal to the private equity crowd that there's money to be made simply by gaining control of the firm and releasing unrealized value in a breakup.

This should be a most interesting year for GE and the private equity funds.

Foreign Stock Brokers

Saturday's Wall Street Journal's Money & Investing section greeted me with an article that I had to start twice to be sure I was reading it right. Suffice to say, it lent more credence to my business partner's belief that the Journal's expansion to a weekend edition has seriously diluted the quality of its columns in that edition.

A guy named Jeff D. Opdyke wrote this piece, extolling the virtues of investing in overseas individual equities using foreign brokers.

According to Opdyke, many "bigger and more important markets" now include: Hong Kong, Auckland, and Cairo. Other markets one may ostensibly access from these include Shanghai, Shenzhen, UAE, Oman, Morocco and Turkey.

Apparently, liquidity and market manipulation are no longer considered risks in these outposts of capitalism. Forget about mutual funds that invest in foreign equities. Or the foreign exposure to be gained by investing in US global large-cap companies.

Further on in the piece, Opdyke warns of various risks, like one-day, 15% drops in the Thailand market due to government currency restraints, foreign exchange value risks, and unexpected closing of outfits like the Beirut exchange for days.

Honestly, I cannot understand who this article helped. Anyone with sufficient money to be able to, as Opdyke writes, "lose a chunk of it if their investments fall apart several time zones away while they are asleep," probably already uses a foreign country mutual fund. Those people would tend to understand these undiversifiable risks. That is why you pay professionals to enter markets like these.

Those who can't afford that, probably shouldn't know any more which helps them to hurt themselves. Frankly, the average retail investor in the US who already uses a broker is being sufficiently badly-served. Why compound the pain by introducing them to the same scourge in overseas markets?

I don't know anyone who still uses, voluntarily, a full-price, full-service retail broker. Between mutual funds and discount, execution-oriented brokers, the role of the stock broker in America is finally diminishing. Information is plentiful and cheap, if not free, while transactions costs are low and self-trading technology is excellent and likewise inexpensive.

When the service-oriented brokerage model is finally near extinction in the US, why is this Journal writer hyping its use in markets that are of far less quality and reliability than the American equities markets that already can deliver so much loss and pain to the average retail investor? This strikes me as, at best, irresponsible journalism and, at worst, reckless in inviting investors to lose even more money on specious investments beyond the reach of recovery for American investors.