Jamie Dimon's "Second Chance"

I honestly don't know whether to laugh or cry. This morning's Wall Street Journal piece on the front page of section C, complete with frameable cartoon of Jamie Dimon carrying a ladder, hammer and blueprints, contains enough material to do both.

My first reaction is to wonder at the paucity of capable leaders and managers which requires that the once-failed protege of Sandy Weill is called on to head a major US bank. Can there really be no better CEO for Chase than this retread? The article correctly points out that Dimon hasn't really had significant management experience in anything but cutting costs and operations, as befits a student of the now-departed Citigroup CEO.

So I guess we are to believe that a cost-cutter is now the best candidate to try to grow a company which (and I say this as a former "old Chase" staffer who has met and worked with several former CEOs of the company, including Mr. Rockefeller) has never successfully grown at a consistently superior rate without engendering serious credit problems and losses.

Without going into detail on each of the article's points regarding Chase's current business positions, let me suggest two things.

First, the management team at Chase, including it's recycled new leader, is probably not up to the task. None of the precursor banks (Chase Manhattan, Chemical, Manufacturers Hanover, JP Morgan, Banc One, First Chicago) which are now embodied in JP Morgan Chase ever attained performances which consistently placed them among the very best US financial institutions. Why should the aggregation of mediocrity change this? As my old boss and mentor at Chase used to observe, "what good would putting Manny Hanny, Chemical and Chase all together do? All you'd get is single larger mediocre bank!"

Second, the mere installation of Dimon as Chase's CEO may well indicate how meaningless the gesture actually is. Chase is but one, and third in size at that, of a new breed of financial utilities. In a world in which technology has allowed more nimble and innovative firms to outperform larger competitors, BofA, Citigroup and Chase predictably have moved to bulk up. I actually doubt it's that important who runs these shops anymore. Their CEOs probably can't profitably exercise all that much influence on such large organizations of risk-averse employees.

For example, Weill left Citigroup amidst a host of problems stemming from his leadership style. His successor, Charles Prince, is still struggling to repair the damage. I can't even tell you who heads up BankAmerica anymore. It seems such a faceless financial conglomerate.

Still, it pains me somewhat to see yet another large US corporation resort to recycling a failed executive, rather than look for fresher, more talented and creative candidates. Perhaps like voters and their elected governments, shareholders get the CEOs they deserve.

It is doubtful to me that a Dimon-led Chase will qualify as a holding among the consistently superior growth companies in my equity portfolio anytime soon.

Market Expectations for 2006

I'm not a professional economist , although I have studied economics, both micro and macro, extensively. As an equity portfolio manager, however, I believe I need to have some sense of what may affect the US equity markets in the coming year. Here is my current “back of the envelope” forecast for the coming year's equity market.

From what I have read, I expect US economic growth will continue to be decent for at least the first few months of 2006- perhaps through June. Estimates seem to indicate a range of 2.5-3%. Maybe less than prior years, but still decent. I don't think energy prices will unreasonably curtail this growth rate.

However, I suspect that by June, the prospect of the Iranian mullah-bomb will begin to affect investor psychology and dampen growth expectations. Fears of destabilized trade, a nuclear-fallout-tainted eastern Mediterranean and southern Europe, may cause market wobbles.

This will become a major drum beat for the mid-term US Congressional and scattered state gubernatorial elections. what to do about Iran? Is it another Iraq in the making? Is that a good or a bad thing? It’s probably a good thing, if you liked the way George Bush defused the outlaw menace that was Iraq under Saddam Hussein. It’s a bad thing if you like Al Gore.

The worst case would be a two-year drift of a weakened Rebublican-controlled House and Senate majority, or maybe even the outright loss of the House, coupled with the increasingly-lamer-duck status of President Bush. This latter development of a split in Congressional control between a Republican Senate and a Democratic House could mark the return of semi-gridlock. Only this time, rather than be a check on the liberal agenda of Bill Clinton, it could be a brake on important foreign policy action.

It is useful to remember that Iraq tried to play with nukes by starting almost from scratch. We know Iran actually has the material, facilities and people to do this. It’s a very different and far more explicit, verified threat this time.

The silver lining may be this. Iran hates Israel and is sworn to destroy it. Israel has the implicit backing of the Democratic party, and the Democrats in particular will not want to see Israel attacked and/or destroyed by an Iranian nuclear weapon. They may surprisingly decide to back George Bush on military action to remove the Iranian nuclear threat.

If I am remotely close in my conjectures, it probably spells another anemic year for US equity markets. Uncertainty, particularly concerning global conflict, tends to have that effect. I hope I’m wrong. Or, if I am right, that the threat is dispatched quickly and cleanly, leaving the markets to rise in subsequent appreciation.

Multimedia Hoopla: Google Everywhere for Everything

As I mentioned in my previous post, I'm making up for lost time over the past few weeks due to the press of portfolio management-related activities. In reading my short list of blog topics, I see I was enamored with the notion of Google and the rise of the "new" multimedia.

Of course, it's sort of apropos that I am writing this in the wake of yesterday's awful tech sector bellwether earnings reports. The S&P is down slightly more than 5 points today as I write this, largely in reaction to the tech sector weakness.

However, back to my theme for this post- the hoopla over Google becoming, in addition to a titan in so many other areas, the new multimedia mogul sourcing everything.

Something about this scenario doesn't make sense to me. First, other than capital and a brand name, what does Google bring to the provision of on-demand accessible multimedia content that is not duplicable? Are not Apple, the old-line networks, Comcast, Microsoft, etc, all equally qualified for this role?

In fact, does not the ubiquity of broadband, and the accessibility of unlimited sources of media content, via unlimited websites offering said content, argue against a monolithic giant with a strangehold on "all" desirable multimedia content?

Is it not reasonable, much as with your (cable or satellite) television now, to expect people to have a clutch of favorite URLs (instead of television channels) to which they go for various movie, television, music, video, news and other entertainment content? Why would anyone expect to find everything valuable at one location?

This reminds me of the ongoing fear various pundits have always had about the current most-valuable technology company. In the past, the villains have been IBM, CDC, Xerox, Microsoft, Dell, Yahoo, and, now, Google. How much longer before Google is on the "prior" list?

If anything, this latest wrinkle in the provision of multimedia content is one of the best "quality of life" breaks the average American, nay, world citizen, has gotten in a while. This sort of change promotes liberty and individual initiative in ways undreamt during my youth in the 1960s.

CBS Redux

I have lately been busy with portfolio management activities. However, I made a note to comment on this new year's return of CBS as a listed equity issue. Viacom split, as of the new year, back into two parts again.

It seems like yesterday when Sumner Redstone went after CBS, declaring how powerful it would be to link content and distribution. Same old same old. Now it's five years later, and there he was, doddering around on the floor of the NYSE, babbling about how much value was being unlocked for shareholders by reversing what he did five years earlier.

Here's what really annoys me. If one of Redstone's lieutenants had made an error of this magnitude (excepting, perhaps, his daughter, now installed in the senior management of Viacom), that guy or woman would be history. Cashiered for wasting shareholder's money and pursuing grossly unprofitable ideas.

Instead, Sumner Redstone dictates to his shareholders that, having undone his colossal mistake, he'll still be chairman of both entities. Nice work if you can get it, eh?

As I noted in a recent post, there's not much to be done but sell the stocks if you owned them, or don't buy them if you don't already own them. Forget "corporate governance" as a relief on this one.

It just goes to show how one needs to take so much of Wall Street's sales pitches, and even those of bumbling, aging CEOs, with large grains of salt. Assuredly, they are more concerned with filling their own pockets than they are with filling yours.

Caveat emptor indeed.

Executive & Star Employee Compensation

There was an interesting juxtaposition of positions on executive and 'star employee' pay today from two staffers of the Wall Street Journal.

Alan Murray spoke on CNBC regarding Sirius radio's payment of many millions of dollars to Howard Stern. Mr. Murray provided stock price and recent product sales information to demonstrate that Stern is, in fact, proving to be worth the immense compensation package he received for switching employers to Sirius.

Meanwhile, in this morning's Wall Street Journal's Money & Investing section, on page one, Jesse Eisinger babbles about the need for hedge funds to be responsible for policing exhorbitant executive pay. He includes some formative academic research results to bolster his case that too much of net after-tax profits of some companies are going, on a percentage basis, to the CEOs of those companies.

Personally, I believe Alan Murray is on the right track. I think Jesse Eisinger has lost perspective.

As portfolio management has been my primary occupation for some time, I have reflected on so-called "corporate governance" issues, executive compensation being one of them, for years. I even have had discussions about it with a friend who is a noted retired Fortune 50 CEO and sometime-speaker on the topic.

As a portfolio manager, I will say that you only really have one effective lever- buy/hold/sell a stock. Period. As my father used to advise me when I was a child, "son, we live in a democracy. But your dollar vote counts much more than your ballot box vote, because you vote more times each year with your dollars while buying things than you ever vote in a year."

And that, dear readers, is what being in a mixed-free economic democracy is all about. Ultimately, dollar votes reflect reactions to political or moral dilemmas.

In this case, after all the brouhaha over executive and key employee compensation, the truth is that you buy or sell stocks of companies based upon relative expected performance. Frankly, so long as a stock is likely to exceed everybody else's expectations, and, thus, earn an above-average return, I could care less what they pay the janitor, the CEO, or anybody else at the company. It's up to the CEO and his team to figure out what levers to pull. I just hope I've bought the right teams of leaders and managers in the right sectors.

In my opinion, people who debate this compensation issue are sadly misinformed as to how much power or control they have over the issue. They would likely be better off accepting that they have none, and stick to selling poor performers, and buying those with good prospects of out-performance. Leave the operating management and board of directors to affect compensation, and stop spilling so much ink, real or cyber, over this red herring.

2005 Equity Markets and Portfolio Strategy Observations

This year has demonstrated once again that our portfolio strategy consistently out-performs the market, despite our infrequent trading and sometimes concentrated positions. We reselected the portfolio once in January and in July. The portfolio’s focus on home building, energy supply and distribution, and retailers, returned 15.2%, which was 10.3 gross percentage points above the S&P500 index for the year.

Despite several mediocre months at the year’s outset, the portfolio actually gained in 8 out of the 12 months of 2005. This is a typical year’s performance pattern. When the portfolio and the index both gained or lost, the portfolio had a greater return in the same direction as the index, with the exception of February’s modest gains. This confirms our conviction that the portfolio’s declines during periods of mild market pessimism are inevitably compensated by its greater gains in the subsequent months of positive market performance. For instance, note the portfolio’s April decline, followed by May’s 8% return, the year’s largest.

This year’s major stories centered around economic weakness, the imminent collapse of what has been termed a “real estate bubble,” two natural disasters, and the effects of energy prices on the economy. Our patient maintenance of portfolio positions paid off handsomely when the pessimists were proved wrong throughout the year.

Last year may be portrayed as one in which the market staggered under a variety of negative forces, bumping along for much of the year with effectively no return at all, as displayed in the chart below.

Early in the year, inflation worries and repeated stories of an economic “soft patch” depressed the market for large cap equities. In a pique of contrariness, good job growth numbers were seen as baiting the Fed to raise rates, and thus choke off any US economic growth. Sell-side analysts’ reports of $100/bbl oil and raw material price inflation added to the malaise. Throughout the period, we remained long, confident that our long/short allocation signals correctly saw no major market decline coming. We felt that reports of energy “paper trading” pressures were partially responsible for energy price spikes, and raw materials price rises reflected economic growth, not pure inflation. We noted that, despite the Fed’s continued tightening, Treasuries were still not yielding above 5%, a level at which the economy is certainly capable of performing robustly. Our expectation at this time was for a modest S&P500 index performance for 2005 in the neighborhood of 5-8%.

In the second quarter, May’s sharp gains for both our portfolio and the index signaled the turnaround in investor confidence. By remaining patiently long, we avoided missing key days of large gains by being on the sidelines. As frequently happens in these circumstances, when investors return to a belief in future healthy economic growth, the portfolio gains even more than the index.

After a –4% return in April, the strategy had its best month in May, for a 7.9% gain, since November of last year. Unlike the index, however, in June, it continued to show strength with a 2.6% return. The various forces reacting to global geo-political and economic news seemed to have achieved a confused and confusing result as the second quarter ended. Oil prices continued to fluctuate at high levels. Interest rates, while higher over the second quarter, were still not high historically.

Rising rates may shift the growth prospects of various economic sectors, but they do not mean the end of growth per se. Most companies have business models designed to profit in conditions with interest rates above current levels. The levels have been rising ever since Alan Greenspan decided that the post-bubble liquidity provision by the Fed needed to be reversed. However, they were and are still not anywhere near the levels of the late 1970s, when the US economy experienced stagflation.

The third quarter featured one negative return month out of three for the S&P 500 index, like the second quarter, resulting in a return of 3.6%. The Pathfinder portfolio returned 12.3% for the quarter. It was the best quarter of 2005 for both the index and Pathfinder.

The Pathfinder portfolio for the second half of this year, which was the portfolio predominantly in place in the third quarter, was markedly different in its sector focus than the January selections.

Taken together, the portfolio indicated an expectation of continued profitability and market price rewards for energy producers and distributors, upscale retail goods, housing and lodging. It fit with a healthy, growing economy that is consuming more energy to fuel such growth—and can afford it. Consumer retail demand was expected to move from the Wal-Mart style discounters to upscale retailers and products.

In July, the S&P500 index posted the third of three consecutive positive months. However, the effects of hurricane Katrina dampened the August performance of the index. As hurricane Rita turned out to be milder than expected, and the aftermath of Katrina began to be clearer in September, the market eked out a small gain that month.

Taken together, however, it still resulted in the market’s best quarter of the year thus far.

The portfolio outpaced the market in July, as pre-hurricane energy concerns began to drive our energy and utility holdings higher. Home builders came under almost immediate pressure again, due to concerns over energy prices and interest rates. August saw the same directional results in these sectors, only more so. With hurricane Katrina, energy prices and the stocks of companies in those sectors skyrocketed. In Katrina’s aftermath, and with hurricane Rita affecting natural gas production and distribution, September added more stimulus to the same sectors.

As a result, the portfolio’s energy and utility holdings more than compensated for softness in the home building, retail, entertainment and upscale luxury brands holdings.

Did the continued rise in interest rates and energy prices again signal an end to growth, as they were expected to do in every quarter of this year? Similar to prior quarters, economic growth fundamentals—specifically, job creation and profits—continued to show strength. So, we believed the answer to this question to be “no,” and remained confidently long in our positions.

Our expectation was that the equity market was positioned for a continued healthy rise over the last quarters of 2005. Not stratospheric, like 2003, but more like the gentler gains of 2004. Our exposure signals remained, at this time, “long.”

The fourth quarter featured one negative return month out of three for the S&P 500 index, like the second and third quarters, resulting in a return of 2%. The Pathfinder portfolio returned 1.4% for the quarter, as October’s –5.4% loss dampened its performance.

Three major forces drove the market in the last quarter of 2005; the fallout from September’s hurricanes, fears of Fed action coupled with economic impacts of its tightening, and then, as always, retail holiday sales. Thus, October was the worst month for both the index and our portfolio since April. However, as the year ended, Greenspan remarked on the US economy’s robust strength in accommodating natural disasters and higher raw material and energy prices, while still continuing its modest, healthy growth. In fact, home building did not completely collapse and energy prices moderated. Inflation was not running away and both job and overall economic growth—despite media insistence to the contrary—remained and finished strong.

For the year overall, we feel our portfolio management approach served to ideally weather the uncertain psychological conditions of 2005. Attempting to time last year’s equity market could have been disastrous. After May, the S&P500 had only one significant positive month until November, but our portfolio had three solid months of performance in that period. We correctly remained long all year and easily out-performed the market.

Our disciplined management of a superior equity selection process resulted in another solid year of performance during an unusually choppy and uncertain year in the US equity markets. The process’ selection of energy-related, home building, luxury goods, basic materials and selected medical-related equities proved effective in capturing healthy growth. This was amidst an uneven response by the market to the year’s various pressures and their effects on various economic sectors.

All's Well That Ends Well

The equity markets staggered to the 2005 finish line with a nearly flat performance for December. For the year, the S&P500 index was up roughly 4.8%, while my equity portfolio returned roughly 14.1% on a gross basis.

Despite all the hand-wringing by sell-side (a/k/a brokerage desk trading-biased marketing reps) analysts over; economic 'soft patches,' oil prices, natural gas scarcity and price, natural disaster impacts on the economy, housing bubbles, declining consumer confidence, the non-existence of a growing US economy, and a lackluster holiday retail season, the economy did grow in 2005. A nearly 5% return for the year may not be excessive, but it hardly represents a recession economy, either.

Being invested in housing and commercial real estate, energy production and distribution, selected retailers, finance and biotech, my portfolio out-performed the index by almost 10 percentage points. I guess energy was a good place to be, even if you didn't trade positions since July. As was biotech, finance and some retailers.

To me, 2005 provided yet another demonstration of why it is typically better to ignore most of the manufactured "news" from the sell-side of Wall Street, and focus instead on key indicators of whether or not a serious market decline is likely to occur. It served me well this past year, and I expect it to do so again in 2006.

AOL & Google Joint Venture

This week's announcement of Google's venture with Time Warner's AOL unit seems almost anticlimactic. The major news about the venture, I suppose, is that Microsoft lost out on the defensive move.

It seems to me that anything Google really needs accomplished will be done on its own, with full control. For some time now, the mating dance by Yahoo, Microsoft and Google around AOL was seen as mostly to keep the latter's customer base out of one of the others' grasp. Just in case it turns out to be useful for something.

Watching Dick Parsons juggle his succession lineup and attempt to fend off Carl Icahn in the midst of this venture is amusing, when it's not sad. I owned AOL at the time of its merger with Time Warner. Then, as now, I thought the latter's board did a profound disservice to its shareholders by accepting AOL's offer, and not spurning it. It is hard to believe that a marquee name investment bank would not have found adequate grounds to reject the offer, protect the board's exposure on the "fiduciary duty" basis, and provide sufficient doubt of the longer-term value of merging with a temporarily-highly valued suitor like AOL.

Perhaps, more than anything else, this deal demonstrated, once again, that "synergies" are rarely realized post-merger, and that simpler business structures are frequently more consistently superior in generating market-beating total returns for their owners.

I don't envy the managers at AOL. Being the "partner" of a celebrity company like Google, and nearly publicly disowned by its management, can hardly be an appealing career opportunity.

CNBC's Squawkbox: Investing As Entertainment

Is it not ironic that within two weeks of the NYSE voting to merge with Archipelago and move decisively away from its open-outcry market method, and the regulatory problems it has experienced with its specialists, CNBC revamped its early morning business program, Squawkbox, moving part of its coverage to a set located inside the exchange?

If this doesn’t demonstrate the networks treatment of investing as primarily entertainment, what could?

The NYSE move to electronic trading, in order to minimize the egregious regulatory infractions of it’s specialist members, including front-running its customers when order filling, makes the trading floor an even less important place in the investing process then it already has been for some time. With the rise of managed funds, 401K plans, etc, institutional management has been the driving force in the market for quite some time. The trading floor is for order execution, but is not, in itself, the locus of investment decision-making that moves the markets.

Thus, CNBC seems to be moving to cover the sizzle, but not the actual “meat” of the capital markets. If you needed to understand what is going on in the markets, you can monitor any number of real-time ticker and index data feeds. Actually seeing the trading floor and filling of orders is superfluous.

However, if you simply want to portray an entertaining drama of market forces at work, I suppose having a program set located within earshot of the trading floor frenzy does that.

Pepsi’s China Potato Farming

The Wall Street Journal carried a feature article this morning discussing PepsiCo’s efforts at growing its own potatos in China for the local production of Lay’s potato chips.

What struck me were the last two paragraphs. After describing the agony PepsiCo has gone through to produce enough potatos in China to drive Lays’ market share to 40%, the piece noted that Wal-Mart (in China) complained about shortages of Lays on its shelves. The article finishes with these lines,

“….The chip-production goal has been increased again to meet rising demand. Mr. Shi’s shoulders slumped.

“We’re under a lot of pressure from the sales guys,” he said. “It’s growing too fast.”

This reinforces my thesis that the best way to buy successful growth companies is to buy those who have already demonstrated successful growth. That is because sustained profitable growth is so hard to achieve.

Isn’t it interesting that a world-class company like PepsiCo, with so many resources available, has to struggle, as the article depicts, just to introduce and grow the Lays potato chip brand in the world’s most populous country? You would think this would be child’s play. But evidently it is not.

PepsiCo has only attained a cumulative 20% total return for the past five years. By comparison, the S&P500 is slightly under a 0% return for the same period. That means that PepsiCo has had an average out-performance of only 4% over the S&P for the last 5 years. Clearly, it is by no means currently successful at turning whatever top-line revenue growth it has into consistently-superior total returns.

However, my portfolio strategy has selected a host of companies over the years which have consistently performed much better than PepsiCo. Thus, my preference for owning companies that have actually demonstrated consistently-superior performance over time, rather than those who one would believe should be able to do so. And the wisdom of my strategy’s approach is evident in the portfolio’s consistently superior returns over time.

“Good To Great” or “Consistently Superior” ?

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. The Wall Street Journal has made a few references recently to that body of work, by Jim Collins in his book, “Good to Great,” published in 2001. I decided to acquire a copy and read it myself. Amazon was very helpful in providing me with an inexpensive copy, with no benefit to Collins in the process.

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 address both here and in subsequent posts.

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.

This is a very non-trivial issue. If, as CEO, your decisions are guided by the desire to “maximize the present value of the firm”, how do you choose when to maximize that value, which in turn maximizes shareholder wealth? Will the decisions you make enrich some shareholders at the expense of others because they own your company’s stock at different points in time?

It is highly likely that a consistently-superior firm’s great wealth creation is a reward for not forcing investors to be market-timers. Collins completely misses this distinction in his work. Since it is the first screen by which he typifies companies, it therefore compromises the entire remainder of his findings and body of work as described in the book.

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.

As I read more of Collins’ book, I will post additional comments on the differences in approach and findings between his work and my own.

GM- The Truth At Last?

I checked my blog posts to see when I first wrote about the GM situation. On October 18th, I first wrote of my expectation that GM is now in what will come to be seen as its death throes. With the title "Speaking Truth to Power," I questioned why so many media and brokerage analysts failed to seriously question GM's future viability, in the face of so much evidence of its travails.

Yesterday's downgrade of the company's debt by Standard & Poors may now give these parties the "cover" they seek to express their true feelings. According to today's Wall Street Journal story on the subject, S&P's rating of GM now places it in a category in which 5.7% of whose companies typically default within a year. So, now we have at least one quantitative estimate of GM's viability over the next twelve months. Since GM is involved with the Delphi situation, I stand by my belief, expressed many weeks ago, that the former will be merged, acquired, or in bankruptcy at the end of two years from now.

It is noteworthy that S&P, perhaps a more "neutral" analyst than many brokerages, is quite clearly concerned about the revenue and market-share dilemmas facing GM, rather than the company's self-diagnosed cost-control challenges.

What I now wonder is how much value in investors' portfolios has been destroyed by GM's roughly -19% return from October 18th until yesterday's closing price? How do the sell-side analysts defend their silence then, given this recent loss in GM's value? I don't track how many downgrades were issued, or when, by various analysts since mid-October. What I do know is that the media and analytic climate two months ago was one of relative silence in the face of what seemed pretty obviously the beginning of the end for GM.

Desiderata

Go placidly amid the noise and haste,and remember what peace there may be in silence.

(Max Ehrmann, Desiderata, Copyright 1952)

I thought of this poem the other day while watching an end-of-day report on trading in the stock market on CNBC. It captures very nicely my style of investment amidst the daily frenzy of the equity markets.

Most portfolio managers trade more frequently than I do. My twice-yearly trading allows my positions to quietly run their course, often amassing substantial returns while others would “rebalance” away profits. This half-year has been no different in that regard, with energy issues earning double-digit returns.

I have, however, come to terms with the steady drumbeat of sell-side analysts and media pundits, such as Jim Cramer. Daily volatility is now something I expect, as it represents other investors and traders entering and exiting the market on any particular day. These daily price fluctuations assure smooth and liquid trading on the two days per year I will trade. With few exceptions, the actual movement of the market over a few hours on any given day is not that large.

So I now “go placidly”, holding my positions patiently while observing the daily frenzy. No matter how volatile the daily price moves, the monthly volatility is less affected. And so are even longer-term moves of prices and indices. My portfolio may experience some volatility due to short-term market exuberance, but in the longer-term, the superiority of the portfolio’s selections typically reappears. The key is to not succumb to daily or weekly concerns due to traders’ constantly-shifting valuations, but maintaining the discipline of my investment process.

GM: The Agony Continues- Part 4

General Motor’s CEO Rick Waggoner’s op-ed piece in the Wall Street Journal Tuesday morning contained an interesting little bit of monetary policy information which almost escaped my attention, and may have eluded yours as well.

"… This ignores the fact that American auto makers and other traditional manufacturing companies created a social contract with government and labor that raised America's standard of living and provided much of the economic growth of the 20th century. American manufacturers were once held up as good corporate citizens for providing these benefits. Today, we are maligned for our poor judgment in "giving away" such benefits 40 years ago…."

Waggoner is saying that GM and other large US corporations privately monetized future promised benefits as a form of currency to lubricate and drive US economic growth. He implies that they promised wealth in order to drive more consumption on the part of the workers. He seems to be arguing that making false promises which accelerated US growth in prior decades is defensible on the basis of the end, namely, falsely promising undeliverable benefits.

Is this amazing, or what?

First, Waggoner effectively admits that corporate America has been privately creating money by issuing dubious pension promises. As if GM hasn’t had enough difficulty just being a consistently-good investment for its shareholders, it apparently dabbled in monetary policy, too.

Then, with unmitigated gall, Waggoner goes on to suggest that making pension promises which have turned out to be unaffordable was justified, because it caused workers to feel wealthier, spend a lot more money, and drive economic growth.

Maybe Rick Waggoner would be better off not speaking or writing anymore, and trying to find a merger partner for his wreck of a company, while it still has some cachet with a few buyers in some of its customer segments.

GM: The Agony Continues- Part 3

General Motor’s CEO Rick Waggoner’s op-ed piece in the Wall Street Journal this morning is a pathetic paean to socialistic corporate policy.

Waggoner first makes a dismissive nod to the need for producing vehicles which people actually want to buy, rather than stuffing GM products with various features that still fail to address the overall demand of the driving public. The extent of his solution is found in this passage, “We will step up our performance in this regard.”

Wow. And all this time, it was so easy. Just write that you will ‘step up …performance,’ and you have it covered. No details as to how your entire heretofore ineffective creative design staffs will change overnight. Or how these people, or perhaps their replacements, will quickly produce newly-interpreted solutions for the vehicle-buying public. No, just tweak a few knobs down in the design department and you are back in the black!

But the really sad part of Waggoner’s article is the roughly one-third of it which wraps his company in the American flag. This tactic sent me to Bartlett’s for this line:

“Patriotism is the last refuge of a scoundrel,” is attributed to Boswell in his Life of Johnson.

According to Waggoner, while GM freely entered into its pension agreements with its workers and their unions, they did it because “….(American manufacturers) were once held up as good corporate citizens for providing these benefits.” He goes on to say that these same companies are now “maligned for our poor judgement in ‘giving away’ such benefits 40 years ago.”

What Mr. Waggoner fails to realize, as apparently did his predecessors, is that his and their fiduciary duty is to GM’s shareowners, not to a faceless holder of opinions about whether a company is a “good corporate citizen.” He takes the easy way out, pleading that GM’s prior and current managements must bend to the will of public opinion regarding their status as corporate citizens.

Never mind their option to make their own case to these same opinion-holders regarding the long-term financial inviability of the agreements GM freely made. Instead, Waggoner effectively blames the social environment of the last 40 years for his company’s plight. I would opine that, if anything, this displays how inept the GM management has been for years at correctly assessing its own costs of business, and putting its shareholders first.

If this kind of scapegoating and avoidance of responsibility is how Waggoner plans to lead GM, I continue to predict that he will have a short tenure.

Productivity Wrongly-Defined

...since we are dealing with an organic process, analysis of what happens in any particular part of it-say, in an individual concern or industry- may indeed clarify details of mechanism but is inconclusive beyond that. Every piece of business strategy acquires its true significance only against the background of that process and within the situation created by it. It must be seen in its role in the perennial gale of creative destruction; it cannot be understood irrespective of it or, in fact, on the hypothesis that there is a perennial lull.

Joseph A. Schumpeter
Capitalism, Socialism and Democracy, 1942

This morning on CNBC, the Squawkbox crew debated recently-revised “productivity” data for the US economy. I use quotes because I have my doubts that the popular use of the term promotes clarity of thinking, as I hope to demonstrate in this piece.

Steve Liesman spent a considerable amount of time discussing how the improved physical output of a machine would improve productivity of its worker, and also profitability of the firm using it. If only life were that simple.

As my old boss and mentor, Gerry Weiss, SVP of Corporate Planning & Development at the old Chase Manhattan Bank used to say, producing another poorly-selling Cadillac Cimarron more efficiently adds little, if any value to the US economy.

Simply put, there is a major difference between efficiency and productivity. I find most classically-trained economists make this mistake, Schumpeter’s passage notwithstanding. To understand the difference, we need to understand the “background,” as Schumpeter stated in his 1942 book.

Liesman made a common mistake in assuming that whatever that machine was producing could be sold at a market-clearing price, thus improving overall profitability and margins. However, this isn’t correct. Productivity didn’t improve from that machine’s added output- efficiency did. We only know about the physical output of the machine per unit of time or other resources- workers, maintenance expense, etc.

We know nothing about the sale price of the product into which the machine’s output goes, nor the price elasticity of the product, the demand for it at various prices, etc. These elements affect what I call the product’s, or sub-component’s “resource value productivity.” This would be the value-added to the firm of that component or product divided by the particular resource, in this case, a more efficient machine.

Confusing efficiency of output with the ability to create more value-added per unit of resource shows a lack of understanding of how economics is morphed in a company into marketing.

For example, what if the management of the firm in question has mis-estimated demand, and the newly-efficient machine is producing unwanted product? Think this is rare? Look at GM, Ford, Merck, or even a Hollywood movie studio. If GM more efficiently produces an SUV that will sit on a dealer’s lot, to be sold at deep discount, was there any productivity gain? Or was an unwanted, little-valued product made more efficiently?

It strikes me as odd that reporters on a leading business program can be so well-versed in economic theory, but miss the major difference that an advanced, consumer-driven market economy has over a production-driven economy. That difference is the need for producers in the former to get product development and price-points right, in order to sell highly-valued merchandise and services to a demanding and selective market. Once you grasp this, you immediately can grasp how production efficiencies are not at all the same thing as resource (value) productivity.

Schumpeter’s observations about the perennial gale of creative destruction makes this so. Too bad so many business people and economists recall the two-word phrase, but not the author’s deeper analysis of its implications.

Over-Compensated American Senior Management as a Source of Competitive Disadvantage

Carl Icahn gave an interview to David Faber of CNBC late last week. Many of Icahn’s remarks were self-serving and postured to support his current involvement in pressuring AOL regarding its current asset divestitures and strategy. He makes no secret of wanting Dick Parsons out. For what it’s worth, I think he is right about that.

However, what really made me sit up and take notice was Icahn’s pointed comment regarding the modern large-cap American CEO. He feels that, on average, and as a group, they are seriously disadvantaging US business relative to foreign businesses. This is a fascinating viewpoint. It echoes my own research, writing and feelings, some of which are found elsewhere on this blog.

Icahn specifically voiced concern that today’s CEOs are so over-compensated that they simply do not pay sufficient attention to maximizing ongoing shareholder wealth. In this, I totally agree ( see my recent post regarding pay-for-performance for large-cap CEOs). He feels that if this trend continues, American business will lose its competitive edge and, over time, fall victim to hungrier, more attentive foreign competitors.

With GM, Ford, UAL, Merck and TimeWarner as examples, it’s hard to argue with him. It is possible that Ricardian economics is responsible for the leadership in steel, airlines and autos going overseas.

But couldn’t these firms have accomplished what Intel has around the world, and remained competitive via global facilities and globally-sourced talent? My suspicion is that Icahn is onto something here. As superior innovative talent in other countries becomes more globally accessible and able to be leveraged, it may signal another round of American industrial restructuring to come on the order of that which we saw in the 1980s and early ‘90s.

“Purpose Brands” ?

Tuesday’s Wall Street Journal featured a piece in the second section’s “Manager’s Journal” that can only be described as remedial marketing.

The piece, entitled, “It’s the Purpose Brand, Stupid,” advances the apparently-novel notion that products (and services) should be focused on customer needs.

Really? Do tell!

What struck me as I glanced at this piece is how low the Journal’s staff must be aiming to waste space on this type of pablum. And, thus, how uneducated the staff must feel their average reading audience is.

But there’s more shocking news. The piece is an exerpt of the authors’ upcoming article in the Harvard Business Review. One of the co-authors is a member of that college’s business school faculty.

The notion of developing products to satisfy customer needs is literally as old as marketing itself, and covered in an introductory marketing course at the undergraduate level. Why this would need to be re-stated as a special topic in the world’s leading business daily makes a sad statement about the state of mediocrity among business executives in general.

Perhaps this is because the MBA as an educational program is insufficient to impart the necessary knowledge in depth to lead and manage businesses effectively. With less than 24 months duration, and the last 6 of those typically wasted on job search, the educational program may be too short to really imbue its students with effective managerial tools. In my opinion, it seems to have become more of a financial- and other functional tradecraft certification, and much less of a management degree.

If this were not true, would an article such as the one mentioned in the beginning of this post be appearing in the leading business daily paper, as well as a well-known business monthly magazine?

Southwest Airlines: A Case for “Right Sized” Airlines ?

This weeks’ Wall Street Journal article about Southwest Airlines’ move into a new hub in Denver brought me back to some insights about the airline sector from a few years ago.

There seems to be an irreconcilable conflict in many sectors between a company’s growth objectives, its profitability, and the real constraints to satisfying both of these. It is especially obvious with airlines.

As a business with large fixed capital assets and varying customer demand levels, both in unit volumes and revenues, airlines have always been management challenges. Factoring in the relevant economic attributes of the typical airline- low barriers to entry, relatively high capital requirements, unionized labor, lack of control over the system in which it operates, tendency towards costly evolution to multiple plane types, underlying derived demand for travel- suggests that there are probably very real limits to profitable growth.

In Southwest Air’s case, when I read about the airline changing its operating model to accommodate growth, I expect financial doom to be in the offing. The stock is down over the last five years as it is, and even under-performs the S&P500 during that period.

Similar to the “wheel of retailing,” about which I have written in an earlier post, budget airlines beg for trouble when they depart from their original low-cost, no-frills, or limited-geographical service model. It does seem that historically financially successful airlines were regional carriers who had identified a fairly self-contained segment of fliers whom they could serve at lower costs than larger airlines could do so. So long as such airlines expanded within a region that provided high load factors while the airline grew service points and passenger volume, there was no problem.

What seems to sound the death knell for these regional carriers is their eventual desire for passenger and revenue growth which requires them to outgrow their original, self-contained market segment of travelers. Just because an airline wishes to profitably continue its growth does not mean it should, or will, happen. Thus, Southwest’s dilemma.

It is pushing for growth while its total returns over the last five years are already penalizing its shareholders.

Hard as it may be to accept, many companies simply run out of profitable market segments in which to grow, and then their days of consistently superior returns are over. Airline total return performances seem to reinforce this conclusion with stunning regularity. So much for learning by example, or even from their own mistakes.

US Financial Super-Utilities

Both Chase and Citibank have become massive, mediocre financial super-utilities in the past decade. But neither one has out-performed the S&P500 over the past 5 years. Chase’s last merger, with the combined Midwest banking conglomerate, FirstChicago-BancOne, hasn’t and won’t change that.

Ironically, my old boss, and SVP of Corporate Planning and Development of the “old” Chase Manhattan, Gerry Weiss, predicted back in 1986 that eventually the major money center banks of Manhattan would merge into one or two giant mediocre financial services companies. He was eerily prescient.

What Gerry saw from his unique vantage point was how difficult it was to effectively manage such a wide range of types of businesses at these banks, in conjunction with the lack of adequate managerial talent. Financial services has never attracted good managers.

Traders, deal-makers, and financial products innovators, yes. Consistently-effective managers, no.

My original research at Oliver Wyman & Company, now Mercer’s financial services consulting unit, confirmed this. Money center banks and large investment bank/brokerages never enjoyed consistent superiority in their shareholder wealth creation. They were out-peformed by single-line firms in credit card lending, mortgage banking, private banking, asset mgt, etc.

Empirical research of over a decade of company performances confirmed my old friend and boss’ hunch, and added a new finding. Not only were and are these financial leviathans simply too complex for the executives that are typically drawn up through their ranks to successfully manage. By being so broadly diversified, and large, they are sure to experience every major financial calamity which befalls the sector- be it real estate lending, sub-prime credit, risky proprietary trading, or, as in the Enron case, over-zealous complex financial products marketing which apparently crossed the line from finance to abetting financial fraud. The result is that consistent total returns prove to be an elusive goal, as these huge financial behemoths are beset with every market excess which occurs in the industry.

That is no doubt why these companies are rarely, if ever selected by my portfolio strategy. Revisiting my original sector research, and Chase’s and Citigroup’s recent performances, is a comforting reminder that my strategy’s bias in favor consistently superior performance is based on sound empirical research. Size for its own sake is of no value when you want to out-perform the market, despite what analysts may believe.