Friday, December 31, 2010

Felix Rohatyn and New York City

The great thing about holiday weeks - besides being able to catch up with my family (whether they want to or not!) - is that I get a chance to read some of the books I've been wanting to catch up on.

For example, I just finished Felix Rohatyn's memoirs entitled Dealings. Rohatyn was a leading investment banker for many years working as a senior partner at Lazard Freres. The book is a fairly easy read, perfect for the holidays. As one review suggested, reading Rohatyn's book is like listening to a rich uncle tell stories, full of anecdotes about famous people.

Rohatyn's most notable work, in my opinion, occurred in the mid-1970's, when he was a major player in helping New York City avoid bankruptcy. The City at that time was desperately short of cash, and when President Gerald Ford told the City's leaders that no federal help would be forthcoming (thus eliciting the famous headline in the New York Post: "Ford to City: Drop Dead") it looked like New York would be forced to default.

Of course, New York did not default, although it did restructure some of the terms of its debt obligations.

It was very instructive to anyone who invests in municipal bonds to read the section of Rohatyn's book which discusses the immense effort that City leaders made to avoid any delays to the payments of their debt.

Everyone involved - from the mayor to the heads of the very powerful unions in New York - realized that any sort of default would be a catastrophe.

Even President Ford - who earlier in the process had been steadfast in his belief that New York would have to figure matters out on their own - eventually approved federal approval of guarantees to aid New York.

This episode - and others like it - make me confident of the credit quality of most municipal debt. Yes, municipal finances are a mess, and tough choices will need to be made.

But the bottom line is that most municipalities need the credit markets more than the markets need any debtor, and municipalities will do almost anything to avoid timely repayment of interest and principal.

Monday, December 27, 2010

Do Rising Commodity Prices Indicate Inflation on the Horizon?

The other day some friends of mine took their parents to see a local bank. Their aging parents, they felt, could benefit from some professional financial management, and this well-respected trust company seemed to fit the bill.

After the meeting my friends asked me to look at the material the bank had given their parents.

I'm not going to comment on the presentations of my competition (even though I would like to!), but I was struck by one aspect of the proposed plan:

"We will keep bond maturities very short in anticipation of higher interest rates ahead".

This is a very common theme among investment professionals: Interest rates are going to rise.

All you have to do, they argue, is look at the prices of commodities, which are roaring higher. Gold and copper in particular are usually cited as good harbingers of future inflation.

Well, maybe, but perhaps the rise in commodities is really more a function of an expanding world demanding more resources.

Paul Krugman's column this morning in the New York Times discusses this. Here's an excerpt, with the full link below:

What about commodity prices as a harbinger of inflation? Many commentators on the right have been predicting for years that the Federal Reserve, by printing lots of money — it’s not actually doing that, but that’s the accusation — is setting us up for severe inflation. Stagflation is coming, declared Representative Paul Ryan in February 2009; Glenn Beck has been warning about imminent hyperinflation since 2008.

Yet inflation has remained low. What’s an inflation worrier to do?

One response has been a proliferation of conspiracy theories, of claims that the government is suppressing the truth about rising prices. But lately many on the right have seized on rising commodity prices as proof that they were right all along, as a sign of high overall inflation just around the corner.

You do have to wonder what these people were thinking two years ago, when raw material prices were plunging. If the commodity-price rise of the past six months heralds runaway inflation, why didn’t the 50 percent decline in the second half of 2008 herald runaway deflation?

The Finite World -

I continue to believe the larger risk to many investors - including the aging parents of my friends - is the possibility that interest rates remain lower than most anticipate. Keeping your money in a money market fund today in anticipation of higher rates ahead may seem like a sound strategy but it is also an expensive one.

Sunday, December 26, 2010

Time to Party Like It's 1999?

I saw in the Financial Times the other day that the market value of companies like Facebook and Twitter have soared in the last few months.

Based on transactions in the private market (since the company is not publicly traded), the value of Facebook has jumped by almost +50% since the summer. Facebook is now apparently valued at $41 billion, even though its total revenue for the past year was around $2 billion.

Now, I am a huge fan (and believer) in the future potential of social media, but reading stories like this give me a gnawing feeling that I've seen this movie before. Remember 1999, when technology stocks were all the rage? Cisco was even supposed to become the first company worth $1 trillion (today the company is worth about 2/3 less than it was valued 10 years ago).

I hope we're not going down this path again, but there seems to be an awful lot of optimism about stocks among the Wall Street community (even though Main Street does not share these same sentiments). Valuations are much more reasonable than 1999, of course, so perhaps the market will be OK, but with the S&P up +20% since early September (thank you Ben Bernanke and QE2) we could be setting ourselves up for a more rocky year in 2011 than many are anticipating.

There was an article in this morning's New York Times talking about this growing optimism; here's an excerpt from Paul Lim's column:

INDEED, some market strategists worry that investor optimism itself may be a headwind to another strong year for the market. Consider how stocks performed in other recent periods of optimism. In October 2007, a survey by the American Association of Individual Investors found that 55 percent of investors were bullish; in the 12 months that followed, the S.& P. 500 fell 37 percent. Similarly, in March 2000, investor bullishness reached 66 percent. And a year after the fact, stocks were down 25 percent.

It just goes to show that by the time the market thoroughly convinces investors to be optimistic, most of the good news is already behind us.

Stock Market Optimism May Be a Red Flag for 2011 -

Friday, December 24, 2010

Floyd Norris of the NY Times: U.S. Investors Turn Away From Domestic Stock Funds -

Just a short blog post today - we're busy getting ready for Christmas tomorrow.

However, there was a good article in this morning's New York Times. Floyd Norris points out the prevailing negative sentiment about the stock market that seems to abound among investors. This despite the fact that it looks like 2010 will be the second year of solid gains for stocks.

Here's an excerpt from the article:

The stock market collapse in 2008 and early 2009 appears to have inflicted far more psychological damage — damage that may have been intensified by the collapse of home values and the deep recession that hit the country, and by the fact that many stocks had not recovered the highs they had reached in 2000. For perhaps the first time since the late 1970s, many Americans seem to have become pessimistic about the future of their country.

For the 10 years through 2010, figures for the final two weeks of the year will determine whether there was any net investment in domestic stock funds. (The estimate for the decade so far is that $4 billion flowed out.) By contrast, in the 10 years before that, Americans put $1.3 trillion into such funds.

In some ways, the current mood is reminiscent of the one that prevailed then. In 1979, Business Week published a cover article on the “Death of Equities,” which it attributed in large part to rising inflation. By 1982, inflation had begun to fall, but the country was in a deep recession. That is when the great bull market of the 1980s began. Few investors seem confident that such a renewal of optimism is likely this time.

U.S. Investors Turn Away From Domestic Stock Funds -

Thursday, December 23, 2010

Deborah Jacobs: Married's Couple to the New Estate Tax Law

I have written about Deborah Jacobs and her excellent book Estate Planning Smarts on this blog before.

If you have any interest in the subject, or know anyone who should, I highly recommend her book (and, no, I do not have any financial interest in this matter, nor have I ever met Ms. Jacobs).

Here's the link to her web page:

Deborah also has written a very useful column in about the new estate tax law. The new package contains a number of features that can be very tax-friendly to wealthy couples. Here's an excerpt from her article, with the full link below:

The sweeping tax overhaul that President Obama signed Dec. 17, raising the exemption from federal estate tax to $5 million a person, includes a wonderful new break for widows and widowers. Starting in 2011, they can add the unused estate tax exemption of the spouse who died most recently to their own. This dramatic change enables spouses together to transfer up to $10 million tax-free. It also eliminates the need in many cases for the tax-planning gyrations that lawyers routinely recommended to preserve each spouse's estate tax exemption amounts. - Magazine Article

S&P 1250

The stock market finally breached the 1250 threshold yesterday despite economic news that was really more on the weaker side.

Not only is level psychologically important (since the market had made several failed attempts over the last few weeks to close above 1250) but it also marks the return to where we were in September 2008, right before the Lehman Brothers collapse.

This morning's Financial Times noted the recovery of the S&P to current levels by making some other comparisons to the fall of 2008:

Most sectors have barely budged but after two years of crisis and recession one surprise is that the consumer discretionary sector is the best performer, worth 22 per cent more than it was pre-Lehman. The financial sector, meanwhile, is down 24 per cent. More surprisingly, Standard & Poor's data show the proportion of the index in financials at 15.9 per cent, is actually larger than the 15.3 per cent pre-Lehman, because new banks have entered the index. This is still down from the 20 per cent peak in 2007. As to the future, the market is cheaper as a multiple of earnings but pays almost a fifth less in dividends. It is not time to relax.

Imagine that: if in the tense days of the September and October of 2008 I had suggested to you that we load up your account on retailing and other consumer discretionary stocks you probably would have thought I was crazy. And yet in hindsight that was the correct decision.

A few other points. In the period since September 2008, where the stock market has returned essentially 0% (since we are just back to where we started), gold has risen by +169%, and oil is up +48%. Commodities have been the true growth of the past couple of years, and with global demand continuing to rise despite tepid economic growth in the developed world this trend seems likely to continue.

Second, while the S&P has recovered the lost ground of the past couple of years, we are still -19% lower than we were in October 2007. From this standpoint, then, the market could easily show significant gains ahead.

Finally, interest rates on longer-dated Treasury securities have barely changed in the last couple of years. The 10-year US Treasury was yielding slightly more than 3.7% in September 2008, and now yields 3.35%. With all of the talk that the rise in stock and commodity prices are foreshadowing a rise in economic growth, as well as inflation, the bond vigilantes remain very calm.

Let's hope that continues into 2011.

Wednesday, December 22, 2010

Meredith Whitney and the Municipal Bond Market

If you've been at the investment management business for a while - as Random Glenings has been - you can recall numerous situations where some analyst makes their fame and fortune through making a market prediction that appears to be outrageous at the time but turns out to be true.

For example, when I first got into the business in 1982, a technical market analyst named Joe Granville correctly predicted that a major stock market correction was imminent.

Elaine Garzareilli was at Lehman Brothers when, in August 1987, she correctly forecast a huge market downturn was near - and sure enough, October 1987 saw the markets drop by -25% in a single day.

More recently, perma-bears like Nouriel Roubini from New York University and economist David Rosenberg (formerly of Merrill Lynch) correctly foresaw the economist crisis in 2008.

But what do all of these folks have in common? They never change their tune. They all attempted to repeat their forecasting feat, and make more outlandish predictions that turn out to be wildly wrong.

I remember talking to a client who told me a story about his grandfather. Right before the crash of 1929, his grandfather had correctly foreseen the crash, and sold all of his stocks.

Problem was, once his grandfather re-entered the market, he kept seeing warning signs ahead, and would try to repeat his feat of 1929 over and over again, only to watch the stock market roar ahead.

Which brings me to Meredith Whitney.

Ms. Whitney is a good bank analyst who correctly predicted the problems in the banking sector in 2007 while she was at Oppenheimer. She was particularly prescient on her views on Citigroup, and forecast the huge drop in price and massive dividend cut that eventually occurred.

So Ms. Whitney took her newly-found fame and went off to start her investment management consulting firm.

She turned her attention to the municipal market and found municipal finances in tough shape (quelle surprise!). She then went public with some very dire predictions for the municipal bond market, and even appeared on 60 Minutes last Sunday (did I mention that Ms. Whitney is very attractive?).

I've gotten a few calls on her appearance, and sufficient to say that I do not agree at all with Ms. Whitney. Today I saw a column on Bloomberg that does a pretty good job at summarizing my thoughts.

Here's an excerpt, with the full link below:

There will be between 50 and 100 “significant” municipal bond defaults in 2011, totaling “hundreds of billions” of dollars.

So said banking analyst and new municipal bond expert Meredith Whitney on the “60 Minutes” show on Sunday, in perhaps the boldest, most overreaching call of her career.

Hundreds of billions of dollars? The one-year record, set in 2008, is $8.2 billion. You can see how an estimate of “hundreds of billions” would get people’s attention...

...This isn’t the Whitney scenario. No, she envisions between 50 and 100 -- or more -- counties, cities and towns making the choice to renege on their bonded debt.

My question is: Why?

Why would a governmental entity go out of its way to provoke or alienate its best source of finance? In the old days you might say that bondholders were a distant class of banks and plutocrats mainly centered in the Northeast. That’s no longer true, and hasn’t been since at least the passage of the Tax Reform Act of 1986, which made bonds less attractive for banks and insurance companies, among other things. Today, a city’s bondholders might live in the municipality itself, and almost certainly reside within the state.

Debt Service

Why would a governmental entity choose to default on its bonds, especially if they make up a relatively small proportion of its costs?

“Debt levels for U.S. local and state governments are relatively low, with annual debt service representing a relatively small part of budgets,” Fitch Ratings said in a special report in November.

Meredith Whitney Overreaches With Muni Meltdown Call: Joe Mysak -

Tuesday, December 21, 2010

Have You Received Many Holiday Cards This Year?

Not us, at least.

The home base of Random Glenings has seen a marked decline in cards. Even my mother hasn't sent us one yet.

Now, truth be told, we haven't sent many cards out ourselves this year, but a few should be going out today.

If past history is any guide, our cards will be received with a bland sigh by the recipient, who will carefully place it in a pile somewhere in their house. Then, shortly after Christmas, our card will be buried in some landfill, forgotten until some future archaeologist unearths it many centuries from now and wonders why civilization in the 21st century still engaged in this ancient ritual.

What's going on here?

It could very well be that the internet in general, and social media in particular is killing old-fashioned customs like Christmas cards.

There was a good article about this trend in Slate magazine (which, come to think of it, is strictly available on-line, i.e. no paper copies like the old days). Here's an excerpt from the article which lists five reasons the holiday card tradition may be kaput, with the full link below:

1) Frugality. Why waste money on a piece of folded paper that's going to be chucked in a couple of weeks? ...

2) The end of the address book. As Slate contributor Noreen Malone wrote, "Honestly, no one really keeps their friends' addresses the way they used to, because there are easier ways to contact them." Many of us don't have the faintest idea where anyone lives these days, so addressing an envelope means sending an e-mail to get the person's address, at which point you have already fulfilled one of the main purposes of the exercise (reaching out to someone you aren't otherwise in touch with)....

3) The triumph of the e-card. ...

4) Mom liberation. This year, women made up a majority of the work force for the first time. But according to the Greeting Card Association, we still buy an estimated 80 percent of all greeting cards. Maybe 2010 is the year we finally said, To hell with it, I'm not staying up late tonight to lick envelopes.

5) Facebook. Also known as the "I already know what you did last summer" theory. This is the one that most appeals to us. It checks the "Why now?" box. And when you look back at the Christmas card's evolution, it feels almost inevitable.

Did Facebook kill the Christmas card? - By Kate Julian - Slate Magazine

I had a meeting the other day with a valued client. Over the course of lunch he allowed how his company no longer sends traditional holiday cards to their clients. Instead, their IT department has come up with a (fairly bland) e-holiday card that expresses best wishes of the season to all of their clients (who of course are on a blast email list).

What's even better, enthused my client, is that his assistant can affix his automated signature to each of the company's e-cards, so essentially he doesn't have to do anything.

So asked him: Why did you even bother?

He just looked at me.

Why indeed.

Monday, December 20, 2010

Congress Gives the Wealthy an Early Christmas Present

I must admit that I was very surprised that Congress and the President made changes to the federal estate tax provisions that essentially eliminated the estate tax for 99.5% of the American population.

I am been going under the assumption for most of this year that Congress would allow the estate tax exemption to lapse to where it was in 2001. This would have meant that "just" the first $1 million of an estate would be exempt from estate taxes.

Instead, for the next couple of years, the estate tax exemption will rise to $5 million (or $10 million for married couples who do the simplest estate planning), with the maximum tax rate dropping to 35% from 45% currently.

There's lots more in the recent tax bill that probably means some near-term work for estate lawyers but this past Saturday's New York Times carried a good article discussing some of the implications.

Here's an excerpt, with the full link below:

OPTIONS FOR 2010 Under the estate tax wording in the bill, the heirs of people who died this year will have two options for a tax bill. If they chose to treat the estate by the tax laws in place in 2010, they will have to calculate the capital gains on all assets in the estate to determine if the value is above a level the Internal Revenue Service is allowing. This “artificial step-up in basis” is $1.3 million to any heir and $3 million to a surviving spouse.

The other option is to apply the 2011 law, which would exempt the first $5 million of the estate and impose a rate of 35 percent on anything above that. This is far more generous than the 2009 law — a $3.5 million exemption and a 45 percent tax rate — which many people thought would be reinstated.

Estate Tax Will Dwindle Under Tax Cut Package -

Friday, December 17, 2010

Have I Got An Investment Opportunity for You

OK, here's the pitch:

The government of this country has just announced that it will be offering hefty tax breaks to foreign companies in an effort to attract business.

In addition, all companies operating in this country will enjoy a 5% cut in the their current corporate taxes, meaning qualifying companies will pay tax between 20.4% and 28.5% (all data according to this morning's Financial Times).

But wait, there's more: this country's central bank has just announced that it will be buying risky assets like exchange-traded funds (ETF's) and REIT's. Think QE2 on steroids.

Also, this country's largest 500 companies saw free cash flow per share grow by almost a fifth over the past 12 months - seven times the rate of cash accumulation at S&P 500 companies.

You want momentum in stock prices? Well, this country's stock market has been the best performing index in the world since the beginning of November, as investors have poured over $10 billion in new investment funds have flowed into this country in that period.

So where is this great opportunity?


And that's the problem. Japan - which I fear is the country whose problems foreshadow our own - has been mired in a deflationary sluggish economy for more than 20 years. And all of the "good news" that I just listed ignores some very important facts.

After years of being battered by prematurely betting on economic recovery, Japanese corporate executives are tired and pessimistic.

Rather than invest all of the cash their companies are generating, they would rather hoard the cash. December's Tankan survey indicates only a slight increase in plans to invest in cap ex, but this is only among big companies: smaller companies indicate they are planning to cut spending in 2011.

Until the mood among Japanese executives changes, the economy is unlikely to show much spirit in 2011, despite the government's best efforts.

So when you read stories about President Obama urging corporate executives in the United States to spend some of the $2 trillion in cash that corporate America is sitting on and hire more people, just look across the Pacific to see how well government entreaties work.

Thursday, December 16, 2010

It's A Good Time to Be An Investor, Not So Hot If You're a Citizen

I thought this piece from The Economist does a pretty good job of laying out the current economic/market conditions.

Fed Ex reported earnings that were below the consensus view of the Street this morning...but the stock has traded higher. To me, at least, this is a good indication that investors are feeling more optimistic than they have in years, since they seem to be willing to look past the headline numbers and focus on the potentially good news that might be coming down the pike.

Corporate America is thriving, but they are doing well at a pretty high social cost. Double-digit unemployment rates and meager wage gains are hardly the stuff of a happy populace (see: last month's election results). Yet from an investor's standpoint - who really should be focused on the financial health of the company - it seems to be not a bad time to be investing in corporations.

Here's an excerpt from the piece:

THE news out of the American economy keeps getting better and better. The country's trade deficit has fallen thanks to improved exports. Retail sales are beating expectations. Industrial production has been growing steadily, and service sector activity is growing at an increasing rate. Consumer confidence is up. And the Dow Jones Industrial Index has finally regained all the ground lost after August of 2008. The deal on extension of the Bush tax cuts led some major macroeconomic forecasters to revise 2011 growth expectations up to around 4%. The retail sales surprise this week led to similar upward revisions for fourth quarter output. It seems, at last, that good times are here again.

Except. Unemployment is at 9.8%. Over 6m Americans have been out of work for more than 6 months. Some 2m jobless workers will exhaust unemployment benefits by the end of 2010. Housing prices, nationally, are falling once again. Nearly 11m households have mortgages larger than the value of their homes. Consumers are still heavily indebted, which will constrain further growth in spending. So, should we be optimistic about the American economy or pessimistic?

The American economy: Finally, everything is good again | The Economist

The article goes on to note that the Fed did a good job last summer, when it looked like the economy was about to backslide into another recession. The problem becomes when the Fed runs out of ammunition, or loses political cover once Ron Paul starts a Congressional investigation into Fed.

Still, with the Fed still on track for QE2, and the Transport index confirming the strong up move in the Dow (thus confirming the rally, at least according to the Dow Theory of technical analysis), I think you have to tilt in favor of stocks.

Tuesday, December 14, 2010

Oh, No! Majority of Strategists Are Bullish on stocks for 2011

So I remain reasonably positive on the outlook for stocks next year - valuations are reasonable, other investment alternatives unappealing - but I now feel that I am squarely in the consensus of investor sentiment.

And that's not a good thing.

It was only 2 months ago, for example, that 66% of investors surveyed were bullish on bonds (according to Merrill Lynch) - right before one of the worst sell-offs in Treasury bonds over the last few years. Now only 26% are positive on the bond market.

(BTW: Chief technical strategist Mary Ann Bartels of Merrill remains of the belief that rates will be moving lower over the next few months, noting that there has always been the seasonal tendency for rates to rise at year-end).

It's not that the consensus opinion is ill-informed, or worse, it's just that when the majority of investors already believe something it probably is already reflected in market prices.

Here's an excerpt from Bloomberg:

Rising profits and cash balances will push the Standard & Poor’s 500 Index to the biggest three- year advance since the 1990s, surpassing forecasts for below- average returns, strategists at Wall Street’s biggest banks say.

The benchmark gauge for American equities will rise 11 percent from last week’s close to 1,379 in 2011, bringing the increase since 2008 to 53 percent, the best return since 1997 to 2000, according to the average of 11 strategists in a Bloomberg News survey. Goldman Sachs Group Inc.’s David Kostin, the most accurate U.S. strategist this year, said sales growth will spur a 17 percent rally in the S&P 500 through the end of 2011.

No New Normal as Strategists Predict 11% S&P 500 Gain (Update3) -

While I am concerned about being in the consensus, I still think that stocks can move higher. Not only are fundamentals appealing, the most recent tax compromise bill passed in Washington should spur the economy. Finally, there is nearly $2 trillion in investor cash that now sits in either money market funds or low-yielding short maturity bonds which may eventually move to the stock market.

But I'm feeling a little uneasy this morning.

Monday, December 13, 2010

Sugar and Spice: Bullish on US equities/Worried about Bonds

To the chagrin of Mrs. Random Glenings - who notes that we have a considerable amount of holiday preparation still to be done - I spent a lot of time this weekend reading about the new tax compromise package that has been reached in Washington.

I'm not sure who comes out the political "winner" in all of this - initially it looked liked the President caved in to the other party, but other observers have suggested that the compromise is really a stealth stimulus package, which is what the President favored all along.

What seems clear to me, however, is that we should see at least a nearer term economic boost in the first half of 2011, and the equity markets should be the beneficiary.

One of the articles I read was from the London Telegraph. The author is based in the U.K., but he believes that the U.S. markets might actually be one of the best performers in the next year:

The rebound in {corporate} margins means that the average earnings for the constituents of the S&P 500 should be higher than at the previous peak in 2007 and around one-and-a-half times higher than in 2000, when the US stock market hit a peak of 1,527, 24pc higher than today's level.

Although valuations were then clearly excessive, the combination of a much lower market and much higher earnings means shares are much better value today. With earnings expected to grow at a double-digit rate both next year and the year after, the multiple of earnings investors will be prepared to pay could also rise. It is that combination of higher earnings and a rising price to earnings ratio that always characterises the best years in the market.

The final reason why 2011 could be America's year is the sheer weight of money that is sitting on the edge of the equity market. I think the rise in yields on government bonds in the past few weeks might mark a watershed moment when investors start to question whether they have got their money in the right place.

Why US equities could be hard to beat in 2011 - Telegraph

All of this being said, I should also note that there seems to be considerable alarm in Europe and elsewhere about the apparent inability of the U.S. government to address our fiscal deficit.

Several articles suggested that the recent rise in interest rates has not been due to any concern about inflation. Instead, these observers suggest that there is a growing unease with U.S. policies in general, and that perhaps the world's creditor nations - China and Japan, in particular - will be demanding a greater "risk premium" for U.S. debt.

Here's a fairly typical piece from the BBC in England:

The competing explanation may appear to be based on an almost diametrically opposite view of the prospects for the US. It is that the tax cut shows a US administration utterly incapable of getting to grips with public-sector deficit and debt as unsustainably large as anything the fringe of the eurozone can boast - which proves that the quality of US sovereign debt ain't what it was, so you sell.

On this interpretation, the US economic recovery won't accelerate enough to generate a sufficiently big increase in tax revenues, to make a sizeable dent in an annual deficit running at around $1.5 trillion or well over 10% of GDP...

But the big question is whether what's happening to US treasury bonds shows that those who control the vast pools of money are becoming more or less confident about the outlook for the biggest economy in the world and for growth prospects in general.

Saturday, December 11, 2010

OpenTable: The Company Resaurants Love to Hate?

I wrote a couple of days ago about OpenTable (ticker: OPEN) after hearing about it from Mark Mahaney at Citigroup.

Here's an article that appeared today in the New York Times about the company. It does a pretty good job of laying out why some restaurant owners don't like the service, even though it might seem to some (including me) that it's a pretty inexpensive way to build traffic.

Here's an excerpt, with the full link below:

{OpenTable's} stellar success has drawn some grumbling in the restaurant industry. Why does OpenTable deserve to prosper while some of its restaurant clients struggle merely to survive?

“Have the ascent of OpenTable and its astronomical market value resulted from delivering $1.5 billion in value to its paying clients, or by cunningly diverting that value from them?” Mark Pastore, the owner of Incanto, a San Francisco restaurant, recently asked in his restaurant’s blog. (With Friday’s close at nearly $72, OpenTable’s market valuation is now over $1.6 billion.)

...What perhaps most rankles restaurateurs is the reservation fee: $1 per patron. All in, OpenTable receives an average of $635 a month from each of its client restaurants, the company says.

OpenTable is in about one-third of restaurants in the United States that accept reservations.

When I spoke with Mr. Pastore last month, he said he was concerned that OpenTable was “becoming a Ticketmaster, a tollbooth to the nation’s restaurant tables.”

OpenTable’s Success, and Fees, Rankle Restaurants -

Thursday, December 9, 2010

Internet Sector Overview from Mark Mahaney at Citi

I had the chance to hear Mark Mahaney from Citigroup yesterday. Mark follows the Internet space for Citi and, in my opinion, is one the best in the group. Mark has been following the internet space for more than a decade, which makes him a true veteran in an area that has really only been around since the mid-1990's.

One of the tough parts of following Internet companies is that traditional valuation method are for the most part fairly useless. Stocks move on news flow and momentum - buy-and-hold might work for some sectors, but the internet space is not one of them.

For example, one of the best performing stocks this year in Mark's coverage universe has been OpenTable (ticker: OPEN) which provides consumers an online method of securing dining reservations either through their PC or their mobile phone.

OPEN is up almost +200% YTD (!) as the market has recognized the company's incredible growth rates; Mark noted that almost 30% of the restaurants in the United States now are part of OPEN's network. Still, buying OPEN today (which Mark continues to recommend) means buying a stock trading a 114x 2011 earnings estimates, which obviously means that it is not for the faint of heart.

I won't go through all of Mark's thoughts, but I wanted to share his thoughts on Google (GOOG).

GOOG remains one of Mark's favored stocks, despite the fact that it is now a pretty big company (I think they employ something like 23,000 people). There have also been rumors that some of their best engineering talent has been leaving to go to smaller, more nimble competitors like Facebook.

Mark's buy on GOOG is based largely on the opportunities the company has in the mobile internet space i.e., smartphones. While other parts of GOOG's business is experiencing reasonably strong growth (e.g. personal computer search, which currently represents 85% of GOOG's revenues, is growing at +30% per year), mobile search revenues are literally doubling every year. Mobile internet now produces $1 billion of revenue for GOOG, but Mark feels they are only beginning to add useful consumer applications in this area.

Mark's eventual price target on GOOG is over $700 per share (the stock is trading around $590 right now). When I pressed him on how he could believe a large cap stock that is widely followed like GOOG could be 20% or so undervalued, he went through his methodology which to me at least sounded like it was pretty reasonable.

Wednesday, December 8, 2010

New Fiscal Agreement: Mostly Good News for Investors

The Big News yesterday in the financial world was the agreement that President Obama and Congress reached on taxes.

Stocks rallied sharply in the aftermath of the announcement, but then sold off in the afternoon to end the day basically flat. Bonds, meanwhile, are getting killed, both in the taxable and municipal areas. At this writing, the 10 year US Treasury is yielding 3.25%, which is up almost 80 basis points from two months ago, as the overall package is apparently viewed not only as pro-growth but also will increase the budget deficit and could potentially stir inflationary pressures.

I won't get into whether this current political compromise is healthy for the longer term - you and I will be reading lots of analysis on this question in the weeks ahead. Instead, I wanted to highlight a couple of things that are pretty good news for investors in these recent developments.

Here's an excerpt from Barron's on-line today (I have added a couple of highlights):

Notwithstanding how it was being played in the media, there was no "extension of the Bush tax cuts" in the deal made by Obama with Congressional Republicans. The tax-rate increases slated to take effect on Jan. 1 were staved off for two years, as most forecasters had assumed would happen. So, no surprise there.

For investors, the favorable 15% tax rates for long-term capital gains and qualified dividends also were extended. In addition, the proposed bipartisan calls for the estate tax to resume at 35% with a $5 million exclusion on Jan. 1, instead of the 55% rate on estates over $1 million, as current law calls for.

The other key parts of the deal were a one-year, two-percentage-point reduction in Social Security withholding taxes (FICA on your pay stub) and a 13-month extension of emergency unemployment benefits. Both are designed to spur the economy by increasing the tax-home pay of those who work and maintain spending by those who aren't.

The news on estate taxes was better than I expected, frankly, since this benefit only helps those at the very highest wealth levels, but the Republican view carried the day.

Higher Interest Rates Could Offset Obama Tax Deal -

Tuesday, December 7, 2010

More on Housing

Ben Bernanke was on 60 Minutes on Sunday discussing, among other things, why the second round of quantitative easing by the Fed was necessary. I agree with the Chairman, although I think the economy could also use some help from the fiscal side (but this seems unlikely to happen).

Much of the Fed's attention is focused on housing, which continues to be mired in a deep slump. I posted a couple of pieces last week about housing, but recent data that has been released reinforces the problems in this very important sector of our economy.

Interesting, although most of us would think that the way to increase demand for housing would be to simply reduce the cost of a home, this really doesn't seem to be the case. Management at Pulte - the largest publicly-traded home builder in the United States - mentioned that they saw no point in reducing the prices of their unsold inventory since consumer confidence, not prices, is what is holding back buyers.

Floyd Norris had a short piece in the New York Times on Saturday noting that lower price houses seem to be dropping at the fastest rate, which would be consistent with Pulte's comments. Here's an excerpt from his column, with the link below:

The S.&P./Case-Shiller indexes released this week showed widespread declines in home prices in the third quarter of this year as the market suffered from the removal of temporary tax credits that had led to a small rally in home prices earlier in the year. No region had lost more than 5 percent in a quarter since mid-2009, but that happened to Phoenix in the third quarter.

Home Value Sinking Fastest at Those Priced Low -

The biggest fear about the future that Pulte expressed was the possible privatization of Fannie Mae and Freddie Mac. According to management, without these two government agencies there would be virtually no financing available for home buyers, since the private market has virtually disappeared.

This morning's Financial Times had article talking about the virtual elimination of the private mortgage securities market. Here's an excerpt:

The lack of new {private mortgage} deals does not mean that there are no new home loans being made in the U.S. Instead of being privately financed, new mortgages are almost entirely funded by the U.S. government, through its backing of mortgage agencies such as Fannie Mae and Freddie Mac. For nearly three years, these agencies have bought the majority of new mortgages from banks and repackaged them into government guaranteed mortgage-backed securities.

However, the private market has been shrinking: It is down by nearly $1,000bn since its peak in 2007. Indeed, {UBS's Paul} Jablansky says this has buoyed demand for other existing debt. Investors are receiving $20bn a month from expiring MBS and re-investing some it in deals that still exist.

In other words, whether the Fed's policies will be effective in helping housing may depend largely on factors outside of its control, such as consumer confidence and the fate of Fannie and Freddie.

Monday, December 6, 2010

Are the Bond Market Vigilanates Pushing Rates Higher?

Bond yields have trended higher in the last few weeks.

There have been a variety of reasons, some technical (an avalanche of new municipal supply) and some fundamental (e.g. doubts on whether the second round of Fed bond market intervention will work).

However, any number of commentators have used the recent bond market weakness as firm evidence that the so-called bond market "vigilantes" are pressing rates higher in response to profligate government spending policies.

Although Random Glenings attempts to avoid political commentary, I must note that I share the disappointment of many about the lack of progress on solving our huge fiscal debt problems. It now seems likely that the current level of tax rates will remain intact for at least one more year, if not two, meaning that our cumulative fiscal debt burden will only continue to grow.

However, whenever someone tells me that our government is trying to inflate our way out of the deficits ("that's what governments always do, you know") I usually ask them to give me some historic examples.

Problem is, there really aren't any examples of government deliberating creating inflation to reduce their debt burden.

Last summer UBS economist Paul Donovan came out with a piece that looked back 150 years, and found very few examples of government policies that debased their currencies to reduce their debt burden. It's not that governments are so altruistic as to care about their creditors (nobody loves a banker!) but the practical methods of reducing debt are more difficult than it would seem.

Here's an excerpt:

"The problem with the idea of governments inflating their way out of a debt burden is that it does not work. Absent episodes of hyper-inflation, it is a strategy that has never worked. Government debt: GDP burdens tend to be positively correlated with inflation. ...OECD government debt rises as inflation rises. Meaningful reductions in government debt will require a low inflation future."

Donovan goes on to note that higher inflation rates can work against governments, since this only raises the rates of interest on their debt burdens.

Myth Busted: Inflation Cannot Cure Government Debt

Friday, December 3, 2010

"Could Your Children Buy Your House?"

I went to go hear a presentation on the housing market at a luncheon sponsored by the Boston Security Analysts Society yesterday.

It was a good meeting, even though the tone of the remarks by the speakers was relatively bearish on the outlook for housing over the next couple of years.

Present on the panel were Karl Case, a Wellesley College professor who also is a founding partner of Fiserv Case Shiller Weiss(the latter publishes the widely followed Case Shiller index of housing prices); Laurie Goodman of Amherst Securities; and Brian Kinney of State Street Global.

I won't go through the whole presentation here; I have attached a link to an excellent summary done by Susan Weiner at the bottom of this post.

The one point on which I do want to comment involves the role of demographics on important economic areas like housing.

In the course of his remarks, for example, Professor Case remarked on the puzzling fact that even though new housing stock is being added an incredibly low rate (echoing the comments from Pulte Homes that I discussed yesterday) the vacancy rate of existing housing remains very high.

It is curious, noted Case, that even though housing would seem to be more affordable today than it has been for decades (through a combination of lower prices and low mortgage rates) the vacancy rate remains stubbornly high. Logically it would seem that vacancies should be declining if there is no new housing stock being added, and yet that has not been the case.

The answer might be that the population of the United States is lower than current estimates. The results of the 2010 census will not be published for some time, but Case hypothesized that maybe the official figures will show that we simply have less people to buy houses than we think, and therefore econometric models need to be adjusted accordingly.

While Case was talking, I was reminded of an anecdote that a very good investment strategist named Chuck Clough used to relate. Chuck worked for Merrill Lynch for a number of years, and was in my opinion an excellent source of investment insights and ideas.

Chuck told me that when he would give talks to groups of senior citizens he would often discuss the future of housing prices. This was back in the 1990's, by the way, long before the housing bubble.

Chuck would look out into the audience of people whose children were mostly grown and ask:

"How many of your children can afford to buy your house?"

Laughs and guffaws would inevitably ensue - what a silly idea, the idea that today's young adults in their 20's would be able to buy their parents' houses.

But then Chuck would ask a follow-up question:

"Well, if your kids can't buy your houses, who will?"


Even though Chuck posed this question more than a decade ago, it still seems relevant today, especially when it relates to house prices.

As we are all aware, real incomes have been stagnant for at least the last 10 years, except for the very highest income bracket. Young college graduates today are struggling to find any work, much less a good-paying job. Yet it remains the case that most people start to buy homes when they are in their late 20's, or early 30's, when they are starting a family. But if they can't afford a new house - even after prices have fallen from a few years ago - this process becomes impossible.

In short - if you want to get really bearish on housing - you could make a case that house prices still have further to fall in order to get prices in line with real incomes.

This would also have implications for older Americans who have viewed their homes as a source of savings. We have always assumed that at some point in your life you will sell your house and use the proceeds to fund your retirement. What if these funds will not be as munificent as we have come to expect?

Food for thought.

Thursday, December 2, 2010

Is the Housing Market Worse Than the Official Numbers would Indicate?

I went to go hear the management of PulteGroup (formerly known as Pulte Homes) yesterday.

Pulte is the nation's largest homebuilder, building single-family homes across the nation. The company also develops residential communities. In other words, if any company has a decent read on the housing market, it would be Pulte.

Unfortunately the story they painted was not a good one. Housing sales across the nation are poor, and most of their sales agents are not painting an optimistic picture for 2011.

Pulte will be focusing on two areas next year: cutting administrative costs (i.e. layoffs) and reducing their debt burdens. They don't see a lot of opportunity to buy land for future development; most of the significant plots they have looked at are either less desirable for building new homes (e.g. the land is near electric power lines or power plants) or there is significant local resistance to more housing developments.

If all of this is not gloomy enough, there doesn't seem to be much they can do about boosting sales. The obvious response - cutting house prices - doesn't seem to be working. Instead, Pulte feels that the real problem is buyer paralysis: no one wants to buy a house now since most are expecting prices to move lower in the months ahead. As they put it, buyers are afraid of feeling stupid by overpaying today.

Then you add this twist: Apparently there is a movement in Washington to privatize both Fannie Mae and Freddie Mac. In their opinion, this would be disasterous for their business, since these two agencies seem to be the only ones offering mortgages for home buyers. Without Fannie and Freddie, they felt, whatever meager housing demand remains would collapse. They even felt that eliminating the mortgage interest tax deduction (one of the current proposals of the deficit reduction committee) would be less harmful to their business than the removal of Fannie and Freddie from the market.

Pulte's gloomy outlook echos comments from another home builder, DR Horton, a couple of weeks ago. Horton too is very pessimistic on the prospects for 2011.

What's interesting about Pulte's comments is how different their view than that of many economists. Already you are seeing talk in the media that housing has stabilized, and that some areas are seeing signs of improvements in house prices. However, these comments seems to be largely based on broad market indices like the Case-Shiller index rather than people with "feet on the ground".

Out of this picture of gloom comes only one hopeful thought: in many industries, companies are often the last to actually see the improvements in business that are coming down the pike. These same housing developers that are so gloomy today were also very optimistic just a few years ago, and were aggressively adding new housing developments to their portfolios.

But if Pulte, are correct, next year might not bring the recovery we all want.

Wednesday, December 1, 2010

Question Authority

In the midst of reading a blizzard of news reports about the bailout of the Irish banks (and, by extension, the euro zone), I came across this article about TARP.

As we all remember, the Troubled Asset Relief Program (TARP) was supposed to be a major financial sinkhole for the government. Pundits from Wall Street to academia declared that the proposed $700 billion program would only scratch the surface of the needs to bail out the banking system.

Well, they were right about $700 billion being the wrong number - but they were wildly wrong when it came to the ultimate cost of the program.

Here's an excerpt from an article in the Los Angeles Times:

The projected cost of the $700-billion financial bailout fund — initially feared to be a huge hit to taxpayers — continues to drop, with the nonpartisan Congressional Budget Office estimating Monday that losses would amount to just $25 billion.

That's a sharp drop from the CBO's last estimate, in August, of a $66-billion loss for the Troubled Asset Relief Program, known as TARP. Going back to March, the budget office estimated that the program would cost taxpayers $109 billion.

Estimate of TARP losses falls to $25 billion -

Which brings me back to Ireland.

A couple of years ago, when Washington was being blasted for their fiscal policies, the government of Ireland was being praised as being a model of fiscal probity. Budgets were balanced through a combination of tax increases and service reductions, and even former Fed chairman Paul Volcker gave a speech praising the Irish.

And now look where we are.

Frankly I am not totally clear on how and why everything went so badly for the Irish, so I have been turning to one of my favorite columnists, Ambrose Evans-Pritchard of the London Telegraph. Here's an explanation from his column yesterday:

Patrick Honohan, the World Bank veteran brought in to clean house at the Irish Central Bank, wrote the definitive paper on the causes of this disaster from his perch at Trinity College Dublin in early 2009.

Entitled “What Went Wrong In Ireland?”, it recounts how the genuine tiger economy lost its way after the launch of the euro, and because of the euro.

“Real interest rates from 1998 to 2007 averaged -1pc [compared with plus 7pc in the early 1990s],” he said.

A (positive) interest shock of this magnitude in a vibrant fast-growing economy was bound to stoke a massive credit and property bubble.

Eurozone membership certainly contributed to the property boom, and to the deteriorating drift in wage competitiveness. To be sure, all of these imbalances and misalignments could have happened outside EMU, but the policy antennae had not been retuned in Ireland. Warning signs were muted. Lacking these prompts, Irish policy-makers neglected the basics of public finance.”

“Lengthy success lulled policy makers into a false sense of security. Captured by hubris, they neglected to ensure the basics, allowing a rogue bank’s reckless expansionism,” he wrote.

The lessons from all of this continue to unfold, but it is worth remembering that even the most knowledgeable among us can be wrong. We should all invest accordingly.