Friday, July 30, 2010

Drip after drip of deflation data – Telegraph Blogs


Last weekend, by mistake, I bought a book on my Kindle called The Greatest Trade Ever: The Behind-the-Scenes Story of How John Paulson Defied Wall Street and Made Financial History by Gregory Zuckerman.

Amazon is usually pretty good about refunding money if you've made a purchase in error. However, in this case I thought, oh, what the heck, I'll just read the book.

And I'm really glad I did.

The book covers the same ground that Michael Lewis's The Big Short does; that is, how a few investment managers made unbelievable amounts of money for themselves and their investors by betting against the U.S. housing market. Paulson, obviously, is covered in great detail, as is Michael Burry.

However, given my profession, I really like the detail that Zuckerman goes into on the nearly daily machinations that the managers went through.

I am going to write more about the book, and the lessons that I have gotten from it (I'm about halfway through at this point), but I wanted to mention one of the main points that really stood out when looking back over that period.

In the middle of the last decade, everyone, it seems, knew that house prices were rising too fast. Everyday the business press had some pundit describing the housing market as a "bubble".

Yale professor Robert Shiller even added a chapter to his book Irrational Exuberance (which had correctly forecast the tech stock bubble of the late 1990's) describing how house prices had risen too far, too fast, for economic reality.

And yet you had to wait several years before house prices began to crack.

Zuckerman's book describes the agony that Burry and Paulson went through as they waited for at least two years before house prices began to fall, as they knew they would. Wall Street laughed at them, their friends thought they were crazy, and some of their investors pulled their money.

But in the end they made billions.

The point is that economic and stock market train wrecks usually take longer to occur than anyone expects. But when they occur, they are often worse than anyone forecast.

Which brings me to the point of this post (finally!).

Most economist dismiss the idea of an economic "double-dip" at this point. They point to rising stock prices, driven by mostly good corporate earnings figures. True, unemployment rates remain unusually high for this point in the economic recovery (assuming the recession ended in June 2009), but this could be due to structural issues, and not necessarily economic weakness.

At the same time, the credit markets are telling a much different story. As I write this, the 10-year Treasury yield 2.94%, and the 2-year Treasury is 0.58% (an all-time low). Corporations are sitting on $1.8 trillion of cash - what are they seeing (or not seeing) that is causing them to hoard so much cash?

Yesterday Fed Governor Bullard came out with a warning on deflationary pressures. Now, this morning, he's backtracking somewhat, but I suspect this was probably the result of a few phone calls from Washington. What what noteworthy about Bullard's comments was that up until recently he was viewed as an inflation "hawk". What is he - and the Fed - seeing in the economic data that is causing worry?

Ambrose Evans-Pritchaird's column in yesterday's London Telegraph points out that the data is slowly pointing to more slowdowns, more downward pressure on prices. Much like the housing market of a few years ago, the trend is in place for all to see, but because it is a gradual process many are not taking it seriously:

I have no idea what assets prices will or will not do. My area of curiosity is the global economy, and where it intersects with political, cultural, and historical forces.

But here is a note I received today from Tom Porcelli at RBC Captial Markets that puts uber-bullish earnings rhetoric in a proper context.

It seems like on a daily basis the headlines point to yet another company beating earnings expectations. The tally thus far shows 142 companies out of 172 have surprised to the upside for a significant 8pc beat-rate. On the face of it this seems promising.

But the sales figures (i.e. the part that measures organic growth) have been less than stellar. Thus far, they have shown just over 9pc growth versus last year’s figures. But sales were down nearly -14pc in 2Q09 – hardly a tough comp to best!

While 68pc of companies have beaten sales estimates, this is hardly anything to get overly excited about. Back in 2Q08, 69pc of companies had beaten sales estimates. We all know where the economy headed shortly thereafter.

The numbers should be taken with a grain of salt. Below the surface, the earnings reports continue to confirm what we have been saying – that this recovery is anaemic at best.

In the end, the global macro economy will dictate the outcome.

So watch the Chinese banking system. Watch Japanese exports. Watch OPEC as it keeps cutting output to hold up the oil price. Watch Euribor rates and the continued contraction in eurozone lending to companies. Watch French industrial output. Watch Polish sovereign debt (that’s a new one).

Watch the M3 money supply in the US as it contracts at a 10pc annualized rate. And for goodness sake watch the Fed Board.

Then sit in a deep leather arm-chair with a good Calvados, listen to Bach Fugues, and think.

The last line is one that I particularly like.

Drip after drip of deflation data – Telegraph Blogs

Thursday, July 29, 2010

Ireland: Selling the Family Silver


A couple of weeks ago I posted a talk by Paul Volcker. Volcker's message was sobering but he did close with a note of optimism: Ireland, he said, seemed to "get it" and was taking the appropriate - albeit painful - medicine now in order to get its fiscal house in order.

Well, maybe, but if you live in Ireland it's not so easy. Apparently the Irish government is trying sell a number of government-owned entities in order to raise cash. These sales are not without its controversy, as this article from the Global Post indicates:

Minister for Finance Brian Lenihan appointed a commission on July 22 to look at the possibility of unloading these assets to help meet Ireland’s crippling national debt of 84 billion euros ($108 billion). The planned sale is an indication of how desperate the financial situation has become since the Irish property bubble burst three years ago.

A nation listed the as the sixth richest non-oil country in the world by Standard & Poor has seen a sharp decline in wealth and economic activity. Tax revenues have collapsed and the government is struggling to keep its controversial pledge of two years ago to bail out the country’s banks, which are floundering under the weight of reckless loans.

And then later:

There will be a furious political and popular response when the “for sale” signs go up. A Sunday Tribune investigation of previous government sell-offs shows that more than 8,000 workers were made redundant once their companies fell into private hands.

Economist Jim Power pointed out that “given the massive failures in the private sector, particularly in the banks, it cannot be taken for granted that the private sector will do any better.”

Irish people remember the debacle over the 1998 sale of the national telephone company, Eircom. Tens of thousands of citizens who — on the urging of the government — took out shares lost out as the stock market value fell. Moreover, the number of employees dropped from 11,000 to 6,000, its nationwide broadband rollout was patchy, many of its assets were stripped and it now has debts of 3 billion euros ($3.9 billion).

Higher taxes, massive layoffs, restrictive fiscal policy - let's see if the Irish approach works, since we may be heading that way in this country in a few years.


http://www.globalpost.com/dispatch/ireland/100726/ireland-economy-sale

Wednesday, July 28, 2010

Harold Meyerson - The job machine grinds to a halt



I don't mean to keep writing about this but the economic picture is so different than anything we have ever experienced.

The S&P is up +8% this month. Corporate earnings are mostly coming at or above expectations. Yet unemployment - human capital - is way too high, and shows no signs of reversing.

The argument that we should be tightening our collective fiscal belts at this point seems to me to be the wrong solution. We need to create jobs, and corporate America just isn't going to do it.

Monetary policy isn't working anymore - the system is flooded with liquidity but no one wants to borrow. Mortgage rates are at generation lows, but the house market continues to suffer (the recent spurt in sales was only due to the new home tax credit which has now expired). Bernanke gets it, but he has no tools left.

So here's where we are (excerpt from the Post column):

Fully 46 percent of the unemployed have been without work for six months or more -- the highest level since the Bureau of Labor Statistics began measuring such things in 1947. Two years ago, just 18 percent of the unemployed were jobless for more than six months. America's private-sector job machine -- the marvel of the world since 1940 -- has clanged to a halt, and there's no place for it in corporations' new business model.

And yet corporate America is typified by General Motors, which our government just bailed out two years ago:

General Motors is going like gangbusters in China, where it now sells more cars than it does in the United States. In China, GM employs 32,000 assembly-line workers; that's just 20,000 fewer than the number of such workers it has in the States. And those American workers aren't making what they used to; new hires get $14 an hour, roughly half of what veterans pull down.

The GM model typifies that of post-crash American business: massive layoffs, productivity increases, wage reductions (due in part to the weakness of unions), and reduced sales at home; increased hiring and booming sales abroad. Another part of that model is cash retention. A Federal Reserve report last month estimated that American corporations are sitting on a record $1.8 trillion in cash reserves. As a share of corporate assets, that's the highest level since 1964.

In short, stocks can continue to rise, since the other alternatives (i.e. fixed income) offer such puny yields. However, the longer term outlook cannot be too exciting if more people can't find work. And right now there are five unemployed for every posted job opening.


Harold Meyerson - The job machine grinds to a halt

Your Taxes In 2011

This short article from Financial Advisor magazine has a link that you can click on to will give you some idea of what your taxes might be under various scenarios. The sponsor of the calculator is the Tax Foundation.

It's actually pretty startling - the Bush tax cuts probably put more in your pocket than you realize, and if they are allowed to expire you're probably going to get a pretty significant hit.

Your Taxes In 2011

Market Outlook from Ned Davis Research

I went to a breakfast meeting this morning to hear the last thoughts on the financial world from Ned Davis Research (NDR).

I have mentioned NDR in previous reports. I like their research since it is based on huge amounts of data rather than "gut feel" or a close reading of the financial press. In addition, once NDR takes a position, they tend to be patient, and not suddenly shift from day-to-day.

There was lots of material, but let me give you a few highlights:

1. NDR remains bullish on stocks and bearish on the outlook for bonds. Their favorite global sectors are found in the emerging markets, where they like the combination of strong growth and attractive valuations;

2.That said, they expect sluggish economic growth. Unemployment, unfortunately, is expected to remain high for a number of years to come due to a number of factors (I have been posting on some of these in recent days);

3.They are also not optimistic on the outlook for housing, since house prices and unemployment rates are inversely correlated;

4. Although they are not excited about the outlook for bonds, they are not abandoning the sector. They noted that with yields so low, and investor desire for safety still high, bonds could continue to at least hold their value. They continue to like corporate bonds, but are less excited about mortgage-backed securities. NDR does not have any strong views on the yield curve, noting that only the 30-year sector seems to offer value albeit with considerably more principal risk;

5. Within the US equity markets, their favorite sectors are consumer staples; industrials; and materials. They remain underweight health care and telecommunications.

The most startling chart they showed concerned the extremely high correlation between all stock price movements that has occurred recently.

According to NDR's work, the median correlation of all stock returns is at an all-time record high: 0.82. Put another way, during the last few weeks, stock picking added no value - it was all about beta, or being in or out of the market.

Naturally this last point received some pushback from the attendees, most of whom pick stocks for client portfolios. Does this most period represent an anomaly, or is stock picking a dying art?

We'll have to see, I guess, but I think the world of opportunity for security analysis is definitely shrinking.

First, you have the widespread use of exchange-traded funds (ETFs), which offer investors immediate access to sectors of the markets. ETFs now represent nearly $1 trillion in assets.

Second is continuing presence of hedge funds. Despite some disappointing results recently, large pension and endowment funds continue to allocate money to this sector, and the funds tend to trade very large positions.

And, third, is the large presence of quantitative models which are able to pick up mispricings quickly and execute trades within seconds. If, for example, stock A and stock B always trade together, but one day stock B is lagging, the quant models will catch this quickly and move to put a paired trade on.

But I digress.

A good meeting with NDR. Hopefully their bullish stance is correct.

Frequently Asked Question on IRA's and RMD's

From Ed Slott's Slott Report:

Wednesday, July 28, 2010

I'm Still Working; What's My RMD?

I get this question frequently. Many of us are looking at working beyond the age of 70 ½. What required distributions (RMDs) do you have to take if you continue working?

If you are participating in the retirement plan where you work and if the plan allows, you do not have to take any RMD from that plan until the year you retire. If you own 5% or more of the company, you have to take an RMD. These rules apply to most employer plans. If the plan is a SEP or a SIMPLE, you have to take the RMD since those are IRA based plans. From any plan where you are required to take a distribution, you can continue to make contributions, as long as the plan allows.

There is no exception for IRAs. Once you reach the year you turn 70 ½, you must take an RMD. You also have to take RMDs from any employer plan if you are no longer working for that employer. The “still working” exception only applies to your current employer.

When you finally do retire, quit, get fired, or laid off, you do have an RMD for the year in which you stop working, even if your last day is December 31st. You have until April 1st of the following year to take this first distribution, but if you wait until that date, you also have to take your second distribution by the end of that year. This results in your having to take two RMDs in the same year. If you die while you are still working, you are deemed to have died before your required beginning date and there is no RMD for your year of death.

By IRA Technical Consultant Beverly DeVeny and Jared Trexler

Tuesday, July 27, 2010

Cost of Freight Shipping Rises, Hurting Retailers - NYTimes.com


Here's another example of what might appear to be good news is actually something else.

Yesterday I posted a note which talked about how corporations seem to be prospering in a time of economic weakness. Top line growth is muted yet margins and the bottom line keep rising as corporations ruthlessly cut costs, especially in headcount. This unfortunate trend does no show any signs of reversing.

Then there are the sectors that seem to be showing signs of strong economic growth, like the transportation sector. If you are a follower of the Dow Theory, transports are an important sector to watch, since a rise in the transports stock prices should foreshadow a rise in the general markets.

And yet some of the apparent strength in transport earnings and pricing power seems to be more the result of a lack of shipping availability than a strong resurgence in underlying demand.

This article in this morning's New York Times is a good example. Here's an excerpt:

Fighting for freight, retailers are outbidding each other to score scarce cargo space on ships, paying two to three times last year’s freight rates — in some cases, the highest rates in five years. And still, many are getting merchandise weeks late.

The problems stem from 2009, when stores slashed inventory. With little demand for shipping, ocean carriers took ships out of service: more than 11 percent of the global shipping fleet was idle in spring 2009, according to AXS-Alphaliner, an industry consultant.

Carriers also moved to “slow steaming,” traveling at slower and more fuel-efficient speeds, while the companies producing containers, the typically 20- or 40-foot boxes in which most consumer companies ship goods, essentially stopped making them.

And yet, as the same article goes on to note, the price of shipping related to commodities continues to drop:

(While container shipping has recovered from last year’s lower spot prices, commodity shipping, where companies ship raw goods like iron ore or petroleum, remains in a depression. This month, the Baltic Dry Index, which measures commodity shipping costs, fell for the longest number of consecutive days in almost nine years because of low demand for materials like steel.)

Mind you, as someone who is buying transport stocks for client portfolios, I don't have any problem with rail and other shipping companies doing well, as the stocks continue to show nice gains. At the same time, from a macro economic perspective, I am cautious to conclude that the hikes in shipping rates are a meaningful economic indicator.

Cost of Freight Shipping Rises, Hurting Retailers - NYTimes.com

Monday, July 26, 2010

Companies Wringing Huge Profits From Job Cuts - NYTimes.com


I originally posted this article on Twitter this AM but I have been talking about it so much with clients that I thought I would show it on my blog as well.

One of the puzzles for many investors is how the stock market seems to be doing just fine in the face of fairly dismal economic statistics.

For example, the S&P 500 is up over +8% this month alone. At the same time, home sales have nose-dived, unemployment remains very high, and consumer confidence is subdued at best.

However, company profits are actually coming in pretty good for the second quarter. How is this? Here's an excerpt from the article:

Many companies are focusing on cost-cutting to keep profits growing, but the benefits are mostly going to shareholders instead of the broader economy, as management conserves cash rather than bolstering hiring and production...

...As companies this month report earnings for the second quarter, news of healthy profits has helped the stock market — the Standard & Poor’s 500-stock index is up 7 percent for July — but the source of those gains raises deep questions about the sustainability of the growth, as well as the fate of more than 14 million unemployed workers hoping to rejoin the work force as the economy recovers.

And then later in the same article:

In 2002, during the recession that followed the bursting of the technology bubble in addition to the Sept. 11 attacks, margins sank to 4.7 percent. Although the most recent downturn was far more severe, profit margins bottomed out at 5.9 percent in 2009 and quickly rebounded. By next year, analysts expect margins to hit 8.9 percent, a record high.

The difference this time is that companies wrung more savings out of their work forces, said Neal Soss, chief economist for Credit Suisse in New York. In fact, while wages and salaries have barely budged from recession lows, profits have staged a vigorous recovery, jumping 40 percent between late 2008 and the first quarter of 2010.

And then you can add a further gloomy note. The jobs that are being created - and there are a few out there - require a skill set that many workers don't seem to have. Here was an opinion piece by Matt Miller in last week's Washington Post:

Broadly speaking, there are two big things we need to do. The first, put well (if not in a sexy slogan) by economist Michael Spence in the Financial Times recently, is "to create capital-intensive jobs that have labor productivity levels consistent with advanced country incomes."

The second big thing is to make sure Americans have the skills to perform these jobs.

How are we doing on this agenda? Dismally. For starters, U.S. elites simply don't think in terms of a national economic strategy of the kind Spence states so simply. To be sure, the stimulus funded some energy technologies with real promise -- advanced storage and lighting technologies, and power conversion devices, for example -- that are poised to lift productivity in these areas dramatically. Such productivity gains can make higher wages sustainable. But we're not yet close to the needed scale of public- and private-sector effort here.

Companies Wringing Huge Profits From Job Cuts - NYTimes.com

http://www.washingtonpost.com/wp-dyn/content/article/2010/07/21/AR2010072103052.html

Big Fight Ahead on Expiration of Bush Tax Cuts - NYTimes.com


I've posted a few times on the estate tax debate going on in Congress. As you recall, the federal estate tax exemption is scheduled to go back to $1 million next year unless Congress acts.

Most people - estate lawyers included - strongly believe that Congress will do something prior to year-end. However, I'm not so sure. In fact, it seems to me more likely that all taxes will be moving sharply higher next year, including taxes on dividends.

To begin with the obvious: the government needs the money. In this morning's papers there were articles noting that the deficit for fiscal 2010 (which ends on September 30) is now scheduled to be around $1.5 trillion. This is higher than previous estimates due to shortfalls in tax revenues. An estate tax - however unfair - is still levied on someone who will no longer be voting (except in part of Chicago or Texas - just kidding).

Next, there is no sympathy for the wealthy, especially as stories continue to come out on executives paying themselves big bucks for mediocre performance, especially in the financial sector.

Finally, Congress is at some loggerheads now that any bipartisan agreements seem almost impossible. With midterm elections only a few months away, no Congressman wants to be seen voting for higher taxes. On the other hand, if no votes are actually taken, taxes will automatically rise without anyone having to act.

Here's an excerpt from the Saturday story in the New York Times:

If no tax legislation is passed, all the major tax reductions passed under President George W. Bush in 2001 and 2003 will expire, with rates reverting overnight on Dec. 31. The top marginal income tax rate, for example, would go back to 39.6 percent from 35 percent now, with corresponding increases in rates for lower income brackets.

Given the partisan gridlock of recent months, there is a chance that the battle could go down to the last minute, or even — in the face of a stalemate — that the tax cuts could be allowed to expire completely, a development that Republicans are already heralding ominously as the largest tax increase in history and that lawmakers in both parties say could be the worst outcome.

Big Fight Ahead on Expiration of Bush Tax Cuts - NYTimes.com

Thursday, July 22, 2010

The Mental Anchor of Money Mistakes - Bucks Blog - NYTimes.com


Normally I wouldn't link to a short blog piece but I thought this was pretty good.

"Loss aversion" is one of the most common emotions that I see in my clients. No one likes to take a loss, but sometimes refusing to take a small loss may mean a missed opportunity, or an even bigger loss.

Stock prices have no memory, nor does a stock know who owns it. The most important consideration for investors should be forward-looking, yet it is always hard to avoid looking back, as the piece discusses:

You buy a stock for $50 a share, and six months later it is $30. You decide that you really shouldn’t own it anymore but you want to wait until you “get back to even” before you sell. This idea of holding on to an investment that is no longer appropriate, or may have been a mistake in the first place, until you get back to even makes no sense. The fact that you paid $50 has no bearing whatsoever on what you should do now.

In fact, I think it is fair to say that getting back to even is never a good reason to hold on to an investment. If you find yourself saying that, it’s time to re-evaluate.


Now, if only I could always remember this....


The Mental Anchor of Money Mistakes - Bucks Blog - NYTimes.com

Bill Miller on Large Cap Stocks


Bill Miller from Legg Mason has one of the strongest investment track records in the mutual funds business.

True, the last couple of years were not kind to Miller, as he lagged the S&P by a wide margin due largely to an ill-timed bet on financial stocks. Prior to this period, however, Miller's fund had outperformed the S&P 500 for something like 14 consecutive years.

So he' s worth a listen

And what is Bill Miller thinking now?

In his most recent quarterly newsletter to Legg Mason shareholders indicate, he thinks that large cap, dividend-paying stocks are the opportunity of a lifetime. Here's an excerpt, with the complete link below:

The point here is simple: U.S. large capitalization stocks represent a once in a lifetime opportunity in my opinion to buy the best quality companies in the world at bargain prices. The last time they were this cheap relative to bonds was 1951. I was 1 year old then, but did not have then sufficient sentience or capital to invest. I do now, and if you are reading this, so do you.

Miller's point is that investors are diving into bonds with record low yields (see my post yesterday), ignoring the fact that the dividends from similar corporate entities are yielding considerably more. And, unlike bonds, stocks at least offer the opportunity to have some capital growth as well.

Here's the link:

http://www.leggmason.com/individualinvestors/documents/economic_perspectives/D9368-Bill_Miller_Commentary.pdf

Wednesday, July 21, 2010

Rational Irrationality: The Stimulus Debate: I’m with Larry (and Keynes) : The New Yorker



If you're like me, you vaguely remember the term "liquidity trap" from your econ class at college.

Last seen in this country during the 1930's, a liquidity traps occur in economies where the banking system is awash with cash that they either refuse to lend or no one wants to borrow. In this relatively unusual economic period, monetary policy becomes fairly ineffective, since additional liquidity from the central bank doesn't provide any additional stimulus.

John Cassidy - a writer for The New Yorker - believes that the U.S. is either close to a liquidity trap or mired in one already, which makes any traditional tools that the Federal Reserve essentially useless.

As he writes:

With interest rates at close to zero, banks reluctant to lend, and many businesses and households hoarding cash because they are too nervous to invest it, monetary policy—the other tool the government can use to stimulate the economy—loses much of its effectiveness. As {White House economic advisor Larry}Summers points out, the U.S. economy is now in, or close to being in, what Keynes referred to as a “liquidity trap,” where a Fed-inspired expansion of the money supply has little impact.

Now, liquidity traps, which economists used to consider historic relics, are not at all pleasant to experience. In many cases, they are associated with falling prices and extended periods of economic stagnation. (Ask the Japanese, who have been trapped in one for close to twenty years.)


Sufficient to say, this is a very challenging time to be an investor. The stock market continues to be choppy as the investment community digests second quarter earnings. Earnings comparisons, by the way, will become more difficult in the next couple of quarters, since the economy had begun to rebound slightly in the second half of 2009.

On the other hand, for investors looking for yield, the stock market is becoming the place to invest, particularly in consumer staples and utilities sectors. Recently we have seen two bond issues where the yield on the stock is nearly 50% more than the yield on a bond issued by the same corporation - and yet investors gobbled up the corporate bond.

The bond market offers very little value except for longer maturity notes. For example, as I write this note, the 10 year Treasury note is yielding 2.88%, while the 2-year Treasury is 0.50% (an all-time record low). Muni rates are also low - you have to go out at least 7 years to get a yield above 2%.

Liquidity traps are no fun.

Rational Irrationality: The Stimulus Debate: I’m with Larry (and Keynes) : The New Yorker






Jim Cramer on ETF's

I am not a big fan of Jim Cramer on CNBC, and really haven't watched the show for years.

However, the broker from JP Morgan that covers my firm for stock trading brought this segment to my attention.

In this piece Cramer discusses how exchange-traded funds (ETF's) have done at least as well, if not better, than picking individual stocks in the financial sector. To a fundamental analyst like Cramer this is painful, since he has made a living on stock picking. But in today's market, as he points out, ETF's are capturing about 90% of the return with less risk than trying to decide on, say, JP Morgan vs. BankAmerica.

It's a longish piece - over 8 minutes - but if you just watch the first half you'll get the idea:












Tuesday, July 20, 2010

Jeremy Grantham: Recommendations for the upcoming period of deflation - Investment News


This quarter's research views from Jeremy Grantham of GMO. Always worth a read.

One of the hallmarks of GMO's research is its long term, disciplined, quantitative approach to asset management. Based on their proprietary asset allocation models, the firm comes up with expected real returns for the next 7 years for various asset classes.

At the top of the list currently is high quality U.S. stocks, followed closely by emerging market equities. Least favored are short maturity Treasurys, where yields are already so low as to make decent returns almost mathematically impossible.

He also has a few paragraphs on the question as to why large cap stocks have continued to lag the overall market despite being consistently "cheap" relative to smaller cap stocks over the last few years.

While he freely admits that he doesn't have a definite answer, he offers two suggestions: one, large cap stocks have tended to be held by older investors who now need to liquidate their holdings for retirement; or, two, that the hedge fund community doesn't find the large cap arena sexy enough, so the group lacks any real investor sponsorship.

Finally he has a section on global warming. On the surface this topic seems off the investment topic yet it is doubtlessly going to more important to all inhabitants of earth over the next few years.

Global warming, in my opinion, is the ultimate economic "free rider" problem: all agree that it would be great to reduce the emissions into the atmosphere so long as it doesn't affect them (the news today that China has now passed the United States as the largest energy user by country on the planet is hardly good news, since the Chinese track record on environmental affairs is uninspiring at best).


Jeremy Grantham: Recommendations for the upcoming period of deflation - Investment News

The Great Reflation | Wealthy Boomer | Financial Post


I haven't read this book yet, but it looks like it could be interesting.

Titled The Great Reflation, the book discusses how governments and central banks intervened in the most recent financial crisis to prevent depression and deflation. However, warn the author Anthony Boeckh, government intervention has its consequences, and there could possibly be more trouble ahead.

At first I was tempted to dismiss the book as just another in a series predicting financial chaos due to inept government actions. However, this is apparently not the theme at all. Instead, Boeckh is suggesting that investors should be prepared for a roller coaster ride in the capital markets as the authorities attempt to gradually withdraw from the markets without creating another credit crisis.

From what I know so far, I would generally agree with the author.

Mr. Boeckh used to write for The Bank Credit Analyst, which I have read for years and believe does a very credible job at dissecting economic trends.

I had attached a column by Jonathan Chevreau in Toronto's Financial Post which discusses the book. Here's an excerpt from the column:

"To rescue the economy and financial system from near-total meltdown, the government created an unprecedented package of bailouts, stimulus, free money and massive fiscal deficits. It succeeded, and a 1930s style debt deflation and depression were aborted. Liquidity on a vast scale was unleashed into the financial system…"

The stock market rally of March 2009 until a few months ago was one of the fastest rebounds on record. But as investors are now starting to realize, it’s not clear whether this can continue, has already stalled or whether we have another gut-wrenching downturn to endure. To quote Boeckh again:

"Just because the system was saved, doesn’t mean it has been fixed."



The Great Reflation | Wealthy Boomer | Financial Post

Monday, July 19, 2010

A hidden world, growing beyond control | washingtonpost.com

When Dwight Eisenhower left the White House in 1960, he warned of the growth of the military-industrial complex. But I doubt that even Eisenhower would have believed how our national security apparatus has mushroomed in the aftermath of 9/11.

This is unbelievable story published in the Washington Post. Here's an excerpt:

The top-secret world the government created in response to the terrorist attacks of Sept. 11, 2001, has become so large, so unwieldy and so secretive that no one knows how much money it costs, how many people it employs, how many programs exist within it or exactly how many agencies do the same work...

The investigation's other findings include:

* Some 1,271 government organizations and 1,931 private companies work on programs related to counterterrorism, homeland security and intelligence in about 10,000 locations across the United States.

* An estimated 854,000 people, nearly 1.5 times as many people as live in Washington, D.C., hold top-secret security clearances.

* In Washington and the surrounding area, 33 building complexes for top-secret intelligence work are under construction or have been built since September 2001. Together they occupy the equivalent of almost three Pentagons or 22 U.S. Capitol buildings - about 17 million square feet of space.

Yesterday's story was the first of a series of stories that the Post will be running this week.

One problem is, of course, is that no government official - from the President on down - wants to cut spending on national security, which is such a sensitive political issue. And yet, as the article points out, it is hard to believe that such a massive effort is really making us safe.

It is also worth remembering stories like this when someone calls for more government regulation or intervention. No matter how good the intentions are, government programs are not always the answer.

A hidden world, growing beyond control | washingtonpost.com

Saturday, July 17, 2010

Talking Business - Was Steinbrenner Bold, or Just Lucky? - NYTimes.com


I posted a note earlier this week about George Steinbrenner and his financial success with the Yankees.

There was a good follow-up piece in this morning's New York Times about Steinbrenner. In it columnist Joe Nocera suggests that at least part of the Steinbrenner's success was due to luck rather than simply good business skills.

Here's an excerpt:

...What would have happened if {former Cleveland Indians owner} Mr. Stouffer had been sober that December day in 1971, and had said yes to Mr. Steinbrenner? Would Mr. Steinbrenner have been as successful if he had owned his hometown Indians rather than the storied New York Yankees? Or was his success due mainly to the fact that he just happened to buy the No. 1 franchise in the biggest television market in the country — at the exact moment the value for sports franchises was about to take off? To put it another way, was George Steinbrenner a good businessman, or just a lucky one?

Mr. Nocera may have a good point (and I thought the piece was very well-written) but I also believe that luck plays a role in many success stories, both business and elsewhere.

One of my favorite stories involves the early days of personal computers. When IBM entered the PC business in the early 1980's, they made the decision to buy the operating system rather than develop one internally. After some investigation, IBM found there were two companies in the Seattle area that had each developed a workable operating system. One made by a fellow named Gary Kildall. The other was a young kid whose mother Mary was on the board of the local United Way, and so had developed a friendship with Frank Cary, then head of IBM.

So a group of folks from IBM flew to Seattle, and went to see Gary Kildall. Unfortunately for Gary, he had decided that it would be a good day to fly his glider, and so literally was not a home when they showed up.

So the IBMers went to their next stop, a little company called Microsoft headed by this scrawny kid named Bill Gates. The rest, as they say, is history.

Was Gates just lucky? Or was he able to see the opportunity, and aggressively purse (note also: Microsoft did not actually have a workable operating system until right before IBM came to visit. Gates bought the system from a local programmer)?

In the end, I would agree that Steinbrenner was probably lucky, but he also deserves credit for using his lucky break so well.

Talking Business - Was Steinbrenner Bold, or Just Lucky? - NYTimes.com

Friday, July 16, 2010

Fed's volte face sends the dollar tumbling - Telegraph


OK, it's a beautiful summer day in Boston, and I snuck out of the office for today to play a little golf with my bride Christina (who, much to my dismay, is beginning to outdrive me).

Then I came in, and turned on the computer to see what some of my favorite columnists are thinking.

Yikes!

Here's the latest thinking from London, via Ambrose Evans-Pritchard of the Telegraph:

... a deep change is under way in investor psychology as funds and central banks respond to the blizzard of shocking US data and again focus on the fragility of an economy where public debt is surging towards 100pc of GDP, not helped by the malaise enveloping the Obama White House...

The Fed minutes warned of "significant downside risks" and a possible slide into deflation, an admission that zero interest rates, $1.75 trillion of QE, and a fiscal deficit above 10pc of GDP have so far failed to lift the economy out of a structural slump.

"The Committee would need to consider whether further policy stimulus might become appropriate if the outlook were to worsen appreciably," it said. The economy might not regain its "longer-run path" until 2016.

"The Fed is throwing in the towel," said Gabriel Stein, of Lombard Street Research. "They are preparing to start QE again. This was predictable because the M3 broad money supply has been contracting for months."

The Fed minutes amount to a policy thunderbolt, evidence of how quickly the recovery has lost steam. Just weeks ago the Fed was mapping out withdrawal of stimulus.

Now, Mr. Evans-Pritchard has been more of the more gloomy writers in recent months, but clearly the markets are on edge. With the 2 year Treasury note now yielding 0.60%, and the 10 year Treasury below 3% again, the worries about double-dip and deflation seem very topical.

Lots to think about - even on the golf course!


Fed's volte face sends the dollar tumbling - Telegraph

Thursday, July 15, 2010

Demand for financing leads global economic recovery toward 'wall of debt'



I suspect we're going to see more of these types of stories in the months ahead.

There is, without question, trillions of dollars of debt that will be maturing in the next few years. In addition, with virtually every government and most municipalities running fiscal deficits, there will be more need to raise capital from the bond market.

As this article from this morning's Washington Post discusses, there are generally two points of view on whether this tsunami of debt is something to be worried about.

The pessimistic view is that interest rates in general will be pushed higher, especially for lower quality borrowers, as massive amounts of debt need to be funded:

"There will be a tightening of financial conditions," said Mohamed El-Erian, chief executive at bond-fund manager Pimco. He said his company expects that governments, corporations and leveraged buyout firms will all have to cope with stiffer requirements as they refinance maturing bonds, "some of which will not be refinanced on any terms."

Then there is the more optimistic view, which says that the funds from the bonds that will be maturing need to be invested somewhere, and that probably will be in new bond issues:

Some analysts play down the risk, arguing that the low-interest-rate policy pursued by the U.S. Federal Reserve effectively pulls down rates across a variety of markets -- including for some corporate debt. Corporations and banks have comparatively large cash reserves, they note, and investors who shun equity markets may put money into well-rated corporate, government or financial bonds.

Even with the large amounts of government bonds to be sold, it was unlikely that the total demand for credit would outstrip supply by so much that interest rates are forced appreciably higher, said Larry Kantor, head of research for Barclay's Capital.

In general I am in the more optimistic camp. There is simply too much money chasing yield in a deflationary world. Moreover, ever since the U.S. government starting running huge deficits in the 1970's, there has always been this worry about governments "crowding out" private sector capital needs, but this never really came to pass.

Demand for financing leads global economic recovery toward 'wall of debt'

Wednesday, July 14, 2010

So where are all the muni bond defaults? - Investment News


One of the most common discussions I'm having with clients these days is about the credit quality of municipal bonds.

Small wonder. It's hard to pick up a newspaper these days without reading about the serious and deep fiscal crisis that many states and local governments are facing. And yet municipal bonds remain essentially unscathed.

The simple truth is that municipalities need the bond market more than it needs them. Delay or default on your debt obligations, and you lose your access to capital. And unlike individuals or corporations - who can use the bankruptcy code to avoid payments - many municipalities are legally prohibited from seeking bankruptcy protection.

Here's a section from today's Investment News:

Municipal credit concerns have diminished,” Janney Montgomery Scott LLC, a Philadelphia-based adviser, said in a note to bond clients on July 12. “Investors continue to seek tax-free income and the strong credit track-record of general- obligation and essential-purpose municipal bonds.”

Lawmakers are willing to anger voters with reduced services and higher taxes to retain the favor of investors, who buy more than $400 billion of state and local debt each year to finance roads and bridges, pay for new schools and maintain parks and libraries...

Municipal bonds default less than company debt, Moody's said in a February report. The average failure rate for investment-grade municipal debt from 1970 through 2009 was 0.03 percent, compared with 0.97 percent for similar corporate bonds, the analysis said. Of 54 municipal defaults in the period, only three were general-obligation bonds backed by the full faith and credit of the issuers, Moody's said.

Defaults occur when a borrower misses interest payments or fails to maintain adequate reserves for future interest. Since the Great Depression of the 1930s, only one state -- Arkansas -- has defaulted. That was after it assumed debts of its municipalities to keep them from financial failure.

Most of the $15.5 billion of such events in the municipal market since 2008 involved debt backed by specific revenue streams, like levies on new Florida housing developments, rather than by a government's obligation to repay investors from taxes.


So where are all the muni bond defaults? - Investment News

Steinbrenner's death raises estate tax issue - Investment News


There have been lots of articles in the press today about the death of George Steinbrenner.

One of the pieces called him the best-known owner in professional sports, which I think is probably true (BTW: the portrayals of Steinbrenner in Seinfeld were always funny).

Since I am in the investment management business, I naturally was interested in some of the investment and estate planning issues raised in Steinbrenner's passing.

Although I doubt he planned it that way, Steinbrenner picked a good year to die from an estate tax standpoint, as the attached article from the Investment News points out:

The late New York Yankee owner, who died on Tuesday of a heart attack, left an estate estimated to be worth $1.15 billion, consisting primarily of his share of the Yankees' YES broadcasting network, according to Forbes. But in all likelihood, the tax man will take the collar on this one — and won't get a penny from the Boss' estate.

Indeed, Mr. Steinbrenner's family looks set to inherit his estate practically tax-free, thanks to the expiration of the federal estate tax in 2010 and the light tax regime of the Boss's home state, Florida. By comparison, New York state has a 16% estate tax.

“It is the ultimate home run,” Ronald Aucutt, a partner at law firm McGuireWoods in McLean, Va., told Bloomberg.

Steinbrenner's death raises estate tax issue - Investment News

A number of the articles have focused on the fact that Steinbrenner bought the Yankees in 1973 for $10 million, and today the Yankees are estimated to be worth $1.6 billion. So I pulled out my calculator, and figured this was a compound return of 14.7%.

http://www.nytimes.com/2010/07/14/sports/baseball/14steinbrenner.html

As it turns out, any way you look at it, the Yankees were a great investment, assuming they will be selling.

That said, according to the articles, while the Steinbrenner family has no plans to sell, it is not really clear who would actually pay that type of money for the Yankees. True, they are on the top of the Majors, but they also have the highest payroll in the league, and highest costs.

If the Yankees falter (we can only hope, says Red Sox nation!), attendance would surely decline (see: New York Mets). In other words, buying the Yankees today is like buying a high P/E stock - there's already a lot of "good news" priced in.

While it is true that the Steinbrenner family is largely avoiding estate taxes, the family also does not get the step-up in basis that previously heirs received at time of death. As you recall, when Congress put the "sunset" provision in the capital gains bill in 2001, they eliminated the step-up in basis at time of death in 2010.

If the Steinbrenners were to sell, they would pay long-term capital gains tax of at least 15% (at the federal level), or about $240 million.

Finally, there is the interesting question of how Steinbrenner's return on his Yankee investment would compare to other investments over the same time period.

For the purposes of this analysis I have ignored taxes simply because it makes the calculations way too complex (e.g. dividend tax rates have changed numerous times over the last 37 years, as have capital gains rates).

So, assuming that Steinbrenner's syndicate took the same $10 million that they invested in the of the Yankees in 1973 and invested in other assets, here's what the total return would have been:
  • Even after the "lost decade" of 0% returns for the last 10 years, the S&P 500 have returned a compound return of 10.1% since 1973. This means the $10 million would have been worth approximately $350 million;
  • Of course, if George had been smart enough to recognize that the stock market was in a bubble in 1999, and sold all of the stocks and reinvested in bonds, he would have received $383 million in 1999 which would today would be worth $705 million;
  • $10 million in Treasury Bills starting in 1973 would have returned 5.5% pa , and be worth $72 million today;
  • $10 million in Treasury Bonds starting in 1973 would have returned 7.5% pa, and be worth about $150 million.
So the Yankee investment was a "grand slam" for the Steinbrenners compared to other alternatives.

One more interesting point: I was surprised to see how much the additional 4% in total annual return from the Yankee investment relative to stocks added to the ending amount of money. That is, the difference between 14.7% pa and 10.1% pa may not seem too much, but over the course of 37 years it is huge - in this case, more than $1 billion more.

Tuesday, July 13, 2010

Football Games Have 11 Minutes of Action - WSJ.com


This is why I stopped watching football - and one of the reasons I enjoy soccer so much more. With soccer you get at least 45 minutes of non-stop action every half (plus any comp time). With football you get:

Here's an excerpt from the article:

According to a Wall Street Journal study of four recent broadcasts, and similar estimates by researchers, the average amount of time the ball is in play on the field during an NFL game is about 11 minutes.

In other words, if you tally up everything that happens between the time the ball is snapped and the play is whistled dead by the officials, there's barely enough time to prepare a hard-boiled egg. In fact, the average telecast devotes 56% more time to showing replays.

So what do the networks do with the other 174 minutes in a typical broadcast? Not surprisingly, commercials take up about an hour. As many as 75 minutes, or about 60% of the total air time, excluding commercials, is spent on shots of players huddling, standing at the line of scrimmage or just generally milling about between snaps. In the four broadcasts The Journal studied, injured players got six more seconds of camera time than celebrating players. While the network announcers showed up on screen for just 30 seconds, shots of the head coaches and referees took up about 7% of the average show.


Football Games Have 11 Minutes of Action - WSJ.com

Obscure book by British adviser becomes cult hit after Warren Buffett tip - Telegraph


OK, so I'm a sucker for books recommended by Warren Buffett.

But in this case I might just have to wait.

According to this story in this morning's London Telegraph, Mr. Buffett has been recommending this book about the collapse of the Germany's Weimar Republic in the 1920's. There are actually other books that have been released in the past year or so about the economies in the 1920's and 1930's - notably Lords of Finance by Liaquat Ahamed - but none carry the imprimatur of the Greatest Investor Who Ever Lived.

So after reading this short article (link below) I went to Amazon.com to see just how much it might cost.

Obscure book by British adviser becomes cult hit after Warren Buffett tip - Telegraph

Problem is, the hardcover version of this "instant" classic (which was actually published in 1975) is a cool $800. The paperback can be yours for "only" $39.

http://www.amazon.com/When-money-dies-nightmare-collapse/dp/0718302141/ref=sr_1_1?s=books&ie=UTF8&qid=1279024796&sr=1-1

For the time being, then, I think I'll just have to wait until the Kindle version comes out.


Monday, July 12, 2010

Op-Ed Contributor - America Builds an Aristocracy - NYTimes.com


Interesting piece from Friday's New York Times on the use of Dynasty Trusts.

This is an estate planning issue that probably most people don't even know exists yet it has been used very successfully by some of America's most wealthy families to pass huge sums of wealth to other generations without paying taxes.

Here's an excerpt:

Dynasty trusts can grow much larger than the $3.5 million exemption amount would suggest. A couple can, for example, put $7 million (their two $3.5 million exemptions) into a life insurance policy owned by the trust. They apply their exemption at the start, and the trust is forever free from taxes — even when, after the death of the second spouse, the life insurance policy pays off at $100 million. Alternatively, a trust can use the $7 million as seed money for a profitable business that the trust then owns.

An ordinary trust dissipates as money is distributed to the beneficiaries. But a dynasty trust can avoid this by discouraging outright distributions and instead encouraging trustees to buy, for the use of the beneficiaries, things like houses, artwork, airplanes and even businesses. Because the trust retains ownership, the assets can pass tax-free and creditor-proof to the next generation.

Beneficiaries don’t pay taxes on the use of this property. In contrast, a worker whose employer provides housing or other benefits is taxed on those benefits.

But tax breaks are not the only special advantages that dynasty trusts provide. Even more troubling, they commonly include a “spendthrift clause,” which provides that trust assets cannot be reached by a beneficiary’s creditors. If a beneficiary causes a car accident, for example, the victim cannot be compensated with assets from the trust, even if they are the driver’s only resources. So beneficiaries are free to behave as recklessly as they like, knowing that their money is forever protected for themselves and their heirs.


Op-Ed Contributor - America Builds an Aristocracy - NYTimes.com

Wall St. Hiring in Anticipation of an Economic Recovery - DealBook Blog - NYTimes.com


The New York Times carried this article the other day on the front page. I'm not sure why this was such an important story, but perhaps the Times was trying to suggest that Wall Street seems to be recovering faster than Main Street.

However, I would note that historically Wall Street managements have done a pretty poor job in anticipating their needs for employees. Put another, it is an old axiom of the markets that you should sell stocks when Wall Street is hiring, or vice versa.

Stay tuned.

Wall St. Hiring in Anticipation of an Economic Recovery - DealBook Blog - NYTimes.com

Saturday, July 10, 2010

‘The Time We Have Is Growing Short’ | The New York Review of Books


In 2005 Paul Volcker wrote an op-ed piece for the Washington Post. In the piece - entitled "An Economy on Thin Ice" - he warned that the apparently healthy U.S. economic recovery (which seemed to be in full swing at the time) was based on shaky grounds. Large current account deficits and rapidly increasing debt leverage were underpinning the U.S. economy's growth at the time, and Volcker warned that the day of reckoning would one day come.

At the time Volcker was dismissed as a tired old man fighting the last battle. He didn't seem to understand the new ways of the economy and of finance, it was argued.

Well, of course he was right. Three years after he wrote his piece for the Post the economy crumbled, and the worst financial crisis since the Great Depression ensued.

The reason I remember that piece so well was that I had printed it out and hung it on a board in my office for several years.

In my opinion, Paul Volcker was one of the most courageous public officials to serve in office. Appointed by Jimmy Carter in the late 1970's as Fed Chairman, Volcker inherited a financial system swamped with inflationary pressures. His predecessors had been totally ineffective - one chairman even joked that his friends thought that "Federal Reserve" was some sort of whiskey.

Volcker knew he had to do something, and in the infamous Saturday night massacre he did. After spending the week in Europe being lectured by other central bankers, Volcker flew home early from the meetings. On Saturday, October 3, 1979, he announced that the Fed would no longer target interest rates as a policy means, but instead would try to control money supply as a way to cut inflation.

Interest rates soared, and the economy buckled. By 1981, the bank prime rate was over 21%, and mortgage rates touched 19%. Still Volcker persisted, despite widespread protests (one favorite was to send Volcker a piece of wood to let him know that he was killing housing).

The medicine worked. Inflation was stopped, and the stage was set for one of the strongest periods of economic growth in U.S. history.

The reason I give you all of this background is because Volcker has always been willing to state what he believes is right, regardless of the political consequences. And at age 82, he doesn't really have any reason to hold back.

So when he gave these remarks a few weeks ago (I only found them on Twitter today) I thought they were worth a careful read.

One of the nice parts of Volcker's talk is the fact that ends with a note of optimism. He's not just a gloom-and-doom guy. Instead, he is arguing that, yes, we have problems, but properly addressed they might still be solved:

I referred at the start of these remarks to my sense five years ago of intractable problems, resisting solutions. Little has happened to allay my concerns. But, of course, it is not true that our economic problems are intractable beyond our ability to react, to make the necessary adjustments to more fully realize the enormous potential for improving our well-being. Permit me a note of optimism.

A few days ago, I spent a little time in Ireland. It’s a small country, with few resources and, to put it mildly, a troubled history. In the last twenty years, it took a great leap forward, escaping from its economic lethargy and its internal conflicts. Responding to the potential of free and open markets and the stable European currency, standards of living have bounded higher, close to the general European level. Instead of emigration, there has been an influx of workers from abroad.

But now Ireland has been caught up in its own speculative excesses and financial deficits, culminating in a sharp economic decline. There is a lot of grumbling, about banks in particular. But I came away with another impression. The people I spoke to had an understanding that the boom had gotten out of hand. There seems to me a determination to do something about the situation, reflected not just in the words of the political leaders but in support for action among the public. And there is a sense of what is at stake, that the gains they made in recent years have been placed in jeopardy. The urgent need to get back on a sustainable budgetary and economic track is well understood.

I hope my quick impressions of Irish attitudes and policies will be borne out and that that small country will not be caught up by a European crisis beyond its control. In the United States, we don’t seem to me to share the same sense of urgency. We view ourselves as a huge and relatively self-sufficient country, in control of our own destiny. We have time to sort out our priorities, to decide what to do, and to do it. There are elements of truth in those propositions, but the time we have is growing short.



‘The Time We Have Is Growing Short’ | The New York Review of Books

LeBron James and After-Tax Salaries

I've never heard of "Reason.com" until I read it in this morning's Wall Street Journal, but they had a pretty interesting take on James moving to Miami (for the record: I didn't watch the ESPN show, and I'm not really much of a NBA fan).

Here's the video, with the excerpt from the narrative below



But LeBron is only doing what more than half of Cleveland's population has done over the in the last 60 years: Getting the hell out of the place.

He didn't leave because of money, though some analyses show that he can take home more in pay in Florida despite a lower salary. Ohio used to be one of the lowest-tax states in the country. Now it's one of the highest.

That's what Clevelanders should be outraged about. Their economy has enough to deal with already without being put in a full court press by high taxes.

Cleveland needs to get rid of its savior complex. LeBron James could never have saved Cleveland--no single sports star or entrepreneur or bailout can--but there are definite, proven steps that any city can take to improve
life for its citizens.

I grew up in Toledo, Ohio. Toledo also has suffered a large decrease in population since the 1970's, including me and most of my high school buddies. Unfortunately there's just not much opportunity anymore in Ohio, so perhaps Reason.com has a point.

Friday, July 9, 2010

Gold: Store of value | The Economist


I still get lots of calls from clients asking about gold as an investment.

I am not a big fan. I know gold historically has served people well during inflationary periods, or when governments do silly things like debase their currencies, but I think gold has several drawbacks.

First, it doesn't give you any yield.

Second, it really has no value other than for jewelry. As The Economist's article notes, even India is reducing it demand for gold jewelry, and they represent a quarter of the world's demand.

Third, it is almost impossible to analyze. Since most of the demand and supply of gold is based on human emotions, projecting gold prices in futures is even more futile than predicting the economy.

Fourth, even if Armageddon arrives as the gold bulls predict, what good would gold be then? Would someone be willing to take a metal for goods or services - or are they more willing to demand something more tangible, like food or shelter.

Finally, the track record of gold in modern times has been mixed, at best. As the chart in the attached article indicates, although in nominal terms gold has risen dramatically in recent quarters, on an inflation-adjusted basis gold's price is unchanged in nearly 40 years. Even stocks - after a decade of futility - have done better.

As the article notes:

But the {gold} price surge has had others shaking their heads. As an investment that does not produce income, its attraction lies solely in the hope that its value will rise or at least be maintained. As a metal, its main use is in jewellery. It defies logic, say the bears, that its price should remain so high without any fundamental change in the sources of demand or constraints on supply. Willem Buiter, a former professor at the London School of Economics who is now the chief economist of Citigroup, has called gold the subject of “the longest-lasting bubble in human history”. He says that he would not invest more than a sliver of his wealth “into something without intrinsic value, something whose positive value is based on nothing more than a set of self-confirming beliefs.”


Gold: Store of value | The Economist

Walking Away From Million-Dollar Mortgages - NYTimes.com


When you hear or read about problems in the housing market, usually the discussion is focused on the lower end, subprime mortgages. But it appears (judging from this article in the New York Times this morning) that people are walking away from their mortgages on the upper end as well.

Here's an excerpt:

More than one in seven homeowners with loans in excess of a million dollars are seriously delinquent, according to data compiled for The New York Times by the real estate analytics firm CoreLogic.

By contrast, homeowners with less lavish housing are much more likely to keep writing checks to their lender. About one in 12 mortgages below the million-dollar mark is delinquent.

Even more disturbing:

The delinquency rate on investment homes where the original mortgage was more than $1 million is now 23 percent. For cheaper investment homes, it is about 10 percent.

Think about that: roughly one out of every four homes in ritzy vacation spots like the Hamptons or Nantucket that have huge mortgages are at least delinquent. Given the fact that if they can't sell vacation homes in the middle of summer, I would bet that by this time next year they are in foreclosure.

Walking Away From Million-Dollar Mortgages - NYTimes.com

Now the tone of the article is one of mild outrage. And while I am not suggesting that we should have any sympathy for these folks, I would also take a step back and ask whether their behavior is any different than what goes on in corporate America.

Corporations walk away from their debt obligations all of time: just look at the airline industry as a prime example. When a company files for Chapter 11 bankruptcy, it is usually thought to be the act of thoughtful managements trying to figure out a way to save jobs (including their own).

Even countries will default - I mean, how many times has Argentina defaulted on its debt over the last century, only to come back to the markets and be greeted with open arms (and open wallets)?

From a purely economic standpoint, then, these borrowers who owe over $1 million on their primary or secondary homes are doing a very rational act: cutting their losses.

Problem is, we don't expect individuals to act as corporations. But if this starts a trend, it could have very serious implications for the housing market.

Thursday, July 8, 2010

Downsizing - Making a Condo Into a Stylish Container for a Downsized Life - NYTimes.com


Maybe it's just my age, but I seem to know more people that are thinking about selling either their primary home or vacation home to try to simplify their lives.

This makes sense to me. Houses take a lot of work to maintain, not to mention the expense, and at some point it seems logical to spend your time and energy elsewhere.

The same holds true for getting rid of the clutter in your house. My wife Christina and I have been on a major campaign to clean out all of "stuff" that has accumulated in our house over the years.

As someone once said, the more stuff you own, the more it owns you.

(My secret agenda is to get rid of most of our books in favor of Amazon's Kindle, but so far Chris isn't buying it).

In this morning's New York Times there is a story about a couple selling their home in favor of a condo. It's an interesting story from a design standpoint, but the part that really caught my eye was the following:

Her own mother, she said, had been an inspiration: she died at 101 with only two small boxes to her name. “She gave away things for years,” Lydia said. “You have to stop accumulating, and start clearing out early.”

Downsizing - Making a Condo Into a Stylish Container for a Downsized Life - NYTimes.com

Wednesday, July 7, 2010

Hobos and welfare for America's Rich – Telegraph Blogs


Leave it to a British columnist to point out a potentially difficult social problem arises in America.

This from Ambrose Evans-Pritchard in the London Telegraph:

...Republicans on Capitol Hill who backed the mobilization of $3 trillion of fiscal and monetary support to bail out the financial system are now going to great efforts to prevent the roll-over of temporary benefits to 1.2m jobless facing an imminent cut-off.

I don’t wish to enter deeply into an internal US dispute....but I do think think that the American political class will have to face up to the new reality of a semi-permanent slump for a decade or more that will blight a great number of lives. The cyclical recovery that normally makes it possible for most Americans to find a job if they want one is not going to happen this time because the overhang of debt, fiscal tightening, and a liquidity trap have combined to jam the mechanism.

And Ambrose goes on:

At some point this will become very political. Everybody knows that the wealthy have in fact been bailed out. Part of the purpose of quantitative easing was to raise asset prices, in the hope that this would course through the economy – and ultimately trickle down. The rich have benefitted enormously from federal action...

...But once welfare has been deployed so generously for the rich, it cannot be denied so easily for the poor. This was the Faustian Pact.

Part of the American ethos, it seems to me, is a belief that if one works hard and plays by the rules they can realize a share of the American Dream.

This is the reason that most Americans don't begrudge somewhat becoming wealthy, since most of us believe that we, too, have the same opportunity.

But with real incomes stagnant for more than a decade, housing prices continuing to fall, and the broader measure of U.S. unemployment 16.5%, it is harder to keep the Dream alive.

Besides being of concern to us citizens, what kind of investment implications does all of this have?

For a start, I would think that tax rates on the wealthy might rise far more than many are anticipating. For example, most of my clients are assuming that the federal estate tax will be permanently moved to begin above $3.5 million, just where it was in 2009. However, I am beginning to think that it might just revert to $1 million, where it was in 2001, and where it still is in many states (including Massachusetts).

I am also thinking that the tax rate on dividend income might go to the maximum 39.6% compared to 15% currently.

More to follow.



Hobos and welfare for America's Rich – Telegraph Blogs

Malcolm Gladwell: The Sure Thing


I'm a latecomer to the Malcolm Gladwell fan club but you can now consider me a full-fledged member.

Malcolm Gladwell, if you don't already know, is a writer for the New Yorker magazine. However, he is better known as the author of a variety of best selling books, including The Tipping Point; Outliers; Blink; and most recently What the Dog Saw: And Other Adventures.

I had the chance to see Mr. Gladwell give a talk here in Boston a couple of weeks ago, and he was great. The title of his talk was "Puzzles and Mysteries". He discussed how we often look at everyday problems as a puzzle to be "solved" when in fact there often is not a clear answer, only a mystery to be pondered.

In fields as diverse as medicine, defense, and even investment management, we expect experts to have solutions, but often there are only a series of choices, each with a different probability of success.

In any event, Gladwell has a website that features a variety of his articles for the New Yorker. I just read one article that I really enjoyed that was originally published in the January 18, 2010, magazine that was titled "The Sure Thing: How Entrepreneurs Really Succeed" I have included the link to his site below.

The article discusses the fact that many of the success stories that we read about - ranging from Ted Turner's billion dollar media empire to hedge fund manager's John Paulson's $4 billion payday (due to his correct assessment that the U.S. housing market was poised for a fall) - are often less risky to the entrepreneur than we might expect.

Gladwell gives numerous examples of how these wildly successful entrepreneurs were constantly worried about downside risk, and structured their investments to try to minimize any potential financial exposure should their investments fail to work out as planned.

This is, of course, tremendously relevant to the investment business. It is axiomatic in my business that the major difference between an older portfolio manager and a younger one is the fact that older investors tend to fret most about downside risk. Younger investors - who either have never been through a bear market or have only known profitable trades - tend instead to think about upside potential.

Given my age (53 years old) and the number of years I have been working with clients on investments (almost 30 years) you can guess what type of investor that I am.



gladwell dot com - the sure thing