Thursday, July 28, 2011

Don't Bank On It

Investment strategist Richard Bernstein had a column in yesterday's Financial Times talking about global bank stocks.

Bank stocks have been poor performers over the last few months, and their valuations would appear to be very enticing. However, it could also be that we are seeing a major shift in the way that multinational financial companies are viewed by regulators, which could lead a significant crimp in earnings.

Here's an excerpt from Mr. Bernstein's column:

Our research suggests that analysts’ earnings projections for the US’s leading financial institutions may be overly optimistic if we are correct in thinking Washington is increasing its vigilance against global risk-taking. The average consensus long-term earnings growth forecast for the US’s global financial firms is 10 per cent. We feel a more realistic long-term growth rate might be about 6-8 per cent a year.

This is significant for valuation, implying that bank stocks should be revalued downward by 10-15 per cent. It is hard to envision the leading financial stocks outperforming for any length of time when secular growth expectations have yet to adjust fully to a post-credit bubble reality.

Then, in this morning's New York Times, Jesse Eisinger writes that it actually make more sense for the big banks to be broken up rather than let them continue to limp along.

He cites Citigroup and Bank of America as being particularly poor performers, and suggests that both companies would probably benefit from simply splitting into different companies.

For example, writing about Bank of America:

Bank of America’s recent quarterly earnings were so weak that investors and commentators wondered whether the bank should sell off Merrill Lynch, the investment bank for which it foolishly overpaid at the height of the crisis. Bank of America trades at half of its book value (the stated value of its assets minus its liabilities), an indication that investors view its asset quality and prospects just a notch below abominable, as Jonathan Weil of Bloomberg News pointed out last week.

And as for Citi, Mr. Eisinger writes that its stock, earnings and revenue growth has lagged for a decade.

We have not had much bank stock representation in client portfolios for some time now. Our concerns have largely centered on loan growth, which remains anemic for nearly all banks. But the points raised by Messrs. Bernstein and Eisinger makes us even more convinced that largely avoiding bank stocks for the time being is the correct decison.

Wednesday, July 27, 2011

Don't Believe Everything You Read

Last week the media was full of reports that several large hedge fund managers - including George Soros, one of the most successful hedge fund managers of our generation - were holding large amounts of cash in their portfolios due to the current market environment.

Here was a typical story from Bloomberg, dated July 19, 2011:

Keith Anderson, who runs the $25.5 billion Quantum Endowment Fund for Soros Fund Management LLC, has seen enough of choppy global markets.

In mid-June, Anderson told his portfolio managers to pull back on trades as the hedge fund’s losses hit 6 percent for the year, according to two people familiar with the New York-based firm. As a result, the fund is about 75 percent in cash as it waits for better opportunities, said the people, who asked not to be identified because the firm is private.

Well, not so fast. Turns out that Soros is actually closing his fund to anyone other than his family, and so much of the cash could have been raised in anticipation of returning funds to his outside investors, and that Soros is trying to cut back on his investing activities.

Here's an excerpt from yesterday's New York Times:

George Soros, the investor who broke the Bank of England and came to represent the swashbuckling style of hedge fund managers and then their entry into the world of global affairs, has decided to return money to outside investors in his Quantum fund.

Mr. Soros, who will turn 81 next month, is the latest hedge fund magnate to forgo managing the money of outsiders in favor of his own, though his move is more symbolic. Of the roughly $26 billion the fund manages, less than $1 billion belongs to outside investors.

And, oh, Mr. Anderson is also leaving the Soros company.

Now, it could very well be that Soros really does have three-quarters of his assets in cash due to market considerations. However, it could also be that the closing of his fund to outsiders may also mean that Soros is really winding down much of his investing activities, so the cash balance is really not a market call at all. Or it could be that the cash positions are collateral for some futures or foreign exchange trades that Soros is doing.

As outsiders, we really don't know, and that's my point.

Hedge fund are notoriously secretive, and to base one's market calls on reported positions is not a particularly good way to develop an investment strategy. George Soros did not become fabulously wealthy by letting others in on his trades, and I doubt he is starting now.

And then there's the Buffett effect. Often a news report that Warren Buffett has taken a position in a particular stock, which inevitably leads to a jump in its share price. Then it later turns out that the rumor is either wrong, or that someone other than Buffett at Berkshire has made the share purchase.

As the old axiom goes, don't believe everything you read.

Tuesday, July 26, 2011

Monday Night Smackdown

As I talked to clients and colleagues this morning, it appears that I must have been one of the few people to watch President Obama and Speaker Boehner last night blame the other party for the looming debt crisis.

Maybe it's just that I need more hobbies to busy myself at night, or maybe the complacency of my immediate circle of friends is more appropriate.

There is some suggestion that the White House has overplayed its hand on this one. Andrew Ross Sorkin writes in this morning's New York Times that maybe the August 2 deadline isn't so hard-and-fast after all:

The administration may have made a strategic mistake in warning too soon that the market would react negatively. It ultimately undercuts the government’s negotiating position because the doomsday scenario has not played out, even though the deadline is fast approaching.

“They have lost all credibility,” said Neil M. Barofsky, the former special inspector general for the Troubled Asset Relief Program. “It’s so typical of the way Treasury and the Fed treat everything — it is always to warn that Armageddon is coming.”

.. the market seems to believe it was a false deadline. Some economists have said the government would have enough cash on hand to continue making payments for several days at least. The administration could also decide how to prioritize payments. The government, for instance, could opt to pay interest on Treasuries and put off other bills.

That seems to be the view of most investors, at least judging from the direction of the Treasury bond market.

As I write this, 10-year Treasury bond yields are down below 3% again. Bonds rallying in the face of financial Armageddon? Something doesn't seem right.

As usual, one of my favorite columnists Ambrose Evans-Pritchard writing in the London Telegraph captures it best. Mr. Evans-Pritchard tells readers to "Calm down: The U.S. will not miss a coupon payment... next Wednesday". He goes on:

..nothing will in fact change when the deadline expires on August 2. The US is the world’s paramount strategic and economic power, with debts in its own sovereign currency. It can do as it pleases.

Yes, the US may be stripped of its AAA by Standard & Poor’s. A nice one-day story, but otherwise irrelevant. Global bond vigilantes are quite able to make their own judgement on the substantive default risk of the US. The rating agencies are out of their league on this one.

(By the way, the serial downgrades of Japan did not stop the yield on 10-year Japanese bonds falling to 0.5pc at one stage. What matters is whether investors really believe that they will be stiffed. In Japan they did not, and still do not.)

Still, Mr. Evans-Pritchard notes that unless the U.S. does something about the continued rise in health care costs - which is after all the major culprit in the budget deficit battle - the day will come when the world should really worry about the credit standing of the U.S.

But for now I think he's right: August 2 will come and go, and rates will largely remain at today's levels.

Monday, July 25, 2011

Should Investors Be Hiding In Gold?

I have had a number of calls from clients during the last few days asking what steps, if any, they should be taking in anticipation of debt default in Washington.

Frankly, I don't have a lot of answers.

Part of my problem, I guess, is that I have not been able to fathom what rationale any elected official could have to put our country in this predicament. I understand that there are strongly held views on both sides of the aisle, but default?

Ah, some are saying, doesn't today's situation scream out for investments in gold?

Well, maybe, but I don't think so. Still, with gold continuing to reach new highs on a daily basis, it is hard to argue with the gold bugs.

I believe that gold's popularity will be short-lived, and that if common sense prevails, investors will see the investment characteristics of an asset that doesn't generate any earnings, and costs something to store, are limited.

Saturday's New York Times compared the current popularity of gold to 1980, when gold soared to $850 an ounce from $35 in 1971. Then, as now, the papers were full of stories of the investment value of the metal, but if you had bought in 1980 your return for the next 30 years would have been around 2% per annum, assuming you hadn't needed to sell any gold to meet living expenses.

Meanwhile, common stocks over the same time period returned more than 9% per annum.

Then there's this: true, the price of gold over the last few years has moved sharply higher. Not only are investors concerned about the policy decisions of the global central banks, but strong demand from Asia has boosted prices. India, for example, has used some of its new-found wealth to increase gold purchases - but mostly for use in wedding dowries, not as an investment.

Here's an excerpt from the Times article:

While the price fell on signs of progress on these nettlesome issues, gold ended the week at $1,602.60. (That’s well below its 1980 inflation-adjusted peak of $2,516, said Edward Yardeni, an independent economist.) Gold hasn’t been flying this high since the halcyon days of supply-side economics early in the Reagan administration...

Even at central banks, gold’s standing has risen in some respects lately. In June, UBS held a gathering of managers of central bank reserves, multilateral institutions and sovereign wealth funds, and found that a plurality believed gold would be the best-performing asset class through the end of 2011....

In Gold's Popularity, Shades of 1980 - Strategies -

Friday, July 22, 2011

Meanwhile, Back at Corporate America

Much investor attention has been focused on government discussions in Washington and Brussels, and market movements this week have been largely driven by macro events.

However, now that we're probably two-thirds through earnings season, it is safe to say that Corporate America is doing just fine.

More than 80% of the S&P 500 companies that have reported have beaten earnings expectations this quarter, according to the Financial Times. Technology companies in particular are doing great: we've seen "blow out" earnings reports from companies like IBM, Apple and Google.

Bloomberg points out that return on equity for the stocks in the S&P 500 rose to 24%. When you compare this to the paltry yields found in the bond market:

Return on equity, a measure of profits relative to investments in plants and labor, rose to 24 percent last month, according to data compiled by Bloomberg. At the same time, a gauge of corporate bond yields fell to 3.61 percent, according to Barclays Plc. That’s the biggest difference in at least 13 years, the data show.

The problem is what what is good for corporate America is not necessarily good for the populace as a whole. Record earnings have largely been achieved through efficiency gains using the internet, and outsourcing jobs to lower cost countries. The average American is not seeing the benefits of the resurgence in business.

What does seem likely is that we will continue to see more M&A activity. Corporations have huge stockpiles of cash - nearly $1 trillion, by some accounts. With top line revenue growth gains difficult, and short term interest rates near zero, there is strong incentives for mergers. Even an old corporate raiders like Carl Icahn is trying to force Clorox management to sell.

On a lighter note, the increase in M&A activity has extended to even the smallest companies, as the Boston Globe noted this morning:

Berkshire Hathaway CEO Warren Buffett is one of the world’s richest men... was in Boston this week for a meeting... Afterward, we’re told, Buffett, his burly bodyguard, and a few folks ...headed over to Boston Speed Dog, the food truck in Roxbury that sells the most scrumptious hot dogs. Not surprisingly, Buffett loved the dog and joked that he wanted to buy the truck. When we asked Speed Dog co-owner Greg Gale about his brush with fame, he was confused. “Really? He was here? I didn’t even know,’’ Gale said. “I love his music.’’ No, we explained, it was Warren Buffett, not Jimmy Buffett. He’s older with gray hair and glasses, we said. “Now that you mention it, I did talk to him,’’ replied Gale. “He said he wanted to buy the place, and I told him, ‘You don’t have enough money.’ ’’

Thursday, July 21, 2011

Everyone's A Contrarian

A few years ago I took my son Michael on college visit to the University of Virginia.

UVA is one of the top universities in the United States, and admission is highly selective and competitive. The school receives thousands of visits every year from high school students from around the world, and the crowd was large on the day of our visit.

When we visited Charlottesville,we heard a talk given by Parke Muth, one of the deans of admission at UVA.

It was an excellent talk, but what I remember most was the beginning of the presentation.

Mr. Muth looked out the audience of parents and top-flight students and asked:

"How many of you think the college admissions process is fair?"

Virtually no hands were raised.

So, with a smile, Mr. Muth said,

"Well, then, if you all think it's an unfair process, doesn't that really mean the process is fair? Doesn't really mean that you're all being treated the same way?"

The audience broke out in laughter.


I'm competing against another firm for a new relationship.

My competition is a small money management outfit here in Boston whose whole investment approach seems to boil down to "we're contrarians".

In my opinion (remember I'm biased), "contrarian" is one of the most overused terms in investment management.

So many firms bill themselves as "contrarians" that being a contrarian is almost the majority. But how can you be contrarian if all of your thinking is mainstream?

Or, to echo Mr. Muth of UVA, if everyone thinks their thoughts and investments are away from the "herd", then by definition they really are part of the "crowd".

For example: my competition's website describes how, through their years of experience and education, they are able to find undiscovered gems in the investment world. However, the insights that they offer up largely seem to center around our broken political system, large amounts of debt, and apparent overvaluation of all markets.

Is this really contrarian thinking?

The problem with true contrarian thinking is that it often is at odds with making a living in the investment world.

For example, Jeremy Grantham - one of the most respected investment strategists in my business - was bearish on technology stocks starting in the mid-1990's. His work was eventually vindicated, but as he said, his firm (GMO) lost three-quarters of their assets under management in the late 1990's due to poor investment performance versus their benchmarks.

More recently, hedge fund managers like John Paulson and Michael Burry made literally billions of dollars betting against the US housing markets during the last decade (and were profiled in books like The Big Short). However, both men suffered huge amount of investor outflows from their firms before ultimately being vindicated.

As John Maynard Keynes said long ago, "Markets can stay irrational longer than you can stay solvent".

In my experience, everyone likes a contrarian - as long as it works out quickly.

Wednesday, July 20, 2011

OMG: Zillow Trades at $60 a share

I wrote a post last week about Zillow, the on-line real estate information company that just went public today. The stock ticker is Z.

When I attended the road show for the deal, I was impressed with the company and its potential. So too were a number of other investors - the meeting room was packed, and the hotel had to set up tables in the hall accommodate the attendees.

At the luncheon, management indicated that it was expecting to price the deal between $12 to $14 a share. Here's what I thought about the offering at those levels:

Zillow has not made any money in its short history. In 2010 it had total revenues of approximately $30 million, and lost about $7 million. Still, traffic at the Zillow site has been soaring, and there is significant revenue potential through both on-line advertising as well as partnering with affiliates such as mortgage companies.

The IPO is offering roughly 10% of the company for $45 million, with the founders and initial investors holding the rest of the shares. Put another way, the company is being valued at around $450 million, or 15x sales, which puts it at a valuation that I will have to take a pass.

Well, shows what I know.

Z opened today at $53, and traded as high as $60 a share, or 500% higher than the price indications of last week (talk about performance!). The trading has been very erratic, however, which is not surprising given the relatively small size of the deal, so who knows where it will close today.

Meanwhile, back at "old tech", Apple reported outstanding results last night. They are barely able to keep up with the demand for iPads. Combined with strong results from other tech companies like IBM and Google, it might appear that techology - which has lagged the general market this year - might be poised for a stronger second half.

Tuesday, July 19, 2011

IBM Rolls On

One of the most remarkable stories in American business, in my opinion, has been the evolution of IBM over its 100 year history.

We're all pretty familiar with the story: started by Tom Watson to sell adding machines, the company was on the forefront of computer technology research. By the late 1960's, IBM was so dominant that the US government brought a monopoly suit against it in an effort to break up the company.

However, as is almost always the case in technology, new and more aggressive rivals sprang up, and IBM slowly began to slide towards what appeared to oblivion. The old way of selling "big iron" to corporate American through an army of men dressed in blue suits began losing badly to more nimble start-ups.

Enter Lou Gerstner. Named as IBM's CEO in 1993, Gerstner brought a whole new mind-set to the company that changed not only the course of IBM but also the way that many other large technology companies operate today.

Gerstner's insight was simple: most CEO's are less interested in technology than they are in simply using technology to deliver products and services.

For example, Gerstner recalled that when he was head of American Express he was really only interested in having customers use his company's service. Technology enabled Amex to deliver a service, but their main product was credit cards, not technology.

Gerstner wrote an excellent book about his time as head of IBM named Who Says Elephants Can't Dance.

I can truthfully say that Gerstner's book is one of the few business books that I have read twice, and think about often in my daily business life.

The idea of looking at one's business from the customer's point-of-view, rather than the other way around, should be central to every company, yet too often the customer is forgotten in strategy discussions.

Here's a quote about Gerstner from Widipedia:

{Gerster} describes his arrival at the company in April 1993, when an active plan was in place to dis-aggregate the company. The prevailing wisdom of the time held that IBM's core mainframe business was headed for obsolescence... Gerstner reversed this plan, realizing from his previous experiences at RJR and American Express that there remained a vital need for a broad-based information technology integrator. His decision to keep the company together was the defining decision of his tenure, as these gave IBM the capabilities to deliver complete IT solutions to customers...

Today a number of companies - including Oracle and Hewlett-Packard - often cite IBM as their role model for how they are trying to structure their companies.

I thought of IBM's history, and how far it is come, when I read the company's most recent earnings release. Big Blue continues to produce strong results:

IBM, which turned 100 last month, delivered better-than-expected quarterly results Monday that showed the old company had a lot of life in it.

The company got a lift from robust sales of new models of mainframes — I.B.M.’s heritage — while its biggest current businesses, software and services, generated healthy growth as well.

The company reported an 8 percent increase in net income, to $3.7 billion. Its operating profits per share rose 18 percent, to $3.09 a share, reflecting fewer shares outstanding because of I.B.M. stock buyback programs. Bolstered by the strong performance, I.B.M. raised its guidance for earnings for the full year, to “at least $13.25 a share” from the previous level of “at least $13.15 a share.”

I.B.M. Beats Analysts’ Forecasts -

Monday, July 18, 2011

A World of Contrasts

"Before I go on with this short history, let me make a general observation– the test of a first-rate intelligence is the ability to hold two opposed ideas in the mind at the same time, and still retain the ability to function.
One should, for example, be able to see that things are hopeless and yet be determined to make them otherwise. This philosophy fitted on to my early adult life, when I saw the improbable, the implausible, often the "impossible," come true.
F. Scott Fitzgerald

Perhaps Fitzgerald would have understood the world that we are facing today, since there seem to be so many contrasting trends.

In the U.S., for example, no one doubts that we have the financial capability to pay our debts, yet we can't agree on how we should go about it.

Meanwhile, in Europe, several countries would very much like to pay their debts, but don't have the financial capability to do so.

Regardless of how the various budget crisises are resolved - and I remain optimistic that at least here in the U.S. we will avoid a major policy blunder - it could be that what we are really seeing is a world struggling with deeper changes.

At least that's the argument of the Economist blog Democracy in America. Published last Friday, the author cites a recent research piece published by Michael Spence, a Nobel-laureate professor of economics at NYU.

Here's a quote from Professor Spence:

"[A]s recently as July 8, after the latest disappointing employment report in the United States, President Barack Obama expressed the widely held view that an agreement on the debt ceiling and deficit reduction would remove the uncertainty that is holding back business investment, growth, and employment. In other words, America’s fiscal problems explain its extremely weak economic recovery. Once a fiscal deal is done, government can step aside and let the private sector drive the structural changes that are needed to restore a pattern of inclusive growth."

However, Professor Spence argues that fiscal policy is not the fundamental problem for our economy. The rise of the emerging markets - in particular China - combined with our huge debt burdens means that America is facing a period of economic readjustment that will involve significant dislocations.

In Professor Spence's view, for example, our high rate of unemployment does not reflect poor government policies, but rather that American industries, and American workers, are having trouble competing in the global market place.

In other words, even if the recent fiscal crisis is resolved, it could very well be that our problems are deeper, and more intractable, that we are recognizing.

Or, on the other hand, we can hope that Fitzgerald was right: that what today seems like a hopeless stalemate in Washington will, in fact, hasten our collective wisdom to recognize that the world has fundamentally changed, and that our policy responses in both the public and private sectors will be made accordingly.

Friday, July 15, 2011

"The US Is Holding the Whole World Hostage"

This was the headline this morning in Der Spiegel, the German news magazine.

It is an illustration that an irresponsible act driven by American politicians could have wide-reaching effects beyond our federal government.

Judging from what I have read, the rest of the world is incredulous that there is even the possibility that the U.S. would deliberately default on its debt obligations.

Here's an excerpt from the Der Spiegel piece (which is quoting another German publication called Bild):

"Irrespective of what the correct fiscal and economic policy should be for the most powerful country on earth, it's simply not possible to stop taking on new debt overnight. Most importantly, the Republicans have turned a dispute over a technicality into a religious war, which no longer has any relation to a reasonable dispute between the elected government and the opposition."

"If it continues like this, the US will be bankrupt within a few days. It would cause a global shockwave like the one which followed the Lehman bankruptcy in 2008, which triggered the worst economic crisis since the war. Except it would be much worse than the Lehman bankruptcy. The political climate in the US has been poisoned to a degree that is hard for us (Germans) to imagine. But we should all fear the consequences.",1518,774666,00.html#ref=nlint

Then there's the municipal market.

Remember Meredith Whitney, the analyst who famously predicted "hundreds of billions of municipal defaults" last December on the CBS television show 60 Minutes?

Well, so far Ms. Whitney has been woefully wrong: Not only have municipal defaults in 2011 been below historic averages, but the municipal market itself has had a solid performance. The 5 year Barclays muni index, for example, has returned +3.4% YTD (or nearly +7% annualized).

But if the unthinkable happens, and the US defaults, the muni market could suffer as well. Moody's warned yesterday that 7,000 municipalities could have their credit ratings downgraded if the US is taken down, which could lead to higher borrowing costs.

Here's an excerpt from an article on Bloomberg:

July 14 (Bloomberg) -- At least 7,000 top-rated municipal credits would have their ratings cut if the U.S. government loses its Aaa grade, Moody’s Investors Service said.

An “automatic” downgrade affecting $130 billion in municipal debt directly linked to the U.S. would occur if the federal level is reduced, Moody’s said yesterday in a report. Additionally, top-rated securities with no direct links to the national government will be reviewed for similar action.

Moody’s Will Cut 7,000 Municipal Ratings If U.S. Debt Downgraded - Businessweek

Somewhere Ms. Whitney awaits vindication.

Thursday, July 14, 2011

More on the Budget Battles

According to several press reports, last night's budget meeting between the President and House Republicans ended on a sour note.

Here's the report from Ezra Klein in today's Washington Post's blog Wonkbook:

House Majority Leader Eric Cantor launched into a stemwinder before the teams had even had time to look at the options papers the staffs had developed. On three separate occasions, Cantor pushed for the sort of short-term increase the administration has explicitly ruled out. Cantor's final effort to push the new plan came as the meeting was breaking up and the president was giving instruction to staff on how to prepare for the next set of talks. "Eric, don't call my bluff," the president said. "I'm going to the American people on this." Then, as the story goes, he walked out.

As I wrote yesterday, I continue to be more optimistic than many of my clients that all of this will be resolved in short order. Still, the more acrimonious the debate becomes, the more worrisome the situation becomes.

Much of the debate seems to center around political calculations, and how any resolution will play to the constituents back home.

Problem is, we tend to forget that a huge amount of our debt is held by foreign creditors, who really don't care about American politics: They just want their money to be safe.

The Chinese, for example, own at least $1 trillion of our debt obligations, and as the New York Times notes this morning, they are less than thrilled about the tempest in Washington:

"We hope that the U.S. government adopts responsible policies and measures to guarantee the interests of investors," ministry spokesman Hong Lei said at a regular news briefing in Beijing, when asked about the Moody's report.

He did not elaborate.

China, the United States' biggest creditor with more than $1 trillion in Treasury debt as of March, fears even a small default could destabilize the global economy and sour political relations.

Bill Gross, bond manager extraordinaire and head of the huge investment firm Pimco, wrote an editorial in today's Washington Post about the implications of a U.S. debt default from a bond investors perspective.

Besides the obvious tarnish that a refusal to meet our obligations would bring to our reputation, a credit default would also mean a serious increase in interest costs:

An actual default — or even the threat of one — might set off a chain reaction that would raise Treasury bond yields by 25 basis points (a quarter of a percentage point) or more, pushing up the cost of debt throughout American financial markets.... If an extra 25 basis points becomes the new benchmark, federal interest expenses might increase by $30 billion to $40 billion annually over the ensuing years as $1.5 trillion of new debt is issued each fiscal year...

Bond investors are a conservative lot. They earn only 1.6 percent on the average Treasury maturity these days, but they expect certainty on when, and whether, they will be repaid. Countries that keep them guessing or that are expected to default are punished severely, as reflected in 20 percent bond yields in Greece or even 5 to 6 percent in AA-rated Italy. Like it or not, James Carville, global investment managers have global choices these days, and a solvent Germany or Canada is just a wire transfer away for trillions of potential investment dollars looking for a safer haven.

Let's just hope that rationality reigns.

Wednesday, July 13, 2011

More On Budget Battles

I have had a surprising number of phone calls and discussions with clients on the current budget impasse in Washington.

I say "surprising" because, to me, it is inconceivable that any politician or political party would ultimately sacrifice our country's pristine credit rating to score a few political points. However, based on my recent conversations, perhaps I am being too sanguine.

In my optimistic view, I think that we have been through this before. I view the current situation as analogous to the showdown in the mid-1990's between the House Republicans lead by Newt Gingrich and President Clinton.

As you probably recall, the Republicans had swamped the Democrats in the mid-term elections in 1994, and the political winds all seemed to be behind Speaker Gingrich and his "Contract with America". After failing to come to any agreement on reducing the size of the budget deficit, the federal government essentially shut down for all but "essential" services. However, in the end, after several weeks of talks, the Republicans blinked, and the President went on to a resounding reelection in 1996.

And, oh by the way, the S&P 500 was up +36% in 1995, and +20% in 1996.

However, many of my savvy clients disagree with my characterization of today's situation with 15 years ago, and think that things are much more dire than I do.

And so too does the London Telegraph, as columnist Tim Stanley wrote yesterday:’s {Obama's} problem: this isn’t 1995 and he ain’t Bill Clinton. In 1995, thanks to Clinton’s wholesale theft of Republican fiscal and trade policy, the country was out of recession and unemployment was low. The underlying issue that year was how to share the proceeds of growth...

Today, the deficit is a very real, very big problem that goes beyond party politics. How America deals with its mounting debt will affect business confidence, external investment, Chinese foreign policy, the solvency of Social Security, and the price of basic goods. America’s entire future as a world power is at stake. Government shutdown in 1995 meant that services were suspended and a few driving test examiners didn’t get their daily fix of failing people. Shutdown or default today could extend the recession for another 12 months. With unemployment already at 9.2 per cent (it was averaged just 5.6 per cent in 1995), that’s a risk that isn’t worth playing chicken over. Even Bill Clinton understands that, which is why he’s called for corporation taxes to be cut.

When it comes to the debt talks, Obama is no Bill Clinton – Telegraph Blogs

Tuesday, July 12, 2011

Are New Tech IPO's Overvalued?

I went to a roadshow for the Zillow IPO yesterday.

Started in 2006, Zillow is a company that has developed and maintains a very extensive database of residential real estate information that is freely available on the net. Zillow can be accessed via

I won't go through all of the features of the site, but if you are thinking of buying or selling a home it is truly useful.

Or, if you just want to be a voyeur, you can check to see the asking price for other houses in your neighborhood, or the prices of recent real estate transactions.

Zillow is easily accessed by the free app that you can download on your iPhone, iPad or Android phone. According to the company founders, the Zillow app is the #1 downloaded financial app on smart phones.

The founders of the company also started Expedia, the on-line travel website that is now widely used by thousands of travelers. The idea behind Zillow, management said yesterday, is the same as Expedia: give the consumer the ability to use an extensive database to make informed purchasing decisions without using an intermediary such as a real estate broker.

The Zillow website is cool, and the idea is truly exciting. But when it comes to valuing the company, well, that's a different story.

Zillow has not made any money in its short history. In 2010 it had total revenues of approximately $30 million, and lost about $7 million. Still, traffic at the Zillow site has been soaring, and there is significant revenue potential through both on-line advertising as well as partnering with affiliates such as mortgage companies.

The IPO is offering roughly 10% of the company for $45 million, with the founders and initial investors holding the rest of the shares. Put another way, the company is being valued at around $450 million, or 15x sales, which puts it at a valuation that I will have to take a pass.

That said, I bet the IPO does well - the lunch meeting was packed, and the hotel had to set up tables in the hallway to accommodate all of the attendees. Zillow is apparently one of this summer's "must have" stocks, like LinkedIn or Pandora Media.

I could be missing something.

Sunday's New York Times had an interview with Marc Andreessen, one of the most prominent venture capitalists in Silicon Valley and the founder of Netscape, which was the first web browser.

Mr. Andreessen thinks that old style investors like me are totally out to lunch:

Contrary to all the recent hype about a bubble, you’ve said that tech companies are actually undervalued. So in true 1999 fashion, should I take my life savings out of mutual funds and toss it into tech stocks?

I’m certainly not an investment adviser, but on a 30-year basis, these things are cheap. If you compare how big industrial companies like G.E. are valued compared with big tech companies like Microsoft, Cisco, Google and Apple, tech stocks have never been valued more poorly in comparison. So not only is there no bubble — these prices are reflective of the fact that the market still hates tech. This bubble talk is about everybody being unbelievably psychologically scarred from 10 years ago.

I'm not convinced, but I am willing to concede that Mr. Andreessen might be on to something.

Take Microsoft, for example. The market cap of Mr. Softy is $225 billion, which makes it one of the largest companies in the S&P 500. Yet its core franchises - the operating system, and ubiquitous Windows software - is under fierce attack. The PC market is shrinking, as consumers move to smart phones, and Microsoft is now offering a package deal on Word, Excel and PowerPoint for $6 monthly subscription fee on iPad.

Put another way: Zillow, LinkedIn, et. al. might not be around 10 years from now - but where will Microsoft be?

Monday, July 11, 2011

Living On the Edge - But With a Net

Last Friday's unemployment report was a disappointment, to put it mildly.

Analysts were calling for job growth to be +100,000 or more, but only 18,000 jobs were added to the economy in June. The unemployment rate rose to 9.2%. There are millions of Americans who have either given up looking, or are taking jobs far below their skills.

For an economy that officially is two years into a recovery, this report confirms that the U.S. remains stuck in a deep economic funk.

And yet, just a day before Friday's horrific jobs number, we received the troubling news that Americans are getting fatter. Obesity - and concomitant health issues like type 2 diabetes - is a serious problem for the U.S.:

Obesity rates among adults now exceed 25 percent in more than two-thirds of the states, according to the report, and these rates climbed in 16 states over the last year. None of the states had a decline. The states with the highest rates tended to be in the South, with Colorado boasting the lowest obesity rate, under 20 percent.

This apparent contradiction between a country mired in economic misery, and a populace that is eating too much, reflects both the benefits, as well as the downside, of the safety nets that protect us all.

Two generations ago - during my grandparents' time - if you didn't have a job, you were in serious trouble. You could literally starve to death, or go without a doctor's care, because you didn't have the money to pay for food or services.

Today, thanks to programs like unemployment insurance, Medicaid, and Social Security, most Americans can receive most of their basic needs. While the debate in Washington rages on as to how to pay for this blanket of security under which we all sleep, no one is seriously discussing eliminating any of these programs.

But benefits might soon be cut, as funding begins to dry up for some of these programs. As this morning's New York Times discusses:

Close to $2 of every $10 that went into Americans’ wallets last year were payments like jobless benefits, food stamps, Social Security and disability, according to an analysis by Moody’s Analytics. In states hit hard by the downturn, like Arizona, Florida, Michigan and Ohio, residents derived even more of their income from the government.

By the end of this year, however, many of those dollars are going to disappear, with the expiration of extended benefits intended to help people cope with the lingering effects of the recession. Moody’s Analytics estimates $37 billion will be drained from the nation’s pocketbooks this year.

Friday, July 8, 2011

Note To Institutional Clients: Second Quarter 2011

Here's what I am telling the institutional clients I work with:

Despite some pretty formidable economic and political headwinds, stocks managed to hold on to most of the gains achieved during the first quarter of 2011. Year-to-date, the S&P 500 has produced a total return of +6%.

For the second quarter, the total return of the S&P 500 was +0.1%. Higher quality stocks lead the way, lead by health care (+7%) and utilities (+5%). Financials continue to lag the broader market averages, and were the worst performing sector for both the second quarter (-6%) and for the first half of the year (-4%).

It would be easy to turn cautious on the outlook for stocks. After all, recent economic numbers indicate an economy that is slowing. Unemployment remains stubbornly high. House prices in many parts of the country have continued to slide despite historically low mortgage rates. Problems in countries like Greece and Portugal threaten to spread across the euro zone, with negative implications for the entire financial system.

Yet we remain positive on the outlook for stocks, at least for now. Valuation of stocks, for example, continues to be attractive. According to financial publication Bloomberg, the S&P 500 is currently trading at just under 13 times income, the lowest level since 1985 (except for the financial crisis in the fall of 2008).

Low interest rates will also attract investors to stocks, in our opinion. Our bond group is not expecting any significant rise in interest rates for the foreseeable future. In many cases, corporate bond yields are lower than the dividend yields from the same corporate entity. Stocks can offer better income plus potential capital appreciation for longer term investors.

While corporations have reported difficulties in raising prices, most earnings reports continue to show improvement over prior periods. Corporations have streamlined operations through creative use of the internet, and in some cases moved manufacturing offshore to lower cost countries. Corporate profit margins remain at record levels, and with commodity prices dropping sharply during the past few weeks we believe corporate earnings will continue to be satisfactory.

Finally, we should note that widespread pessimism is usually a good time to be buying stocks. Bullish sentiment hit a peak in the spring of this year, and has been steadily declining ever since. The best opportunities in any markets are found when others are too focused on potential risks, rather than opportunities.

Thursday, July 7, 2011

1995 Redux?

I have been surprised by the number of calls that I have been receiving regarding the political stalemate in Washington.

More specifically, my clients are worried that our government might decide to either delay or default on its debt obligations.

All recognize, of course, that the U.S. has the ability to pay its obligations, but there is a real concern that some elected officials are willing to permanently scar our pristine credit rating in order to score a few political points.

Perhaps it reflects the national mood (please see my post from yesterday), but there seems to be a widespread cynicism about our elected officials - even more than normal.

The last time we had this degree of acrimony regarding our budget deficit was in the mid-1990's.

As some of you might recall, President Clinton had just suffered a "shellacking" in the mid-term election in 1994, and the House Republicans lead by Newt Gingrich were determined to change the direction of the federal government (sound familiar?).

Thus, in the fall of 1995, the federal government essentially shut down for a few weeks as an intense political battle ensued. Here's an excerpt from Wikipedia:

When the previous fiscal year ended on September 30, 1995, the president and the Republican-controlled Congress had not passed a budget. A majority of Congress members and the House Speaker, Newt Gingrich, had promised to slow the rate of government spending; however, this conflicted with the president's objectives for education, the environment, Medicare, and public health.[1] According to Clinton's autobiography, their differences resulted from differing estimates of economic growth, medical inflation, and anticipated revenues.[2]

In response to Clinton's unwillingness to make the budget cuts that the Republicans wanted, Newt Gingrich threatened to refuse to raise the debt limit, which would have caused the US Treasury to suspend funding other portions of the Government to avoid putting the country in default.[

As unsettling as it might have been to the public, the shutdown actually improved the mood of stock market investors: the S&P 500 rose by +36% in 1995, and another +20% in 1996.

Put another way, then, in the current situation is that it is not clear what the reaction of the market will be if the budget showdown cannot be resolved.

In addition, simply selling stocks at this point raises the same question: What do you do with the money?

Hopefully all of this is simply hypothetical.

Wednesday, July 6, 2011

Gauging the (Pessimistic) National Mood

Over the last few years there has been a considerable debate in economics circles as to the best way to measure a country's economic health.

The conventional way, of course, is the method that we all learned in Economics 101*:


Put another way: the economic health of a nation can be defined by what it produces and consumes.

And yet some economists are arguing that this textbook definition of economic well-being misses the very important measure of the emotional state of a nation.

It is axiomatic in my business, for example, that money does not buy happiness, yet our various measures of our economy have no way of being able to answer the very simple question of whether we are happy or not.

By many measures, the United States economy has clearly improved from 2008. True, the recovery has been a tepid one, with unemployment rates still unacceptably high and real wages stagnant, yet the official data would suggest a clear rebound from the recession.

Meanwhile, the stock market has nearly doubled from the lows in mid-2009, suggesting that investors at least feel much cheerier.

At the same time, many observers believe that the national mood is in a deep funk. Several polls suggest that many of our citizens see the country headed in the wrong direction. A large percentage of us seem to believe that the best days our country are behind us - a view, by the way, encouraged by numerous politicians hoping to score political points.

There was an article discussing this phenomena in last Sunday's London Telegraph. Entitled "Down on the Fourth of July: The United States of Gloom", the author wrote in part:

Frank Luntz, perhaps America’s pre-eminent pollster, argues that his countrymen are much more downbeat now than in 1980. “The assumption with the Carter years was that it was a failure of the elites, not the system. We thought the people in charge screwed up. We didn’t blame ourselves.” Remarkably, many Americans think things will only get worse and the good times will never return.

A recent New York Times/CBS poll found that 39 per cent think that “the current economic downturn is part of a long-term permanent decline and the economy will never fully recover”. That was up from 28 per cent last October. Last month, a CNN poll found that 48 per cent of Americans believe another Great Depression is somewhat or very likely.

Luntz has found that 44 per cent of Americans believe their country’s best days are in the past, 57 per cent that their children will not achieve the same quality of life, and 53 per cent that they are less free than five years ago. So what is going on? How did the land of the free, the home of the brave, and a country that less than three years ago elected a young, untested black man as president on a platform of hope and change, get into this funk?

Down on the Fourth of July: the United States of gloom – Telegraph Blogs

I don't know if I agree with this pessimistic view - after all, the late 1970's were hardly periods of hilarity in the U.S. - but it is an interesting point.

And perhaps it helps to explain why investors think that investing in 2-year Treasury notes yielding 0.41% is better than any other alternative.

*In case you've forgotten: GDP = Consumption + Investment + Government Spending + Net Exports

Tuesday, July 5, 2011

Goodbye Kindle, Hello iPad

A couple of years ago I bought a Kindle from Amazon.

I love the Kindle - it's simple to use, lightweight, and is easy to read, even in direct sunlight.

While I was initially hesitant to buy the Kindle - after all, buying a book is just as easy as carrying a Kindle - I have spent the last two years telling anyone who would listen that they, too, should join the ebook revolution.

So why is my Kindle now on my bookshelf at home?

Well, I took the plunge this past weekend, and bought an iPad from Apple.

Like my Kindle purchase a couple of years ago, I was initially reluctant to buy an iPad. It's not cheap - the lower end models go for around $500 - and most people get a monthly service plan to get 3G access from either AT&T or Verizon. The iPad is also a little bulkier than the Kindle, and the glass front makes it less harder to read in bright light.

But the functionality of the iPad is hugely greater than the Kindle. The iPad can seemingly do everything, and like all Apple products is so beautifully designed that even the least computer literate can figure out how to use it. The graphics are also astonishingly good

If you haven't done so already, you owe it to yourself to take a look at an iPad (and, no, I don't work for Apple). Even if you don't wind up buying one, I think you will wind up agreeing with me that the potential applications for tablets like the iPad are enormous.

For example, this morning's New York Times carried an article (which I read on my iPad, by the way) describing how pilots are now using the iPads instead of bulky paper manuals:

..a growing number of pilots are carrying a 1.5 pound iPad.

The Federal Aviation Administration has authorized a handful of commercial and charter carriers to use the tablet computer as a so-called electronic flight bag. Private pilots, too, are now carrying iPads, which support hundreds of general aviation apps that simplify preflight planning and assist with in-flight operations.

“The iPad allows pilots to quickly and nimbly access information,” said Jim Freeman, a pilot and director of flight standards at Alaska Airlines, which has given iPads to all its pilots. “When you need to a make a decision in the cockpit, three to four minutes fumbling with paper is an eternity.”

iPads Replacing Pilots’ Paper Manuals -

The article goes on:

"I don’t remember a time when one product seemed to get so much buzz and acceptance,” said Ian Twombly, spokesman for the Aircraft Owners and Pilots Association. “Many pilots approach new toys with skepticism, and the iPad seems to be almost universally appreciated as a cockpit device.”

There are now more than 250 aviation apps for the iPad, and one called ForeFlight is among the top grossing apps listed on iTunes. Its closest competitors are WingX, Jeppesen Mobile TC and Garmin My-Cast.

It may very well be that in two years time I will be writing about another electronic device that will outshine even the iPad.

For example, research analyst Toni Sacconaghi of Sanford Bernstein wrote a piece this morning suggesting that ultralite laptops like the Macbook Air could offer even more applications than the iPad in a couple of years.

But for now, I'm going to enjoy my new purchase.