This is a small update of my last piece.  I wish that I had put this graph in that piece, because it completes it.

Over the interest rate range of 0% to 30%, the average absolute deviations from perfect doubling using the Rule of 72 was 2.794%.  Given the simplicity of the Rule of 72, that is wonderful.

But the “Rule of K” is virtually exact.  The average absolute deviations from perfect doubling using the Rule of K was 0.036%.

Is this great?  Well, with modern computers, exactitude is easy to come by.  But if you are in a pinch to figure out the time to double, and all you have is a pencil and paper, the rule of K can do it with addition, subtraction and division.  No fancy powers or logarithms.  A four-function calculator will handle it, which, if you are using a rate that does divide into 72 easily, you will still need for the calculation.

At 8% the two are equal.  Near 8%, the Rule of 72 is pretty good.  The Rule of K gives an almost exact answer at the cost of a little complexity.  Your choice depends on whether you need exactness or simplicity when all you have to work with is a four function calculator.

The Rule of K: If R is the interest rate multiplied by 100, money doubles in K/R years, where K = 70 + (R – 2)/3

Picture Credit: Vincent Brown || Einstein never said this, either…

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If you are famous and dead, many people will attribute clever sayings to you that you never said.  As Yogi Berra said:

I really didn’t say everything I said.

Except that Yogi did say that.  Now, if Einstein didn’t do enough for us, he supposedly made many statements praising compound interest, but the articles I have seen haven’t been able to trace it back to an original source.  Personally, I think compound interest is overrated, because business processes can’t forever compound wealth at a steady rate.

But some also have tried to credit Einstein with the Rule of 72.  You know, the rule that says the time it takes to double your money in years is equal to 72 divded by the annual compound interest rate expressed as as an integer.  E.g., at 8% your money doubles in 9 years.  At 9% you money doubles in 8 years.

Pretty nice, and easy to remember.  It is an approximation though.  If Einstein ever did look at the rule of 72, he would have noticed that the approximation is pretty good between 3% and 13%.  Outside that it gets further away.

One advantage of the rule of 72 is that it is simple.  The second one is that 72 = 3 x 3 x 2 x 2 x 2.  That makes it divide more intuitively by many integral interest rates, e.g., 3, 4, 6, 8, 9, 12 — allowing for some intuitive interpolation to aid it.

There is a more complex version of the doubling rule though:

The doubling constant starts (in the limit) at 100 times the natural logarithm of 2 [69.3147], and increases almost linearly from there.  If you estimate a “best linear fit” line on the observations where the interest rate is between 0 and 30, the R-squared will be over 99.98%.  The equation would be:

K = 69.3856 + 0.3313 * interest rate  [Linear Fit K]

To make it a little more memorable rule, it can be turned into:

K = 70 + (interest rate – 2)/3  [Rule K]

Thus at 2% the doubling constant would be 70 — money doubles in 35 years.  At 5%, 71, money doubles in 14.2 years.  8% is the rule of 72 — nine years to double.  At 11%, 73, 6.6 years to double.  At 14%, 74, 5.3 years to double. 17%, 75, 4.4 years to double. 20%, 76, 3.8 years to double.  I did those in my head.

As you can see from the graph above, the actual doubling constant and its two approximations lie on top of each other.  Not that I hope we see ultrahigh interest rates, but Rule K does quite well over a long span of rates.  Here’s how small the deviations are:

Now, almost no one will use “Rule K” because the two advantages of the Rule of 72 are huge, and if interest rates get really high, someone could create an easy smartphone app to calculate the doubling period. (and constant if they wanted)

This is interesting for me, because I ran across what I call the “Rule of K” earlier in my career, and I was able to reproduce it on my own after reading the WSJ article that I cited above.  Who knows, maybe Einstein took the doubling rule and did a first order Taylor expansion around 2% — that would have produced something very close to the “Rule of K” back when regressions were hard to do.

That’s all, and if you made it this far, thanks for bearing with me.

 

May 2017June 2017Comments
Information received since the Federal Open Market Committee met in March indicates that the labor market has continued to strengthen even as growth in economic activity slowed.Information received since the Federal Open Market Committee met in May indicates that the labor market has continued to strengthen and that economic activity has been rising moderately so far this year.Shades GDP up
Job gains were solid, on average, in recent months, and the unemployment rate declined.Job gains have moderated but have been solid, on average, since the beginning of the year, and the unemployment rate has declined.Shades labor conditions down
Household spending rose only modestly, but the fundamentals underpinning the continued growth of consumption remained solid.  Business fixed investment firmed.Household spending has picked up in recent months, and business fixed investment has continued to expand.Shades up household spending and business fixed investment
Inflation measured on a 12-month basis recently has been running close to the Committee’s 2 percent longer-run objective. Excluding energy and food, consumer prices declined in March and inflation continued to run somewhat below 2 percent.On a 12-month basis, inflation has declined recently and, like the measure excluding food and energy prices, is running somewhat below 2 percent.Shades inflation down.
Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.No Change
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.No Change
The Committee views the slowing in growth during the first quarter as likely to be transitory and continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, labor market conditions will strengthen somewhat further, and inflation will stabilize around 2 percent over the medium term.The Committee continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, and labor market conditions will strengthen somewhat further. Inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee’s 2 percent objective over the medium term.Inflation down, growth up
Near-term risks to the economic outlook appear roughly balanced. The Committee continues to closely monitor inflation indicators and global economic and financial developments.Near term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely.Watches inflation closely, no longer looking at the rest of the world.
In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 3/4 to 1 percent.In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1 to 1-1/4 percent.Raises the Fed funds target range 1/4 percent.
The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.No Change
In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation.In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation.No Change
This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.No Change
The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal.The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal.No Change
The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run.The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run.No Change
However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.No Change
The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction,The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction.No Change
and it anticipates doing so until normalization of the level of the federal funds rate is well under way.The Committee currently expects to begin implementing a balance sheet normalization program this year, provided that the economy evolves broadly as anticipated.I guess the low 1% region is what is considered the low end of a normal federal funds rate.
This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.This program, which would gradually reduce the Federal Reserve’s securities holdings by decreasing reinvestment of principal payments from those securities, is described in the accompanying addendum to the Committee’s Policy Normalization Principles and Plans.Promises the slow end of QE, as they may start to let securities mature.
Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Charles L. Evans; Stanley Fischer; Patrick Harker; Robert S. Kaplan; Neel Kashkari; and Jerome H. Powell.Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Charles L. Evans; Stanley Fischer; Patrick Harker; Robert S. Kaplan; and Jerome H. Powell.All but one follow through on the idea that tightening is needed.
Voting against the action was Neel Kashkari, who preferred at this meeting to maintain the existing target range for the federal funds rate.Kashkari is a quirky guy.  Who knows?  Maybe he notes the flattening yield curve.

 

Comments

  • Labor conditions are reasonably good. GDP might be improving.
  • The yield curve is flattening, with long rates falling.
  • Stocks and gold fall. Bonds rose this morning and remain up.
  • I think the Fed is too optimistic about the economy. I also think that they won’t get far into letting securities mature before they stop reinvestment.
  • Interesting that they dropped the statement about following global financial conditions.

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Stocks always return more than Treasury Bonds.  So why doesn’t Social Security invest the trust funds in stocks rather than Treasury bonds?

The first reason is simple.  The government wanted Social Security to be free from accusations of favoritism.  Why should public businesses have access to government capital, when private capital doesn’t have that same advantage?  The second reason is also simple: do we want the government to be an owner of a large percentage of the businesses of the country?  Do you want the government to have even more influence on businesses than activist investors do?

The third reason is complex.  Do you want to mess up the stock market?  A large dedicated buyer would drive the market up to levels where future returns would be very low, much lower than at present.  Very marginal businesses would go public to take advantage of the dumb capital.

Far from earning more money for Social Security, the investment would put in the top of the market.  There would be a generational top where the brightest investors would leave the market,,  Future returns would be low.

Not that anyone significant is suggesting it at present, but it is wiser to keep governments out of business management.  Don’t reach for false gains in investment performance if the price is government involvement in the details of business.

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One more note: all of the benefits of Social Security are based off of labor earnings, not capital earnings.  Most taxes are collected from labor income.  That’s why Treasury bonds make sense — it is a neutral asset that is similar to those who receive the benefits.  Treasury bonds are as broad-based as those who receive benefits.

26 paths, and all of them wrong

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I lost this post once already, hopefully it will be better-written this time.  I’ve been playing around with the stock market prediction model in order to give some idea of how the actual results could vary from the forecasts.

Look at the graph above.  it shows potential price returns that vary from -1.51%/year to 4.84%/year, with a most likely value of 2.79%, placing the S&P 500 at 3200 in March 2027.  Add onto this a 2% dividend yield to get the total returns.

The 26 paths above come from the 26 times in the past that the model forecast total returns within 1% of 4.79%.  4.79% is at the 90th percentile of expected returns.  Typically in the past, when expected returns were in the lower two deciles, actual returns were lower still.  For the 26 scenarios, that difference was 0.63%/year, which would imply 10-year future returns in the 4.16%/year area.

The pattern of residuals is unusual.  The model tends to overestimate returns at the extremes, and underestimate when expected returns are “normal.”  I can’t think of a good reason for this.  If you have a good explanation please give it in the comments.

Now if errors followed a normal distribution, a 95% confidence interval on total returns would be plus or minus 3.8%, i.e., from 1.0% to 8.6%.  I find the non-normal confidence interval, from 0.5% to 6.8% to be more plausible, partly because valuations would be a new record in 2027 if we had anything near 8.6%/year for the next ten years.  Even 6.8%/year would be a record.  That”s why I think a downward bias on results makes sense, with high valuations.

At the end of the first quarter, the model forecast total returns of 5.06%/year for the next ten years.  With the recent rally, that figure is now 4.79%/year.  Now, how excited should we be about these returns?  Not very?  I can buy that.

But what if you were a financial planner and thought this argument to be plausible?  Maybe you can get 3.5%/year out of bonds over the next ten years.  With 4.79% on stocks, and a 60/40 mix of stocks/bonds, that means returns of 4.27%.  Not many financial planning models are considering levels like that.

But now think of pension plans and endowments.  How many of them have assumptions in the low 4% region?  Some endowments are there as far as a spending rule goes, but they still assume some capital gains to preserve the purchasing power of the endowment.  Pension plans are nowhere near that, and if they think alternative investments will bail them out, they don’t know what they are doing.  Alternatives are common enough now that the face the same allocative behavior from institutional investors, which then correlates their returns with regular investments in the future, even if they weren’t so in the past.

I don’t have much more to say, so I will close with this: if you want to study this model more, you need to read the articles in this series, and the articles referenced at the Economic Philosopher blog.  Move your return expectations down, and diversify away from the US; there are better returns abroad — but remember, there are good reasons for home bias, so choose your foreign investments with care.

 

What could be more a propos to investing than a bubble spinner?

What could be more à propos to investing than a bubble spinner?

 

A letter from a “reader” that looked like he sent it to a lot of people:

Hello my name is XXX,
After looking through your website I have really been enjoying your content.
I am also involved in the investing space and wanted to ask a quick question.
I was curious as to what you think the biggest problems are for investors today?
For example do they not have enough investment choices? Do they just not have enough knowledge? Really anything that you have noticed.
I would love to hear your perspective on this. I really appreciate the help. If you have any questions feel free to ask. Thanks.

This was entitled “Love what your doing, my question will only take 2 minutes.”  I wrote back:

This is not a 2 minute question.

That said, it’s a decent question.  Here are my thoughts:

  • The biggest problem for investors is low future returns.  Bonds have low rates of returns, and equities have high valuations.  You’ll see more about equity valuations in my next post.
  • The second largest problem is investment monoculture — there is a handful of large cap growth stocks that dominate the major indexes, and there is a self-reinforcing cycle of cash flow going on now that is forcing their prices well above what can be justified in the long run.
  • Third is inadequate ability to diversify.  This is largely a function of the two problems listed before, and benchmarking and indexing, which has been correlating the markets more and more.  I’m not talking about short-term correlations — diversification applies of the time horizon of the assets, which is long.
  • Fourth is bad government and central bank policy.  The growth in government debt is the growth in unproductive capital, which drives the first problem.
  • Fifth, too many people are relying on investments to fund their future spending — that also exacerbates the first problem.

That’s all — if you can think of more, leave your suggestion in the comments.

PS — my apology to those I tweeted to on Friday about a post on equity valuations.  That will appear Saturday night.  Thanks.

Markets always find a new way to make a fool out of you.  Sometimes that is when the market has done exceptionally well, and you have been too cautious.   That tends to be my error as well.  I’m too cautious in bull markets, but on the good side, I don’t panic in bear markets, even the most severe of them.

The bull market keeps hitting new highs.  It’s the second longest bull market in the last eighty years, and the third largest in terms of cumulative price gain.  Let me show you a graph that simultaneously shows how amazing it is, and how boring it is as well.

The amazing thing is how long the rally has been.  We are now past 3000 days.  What is kind of boring is this — once a rally gets past two years time, price return results fall into a range of around 1.1-2.0%/month for the rally as a whole, averaging around 1.4%/month, or 18.5% annualized.  (The figure for market falling more than 200 days is -3.3%/month, which is slightly more than double the rate at which it rises.  Once you throw in the shorter time frames, the ratio gets closer to double — presently around 2.18x.  Note that the market rises are 3.2x as long as the falls.  This is roughly similar to the time spans on the credit cycle.)

That price return rate of 1.4%/month isn’t boring, of course, and is close to where the stock market prediction model would have predicted back in March 2009, where it forecast total returns of around 16%/year for 10 years.  That would have implied a level a little north of 2500, which is only 3% away, with 21 months to go.

Have you missed the boat?

If you haven’t been invested during this rally, you’ve most like missed more than 80% of the gains of this rally.  So yes, you have missed it.

“The Moving Finger writes; and, having writ,
Moves on: nor all thy Piety nor Wit
Shall lure it back to cancel half a Line,
Nor all thy Tears wash out a Word of it.”

Omar Khayyám from The Rubaiyat

In other words, “If ya missed the last bus, ya missed the last bus.  Yer stuck.”

We can only manage assets for the future, and only our decrepit view of the future is of any use.  We might say, “I have no idea.” and maintain a relatively constant asset allocation policy.  That’s mostly what I do.  I limit my asset allocation changes because it is genuinely difficult to time the market.

If you are tempted to add more money now, I would tell you to wait for better levels.  If you can’t wait, then do half of what you want to do.

A wise person knows that the past is gone, and can’t be changed.  So aim for the best in the future, which at present means having at least your normal percentage of safe assets in your asset allocation.

(the closing graph shows the frequency and size of market gains since 1928)

Photo Credit: Daniel Broche || To the victor goes the spoils, or, does a victory get spoiled?

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I was at a CFA Baltimore board meeting, and we were talking before the meeting.  Most of us work for value investors, or, growth-at-a-reasonable-price investors.  One fellow who has a business model somewhat like mine, commented that all the money was flowing into ETFs which were buying things like Facebook, Amazon and Google, which was distorting the market.  I made a comment that something like that was true during the dot-com bubble, though it was direct then, not due to ETFs, and went to a different group of stocks.

Let’s unpack this, starting with ETFs.  ETFs are becoming a greater proportion of the holders of stocks, and other assets also.  When do new shares of ETFs get created?  When it is profitable to do so.  The shares of the ETF must be worth more than the assets going into the ETF, or new shares will not get created.

It is the opposite for ETFs if their shares get liquidated. That only happens when it is profitable to do so.  The shares of the ETF must be worth less than the assets going out of the ETF, or shares will not get liquidated.

Is it likely that the growth in ETFs is driving up the price of shares? Not much; all that implies is that people are willing to pay somewhat more for a convenient package of stocks than what they are worth separately.  Fewer people want to own individual assets, and more like to hold bunches of assets that represent broad ideas.  Invest in the stock market of a country, a sector, an industry, a factor or a group of them.

The creators and liquidators of ETF shares typically work on a hedged basis.  They are long whatever is cheaper, and short whatever is more expensive — but on net flat.  When they have enough size to create or liquidate, they go to the ETF and do that.  Thus, the actions of the creators/liquidators should not affect prices much.  Their trading operations have to be top-notch to do this.

(An aside — long-term holders of ETFs get nipped by the creation and liquidation processes, because both diminish the value of the ETF to long-term holders.  Tax advantages make up some or more than all of the difference, though.)

Does the growth in ETFs change the nature of the stickiness of the holding of the underlying stocks?  Does it make the stickiness more like a life insurer holding onto a rare “museum piece” bond that they could never replace, or like a day trader trying to clip nickels?  I think it leans toward less stickiness; my own view of ETF holders is that they fall mostly into two buckets — traders and investors.  The investors hold a long time; the traders are very short term.

As such, more ETFs owning stocks probably makes the ownership base more short-term.  ETFs are simple looking investments that mask the underlying complexity of the individual assets.  There is no necessary connection between a bull market and and growth in ETFs, or vice-versa.  In any given market cycle there might be a connection, but it doesn’t have to be that way.

ETFs don’t create or retire shares of underlying stocks or bonds.  And, the ETFs don’t necessarily create more net demand for the underlying assets.  Open end mutual fund holders and direct holders shrink and ETFs grow, at least for now.  That may make a holder base a little more short-term, but it shouldn’t have a big impact on the prices of the underlying assets.

My friend made a common error, confusing primary and secondary markets.  No money is flowing into the corporations that he mentioned.  Relative prices are affected by greater willingness to pay a still greater amount for the stock of growthy, highly popular, large companies relative to that of average companies or worse yet, value stocks.

Now the CEOs of companies with overvalued shares may indeed find ways to take advantage of the situation, and issue stock slowly and quietly.  The same might apply to value stocks, but they would buy back their stock, building value for shareholders that don’t sell out.  In this example, the secondary markets give pricing signals to companies, and they use it to build value where appropriate — secondary markets leads primary markets here.  The home run would be that the companies with overvalued shares would buy the companies with undervalued shares, if the companies were related, and it seemed that management could integrate the firms.

What we are seeing today is a shift in relative prices.  Growth is in, and value is out.  What we aren’t seeing is the massive capital destruction that took place when seemingly high growth companies were going public during the dot-com bubble, where cash flowed into companies only to get eaten by operational losses.  There will come a time when the relative price of growth vs value will shift back, and performance will reflect that then.  It just won’t be as big of a shift as happened in the early 2000s.

Photo Credit: Philipp Messner || Every culture should learn their alphabet 😉

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In my view, these were my best posts written between May and July 2014:

Look to the Liabilities to Understand the Assets

Why do new asset classes work very well for a time and then fail?

I Have My Doubts

Learning to live with uncertainty and thrive amid it.

Asset Value Illusion

People don’t need assets as much as they need streams of income derived from the assets (dividends, capital gains) that allow them to purchase the goods and services that they want and need.  (Low interest rates mean assets aren’t worth as much.)

Illusory Investment Income

Some naively say, “Dividends don’t lie.”  Well yes, the money you receive is yours, but is the company as healthy after the dividend?  Will they be able to keep it up?  Often that is not the case.

A Bond Manager Thinks about the Equity Premium

This is a more logical way to think of the equity premium by decomposing it into three more understandable parts: yield curve slope, credit spread, and economic earnings.

A Survey on Trading/Investing

How I think about Buying and Selling Stocks

Investment Management: A Science to Teach or an Art to Learn?

It is better to have an accurate uncertainty, than an inaccurate certainty.  We are better of professing ignorance of what we don’t know, than being certain about things where we are wrong.

Self-Regulation in the Financial Markets: My Thoughts

Self-regulation is a better idea in theory than practice.  Either it needs to be regulated, or not.  Adversarial regulation is unavoidable if regulation is needed.

The guy from the National Futures Association emphasized the idea that mandatory membership in the association as a requirement to do business was paramount for an SRO and I can see that.  The SRO then has the “death penalty” hanging over the heads of those they regulate.  That said, consider this: the CFA Institute may dream of the day when all involved in investing *must* hold a CFA Charter.

I have no doubt that this would be a good thing.  Ethics codes are good for the industry, and to kick out bad apples would be a good thing.

Enabling Others

Whether on a micro-level (a business) or on a macro-level (a government) the way to build value comes from a simple concept.  What can I/we do to enable the goals of others?  Growth and success come through service.

The Tails of the Distribution do not Validate the Mean

Asset classes that average in the results of astounding successes and total failures do not adequately represent what can happen to individuals in their specific investments.

Avoid Illiquidity

What are the significant costs and benefits of investing in illiquid assets?

The Value That Investment Advisers Deliver

Registered Investment Advisers [RIAs] offer value to their clients in 10 ways, most particularly helping them to not sell in a panic or buy out of greed.

On Fixed Payment Annuities

The value of having income that you can’t outlive

Pity the Multiemployer Pension Plans

Why many of these pension plans will fail

On Berkshire Hathaway and Asbestos

Why Berkshire Hathaway reinsures a huge amount of all of the asbestos claims outstanding

On Learning Compound Interest Math

Why it is important for everyone to learn it.

One More Note on Failure

What does it take for a big failure of any sort to occur, despite some planning?

The Reason for Failure Matters

How to see in advance how failures can indicate that a bigger problem is here, or not.

Understanding Insurance Float

Why most people who read Buffett don’t understand the value of insurance float properly.  It is valuable, but not as valuable as naive acolytes of Buffett believe.

Full disclosure: long $BRK/B for clients and me

 

There’s a lot of bits and bytes spilled in the war between Elliott Associates (and those that favor their position) and the current board of Arconic.  I want to point out a few things, having held Alcoa since prior to the breakup, and added to my positions in both new Alcoa and Arconic post-breakup.

  • Profitability will likely improve more if Elliott’s nominees are elected to the board, and Larry Lawson is CEO.
  • The existing management team does not deserve credit for the recent rise in the stock price for two reasons: a decent amount of the rise in Arconic’s stock price anticipates a rising probability that the board and management team will be replaced.  Second, a decent amount of the increase in the stock price of Alcoa has been due to a rise in the price of aluminum, for which no single entity can take credit.  Current Arconic benefited from that, at least until it sold its whole stake in Alcoa.
  • To their discredit, the existing management team and board resisted the breakup of the company into upstream and downstream for years.  (See point 2 of this Elliott letter, Was Dr. Kleinfeld the Driving Force Behind the Separation?)
  • Existing management was not a good capital allocator.
  • Prior to the agitation by Elliott, Alcoa and Arconic sold at low valuations, because earnings prospects were poor.  Now new Alcoa is in better hands, and that might be true for Arconic in the future, which may further improve valuation.
  • The existing board has low ownership in Arconic.  Many of the existing board members have been around too long.
  • The current board are late to the party of improving corporate governance.  Though their proposals are good, it looks like they were dragged there by the activists, and therefore, can’t be trusted to maintain these improvements.

That’s my short summary; it is not meant to be detailed, as Elliott’s arguments are.  In general, I agree with the arguments over at New Arconic, and will be voting the blue proxy card.  If you disagree, then you should vote the white proxy card sent out by the existing board.

I’m not telling you what to do.  Vote the proxy that reflects your view of what will improve Arconic the most.

Full disclosure: long AA & ARNC for my clients and me (Note: Aleph Investments, LLC, is dust on the scales in this fight, representing less than 0.01% of outstanding shares.)