• Stinks RT @s_m_i: RT @hedgefundinvest: RT @financialpost: Twitter to censor content in some countries http://t.co/zhnzV1Qo Jan 27, 2012
• When the Reps win, wants 2b FedChair RT @pdacosta: Fed activism harms US growth, former Fed board governor Warsh says http://t.co/Tht5YyHi Jan 27, 2012
• I’m different. I gained my net worth little by little through investing, and have kept it. My wife is glad she married me, and not my friend Jan 27, 2012
• that I made to him in March 2009, with stock conversion rights. Many entrepreneurs r this way; they are not geared to preserving wealth. $$ Jan 27, 2012
• An example: I have a friend who is presently very wealthy. He has nearly gone broke four times in the last decade. Pays me 13% on a loan + Jan 27, 2012
• Angry about inequality? Don’t blame the rich. http://t.co/CV0GE1Gg Being rich is more fluid than most think. Rise fast, fall fast 4 many $$ Jan 27, 2012
• Apple’s Dirt-Cheap Stock and the Fiduciary Theory of the Firm http://t.co/DtV2kK7P Me: Risk of tech obsolesence & mkt saturation -> low PE Jan 27, 2012
• @Nonrelatedsense That’s funny. I didn’t see that because my browser blocks pop-ups. Jan 27, 2012
• The chase for yield is on http://t.co/ISJ6MmLx High yield market looks a little frothy now. 73% of all HY CEFs trade at a premium to NAV. $$ Jan 27, 2012
• Risk Bites Back: Lessons Learned From The Harvard Endowment http://t.co/Ch4s7jbP Similar to my article: http://t.co/Ycu95PCU Guard liquidity Jan 27, 2012
• At minimum, desirable asset classes must be chosen and given weights. Then adjustment strategy; rebalance vs momentum. These invlv forecasts Jan 27, 2012
• Tactical Management and Flawed Forecasting http://t.co/2VWePjbf All asset allocation implicitly involves a forecast. Jan 27, 2012
• US Sovereign Debt Tipping Point Scenarios, Symposium by George Mason University http://t.co/QDFe1BJP 5 scenarios, but I can think of more $$ Jan 27, 2012
• Tin Gains as Prospect of Low Fed Rates Boosts Speculation of Higher Demand http://t.co/zYYQXHVM I think the correlation is rather tenuous Jan 27, 2012
• The GOP Goes MAD http://t.co/F7CoZQBl The candidates go thermonuclear, but the party itself may get hit. Lotta mudslinging going on $$ Jan 26, 2012
• @groditi Yes, and Vale tried to strike some deal w/the Chinese to lessen the pain, and the Chinese stiffed them Jan 26, 2012
• New Jersey Pensions Earn 1.7% in 2011 http://t.co/8vHP7Ok7 Add in the effects of low interest rates & funding levels fall considerably $$ Jan 26, 2012
• One Third of New Yorkers Can’t Retire http://t.co/o8VFsw2v This is not news; a lot of people did not plan well, compounded w/no interest Jan 26, 2012
• Merkel Masters Markets With Euro Austerity Mollifying Investors http://t.co/DSrJaAFZ She seems to be getting her way, bit by bit $$ Jan 26, 2012
• Gingrich Attacks Romney Over Swiss Account http://t.co/AXzEC9ij Populism is a dangerous thing to swallow; read the warning label first $$ Jan 26, 2012
• The squeeze on dollar funding in the Eurozone continues http://t.co/BZxSdJOc Will probably continue the demand for USD swap lines by ECB $$ Jan 26, 2012
• US Banks Face Pressure on Margins From Fed Policy http://t.co/yzXGroUm Flat front end of yield curve steadily crushes interest margins $$ Jan 26, 2012
• No Slower Steaming as Container Lines Run Like Clippers http://t.co/N9G7Ltgu This one made me pause. The shipping glut has funny effects Jan 26, 2012
• Deteriorating employment situation in France http://t.co/EuTX0Go0 A clear sign of deteriorating economic conditions in the E-Zone as a whole Jan 26, 2012
• Uralkali Ready to Cut Potash Output to Shield Price http://t.co/yqPjHQEZ Potash producers cutting production globally; can’t b good 4 Agri Jan 26, 2012
• ‘Stop-Newt’ Republicans Confront New Base http://t.co/UZEdELQr This ain’t your Father’s Republican Party. Less of a party more of a fracas Jan 26, 2012
• The Real Margaret Thatcher Story http://t.co/Ul6dyr3N “Lesson: governments cannot permanently live beyond their means had been learned.” Jan 26, 2012
• More Drones, Fewer Troops http://t.co/D94fBRsm This doesn’t look smart to me, & makes America look like more of a empire than it is. $$ Jan 26, 2012
• @The_Analyst After Great Depression the Flubs were established by the Flub Act of 1932 – provide funds 2 “building and loan” institutions $$ Jan 26, 2012
• Egypt Bans LaHood, Other Americans From Leaving http://t.co/SVz5DBAn Military alleges foreign nationals are sowing dissent among masses Jan 26, 2012
• Banks Hoarding ECB Cash to Double Company Defaults http://t.co/TPPvb33z European companies needing liquidity are not getting it from banks Jan 26, 2012
• Ron Paul, the Fed and the Need for a Stable Dollar http://t.co/fwTrW2B3 Fed policy hurts savers aids government. Policy stability needed Jan 26, 2012
• 2 bright ladies who know bonds RT @cabaum1: I’ll be opining on Fed folderol w/ my pal @Kathleen_Hays on WBBR’s Hays Advantage @12:45pm today Jan 26, 2012
• @munilass It’s been fun 4 us. I hope u have an even better time of it. Jan 26, 2012
• @munilass My wife says that u forget the pain w/the joy of the child. We also have 5 adopted kids; youngest turns 10 soon. Life changes fast Jan 26, 2012
• @munilass My sympathies. Having a baby is wonderous, though I always pitied my wife during her 3 deliveries. Hope it goes well for u & baby. Jan 26, 2012
• @SoberLook Thanks. Appreciate your blog. Jan 26, 2012
• @interfluidity Thanks. Many thanks. Jan 26, 2012
• @interfluidity Thanks, I appreciate it. I always wonder at myself when I get too hard. Jan 26, 2012
• @interfluidity Thanks. I am not trying to beat up on Bernanke, as much as trying to point out the inconsistencies involved in his policies. Jan 26, 2012
• @PlanMaestro Not sure, I am imitating @HistorySquared, who I appreciate. Aside from that, a number of readers asked for it. $$ Jan 26, 2012

If someone were to ask me my opinion on Junk Bonds at present, fool that he would be to ask me because I know real experts elsewhere, I would say this: They are good for a speculative trade, but dumb money has arrived.  Be ready to sell when the momentum fails.

High yield ETFs sell at decent premiums which leads to the creation of more units.  High yield closed-end funds — 73% trade at a premium.  You could issue a new high yield CEF, and come out at a lower premium than the current average.  I think I smell smoke.

Hmm….  If I owned junk bonds I would hold, and wait for momentum failure.  Buying now seems risky to me.  Most of the risk stems from global conditions.  We don’t know what will happen in the Eurozone. The rest of the risk stems from speculation.

I am a fan of junk bonds when nobody likes them, but there are too many fans now, and for bad reasons, most of which boil down to “I am old and I need income.  The fed has eliminated good choices for income, but I need income anyway, so get me yield.”

I had a conversation with a friend of mine in her upper 70s today where she asked “why are you suggesting I sell my funds that provide the most income?”  I said that I did not trust junk bonds at present and would look to lighten up, besides, the fund she owned has underperformed over the last 10 years.  If she really wanted income from junk bonds, I would look for a new fund for her.  So I am looking for a new HY fund, with an arm twisted behind my back.  It’s not the right idea, but she won’t listen.  (She’s not paying me.  I help my friends as best I can.)

The illusion of yield drives many older investors; they need income, and the delusional Fed thinks that low yields will yield prosperity.  It may make some people take more risk, but it will not yield prosperity.  There will be a lot of impoverished old people at the end of this, and they will be angry — at themselves, their advisors,  and the powers that be.

-==-=-=–=-==–=-=-=-=-=-=-=-==–=-=-=-=-=-=-=-=

This is not to say say that junk spreads are low; they are moderate to high at present.  But the spread relationship is manipulated by the Fed at present, making spreads seem high.  No market is truly free, but the Treasury market is affected by the Fed to a high degree.  The high quality bond market follows Treasuries closely.  Junk bonds don’t.  Junk bonds follow a hybrid of what Treasuries and common stocks are doing.  With stocks doing well, junk bonds run as well.

But we are still in an environment where more things can go wrong than right.  Until the US government figures out how to finance itself, we are in dangerous territory.  Given present political conditions, I don’t see how that works out; everything looks like a stalemate at present.

So be wary, and don’t overcommit to risk assets.  I would be neutral on risk assets at presemt, but ready to be bearish if there are problems in Europe or China.

There are two things that I want to comment on Fed policy this evening: Transparency is overrated, and Bernanke does not understand savings.

Transparency is Overrated

Ever heard of the phrase “data overload?”  Greenspan would do that verbally in his testimony to Congress, providing them with more data than they needed, and occasionally contradictory so that each side could quote what they wanted.

Well, the present transparency policy of the Fed is another version of data overload.  Give lots of data — some similar, some different.  Opinions, forecasts, policies — average people have a hard time with the nuances; even some professionals do.

After a certain point, the more data you reveal, the harder it gets to evaluate what is going on.  Far better to reveal to the public the core data that explains policy than to make them slog through big data releases.

Transparency is overrated.  Not sure which foolish economist thought of this one, but more data does not mean better decisions, or better public understanding.  Humans are not Vulcans (only logical), nor Ferengi (only greedy); we are complex, and that makes prediction of actions difficult.

Bernanke does not Understand Savings

Twice in his press conference yesterday, Bernanke showed that he was out of touch with average Americans.  He argued that average people could keep up with a 2% increase in the price level by investing in stocks and (presumably short-term) bonds.

(Speaking to The Bernank)

I’m sorry, Ben, but ya gotsta come down from the uneducated ivory tower and wallow in the mud wit da restov us.  There are three problems with what you said:

• It’s hard to earn 2% (after-tax) consistently when the Fed funds rate is zero.
• Only the top 20% of the wealthy have enough assets to keep themselves afloat using the asset markets.  Most people would like to do something to protect themselves from inflation, but lack the means to do so.
• Average people do not invest, they save at financial intermediaries like banks, S&Ls, and life insurers.  Fed policy kills rates for savers.  They will not become investors, because they lack the knowledge to do so.

I am again sorry, Ben, because your policies discriminate against the poor, and the lower middle class.  Yes, the rich and the upper middle-class clever can escape the penalties stemming from your policies, but the lower-middle class and the poor can’t.

Think of it this way: your policies are making it more palatable for average people to buy gold, because the alternatives in savings are lousy.  If there is no income, why not grab safety from inflation?

Are you really trying to wrest the thorny crown of “worst Fed Chairman” from Arthur Burns?  If so, well done, you are achieving your goals.  Even Alan Greenspan did not do that, though he tried.

My advice to you is simple.  Raise the Fed funds rate to 1%, and stop the QE, and pseudo-QE.  At the zero bound, monetary policy has no punch, and the same for QE.  It affects asset markets; it does not affect goods markets.

Time to abandon useless theories about the Depression, and embrace the practical difficulties that we now face.  Ben, grow up and abandon your failed theories on the Great Depression.  And resign, if you can’t grow up.

• @The_Analyst does Hempton do Twitter? Bright guy. Jan 26, 2012
• RE: @SoberLook It’s not a pledge, indeed, but it is an estimate.  The bond market has reacted quite strongly to the e… http://t.co/crpU3QpH Jan 26, 2012
• RE: @SoberLook Does this post from Alea change your opinion at all? http://t.co/2hs1LTyN… http://t.co/p3Plmjnb Jan 26, 2012
• MF Customers Face Long, and Possibly Fruitless, Slog http://t.co/MoMIalrc Law s/b modified: customer accts s/b top priority in broker BK Jan 26, 2012
• Solar Cheaper Than Diesel Making India’s Mittal Believer http://t.co/ZW2ta2aB This is the right way 2 employ solar; with no subsidies $$ Jan 26, 2012
• Obama Pushes Salad in Schools at $3B Cost to States http://t.co/M9nWkW4T Healthier food is no good if the kids don’t eat it, ask L.A. $$ Jan 26, 2012
• Con Artist Starred in Sting That Cost $GOOG Millions http://t.co/ErAgeziD New motto: Don’t be evil, but if you are evil, make $$ by it Jan 26, 2012
• This is y well-capitalized P&C insurers r hard 2 kill, & usually make $$ over the int-term: past losses r more than paid 4 by higher prems Jan 26, 2012
• US Commercial P&C Rates to Climb, Marsh Says http://t.co/OxCUuSsU The insurance brokers know; after a year of losses comes a hard market Jan 26, 2012
• @researchpuzzler @The_Analyst “There’s an institutional hedge fund analyst born every minute.” Alleged 2 PT Barnum but, http://t.co/ku1NlqZG Jan 26, 2012
• @BarbarianCap What I am saying is that structural legal protections around economically necessary authorities & municipalities r significant Jan 26, 2012
• @BarbarianCap PV of losses are typically small, except on odd munis that don’t have any necessary economic value 2 a municipality + Jan 26, 2012
• @BarbarianCap Part of the difficulty is that states can’t default, and Ch 9 4 what municipalities can use it, merely gives breathing room + Jan 26, 2012
• @BarbarianCap There will be significant issues, but even during the Depression, losses were remarkably small on munis. Taxes will rise. $$ Jan 26, 2012
• @The_Analyst Then again, it’s probably more “a fool and his money are soon parted.” Due diligence ain’t always that great 4 institutions $$ Jan 26, 2012
• @The_Analyst Typically they were pretty good salesmen to get fund #1 off the ground, even better 4 #2. W/fund #3 they sell “It’s fixed.” $$ Jan 26, 2012
• Iran’s Ahmadinejad ups rates to stem money crisis http://t.co/6IhpevuO Sanctions r having an internal effect on the Iranian economy. $$ Jan 26, 2012
• Niederhoffer Discusses Being Wrong http://t.co/mWrnI7mg Frank talk from one who blew up twice. Perhaps he has a risk control discipline now. Jan 26, 2012
• What’s In Your 401(k) Fund Line-Up? http://t.co/1ufb7xk2 Plan sponsors have an obligation 2 remove poorly performing funds but many don’t Jan 26, 2012
• Wither the Wirehouse RT @ReformedBroker: Whither the Wirehouse? http://t.co/E4Xtz5Ul Jan 25, 2012
• Wither the wirehouse http://t.co/TnuMFvDE Jan 25, 2012
• RE: @wallstCS None of the competitor companies you list compete w/ $RGA. $PRE does a little bit of life reinsurance &… http://t.co/v9r3kg5z Jan 25, 2012
• @TimABRussell Yes, I think Bernanke is sincere in what he is doing. That doesn’t mean that it doesn’t confuse, or get the right result. $$ Jan 25, 2012
• @TimABRussell That was the Greenspan strategy. Talk about the six sides of the square & confuse: Top, bottom, right, left, inside, outside Jan 25, 2012
• Fed learns that it is easier to hide a needle if they put it in a larger haystack. $$ All for now on the Fed. Back to normal activity. Jan 25, 2012
• Final Q on fiscal policy asking what if deficits aren’t cut. B says that deficits need to be cut. IT’S OVER!! Jan 25, 2012
• Bernanke essentially says that everyone has a lot of slack assets, and can invest them after-tax at 2% in the long run. Jan 25, 2012
• Q on CPI vs PCE, critics saying Fed planning to destroy 2% of currency value per year. B: CPI has made up numbers, healthcare differences $$ Jan 25, 2012
• French reporter asks whether Fed would extend a loan to the IMF. “Raison detre” cute response, punts to Tsy and Congress $$ Jan 25, 2012
• Mkt news intl reporter: why have forward guidance when you give out forecasts? Bernanke: guidance describes Fed’s decision, vs expectations Jan 25, 2012
• Bernanke gets symmetric questions asking whether policy is doing too much or too little, on inflation and unemployment. $$ Jan 25, 2012
• WP reporter: could the Fed bring unemployment down faster if it were more aggressive? Bernanke really doesn’t answer. Jan 25, 2012
• In general, people analyze better with limited amounts of data — zero data (w/Kremlinology) and lots of data make analysis harder $$ Jan 25, 2012
• I think the more data the Fed hands out, the more lost the press and average people get confused. Jan 25, 2012
• Q: Why isn’t Fed doing more now if you think things will be bad for so long? Internally Bernanke reconsiders the value of press conferences. Jan 25, 2012
• Bernanke says that low rates conquer all and so providing more data won’t hurt things — expectations are a lesser thing $$ Jan 25, 2012
• Peter Barnes, Fox Business: possibility of negative expectations because the economy is viewed as much worse than previously thought $$ Jan 25, 2012
• AP reporter asks about principal reductions for the housing crisis. Bernanke says that the FOMC is concerned, but doesn’t say much really $$ Jan 25, 2012
• Median b/c FOMC is a “democracy.” In practice, though, the Fed chair has 12 votes Jan 25, 2012
• Robin Harding of FT asks about forecast, and what it implies for FOMC policy: Bernanke says there’s no mechanism, look at the median Jan 25, 2012
• to be able to be released — mentions that June 2011 principles are still in force for shrinking the balance sheet (in 2015?!) Jan 25, 2012
• Reuters reporter asks for more data on balance sheet data, versus data on Fed funds — Bernanke says there is only so much data at a time + Jan 25, 2012
• RT @joshuademasi: @AlephBlog All fed needs to do is create esoteric invesment vehicle cross hedging USHY in Rand and Real. What could g … Jan 25, 2012
• Donna Moran (?) of Amer Banker — Basel 3, capital requirements, etc. Me: Fed supervision of biggest institutions not done well in past $$ Jan 25, 2012
• Bernanke waffles on the question of what happens to savers, confusing saving and investing. Needs to consider what finl intermediation does Jan 25, 2012
• Greg Robb(?) Marketwatch asks about Republicans, and how older people on fixed incomes survive, and whether he might resign if Reps win Jan 25, 2012
• Greg Ip questions the asymmetry comments — I think Bernanke would be better off saying “asymmetric in the long run.” Jan 25, 2012
• @joshuademasi The hate for the Fed exists because they were overly loose 1984-2006, regulated banks poorly & created much of this crisis $$ Jan 25, 2012
• Hilsenrath asks about confidence in the FOMC’s forecasting abilities. Wonders which dot is Bernanke’s… Bernanke affirms limitations Jan 25, 2012
• Torres of Bloomberg asks about near-term inflation — The Bernank points to falling commodity prices, slower global growth Jan 25, 2012
• Decent question on the symmetric nature of monetary policy Jan 25, 2012
• Toady comments on what he views as strength RT @agwarner: Liesman Alert! $FED Jan 25, 2012
• Full set of projections from the FOMC: http://t.co/VqWfrYgL Worthy of note that their forecasting ability is subpar. Jan 25, 2012
• Fed Funds Projections: http://t.co/Wd9lmEeO Jan 25, 2012

Comments

• So they extend the period of accommodation by a little more than a year.  Sends financial markets flying, and especially TIPS prices, but will have little impact on the economy.  (Do they want the yield on 30 year TIPS to go negative?  Looks that way.)
• GDP growth is not improving much if at all, and the unemployment rate improvement comes more from discouraged workers.  Inflation has moderated, but whether it will stay that way is another question.
• In my opinion, I don’t think holding down longer-term rates on the highest-quality debt will have any impact on lower quality debts, which is where most of the economy finances itself.
• Also, the reinvestment in Agency MBS should have limited impact because so many owners are inverted, or ineligible for financing backed by the GSEs, and implicitly the government, even with the recently announced refinancing changes.
• The key variables on Fed Policy are capacity utilization, unemployment, inflation trends, and inflation expectations.  As a result, the FOMC ain’t moving rates up, absent increases in employment, or a US Dollar crisis.  Labor employment is the key metric.
• The Fed is out of good policy tools, so it will use bad policy tools instead, and for longer than before.

Questions for Dr. Bernanke:

• Why do think extending the period of accommodation by a little more than a year will have any significant effect on the economy, aside from stock and bond prices?
• Is it possible that you don’t really know what would have worked to solve the Great Depression, and you are just committing an entirely new error that will result in a larger problem for us later?
• Discouraged workers are a large factor in the falling unemployment rate. Why do you think the economy is doing so well at present?
• Why do you think that holding down longer-term rates on the highest-quality debt will have any impact on lower quality debts, which is where most of the economy finances itself?
• Why will reinvestment in Agency MBS help the economy significantly?  Doesn’t that only help solvent borrowers on the low end of housing, who don’t really need the help?
• Couldn’t increased unemployment be structural, after all, there is a lot more competition from labor in emerging markets?
• Isn’t stagflation a possibility here?  I mean, no one expected it in the ‘70s either.
• Could we end up with another debt bubble from keeping short rates so low?
• If the Fed ever does shrink its balance sheet, what effect will it have on the banks?

• They may not have meant to publish it, but the results don’t seem too earthshattering — … http://t.co/MkmCtxnJ Jan 25, 2012
• @Convertbond He was 1 of my professors @ Hopkins, & the only 1 w/a consistently free market viewpoint; Talked w/him @ http://t.co/k4mL15rp Jan 25, 2012
• India to pay gold instead of dollars for Iranian oil. Oil and gold markets stunned http://t.co/ZRmnIjOz @JamesGRickards sounds like Ch 1 $$ Jan 25, 2012
• Bears gone wild! http://t.co/s0mvx9LK What does it mean when bears get less pessimistic? Do we rally, or do things fall apart? Or both? $$ Jan 25, 2012
• Retail in the Age of the Internet http://t.co/4wovantW Difficult 2c how the internet doesn’t change retail; has changed so many things $$ Jan 25, 2012
• What Makes FPA Crescent Tick? http://t.co/ngisagdY A lot to learn from businesslike clever managers who insist on a margin of safety $$ Jan 25, 2012
• You don’t WANT to be making iPhones, really http://t.co/cvG1rVqJ Baruach of Ultimi Barbarorum sets the record straight on manufacturing $$ Jan 25, 2012
• The end of mutual funds is coming http://t.co/V9FhizVt @reformedbroker on the coming dominance of ETFs in 2022. My take in a comment below. Jan 25, 2012
• The Pimco Premium–Totally Gross? http://t.co/QXBqRSpH Amazing what premiums to NAV some junk CEFs run by Pimco get up to. $$ >+70% Jan 25, 2012
• Mitt Romney’s SOTU Challenge on the Mortgage Crisis http://t.co/xeTaeswA “u recognize the distress, u take the loss & let people reset.” $$ Jan 25, 2012
• @MebFaber @onetwoko @The_Analyst Good stuff. I’ve written similar from both equity and debt perspectives. Alternative: NGDP growth+1% $$ Jan 24, 2012
• @valuewalk yeh, especially for the highly compensated in private DB plans, b/c the PBGC limits the coverage any one person gets. $$ #ouch Jan 24, 2012
• Examples: Autos and Telecom Bonds back in 2000, MBS (Esp non-GSE), GSEs, CDOs and finance 2007. Today? Governments. The poison of AAA/AA $$ Jan 24, 2012
• It is usually wise to avoid investing in the largest or fastest growing sectors and subsectors in debt markets; boom presages a bust $$ Jan 24, 2012
• @valuewalk Yes, that’s right, and the standards for that are squishy. Funny that life co acctg has 2b conservative, but not DB pensions $$ Jan 24, 2012
• @The_Analyst Been writing about this off and on for the last 20 years in various forms. Sadly, doesn’t get traction because it’s complex $$ Jan 24, 2012
• @The_Analyst yeh, especially since ERISA doesn’t apply to state & local DB plans; beneficiaries have 2 rely on protection from local laws $$ Jan 24, 2012
• @The_Analyst There are no actuarial assumptions police for DB plans. W/private corps, the auditors can object (though they rarely do) $$ Jan 24, 2012
• The Real Problem With the Global Bond Markets http://t.co/rYHw673u Catch my comment here: http://t.co/UCkhtXZx $$ Jan 24, 2012
• CalPERS 2011 return below its assumed rate by 6.65 percentage points http://t.co/GDoBD6H2 Gets worse when you count in the fall in int rates Jan 24, 2012
• Rob Arnott is doing enhanced indexing. So do most bond indexers; they match broad characteristics of the index, and … Jan 24, 2012
• RE: @valuewalk Someone send the memo to Soros: http://t.co/ShMY4LWN http://t.co/6oA7kfMR Jan 24, 2012
• New from Aleph Blog Against Simple Valuation Metrics: There have been a lot of articles dealing with use of corp… http://t.co/PaZElTUQ Jan 24, 2012
• The new American divide http://t.co/lOmLT2xs Working class falls further away from marriage & religion & upper class becomes more isolated Jan 23, 2012
• We Found Bin Laden So Now We’re In Search of Yield http://t.co/4veqJ6xB Y Buffett likes consistent $$ to flow from subs, but he pays no div Jan 23, 2012
• The biggest Mark to Model error in the country http://t.co/Tgi5DVx7 “Price indexes are more an art than a science.” Manipulable indeed. $$ Jan 23, 2012
• How executives spend their company’s cash http://t.co/4xadWZqy Buybacks tend 2b procyclical; economically rational w/b countercyclical $$ Jan 23, 2012
• Europe Stocks Cheapest to US Since ’04 as Net Rises Amid Recession Worry http://t.co/54ajiIQD Worth kicking the tires on nonfinancials $$ Jan 23, 2012
• Generals have led the US three times already — Washington, Grant, and Eisenhower. That i… http://t.co/9w9C3AM2 Jan 23, 2012

I appreciate Steve Randy Waldman, who writes the excellent blog Interfluidity.  Even before I started blogging, while I was at RealMoney, we interacted over CPDOs, along with Alea, and several others that were onto the scam.  That was a fun time, because aside from the Canadian rating agency Dominion, there was no one else questioning the idiocy of the AAA ratings aside from a few bloggers — we are the conscience of Wall Street, but that doesn’t mean that we get any pay as a result.  We write these things as a public service.

Recently, he wrote two  articles on financial intermediation.  Now I’d like to try my own thoughts on the topic.

Financial intermediation has two purposes: transactions and safety.  People want to buy and sell, but don’t want to have a currency where its value shifts radically day-to-day, which would complicate their decisions considerably.  They want a stable unit of account, and don’t want the possibility that they lose a lot of money as a result.  (Yes, during conditions of hyperinflation that boundary disappears, but that’s because they are already losing value already each day from holding the formerly “safe” transactional asset.  They get more careless on the intermediary, because of the risks of holding the safe asset.)

The second goal is safety/preservation/growth of purchasing power.  Can I park money or a short to long amount of time and be assured that when the term is up, I will:

• Receive receive back as much or more in purchasing power terms.
• Reduce my risks or the risks of those I care for from death and other calamities.

Financial intermediation leaves money on the table.  It does not seek the best investment outcome, but takes a lesser return, so that goals can be achieved with greater certainty.

Now, that provides an advantage to the financial intermediaries.  It means that they get cheap funding under most conditions.  Now, can they invest it over the likely lifetime of the funding and not lose money?  That’s a lot of what solvency regulation is about in banks and insurers.   Because financial promises made can’t be easily analyzed for quality by those that offer money, there are two responses by the government:

• Capital rules (which vary by liability and investments)
• Insurance, so that users don’t have to worry about loss.

And, for what it is worth, 12 years ago I played a large role in setting the rules for Maryland life insurers in place, both writing the law, and explaining to the legislators how it protected the public interest.  (Hey! Passed unanimously on the first try, and with the d-word! (Derivatives)  My bill allowed risk mitigation but not risk taking with derivatives.)  The then-governor dressed like a mafia don at the bill signing, for what it is worth… My boss and I and our external and internal legal counsels spent a lot of time on this, but I was the prime mover on getting it done.

As an aside, sitting around in hearings in Annapolis, not knowing when your bill will come up is a chore.  If you know me well, you know I brought work to do, and if that wore out, good books to read.  I was never sitting there with nothing, bored. In the process I learned that Johns Hopkins owns Maryland, but declines from making that public, except when they care. When they spoke up, the legislature rolls over and asks for a scratch on the tummy. Arf!

Sorry, got lost in reminiscing.  Can I say that it was weird?  (I will leave out my dealings with the Department of Insurance, which were surreal.)  I’m not political for the most part, but in the end, the Maryland life insurance investment code is one of the best of the 50 states.  Kind of sad that we don’t have more life insurers here.

The last three paragraphs were quite a detour.  Let me take a different tack.  Yes, intermediation is opaque; that is true by necessity.  Depositors and insureds do not know how their money is invested.  I am here to tell you that that is a feature and not a bug, because the regulators know you can’t analyze the safety of your deposited assets.

In most things, I am a libertarian, but in areas where average people can’t ascertain truth or or falsehood, I support some form of regulation.  Financial promises fall under that rubric, because they are hard to discern.

To close this off, my main point is this: people want financial intermediation, particularly during the bear phases of the financial cycle.  They want to be protected, and transact, and save.  It is reasonable that the government regulates this, because the ability to make future promises that people rely on is valuable to society as a whole.

There have been a lot of articles dealing with use of corporate free cash flow lately:

• Dividends — get them, are they sustainable?
• Buybacks — do they add value or not?
• Acquisitions — are they overpaying?  What are the synergies?

But you never hear about the last one — internal investment for organic growth.  There is a simple reason why — it is silent as night.  No one makes announcements on it.  If done properly, it is as quiet as a plant growing.

Dividends are simple — is there enough free capital to issue them, and do the other three priorities?  It is useful to ask how much room there is to increase the dividend, and how well the company can grow its earnings at the present rate.  Companies that pay a dividend understand that equity deserves a return, and are more careful with their capital as a result.  They often grow faster than companies that do not pay dividends.

But I never analyze a company primarily on its dividend yield.  I would rather look at the full set of the drivers of value.

Buybacks are harder because we don’t really know what the company is worth, and buybacks add value when you buy below the value of the company, and lose value when you buy above it.  In the reinsurance industry, it is understood that buybacks above 1.3x tangible book destroys value.  The threshold will be different in other industries because the value of intangibles will differ — but for industries where intangibles mean little, that 1.3x tangible book can be a useful limit.

We can do pro-forma analyses on acquisitions to see if they add value or not.  The best simple proxy is how large the acquisition is relative to the acquirer.  Small acquisitions typically add value  because they add a complementary product, a new marketing channel or region, lower costs, or raise product quality.

Large acquisitions typically lose value because acquirers overpay and integration is difficult.  One exception: negotiated sales by large private sellers.  There is no auction, and no winner’s curse.

The best acquisitions are small, but lead to an increase in organic growth.  Also, the best acquisitions are early; the worst acquisitions are imitative and late.  Typically the best deals get done first.

But much as I like managements who think that the equity deserves a return, via dividends and intelligent buybacks, the hard stuff gets done in organic growth: how are last year’s profits being increased on the existing infrastructure?  In mature industries, this is tough, which is why they typically return free cash flow to shareholders.  But when you find a company that can eke out improvements in a mature industry, finding changes that no one else does, hang onto that company, because it is driving profitable change in the industry.  (And probably taking share from others…)

The less mature the industry, the more room for organic improvement, and thus more free cash flow is dedicated to internal investment, and less to rewarding current shareholders.  In such a situation, it pays less to look at dividend yields, and more at dividend growth, adjusted for ability of growth to be sustained.

-=-=-=- begin rant mode -=-=-=-

This is why I am not crazy about simple articles that say:

• Here are the five highest yielding companies of this industry, or
• Here are the seven highest yielding investments of [famous investor, or company], or
• Here are the companies that are buying back stock rapidly, or
• Look at the combined dividend plus buyback yield of these companies…

Everyone wants to squish value investing into one simple metric and from what I have seen, it does not squish well.  That is one reason why I try to view companies off of the competitive dynamics of the industry in question, and adjust the metrics accordingly.  After all, no matter how cheap a company looks in an industry that is obsolete, like newspapers, it is rarely a good idea to buy.

Thus, I am skeptical of the many articles that are spit out by inexperienced investors that have a computer and can crank out a few simple ratios, and spew out some canned facts about a company — these articles are widespread, and not limited to writers on Seeking Alpha, or Zacks, or those that submit to Yahoo! Finance, and they have some canned and wrong way of identifying competitors.

Avoid these articles, and instead, look for some degree of qualitative reasoning — some depth that shows genuine industry knowledge, and not an ability to automate the provision of web “content.”

-=-=-=- end rant mode -=-=-=-

Maybe I should be quiet.  After all, the provision of bad advice on the web is a good thing for me.  The more people are misled, the better value investors with broader skill sets do.

But that’s not why I started writing on investments.  I was not a professional investor until I turned 39.  I read widely, and spent a lot of time reading the works of many different investors as I worked to develop a theory that encompassed most of it.  No, I don’t see how to encompass all of it… and what I can encompass is understood with some amount of error.

My view as I write is not so much to give “buy this” or “sell this” ideas so much as to get people to think differently about investing.  I recently looked at the amount of business/economics/finance/investment books that I have read over the past 25 (post-academic) years, and it would fill 3-4 bookcases.

So try to think of the companies that you own, or might own, like businesses.  Look at the dividends, and to buybacks at bargain prices, and analyze sustainability and growth prospects, but also look at opportunities for growth.  Many aspects of value can’t be encapsulated in simple ratios or rankings, but sadly, the majority of articles touting stocks will do just that, and for the most part, they are useless.

There.  I said it.  But it needs to be said.  The practical question to me is whether I should stop submitting my content to sites like Seeking Alpha, which to me have become a lot of noise, and which I wish I could get Yahoo! Finance to allow users to filter out of the news stream.

I let almost anyone republish my content, so dropping anyone would be unusual for me.  Or, should I drop all external users of my content, and allow no republishing?  If you have a strong opinion, submit it in the comments.  I’ve been a nice guy with all of this, but if you have good reasons for exclusivity, let me know, and I will consider it.

But to close I will say, look at a full range of valuation and performance metrics when buying a stock, and consider the industry dynamics to understand what matters most given the maturity of the industry.  That takes some work, but guess what?  Working intelligently and hard leads to better profits in investing.

• This applies more to private equity than hedge funds.  Adjust the headline. http://t.co/Zy4kRVlg Jan 21, 2012
• Economists: A Profession at Sea http://t.co/86wZognH Too much math, & not enough knowledge of how people, business & finance really work $$ Jan 21, 2012
• Clever article $$ RT @srussolillo: A Standard, and Poor, Way of Investing http://t.co/mRr6rlve via @WSJ Jan 21, 2012
• Collateral squeeze as strong as ever, Icap says http://t.co/v4QZvndP The big Draghi LTRO reduces repo rates & reduces repo volumes $$ Jan 21, 2012
• Deutsche Analyst Sounded Alarm When Asked to Alter Numbers http://t.co/kPBGzk3o The pressure to get AAA ratings may have led to cheating $$ Jan 21, 2012
• Investors plowing money into farmland — but could come a cropper http://t.co/129i3pbR With all of the debt being applied, likely a bubble $$ Jan 21, 2012
• I would not be quick to criticize all hedge funds off of this.  Most investors are trend-followers, and this affects … http://t.co/50fK1lG8 Jan 21, 2012
• point counterpoint http://t.co/VerP28OY @researchpuzzler explains why many investment organizations need a process for challenging theses $$ Jan 21, 2012
• More myths around Greek CDS trigger risk http://t.co/PH8s3iwB @soberlook sets the record straight; risks are lower than most think $$ Jan 21, 2012
• Your Inner Beardstown Lady http://t.co/QKPIopWf We all need to feel good about our investing, so we systemically overestimate our returns $$ Jan 21, 2012
• How the Fed defeated President Truman to win its independence http://t.co/srUcFrKq Independence squandered by Greenspan & Bernanke $$ Jan 21, 2012
• RT @maoxian: For every ~5000 followers you should be on ~350 lists. Easy to calculate number of fake followers on Twitter with the follo … Jan 20, 2012
• About Rising Inflation, Please Remain Worried http://t.co/u8tIk0RA Maybe someone should suggest 2Krugman the fiscal multiplier is negative Jan 20, 2012
• Global Deleveraging – You Are (Not) Here http://t.co/J4rCGvGL US only 1/3 of the way to Swedish levels of deleveraging $$ ht @historysquared Jan 20, 2012
• RT @historysquared: Japan’s turn, or another false start. $USDJPY http://t.co/0ncucYLE $$ Which straw will break the camel’s back? #crunch Jan 20, 2012
• Japan, Spain & France go up $$ RT @historysquared: Debt & deleveraging: Uneven progress on the path to growth http://t.co/sj3cljZU #ouch Jan 20, 2012
• Portugal to need “debt haircut” as economy tips into Grecian downward spiral http://t.co/F40Huo5a Just when you thought Greece was all $$ Jan 20, 2012
• Shilling says new global recession is here http://t.co/hWEMiSkg Europe leads downturn, US poised for milder decline; he suggests long Tsys Jan 20, 2012
• RT @herbgreenberg: JP Morgan today: “We are currently witnessing THE LARGEST DROP IN REALIZED CORRELATION IN THE HISTORY OF THE US MARKE … Jan 20, 2012
• Governments in a Hole as Land Sales Plummet http://t.co/pJA2dZN7 Local govts in China rely on land sales 2 fund budgets, slowdown bites $$ Jan 20, 2012
• Further Thoughts on Real Estate’s Impact on GDP http://t.co/86NwJQ6S 0% growth in property investment could push China into “hard landing” Jan 20, 2012
• Retiree Imbalance Underlies Filing http://t.co/thdWL5sw Re $EK, always easier 2 offer more benefits, play w/assumptions, pay no $$ cost Jan 20, 2012
• Three of a Kind http://t.co/YV57WRl5 Debt ceiling issues; Corporations lobby, get subsidies & pay no taxes; cost savings in Medicare, not $$ Jan 20, 2012
• Corporate Debt to Surge in Sweden as Bank Credit Dries Up http://t.co/11mDdeYP Rising bank capital requirements reduce lending, +bonds $$ Jan 20, 2012
• Students Shift to Computer Science http://t.co/cYPCTqwO Computing now penetrates into most lines of business and academic discipline $$ Jan 20, 2012
• ITU Global Market Data http://t.co/VsUK6MEE Cool graphic showing the global growth of wireless & broadband over the last 10 years $$ #cool Jan 20, 2012
• Army Foresees Expanded Use of Drones in US Airspace http://t.co/atcbzCmW Aren’t there some civil liberties issues here? Posse comitatus? $$ Jan 20, 2012
• Housing Inventory Ends Year Down 22% http://t.co/xNbdrJkq There is a lot of dark supply out there, waiting to sell when prices rise $$ Jan 20, 2012
• RE: @bloombergview It also perpetuates malinvestment.  We overinvest in housing and banking in the US, to the detrime… http://t.co/2yLTBqH5 Jan 20, 2012
• @D_T_A_F In 1988, I read The Media Lab: Inventing the Future at M. I. T. http://t.co/orSrsFsa Xerox lost a lot, I learned a lot, great book Jan 20, 2012
• New from Aleph Blog The Rules, Part XXIX: Risk premiums should never be capitalized, they should only be taken i… http://t.co/rrhWkItf Jan 20, 2012
• New from Aleph Blog On Predicting the Future, Redux: From a reader, ptuomov:If you run a regression of the magen… http://t.co/MGBbnUAq Jan 20, 2012

In the recent run-up, there was talk of the infallibility of equities.  This led to a higher level of variable compensation in the economy through option and share issuance and low pressure to raise fixed wages.  This was yet another form of hidden leverage, which hid the unprofitability of enterprises through share dilution.

That was written in 2001, after the flop of the Nasdaq.  I have sometimes said that bubbles are financing phenomena.  That’s true, but we can phrase it more generally: bubbles occur because of an asset-liability mismatch.  People go long a long-duration asset with short-duration funding.  The short duration funding can be borrowing, or vendor finance, or it can be a labor commitment in order to get equity or option awards.

People chase the long-term asset that seems so valuable, and give up time and interest (money’s version of time) to get it.  They give up more than they imagine for something of uncertain value.  In other words, a mania.  Give up something relatively certain in the short run for something with uncertain long run potential.

The attitude could be summed up with a conversation I heard in early 1998 between my boss and his best salesman, where the salesman said, “It’s a no-brainer, have the market pay your employees.”  His idea was that a constantly rising stock market would provide compensation to employees through stock awards, options, 401(k)s, etc., even as the market was straining at valuation limits.  It is probably a sign that the market is overheated, when market-based rewards become common.

Startups by their nature require that employees be flexible, and give up a lot of fixed guarantees.  What payments they receive at the beginning are small, and less than their work might deserve in most established contexts.  But there is the possibility of the big payoff, and the possibility of total loss.  The asset in question has a lot of variability, but the liability, the work that must be put in, is big, and may not vary much for success or failure.

In the tech bubble, many parties extended vendor credit because there were big profits to be made in the future.  Alas, but they lent to those with very uncertain prospects, and in March of 2000, the chain of leverage started to collapse, both for vendors, and for those that worked in the industries.  Just as hedge funds have a hard time holding onto good employees when performance goes bad, so it is for tech companies when financing dries up, and the stock price craters.  Rats desert the sinking ship.

“Free money” brings out the worst in people.  Do something small in the present and reap a huge future.  Sadly, it rarely works that way, except at the very beginning of a boom.  At the end of the boom, it is a maelstrom, with many people demanding to throw their money away in search of riches that will never be.

From a dated piece:

Crowd-following is common to humanity.  It takes a lot to stand apart from highly correlated behavior.  I’ve told this story before, but in late 1999, I was talking with my mother (a very good self-taught investor), she told me about many of my cousins who were speculating in tech stocks.  I said to her, “They don’t know anything about investing!”  My mom replied, “Oh, David.  You’re such a fuddy-duddy.  I just bought some Inktomi!”

Now, to set the record straight, that was just 1% (or less) of my mom’s assets, so an occasional flyer is acceptable.  Call it “Mad Money.”    For my cousins, it was most of their investable assets.  My mom is fine, and the fuddy-duddy did all right also, but the cousins swore off stock investing.

I am close to concluding that it is impossible to teach the average person how to do well in investing.  They don’t have the patience or the willingness to learn. (Few want to be called “fuddy-duddy” by their mothers.)

Getting rich quick is very rare, but it entrances some people several times in their lives, and rarely does it end well.  It is far better for most people to work hard in areas of the economy that are being rewarded, and invest excess cash in a mix of  stocks, long-dated investment grade bonds, money markets, and a little gold.

After all, it’s not what you make, it’s what you keep.