The Aleph Blog

Book Review: The Death of Money

103729This is a hard book to review. I have respect for the author, and most of his opinions.  But extraordinary claims require extraordinary proof.  There is evidence here, but not extraordinary proof.  I agree that we are in a bad spot, and that there is reason to be cautious.  To claim that the current international monetary system will disappear by 2020 or so requires more than the book delivers.

Let me begin by saying the book is worth buying.  It will make you think.  Thinking is a valuable exercise in which few engage.  Most of us imitate, which is far easier to do than thinking, and usually saves time on common issues.

The author focuses on the weaknesses of US economic policy, but is less critical of bad economic policies being pursued around the world, with the poster children being Japan, China, and the EU.  The US has its problems, but also its unique strengths.  Though I am a critic of US economic policy, we are better off than most other large nations.

One criticism of the book is that it is not focused.  Make your case, and don’t go down many “rabbit trails.”  That said, the rabbit trails are interesting, and you will learn a lot from them, though they don’t support the central thesis of the book.  I think the book needed a better editor, because a tighter book would have made the case better.

Here’s the main difficulty: Okay, so the US Dollar is not a great store of value.  Imagine another nation who wants a better store of value, who lets their currency rise, and their politically powerful exporters scream.  Who will likely win?  The exporters.  At least, that has been the way it has worked for the last 30 years.

In order for a gold-backed currency to be introduced, there will be sacrifices, and under most conditions, it will produce some deflation.  It is not at all certain that the nation(s) that might do this will take the short-term punishment.  Our world is geared toward short-termism, and it harms us all.

Quibbles

The book is far too kind to the IMF, an incompetent institution, and far too kind to China, which faces a collapse in its financial system far more quickly then the US will see.

The book is also too kind to the EU, which continues the experiment of monetary union without political union, which has never worked  before on a large scale.

Who would benefit from this book: Anyone could benefit from this great book.  If you want to, you can buy it here:The Death of Money: The Coming Collapse of the International Monetary System.

Full disclosure: I asked the PR people for a copy of the  book, and they sent it.

If you enter Amazon through my site, and you buy anything, I get a small commission.  This is my main source of blog revenue.  I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip.  Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book.  Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.  Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.  Whether you buy at Amazon directly or enter via my site, your prices don’t change.

Sorted Weekly Tweets

Stocks & Industries

  • Invest In Stubs, Spin-Offs And Liquidations For Alternative Returns http://t.co/ccezep0K9Y Cites a Gabelli article http://t.co/xTrqEfmQeq $$ Apr 19, 2014
  • Real Estate Management Better Than Owning Real Estate? http://t.co/IFaDLiwTRa Sometimes yes, sometimes no. Definitely adds more leverage $$ Apr 19, 2014
  • Wells Fargo Securities Lending Lawsuit Ends in Settlement http://t.co/w3lSY4Cw8D Low margin business that can go badly wrong in a crisis $$ Apr 19, 2014
  • Makani, a $GOOG subsidiary makes an airborne wind turbine that dramaticlly increases power generation efficiency http://t.co/0Fug49o7gC $$ Apr 18, 2014
  • Google to Buy Titan Aerospace as Web Giants Battle for Air Superiority http://t.co/HjJ8wKtnjM Makes me think $GOOG has 2much $$ 2spend Apr 18, 2014
  • Profit Tastes Like Chicken in Hunt for Cheaper US Meat http://t.co/drgQbwEiKR With recent rise in beef & pork prices people substitute $$ Apr 18, 2014
  • Roads Versus Rail:The Big Battle Over Public Transportation http://t.co/ydBxEglexC Makes case that American will own fewer cars in future $$ Apr 18, 2014
  • Barclays Ups $LNC To Buy, Says $MET , $PRU Are Undervalued – Stocks To Watch http://t.co/c7yNaVZqdp Stock Market sensitive insurance cos $$ Apr 18, 2014
  • Bidding War Looming for Aspen? Analysts Say Don’t Count On It http://t.co/iMotqyAgHv Offer 4 $AHL looks pretty full 2me, dont look4more $$ Apr 18, 2014
  • Biggest LBO Demise Poised to Put Oncor in Play http://t.co/d30djwOa5M Buffett is unlikely 2 enter into bidding in a competitive sale $$ Apr 18, 2014
  • Target of Naked Short Sellers Is Angry, Confused http://t.co/I3ZZDn5JNp @matt_lavine takes on imaginary naked shorting in $LPHI $$ Apr 18, 2014
  • Radioactive Waste Is North Dakota’s New Shale Problem http://t.co/BiMkO0ZdgK Significant amounts of low level radiation from radium $$ Apr 18, 2014
  • The death of mortgage lending http://t.co/u8uQBvZCuS Loan yields must rise in order to compensate for higher required capital at banks $$ Apr 19, 2014
  • Kochs’ Flood Insurance Opposition Becomes Campaign Issue http://t.co/b1iuvoVhZK 1 of the few businesses the Kochs’ aren’t in is insurance $$ Apr 18, 2014
  • Office Markets Strengthen Where Tech, Energy Jobs Are http://t.co/sESuHUeAVr Helps explain the spottiness of commercial RE prices $$ $CMBS Apr 18, 2014
  • Labor Shortage Threatens to Bust the Shale Boom http://t.co/R1TctaTelD Can’t find a job? Consider learning to weld; monotonous but pays $$ Apr 18, 2014
  • Koch Brothers Net Worth Tops $100B as TV Warfare Escalates http://t.co/XgH0M6CNIR Almost as wealthy as extended Walton family $$ $WMT $SPY Apr 18, 2014
  • Big Banks Ramp Up Business Lending http://t.co/83dMAPIQia Signs of life spotted in big corporations, but r they just buying back stock? $$ Apr 18, 2014
  • How Can Yahoo Be Worth Less Than Zero? http://t.co/sr3owwkyNE @matt_levine argues a breakup of $YHOO makes sense even if core biz loses $$ Apr 18, 2014
  • Wal-Mart Undercuts Rivals With New U.S. Money Transfer Service http://t.co/a4vq0HYALi Useful if u need 2 transfer $$ inside the US $WMT $SPY Apr 18, 2014
  • How Chick-fil-A Spent $50M to Change Its Grilled Chicken http://t.co/Q9kpXoSIbF The marinade matters, but the grill design was the key $$ Apr 15, 2014
  • Small US Colleges Battle Death Spiral as Enrollment Drops http://t.co/nHRhO4Gc1R Too much capacity & affordability is a problem $$ $APOL Apr 14, 2014

Outside the US

  • China GDP Gauge Seen Showing Deeper Slowdown http://t.co/ntIxxdXcpO If China increases consumption GDP growth will fall faster still $$ $FXI Apr 18, 2014
  • Housing Trouble Grows in China http://t.co/Z4tKUuqLFd Overbuilding by Real-Estate Developers Leaves Smaller Cities W/Glut of Apartments $$ Apr 18, 2014
  • Suddenly, Europe Is Taking a Harder Line on Russia Sanctions http://t.co/MnzxvMP3pe Nations can solidify when they face a common threat $$ Apr 18, 2014
  • Las Bambas Copper Mine Purchase Shows China’s Still in the Hunt for Commodities http://t.co/h1cqGERGCu China may not b changing much $$ Apr 18, 2014
  • Forgetting How to Speak Russian http://t.co/D0UwT6unki Among former Soviet republics knowing Russian is less important for business $$ Apr 18, 2014
  • The Middle East War on Christians http://t.co/BW1NwCAXuH Israeli Ambassador 2 UN argues Israel is tolerant of Christians, not like some $$ Apr 18, 2014
  • Britons Struggle to Save for Home Down Payments as Prices Surge http://t.co/M6vH0vDlDs Space is constrained in London & foreigners buy $$ Apr 18, 2014
  • US Said to Warn Money Managers of More Russia Sanctions http://t.co/rB8AUQTsnc Putin knows Iran survived worse sanctions; Russia tougher $$ Apr 18, 2014
  • China Sentences Four Activists on Disturbing Public Order Charge http://t.co/Tx95rrhWsb Mostly, US has rule of law, China has rule by law $$ Apr 18, 2014
  • US govt isn’t perfect, but in principle the govt is subject to the Constitution & laws, & not merely able 2 use law 2 enforce its will $$ Apr 18, 2014
  • Frontier Fund Buyers Find It Pays To Look Under The Hood http://t.co/JQ6khwYllJ 2much $$ is being thrown @ frontier mkts; crowded trade $FM Apr 18, 2014
  • Why iShares’ ‘FM’ Is About To Get Better http://t.co/4FiqlfW0YS Diversifies out of Middle East, but frontier market vals r stretched $$ $FM Apr 18, 2014
  • Putin’s 21-Year Quest to Be Russian Guardian Began in Estonia http://t.co/5oelLBHCmN Father was betrayed by Estonians in WWI, almost died $$ Apr 15, 2014

Market Dynamics & Fundamentals

  • Bridgewater Founder Says 85 Percent Of Pensions will Go Bankrupt http://t.co/YknEmyGgfJ 9% pension returns required, 4% is most likely $$ Apr 19, 2014
  • The Fitch Fundamentals Index Dashboard http://t.co/OzI6KWUFfs Interesting little utility 4 understanding where we are in the credit cycle $$ Apr 19, 2014
  • Rich Start-Ups Go Back for Another Helping http://t.co/ZbFbpLVgmM When capital is plentiful, bad decisions get made. expected returns low $$ Apr 18, 2014
  • Stumbling S&P 500 Reaches Worst Stretch of Election Cycle http://t.co/zgJTynu2od Interesting timing, wonder whether past is prologue? $$ Apr 18, 2014
  • How a 56-Year-Old Engineer’s $45K Loss Spurred SEC Probe http://t.co/3HfdH2aqxK Always read the risk factors in the prospectus or 10K $$ Apr 18, 2014
  • High-Speed Traders Said to Be Subpoenaed in NY Probe http://t.co/2qxmrxeVd7 What level of technology is legitimate 2 gain an advantage? $$ Apr 18, 2014
  • Nuggets of Corporate Governance Wisdom From Charlie Munger http://t.co/gMFIE9jlRM Also c this paper: http://t.co/033v0bgdYr $$ $BRK.B $SPY Apr 18, 2014
  • Global stock rally: World market cap reached record high in March, &is $2.4T above pre-recession, pre-crisis level http://t.co/iMq0IoBhch $$ Apr 18, 2014
  • Speed—the only HFT advantage? Not so fast—Flash Boyshttp://www.cnbc.com/id/101586488 Algorithms may also be an advantage w/price patterns $$ Apr 18, 2014
  • Investor Alert – Exchange-Traded Notes—Avoid Unpleasant Surprises http://t.co/NqhUr2whsJ A helpful reminder 2b wary of exotic ETNs $$ $SPY Apr 18, 2014
  • Americans Sold on Real Estate as Best Long-Term Investment http://t.co/La4UROU0ie Helps explain y retail investors lose on average $$ $GLD Apr 18, 2014
  • Destroying Smart Beta 2: Ground Rules http://t.co/uecYqZLCEe Smart beta is a trendy but vapid concept, factors should be part of alpha $$ Apr 18, 2014
  • Gross Loses to Goldman in Hot Bond Strategy as Pimco Lags http://t.co/VWv7UC72bS Series of bad bets makes Pimco a laggard as AUM flees $$ Apr 15, 2014
  • Trillion-Dollar Firms Dominating Bonds Prompting Probes http://t.co/RXZNkNwtFs Concentrated markets can lead to bond pricing distortions $$ Apr 15, 2014

US Politics & Policy

  • What’s the Matter With Illinois? http://t.co/wmDiyWDN1e They r the exemplary state for shortsightedness & corruption $$ Apr 19, 2014
  • Heartbleed Hackers Steal Encryption Keys in Threat Test http://t.co/dYfezfXe8A >6 people were able to extract private key of a website $$ Apr 19, 2014
  • Elijah Cummings, W/IRS, Targeted Tea Party Group True The Vote http://t.co/TE5A1zTM0y I live in his gerrymandered district; kick him out $$ Apr 18, 2014
  • Yellen Lays Groundwork for Rules on Short-Term Credit Markets http://t.co/z03MWlpsqI Fed doesn’t regulate the banks well, y try 4 more? $$ Apr 18, 2014
  • Schooling on a ‘Debit Card’ http://t.co/wwixbB0pqy Arizona created a program so that special needs kids can get specialized schooling $$ Apr 18, 2014
  • IRS Among Agencies Using License Plate-Tracking Vendor http://t.co/HTs5aEMNtK Howard County Police use it & catch people 4 old crimes $$ Apr 18, 2014
  • Wealth Effect Failing to Move Wealthy to Spend http://t.co/R3vfD5i94J Wealth effect, if it exists, is small, FOMC is pursuing illusions $$ Apr 18, 2014
  • NSA Said 2 Exploit Heartbleed Bug for Intelligence for Years http://t.co/9XvcLX9ZTE NSA quietly knows security vulnerabilities; uses them $$ Apr 15, 2014
  • The Wall Street second-chances rule: scandal makes the rich grow stronger http://t.co/8HhscWJjMN What does not kill us makes us stronger? $$ Apr 14, 2014

Practical

  • How well do you know your insurance policy? http://t.co/szp3G8H4kN Know what is covered & what isn’t, how much is covered & options $$ Apr 19, 2014
  • Attention Shoppers: Fruit and Vegetable Prices Are Rising http://t.co/MMdPOLry9A As are meat prices & most food prices $$ #agflation Apr 18, 2014
  • How to start investing http://t.co/yGyziE8Tac Good advice from a credible source $$ Apr 18, 2014

Other

  • El Nino Signs Detected, Presaging Global Weather Change http://t.co/D1uDLS9aJ0 El Nino exists 2 give us something 2 blame when frustrated $$ Apr 18, 2014
  • More People Pick Elimination Diets to Discover Food Sensitivities http://t.co/ftQkzs3PxP Fad and Science of Not Eating Entire Food Groups $$ Apr 18, 2014
  • SAT Adopts Real-World Questions and Jettisons Obscure Words http://t.co/Mspw9EG3OV In 2016, changes from intelligence to achievement test $$ Apr 18, 2014
  • Scientists Make First Embryo Clones From Adults http://t.co/e5qlwyiWwj Cloned cells 2create early-stage embryos, matching DNA tissue $$ Apr 18, 2014

Comments, Replies & Retweets

  • RT @howardlindzon: Funds still paying up (I say silly overpay) for private over public, this is spooking IPO ‘s for sure http://t.co/mclSd9… Apr 15, 2014

The Good ETF, Part 2 (sort of)

About 4.5 years ago, I wrote a short piece called The Good ETF.  I’ll quote the summary:

Good ETFs are:

  • Small compared to the pool that they fish in
  • Follow broad themes
  • Do not rely on irreplicable assets
  • Storable, they do not require a “roll” or some replication strategy.
  • Not affected by unexpected credit events.
  • Liquid in terms of what they repesent, and liquid it what they hold.

The last one is a good summary.  There are many ETFs that are Closed-end funds in disguise.  An ETF with liquid assets, following a theme that many will want to follow will never disappear, and will have a price that tracks its NAV.

Though I said ETFs, I really meant ETPs, which included Exchange Traded Notes, and other structures.  I remain concerned that people get deluded by the idea that if it trades as a stock, it will behave like a stock, or a spot commodity, or an index.

What triggered this article was reading the following article: How a 56-Year-Old Engineer’s $45,000 Loss Spurred SEC Probe.  Quoting from the beginning of the article:

Jeff Steckbeck didn’t read the prospectus. He didn’t realize the price was inflated. He didn’t even know the security he read about online was something other than an exchange-traded fund.

The 56-year-old civil engineer ultimately lost $45,000 on the wrong end of a volatility bet, or about 80 percent of his investment, after a Credit Suisse Group AG (CSGN) note known as TVIX crashed a week after he bought it in March 2012 and never recovered. Now Steckbeck says he wishes he’d been aware of the perils of bank securities known as exchange-traded notes that use derivatives to mimic assets from natural gas to stocks.

“In theory, everybody’s supposed to read everything right to the bottom line and you take all the risks associated with it if you don’t,” he said this month by phone from Lebanon, Pennsylvania. “But in reality, you gotta trust that these people are operating within what they generally say, you know?”

No, you don’t have to trust people blindly.  Reagan said, “Trust, but verify.”  Anytime you enter into a contract, you need to know the major features of the contract, or have trusted expert advisers who do know, and assure you that things are fine.

After all, these are financial markets.  In any business deal, you may run into someone who offers you something that sounds attractive until you read the fine print.  You need to read the fine print.  Now, fraud can be alleged to those who actively dissuade people from reading the fine print, but not to those who offer the prospectus where all of the risks are disclosed.  Again, quoting from the article:

Some fail to adequately explain that banks can bet against the very notes they’re selling or suspend new offerings or take other actions that can affect their value, according to the letter.

[snip]

“My experience with ETN prospectuses is that they’re very clear about the fees and the risks and the transparency,” Styrcula said. “Any investor who invests without reading the prospectus does so at his or her own peril, and that’s the way it should be.”

[snip]

The offering documents for the VelocityShares Daily 2x VIX (VIX) Short Term ETN, the TVIX, says on the first page that the security is intended for “sophisticated investors.” The note “is likely to be close to zero after 20 years and we do not intend or expect any investor to hold the ETNs from inception to maturity,” according to the prospectus.

While Steckbeck said a supervisor at Clermont Wealth Strategies advised him against investing in TVIX in February 2012, he bought 4,000 shares the next month from his self-managed brokerage account. The adviser, whom Steckbeck declined to name, didn’t say that the price had become unmoored from the index it was supposed to track.

David Campbell, president of Clermont Wealth Strategies, declined to comment.

Steckbeck, who found the TVIX on the Yahoo Finance website, doesn’t have time to comb through dozens of pages every time he makes an investment, he said.

“Engineers — we’re not dumb,” said Steckbeck, who founded his own consulting company in 1990. “We’re good with math, good with numbers. We read and understand stuff fairly quickly, but we also have our jobs to perform. We can’t sit there and read prospectuses all day.”

If you are investing, you need to read prospectuses.  No ifs, ands, or buts.  I’m sorry, Mr. Steckbeck, you’re not dumb, but you are foolish.  Being bright with math and science is not enough for investing if you can’t be bothered to read the legal documents for the complex contract/security that you bought.  I read every prospectus for every security that I buy if it is unusual.  I read prospectuses and 10-Ks for many simple securities like stocks — the managements must “spill the beans” in the “risk factors” because if they don’t, and something bad happens that they didn’t talk about, they will be sued.

In general I am not a fan of a “liberal arts” education.  I am a fan of math and science.  But truly, I want both.  We homeschool, and our eight kids are “all arounds.”  They aren’t all smart, but they tend to be equal with verbal and quantitative reasoning.  Truly bright people are good with both math and language.  Final quotation from the article:

“The whole point of making these things exchange-traded was to make them accessible to retail investors,” said Colbrin Wright, assistant professor at Brigham Young University in Provo, Utah, who has written academic articles on the indicative values of ETNs. “The majority of ETNs are overpriced, and about a third of them are statistically significant in their overpricing.”

So, I contacted Colby Wright, and we had a short e-mail exchange, where he pointed me to the paper that he co-wrote.  Interesting paper, and it makes me want to do more research to see how great ETN prices can be versus their net asset values [NAVs].  That said, end of the paper errs when it concludes:

We assert that the frequent and persistent negative WDFDs [DM: NAV premiums] that appear to be driven by uninformed return chasing investors would not exist to the conspicuous degree that we observe if ETNs offered a more investor-driven and fluid system for share creation. We believe the system for share creation is ineffective in mitigating the asymmetric mispricing investigated in our study. Hence, we recommend that ETN issuers reformulate the share creation system related to their securities. Specifically, we recommend the ETN share creation process be structured to mirror that of ETFs. At a minimum, the share creation process should be initiated by investors, rather than by the ETN issuers themselves, as we believe profit-motivated investors will be more diligent and responsive in creating ETN shares when severe mispricing arises.

Here’s the problem: ETNs are debt, not equity.  To have the same share creation system means that the debtor must be willing to take on what could be an unlimited amount of debt.  In most cases, that doesn’t work.

So I come back to where I started.  Be skeptical of complexity in exchange traded products.  Avoid complexity.  Complexity works in favor of the one offering the deal, not the one accepting the deal.  I have only bought one structured note in my life, and that was one that I was allowed to structure.  As Buffett once said (something like this), “My terms, your price.”

To close, here are four valuable articles on this topic:

So avoid complexity in investing.  Do due diligence in all investing, and more when the investments are complex.  I am astounded at how much money has been lost in exchange traded investments that are designed to lose money over the long term.  You might be able to avoid it, but someone has to hold every “asset,” so losses will come to those who hold investments long term that were designed to last for a day.

On Approximate Valuation Methods

The growth of corporations is always constrained by something.  The trick is figuring out what the “something” is.  Tonight, I am here to simplify it for you.

Financial businesses that are regulated

We value these via book value or tangible book value.  Capital levels constrain business growth, so look at the return on equity to help modify what the proper valuation level should be.  Book value and return on equity are what govern.

Non-financial businesses that are regulated, such as utilities 

Look to the rate base that the regulators use.  Book value might be a good substitute, but look to see how companies might invest to increase their “rate base.”  Market Cap as a ratio to what the regulators allow profits on would be ideal.

Unregulated businesses that are mature

These are governed by sales per share, calculating the price-to-sales ratio.  In general, it is wise to buy these when the P/S ratios are low, and sell them when they are high.

Unregulated businesses that are not mature

This is the complex part of valuation, but in this case the PEG Ratio makes sense.  Companies that grow their earnings rapidly can justify high P/E multiples, but in general they need to grow earnings more rapidly than their P/E ratio expressed in percentage terms.

I don’t invest in many immature businesses, so this is not so relevant to me.  I look for places where businesses are neglected, and I buy, while selling businesses that are more then fully valued.

Summary

Think about compounding.   Ask what will best compound the growth of your capital.  I suspect that it will resemble what I have written here.  Focus on compounding and ignore Modern Portfolio Theory.  Compounding is real business.  MPT is fakery from men who could not build a business.

Peterson’s Guide to Financial Blog Commenters

I’ve been blogging for over seven years… this is just an experiment, and unlikely to be repeated.  Here goes:

Have you ever read through comment streams on major financial news and blogging websites?  Or the Message Boards at Yahoo?  It is often ugly, bitter, and uninformed.  That’s why I am bringing to you the Peterson’s Guide to Financial Blog Commenters!  Let’s have a look at the zoo:

The Insult Masters

Couple arguing

There are many who can’t argue the details of an article, so it saves time and face to insult the author or other commenters.  These are all too common, and make life dreary for serious thinkers.

The Person with a Little Insight

geek

 

There are well-meaning and knowledgeable commenters, and they are a breath of fresh air compared to most of those who comment.  Would that we had more of them.  More often found in places where authors don’t write offensively.

The Person with a Lot of Insight

01_Steve-Jobs_full

 

This is rare, but occasionally you get commenters that know more than the writer, or at least are on a par.  If you spot them in the wild, take a snapshot of them, and send it in to the Aleph Blog.  I appreciate great wisdom wherever it is found.  Usually found as blogs that take a studious and serious tone.

Cult Members / Victimhood

satanic-cults1

 

Calvin-and-Hobbess-victimhood-21

 

The internet has many nooks and crannies, more than a mountain of English muffins.  Let me point out a few with respect to cults & victimhood:

Cults

  • Bitcoin
  • Xenophobia
  • Guns

Victimhood

  • Bush
  • Obama
  • 1%
  • Bankers
  • Government
  • Big Biz & Big Government
  • The Purple Party (I.e. “there ain’t a dime’s worth of difference between the Republican and Democrat parties.” George Wallace)
  • Jews — Really?  We haven’t gotten past this?  Anti-Semitism is so 20th Century.

Partisan Hacks

krugman

 

You know how the world works, and you talk down to the unwashed who don’t agree.  Though they may deprecate religion, they are as bad as the worst of the religious in not listening to the views of the other side — after all, they have the knowledge that few do.

Too Much Time on Your Hands

Too-Much-Time-On-Their-Hands

 

I don’t know why some people leave incredibly long comments at a website or blog.  It would be far better for them to start their own blog where they can showcase their work, and put it forth positively, rather than merely reacting.

The Writer is a Shill

shill-busted-glp

 

There are some commenters that exist only to push a view for which they are compensated.  Be wary of those who stridently comment in areas where there is some financial advantage to do so.

Pushes Pet Issue

pushes pet issue

 

Much like the cult members and victims, there are those that will push their pet issue, because that is a main goal of theirs.

Tells Sob Story

sob story

 

Cute kid, huh?  But some people use comment threads to grieve over their story where they allege they were abused by powerful corporations, governments, etc.

Joker

http://www.dreamstime.com/stock-images-jolly-joker-bright-dress-who-stands-welcoming-pose-image31983994

 

Some just make jokes about the article or comments, and this is perhaps the most common of all… after all, who doesn’t like a good joke?  Unless, of course, you are the target…

Pot Shots

pot shot

 

There are many who go for quick hits on authors or commenters.  After all, in an anonymous culture, there is no cost to being insulting or rude.  So take a pot shot, right?

Ranters

rant

 

Like those that have to much time on their hands, those that rant have a lot to say, and you are entitled to all of it.

Pedant

education-teaching-pedant-pedants_society-pedants__society-society-apostrophe-rjo0604l

 

Finally, the least valuable — those that insist on points of grammar, when the sense of the communication is easily known.

Summary

My main point here is that most who comment on financial websites and blogs should not do it, or they should change, so that they comment in such a way that they elevate the discussion above the analogy of a common brawl.  Do unto others as you would have others do unto you.  Aim for the good of others, rather than putdowns.  It’s that simple.

 

On a Concentrated Bond Market

There have been a few articles recently on the underperformance of Pimco, and on the increasing concentration on the buy side of the bond market.  There is danger here for large active managers and their clients.

Two years ago, I wrote a piece called Don’t Become the Market.  Though the piece doesn’t talk about it, I wrote it partly to explain the “London Whale” problem of JP Morgan.  Anytime you become big relative to a market that you use, your own actions affect the prices of the market.  This means that a market dominated by a firm or set of firms pursuing a similar strategy will no longer be able to rely on prices as a reasonable guide in assessing risk.

Smaller players, who can trade without affecting prices, can still make their estimates of risk at current prices, and they can trade against larger players.  Though there are initially economies of scale, once you get big enough as an active investment manager, the diseconomies of scale kick in.

It is relatively easy to outperform when you are a small manager.  But when you get big as an active manager, you begin to find that you can’t find so many good investable ideas.  Now, if you were a passive manager like Vanguard, you wouldn’t have to worry — just own an even slice of everything, and complain that you don’t get a decent allocation on bond IPOs.

Because of this, I tend to use smaller managers for money that is not passively managed.  The smaller the manager, the more he can take advantage of off-the-beaten-track ideas.  If he is a trader (unlike me), being small is an advantage if he has skill.

There is an exception to this, and it is for institutions that buy and hold fixed income obligations.  In that case, holding 50% of the issue is not a problem if you’ve done your credit work right.  You have no intention of selling, and you will bear the few losses that you take.  If a large manager acts like that, it can work so long as its financing cannot run, and the defaults are not overwhelming.

My advice to readers is to use lesser-known and smaller investors if doing active investing.  If they have a a good record, use them.  You can benefit with them as they grow.

Sorted Weekly Tweets

US Policy & Politics 

  • Nearly Half of Dodd-Frank Rules Still Unwritten http://t.co/TwzSawT298 Experiment of regulation by study committees continues albeit slow $$ Apr 12, 2014
  • Banks Given Two Extra Years to Fully Comply With Volcker Rule http://t.co/XVfO9CKMm7 Banks prefer abolition; Fed offers a delay $$ #more? Apr 12, 2014
  • How Big Banks Created a Fed to Serve Their Own Interests http://t.co/tUlNYE3px5 Fed almost always ends up being a shill 4 the banks $$ $XLF Apr 12, 2014
  • Angry students snap photos of lunches, tell Michelle Obama: ‘You call this a [expletive] lunch?’ http://t.co/PY4gfa90oI Food Nazis r mean $$ Apr 12, 2014
  • On equal pay for women, Obama challenges GOP to ‘join us in this the 21st century’ http://t.co/wthQJKwsOO White House has own disparities $$ Apr 12, 2014
  • When the Messenger Is Worth Shooting http://t.co/GGuAxpkizc Fewer & fewer people think teaching financial literacy 2 avg ppl works $$ $SPY Apr 12, 2014
  • Republicans should be friendly to markets, not to business http://t.co/YXEWNr9MEh Big business excellent at co-opt laws 4 their own good $$ Apr 12, 2014
  • Maybe a Gender Pay Gap Is OK http://t.co/2rtYIZ6MFo This argumentation isn’t new; economists have been making this argument since the 70s $$ Apr 12, 2014
  • The Best SEC Money Can Buy http://t.co/wbwBB0CYd4 @ritholtz on Jim Kidney’s excellent retirement speech on the SEC which is worth reading $$ Apr 12, 2014
  • Food Price Shock, 2014 Edition http://t.co/u79xlrwK1I Note that the last time this happened, wars & other pains hit developing world $$ Apr 12, 2014

Market Impact

  • Hedge Fund Industry Growing With Pensions To Thank http://t.co/RF2FTh3YsD Probably a mistake as hedge funds tend not 2b good w/volatility $$ Apr 12, 2014
  • Hedge Funds Unwind As Growth To Value Rotation Intensifies http://t.co/XoK1RFKiAg As growth stocks correct, hedge funds chase performance $$ Apr 12, 2014
  • How Money Managers Fight Their Emotions and Sometimes Lose http://t.co/J0KH06m12P Too Bold? Not bold enough? Tough 2strike right balance $$ Apr 12, 2014
  • The Buys You Can’t Make Yourself http://t.co/0swRNG0Eyo @reformedbroker points out the value of @MebFaber ‘s global value ETF $GVAL $$ Apr 12, 2014
  • Humble Student of the Markets: A quant lesson from a technician http://t.co/svQilIRW4m Useful way to understand indicators & mkt regimes $$ Apr 12, 2014
  • 2014 crash will be worse than 1987′s: Marc Faber http://t.co/Guil41sSvP Bold w/respect to timing &severity of the next crisis, prob wrong $$ Apr 12, 2014
  • Do ‘rising rate’ ETFs really protect investors? http://t.co/tcx2p4qtuc I would b wary here; additional yield often carries hidden risks $$ Apr 12, 2014

Rest of the World

  • Kuroda Seen Brewing Yen-Weakening Surprise Action http://t.co/fVpFvwEiJz Don’t b shocked if the BOJ does yet more to weaken the yen $FXY $$ Apr 12, 2014
  • This is the bank to watch for a Chinese credit implosion http://t.co/sKL9NPruZz Minsheng is an aggressive lender 2the most dodgy credits $$ Apr 12, 2014
  • China’s steelmakers have branched out into shadow banking—which is funny since they owe $484B http://t.co/Z1IzHBJJ7G Brief stmt of prob $$ Apr 12, 2014
  • China Pizza Passion Has Fonterra Riding Mozzarella Wave http://t.co/J4605GnGK4 Pizza is so different than traditional Chinese food $$ $YUM Apr 12, 2014
  • Ukraine’s Rust Belt Faces Ruin as Putin Threatens Imports http://t.co/7BYk6ULy3t Russia has more ec influence on Ukraine thn US on Russia $$ Apr 12, 2014
  • Saudi Banks Reject Algosaibi Meeting on $5.9B Default http://t.co/6eZwowBlZW Islamic finance struggles w/debt that isn’t debt but is debt $$ Apr 12, 2014
  • Lavender-Filled Teddy Bears From Tasmania Are a Big Hit in China http://t.co/ubhWoUSnQz Bobbie Bear touches the hearts of Chinese ladies $$ Apr 12, 2014
  • Top economists warn Germany that EMU crisis as dangerous as ever http://t.co/gsqrbZ5ox0 Overall & banking leverage still higher than safe $$ Apr 12, 2014
  • Fracking’s hottest year in China http://t.co/5xVoKK6K0d China finds gas & tight oil in their shale formations. Who knew? $$ $FXI $XLE Apr 12, 2014

Companies & Industries

  • Time Inc. to Raise $1.4B in Debt for Spinoff http://t.co/8QUGvyKhrv I would b careful here; levering up old media not a recipe 4 success $$ Apr 12, 2014
  • Vox Takes Melding of Journalism and Technology to a New Level http://t.co/YdMuuu0ZQC Vox Media creates a content mgmt system 4 journalism $$ Apr 12, 2014
  • Trailer Parks Lure Wall Street Investors Looking for Double-Wide Returns http://t.co/zym4OmSDP5 Poor people have a hard time moving $$ Apr 12, 2014

Other

  • Stay-at-Home Moms Rise in Reversal of Modern Family Trend http://t.co/sCBErpTIhk Children deserve attention to help them grow up $$ $SPY Apr 12, 2014
  • More Moms Staying Home, Reversing Decadeslong Decline http://t.co/w7bnhw8tQd Value in efforts 2 produce better children w/more parenting $$ Apr 12, 2014
  • Font War: Inside the Design World’s $20M Divorce http://t.co/4YpYf1x5UN Not clearly spelling out a partnership agreement: font of trouble $$ Apr 12, 2014
  • Windows XP Goes Dark; Will Hackers Be Lurking? http://t.co/GPBJKpzdhf XP has been debugged; odds of significant holes are low $$ Apr 12, 2014
  • After Heartbleed Bug, A Race to Plug Internet Hole http://t.co/HCBfcHBl5O A significant part of internet affecting privacy had a hole $$ Apr 12, 2014
  • Global solar dominance in sight as science trumps fossil fuels http://t.co/BZOdAVwYbA Can capture 31% of sun’s energy with a 111V Solar Cell Apr 12, 2014
  • At Gross’s Pimco, El-Erian Says ‘Different Styles’ Stopped Working Well Together http://t.co/vRqPfRA67m Oil & water eventually separated $$ Apr 12, 2014

Wrong

  • Unsafe: Greece Plans to Issue Long-Term Bond on Wednesday http://t.co/X4gnld481q Lust 4 yield guides the behavior of debt investors $$ Apr 12, 2014
  • Misleading: Oklahoma Swamped by Surge in Earthquakes Near Fracking http://t.co/nHfPIWys3q All quakes r little which avoids big quakes $$ Apr 12, 2014
  • Wrong: Are Safer Cars Worth the Money? http://t.co/1N0Y9aklJb Misapplies benefit-cost analysis; may b cheaper ways 2 save more lives $$ $F Apr 12, 2014

Retweets, Replies & Comments

  • ‘ @foxjust Nice going; EEBS is breaktakingly honest with respect to earnings manipulation. cc: @jciesielski $$ Apr 12, 2014
  • RT @ReformedBroker: Reminder: The Fed’s own economic forecasts are basically worse than your dog’s. http://t.co/uLYirMA5zB Apr 09, 2014

On Rising Rate Funds, or, Who Remembers ARM Funds in the Early ’90s?

In the early 90s, there were not many investment actuaries.  One of the Holy Grail ideas of the early-to-mid ’90s was creating floating rate funds with yield so that floating rate Guaranteed Investment Contracts could be profitably written.  I chronicled my efforts there in this article.

One avenue that I went down and rejected was ARM [Adjustable Rate Mortgage] funds.  There was a minor craze for them in the early-to-mid ’90s, and there were not enough ARMs issued to meet the demand for high floating rates.  As such, the prices for blocks of ARMs rose above par, sometimes significantly.

One truism of buying mortgages at a premium in the ’90s was that the ability to refinance got sharper and sharper.  Those willing to buy mortgage securities above par usually took losses as rates fell.

Thus when I read articles about rising rate ETFs, which either invest short-term, or short the bond market synthetically or actually, I think “we’ve been here before.”  It is difficult to gain incremental yield on short duration instruments without taking on risks like:

  • Credit, including weak covenants
  • Structure (another form of credit & illiquidity)
  • Negative optionality

So be wary here.  Pay more attention to the return of your principal than the return on the principal.

I’m Not in This for Love

Much as I appreciate those who like what I write at this blog, I don’t write to be loved.  I don’t write to be hated, either.  I am sensitive to what people think of me, but not to the degree that it changes what I write.

I may have nonconsensus views on:

  • The Federal Reserve
  • Gold
  • Social Security & Medicare (and their cousins around the globe)
  • The current Bull Market in Stocks and Corporate Bonds
  • Long Treasuries
  • and more…..

But I write what I write to disclose the truth.  I am an active equity manager, but I encourage people to use passive investing via index funds, unless they can find a manager who can reliably obtain outperformance.

I don’t blog for economic advantage.  If I wanted to do that, I could channel a wide variety of ideas on investing that are popular, but I know are marginal at best in terms of effectiveness.

Some friends of mine have told me, “Why don’t you write about companies that you own, or companies that look attractive to you?”

I’ve been burned by doing that.  For every ten that you get right, you get the same response from every one you get wrong.  As with most of the web, the complainers dominate.  That’s why I don’t trot out many individual stock ideas.  It’s not that I don’t have them, but I only share them as a group, not as a single idea, most of the time.

Summary

I’m here to tell the truth, even if it cuts against my own short-term economic interests.  Most of the time, I adjust my portfolio so that it is ready for everything, but sometimes I delay, because I know that changes in the market usually happen slowly.

I do not write to be popular.  I write to change the consensus, unlikely as that will be.  Finance is a perverse area of life where fear and greed take over.  And with academics, they have these lame models that are fit for Vulcans (maybe) but not humans (and certainly not Ferengi).

We need new models that reflect the fear-greed cycle, and make valuation a significant input in risk assessments.

I’m not in this for love; I only want to change the way that we view investment decisions.

To Live off of, and Die from, the Equity Premium and Alpha

I’m working on my taxes.  I’m not in a good mood.  Okay, writing that made me chuckle, because I am usually in a good mood.

Let me divide my working life into four segments:

  • 1986-1998: Actuary — reasonably well paid, and significantly underpaid compared to the value I delivered.
  • 1998-2007 — Investment risk manager, Mortgage bond manager, Corporate bond manager, and Senior Analyst at a long/short hedge fund.  Paid well for my efforts, and the  rewards to clients were far more than what I was paid.
  • 2007-2010 — Almost no pay, as I deal with home issues, provide research to a small minority broker-dealer, and try to gain institutional asset management clients.  Living off of assets from earlier days.
  • 2010-2014 — Living off of asset income as I slowly build a retail and small institutional client base for my value investing.

The last two periods are the most interesting in a way, because I was drawing more income from investments than I was from any other source.  Even during my time at the hedge fund, I made more money from my own investing every year than I was paid, and I was paid well.  That said the mid-2000s were a hot time, particularly if you made the right calls on a growing global economy.

My net worth today is roughly where it was at the peak of the markets in 2007, despite my low wage income.  I have been bailed out by the returns of the equity market and my alpha.

This is not a comfortable place to be, because general equity returns are not predictable, and alpha, though I have had it for years, is not predictable either.  That said, my client base has been growing, and in another year or so, my practice should support my family even if the markets don’t do well.

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

Though I just told a story about me, the real story isn’t about me.  Think of all of the people who are trying to manage their lump sum in retirement.  They are relying on strong equity markets; they are hoping for alpha.  They are not ready for setbacks.

Unless you are seriously wealthy, when you are not receiving reliable income from a wage-like source, you can feel like you are in a weak position. I have felt that on occasion, but in general  I have not worried.

I write this because equity outperformance over bonds will likely be limited over the next ten years.  I peg equities at about a 5%/year average nominal return, with a diversified portfolio of bonds at around 2-3%/year.  Also the ability to add alpha is limited, because alpha is zero in total, and are you smart enough to find the managers that can do it?

In desperate times desperate men do desperate things.  Low interest rates are leading many to speculate more than they ordinarily would.  Equity allocations go higher.  Allocations to “alternatives” go higher.  People start using nonguaranteed income vehicles as if they had the structural protections of bonds.

As I always say, be careful.  Those trying to manage a lump sum for income in retirement are playing a dangerous game where if you try to draw more than 3.5%/year with regularity will prove challenging, because that is playing at the boundary of what the assets can deliver, and leaves little room for an adverse scenario.  Be careful.

Disclaimer


David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures.


Also, though David runs Aleph Investments, LLC, this blog is not a part of that business. This blog exists to educate investors, and give something back. It is not intended as advertisement for Aleph Investments; David is not soliciting business through it. When David, or a client of David's has an interest in a security mentioned, full disclosure will be given, as has been past practice for all that David does on the web. Disclosure is the breakfast of champions.


Additionally, David may occasionally write about accounting, actuarial, insurance, and tax topics, but nothing written here, at RealMoney, or anywhere else is meant to be formal "advice" in those areas. Consult a reputable professional in those areas to get personal, tailored advice that meets the specialized needs that David can have no knowledge of.

 Subscribe in a reader

 Subscribe in a reader (comments)

Subscribe to RSS Feed

Enter your Email


Preview | Powered by FeedBlitz

Seeking Alpha Certified

Top markets blogs award

The Aleph Blog

Top markets blogs

InstantBull.com: Bull, Boards & Blogs

Blog Directory - Blogged

IStockAnalyst

Benzinga.com supporter

All Economists Contributor

Business Finance Blogs
OnToplist is optimized by SEO
Add blog to our blog directory.

Page optimized by WP Minify WordPress Plugin