Month: June 2010

Changes for David

Changes for David

I delayed writing about this for a few days to give Finacorp time to take care of a few items.? Here is what Finacorp distributed to clients last week:

[deleted] — for legal reasons, I have had to take that down.? Let’s just say that I am without employment at present.

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I have nothing but gratitude for Finacorp over the past 2.5 years.? After leaving my prior employer, I needed something flexible that would enable me to work from home.? Finacorp provided that, but as it is now, I no longer need to work from home.? I’m ready for new challenges, and though I don’t want to move from Maryland, I look at the situation as one that offers more upside than downside versus the past.

So what am I thinking about to employ myself?

  • Equity management?? I’m still doing well against the markets, and am trying to figure how I could make a business out of this.? My track record is approaching 10 years with my own money, and I continue to do well.? If you have ideas for me here, I am open.? I can share an auditable track record with anyone that makes a credible proposal to me.? I will be talking with a number of parties that have expressed interest in the past.
  • Working for an investment firm in the area?? Could be a good idea, I’ll be talking to friends and contacts.
  • Go back to being an actuary?? Mmm… not that many opportunities around here for that, but if anyone has ideas, I will listen.
  • Consulting?? I already have one good consulting project.? If I could get enough clients, that could be workable.? Potentially, I could consult for buy or sell-side firms in investing.? I could also do that on the insurance side.? As it is, in most of my jobs, I acted as an internal consultant to the firm when weird projects would come up.? I love big, broad, unstructured problems.? Consulting could also go along with…
  • Writing?? I have a few book ideas, but that doesn’t pay.? I would be willing to consider “corporate blogger” type positions, but I have no idea whether any companies would want to consider me for that.
  • Publish a newsletter around my investing models?? I really don’t like this idea; I think most newsletters aren’t worth buying, and I am not sure I would want to be associated with doing writing one.
  • Work for the government?? Oddly, I have applied for an “Asset Management Specialist” position at the SEC, and have been talking with contacts that I have within the government about a variety of possibilities.? I’ve written enough about economic and finance reform — it may be time to move from theory to practice.
  • Other ideas?? You want me to work for you from a distance?? I will listen to proposals.

For the next month or so I am going to be batting around ideas.? After that, I will try to focus on the most promising ideas.? I welcome your support at this time of transition.? Feel free to e-mail me.

Again, thanks for reading.? My readers make my blog better.

Sincerely,

David

A Summary of my Writings on Analyzing Insurance Stocks

A Summary of my Writings on Analyzing Insurance Stocks

Well, whaddaya know?? I received a nice mention at The Ideas Report For Serious Investors. Unexpected, and an honor. I really like their blog and have added it to my RSS reader.? So, I left them this comment, which is not published yet:

Hey, thanks for mentioning me. Here’s a bonus for those with access to RealMoney:

And away from RealMoney:

I hope you enjoy these. They are the bulk of my thoughts on insurance stocks, aside from issue-specific commentary.

David

Disclosure: long ALL NWLI SAFT RGA AIZ PRE CB

I went back through all of my blog posts in insurance to analyze what were the best things I had written on insurance investing.? I also added one more blog post idea to my list.? A long time ago, I wrote a 16-page paper summarizing the whole insurance industry for a former employer.? It was urgent, so I pulled an all-nighter at the ripe old age of 43.? He was deeply grateful for the piece, and then it never got published.? It was supposed to span three issues of his newsletter, but it never appeared in one.? I have no idea why it never ran, but it bugged me that it never did.? So, with a little updating, I hope to release it in serial form sometime in the next few months.? I have lost the original file, so I will have to scan it in and edit it.

But enough of that — the articles listed above are a reasonable summary of how I analyze insurance and other financial stocks.? For those that invest in stocks, I hope you enjoy these posts.

PostscriptApologies to PlanMaestro, Manual of Ideas republished his work, and I appreciate the two mentions from him at his blog, Variant Perceptions.? He expands his thoughts on my most recent piece on AIG’s under-reserving.? Keep it up PlanMaestro, and remember, PartnerRe does not discount its reserves.

Using Industry Rotation to Gain an Edge, Maybe

Using Industry Rotation to Gain an Edge, Maybe

For the last year and three months I have written a weekly piece on industry rotation that is largely based off of price momentum, and described in this old piece that I wrote: A Different Look at Industry Momentum. I have my doubts about that piece around turning points and in choppy markets.? I stated as much in my later piece A Different Look at Industry Momentum ? II.? It seems that the momentum effect has been declining over time.

In the near future I hope to do an update for both pieces, which will show whether I have been wrong in the short run.? Unfortunately, since the original piece, I have been through a hard disk crash, so I will be rebuilding from scratch.

All that said, here are the industries with strong momentum (new industries in italic; as for the particular companies mentioned here, these are promising candidates for further due diligence):

  • Catalogue Retailers ? HSNI
  • Broadcasting & Cable TV ? CBS
  • Household Appliances ? WHR
  • Residential REITs ? AIV, UDR
  • Real Estate Services ? JLL
  • Internet Retail ? NFLX
  • Auto Manufacturers ? F
  • Computer Storage & Peripherals ? SNDK, LXK, NTAP
  • Hotels ? HOT
  • Airlines ? ALK
  • Multiline Insurance ? AIG, GNW
  • Leisure Products ? BC, ACAT
  • Health Care Technology ? CERN
  • Commercial Printing ? CGX
  • Apparel Retail ? LTD, BWS, FINL, ANN, ZUMZ, DBRN
  • Health Care Distributors ? ABC, CAH
  • Apparel & Accessories ? PERY, ZQK, MFB, LIZ
  • Cable & Satellite ? TWC
  • Gold & Precious Metals Miners ? NEM
  • Footwear ? SKX, CROX
  • Consumer Finance ? EZPW, WRLD
  • Info Tech Consulting ? ACXM, CTSH, IT
  • Real Estate Development ? FOR
  • Home Furnishings ? WSM
  • Photographic Products ? EK
  • General Merchandising ? BIG
  • Movies & Entertainment ? LYV
  • Retail REITs ? PEI, MAC, KRG
  • Office REITs ? SLG, ARE

And here are the weak industries:

  • Oil & Gas Refining & Marketing
  • Semiconductor Equipment
  • Building Products
  • Industrial Gases
  • Communications Equipment
  • Construction Materials
  • Education Services
  • Homebuilding
  • Human Resources & Employment Services
  • Brewers
  • Integrated Oil & Gas
  • Oil & Gas Drilling
  • Electric Utilities
  • Water Utilities
  • Integrated Telecommunication Services
  • Reinsurance
  • Diversified Support Service
  • Asset Management & Custody Banks
  • Heavy Electrical Equipment (AZZ)
  • Agricultural Products
  • Independent Power Production
  • Construction and Engineering
  • Investment Banking & Brokerage
  • Biotech
  • Aluminum
  • Diversified (it’s Leucadia)
  • Home Entertainment Software
  • Fertilizers & Agricultural Chemicals
  • Tire & Rubber (Goodyear)
  • Alternative Carriers

I am less than a momentum player, even though I know it works generally.? At turning points, models like these do not work well.? That has been my worry since I began writing a weekly industry rotation report for my employer in March of 2009.? Though momentum works enough of the the time that it overcomes the turning points in the long run, when the market is volatile, choppy, etc., using momentum seems to be a fool’s errand.? Industry momentum trends usually last for years, but what if they only last for months?

That is what makes analysis of price trends in the market difficult.? There is not a consistent periodicity to market cycles.? I might argue that bull markets tend to correspond to long cycles, and bear markets to short/nonexistent cycles.? So, maybe the answer stares me in the face — though I have a variety of models for industry rotation, I use them as guides, not rules.? When I am more concerned that short term performance may not persist, I pick from the bottom of the list rather than the top, seeking mean reversion.? When I don’t see headwinds for the economy as a whole, I pick more from the top of the list.

But, I like picking from both ends of the list, because the top end makes me ask the question: “have people underestimated this?”? The bottom of the list makes me ask: “is there are great big sign over the industry that reads, ‘Abandon all hope, all ye who enter here.’ ?”? Both conditions offer opportunities for profit.

And, given the preponderance of top-down players out there who hug the indexes (much institutional money), and my friends who are bottom-up stock pickers (but still glance at the indexes and adjust), it leaves room for those of us who are willing to express distinct views regarding industries.? For me today, it is fourfold:

  • If you are going to buy cyclicality, you may as well own energy names.? Energy drives the economy, and they aren’t making any more of it.? (Unless we get higher efficiency means of converting solar, wind, or tides.)
  • Insurers are relatively safe from an asset standpoint and undervalued.
  • Utilities throw off relatively safe cash flows in a bad environment.
  • Well-financed companies that are needed regardless of the cycle, and are cheap-ish.

If you have been reading me for any significant length of time, you know that I eschew simple answers.? Life, and investment performance, are complex beasts.? My view of the markets at present is mixed; there are reasons for optimism, and reasons for fear.? Typically, I don’t give into fear in full, rather than leave the markets, I take a more conservative position within them.

And, I don’t let inflation fears scare me out of the markets.? Equity markets don’t respond to inflation that much.? Scarcity of capital, or high real interest rates are another matter — at that point, far better to hold money market funds, gold, etc., though? energy stocks should work there as well, and utilities will be middling.

Depression would be another matter, but I see our politicians fighting depression as they see it, leading to a Japan-style economy, where there is no bad asset that can’t be financed through the monetary base at 0%.? (They are willing to inflate assets, but not goods prices.)? That is, if they can avoid a full-scale run on the currency, such as may be beginning to happen with the Euro now.? (What taxation authority stands behind the Euro?? Please ask Mr. Sarkozy or Ms. Merkel, though I think you will get different versions of obfuscation out of each.)

I am working to preserve capital now, and year-to-date in 2010 I am down a little less than a percent.? Though Value Line recently got a little more bullish, I am waiting to get more bullish.? I will add little bit by little bit to my positions as they go down, but I see no reason to add dramatically today.

So, be wary as always, and conservative in your decisions.? Better to avoid errors than to hit home runs in this environment.

Morning Financials Update

Morning Financials Update

Big Movers

Top 20 Financial Stock Movers

Company [ticker] News Price Move
Washington Mutual Inc [WAMUQ] Valuation-insensitive buyers on high volume and no news.

13%

Pacific Capital Bancorp NA [PCBC] Strong buying at the open leads the stock up on no news.

6%

Ashford Hospitality Trust Inc [AHT] No news materially driving the stock price

6%

First BanCorp/Puerto Rico [FBP] No news materially driving the stock price

4%

Radian Group Inc [RDN] No news materially driving the stock price

4%

EastGroup Properties Inc [EGP] Jim Cramer likes it for the yield.? Mentioned on Mad Money.

3%

Advance America Cash Advance C [AEA] No news materially driving the stock price

3%

LoopNet Inc [LOOP] No news materially driving the stock price

3%

Heartland Financial USA Inc [HTLF] No news materially driving the stock price

3%

China Real Estate Information? [CRIC] No news materially driving the stock price

3%

Move Inc [MOVE] Banxquote.com sues them for antitrust reasons.

2%

First Bancorp/Troy NC [FBNC] No news materially driving the stock price

2%

United America Indemnity Ltd [INDM] No news materially driving the stock price

2%

Enstar Group Ltd [ESGR] No news materially driving the stock price

-3%

New York Community Bancorp Inc [NYB] No news materially driving the stock price

-3%

Stewart Information Services C [STC] No news materially driving the stock price

-3%

Waddell & Reed Financial Inc [WDR] No news materially driving the stock price

-3%

Artio Global Investors Inc [ART] Dilution.? Issuing shares to buy back units from principals.

-4%

First American Financial Corp [FAF] Index investors sell off FAF as CLGX remains in the S&P 400.

-4%

Assured Guaranty Ltd [AGO] Determined sellers on light volume and no news.

-4%

Thoughts:

Group Price Movements for this Morning

Real Estate Mgmnt/Servic

1.2%

Reinsurance

0.0%

REITS-Health Care

-0.3%

Commercial Serv-Finance

1.1%

Diversified Banking Inst

0.0%

REITS-Storage

-0.3%

Finance-Consumer Loans

1.0%

Multi-line Insurance

0.0%

Commer Banks-Western US

-0.3%

Insurance Brokers

0.7%

Exchanges

0.0%

S&L/Thrifts-Central US

-0.4%

Life/Health Insurance

0.7%

Property/Casualty Ins

0.0%

Commer Banks-Central US

-0.5%

Other

0.5%

Fiduciary Banks

-0.1%

Invest Mgmnt/Advis Serv

-0.5%

Retail-Pawn Shops

0.4%

REITS-Hotels

-0.1%

REITS-Diversified

-0.5%

Real Estate Oper/Develop

0.4%

Commer Banks-Eastern US

-0.1%

REITS-Single Tenant

-0.5%

Finance-Invest Bnkr/Brkr

0.4%

Grand Total

-0.1%

Finance-Credit Card

-0.5%

REITS-Mortgage

0.4%

REITS-Office Property

-0.1%

S&L/Thrifts-Eastern US

-0.7%

REITS-Regional Malls

0.1%

REITS-Forestry

-0.1%

Finance-Auto Loans

-0.7%

Commer Banks Non-US

0.1%

REITS-Warehouse/Industr

-0.1%

Super-Regional Banks-US

-1.0%

REITS-Apartments

0.1%

REITS-Shopping Centers

-0.2%

Financial Guarantee Ins

-1.1%

S&L/Thrifts-Western US

0.1%

Commer Banks-Southern US

-0.2%

GSEs

-2.3%

I look at these companies for big news events that have occurred since the last close.? Often there isn?t any, but big changes here can be an indication that someone knows something, or there is trading noise.? After that, it is up to the analyst to dig.? Often, the dog that does not bark is the clue, as stocks move up or down on no news, as well as unexplained large spikes in volume, CDS spreads, and implied volatility of options.

Note: If I use the phrase ?better seller,? it does not mean ?sell.?? If I use the phrase ?better buyer,? it does not mean ?buy.?? ?Better seller? and ?better buyer? are bond portfolio manager terms that simply mean that if I were forced to take action on a security, what would I do as a trader in the short run, given the current news.

Disclosure: long ALL NWLI SAFT RGA AIZ PRE CB

Yield, the Oldest Scam in the Books

Yield, the Oldest Scam in the Books

There are two ways to fleece (cheat) someone: appeal to their greed, or appeal to their fear.? But the most effective approach that I know of is to appeal to elderly investors who did not save enough, and are finding it difficult to make ends meet.? They don’t want to take big chances, but they do need the yield.

Before I go on, what is yield?? This sounds like a dumb question — the simple answer is the percentage of money remitted to investors relative to the market value of the security.? And that is true as far as it goes, but there is more wood to chop here.

Yield is four things:

  • The risk free return on capital over a specified horizon.
  • The return required in order to induce someone to give up liquidity if the bond is not marketable.
  • The return required to take on any optionality, whether call or put risk, conversion, prepayment or extension risk.
  • The return needed to compensate for the possibility of default.

I have written before against buying structured notes from Wall Street.? Retail investors, take note.? Wall Street knows more than you do, and you are the patsy at their poker table.? The deck is stacked against you.? Avoid buying their products where they try to sell you an enhanced yield in exchange for a less certain return of principal, whether due to default, prepayment, call, or extension.

Though there are instruments that are undervalued, yielding more then they ought to, most of the time high relative yields indicate high risk.? Stretching for yield is usually a mistake.? With bonds and preferred stocks, it usually means more credit risk.? With equities and LPs, it usually means paying out more than the underlying cashflows from operations can handle, which is another form of credit risk.? Dividends can be reduced quickly if the cashflows can’t support them.

Now I turn to the article that drove this piece: Nonlisted REIT Sales Get Heightened Scrutiny by Finra.? Anytime you buy a security without a secondary market, you leave yourself at the mercy of the company.? Liquidity is poor, but the poor fool who buys these investments does not consider how much extra yield he needs to compensate for illiquidity.? Instead, he looks at his income needs, and buys.? Do you really want to play in someone else’s casino?? The casino analogy is apt, because the company controls the dividend payout and the buyback price.? Worse still, they have a better idea of what the asset are worth than the investors do.? Those with short-term cash flow needs are in a bad spot investing with them; they will not get the true economic value of their holdings.? (But, they should have planned for it — anytime one takes on illiquidity, one should make sure that there is enough liquidity elsewhere to compensate.)

With listed REITs, an investor has real estate equity or debt levered up through borrowings.? A nonlisted REIT is the same, except that there is no third party market to buy and sell shares.? You owe your soul to the company store, though you the the creditor, not the debtor.? My view is simple here: don’t buy into roach motels for cash, where the cash goes in easy, and comes out hard, unless you can negotiate your own terms.

Don’t give up liquidity without fair compensation.? I am happy to say that in my personal and professional investing career, I have never taken a loss off of illiquid investments.? Why?? Because they have to be bulletproof to me before I invest.? They must have table stability, not just bicycle stability.? Can they pay me back when liquidity is scarce?

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I have been through three exercises at the firm I work for where a life settlements securitization has been proffered to us as a great way to start up a securitization business.? Every one of them was bogus, and I protected the firm by telling them not to do the deals.

The life settlements seemingly carry a lot of yield, so it takes some backbone to suggest that there is not enough yield, or that capital losses will eat up yield, so the deal should not be done.? For a time, I ended up saving the firm.? The lesson is this: in investing, ignore yield to the greatest extent possible.? Focus instead on earning a good return, with safety, and ignoring the payout.? It is a little known secret that REITs with the lowest payouts tend to be the best performers over the intermediate-to-long term.? It is easier to earn money off of taking equity risk than credit risk.

So, aim for best advantage in investing.? Don’t trust yields, but rather look at the underlying economics of the business that you are investing in or lending to.? Yes, it is a lot more work, but it is work that you should be doing.

“The New Normal” aka Ruin Nation

“The New Normal” aka Ruin Nation

I have a phrase that I use to describe the current difficulties within state and local governments; I call it “The New Normal.”? The phrase is cribbed from PIMCO, but with me this phrase has a different meaning.? It starts with the difficulties that states and municipalities are having in meeting their budgets.? Much of this stems from pension and retiree healthcare promises.? Much of it stems from a loss of revenues from home sales, sales taxes, and lower income taxes.? In any case, it is a mess, and it is a mess that will get worse.

I suspect that lower sales and income taxes will persist for a little while.? Home prices and sales will be subdued for around 3-5 years.? The oversupply is that great.

But the difficulties from pensions and employee healthcare will last for decades.? States made generous promises that they did not fund.? Like profligate private corporations, the assumed that they could grow their way out of the promises that they had made.? But few considered the possibility that state or local tax revenues could shrink for a protracted period.? Also, few considered that the current cost of pension promises would eventually force its way into government funding.

So now state and local governments are faced with the perfect storm.? With pension and retiree healthcare costs rising, and tax revenues either falling, or not rising so rapidly, that squeezes out money from other public services.? As Roger Lowenstein wrote about in his book While America Aged, the NY Subway system got to the point where?pension costs were equal to the cost of wages.? Thus for every employee working, there was another person or more being paid a pension.

That is the present of many American municipalities, and the future of most of the rest.? Few municipalities and states set their pension and healthcare assumptions in a conservative way.? Rather, they let those soft costs slip into the future, compounded with interest and survivorship, while they spent money in other areas that were more pressing.

The bill has come due in some municipalities, and will come due in far more before long.? Here’s that problem: if you engaged in this hopeless game of pushing pension and retiree healthcare costs into the future, it will not do to merely make cuts to meet the present shortfall.? You must get ahead of the curve and fund benefits, or, you can play a colossal game of chicken and say that you won’t pay benefits unless workers and retirees compromise and accept less.? Aside from states, I know that means chapter 9 of the bankruptcy code.? As for states, that could be a constitutional crisis, because states can’t go broke.? But would the Federal Government enforce it?? How?? What if a state decided to secede?? (Oh, wait.? We’ve been through that.? But does Obama have the guts of Lincoln?? No, but who does?)

I’ve seen many articles on this topic recently.? Here are a few:

  • The Union Pension Bailout — Multiemployer private plans are underfunded, and unions are making a grab for taxpayer funds.? Remember that the PBGC guarantees less of the benefits on multiemployer plans.
  • Public Pensions Headed for Disaster — Megan McArdle sounds a theme that I have been sounding for five years or more.?? (I have one piece written in 1992, but it is not on the web.)
  • An excellent example of liberal accounting for pensions is California.? I would not want to be the next governor.? The choices will get harder over the next ten years, as retiree benefits overwhelm the budget, and all manner of services get cut, necessary or not.
  • This applies to teachers as well, and pity aspiring younger teachers who can’t get jobs, and middle-aged teachers that have trouble with larger class sizes.? Their agonies support retired teachers with generous pensions — generous because governments would not pay up with salaries in the past.
  • Now, cities can take on unions, but they are limited.? They can’t eliminate past promises, but they can reduce current promises.? Current employees can yell foul, but what can they really do?? Most governments are in this pickle, so bargaining power is not strong.
  • This article is three months old, but it is comprehensive.? It compares the troubles at GM to those of the states and municipalities, and concludes that many unthinkable things are happening today.? Who can tell what will happen?
  • This is not a time to raise risk in pension funding, but many are doing so.? And they accuse actuaries of driving through the rearview mirror?? The pension consultants are worse; the models of investment risk are not as stable as those of insurance risk.? It is rewarding in the short run to take more investment risk; the reward is often short-lived, but the risk has a much longer tail.? The funds that raise risk now will regret it.
  • Though it is long and somewhat wonky, this post by Keith Hennessey is worth reading.? He argues, as I would, that promises to fund pensions should not be watered down.? If you don’t want? larger future insolvencies of pension plans, oppose the efforts to extend payment terms.? It may mean more terminations of pension plans in the future, but that is better than extend and pretend.

A few notes:

  1. Discount rates change the timing of costs, but not the ultimate costs.? A low discount rate forces costs into the present.? A high rate pushes them out into the future.? (“We can earn more over the long haul, so we don’t need to fund as much today…”)
  2. The “New Normal” affects everything municipal.? Budgets will continue to be cut, and employees laid off.? Services will be cut, and morale will fall, but budgets will still rise, as funding for employee benefits expands because it was not properly prefunded.
  3. Learn to do without your local government’s optional services.? Aid that was not dreamed of 50 years ago will slowly be eliminated, and people will need to pay their own way for what they need.

That’s the “New Normal” as the Aleph Blog sees it.? State and municipal governments starve, as pension payments grow.

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