After reading an article at FT Alphaville on Gross Domestic Income, it reminded me of articles I have written on Gross Domestic Purchases, and so I decided to post again.

This time, I have quarterly data going back to 1947, and I post it all here:

Let’s start with the definition of Gross Domestic Purchases, which I think more closely tracks the way average Americans feel than Gross Domestic Product does.

Gross domestic purchases

The market value of goods and services purchased by U.S. residents, regardless of where those goods and services were produced. It is gross domestic product (GDP) minus net exports of goods and services. Equivalently, it is the sum of personal consumption expenditures (PCE), gross private domestic investment, and government consumption expenditures and gross investment.

Source: U.S. Bureau of Economic Analysis

Pretty simple — GDP minus net exports equals Gross Domestic Purchases.  The trouble is that import price increases increase real GDP relative to real GD purchases.

Note well: IPD stands for implicit price deflator, which is a comprehensive measure of inflation.  Also, figures may not add due to rounding, timing differences, and errors in revisions.

But what I would like to point out from the last three quarters on Gross Domestic Purchases, is that the economy is growing at less than 1%, and inflation is running higher than 3%.

I realize that these could be statistical anomalies, but Gross Domestic Purchases is far closer to what the average American feels than GDP or GNP.  My main point is that we have a slow-growing economy in inflation adjusted terms, while felt inflation is rising.

After yesterday’s piece I received an e-mail and a comment.  I also realized that I want to say more.  Here is the redacted e-mail:

David,

I enjoy reading your blog and your recent post “How Do I Find A Job In Finance?”, was very close to home for me. Before I ask for advice, here’s some background for you:

• BA in Economics from The XXX University, 2007
• 4 years working as a Financial Assistant for a financial service firm
• Currently volunteering with the CFA Society of YYY
• I am a level III candidate in the CFA program
• Hold a series 65 license
• Live in YYY, XXX  not willing to relocate

Since 2009, I’ve had 2 interviews with a sell-side equity research firm, 1 interview with a REIT firm and recently 2 interviews with a buy-side fixed income firm. Each time once I received a rejection notice, I followed up and was told “other experienced candidates” as the reason I was not chosen. 

I’ve put in a lot of time and effort into education and I truly have passion for investing. I read, write and even build research reports (which I share in interviews) and manage my own and family’s portfolios. 

This last rejection really hurt and most of the investment firms in YYY are relatively small. The last two months I’ve found myself losing the faith. Am I following an unrealistic path or is there more I can do I’m not already doing?

Friend, it takes time, particularly if you are in a smallish area financially, and are not willing to relocate.  As for me, it was six years before I got an investment-related job, and twelve years before I was investing professionally.  And that was with two moves.

If you are not willing to relocate, local networking is all the more crucial.  Develop friends and mentors; seek a champion that wants to see you succeed.

And then a comment from yesterday:

David,

The investment management industry is very dysfunctional. This is a major reason why your advice for career changers to consider working on “projects with dotted-line relationships to the investment function of the company” and to “look for adjacencies … jobs that are close to investing” is excellent.

The investment management industry is all about who you know and your pedigree, with an exception for those with their own capital. Getting hired to manage investments is not about what you know or having an above average investment track record, never mind that these are major considerations of investment management clients. The business of investment management is about the marketing sizzle and not the steak.

My own career demonstrates this. I will spare you the gory details, but suffice it to say that even after building an investment track record that is noticeably above average (in large part because I successfully maneuvered through much of both the dot-com and credit busts), earning a CFA, getting along with people, demonstrating “energy and a willingness to learn”, and following your eminently logical concluding suggestions (“network. Join your local CFA Society; get the credential if you can. Talk with people in investing. Volunteer and show your competence.”), my career has been a struggle and basically did “return void”.

I feel sorry for both of you.  Much of finding a job is creating a firm that will sell one product once.  To that end, create a team of helpers and advisors that will be a spider-web that will catch a job-fly.

I also have experienced that a good past track record is insufficient to attract a job or clients.  In talking with investment management consultants, they look at my track record and tell me it is impressive, but they don’t hire me because I do things differently than their standard risk model.

Maybe the answer for both of you is to start your own firms, at least in the mornings before work, or the evenings afterward.  If it grows, you might be able to leave your work, and grow your business.

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Also, if you have excellent mathematical skills, there are more doors open to you in finance.  It is usually easier to teach qualitative reasoning to one who is good with math, than to try to teach math to one who is good with qualitative reasoning.  Thus knowledge of the investment math can be another entry point; it can aid risk control and model building.

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I want to reinforce one more time that a person with investment skills can be a benefit to almost any organization that one works at or volunteers for.  Many firms I have worked for, even though I was not in the investment department, benefited from my investment knowledge, because it led to approaches and strategies that were borrowed from other areas of industry.  One with generalist investment skills is the sort of person that can do what the hackneyed phrase asks — think outside the box.  As an actuary, my ability to reason through complex situations and come up with unusual solutions created a lot of value for owners.

You become that person that Munger idealizes.  You have a series of mental models covering different areas of reality, and apply them flexibly to the situation at hand.

That’s what I did for years with my friend who made commercial lawn mowers.  I can’t do what he does; he’s a native engineer who is a genius at design/engineering.  But I could give him advice on how his business was losing money because of a lack of a basic finance function inside his firm.

Even with nonprofits, one with investment skills can add value simply by having the broad knowledge that keeps the organization from being bilked by charlatans. He asks the questions that keep the nonprofit on its mission, while avoiding costly mistakes.

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My life is a work in progress.  I have no idea whether I will gain enough clients to make my firm viable over the next two years, or not.  But even if I fail, and I don’t find work in a traditional asset management business, I still think I will be able to add value to any firm that I work or consult for.  What I know can benefit any firm, and that is true for all of us that have knowledge of investing.

You may not be applying that knowledge as a mutual fund manager does; many markets are far less liquid.  But knowledge of investing turns the technical specialist into a businessman, and makes him far more valuable.

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So, on that front, I turn the question on its head, and say, “How can you use your knowledge of investing to benefit others?”  If you have real investment knowledge, you are one of the adults in the room, protecting the organization from frauds, and managing it for results.

I end this series (for now) by saying that if you have knowledge on investing, you can potentially benefit any organization that you work with — enhancing, protecting, and guiding.  These are no small things, so use your abilities for the good of others, and see what new opportunities come as a result.

I regularly get people asking me how they can get jobs in finance.  Many of them are young.  Some are older and have done other things, but have been bitten by the investing bug, and want to make a shift.

Now, before I start, let me say that if you are smart, driven, motivated, organized, and generally capable at all that you do, and you are working in another field, say chemical engineering, and you want to move to investing, you might be better off asking your supervisors to give you projects with dotted-line relationships to the investment function of the company.  That could propel you to later roles where you head a division, or run a smaller company.  The ability to invest wisely has all sorts of positive spillover effects in managing an enterprise.  So before you head off to work in investing in the public markets, take a step back, and see how you can combine your existing expertise, and try to invest in the private markets, where you may have Buffett’s “unfair advantage.”

The first thing I tell them about is my career.  In short, here it is:

• Actuarial Trainee — Pacific Standard Life
• Actuary for the Domestic Annuity Lines at AIG
• Investment Actuary for the Pension Division at Provident Mutual
• Investment Actuary for the Annuity Division at Provident Mutual
• Mortgage bond manager and Risk Manager for Mount Washington Investment Group, which was managing the assets of Fidelity and Guaranty Life.
• Manager of of the investments for Fidelity and Guaranty Life. (Still risk manager too)
• Corporate bond manager for Dwight Investment Management (Still risk manager too)
• Senior Investment Analyst for Hovde Capital Advisors, covering insurance companies, and managing the profit-sharing and charitable endowment funds.
• Concurrently, writing for RealMoney.com.
• Chief Economist and Director of Research for Finacorp Securities, which allowed me to work from home during a difficult personal time for my family.
• Concurrently, writing the Aleph Blog.
• Principal of Aleph Investments, offering stock and bond management strategies, and a strategy to switch between them.

That’s a lot for 25 years.  Do you notice something unusual here?  Most of the jobs I switched to I did not have the full complement of skills to handle.  I learned as I went, but there were two costs to that:

1. Only risk-taking businesses would hire me.  That meant more pressure, which in general, I did not mind.  I liked challenges.
2. I had to learn more as I took the jumps.  Not everyone likes to do that.  I love a challenge.

For those looking for jobs in investments, if you can’t find the opportunities you would like, I would encourage you to look for adjancencies. Look for jobs that are close to investing.  Here are examples:

• Investment marketing
• Investment accounting
• Investment auditing
• Investment management consulting
• Working for the rating agencies (anyone can get a job there)
• Working for the regulators
• Working for government investors, pension plans, GSEs, Supranationals, etc.
• Working for endowments
• Working in the Treasury arm of a corporation.  Hedging, pension plan, short-term investments, etc.
• Work in a bank, thrift or insurance company.  Look for projects where you can show off investment expertise.
• And more.

And in all of these ideas, network.  Join your local CFA Society; get the credential if you can.  Talk with people in investing.  Volunteer and show your competence.  This will not return void.

Those with energy and a willingness to learn have a huge advantage over the rest.  If this article benefits you please e-mail me, and let me know how your career has benefited.

He finally decided to do it.  He’s going to buy back stock.

Don’t get me wrong.  I am not a critic here, nor an admirer; I am just an observer.

Buffett is a rational guy. Hyper-rational.  More rational than I am.

He thinks that his stock is a good buy below 1.1x unadjusted book value.  I don’t know that he is right there, but I give him and Whitney Tilson the benefit of the doubt.

My friend Josh Brown said:

Full disclosure, I’m long Berkshire Hathaway B shares for client and family accounts and have been forever and a day, so of course I’m thrilled with the news this morning.

Normally I detest buybacks.  The primary reasons are:

They usually occur at the top of a cycle and are a sign of a top when they peak en masse

They usually are used to mask massive stock option issuance to enrich insiders while doing nothing other than offsetting dilution to shareholders

They are financial engineering and are thus suspect

They are inferior to dividends

They can be a sign that management has no idea what to do to grow or improve a business

But Buffett is not masking stock issuance, he is purely concerned with building shareholder value and sees an investment in his own stock (and hence the various companies he owns) as the best use of capital.  This is very different from when Cisco issues 50 million in options and then announces the requisite buyback that would offset it.

As far as buybacks go, this is a good one, but the question remains, how good is it?  If Buffett had better uses for cash, he would not be buying back stock, and this is at a time when all equity valuations are depressed.

To me this indicates that Buffett does not have any large places to deploy cash superior to the cost of capital of Berkshire Hathaway, which is pretty low, aside from investments with an inadequate margin of safety.

That doesn’t mean the whole market is overvalued, but it does mean that a bright guy like Buffett anticipates no more large productive places in the near future to put large amounts money to work than by shrinking his own balance sheet.  Not a good sign for the economy.

He could sit on the cash and wait.  He has done it before at valuation levels like this in the mid-2000s.  It’s not as if the compression in valuations has only hit BRK.  Many companies seem cheap now on a current earnings basis.  This is especially true of many insurers, of which BRK is one.

Buffett was willing to expend cash to make a superior offer for Transatlantic Reinsurance at a little more than 70% of book, and 8x forward earnings.  Granted, that would have only deployed $3B+, and given him more float to invest.  Still, it shows the cheapness of the environment.  But perhaps there is more uncertainty around the valuations of less well-capitalized firms than BRK, so buying back higher quality BRK stock is preferred to buying in the liabilities of companies of which Buffett has less knowledge.

There is the more radical act: Buffett could buy the stock outright himself.  He has significant personal outside holdings; why not sell them and buy more BRK?  That would make an even greater statement then the buyback.  An insider buy from the ultimate insider at BRK would say a lot more than shrinking BRK’s balance sheet through buybacks.  Think of it this way: Buffett’s interest in BRK increases 4 times as fast if he uses his own money versus the corporation doing the buyback.

As an investor in insurers here, I have better places to put money than BRK.  I like BRK, but the whole industry is cheap amid the uncertainty of the macroeconomic environment.  BRK deserves the higher valuation because it is a diversified industrial/insurance conglomerate, and not merely a despised insurer.

I will sit and own my cheap insurers because their cash flows will more than justify higher valuations eventually.

PS — there had to be a better way to do this.  BRK could have struck a deal to do an accelerated share repurchase, without jolting the market, and pushing up the price of a repurchase.  Perhaps it could have been done by simply announcing that the Board has approved buybacks, should the price ever become favorable for that, and then repurchase slowly and quietly.

Every 100 posts or so, I take a step back to think about the broader issues I face in blogging, and describe what I am up to in my life, so that my readers can understand more about me.

Since my last post on this topic, I have had a difficult time.  Why?  I worry that my firm will not grow fast enough that it will support my family.  That said, I pick up 2-4 new clients per month, and my friends in the Baltimore CFA Society tell me that I am doing better than most.

So, I try to take heart amid the bear market, where it is more difficult to gain clients. Now, it would be nice if there were a database of dissatisfied investment management clients, but that doesn’t exist.  Thus I have to look to others for referrals of those who are dissatisfied with competitors in my business.

Over the last 100 posts, the economic/financial environment has turned from optimistic to pessimistic.  I haven’t changed much.  I still think there is more pain to come, where the big banks have to take losses.

I am more bullish now, but I am waiting for a turn in the momentum to get more aggressive.   With momentum so negative, I commit small amounts of capital to my best ideas as they fall, like my RGA piece yesterday.

With all that, I thank my readers for reading me.  You have a lot of things you can do with your time, and if you decide to read me, I am flattered.   I am grateful for any investing referrals.

Aside from that, I still enjoy blogging.  It is an opportunity to call out the powers that be and tell them they don’t know what they are doing.  Away from that, explain to people to avoid common scams.  I have a post coming on one of the scams soon.

I really enjoy writing for all of you.  I hope you enjoy my writing as much.

I read an article by Zacks on RGA.  I thought it was poorly reasoned.  Here’s what I wrote as a comment:

“However, the primary factors to our Neutral recommendation are Reinsurance Group’s reliance on availability for affordable retrocession. The company had increased the maximum amount of coverage that it retains per life in the U.S. from $6.0 million to $8.0 million. This reduces the amount of premiums it pays to retrocessionaires, but increases the maximum effect a single death claim can have on its results, and therefore may result in additional volatility to its results.

Also interest rates are likely to remain low in 2011 and spreads narrow further. We expect to see additional pressure on the Reinsurance Group’s investment income. Moreover, management’s conservative positioning of the investment portfolio is expected to exert pressure on yield.”

I hate to say this, but you don’t know life reinsurance that well if this is your reasoning. Interest spreads are not a major factor in RGA’s profitability. Also, the retrocession cartel charges an arm and a leg for coverage. The earnings will be more volatile, but they have always been volatile with RGA. The time to buy is after a bad quarter, because mortality is random, but RGA underwrites well.

Let me get this straight. This company has a big moat; it’s part of the life reinsurance oligopoly. It’s trading at a forward P/E of 6, a trailing P/E of 5.5, and 65% of unadjusted book. This company is a leader in its industry globally, and you rate it a hold?

Let me tell you a secret. You almost never lose on companies with little debt, trading at single digit P/Es, and trading below book, conservatively stated.

I own this stock, and so do my clients.

RGA is trading cheap enough that I am considering making it a double-weight in my portfolio.  It is a single-weight at present.  It is genuinely rare that one finds such a quality company with protected boundaries trading at such levels.  There are five companies that dominate life reinsurance globally, and in my opinion, RGA is the best, though they are a close number 2 by most measures of market share.

I don’t like writing about individual companies, because when you are right, one person praises you.  When you are wrong 10 people criticize you.  But for all that I simply say that I am long RGA for myself and my clients.

In general, the higher quality the debt, the lower the yield.  Also, the same applies to maturity for non-callable or prepayable debt.   The longer the maturity, the higher the yield.  This is normal because longer debts are less certain, aside from well-financed governments.

So when the Fed tries to twist the yield curve it is no surprise that that the Treasury curve twists (for now) and the stock market panics.  The Treasury yield anticipates future purchases.  The stock market looks at the recklessness of the Fed, and prices stocks lower.  Prices Yields on low quality bonds go lower as a result.

The Fed is making a lot of noise, but does little for the economy as a whole.  The low interest rates it offers is only valuable to companies that don’t need help — high quality, those that have no difficulty borrowing.  The rich get richer, and the poor get poorer.  That is Fed policy, for now.

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Thanks to wsm for the correction on my piece.  I meant to say prices, not yields, in the last sentence of the middle paragraph.

A friend of mine asked me the following:

I read an article or a comment from a blog that inked to your sight.  the statement was akin to this. ” The market is dead.  The lack of growth over ten years shows the deadness of the market.  If the market had kept pace with inflation over the last ten years it would be at 32,000 not the 11,000 we see today.”

I am not all that concerned that this is a true statement, nor am I convinced that their is any better long term investment then a good market strategy.  but I do not have the wisdom to know how to answer this sort of claim in my mind.

The Other Question also comes from a blog that linked to your site:  http://pragcap.com/the-importance-of-understanding-macro

“Whitney Tilson’s latest monthly letter provides us with some insightful lessons for the current market environment.  Regular readers will know that I believe there is no such thing as a one size fits all investment strategy or a holy grail approach.  Instead, investors must understand the macro environment and apply the correct strategy to fit that particular environment.  That micro approach could involve buy and hold, trading, value investing, etc.  But the likelihood of success using one strategy in all environments is unlikely. The current turmoil and unusual asset class correlation is making for a very difficult environment for value investors.  Tilson explains (thanks to Zero Hedge):”

Later on he states the following: “Value investing might not be dead (it’s certainly not dead for those who have the ability to implement it in the actual way that Warren Buffett implements it – no, not the “buy and hold” myth that Wall Street has sold to everyone), but we can be almost certain that it’s more important than ever to understand the macro.  If there’s one great lesson to learn from the recent turmoil that should be it….”

Is the above author stating the difficulty of being a value investor, or is this a man trying to validate his own lack of plan or strategy in a difficult market?  Besides a difficult month for some value investors what is their augment against it.  Would your “bloodless” strategy of quarterly trading be the answer their the accusation of the “buy and hold myth.”

With respect to the tripling of the index level due to inflation, that seems really high to me, akin to a 10% inflation rate.  I think that government inflation statistics are biased low, but by 1-2%/year not 6-8%/year.

On value investing, I rely on Ben Graham’s dictum that the stock market is a voting machine in the short run, and a weighing machine in the long run.  Periods of high correlation where the voting machine dominates eventually go away, and when they go away the weighing machine comes back and patient holders of cheap quality stocks get rewarded.

Value investing has gone through far deeper periods of underperformance such as the one in the late ’90s where many famous value investors got fired, just before the paradigm was about to shift, and value outpace growth by more than the underperformance.

“Buy and hold” is always lionized in a bull market, and castigated in a bear market.  That’s normal.  I grew up in the ’70s watching Wall Street Week with Louis Rukeyser, and at that time, traders were dominant in a static market.  That was not true in the ’80s and ’90s.

My quarterly trading strategy strikes a balance between too-frequent trading that most mutual fund managers do, and the never trade strategies that those who misunderstand value investing do.  Most investors trade at the wrong times, giving up on a stock merely due to bad performance, or buying because it is fashionable.  But if the business is fundamentally sound, it can be held through periods of weakness, and even add to the position.

That’s what I do, and it has worked well for me.  May it work so well for my clients.

I lead a finance class for church.  I think we have talked of it before.  I do not deal much with investing. Mostly I work with cleaning up the personal finances of the families.  Paying down debt, increasing savings, Setting and living below your income, budget, basic investing, using your tax shelters, and avoiding risky investments.

I have a family who some years ago purchased $8000 worth of Microsoft stock.  This has over the course of their holdings dropped between $8-10 a share.  Their financial situation requires cash, cash they do not have.  They need to pay off debts, and their current income gives them very little wiggle room to pay extra on debts.  They asked me what to do with the Microsoft stock, that is now down about $1500 from when they purchased it.  Microsoft stock has remained at a price of $23-29 a share for over a year now.  with the average being somewhere around $24-27 My thoughts have been: That the stock has corrected for the time being and

$25 is probably the true value.  IF $6500  would make a big diffrence in you budget, let you pay down alot of debt and free up some extra cash in your budget to pay off other debts, then sell the stock now.  $1500 is a cheap price to pay for a not so wise investment decision, if it can be use to improve your overall financial standing.  I told him he might ask his broker to sell as soon as it hits $26.

I have however read that Microsoft is a company that has put up good sales and profits in the past few years and that their stock price might be well undervalued.  should I encourage him to hold or sell.  Not asking you to predict the future, simply wanting to get counsel on the advise I have given.

If you think this is good advice let me know.  He is able to get by without the funds immediately, but it will be best if he sell them and use them eventually.

Microsoft is a test for value investors.  What do you do with a company that is cheap on a price-to-earnings basis, but tends to waste free cash flow on foolish acquisitions, investments, and stock buybacks?  My view is that you reject Microsoft; there are better things to buy.

But what of the decision of Microsoft versus cash?  Look, one of the first principles of investing is never invest what you can’t afford to lose.  If you might need the money to spend in the near term, don’t invest it in stocks.

Reconsider my article, Build the Buffer.  Until someone can meet all cash needs easily, including small disasters, he should not be investing in stocks.

With that, I would say that he should sell the stock to the degree that he needs liquidity.  Ability to pay cash in advance is worth far more than equity market returns.

Comments

• Announces an operation to twist the yield curve, sending the long bond up almost 3% in price.  Also announces the reinvestment of proceeds from Agency Bonds and MBS into more Agency MBS.
• 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 is located.
• 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.
• Still engages in wishful thinking regarding inflation, thinking that it is declining.  Points at energy and commodities, but that’s not the largest part of what drives inflation.
• 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.
• Difficult to tell how much the hawks disagreed with the new “easing tools.”
• The Fed is out of good policy tools, so it will use bad policy tools instead.

Questions for Dr. Bernanke:

• 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 is located?
• 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?
• 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?
• How big is the effect on employment from higher food and energy prices on consumer purchasing power and spending as well as supply chain disruptions associated with the tragic events in Japan?

This will be a short post.  I am not worried about China selling its US Treasury bonds for several reasons:

1. As they sell, the Yuan will rise versus the Dollar, which the Chinese Government does not want. Eventually their exports will fall, as US exports rise.
2. After that, the Chinese Government faces a reinvestment problem.  What do they reinvest in?   The Euro is under threat, the Yen doesn’t want more investors, and the rest of the developed world’s currencies are in the stratosphere.

I think the threat of the Chinese Government to sell US Treasuries is empty.  They can’t do it without hurting themselves significantly.

Options:

• Buy storable commodities, gold? Done that.  Hoard more?  At these prices?
• Switch to other types of debt than government debt? After the brouhaha with Agency debt, I suspect they would be less than willing to wander off the beaten path.  Besides, they are pretty big, and they are dealing with thinner asset classes.  If they have driven up the prices of Treasuries, imagine what they could do to corporates?
• Start buying companies around the globe?  If governments would let them, maybe, but there would be a political stink.
• For a weird idea, China could buy surplus US housing and restore liquidity and collateral levels to a market in oversupply.  After a decade they get out at a profit, probably.

Also, the lower level of liquidity could be an issue if actions need to be taken to recapitalize their banks when the next crop of bad loans has to be reconciled in the next few years.

China’s options for holding the proceeds from its trade surplus are limited.  For all of their deficiencies, US Treasuries are a liquid and deep market.  Chinese exporters benefit from keeping the Yuan weak versus the US Dollar.  I don’t see things changing soon, absent a bolt from the blue.