February 2012 – Page 3 – The Aleph Blog

Sorted Recent Tweets

Posted on 6 February 2012 by David Merkel

Trying a new format here, I think readers will like it better.? Most things are better after additional effort.? Think of this as a news links by subject post.

Economics

If you look in the back, it seems that there were 58 respondents. From page 13: Methodology & Panel Selection Invi? http://t.co/p8sVZl9g Feb 06, 2012
Will the great interest rate gamble pay off? http://t.co/hgj5XSKc People want to believe that you can get something for nothing; ain’t true. Feb 05, 2012
Central Planning at the Federal Reserve http://t.co/X8qmqU6C Fed: we can create prosperity by holding interest rates down, right? $$ #wishes Feb 05, 2012
Labor Force Participation Rate: 28-year Low http://t.co/kLgQ61iK Everyone still happy about the lower unemployment rate? $$ Feb 05, 2012
Bill Gross: Free Money Ain?t Really Free http://t.co/LXWxpxp5 It will lead to stagflation, IMO, depending on what fiscal policy does $$ Feb 05, 2012
Life & Death Proposition http://t.co/XuZS5Snn Where does credit go when it dies? Back where it came. It delevers, slows & inhibits ec growth Feb 02, 2012
US unemployment ?progress? http://t.co/WoIVZPGp If you add back the discoraged workers, all of the improvement in U-3 goes away $$ Feb 02, 2012
The Perniciousness of ZIRP http://t.co/dYlFMbLe Gonzalo Lira on how ZIRP loses effectiveness b/c people think it’ll b there a long time $$ Feb 01, 2012
Why Neoclassical Economics Doesn’t Work In The Age Of Deleveraging http://t.co/D3IAhTyv Steve Keen explains y Krugman & others r wrong $$ Feb 01, 2012
Warning: Goat Rodeo http://t.co/JQ2FV9LS Hussman makes his case that equities are overvalued and could pull back 25% $$ Feb 01, 2012
Who Owns World’s Financial Assets? & Why R US Households So Fascinated W/Stocks? http://t.co/5rp52OM4 American Exceptionalism in investing Feb 01, 2012
As an aside, that is one reason why the US net foreign debt hasn’t spiraled up. We own equities abroad & they own our debt. $$ declines + Feb 01, 2012
$$ declines reduce the value of our debts, but not the value of r foreign holdings. I think the US will come out of this crisis rel well $$ Feb 01, 2012

Housing

Home Prices Tumble http://t.co/N1gdNslr No surprise here with all of the dark supply; houses come onto mkt when ppl can bear loss $$ Feb 01, 2012
Too lazy to be knowns http://t.co/flXRR6fM I know many who understood what would happen if home RE prices fell, but none who got the size $$ Feb 01, 2012
Freddie Mac’s “inverse floater” allowed more loan origination http://t.co/5devKZ17 Other side to the Propublica story http://t.co/KjXJHU1x Feb 01, 2012
I’m no fan of the GSEs; I think they should be abolished, but the GSEs have always made a variety of bets on prepayment over time. $$ Feb 01, 2012

International

On China, Henry Kissinger and Fareed Zakaria see Domestic Tension and Risk of Geopolitical Conflict http://t.co/1bhvrI3U Ferguson is wrong. Feb 05, 2012
Tightening lending standards vary materially across the Eurozone http://t.co/ciWUK9cm Conditions tight in Italy & France, but not Germany $$ Feb 02, 2012
Japan Auto Sales Notch Record Jump http://t.co/0VzF4WST Another small bright spot. Of course, bouncing back from a low level $$ Feb 02, 2012
Socialist Hollande, Who Wants Full European Treaty Renegotiation, Increases Lead Over Sarkozy http://t.co/J3qCpZZ3 Eurozone Wild Card $$ Feb 01, 2012
Hong Kong Homes Face 25% Drop as Loans Fall in Year of Dragon http://t.co/ifg1146H And this is with wealthy mainlanders fleeing China. $$ Feb 01, 2012

Markets

RBC Takes On High Frequency Predators http://t.co/MfA5qdxm Where there is offense, there will b defense; nothing goes unanswered in the mkts Feb 05, 2012
Global Strategists Abandoning Bearish Views http://t.co/dOXCUMA7 Makes me think we r getting close to a turning point. Feb 02, 2012
Dividend stocks: Buyer beware http://t.co/SvMCHtCj Makes the valid & missed point: high qual div paying stocks r stocks & can lose $$ #yeah Feb 01, 2012

Credit

6 High-Yield Canaries-in-the-Coalmine http://t.co/4pz6SSQc 6 reasons y high yield is overheated http://t.co/fKnHmBqD & http://t.co/UPVev0iD Feb 02, 2012
QOTD: Regulators Watching Aggressive Yield Chasing http://t.co/iWimo3eg FINRA warns of undue risk in income seeking. Advisors take note $$ Feb 02, 2012
Contra: The Safest 7% Yield in America http://t.co/VrXoLEFH Poor analysis does not take into account the highish leverage on mtge repo $$ Feb 02, 2012
Shipping Loans Go Bad for European Banks http://t.co/y5Z0wt3R Highly glutted area w/many dead firms walking; how far down will the losses go Feb 02, 2012

Politics

Group lists top stock investments by members of Congress http://t.co/CarxUCjS Top 50 hldgs -> in top 100 cos by mkt cap. Hard2manipulate $$ Feb 05, 2012
Obama Re-Election Odds Versus the Stock Market http://t.co/F5EETcve Example of 2 variables that r correlated b/c they anticipate GDP changes Feb 05, 2012
RE: @abnormalreturns Gold is mostly political philosophy. How much control do you want the government to have over mo? http://t.co/hRxIkaoo Feb 03, 2012
Getting back to the gold standard http://t.co/pCk8Ij6j Gingrich & Ron Paul have said they would like to appoint James Grant as Fed Chairman Feb 02, 2012

Companies

Carlyle’s proposed IPO disaster http://t.co/OqGke8eN So there’s no board. Most boards don’t do much. Mgmt will have no board 2 shield them Feb 05, 2012
For These Fans, a Day With Buffett Offers Wealth of Photo Opportunities http://t.co/UpcwVKe7 I think Buffett is enjoying life more now. Feb 05, 2012
Buffett Railroad Boosts Capital Plan to $3.9B http://t.co/9XEw2gyT Buffett changes; organic investment in capital-intensive biz $$ #olddog Feb 01, 2012
Pep Boys Seen Gaining 27% as Cheapest Value Lures Bids http://t.co/GyfH7qRL Could a bidding war start? Company is undermanaged $$ Feb 01, 2012
Jefferies Allows Bonus Recipients to Swap Stock 4 Cash With 25% Discount http://t.co/pfGB3Vmc Fair way2 let employees disconnect from $JEF Feb 01, 2012

Financial Services

I’ve just started “Acts of God and Man,” by Michael Powers. In the intro, he goes through the various meanings of th? http://t.co/tX7uAlWl Feb 05, 2012
When evaluating Investment Funds, use Dollar-weighted Returns http://t.co/N5g7PI0d This is a neglcted concept that is enjoying a rebirth $$ Feb 02, 2012
After a Delay, MF Global?s Missing Money Is Traced http://t.co/4s6U8yOe Investigation moves to how to recover the $$ and who is at fault. Feb 01, 2012
http://t.co/wBbJTe3D FINRA Alert: Do you use complex products? What additional work do you do 2 assure that they are being used properly? $$ Feb 01, 2012
Banks Need Higher Interest Rates to Start Making Money http://t.co/SneRACCi Flat front end of yield curve squishes bank interest margins $$ Feb 01, 2012
401(k) Plans Step Into the Sunshine http://t.co/fvKeup2L But as with DB plans, as costs rise, companies will offer them less. $$ Jan 31, 2012

Value Investing

The SEC’s “90% Convergence” Fantasy http://t.co/bkWaAS5S US GAAP has many flaws, but we know them. IFRS will introduce abusable flexibility Feb 02, 2012
But on the bright side, value investors may do relatively better as financials become less trustworthy; the accruals anomaly will sing $$ Feb 02, 2012
Need to consider (Cost of goods sold)/user $$ RT @ErikSchatzker: Facebook gets $4.39/yr of revenue per user. ESPN gets $4.69/mo. Feb 02, 2012
Berkowitz: Fund Plunge ?Makes Little Sense? http://t.co/pcoPLahW BB, appoint someone in your group 2 seek out opinions contrary 2 yours $$ Feb 01, 2012
@ADayforRabbit I have argued in the past that BB is not paying attention to the delevering, which is a real headwind for the banks. $$ Feb 02, 2012
New Fund Hopes to Prove Outspoken Analyst?s Thesis http://t.co/cuVpRzvO I bet @rcwhalen does well like my friends @ Hovde or M3 Partners $$ Feb 01, 2012

Hedge Funds

Are Hedge Funds Worthwhile Investments? http://t.co/Lw2EhRPr Yet another “Hedge Fund Mirage” citation; the book is having a lot of influence Feb 02, 2012
Are the hedge fund and private equity boys pulling a fast one? http://t.co/TNXFJo62 Beginning 2c the args of “Hedge Fund Mirage” everywhere Feb 02, 2012
Did Hedge Funds Trigger the Financial Crisis? http://t.co/lNIb2dgF Secured asset classes can be overlevered; when they collapse, big mess $$ Feb 01, 2012

Miscellaneous

Do the Job You’re Meant to Do http://t.co/wR3OX20N LIfe is too short to work with people you don’t respect, or tasks unfit for you $$ Feb 02, 2012
Millionaire adopts girlfriend as daughter http://t.co/zffGCWbu Asset shelter. Does incest rely on consanguinity or on legal relationship? Feb 02, 2012
Charles Murray Reiterates Willpower http://t.co/smeXZKNh Lack of self-control can destroy relationships, jobs, firms & lives $$ Feb 02, 2012
I ran into @twitalyzer today. Lots of interesting analytics for tweeting. Here are some for me: http://t.co/HDdcFYaU & http://t.co/8uFFOMuP Feb 01, 2012
At the first blogger summit at the UST, I recommended to the powers that be that they issue floaters. I also recommen? http://t.co/R3U8OHSi Feb 01, 2012
California Faces Cash Shortfall by March on Low Receipts, Controller Says http://t.co/QxH1a6Re Could be interesting given the elections $$ Feb 01, 2012

Against Risk Parity

Posted on 4 February 20125 February 2012 by David Merkel

Many investment ideas are promising so long as few do them.? Yes, there is an opportunity, but it is limited.? “Shh, don’t tell everyone about it.”

Thus, the concept of “risk parity.”? Lever every asset class up until it has the same volatility as common stocks. Under theoretical conditions, one could make extra money doing this, and with less risk than just a common stock portfolio.

That makes sense when few are doing it, but not when many are doing it.? When I worked for Hovde Capital Advisors, I highlighted to the group how hedge funds were forcing every asset class to the same level of riskiness.? A Grants Interest Rate Observer article on Leveraged Non-prime Commercial Paper is etched on my mind as emblematic of that era.

Risk parity can work so long as the total riskiness of the system does not get too high, as it did in 2007-8.? But if it does get too high, the assets that are levered face disadvantages versus volatile unlevered assets.? Failures of leverage feed on themselves, and lead to a real washout.? Failures of growth stocks don’t do that to the economy.

Risk parity turns managers into bankers, or worse yet, asset managers that specialize in non-AAA investment grade portions of structured securities deals.? Most asset managers are not used to thinking like bankers, largely because they think in terms of total return, and because they don’t have a balance sheet.? Their capital can run at will, unlike banks that have deposit stickiness, savings accounts, CDs, ability to borrow from the FHLBs, etc.? The banks can hold the assets to maturity, they have a buffer against losses in their capital, and don’t have to mark to market in an assiduous manner (though they *should* have to do so).

Think of the mortgage REITs in the most recent crisis — the ones that did the best were the least levered and had the longest terms for their repo lines.? In the short run, that costs more than the vain idea that one can roll over their repo lines every night, and that repo haircuts won’t rise.? Crises lead to a failure of both ideas, together with a set of forced sellers driving down the price of assets being repo-ed, which sometimes leads to a cascade where repo terms get progressively tighter, and only those that were the most conservative at the start of the crisis survive.

There is a Wall Street aphorism, “The fool does at the end of a bull market what the wise man does at its beginning.”? Risk parity falls into that bucket.? Early adopters of new asset classes and liability structures typically do well, but when they become mainstream, the dynamics can be ugly, as we learned in 2007-present.

So ignore the idea of risk parity.? Risk managers are not bankers, they don’t have the capacity to play leveraged spread games to maturity.? Risk parity if practiced on a large scale will produce wipeouts akin to the recent crisis.

Industry Ranks February 2012

Posted on 4 February 2012 by David Merkel

I?m working on my quarterly reshaping ? where I choose new companies to enter my portfolio.? The first part of this is industry analysis.

My main industry model is illustrated in the graphic.? Green industries are cold.? Red industries are hot.? If you like to play momentum, look at the red zone, and ask the question, ?Where are trends under-discounted??? Price momentum tends to persist, but look for areas where it might be even better in the near term.

If you are a value player, look at the green zone, and ask where trends are over-discounted.? Yes, things are bad, but are they all that bad?? Perhaps the is room for mean reversion.

My candidates from both categories are in the column labeled ?Dig through.?

If you use any of this, choose what you use off of your own trading style.? If you trade frequently, stay in the red zone.? Trading infrequently, play in the green zone ? don?t look for momentum, look for mean reversion.

Whatever you do, be consistent in your methods regarding momentum/mean-reversion, and only change methods if your current method is working well.

Huh?? Why change if things are working well?? I?m not saying to change if things are working well.? I?m saying don?t change if things are working badly.? Price momentum and mean-reversion are cyclical, and we tend to make changes at the worst possible moments, just before the pattern changes.? Maximum pain drives changes for most people, which is why average investors don?t make much money.

Maximum pleasure when things are going right leaves investors fat, dumb, and happy ? no one thinks of changing then.? This is why a disciplined approach that forces changes on a portfolio is useful, as I do 3-4 times a year.? It forces me to be bloodless and sell stocks with less potential for those with more potential over the next 1-5 years.

I like some technology names here, some energy some healthcare-related names, P&C Insurance and Reinsurance, particularly those that are strongly capitalized.? I?m not concerned about the healthcare bill; necessary services will be delivered, and healthcare companies will get paid.

A word on banks and REITs: the credit cycle has not been repealed, and there are still issues unresolved from the last cycle ? I am not interested there even at present levels.? The modest unwind currently happening in the credit markets, if it expands, would imply significant issues for banks and their ?regulators.?

I?m looking for undervalued and stable industries.? I?m not saying that there is always a bull market out there, and I will find it for you.? But there are places that are relatively better, and I have done relatively well in finding them.

At present, I am trying to be defensive.? I don?t have a lot of faith in the market as a whole, so I am biased toward the green zone, looking for mean-reversion, rather than momentum persisting.? The red zone is pretty cyclical at present.? I will be very happy hanging out in dull stocks for a while.

P&C Insurers and Reinsurers Look Cheap

After the heavy disaster year of 2011, P&C insurers and reinsurers look cheap.? Many trade below tangible book, and at single-digit P/Es, which has always been a strong area for me, if the companies are well-capitalized, which they are.

I already own a spread of well-run, inexpensive P&C insurers & reinsurers.? Would I increase the overweight here?? Yes, I might, because I view the group as absolutely cheap; it could make me money even in a down market.? Now, I would do my series of analyses such that I would be happy with the reserving and the investing policies of each insurer, but after that, I would be willing to add to my holdings.

Do your own due diligence on this, because I am often wrong.? One more note, I am still not tempted by banks or real estate related stocks.? I am beginning to wonder when the right time to buy them as a sector is.? As for that, I am open to advice.

Implications

So, given that the Industry Rank categories above come from Value Line, I went to their stock screener, selected the industries, and asked for all of the companies that:

are in their top 5 (of 9) categories for balance sheet strength, and
their horribly overworked analysts think can return at least 15%/yr over the next 3-5 years.

This combines safety, growth potential, valuation, and in my view, how promising industry prospects are.? Here are the results:

ABC ADM ADTN AKAM ALL AMAT AMX AOL APOL ARB ARRS BIDU BRKR BX CAH CBEY CECO CELL CKP CL CNQ CPB CPSI CREE CTRP DNR DRIV DV EBAY EDU EFX ERIC ESI FST GMCR GOOG HCC HRC IN INFA INTC ISIL ITRI IVC JNPR K KKR KR LIFE LRCX LTRE MASI MCHP MDCI MKC NFLX NIHD NILE NOK NTRI NVDA NXY ONNN OTEX QGEN QLGC QSII RAX RIMM RMD SHEN SOHU STM STRA SWKS SWY SYY T THG TMO TNDM TRH TRI TSM TSRA TUP TXN UNTD UPL UTHR VOD VOLC VZ WBMD WBSN YHOO ZBRA

When I do my next portfolio reshaping for clients in the next week or so, these stocks (and a few others) will compete against the 35 existing portfolio names for the 34-36 slots in the portfolio.

Full disclosure: Long HCC, INTC, THG, VOD

We Eat Dollar Weighted Returns — III

Posted on 2 February 2012 by David Merkel

Somebody notify the Bogleheads, they will like this one, or at least Jack will.? Yo, Jack, I met you over 15 years ago at a Philadelphia Financial Analysts Society meeting.

How bad are individual investors? at investing?? Bad, very bad.? But what if we limit it to a passive vehicle like the Grandaddy of all ETFs, the S&P 500 Spider [SPY]?? Should be better, right?

I remember a study done by Morningstar, where the difference between Time and Dollar-weighted returns was 3%/year on the S&P 500 open end fund for Vanguard, 1996-2006.

But here’s the result for the S&P 500 Spider, January 1993- September 2011.? Time-weighted return: 7.09%/year.? Dollar-weighted: 0.01%/yr.? Gap: 7%/yr+

Why so much worse than the open-end fund?? Easy.? Unlike the professional managers at Vanguard, and the relatively long term investors they attract, the retail short term traders of SPY trade badly; they arrive late, and leave late on average.

There is far more analysis to be done here, but to me, this confirms that Jack Bogle was right, and ETFs would be a net harm to retail investors.? The freedom to trade harms average investors, and maybe a lot of professionals as well.? It may also indicate that short-term trading as practiced by technicians may underperform in aggregate.? Not sure about that, but the conclusion is tempting.

One thing I will say: I am certain that profitable trading is not easy.? If you are tempted to trade for a living, the answer is probably don’t.

Anyway, here’s my spreadsheet on the topic:

Full disclosure: I have a few clients short SPY, hedged against my long positions.

A Book on Value Investing

Posted on 1 February 20121 February 2012 by David Merkel

A medium-sized publisher has approached me to write a book on value investing.? I might do it, or I might not.? I also might try to do it with another publisher, or I might do it through Amazon.? I solicit advice from my readers on the prospect.

Anyway, I thought about what the book might look like, and to do so, I went through the entirety of my Value Investing category, and my page called Major Article List,? which described my best articles from my RealMoney days.

What you will see after this is less than a first draft of chapters.? I plan on categorizing it and simplifying, but here it is for now:

Bonds
Use of cash ? buybacks, dividends, strategic use, delay
Valuation
Cycles
On being wrong ? planning for failure
On financial companies
Growth expectations
Following leaders vs surfacing your own ideas; who are you playing with/against?
Weighing vs Voting
Use of free cash by management
Avoid buggy whips
Industry analysis and economic sensitivity
Embrace trends, resist trends
Take prudent risks
Three year horizon
Understand balance sheets; quality, anomalies
Management incentives
Discipline: tie your hands, do something, but don?t react; you are you own worst enemy
Risks, not risk
Markets are mostly, but not entirely efficient
Margin of safety
Diversify, but not too much
Safe assets and Risk assets
Avoid complexity; embrace complexity
Sum of the parts
Realistic expectations
On shorting
Ask the opposite question
Rank your ideas
No, macroeconomics *does* matter

This could be one, two or three books depending on me and the goals of the publisher.? As I read through my blog, I realized that I wrote a lot more about value investing at the beginning of this blog.? I think the crisis caused me to shift.

But as I went through what the book could look like, I got more excited about it — there is a lot of potential here to explain value investing in a comprehensive? way to readers.

PS — Any publisher contacts that you want to share are appreciated.? Thanks to those who have given me advice so far.