The Aleph Blog » 2012 » September

Archive for September, 2012

Sorted Weekly Tweets

Friday, September 28th, 2012
  • My week on twitter: 34 retweets received, 1 new listings, 33 new followers, 40 mentions. Via: Sep 27, 2012




  • Natural Gas Cars Are On The Road; Potholes Remain Optimistic that CNG & LNG will get enough distribution 2b viable $$ Sep 29, 2012
  • United Airlines will study Delta’s refinery bid This will not end well; fundamentally different businesses $$ $UA $DAL Sep 29, 2012


Rest of the World


  • Japan Data Show Recession Risk Growing “Find someone who is optimistic about the economy & ask them how they can b” Sep 29, 2012
  • Shanghai Bonded Copper Stocks May at Record, Survey Shows Glut of gluts, what will China do with a flat economy? $$ Sep 28, 2012
  • Toyota Unplugs Electric Car Hype Indeed it is hype, better 2 run cars on Natgas or gasoline $$ less waste 4 now Sep 28, 2012
  • China Bankrolling Chavez’s Re-Election Bid With Oil Loans China wants oil, Chavez wants $$ , a match made in… Sep 28, 2012
  • SNB Disputes S&P Estimate of Bond Purchases Well of course they would dispute it, harms their policy credibility $$ Sep 28, 2012
  • Spanish Bonds Slump as Marchers Plan Further Protests Eurozone is a political construct, will agreement persist? $$ Sep 28, 2012
  • Why Asian Airlines Reign Supreme It is amazing how great service drives the rankings $$ Sep 28, 2012
  • The real extent of China’s economic hard landing By one measure, China’s real GDP growth rate is 1.6% $$ Sep 24, 2012
  • Is China Burning? China stirs up anti-Japanese hatred to divert attention away from the weakening economy $$ Sep 24, 2012
  • India Bids for ConocoPhillips Assets in Canada Spidey sense says India will get the worse of it $$ FD: + $COP Sep 24, 2012
  • Aussie Debacle Flags China Hard Landing as Iron Market Melts China sneezes, the Australians catch a cold $$ Sep 24, 2012
  • How weak must the Danish economy be, for them to do this? Are their banks in that bad of a shape? $$ Sep 24, 2012


Credit Markets


  • Junk Bonds in US Poised for Biggest Retreat in 4 Months 2 early 4 a washout; no significant defaults on the radar $$ Sep 29, 2012
  • U.S. 30-Year Mortgage Rates Fall to Record Low of 3.4% Those that r not inverted can refinance; tough 4 rest $$ Sep 28, 2012
  • Mortgage-Bond Spreads Cap Biggest Weekly Drop Since December ’08 Anticipates Future Fed buying, doesn’t help much $$ Sep 22, 2012

Central Banking


  • Money For Nothing: Inside the Federal Reserve Independent, non-partisan, non-conspiracy-theorist documentary comingsoon Sep 29, 2012
  • Bernanke Put: Beware of Easy Money The lure of free money brings out the worst in all of us. $$ Sep 28, 2012
  • Plosser Says QE3 Risks Fed Credibility, Won’t Boost Jobs Right; once we r @ the zero bound the Fed is impotent $$ Sep 28, 2012
  • Fed Helps Lenders’ Profit More Than Homebuyers Offering 2buy RMBS benefits existing holders more than anyone else $$ Sep 28, 2012
  • Sean Fieler: Easy Money Is Punishing the Middle Class Who gets benefits of productivity improvement? Ppl or Govt $$ Sep 28, 2012
  • A time of hoarding and inflation fears, 1930s edition @izakaminska tells us about inflation worries in the 1930s $$ Sep 25, 2012
  • Signs Of The Gold Standard Are Emerging From Germany Not likely; would be interesting 2c Germany go Euro -> Gold $$ Sep 24, 2012
  • ‘Free’ Checking Costs More Another casualty of Fed policy, which disproportionately hurts those less-well off $$ Sep 24, 2012


US Politics


  • U.S. Unease Over Drone Strikes This is yet another reason y much of the Muslim world hates the US $$ Sep 28, 2012
  • US Ties Libya Attack to ‘Powder Keg’ in Mali When did the Obama administration know this, y wasn’t it disclosed? $$ Sep 28, 2012
  • Ryan at the AARP He didn’t trim his ideas and still won applause. AARP leaders more liberal than members $$ Sep 24, 2012


Market Dynamics


  • Where stock market will be in fall of 2016 Seiver’s model indicates a flat market for the next four years $$ Sep 29, 2012
  • Wrong: An Easy Strategy For Bulking Up On Yield Better to buy companies w/strong dividend capacity than high divs $$ Sep 28, 2012
  • New Wave of Workers Tries Novel Approach: Save More Everything old is new again; save $$, do not rely on returns Sep 28, 2012
  • Ken Fisher: Bull Market Is Halfway Done I am a moderate bull now, but I find that large cap leadership could fail. $$ Sep 28, 2012
  • Are financial advisers worth their fee? Gamma: value of protecting an individual from buying high & selling low $$ Sep 28, 2012
  • Prospects for Stock and Bond Returns Are Dim The performance difference will depend on inflation vs deflation $$ Sep 24, 2012
  • Pension Crisis Looms Despite Cuts Eventually state constitutions will be amended 2 roll back existing benefits $$ Sep 22, 2012
  • Borrowing Against Yourself Debt against investments is usually a bad idea unless ur a specialist in the business $$ Sep 22, 2012




  • Auto-Insurance Cost to Rise 2.8% to $839, Group Says Insurance companies pass costs & reduced interest through $$ Sep 28, 2012
  • Scientific Reproducibility: Begley’s Six Rules Following the 6 rules would reduce the # of articles published $$ Sep 28, 2012
  • Gordon Moore’s journey Long Q&A w/a founder of Intel; An accidental entrepreneur who knew his weaknesses $$ FD: + $INTC Sep 24, 2012
  • Bronte Capital’s short waves Do not underestimate John Hempton; bright guy. Very good @ spotting bad ideas/frauds $$ Sep 22, 2012
  • Yale Versus Norway Worth a read. My sympathies r w/Norway here, but I fear they r tooting their horn @ a bad time $$ Sep 22, 2012
  • Cheating Upwards Children r less ethical now than 35 years ago, who were less ethical than 35 years ago, who were… $$ Sep 22, 2012
  • Push to Let College Students Carry Guns Picks Up Steam Who is responsible for my protection? Me or the Govt? Me $$ Sep 22, 2012
  • How to Stop Hospitals From Killing Us Should b known: going 2a hospital can kill you. 6th leading cause of death $$ Sep 22, 2012




  • @AOverheard Could b a good move, would have to review the Stat statements. I sold my shares at a split-adjusted $290. Buying debt:no-brainer Sep 29, 2012
  • @historysquared In the process of raising 8 children (5 adopted) I have seen 1) those w/limited abilities expand them 2) those w/great + Sep 29, 2012
  • @historysquared abilities waste them. 3) those w/great abilities improve them, & 4) those w/limited abilities improve only a little Sep 29, 2012
  • @groditi Of all the companies that I own $SPLS worries me the most. Stronger than bricks & mortar competitors, but can they beat $AMZN? $$ Sep 28, 2012
  • @munilass I think both of those insights r correct; algorithms r only as good as the problems they r applied 2; most people don’t like logic Sep 28, 2012
  • RE: @bloombergview Well reasoned.  No arguments here. $$ Sep 26, 2012
  • RE: @bloombergview “Luck” happens when preparation meets opportunity, There are exceptions like Sixto in South Africa… Sep 26, 2012
  • @volatilitysmile All financials, or just depositary financials… would agree if it is the latter. Sep 25, 2012
  • @pjackson @LaurenLaCapra @_tpr @japhychron As an example, consider the tax reform act of 1986; almost all tax preferences lost. $$ Sep 25, 2012
  • @pjackson @LaurenLaCapra @_tpr @japhychron Or prepare for the day of the “grand bargain” where everyone’s ox is gored 4 the good of all $$ Sep 25, 2012
  • @pjackson @LaurenLaCapra @_tpr @japhychron I think you have to plan for the day of crisis, so that you can be ready to say, “Do this.” $$ Sep 25, 2012
  • @MerrittJennifer @LaurenLaCapra It would not be immediate, but housing prices would fall, & so would refinancing $$ Sep 25, 2012
  • @pjackson @LaurenLaCapra @_tpr @japhychron Lauren asked what we would do, not what was possible. Only a crisis will see actions taken $$ Sep 25, 2012
  • @japhychron @LaurenLaCapra @_tpr so that Medicare covers less: cheap fixes & palliative care; state rtees: deal to reduce all benefits $$ Sep 25, 2012
  • @LaurenLaCapra @_tpr @japhychron Hard to fit into a tweet; phase out GSEs & Int ded, shrink FHA, ag lending, scale back SS, redo Medicare + Sep 25, 2012
  • @LaurenLaCapra @_TPR @japhychron Ultimate Q is how many things we *can/should* subsidize, particularly w/GSEs, entitlements, state rtee bens Sep 25, 2012
  • RE: @bloombergview When the government or Fed buys the securities of companies, it plays favorites. We should make th… Sep 24, 2012
  • @GregorMacdonald Re: gold, have u seen this? Re: solar, have u seen this? Wonder what it costs? Sep 22, 2012
  • @abnormalreturns Stocks r correlated w/inflation expectations. Gold is negatively correlated w/real rate of interest. Facts. $$ Sep 22, 2012
  • @etpxp Hard to do a real test. Sep 22, 2012




  • In praise of all-cash compensation. RT @EpicureanDeal: Defending the Indefensible featuring @LaurenLaCapra Obvious $$ Sep 22, 2012
  • RT @volatilitysmile: “a failed president is running slightly ahead in the polls of a challenger who has a real CV but is so politically … Sep 24, 2012
  • At low OASs?! No $$ RT @PIMCO: Gross: How many Treasuries you own is not the question. How many 3 and 3.5% 30 year mtges is. Own mortgages Sep 24, 2012


Book Review: The Value Investors

Thursday, September 27th, 2012

Value investing shares several attributes which are mentioned in the final chapter of this fine book:

  • Humility in portfolio construction.
  • Valuation, though difficult, is important.
  • Good value investors read widely.
  • It’s not just math, but understanding competitive advantage.
  • Having a good sell discipline.
  • Having the right attitude in investing

This book examines 12 men in 10 organizations who are value investors.  As noted above there are common elements to value investing, but in the minor aspects, there are many different ways to pursue the topic.

Some diversify more; some less.  Some are more quantitative, some are more qualitative.

Now the fun of a book like this is that there are faces old and new, at least for me.  I knew of:

  • Walter Schloss
  • Irving Khan and his son Walter Khan
  • William Browne
  • Jean-Marie Eveillard
  • Mark Mobius
  • Shuhei Abe of SPARX Group (Japan)

But I did not know of:

  • Francisco Garcia Parames (Spain)
  • Anthony Nutt (England)
  • Teng Ngiek Lian (Singapore)
  • V-Nee Yeh & Cheah Cheng Hye (Hong Kong)

What impresses me is that among many different sub-approaches, approaching the stock market like an intelligent businessman works no matter where in the world you are, so long as it is subject to the rule of law.

I particularly enjoyed the biographical information about these men.  Many of them were good businessmen in onther industries before they began to do investing.  Their experiences in operating a business informed that way that they invest — think of stocks as fractional ownership in a business, and ask whether it is an attractive opportunity or not.



Who would benefit from this book:   All those exploring value investing would benefit from this work.  Those the know the topic well already can disregard it.  If you want to, you can buy it here: The Value Investors: Lessons from the World’s Top Fund Managers.

Full disclosure: The PR flack sent me a copy of the book after asking me if I wanted 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.

Too Much Investment

Monday, September 24th, 2012

Investment is usually a good thing, but it can be overdone.  How?  Let me list some of the examples:

  • China has overinvested in export industries, infrastructure, and housing, among other things at present.
  • The US and most of the developed world overinvested in housing, or at least, borrowed too much against it.  The same applies to the banking, investment banking and shadow banking industries.
  • The US invested too much in internet companies in the late 1990s.
  • The US invested too much in commercial real estate in the late 1980s
  • Japan overexpanded its heavy industries and real estate in the late 1980s.
  • Some invested too much in gold in the late 1970s.
  • Most developing nations invested too much money in national industrial champions for the purpose of import substitution in the 1960s-80s.
  • Banks lent too much to developing countries in the 1970s
  • The US put far too much money into growth stocks in the 1960s.
  • The Soviet Union continually overinvested from the 1960s until the 1980s.
  • People in the US put too much money into speculative investments in the 1920s.

If I really wanted to I could expand this list a great deal.  Almost every boom involves overinvestment, and often too much debt finance.  The above  are mostly macro examples of overinvestment, but it happens on the micro level as well.

  • People who are determined to get rich at all costs and lose in the process
  • People who are determined to get rich at all costs and win in the process, but lose many of the good basic things of life — family, friends, and deny themselves the enjoyment of their wealth.
  • Growth companies that invest in low ROE ventures rather than return cash to shareholders.
  • Growth companies misestimate more, and take chances that are not economic.
  • Companies that try to grow faster than their markets without a sustainable competitive advantage usually fail miserably.

It happens with governments as well, where they recharacterize spending as investment.  One particular example would be education, where little improvement comes from additional dollars spent.  Far better to move the curriculum back 60 years, and have students learn the basics.  More money is not needed; a better parenting culture is needed, plus a scope & sequence that is realistic in its pedagogy.

Fast growth is often bad growth if the return on equity for new investment is falling.    That means that the carrying capacity of the current strategy is being exhausted.  It is even worse for central planners, who don’t have good data and keep throwing money at projects with little idea of the true effectiveness.

In vestment is a good thing when it serves an area of scarcity.  It is a bad thing when it serves an area of glut.  That’s the simple summary.  I may expand on this in a future article.

Industry Ranks September 2012

Saturday, September 22nd, 2012

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, 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.

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.

That said, dull is hard to find these days.  Where will demand remain strong, or where will demand rebound are tough questions.

The Red Zone has a Lot of Noncyclicals

What I find fascinating about the red momentum zone now, is that it is laden with noncyclical companies.  That said, it has been recently noted in a few places how cyclicals are trading at a discount to noncyclicals at present.

So, as I considered the green and red zones, I chose areas that I thought would be interesting.  In the red zone, I picked energy services, and very basic goods.

In the green zone, I picked more than half of the industries.  If the companies are sufficiently well-capitalized, and the valuation is low, it can still be an rewarding place to do due diligence.

That said, it is tough when noncyclical companies are relatively expensive to cyclicals in a weak economy. Choose your poison: high valuations, or growth that may disappoint.

But what would the model suggest?

Ah, there I have something for you, and so long as Value Line does not object, I will provide that for you.  I looked for companies in the  industries listed, but in the top 4 of 9 financial strength categories, an with returns estimated over 15%/year over the next 3-5 years.  The latter category does the value/growth tradeoff automatically.  I don’t care if returns come from mean reversion or growth.

But anyway, as a bonus here are the names that are candidates for purchase given this screen.  Remember, this is a launching pad for due diligence.

Full disclosure: long for me and clients: HPQ, INTC, CSCO, TEL


Sorted Weekly Tweets

Saturday, September 22nd, 2012

Federal Reserve Policy / Treasury Yields


  • Great Tips-pectations Future inflation expectations are rising. Twenty year TIPS are flat to expected CPI $$ Sep 22, 2012
  • ‘Titanic battle’ over deflation about to sink long bonds: Gross Didn’t he say this in 2011 & lose? Try, try, again? $$ Sep 22, 2012
  • Lacy Hunt at Hoisington called the trajectory on Treasury yields years ahead of time. Sep 21, 2012
  • Former FDIC chairman Sheila Bair: TARP wasn’t necessary Would have been better to let stockholders get wiped out $$ Sep 20, 2012
  • Fed’s Fisher Says U.S. Inflation Expectations Rising Definitely: QEternal moved the TIPS $$ Sep 20, 2012
  • Stephen Roach: Fed’s Asset Purchases Are A ‘Charade’ QE is a theory that has no successes; Y does anyone believe it? $$ Sep 20, 2012
  • No Exit in Sight from Fed’s Bond Buying: Gundlach It will be very difficult 4 the Fed 2 exit from their “stimulus” $$ Sep 20, 2012
  • The Road to Recovery John B. Taylor is the man who should have been our Fed Chairman, unlike the pretender Bernanke $$ Sep 18, 2012
  • Fed’s ‘QE Infinity': 4 Things That Could Go Wrong Moral Hazard4Washington &Wall St, Hurting Confidence, May not work $$ Sep 16, 2012
  • Bernanke’s Battle for Jobs Eclipses Inflation Concerns How QE-inf will produce jobs is a mystery; OTOH stagflation $$ Sep 16, 2012
  • Mortgage-Bond Spreads Fall to Record Low as Fed Starts Buying Fed breaks agency RMBS mkt; some OASs drop to zero $$ Sep 16, 2012


Credit Markets


  • Credit rollovers & rally monkeys Feels like 2005 in corporates, but w/easier money, & fewer securitizations $$ Sep 22, 2012
  • Company bond sales in US in Sept-12 total >$135.8B, fastest pace 4 any September & exceeds $124.6B sold in Sept-09 $$ Sep 21, 2012
  • Private Debt Is Crippling the Economy Deleveraging has not taken place 2 the degree needed 2make the economy healthy $$ Sep 20, 2012
  • Risk Aversion Falls to Lowest Level in 2 Years When risk measures r low, it is time to start being conservative. $$ Sep 18, 2012
  • Junk-Bond Yields Drop Below 7% for First Time, Index Data Shows This is significant. Watch 4 leverage 2 grow $$ Sep 18, 2012
  • ETFs Overtaking Swaps for Junk-Bond Speculation If this continues, I suspect it will lead 2 ETF underperformance $$ Sep 17, 2012
  • Cheaper Student Loans. Who Knew? About 2.6% of all borrowers—are using income-based repayment $$ 15%, 15 years Sep 17, 2012


Rest of the World


  • China Slowdown Seen Longer Than in Crisis by State Economist Will take a while reconcile a decade of malinvestment $$ Sep 21, 2012
  • Japan launches QE8 as 20-year slump drags on Poster child 4 the efficacy of unlimited QE 4 economic stimulation $$ :( Sep 20, 2012
  • In Spain, economic crisis fans Catalan separatism Good for them & may they create their own currency & not the euro $$ Sep 20, 2012
  • Deposit Flight From Europe Banks Eroding Common Currency Wouldn’t u withdraw deposits from Greek & Spanish banks? $$ Sep 20, 2012
  • Missed Chances Stoke Skepticism Over EU’s Crisis Fight Works other way: earlier the break-up, smaller the damage $$ Sep 20, 2012
  • Sword-Bearing Islamist Signals Peril 4 Arab Democracies “Islam is a religion of peace” Overheard in a DC bar $$ Sep 20, 2012
  • EU Track Record Casts Doubt on Crisis Fight as Draghi Rally Ebbs You can’t solve debt problems with more debt $$ Sep 19, 2012
  • Europe Takes On Gazprom at Last, Now Must Hang Tough New delivery methods & supplies lessen need 4 Russian natgas $$ Sep 19, 2012
  • Europe Banks Fail to Cut as Draghi Loans Defer Deleverage Same thing for the Fed. $$ policy inhibiting delevering Sep 19, 2012
  • Kaiser’s Postulate: Bringing Free Market Economics to South America Brings an Austrian perspective 2 S. America $$ Sep 18, 2012
  • US military suspends combat patrols with Afghan forces In this chess game, there are some pieces that r gray. $$ Sep 18, 2012
  • A little problem of maturity mismatch Many Chinese firms have financed long assets w/short debt. But how big is it? $$ Sep 18, 2012




  • The guys at LTCM weren’t that good w/math. Part of being an applied mathematician is knowing limitations of your models Sep 21, 2012
  • July 2012 severe enforcement actions; Capital One units pick up 3 Interesting improving graph: $$ Sep 20, 2012
  • Microsoft, HP skirted taxes via offshore units: Senate panel What u get 4 creating a complex tax code. FD: + $HPQ $$ Sep 20, 2012
  • Bored? Consider this Total risk-taking value play FD: + $TOT very diversified geographically, seems cheap $$ Sep 20, 2012
  • Insurers are middlemen. They just pass the costs on. They have no need to do climate research. $$ Sep 20, 2012
  • Dow Corning Offers Workers Cold Showers w/Bugs to Build Sales Fascinating tales of voluntary adventures @ Dow Corning Sep 18, 2012




  • Welfare Reform as We Knew It Inside the Obama work waiver: It’s worse than Romney says. $$ Sep 20, 2012
  • Tortoises Manhandled for Solar Splits Environmentalists Solar works well in sunny deserts: solar or tortoises $$ Sep 20, 2012
  • Why the Current Account Deficit Helps Explain the Economics of QE3 Explains similarities between CA deficit & QE-inf $$ Sep 19, 2012
  • Don’t Stick Taxpayers With Underfunded Corporate Pensions Against the liberalization of DB plan funding rules Sep 19, 2012
  • Snip, snip, snip. Cutting up AARP membership cards. The Baby boomers ask for too much through Social Security & Medicare. $$ snip, done Sep 19, 2012
  • Should the Eligibility Age for Medicare Be Raised? Yes, & by more than the suggestions in the article $$ Sep 19, 2012
  • Election Uncertainty Raises Odds Of Fiscal Cliff Regardless of who wins, there will be gridlock. $$ Sep 18, 2012
  • Harry Reid Has a Glass-House Quandary on Taxes Let Congress begin doing detailed disclosure of their taxes $$ Sep 17, 2012




  • Gold shines & $$ Sep 21, 2012
  • Big Data Upends the Way Workers Are Paid Basic kindness & fairness goes a long way in retaining competent staff $$ Sep 20, 2012
  • Do New Job Tests Foster Bias? Maybe, but it does prevent many good people from getting hired. Ppl >> algorithms $$ Sep 20, 2012
  • Harvard Losing Out to South Dakota in Graduate Pay Economics is relative; different things r valuable @ diff times $$ Sep 19, 2012



  • Farmer’s Daughter Haugerud Reaps Riches on Drought-Struck Corn Know I’ve read about her b4, can’t remember where $$ Sep 20, 2012
  • For Superfast Stock Traders, a Way to Jump Ahead in Line This is important & may explain HFT & its profitability $$ Sep 19, 2012
  • Fidelity’s Abby Johnson faces challenges on many fronts Fidelity not just mutual funds but retirement plan services $$ Sep 17, 2012
  • When Playing It Safe Means Taking On More Risk Safety is a function of price paid vs value & intrinsic solvency $$ Sep 16, 2012



  • 6 Reasons Why Evolution Isn’t A Sure Thing 7. Which evolution r u talking about? Many versions, low agreement btw them Sep 20, 2012
  • Heavy rain in Baltimore now; supporting efforts to ship it to the Midwest $$ Sep 18, 2012



  • RE: For areas where there is significant data, they do research. Lots of it.  The models are huge and complex. The e… Sep 21, 2012
  • .@OVVOFinancial Part of what I am saying is economists don’t understand macro well. Free lunches rarely emerge; hard2remove accommodation $$ Sep 21, 2012
  • @felixsalmon I give proportionate to income, so if I were in Romney’s situation, it is likely I would be giving more Sep 21, 2012
  • . @OVVOFinancial I’m a skeptic. Economists didn’t expect stagflation in ’70s; did not tag the great moderation properly, or call the bust $$ Sep 21, 2012
  • Why this doesn’t work: too many mortgages are inverted & there is too much supply that will appear as… Sep 21, 2012
  • @fundmyfund If you can infinitely defer income recognition, or reclassify income, the tax rates don’t matter much $$ Sep 21, 2012
  • “I want to clarify what I wrote on my your last post. It wasn’t one of my finer comments…” — David_Merkel $$ Sep 21, 2012
  • RE: @bloombergview This is another reason why the definition of income matters more than tax rates. Taxes deferred ar… Sep 21, 2012
  • RE: @bloombergview How do you distinguish between Dworkin who lost to Flynt, Carol Burnett who beat the National Enqu… Sep 21, 2012
  • @williamalden Interesting curiosity, but they don’t have much musical talent Sep 21, 2012
  • @ianbremmer Not too surprising, U would probably get the same result in Vallejo, Stockton, Jefferson County, AL, & other bankrupt places $$ Sep 21, 2012
  • “I hope they kill this one while it is little. Residential Rental Income ABS sounds like a disaster.” — David_Merkel $$ Sep 20, 2012
  • @e_d_sanders That wouldn’t surprise me, to me it is funny how we end up overriding law with administrative action Sep 20, 2012
  • “I’ve owned $CVX for a long time for clients. $BRKB is interesting; I really like what Buffett does…” — David_Merkel $$ Sep 20, 2012
  • . @hassankhan Sometimes there is research, sometimes it is little better than a guess. And yes, new insurance biz has sometimes lost $$ Sep 20, 2012
  • . @hassankhan New coverages start with a guess. As claims emerge, pricing & terms adjust to reflect claim incidence & severity $$ Sep 20, 2012
  • @Fullcarry People want to lock in a smaller loss Sep 20, 2012
  • @dcarpenter14 Good point, thanks for making it Sep 19, 2012
  • @XQuickFixX investors that buy & hoard 4 DB plans, ETFs, commodity funds, etc, even the SPR, that speculation does affect prices Sep 19, 2012
  • @XQuickFixX Besides, prices r set at the margin — what it costs to get the next barrel. Last point, if speculators includes the commodity + Sep 19, 2012
  • @XQuickFixX But the evidence in the article is hearsay. The extraction cost of $11/bbl looks really low. It has 2b higher than that. Sep 19, 2012
  • @XQuickFixX 2 thoughts: 1) my reform for derivative markets is hedgers must initiate all trades. Speculators can’t trade with each other Sep 19, 2012
  • I don’t believe the oil market is manipulated. It’s too big;keep the bid price too high, they will sell you a lot of … Sep 19, 2012
  • @izakaminska Thanks, Izabella. My best to all at FT Alphaville. $$ Sep 19, 2012
  • @izakaminska I admire you all at ft alpha, you write about big things that many of us miss; I would work with u all if u wanted me $$ Sep 19, 2012
  • RE: Average people can’t invest well & can’t get longevity insurance at a fair price. DB plans r better than DC plans… Sep 18, 2012
  • RE: Sorry, public pensions are not included; their rules are weaker than this. Also, no PBGC for muni DB plans. $$ Sep 18, 2012
  • @moorehn The eyewitness accounts of the life of Jesus would have noted a wife; Peter had 1. Definitive scholarly book Sep 18, 2012
  • “I disagree, mostly. Value is often its own catalyst. People ignore many low P/E stocks just b/c…” — David_Merkel $$ Sep 18, 2012
  • @LDrogen low likelihood, high severity Sep 18, 2012
  • “”How long until a producer comes in yelling, “wait…wait, he’s just a loud-mouth with a blog…” — David_Merkel $$ Sep 18, 2012
  • @rcwhalen We had 3 & adopted 5. Used zone defense metaphor 2 explain it 2 guys. W/a zone u r rules-based; need more rules w/more kids. $$ Sep 18, 2012
  • @groditi The only thing that gives me pause is that my old friends from my bond manager days r still constructive on HY Sep 18, 2012
  • “Exactly. I read the same piece, and for some reason I didn’t comment on their lack of understanding.” $$ Sep 18, 2012
  • Exactly. Every asset they inflate, inflates liabilities for those who fund them.  Commodities rise due 2 financial re… Sep 18, 2012
  • @TheStalwart Pie charts provide the least information of any type of graph, I think that’s why the chart nerds like them less $$ Sep 18, 2012
  • @MikeLanter Yes, THE ELEPHANT! Sep 16, 2012
  • “Well said. My but the Fed has become an elephant in the agency RMBS market” — David_Merkel $$ Sep 16, 2012



  • If we don’t get stagflation RT @OVVOFinancial @Vermeer1097 Martingale works for Fed playing w/o table limits and unlimited balance sheet. $$ Sep 21, 2012
  • RT @SullyCNBC: Instead of being angry at individuals for paying the least amount in taxes they legally angry at Congress for our … Sep 21, 2012
  • Double down, BABY!! $$ RT @Vermeer1097: @AlephBlog Bubbles Bernank simply using a very old betting system: the Martingale. Sep 21, 2012
  • You can either think binary or not $$ RT @daveinbawlmer: @AlephBlog @ritholtz a sort of binary way of thinking about being binary Sep 21, 2012
  • There r only 10 types of people in the world, those get binary & the rest RT @ritholtz: Either you believe the world is binary or you don’t Sep 21, 2012
  • RT @researchpuzzler: RT @DDInvesting: An Open Letter to CFOs Across America ~ must read, for investors as well as C … Sep 19, 2012
  • RT @prchovanec: When will Chinese authorities figure out that developing new financing vehicles does not change underlying asset quality? $$ Sep 19, 2012
  • Bigtime $$ RT @historysquared: Chinese banks are “the nexus for… all of this credit-driven investment.” ~ Jim Chanos Sep 18, 2012
  • What reputation? Perpetuating a bad idea $$ RT @credittrader: Tuesday Humor – *JUNCKER SAYS GREECE EURO EXIT WOULD HARM EURO REPUTATION Sep 18, 2012
  • +1 RT @ReformedBroker: “When we encounter pain, we are at an important juncture in our decision-making process.” $$ Sep 18, 2012
  • RT @groditi: @AlephBlog i’d much rather hold some decent stocks w/ good FCF/Earnings yields and an overweight cash position the the same … Sep 18, 2012
  • Well-stated $$ RT @felixsalmon: #Romneyshambles: the conservative take is no less damning. Sep 18, 2012
  • You said it $$ RT @BoydRoddy: You get the feeling that @John_Hempton is having fun with $FMCN a la a Cat and a stalked mouse? Yeah, me too. Sep 18, 2012
  • You betcha. BTW, @soberlook has posted good stuff RT @merrillmatter: not buying any MBS here $$ Sep 16, 2012


The Dilemma of Adding Yield, Redux

Saturday, September 22nd, 2012

After my post last night, I was asked how I make corrections in analyzing premium versus discount bonds.  (Note: if a bond trades at a higher price than the final amount of principal to be paid at maturity, it is called a premium bond.  If lower, it is called a discount bond.)  Happily, there is a story attached to it.  Here it is:

In early 2002, most investment banks placed their cash and CDS traders next to each other. It improved the ability of Wall Street to trade against the rest of us significantly.  By the end of 2002, every major investment bank was doing this.  Many were publishing data on CDS premiums.

I had a habit where I would go out for Chinese food once a week — get out of the office, clear my mind, bring stuff that was important to think about.  One week there was a piece about using CDS spreads to correct for premiums and discounts to par.

The idea was this: if a bond trades at a premium to par, pretend you have bought CDS protection on the amount of the premium.  Deduct the cost of that from the coupons you are paid and re-estimate the yield.  When a bond bought at a premium defaults, guess what? You will never get the premium back — thus using CDS to estimate the insurance cost.  You might not seek the default protection, but it would be valuable to know how much it was worth.

Vice-versa for discount bonds: pretend you have sold CDS protection on the amount of the discount.  Add the the premiums you might receive to the coupons you are paid and re-estimate the yield.  When a bond bought at a discount defaults, guess what? You will fare better than those that bought at par or a premium — thus using CDS to estimate the added yield from that benefit.  You might not sell the default protection, but it would be valuable to know how much it was worth.

Then one day I asked on of my dealers where the CDS was trading on a medium-sized company.  After a pause to talk to the trader he came back, there was no CDS trading on that company.

Okay, what to do? Then it struck me.  Use the credit spread (yield difference over a similar length Treasury Note) as the proxy for the CDS premium.  Bing! problem solved, and more relevant because I didn’t use CDS — it gave me a standard to use in many situations where bonds with different levels of premium or discount were being compared.  I could use this for any bond.

Here are two examples for how it would work.  Here is the analysis for a premium bond:


Cash flows

Swap pmts

Adjusted Cash Flow
























Premium/(Discount) to immunize —>         100.00


Spread over Treasuries




Treasury rate





Initial Price


Coupon Rate


And then what it looks like for a discount bond:


Cash flows

Swap pmts

Adj Cash Flow
























Premium/(Discount) to immunize —>      (100.00)


Spread over Treasuries




Treasury rate





Initial Price


Coupon Rate


So if I had two annual five-year bonds from the same issuer: 10% discount, 2.3% coupon versus 10% premium, 7% coupon, with the equivalent Treasury at a 4% yield, I would be indifferent between the two, even though the yield to maturity on the premium bond is 0.13% higher than that of the discount bond.

If you want to download the simple spreadsheet (be sure to allow for calculations to iterate) you can find it here: Premium-discount adjustment calculator.

That’s all, and for those that try it, I hope you enjoy it.  Wait, one last story:

In late 2002, a broker proposed a relatively complex swap trade.  I suspect he was trying to get an odd bit of paper off of the balance sheet for something more liquid.  As I recall there were premium/discount differences, but also, liquidity, subordination, duration, deal size, and credit rating.  The swap almost looked good, so I decided to “bid him back,” offering the swap at terms more advantageous to my client (and adding in a margin for error — ya wanta rent our balance sheet for illiquidity purposes, ya gotsta pay).

The broker was a little surprised, because the trade looked optically good by most common standards, but as I described to him all of the yield tradeoffs in the swap, he said, “Wow, never hear a trade taken apart like that before. I’ll take it to the trader.  Are you firm at your level? (I.e. will you hold to your terms proposed, or is this just the start of negotiations?)” I assented, and he went to the trader, who agreed to the swap at my terms.  You always have to blink when they do that, because you may have made an error, but my adjustment carved 1% of par off of the swap terms.

I suspect that I got a good trade off, and he needed to get rid of illiquid security that had overstayed its welcome.

In any case, that’s how to do swap trades.  Have fun.  I certainly did.

The Dilemma of Adding Yield

Friday, September 21st, 2012

Back when I was exclusively a bond manager, 2001-2003, which I chronicled in my series “The Education of a Corporate Bond Manager,” I successfully struggled with one concept: when do you try to add more yield to your portfolio, and when don’t you?

This is a tough question, because in the short run, it almost always makes sense to add yield to any portfolio.  Additional yield seems like free money.  What’s worse, your sales coverages at the major investment banks are programmed to offer more yield, so what do you do?

I had to learn the hard way myself, with few to teach me.  There are two aspects to this question: the micro, and the macro.


Know how to compare bonds so that you are able to figure out what a good swap is.  Thus you must understand:

  • The yield gained for illiquidity — public, 144A, private.
  • The yield lost for size — micro, small, medium, large.
  • The yield gained from duration — what is the proper yield give-up for investing “x” fewer years?
  • The yield gained from going down in credit — what names are mispriced, and offer value, though lower-rated?  What is the proper yield give up at various ratings, and how do you adjust them to reflect reality?
  • The yield differences regarding premium vs discount bonds — this is a relatively simple one, as you can take any spread of a bond over Treasuries, and recalculate it to be the spread against a par bond.  You’d be surprised how few people do that.  As a result two things happen: people buy expensive premium bonds that look cheap but aren’t, and some firms never buy premium bonds, even in cases where it makes sense.
  • The yield change for optionality, whether positive for puts, or negative for calls.
  • The yield differences across industries
  • The yield differences across special names — there are always a variety of names that trade wide or narrow — consult your analysts to understand which ones are mispriced.
  • The risk of a “special situation.”  Why are you the smart one, and others not?


This is the risk cycle. Think about:

  • How quickly are deals completed
  • How tight is the pricing in new deals
  • The tone of voice from your brokers
  • Your intermediate-term view of economics — if things are getting better be bullish, if worse be bearish.
  • Failures. Be wary as they begin, but be a buyer when you think things are at their worst. You will get the best prices for the recovery.  Few do this.

As a Wall Street Journal article pointed out, many bond mutual funds are reaching for yield now.  This is a time to be wary, but if you are playing for the end of cycle we aren’t there yet.  We have not had a significant default, or a series of small defaults.

So be on your guard, I am neutral at present, but I am watching for items that would make me more bullish or bearish.

Neoclassical vs Austrian Economics

Thursday, September 20th, 2012

Before I start, I want to say that I have not read Mises, Hayek or Rothbard.  I arrived at these conclusions on my own.  I also want to quote Buffett:

“It is better to be approximately right, than precisely wrong.”

Applying math to economics has been a loser.  Who has a consistently good macroeconomic model?  No one that I know.  Estimates of future GDP growth and inflation are regularly wrong, and no one calls turning points well.

Even microeconomic models are bad shape; most of the major hypotheses get rejected when doing general equilibrium tests.

Why?? Because capitalistic economies are more dynamic than mathematical models can mirror.  Live with the volatility, and don’t try to model it.  We face the same in the asset markets, behavior is not predictable.

Austrian economics understands the boom-bust cycle.  Neoclassical economics assumes we move to an equilibrium.  Have you ever lived in an equilibrium?!  There is never an equilibrium, or it is always unstable, and that is the beauty of Austrian economics.  The lack of an equilibrium means the system is always adjusting it does not rest.

Why do neoclassical economists assume equilibrium?  To make their stupid math work.  It is the same for guys in finance.  Why do they assume normality?  To make their stupid math work.  The world is complex, but the economists assume that it is not complex in order to make their models work.


There is a bias that exists below the surface of all macroeconomic commentary.  Do we look at the income statement, or do we look at the balance sheet?  Neoclassical economists mostly look at the income statement.  Austrian economists look at the balance sheet.  (Neoclassical economists are friends with growth investors, Austrians are friends of value investors.)

Think of the “brick through the window” fallacy.  On the Neoclassical version of GDP, a brick through the window raises GDP.  The Austrians are smarter, and realize that the change in aggregate net wealth is negative.

Neoclassical economics believed debt levels were neutral and were proven wrong in the recent crisis.  They did not look at the balance sheet.

Neoclassical economists, who have dominated the Fed for over 40 years, drove us into a huge inflation, which Volcker choked, and then Greenspan & Bernanke drove us into a liquidity trap by refusing to let recessions eliminate bad debt, creating the “great moderation,” which is now known as a sham.

What You Can’t Quantify Well

Quantitative economics has not improved understanding.  Ben Bernanke flies blind but claims that he sees; the Fed has been a lousy predictor of economic outcomes, despite the legion of academic economists they employ.  There are no economists that have consistently forecast the economy well.

That’s why I don’t agree with those that criticize Austrian economics for avoiding quantifying their theories.  Economics is not a science; it does not quantify well, at least in detail.

Economics should be primarily an ethical discipline.  The government is a referee rather than an overlord.  The government should assure equality of opportunity rather than equality of result.

It’s not as if the government can use its “policy levers” to create any degree of lasting prosperity.  Prosperity lies within the control of individuals who apply their acumen to the situation, and come up with creative ways of meeting human needs.


Thus, I don’t have much sympathy for those that reject Austrian economics because we don’t have a mathematical means of expressing it.  Paraphrasing the Buffett quote, “I would rather be approximately right than precisely wrong.”  There are many things that I don’t have an exact economic model for that I know a decent amount about.  Qualitative knowledge is valuable, and should not be disrespected by those that do not have a better model, such as the broken model of the neoclassical economists.

On Low Volatility Investing

Wednesday, September 19th, 2012

Recently a friend of mine sent me an e-mail after my review of Eric Falkenstein’s latest book.  Here it is:

David, I’ve been reading a decent amount of the academic literature on low vol investing and it’s certainly got my attention.  I’ll definitely be purchasing his book to read thru it, but I think he and Mebane Faber have had quite a bit of this stuff on their respective blogs.  Frankly I liked the research enough that I decided to part ways with some gifted Verizon stock that the in-laws gave us and bought a global low-vol ETF (ACWV).

I wish it had a bit more international tilt, but there is a sister international ETF that I can buy, so I might add that at some point to balance out the geographic exposure.  The one thing that really surprised me the most was that I figured this thing would have huge weights in Utes/Telecom.  Not so–actually the industry diversification looks very attractive.  And for 35bps of fees vs nearly 4% yield, hard to go wrong with this product for a nice LT buy and hold.  Kinda funny when I find myself, as a stock guy, actually liking a highly diversified index-type product… I just needed a bit more balance in the portfolio from all my very idiosyncratic idea.

Some of your readers might be interested in some of these ETFs if you think they are worth talking about.

For raw quantitative index investing, funds like these are good ideas, at least for now.  But with all new strategies, I ask the question, what will happen when a lot of people do this?  It is possible for stocks that minimize volatility as a group to become overpriced.

Think about what a minimum volatility portfolio looks like.  The companies pay decent dividends, are mostly not in cyclical industries… the portfolio looks like growth at a reasonable price.  Company financial & operating leverage is relatively low.  When I think of all of these together, it sounds like high free cash flow, and/or high growth of free cash flow.  This would be similar to high-quality growing companies that don’t take on a lot of debt.

A minimum variance portfolio, should the portfolio characteristics continue over the rebalancing horizon, will behave somewhat like a high yielding bond, but noisier.

The fund that my friend mentioned has an above average P/E ratio, an above average dividend yield, and an above average Price-to-Book ratio.  It tends to choose stable, eclectic companies within each economic sector.  For example, when I looked at financials, I saw a disproportionate amount of REITs, Insurers, and obscure Japanese and Asian banks.

This is a little quirky, but the stable elements of a variety of different sectors seem to do well over time as a portfolio.  But just as “value stocks” as a group can become overvalued, the same can happen for the stocks in the minimum volatility portfolio.  It would be good to track the average E/P & B/P (trailing twelve months) for the portfolio.  If the valuation metrics get too high, it could be a sign that low volatility is becoming a crowded trade.

That said, given the dynamism inherent in re-estimating a minimum variance portfolio, it might not be so obvious when low volatility is over-invested.  Maybe watching when the ratio of the Morgan Stanley Cyclicals index versus the S&P 500 might give us a negative clue. It was less attractive to invest in stable stocks in August of 2000 and February 2009.  These are two very different dates.  The former showed stable stocks peaking, while the latter was cyclical stocks troughing.

My own investing methods rely on no one factor, but looks at what makes a stock valuable through multiple lenses.  But tonight I highlight low volatility, because I think that investors do occasionally overpay for quality, but in general a quality bias pays off over time, as does a value bias.

We Eat Dollar Weighted Returns — V

Tuesday, September 18th, 2012

This is the first episode of “We Eat Dollar Weighted Returns” where the fare is yummy.  Here’s the twist: investors in some bond ETFs have done better than one who bought at the beginning and held.

Now, all of this is history-dependent.  The particular bond funds I chose were among the largest and most well-known bond ETFs — HYG (iShares iBoxx $ High Yield Corporate Bd), JNK (SPDR Barclays Capital High Yield Bond), and TLT (iShares Barclays 20+ Year Treas Bond).

As bond funds go, these are relatively volatile.  TLT buys the longest Treasury bonds, taking interest rate risk.  HYG and JNK buy junk bonds, taking credit risk.

Let’s start with TLT:


Cash Flow

Buy & Hold Return














































Buy & Hold





I analyzed this back in June, saw the anomalous result, an decide to sit on it until I had more time to analyze it.  The way to think about it is that investors reached for yield at a time when stocks were in trouble, and indeed, rates went lower.  The average investor beat buy-and-hold by 3%.

Here are the results for the junk ETFs:














Net Additions






Net Assets






Investment Return




























Buy-and hold















Net Additions






Net Assets






Investment Return





























Buy-and hold



Both funds were small in advance of the credit crisis, and investors bought into them as yields spiked, and bought even more as income opportunities diminished largely due to the Fed’s low-rate monetary policies. The average investor beat buy-and-hold by 6%+.

Now, the  junk funds were small during default, and grew during the boom, amid unprecedented monetary [policy from the Fed.  (Note: I think that Bernanke will rank below Greenspan in the history books in 210o, and both will be judged to be horrendous failures.  It is better to let things fail, and clear out the bad debt, rather than continue malinvestment.  We need fewer banks, houses, and auto companies, among others.  The government, including the Fed and the GSEs, should not be in the lending business.  Lending should be unusual, and applied mostly to financing short-term assets.  Long-term assets should be financed by equity, or at worst, long-dated debt.

For all three funds, we have the historical accident that the Fed dropped Fed funds rates to near zero, leading to a yield frenzy.  But what happens when defaults spike?  What  happens when no one want to buy long dated Treasuries at anything near current levels?

I think bond investors are more rational than stock investors; they have more rational benchmarks to guide them.  Bond investors have cash flows to analyze against EBITDA (earnings before interest, taxes, depreciation and amortization.  Stock investors wonder at earnings, which are easily gamed.

The real question will come when we have the next credit crisis?  How many holders of HYG or JNK will run then?  Or when inflation starts to run, and the Fed stops buying long Treasury bonds, and even starts to sell them, what will happen to dollar-weighted returns then?

This is an interesting piece for bond assets in a bull market.  We need to see bear market results to truly understand what is going on.

Full disclosure: long TLT for myself and clients


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.

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