October 2012 – Page 2 – The Aleph Blog

Sorted Weekly Tweets

Posted on 19 October 2012 by David Merkel

Sorry I missed last week.? Thanks to those who like this.

Monetary Policy

Black Monday and the Greenspan put http://t.co/f9nvCtLd Initial error of Alan Greenspan. Fine-tuning monetary policy 2 remove volatility $$ Oct 20, 2012
Southeast Asia Seen Leading Rate Increases Next Year http://t.co/KFsz14Wj I doubt it; $$ laxity is the rule of the time; tough 2 fight Oct 19, 2012
Wall Street CMOs Crushed as Sales @ 3-Yr Low http://t.co/n4avsQeR Wouldn’t call a 15% drop “crushed.” Fed feeding on their collateral $$ Oct 18, 2012
Fed-Induced Stock P/E Gains Seen Ending Soon http://t.co/FdN3zvgm Effects of QE3 s/b fully anticipated by now. $$ Oct 18, 2012
Currency Wars: US Attack http://t.co/XbjCmjhB Axel Merk criticizes Bernanke’s claim that US monetary policy isn’t a major prob 4 emg mkts $$ Oct 17, 2012
Yes, it is more complex, but easy developed country monetary policy does make life tough for emerging… http://t.co/qPiFz9pQ Oct 15, 2012

Financial Blogging

The Critic Wall Street Loves to Lunch With http://t.co/ZdomDj3R @felixsalmon one of the leaders of financial blogging gets profiled here $$ Oct 20, 2012
6 blogs u should be reading http://t.co/7aohlAcp @reformedbroker @thestalwart @calculatedrisk @pragcapitalist @convertbond & Bess Levin Oct 18, 2012

Hoisington

Prior tweets courtesy of Van R. Hoisington & Lacy H. Hunt, Ph.D. Whole thing will be posted here http://t.co/pZ4jJrQ1 in a few days $$ Oct 12, 2012
Until the excessive debt issues r addressed, the multiyear trend in inflation, & thus the long Treasury bond yields will remain downward $$ Oct 12, 2012
“During all of the Fed actions since 2008 the velocity of money has plummeted and now stands at a five decade low” Hoisington & Hunt Oct 12, 2012
A jump in daily essentials has a more profound negative impact on living standards in economies with lower levels of real per capita income. Oct 12, 2012
How the Fed expects economic traction from higher stock prices when rising commodity prices r curtailing real income & spending is puzzling Oct 12, 2012
These three studies show that the impact of wealth on spending is miniscule?indeed, ?nearly not observable.? Hoisington Oct 12, 2012
“Fed Chair Ben Bernanke and other Fed advocates believe the ?wealth effect? of QE3 will bring life to the economy.” Hoisington Oct 12, 2012
Prior Tweet quotes Hoisington & “unintended consequence of these Federal Reserve actions, however, is to actually slow economic activity” Oct 12, 2012
QE3 is a tacit admission by the Fed that earlier efforts failed, but this action will also fail to bring about stronger economic growth. $$ Oct 12, 2012

Rest of the World

Devastating Photos Of India’s Illegal Coal Mines http://t.co/iiuN8bo9 Government nationalizes coal mines; mafia springs up2 mine coal $$ Oct 20, 2012
Why China Has The Worst Farms In The World http://t.co/zFnHnLH8 Worst in the sense of productivity per worker; they have lots of workers $$ Oct 19, 2012
Why Indians Are Getting Poorer http://t.co/PMyTpfEC Over past year, the Indian currency lost around 20% of its value against the US $$ Oct 19, 2012
China Faces Tough Choice on Growth http://t.co/i0i1n35l Does the CCP continue to favor short-term self-interest, or long-term power? $$ Oct 19, 2012
Zhang Weiying: China’s Anti-Keynesian Insurgent http://t.co/TGNGlo9e Fascinating tale of an Austrian economist surviving in China $$ Oct 13, 2012
Iran Low on Options as Hyperinflation Concerns Spark Gold Dash http://t.co/rYqDjinO Hyperinflations spawn currency substitutions: gold, $$ Oct 09, 2012
Chavez Win Called by BofA Sparks Selloff as Barclays Flops http://t.co/DNPxpVzO Sad that Chavez won, but the bonds reflected a loss $$ Oct 09, 2012
Cheapest Chinese Stocks Since ?97 Not Enough to Signal Rally http://t.co/rTEm2MNF Noneconomic actors compete & drive down future profit $$ Oct 08, 2012
The Iran Hyperinflation Fact Sheet http://t.co/bitjVaqn From my former professor @ JHU, Steve Hanke. Financial sanctions r biting in Iran $$ Oct 07, 2012

Financial Reform

A Simpler Way to End Too Big to Fail http://t.co/z680Sq1q Limit non-deposit liabilities; banks will scream; worthy 2b tried $$ Oct 19, 2012
EU, Japan Warn Against New US Swaps Rules http://t.co/9F7hTHpy Technical efficiency of mkts is less important than resiliency of mkts $$ Oct 18, 2012
Ex-GE Bankers Convicted of Municipal Bond Bid-Rig Scheme http://t.co/fFnANPyk 4 years of jail time; restitution plus 20% would b better $$ Oct 18, 2012
Swaps Collateral Costs May Increase Under Rules Weighed by SEC http://t.co/hbrVnyHx Raises costs some, probably the right idea $$ Oct 17, 2012
Treasurers Worry Over Accounting for MMF Changes http://t.co/RtF6jlve Geithner tries MMF reform. Better: http://t.co/vuNGATPK $$ Oct 16, 2012

Energy

Gasoline prices _ finally _ begin to slide http://t.co/zuEXNaIx Refineries finally catch up w/maintenance, outages & demand $$ Oct 19, 2012
First oil nears for Kazakhstan’s supergiant field http://t.co/Bzx5q6Td Kazakhstan reduces the amount of time that foreigner scan profit $$ Oct 18, 2012
California Asks Court to Reinstate Carbon Fuel Standard http://t.co/gLqnqTdj I am happy that I left California at age 27; unrealistic $$ Oct 17, 2012
Gas Market Stung by Rapid Traders http://t.co/UI9DqJjI HFT and “news” trading games in the futures markets. Running stops is not new $$ Oct 16, 2012

Eurozone

Spanish Borrowing Costs Ease http://t.co/evRNryY7 It won’t last, but enjoy it 4 now. $$ Oct 18, 2012
Retirement No Option for Older Workers in Europe?s Crisis http://t.co/KgjUYc01 Problem is greater in Europe because of lower fertility $$ Oct 17, 2012
Hollande Robbed of Growth Engine as Companies Cut Investment http://t.co/ZGdrllIG Logical 2 invest less when EU & France r a mess $$ Oct 12, 2012
EU Wins Nobel Peace Prize http://t.co/VoTaN3ZK Nobel committee finally “jumps the shark.” The EU is unstable; a war waiting 2 happen $$ Oct 12, 2012
Spanish Bonds Risk Forced Selling as Rating Approaches Junk http://t.co/yO8XWNl4 The Rating agencies r flawed, but on credit they r honest Oct 12, 2012
IMF?s Blanchard: Healing From Crisis Could Take Decades http://t.co/NXYmLjU3 Crisis won’t b healed until total debt levels normalize $$ Oct 11, 2012
IMF Sees ?Alarmingly High? Risk of Deeper Global Slump http://t.co/B7Dg9Ah9 A stopped clock is right twice/day, $ the IMF is right now $$ Oct 09, 2012
Why a U.S. buyout firm is investing in Greece http://t.co/26oB31e9 ht: @danprimack – Companies w/global markets insensitive 2 local probs $$ Oct 08, 2012
Sicily, a Portrait of Italian Dysfunction http://t.co/w3dn2JFe Core Europe is to Italy as Italy is to Sicily. $$ gone & hard work starts Oct 08, 2012

Politics

Dem convention used corporate cash, despite pledge http://t.co/vCJuCrSa No one is truly a politician until they break a promise $$ Oct 18, 2012
Obama Pursuing Leakers Sends Warning to Whistle-Blowers http://t.co/hZ86Cx6O Hard to believe, but Obama outdoes Bush, Jr. 4 opacity $$ Oct 18, 2012
Romney?s Rates Seen Spurring Growth Too Little 2 Late http://t.co/fcogGy0V Nice 2c Obama & Romney competing 4 who can harm economy most $$ Oct 18, 2012
A123 Bankruptcy Gives Romney New Example of Green-Energy ?Loser? $$ $AONE http://t.co/gR2LvxRV Make green energy advocates take Physics Oct 17, 2012
Sorry, US Recoveries Really Aren?t Different http://t.co/5cseU4Nn Reinhart & Rogoff take on Romney’s advisors who say the US is different Oct 16, 2012
Romney Rolls in Rural Vote That May Provide Swing-State Margins http://t.co/D3dSdJBB Interesting perspective, but is that a big bloc? $$ Oct 16, 2012
Dividends: Start Screaming http://t.co/B37C7k9a This one is tough. Probability of a cooperative Congress after the elections is low $$ Oct 13, 2012
California Facing $5 Gasoline Stirs Brown to Relax Rules http://t.co/uQUPOz8f There is a pain point 4 everyone, just found 4 CA gas $5 $$ Oct 08, 2012

Economic Strength / Weakness

Winners and losers as US weather patterns change http://t.co/1txs8dcg Worth a read 4 the list of winners & losers near the end $$ Oct 18, 2012
Challenges forcing change in trucking strategy http://t.co/mHjc4udb Definitely a soggy data point; US & global economies seem 2b slowing $$ Oct 18, 2012

Agriculture

Corn States Lead Record Crop-Loss Payout http://t.co/c1wzXD14 Crop insurers take a hit.

Taxpayers get hosed. Farmers doing fairly well $$ Oct 18, 2012

Drought brings record US cost for crop insurance subsidy http://t.co/ceUOLMUQ 2012, Taxpayers pay more, Insurers pay some, farmers benefit Oct 17, 2012
Milk-Cow Drought Culling Accelerates as Prices Jump http://t.co/WvHEturP Anything involved in animal husbandry is having tough time now $$ Oct 11, 2012
Midwest Drought Claims Poultry Producer http://t.co/9K4cL3Gx Many firms involved in the meat biz r having a rough time now. $$ Oct 11, 2012
At this rate, growing tobacco should be prohibited. Oh, wait, we tried that with alcohol. Never mind. $$? http://t.co/hU9nI6l2 Oct 09, 2012

Market Dynamics

Throwing Out Insiders Won’t Fix Corporate Boards http://t.co/ANKyNPiq Good boards watch over mgmt & have decent industry & company knowledge Oct 17, 2012
All-Time Highs, Almost There http://t.co/Aj1LR8AY Will the market hit new highs this year, in 2013, or when? $$ Oct 17, 2012
Legg Mason?s Miller Redeemed as Housing Bull http://t.co/n3tRTmF6 2 soon 2 say. Miller doesn’t seek a “margin of safety” when investing $$ Oct 15, 2012
Vanguard to JPMorgan Dodging Neediest Borrowers http://t.co/PsNN8UKG This is what you tend to see 1-2 years in advance of the crash $$ Oct 14, 2012
As an aside, there’s kind of a rule of thumb for Bermuda insurers on buybacks: >1.3x tangible book: special dividends. <1.3x TB buybacks $$ Oct 12, 2012
The Buyback Epidemic http://t.co/l9SvTwZM @reformedbroker notes that buybacks make less sense, the higher valuations get. I concur $$ Oct 12, 2012
New Regime http://t.co/L2JaQC2J @reformedbroker notes a sea change in the markets. I’ve been heading that way; still thinking about it $$ Oct 12, 2012
CNBC: Jim Rogers vs. Marc Faber (FULL) 10/04/2012 http://t.co/b5sEOEZb Faber & Rogers on the same segment? What a hoot! $$ $GLD $SPY $TLT Oct 12, 2012
OCC Forced JPMorgan, Wells Fargo to Write Down Home-Equity Loans http://t.co/qxXjXBoS FD: + $WFC – ’bout time. Recoveries poor on HEL $$ Oct 12, 2012
California Leading U.S. Out of Housing Bust http://t.co/oEaOG4nf I would be wary of “dead cat” bounces here $$ Oct 12, 2012
Bubble-Era Financing Returns as Profits Falter http://t.co/yhxBEFxq Pay-in-kind bonds return, very nice. 2 years of rally left at most $$ Oct 11, 2012
Wrong: Bullish Sign for Stocks: Leverage Is Up http://t.co/1Qvcdkh9 What matters more is whether leverage will rise in the future $$ Oct 09, 2012
Not New York Towers Rise With Embrace of Yield http://t.co/3MKpRdVi When vacancy rates r this high, ordinarily rents fall. Y not now? $$ Oct 08, 2012

Other

Welcome to the ?Desert of the Real? ? a postmodern economy http://t.co/g42NKcoa Increasing abstraction destroys economic intuition $$ Oct 18, 2012
Why Data Will Never Replace Thinking http://t.co/Yhi5xWaR Every bit of data requires the creation of a hypothesis to give it meaning $$ Oct 17, 2012
Global Finance Chiefs at Odds http://t.co/av5MQ01i Everyone pursuing similar policies (Loose $$ & deficits) reduces effectiveness 4 all Oct 15, 2012
Heidi N. Moore joins the Guardian’s US Team as Finance & Economics Editor http://t.co/In2oDnC6 Congrats @moorehn ! Will b reading u there $$ Oct 15, 2012
I’m not much of an #Orioles fan, but don’t you have to love a team of nobodies who can challenge the highly paid #Yankees? $$ Oct 12, 2012
Tech Firms Become Real- Estate Trusts http://t.co/GrHU2bo5 Tech firms that own a lot of real estate take advantage of becoming REITs $$ Oct 11, 2012
The UN has declared today as the International Day of the Girl Child http://t.co/L0nS6wtd Sex selection abortion kills the most girls $$ Oct 11, 2012
Please follow Cato Scholar and JHU professor that I learned a lot from: @steve_hanke Oct 10, 2012
Musk?s SpaceX Launches Craft for Space Station Deliveries http://t.co/Z3MH68Ud Space age begins as governments r less of a factor $$ Oct 08, 2012

Insurance

Insurers Shed Annuity Assets http://t.co/bUZ2brqT This doesn’t feel right. other times when financial guys buy insurers, doesn’t work $$ Oct 18, 2012
If Only T. Boone Pickens Had Died http://t.co/tpXYGeCV Score: TB Pickens 0, Wealthy donors 0, Oklahoma State Univ. 0, Life Actuaries 1 $$ Oct 08, 2012

Replies & Comments

@PlanMaestro 2 notes: rsv strengthing in Australia a concern, but not big. 2) Low ROE biz of the 90s is fading; life re was a loser then $$ Oct 20, 2012
@PlanMaestro I love $RGA . Good mgmt team. Less interest rate & stock market dependent than life insurers FD: long RGA for me and clients $$ Oct 20, 2012
@TheStalwart I get a few ridiculous marketing requests/day. Do all bloggers get them? I reply2them this picture $$ http://t.co/TGc2q4Er Oct 19, 2012
@BarbarianCap Sigh. Baltimore County is not as far gone as Baltimore City (which is also a county), but this is not wise or arms length $$ Oct 19, 2012
I just left a comment in “6 Wall Street blogs you should be reading – Jon Friedman’s Media Web – MarketWatch” http://t.co/qpeTAHcI Oct 18, 2012
@MattGGriffith Thanks. Will probably do a post in the near future expaning on that last paragraph. It struck me at the end $$ Oct 18, 2012
@laurenfosternyc Have you ever seen the “Gold Medal Gold Model?” http://t.co/5rPvqfEz Gold prices r a function of real interest rates $$ Oct 18, 2012
@CflGator these are deferred annuities so the life table plays no role. Problem is investing “too clever” inside a regulated life insurer $$ Oct 18, 2012
I just left a comment in “Student-loan debt is a good investment – Outside the Box – MarketWatch” http://t.co/AnaHcGKh Oct 15, 2012
I just left a comment in “Student-loan debt is a good investment – Outside the Box – MarketWatch” http://t.co/22AyCQ9I Oct 15, 2012
. @paulnovell It will be public in a few days — they e-mail it out to friends & clients b4 posting it here: http://t.co/pZ4jJrQ1 $$ Oct 12, 2012
@wanderinggull Which? I don’t know. What was meant to produce “ever closer union” seems to be producing the opposite. Nobel = Pollyanna Oct 12, 2012
“Good post, Josh. You have identified many of the best. No one of us covers it all; it’s a strong list” ? David_Merkel http://t.co/3Qg6WWZk Oct 10, 2012
@munilass Get to sleep, Babylass will need you tomorrow. 🙂 Oct 09, 2012
@PavChyt @matinastevis Her *former* husband. She kept the name b/c it was good politics. She did not keep him. Oct 08, 2012
@PavChyt @MatinaStevis I received the name Merkel at birth. Angela got it from her 1st husband. At least people r spelling it right now $$ Oct 08, 2012

Retweets

Yeah, & that is BV net of AOCI RT @PlanMaestro: $RGA : book value per share http://t.co/EQWDgiSL FD: long $RGA for myself & clients Oct 20, 2012
Jack speaks the truth, listen 2 him $$ RT @ReformedBroker: Jack Bogle: Get Out of the Casino http://t.co/gL0siD6v Oct 18, 2012
RT @fivethirtyeight: All polling data is massaged A LOT in an era when only 10% of people respond to surveys. So that also introduces a … Oct 17, 2012
RT @MuniCredit: Citi Muni Presentation: http://t.co/ONrQe9gA #muniland h/t: @bondgirl Oct 12, 2012
I appreciate retweets RT @LSilverspar: Not enough for the value of your posts. If you value the retweets, I will do so far more often. $$ Oct 12, 2012
RT @danprimack: Every time people get all worked up over a national presidential poll, I wonder if the electoral college was eliminated … Oct 08, 2012
True of many notable CEOs w/earnings 2 smooth RT @rcwhalen: GE’s Jack Welch Knows All About Cooking the Books http://t.co/5vJeRux6 $$ Oct 08, 2012
RT @Convertbond: “Markets are increasingly distorted by Central Banks, attempts to squeeze drops of growth from overindebted developed w … Oct 07, 2012
Shock! $$ RT @BarbarianCap: Revised Greek GDP figures show recession deeper than thought http://t.co/FCspv2gU. > data released friday night Oct 06, 2012

Match Assets and Liabilities

Posted on 19 October 2012 by David Merkel

?Good investing stems from matching assets to the eventual need to pay cash at a future date.? True for individuals and institutions.?

So I said yesterday.? A few people said to me that I needed to expand on that, and so now I expand.

The most common error in mismatching investment horizons is borrowing short to own long assets.? We institutionalize this in the banking sector, though I believe it is a policy error to do so.? Deposits should finance working capital, and not fixed capital.? Long-term assets should be financed by long-dated loans or equity.

When you borrow on a short-term basis, where the terms are not locked-in, to buy a long dated asset, you take the risk that financing terms could move against you, changing that you can no longer hold the asset.? This happens in asset bubbles, particularly toward the end.

It happens because it is the cheapest type of finance in the short-run, but often the most costly in the long run.? Someone who pays up, and locks in lending terms for the life of the asset has far more predictability.

This is one reason why I try to analyze lending terms when analyzing manias.? Typically, manias occur when enough people are willing to buy and finance a lot of it short term.

But, the opposite sometimes happens.? There are some that will borrow long to invest short.? We saw that in 2009-10, when companies were borrowing long to insure liquidity.? Maybe you can consider it an insurance premium to make sure you stay alive as a company.

I have two other examples, both from the third insurance company that I worked for.? In the middle of my time there, the company hired a consultant to analyze the investment policy of the company.? The analyst had a big name, and he found that the company as a whole was mismatched short by two years.

If you are a well-run life insurer, you are either matched or as much as two years long.? (I think a one-year gap between assets and liabilities is optimal, and so does Pimco.)? It was a free lunch to lengthen the portfolio ? returns increase, and risks decrease.

Sadly, or happily, depending on how you view it, in the annuity line of business that I was running two years later, after the first annuity withdrawal study was complete (one year ahead of the Society of Actuaries study, which mimicked my approach), I realized that the long-term guaranteed rates were significant, and I realized that the asset portfolio should be lengthened to reflect that.

I remember the investment department questioning me regarding putting 20% of annuity assets into 30-year bonds, and I said, ?They hedge us against the long term guarantees.?? They bought in, and it was another example where there was a free lunch ? increase in income, decrease in cash flow risk.

On Investment Policy

This is why my most important question for investors is ?When do you need the cash??? There is a gradation of approaches for maximizing returns with reasonable certainty in investing, and the approaches vary as the time horizon expands.

To all investors: try to match your investment strategy to the time that you need the money.

Total Return Versus Long Liabilities

Posted on 17 October 2012 by David Merkel

Very briefly in my career, I was Chief Investment Officer of a significant life insurer.? Sadly, that was my dream job, and to have it and lose it was a blow that I accepted, because I did what was right.

At my first meeting with the new CEO, he expressed that investment returns had been inadequate.? I explained to him that that was false — the investment department, inclusive of defaults had provided returns 0.7% better than single-A bond returns, which was notable for the industry.? He insisted that was not good enough, and that he wanted to see us trade aggressively, and produce total returns.? I tried to explain to him that that was the wrong way to manage investments for a life insurer.? The right way was occasional trading for loss mitigation, and maximization of investment spreads over the term of the liabilities.? Being the sort of Brit that disdained Americans, he told me that I didn’t know anything, and that total return was the only way to go.

For the good of the relationship between our two firms, I let it drop, but he held a grudge against me after that, which led my firm to change my position to corporate bond manager, letting another of our group be the CIO, who solicited my feedback to a high degree, because he knew that I knew what was going on, far better than the CEO did.? This is just my guess, but I think the CEO resented that I could see through him and the way he and Chief Actuary manipulated accounting results.? (I eventually spilled the beans to the regulators.? The state in question was kind of lazy — I really think they didn’t do anything with it.)

Leaving behind the past, here’s the theoretical problem: total return is a wonderful idea, but vapid, because the challenge is gaining total returns over a time horizon, after which the assets will be used to fund a liability.? In a life insurer, yes, you could manage the bonds to maximize total return in the short run, which might maximize short-run GAAP income, but might destroy long-term economic value because as high quality interest rates fall, it becomes harder to meet the longer-term promises previously made using new money interest rates.? Yes, you can realize the capital gains today, but only at the cost of reducing future net income, until net income goes negative, and recoverability testing indicates you are locking in a loss, and you have to do a writedown of your deferred acquisition cost asset.

This is why I am skeptical of hedge funds and other total return investors buying life insurers.? Good investing at a life insurer means improving the investment income spread between assets and liabilities, over the term of the liabilities, while taking account of capital use, and avoiding defaults.

It would be very difficult now to be managing a life insurer that had a large deferred annuity block, particularly one with high guarantees.? Your flexibility is strained — if rates go down, you have to still fund the guaranteed rate, and if rates go up you will wish you were invested short so that your credited rates go up, and you don’t lose money because the income off your bonds is rising.

The only normal option in such a situation would be to run a barbell — short assets and long assets, with little inbetween.? Long assets for the guarantees, short assets for the crediting rate sensitivity.? And even that might not be adequate.

I started my career at a small life insurer that grew into a medium-sized one in three short years off of capital raised by its holding company issuing junk bonds.? The holding company, Southmark (spit, spit), knew something about investing, but not about running regulated subsidiaries.? What looks simple is actually very hard.? The cash flows of the assets and the liabilities are not freely available to be used through the consolidated company.? The regulatory limits of each subsidiary are applied separately, limiting what cash flow can be sent to the overly-indebted holding company.

In the end, after interlacing the capital of the subsidiaries, such that our insurer held a lot of the equity and preferred equity of other insurers, the holding company declared bankruptcy (a two-time loser there), and the life insurer went into conservation with the California Department of Insurance.

I was just a junior actuary then, and my investment knowledge was small but growing, so I didn’t get much of it then. The company took too much credit risk with junk bonds (the regulations were loose then), and mismatched their investments short (can’t buy long junk) versus long liabilities.? As rates fell, fell and fell, junk bonds defaulted or were called.? Each reduced income, but the guarantees remained the same.

Thus I remain a skeptic of clever investors trying total return strategies versus long term promises.? In the situations I have been in, it has not worked, and with bad management teams, it is another way to make things look good for a time, until things blow up.

Now, as for the two insurers that I mentioned, their management teams didn’t end well.? The first one that I worked with left to start another insurer, while bidding unsuccessfully for the firm they left.? They never went far.

The one I mentioned at the beginning of this piece — the entire management team was let go, except for the CEO, who was forced into retirement, and the CEO of the holding company was forced to resign for wasting money pumping it into the life company.

Good investing stems from matching assets to the eventual need to pay cash at a future date.? True for individuals and institutions.

With Preston Athey at the Baltimore CFA Society

Posted on 16 October 2012 by David Merkel

I don’t think I have mentioned this publicly, but I am on the board of the the Baltimore CFA Society.? My main task is to be co-chair for Programs, though I also like working with college students via the CFA Institute’s Global investment Research Challenge.

In general, I help where I am asked to help.? The two times that I have been on the board of the Baltimore CFA Society, I joined because I was asked.? I don’t need to lead.? I am very happy to not lead, except when things are confused, and no one is leading.

One of the fun things about being on the program committee is that you get to interact with a bunch of interesting potential speakers, some of whom turn you down, and others that accept the invitation.

And so it was my great pleasure to introduce Preston Athey (AY-thee), to speak to the Baltimore CFA Society.? He manages the T. Rowe Price Small Cap Value Fund.? That fund has 4 stars from Morningstar over 3 and 5 years, and 5 stars over 10 years.? It has other awards from Money Magazine and Kiplinger’s, and I’m pretty certain a number of others.

When he sat down at our table, prior to the talk, we talked about finding good companies in bad industries, which is a concept near and dear to me.? So he asked us what industries are hated now?? I volunteered shipping and coal, and later mentioned steel.

I then introduced him to the Society, and he gave his talk.? He highlighted four things:

The CFA Institute has capitulated to the academics who teach the nonsense of the CAPM.? Volatility is not risk.? Risk is the permanent impairment of capital.? (I commented that when the economics profession went mathematical in the ’40s and ’50s, they felt everything had to be quantified, whether it was correct or not, and that anything that made the math simple was a boon to being able to publish “research.”
The companies that actually do buybacks, as opposed to merely announcing them, do very well, and that is intensified for those that buy back stock at high free cash flow yields.
Lower turnover in mutual funds tends to lead to better performance.? He attributed it to having more conviction in the companies that you buy.? His turnover rate is 10%, and half of that is due to buyouts.
As a result, he talked about letting your winners run, though he also mentioned trimming positions to reduce risk.? That is similar to what I do.

He also mentioned how new management with a company that has gone nowhere can produce large returns.? Analyzing the nature of the new management is necessary — their past track record, current incentives, etc.? During the Q&A, he handled a number of questions — one that stuck out to me was industries where there are non-economic competitors.? I think of Chinese steel companies as an example that has finally failed.? The world does not need that much steel, even at current prices.

Aside from that, he was a Gentleman, as a few informed me he would be… a really nice guy.? Wish I had gotten to know him earlier.

Now if you want to know more about him, I have some articles here:

We had a great time with Preston Athey today, and for those that hung around thereafter, he answered many more questions.? Truly generous with his time, and gracious.

Book Review: The Financial Domino Effect

Posted on 16 October 2012 by David Merkel

This is a good book.? It has one significant problem, though.? It is very good at describing the problems that exist, but does not follow through on the subtitle: How to Profit Now in the Volatile Global Economy.? That might be a publisher error.? They want to sell books, and a book that describes the problem will have a small audience, while a book that shows how you can profit from a problem would have a wide audience.? For the most part, this book describes the problem well, and that is good.

So what’s the problem?? Most bond managers intuitively know that most bonds either trade at “normal” or “distressed” levels — there is very little in-between.? Those are two “stable” places where bonds trade, and with a few exceptions, different groups of investors are involved in each place.? They have different ratios, standards, and metrics.

The book spends a lot of time on the Eurozone, with its bevy of distressed governments.? The distress stems from deficits, over-regulation, and entitlements. The “domino effect” part of the title comes from core Eurozone banks lending to distressed fringe Eurozone entities.? If the fringe fails so do core Eurozone banks.? If core Eurozone banks fail, so does the Eurozone.

But the book offers us precious little of new information on how to profit in an uncertain environment.? The last few pages offer a few general ideas, but even with my outside knowledge I have no idea on how to apply that easily.

Quibbles

On page 43, he describes government liabilities as “future tax receipts.”? Sorry, future tax receipts are assets, not liabilities.

Who would benefit from this book: ? If you want to understand the nonlinear dynamics of the bond market, buy this book.? If you want to make money, don’t buy this book.? If you want to, you can buy it here: The Financial Domino Effect: How to Profit Now in the Volatile Global Economy.

Full disclosure: The publisher sent me a hard copy of the book, without my asking.

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.

Book Review: How To Really Ruin Your Financial Life and Portfolio

Posted on 13 October 201213 October 2012 by David Merkel

Before I start, a thanks to all of my readers who have voted on my reviews. Note: if you have voted on many of my reviews favorably, further votes won’t help.? Amazon limits the effects of fans.? Onto the book:

For those unfamiliar with Ben Stein, he has done a series of books on “How to Ruin…” for example: How to Ruin Your Life and How to Ruin Your Financial Life. I have not read either of those two books, but after a glance at the table of contents of each book, I can say that what he wrote there is right, even if it is short.

If you can avoid making wrong moves, right moves will occur on average.

But… most of this is simple commonsense stuff reported from a negative angle.? If you have read the personal finance category at my blog, you would know what he has written and far more, and it is free.

There is no bad advice in this book, if you understand that it is offering you bad advice.? By telling you you to do stupid things, it incites you to do what is right.

Quibbles

The book is not worth $12 to those with a reasonable understanding of the markets.? It is worth a lot to the uninformed who think they know something but don’t.? This is a book you give; it is not a book that you buy.

Who would benefit from this book: ? This is the sort of book that you give as a gift to your clueless brother-in-law.? It has value there, to raise the awareness of those who are destroying their financial lives.? If you want to, you can buy it here: How To Really Ruin Your Financial Life and Portfolio.

Full disclosure: The publisher sent me a hard copy of the book, without my asking.

Forest Fires and Central Banking

Posted on 13 October 2012 by David Merkel

We can create a force that eliminates forest fires, but there will be a cost.? A certain amount of forest fires are normal, and if we don’t have small forest fires, we will have big ones that happen infrequently, and cause a lot of damage.

Central banking is similar. Good central banking allows for the extinguishing of a lot of bad debts.? Bad debts should fail, and the Fed should not rescue them.? Better that the Fed should imitate William McChesney Martin, Jr., and allow recessions to do their good work, eliminating bad debts that would otherwise encumber the economy.

?I?m the fellow who takes away the punch bowl just when the party is getting good.? ? Fed Chairman William McChesney Martin, Jr.? He was a great central banker, as was Volcker.? Both of them embraced pain.? Wimps, like Greenspan, Burns, and Bernanke, embraced no pain, and assumed that their lame efforts to support the economy would actually aid things.

The Fed should have a single mandate, but it is not the mandate commonly proposed.? The Fed should restrain the total growth of credit in the economy, and ignore inflation and unemployment.? Let the Fed defend us against depressions.? It can succeed at that.

As for inflation and unemployment, the Fed can state that they can’t do anything about unemployment, which is largely true.? Inflation — that they can do, if it is desired, but they will need to stop doing QE, and do unsterilized purchases of debt.

That’s all for now.? Just remember that the government has a hard time interfering in the economy.? It doesn’t work, but they try to make it look like it works.

Democrats, Republicans — just remember that they can’t deliver what they promise you.

Sorted Weekly Tweets

Posted on 12 October 2012 by David Merkel

Hoisington Capital Management

. @paulnovell It will be public in a few days — they e-mail it out to friends & clients b4 posting it here: http://t.co/pZ4jJrQ1 $$ Oct 12, 2012
Prior tweets courtesy of Van R. Hoisington & Lacy H. Hunt, Ph.D. Whole thing will be posted here http://t.co/pZ4jJrQ1 in a few days $$ Oct 12, 2012
@wanderinggull Which? I don’t know. What was meant to produce “ever closer union” seems to be producing the opposite. Nobel = Pollyanna Oct 12, 2012
Until the excessive debt issues r addressed, the multiyear trend in inflation, & thus the long Treasury bond yields will remain downward $$ Oct 12, 2012
“During all of the Fed actions since 2008 the velocity of money has plummeted and now stands at a five decade low” Hoisington & Hunt Oct 12, 2012
A jump in daily essentials has a more profound negative impact on living standards in economies with lower levels of real per capita income. Oct 12, 2012
How the Fed expects economic traction from higher stock prices when rising commodity prices r curtailing real income & spending is puzzling Oct 12, 2012
These three studies show that the impact of wealth on spending is miniscule?indeed, ?nearly not observable.? Hoisington Oct 12, 2012
“Fed Chair Ben Bernanke and other Fed advocates believe the ?wealth effect? of QE3 will bring life to the economy.” Hoisington Oct 12, 2012
Prior Tweet a quotes Hoisington & “unintended consequence of these Federal Reserve actions, however, is to actually slow economic activity” Oct 12, 2012
QE3 is a tacit admission by the Fed that earlier efforts failed, but this action will also fail to bring about stronger economic growth. $$ Oct 12, 2012

Please Follow

#FF @japhychron @danprimack @treehcapital @insidermonkey @vitaliyk @herbgreenberg @tracyalloway @nancefinance @marykissel @diana_olick $$ Oct 13, 2012
Please follow Cato Scholar and JHU professor that I learned a lot from: @steve_hanke Oct 10, 2012

Market Dynamics

As an aside, there’s kind of a rule of thumb for Bermuda insurers on buybacks: >1.3x tangible book: special dividends. <1.3x TB buybacks $$ Oct 12, 2012
The Buyback Epidemic http://t.co/l9SvTwZM @reformedbroker notes that buybacks make less sense, the higher valuations get. I concur $$ Oct 12, 2012
New Regime http://t.co/L2JaQC2J @reformedbroker notes a sea change in the markets. I’ve been heading that way; still thinking about it $$ Oct 12, 2012
CNBC: Jim Rogers vs. Marc Faber (FULL) 10/04/2012 http://t.co/b5sEOEZb Faber & Rogers on the same segment? What a hoot! $$ $GLD $SPY $TLT Oct 12, 2012
Bubble-Era Financing Returns as Profits Falter http://t.co/yhxBEFxq Pay-in-kind bonds return, very nice. 2 years of rally left at most $$ Oct 11, 2012
Wrong: Bullish Sign for Stocks: Leverage Is Up http://t.co/1Qvcdkh9 What matters more is whether leverage will rise in the future $$ Oct 09, 2012

Rest of the World

Zhang Weiying: China’s Anti-Keynesian Insurgent http://t.co/TGNGlo9e Fascinating tale of an Austrian economist surviving in China $$ Oct 13, 2012
Hollande Robbed of Growth Engine as Companies Cut Investment http://t.co/ZGdrllIG Logical 2 invest less when EU & France r a mess $$ Oct 12, 2012
EU Wins Nobel Peace Prize http://t.co/VoTaN3ZK Nobel committee finally “jumps the shark.” The EU is unstable; a war waiting 2 happen $$ Oct 12, 2012
Spanish Bonds Risk Forced Selling as Rating Approaches Junk http://t.co/yO8XWNl4 The Rating agencies r flawed, but on credit they r honest Oct 12, 2012
IMF?s Blanchard: Healing From Crisis Could Take Decades http://t.co/NXYmLjU3 Crisis won’t b healed until total debt levels normalize $$ Oct 11, 2012
IMF Sees ?Alarmingly High? Risk of Deeper Global Slump http://t.co/B7Dg9Ah9 A stopped clock is right twice/day, $ the IMF is right now $$ Oct 09, 2012
Iran Low on Options as Hyperinflation Concerns Spark Gold Dash http://t.co/rYqDjinO Hyperinflations spawn currency substitutions: gold, $$ Oct 09, 2012
Chavez Win Called by BofA Sparks Selloff as Barclays Flops http://t.co/DNPxpVzO Sad that Chavez won, but the bonds reflected a loss $$ Oct 09, 2012
Why a U.S. buyout firm is investing in Greece http://t.co/26oB31e9 ht: @danprimack – Companies w/global markets insensitive 2 local probs $$ Oct 08, 2012
Sicily, a Portrait of Italian Dysfunction http://t.co/w3dn2JFe Core Europe is to Italy as Italy is to Sicily. $$ gone & hard work starts Oct 08, 2012
Cheapest Chinese Stocks Since ?97 Not Enough to Signal Rally http://t.co/rTEm2MNF Noneconomic actors compete & drive down future profit $$ Oct 08, 2012
The Iran Hyperinflation Fact Sheet http://t.co/bitjVaqn From my former professor @ JHU, Steve Hanke. Financial sanctions r biting in Iran $$ Oct 07, 2012

US Real Estate

OCC Forced JPMorgan, Wells Fargo to Write Down Home-Equity Loans http://t.co/qxXjXBoS FD: + $WFC – ’bout time. Recoveries poor on HEL $$ Oct 12, 2012
California Leading U.S. Out of Housing Bust http://t.co/oEaOG4nf I would be wary of “dead cat” bounces here $$ Oct 12, 2012
Tech Firms Become Real- Estate Trusts http://t.co/GrHU2bo5 Tech firms that own a lot of real estate take advantage of becoming REITs $$ Oct 11, 2012
Not New York Towers Rise With Embrace of Yield http://t.co/3MKpRdVi When vacancy rates r this high, ordinarily rents fall. Y not now? $$ Oct 08, 2012

Agriculture

Milk-Cow Drought Culling Accelerates as Prices Jump http://t.co/WvHEturP Anything involved in animal husbandry is having tough time now $$ Oct 11, 2012
Midwest Drought Claims Poultry Producer http://t.co/9K4cL3Gx Many firms involved in the meat biz r having a rough time now. $$ Oct 11, 2012

Other

I’m not much of an #Orioles fan, but don’t you have to love a team of nobodies who can challenge the highly paid #Yankees? $$ Oct 12, 2012
The UN has declared today as the International Day of the Girl Child http://t.co/L0nS6wtd Sex selection abortion kills the most girls $$ Oct 11, 2012
If Only T. Boone Pickens Had Died http://t.co/tpXYGeCV Score: TB Pickens 0, Wealthy donors 0, Oklahoma State Univ. 0, Life Actuaries 1 $$ Oct 08, 2012
Musk?s SpaceX Launches Craft for Space Station Deliveries http://t.co/Z3MH68Ud Space age begins as governments r less of a factor $$ Oct 08, 2012
California Facing $5 Gasoline Stirs Brown to Relax Rules http://t.co/uQUPOz8f There is a pain point 4 everyone, just found 4 CA gas $5 $$ Oct 08, 2012

Comments

“Good post, Josh. You have identified many of the best. No one of us covers it all; it’s a strong list” ? David_Merkel http://t.co/3Qg6WWZk Oct 10, 2012
At this rate, growing tobacco should be prohibited. Oh, wait, we tried that with alcohol. Never mind. $$? http://t.co/hU9nI6l2 Oct 09, 2012

On Angela

@PavChyt @matinastevis Her *former* husband. She kept the name b/c it was good politics. She did not keep him. Oct 08, 2012
@PavChyt @MatinaStevis I received the name Merkel at birth. Angela got it from her 1st husband. At least people r spelling it right now $$ Oct 08, 2012

Retweets

RT @MuniCredit: Citi Muni Presentation: http://t.co/ONrQe9gA #muniland h/t: @bondgirl Oct 12, 2012
I appreciate retweets RT @LSilverspar: Not enough for the value of your posts. If you value the retweets, I will do so far more often. $$ Oct 12, 2012
My week on twitter: 22 retweets received, 22 new followers, 16 mentions. Via: http://t.co/SPrAWil0 Oct 11, 2012
RT @danprimack: Every time people get all worked up over a national presidential poll, I wonder if the electoral college was eliminated … Oct 08, 2012
True of many notable CEOs w/earnings 2 smooth RT @rcwhalen: GE’s Jack Welch Knows All About Cooking the Books http://t.co/5vJeRux6 $$ Oct 08, 2012
RT @Convertbond: “Markets are increasingly distorted by Central Banks, attempts to squeeze drops of growth from overindebted developed w … Oct 07, 2012
Shock! $$ RT @BarbarianCap: Revised Greek GDP figures show recession deeper than thought http://t.co/FCspv2gU. > data released friday night Oct 06, 2012

On Dividends

Posted on 10 October 201210 October 2012 by David Merkel

Dividends are kind of a craze now, as people focus on income in an environment where income with reasonable risk is hard to come by.? Now, I used data from S&P to create this graph.? I suppose I could go further back in history and use Schiller’s dataset, but the era of high dividend yields on stocks is over, at least for now.? I can be taught, but I don’t see a lot of present relevance to pre-1990 dividend yields.? The prices of stocks as income vehicles has been bid up, and buybacks absorb much of the free cash flow from mature corporations.

That said looking at 1989 to the present, what do we see?? Dividends rose at a rate of 4.72%/year over the period, and people were willing to capitalize dividends at a rate that grew at a rate of 2.07%/year over the period.? The total return being 9.47%/year over the period leaves 2.42%/year to be the return from the dividends, and capital gains from reinvested dividends.

In one sense, the blue line above gives a fair statement of the crisis we have gone through.? Profits got smashed in 2008-2009, much more than in 2002.? (Note that financials were the core of the recent crisis but were in good shape in 2002.)? In both cases, dividends came back.

In another sense, the blue line is not indicative of the crisis.? Labor force participation has dropped incredibly.? The unemployment rate may be low, but only because many have given up on finding jobs.

My only counsel here is not to seek dividends for their own sake, but accept them if offered in a firm that offers good prospective returns.? I do not look for dividends, but 31 out of my 34 holdings pay dividends, and the average dividend (including non-payers) is 0.7% higher than the S&P 500 dividend yield at 2.75%.

I don’t so much believe that dividends have value, as many companies that pay dividends have value.? Free cash flow is valuable, and results in dividends, buybacks, and reinvestment in the business.? Find those firms that produce free cash flow, and dividends will typically follow.

Set it and Forget it

Posted on 9 October 2012 by David Merkel

This post is directed at people who don’t get the markets.? People who think they they are experts can stop reading now.

I’m the Chairman of the Pension Board of the Reformed Presbyterian Church of North America.? Yes, that long-lived but small denomination that never went through the controversies of modernism, still teaching that Jesus Christ rules everything on earth NOW, and we exclusively sing the psalms of David without accompaniment in our worship.

Here is something that is no surprise: most pastors who are serious students of Scripture don’t get financial markets.? Truth, that is true of most people who know their technical crafts, but don’t get how financial markets work.

What I am about to say should work for most people who don’t get investing — choose a blend of risky and less-risky assets.? Ask your self this question: how much are you willing to lose in a year at worst as a percentage of assets? Take that amount and multiply it by 2.0-2.5.? That is the maximum amount that you should allocate to risky assets.? (Strangely, that mostly corresponds to the current margin rules.)

Average people can’t monitor the markets, and even if they did, they would not know what to do.? Far better that they “set it and forget it,” than that they panic when things are are going bad, or get greedy when things are running hot.

Thus we encourage the pastors to buy blended funds.? I encourage them to buy one notch down on their risk tolerances, because the return give-up is small, but the likelihood of them not panicking is large.

For those who are uninformed, that is important.? Buy-and-hold is a good strategy if maintained at a risk level that avoids panic.

Now. I’m not crazy about the market at present.? I would shade allocations to the 2.ox side of risk, not the 2.5x side.? But what we have found at the pension board of the RPCNA is that the pastors do best who choose a blended fund that they can stick with through tough times.

My own pastor is squeamish with investing, but I looked at what he “should” do in investing, and told him to dial it back one notch.? It has been to his benefit.? He has not panicked, and has made decent money over the last 10 years.

Thus to summarize: estimate your willingness to lose money over a year, and size your allocation to risky assets appropriately.