Month: March 2014

Redacted Version of the March 2014 FOMC Statement

Redacted Version of the March 2014 FOMC Statement

Posted on by David Merkel
January 2014 March 2014 Comments
Information received since the Federal Open Market Committee met in December indicates that growth in economic activity picked up in recent quarters. Information received since the Federal Open Market Committee met in January indicates that growth in economic activity slowed during the winter months, in part reflecting adverse weather conditions. Weather is always a weak reason for a bad result.? You almost never see anyone claim good weather boosted results.
Labor market indicators were mixed but on balance showed further improvement. The unemployment rate declined but remains elevated. Labor market indicators were mixed but on balance showed further improvement. The unemployment rate, however, remains elevated. No significant change.
Household spending and business fixed investment advanced more quickly in recent months, while the recovery in the housing sector slowed somewhat. Household spending and business fixed investment continued to advance, while the recovery in the housing sector remained slow. No significant change.
Fiscal policy is restraining economic growth, although the extent of restraint is diminishing. Fiscal policy is restraining economic growth, although the extent of restraint is diminishing. No change.? Funny that they don?t call their tapering a ?restraint.?
Inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable. Inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable. No change.? TIPS are showing slightly lower inflation expectations since the last meeting. 5y forward 5y inflation implied from TIPS is near 2.56%, up 0.02% from January.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. No change. Any time they mention the ?statutory mandate,? it is to excuse bad policy.
The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate. The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace and labor market conditions will continue to improve gradually, moving toward those the Committee judges consistent with its dual mandate. Unemploys the concept of the Unemployment rate as the sole measure of labor conditions.? Maybe aggregate wages would be better.
The Committee sees the risks to the outlook for the economy and the labor market as having become more nearly balanced. The Committee sees the risks to the outlook for the economy and the labor market as nearly balanced. No significant change.
The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term. The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term. No change.? CPI is at 1.1% now, yoy.
Taking into account the extent of federal fiscal retrenchment since the inception of its current asset purchase program, the Committee continues to see the improvement in economic activity and labor market conditions over that period as consistent with growing underlying strength in the broader economy. The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions. Drops the language on fiscal retrenchment.? Continued overestimate of economy and labor conditions.
In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in February, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $30 billion per month rather than $35 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $35 billion per month rather than $40 billion per month. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in April, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $25 billion per month rather than $30 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $30 billion per month rather than $35 billion per month. Reduces the purchase rate by $5 billion each on Treasuries and MBS.? No big deal.

 
The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. No change
The Committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate. The Committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate. No change.? But it has little impact on interest rates on the long end, which are rallying into a weakening global economy.
The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. No change. Useless paragraph.
If incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings. If incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings. No change.? Says that purchases will likely continue to decline if the economy continues to improve.
However, asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases. However, asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases. No change.
To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate.

 

 No change.
The Committee also reaffirmed its expectation that the current exceptionally low target range for the federal funds rate of 0 to 1/4 percent will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.   Drops the contentious sentence locking themselves into a policy.
In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. Monetary policy is like jazz; we make it up as we go.? Also note that progress can be expected progress ? presumably that means looking at the change in forward expectations for inflation, etc.
The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored. Makes its standards for raising Fed funds more arbitrary.
When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. No change.
  The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run. New sentence.? Says loose policy will stay longer than needed.
  With the unemployment rate nearing 6-1/2 percent, the Committee has updated its forward guidance. The change in the Committee’s guidance does not indicate any change in the Committee’s policy intentions as set forth in its recent statements. New sentence.? Says loose policy will stay longer than needed.? Also, disregard any change in policy that you might have seen here.? We still felt the need to change the statement, but really, nothing has changed.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Richard W. Fisher; Narayana Kocherlakota; Sandra Pianalto; Charles I. Plosser; Jerome H. Powell; Jeremy C. Stein; Daniel K. Tarullo; and Janet L. Yellen.

 

 Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Richard W. Fisher; Sandra Pianalto; Charles I. Plosser; Jerome H. Powell; Jeremy C. Stein; and Daniel K. Tarullo.

 

 Bernanke is gone.? Good.? Yellen is Chair. Bad.
  Voting against the action was Narayana Kocherlakota, who supported the sixth paragraph, but believed the fifth paragraph weakens the credibility of the Committee’s commitment to return inflation to the 2 percent target from below and fosters policy uncertainty that hinders economic activity. This is perhaps the lamest vote against an FOMC decision that I have ever seen.? The differences between the fifth and sixth paragraphs are minuscule.

?

Comments

  • Small $10 B/month taper.? Equities, commodities, and long bonds both fall.? The FOMC says that any future change to policy is contingent on almost everything.
  • They have an optimistic view of the economy, especially on labor.? At least they are abandoning the unemployment rate as their measure of labor conditions.
  • They missed a real opportunity to simplify the statement.? More words obfuscate, they do not clarify.
  • Current proposed policy is an exercise in wishful thinking.? Monetary policy does not work in reducing unemployment, and I think we should end the charade.
  • In the past I have said, ?When [holding down longer-term rates on the highest-quality debt] doesn?t work, what will they do?? I have to imagine that they are wondering whether QE works at all, given the recent rise and fall in long rates.? The Fed is playing with forces bigger than themselves, and it isn?t dawning on them yet.
  • The key variables on Fed Policy are capacity utilization, unemployment, inflation trends, and inflation expectations.? As a result, the FOMC ain?t moving rates up, absent increases in employment, or a US Dollar crisis.? Labor employment is the key metric.
  • GDP growth is not improving much if at all, and much of the unemployment rate improvement comes more from discouraged workers, and part-time workers.
As Light As Hydrogen

As Light As Hydrogen

Posted on by David Merkel

Okay let?s roll the promoted stocks scoreboard:

Ticker Date of Article Price @ Article Price @ 3/18/13 Decline Annualized Splits
GTXO

5/27/2008

2.45

0.040

-98.4%

-50.8%
BONZ

10/22/2009

0.35

0.001

-99.7%

-73.0%
BONU

10/22/2009

0.89

0.001

-99.9%

-79.1%
UTOG

3/30/2011

1.55

0.000

-100.0%

-95.1%
OBJE

4/29/2011

116.00

0.167

-99.9%

-89.7%

1:40
LSTG

10/5/2011

1.12

0.010

-99.1%

-85.7%
AERN

10/5/2011

0.0770

0.0001

-99.9%

-93.4%
IRYS

3/15/2012

0.261

0.000

-100.0%

-100.0%

 Dead
RCGP

3/22/2012

1.47

0.300

-79.6%

-55.1%
STVF

3/28/2012

3.24

0.420

-87.0%

-64.5%
CRCL

5/1/2012

2.22

0.026

-98.8%

-90.6%
ORYN

5/30/2012

0.93

0.110

-88.2%

-69.5%
BRFH

5/30/2012

1.16

0.515

-55.6%

-36.3%
LUXR

6/12/2012

1.59

0.009

-99.4%

-94.7%
IMSC

7/9/2012

1.5

0.900

-40.0%

-26.1%
DIDG

7/18/2012

0.65

0.042

-93.5%

-80.7%
GRPH

11/30/2012

0.8715

0.085

-90.3%

-83.5%
IMNG

12/4/2012

0.76

0.045

-94.1%

-88.9%
ECAU

1/24/2013

1.42

0.240

-83.1%

-78.8%
DPHS

6/3/2013

0.59

0.010

-98.3%

-99.4%
POLR

6/10/2013

5.75

0.070

-98.8%

-99.7%
NORX

6/11/2013

0.91

0.210

-76.9%

-85.2%
ARTH

7/11/2013

1.24

0.360

-71.0%

-83.6%
NAMG

7/25/2013

0.85

0.164

-80.7%

-92.2%
MDDD

12/9/2013

0.79

0.320

-59.5%

-96.4%
TGRO

12/30/2013

1.2

0.220

-81.7%

-100.0%
VEND

2/4/2014

4.34

4.900

12.9%

187.3%

3/18/2014

 Median

-93.5%

-85.2%

Tonight’s loser-in-waiting is HydroPhi Technologies [HPTG]. ?This one can’t even get basic science right. ?It claims to be able to split water into hydrogen and oxygen, and then recombine them to create energy. ?Circular processes in general lose energy, otherwise we would have perpetual motion machines.

And behind the vapid analysis is an uber-loser. ?His analyses never pan out over one year. ?A clever speculator might make money occasionally, but not regularly, because the stocks he pumps are like this one. ?Little revenues, negative earnings, negative net worth. ?This is a recipe for disaster.

Think about it — if you had a miracle energy technology, would you merge your company with a failed internet advertising company “BigClix?” ?I would think not. ?You would keep your company private and enjoy the significant profits.

As it is, there are no profits, so where is this great energy technology? ?This is a scam, and laws should be revised to allow prosecution of those who write such promotional garbage as we have seen. ?It is no good to have the 4-point type disclaimers telling some of the truth, while the big type says “Buy, buy BUYYY!!!” ?Also, as far as the web version of this promotion goes, the promoters pour in half a million. ?As it says in the 4-point type:

Third Party Advertiser IMPORTANT NOTICE: Esquire Media Services Inc (EMS) has managed up to a $500,000 USD advertising production budget as of January 21, 2014 in an effort to build industry and investor awareness for HydroPhi Technology Group Inc (ticker symbol: HPTG).?

It’s easy to affect the price of a company that has bad fundamentals. ?It’s overvalued to start; it will only be more overvalued at the crest of the promotion. ?If you attract a bunch of people to the pump-and-dump who want to play the momentum, some may think they will be clever enough to scalp a quick profit along with the insiders. ?Some of them win, and others lose. ?Others believe the advertising, and stay to lose a ton.

Seth Klarman recently said,??It might not look like it now, but markets don?t exist simply to enrich people.? ?This needs to be remembered by all. ?Markets are for trading, and trading is a negative-sum game. ?Those who buy & hold valuable businesses for a span — that is a positive-sum game, because the underlying asset is appreciating.

To close: don’t buy promoted stocks. ?Never. ?Those who are paid directly or indirectly to encourage you to buy are at best sub-agents for the seller — they aren’t on your side. ?In buying promoted stocks, it’s like going to Vegas, minus the fun. ?You will lose. ?You will lose a lot. ? The house edge is fixed — it’s only a question of how much you will lose.

Avoid promoted stocks. ?As I often say: “Don’t buy what someone else wants to sell you, buy what you have researched and know has value.”

The Idea of Contributory Defined Benefit Plans

The Idea of Contributory Defined Benefit Plans

Posted on by David Merkel

In the good old days, there were Defined Benefit [DB] plans for pensions, and only those. ?Why were those good?

  • The sponsor took care of the investing
  • Participants received a level, or inflation-adjusted payment.
  • Payments offered longevity insurance — you could not outlive them.

Then, by accident, the 401(k) plan, and other defined contribution [DC] plans came into existence. ?Employees could invest their money pretax, and make money during the bull markets of the ’80s and ’90s. ?Many companies terminated their DB plans, and replaced them with DC plans, cash balance plans, etc.

DC plans were attractive to most participants because:

  • They could see the value easily — it was expressed in a single number, and a higher number is always better, right?
  • The employer match was an obvious source of value.
  • Since most of the plans were participant directed, many enjoyed control of the asset allocation, particularly in bull markets.
  • The benefits were portable, they did not rely on continued employment with the same firm.
  • They could take loans against their ?balances.

After the bull market of the ’90s, what did participants in DC pension plans lose?

  • They weren’t natural investors, so they lost there through underperformance. ?Fear and Greed led them to lose.
  • They lost longevity insurance — it is a lot cheaper to get it early, when you don’t need it.
  • As interest rates fell, so did the ability to buy a future income ?by buying an annuity. ?Yes, the balance was higher, but you could not earn as much from it with safety.
  • Managing a lump sum for income is a very tough task, and one that most average investors are not equipped to tackle.

This is why I would like to propose replacing DC plans with DB plans, but give employees the option of adding more to their DB plans, and making DB plans portable. ?This would require:

  • Making DB plans tax-favored relative to DC plans. ?Drop the tax-advantaged status for DC plans.
  • Have standard transfer assumptions for the valuation of DB plans.

The great advantage of contributory DB plans is that they divide responsibilities/advantages where they are best held:

  • Plan sponsors are better at investing than participants.
  • DB plans provide longevity insurance.
  • If participants want to save more, they can do so, buying streams of future income.

I know this piece is nonstandard — out of step with the current “reality.” ?If pensions were structured this way, it would save many people a lot of headaches:

  • How do I invest?
  • How can I lock in a good future income for life?
  • How can I get more than what the company is putting aside for me?

Contributory Defined Benefit plans would divide the duties of pensions properly. ?Participants would decide how much to save, and sponsors would invest and provide longevity insurance. ?Can you think of a better way to do pensions? ?I’m all ears.

“Different from the Consensus”

“Different from the Consensus”

Posted on by David Merkel

At a recent investment competition that I attended, one of the judges asked the question to all teams, in a somewhat long-winded way, “How is your opinion different than the consensus?” ?Perhaps because I have heard it for too many years, I got a little tired of it.

So what is the consensus? ?There is no “consensus” document that is publicly available.

  • The consensus could be any collection of factors that justifies the current market price.
  • The consensus could be generally agreed upon ideas of a large majority of “sell side” analysts.
  • The consensus could be a few critical factors that are widely agreed on.

A correct insight that is different from that of the majority is valuable. ?But the majority is often right, at least in the short run. ?I often found as a buy side analyst that some sub-industry sectors were rationally priced and there were no plays to be made.

Therefore I would say don’t force yourself to be different from the consensus. ?If you have good reasons to be different from the consensus, pursue those views.

Sometimes the best answer is, “I don’t know,” or “This seems fairly priced to me.”

You don’t always have to make a decision. ?Even Buffett has a “Too Hard” pile for documents. ?As an aside, he tossed Assurant into the “too hard” pile, while I immediately embraced the IPO. ?And yes, I did have a view that was different than the seeming consensus.

Some say, “Not to Decide is to Decide.” ?Well, yeah, but as investors, we have to guard against false certainty. ?We will be hurt more by wrong actions we take than by right actions that we miss. ?There’s more than one fish in the sea. ?If you can’t find a good opportunity, well, keep looking. ?Peruse 13Fs of clever investors for ideas. ?Look for good companies in bad industries. ?Those will make you different than the consensus.

Don’t ever feel forced into making an investment decision. ?If it is not compelling, pass it up and wait. ?Yes, time is money, but haste makes waste. ?Particularly where fear or greed is involved, there are real risks of making bad decisions. ?Channel your inner Vulcan, and be as dispassionate as possible.

There is a consensus in investing, but it is an abstract thing, and not easily measured. ?Don’t aim to be different than the consensus; aim to be right, because often the consensus is right, and there is no reason to invest in a given company.

Full Disclosure: Long AIZ BRK/B

Sorted Weekly Tweets

Sorted Weekly Tweets

Posted on by David Merkel

Rest of the World

  • China premier warns on economic slowdown as data fans stimulus talk?http://t.co/B4uN1uP6OU?Stimulus just leads 2more overcapacity & debt $$?Mar 14, 2014
  • Teslas in California Help Bring Dirty Rain to China?http://t.co/YTBdiM77Pi?Mining graphite adds 2 Chinese air pollution $$ Ironic, huh??Mar 14, 2014
  • Deeper Ukraine Invasion Lurks in Putin’s Warnings, ?’Provocations,’ Clashes in East?http://t.co/L5GbJqx8j6?1 mistake away from major war $$?Mar 14, 2014
  • Finland Trapped in Recession as Investment Fades?http://t.co/DL9m3nGy13?Punk global economy exhausted from 2 much stimulus & debt $$ $SPY?Mar 14, 2014
  • Norway?s Oil Stimulus Nears Tipping Point as Growth Fades?http://t.co/ct5Mt8RY5i?Government economics stimulus fails; ppl have 2much debt $$?Mar 14, 2014
  • Warnings From the Ukraine Crisis?http://t.co/lcC1RDpjRv?Not being George W. Bush is not a foreign policy. Let Nobel winner get a strategy $$?Mar 14, 2014
  • US Investigators Suspect Missing Malaysia Airlines Plane Flew On?http://t.co/dhM6rlQlf1?Engine Data Suggest Flight Airborne for 5 hrs $$?Mar 13, 2014
  • Treasury?s Lew Uses Mideast Toolkit to Back Ukrainian Bonds?http://t.co/QeyvWdDKZ1?Another example of ways to buy US credit with spread $$?Mar 13, 2014
  • Qatar World Cup: 400 Nepalese die on nation’s building sites since bid won?http://t.co/uUY4neKHbF?Slavery is alive & sick in Qatar $$?Mar 13, 2014
  • The Malaysia Airlines Disappearance Shows Technology’s Limits?http://t.co/dWgmOKk42v?Interesting read: rare cases of disappearing planes $$?Mar 13, 2014
  • Ukraine Starts Military Exercises as Russia Warns on East?http://t.co/8ZeISGvEcA?All u need is 1 significant mistake & u could have war $$?Mar 10, 2014
  • Israelis in Berlin Signal Middle Class Struggles at Home?http://t.co/mydWWz9j7M?It’s cheaper living in Berlin, forget the past, live well $$?Mar 10, 2014
  • China Strike Illustrates Shift in Labor Landscape?http://t.co/DDWIN8KLhM?Would rather work 4 a foreign firrm than Chinese firm $$ $FXI?Mar 10, 2014

 

Companies & Industries

  • $GLCH Gleacher & Co is liquidating. Looking at the price chart, it has seen better days?http://t.co/aIYv7zxrfd?$$ $SPY $TLT?Mar 14, 2014
  • IBM’s double dilemma?http://t.co/HJfljGY7Wq?If you buy back stock at levels over the company’s intrinsic value, you destroy value. $IBM $$?Mar 14, 2014
  • Even in its final days, Windows XP still looms large?http://t.co/m2VUtiTJIp?Last night friend told her hospital just upgraded to XP $$ $MSFT?Mar 14, 2014
  • BNSF pledges 2get caught up on ND ag shipments?http://t.co/XGah5Xmop6?$CNI made a similar promise in Canada recently. Coincidence? $BRK.B $$?Mar 13, 2014
  • Target Missed Alarms in Epic Hack of Credit Card Data?http://t.co/lYLAWDI04m?$TGT got ample warning from $FEYE & $SYMC but ignored it $$?Mar 13, 2014
  • Candy Crush Maker’s Realm Spans Across Continents?http://t.co/9dZyVNhqWp?A global firm that uses tax & regulatory haven 2 their advantage $$?Mar 13, 2014
  • ?Candy Crush? Maker Seeks Valuation Up to $7.6B?http://t.co/L1Kaf4WLjK?I would b wary here, not just the IPO, but a faddish company $$ $SPY?Mar 12, 2014
  • US Wind-Down Bill Clips $FNMA $ FMCC Shares?http://t.co/rZxsLenQk4?Would require most borrowers 2make down payments of >5%, lenders hit 2 $$?Mar 12, 2014
  • Fannie, Freddie Shares Plunge?http://t.co/XfNZ1Jv5Rv?Taxpayers should reap the reward for bailing out $FNMA & $FMCC as mtge gtees change $$?Mar 12, 2014
  • Buffett?s Berkshire Reaches $300B Market Cap?http://t.co/lqnyQ0F4sN?As he buys profiable businesses, growing retained earnings builds MC $$?Mar 10, 2014
  • Chiquita to Acquire Irish Fruit Distributor Fyffes in Stock Deal?http://t.co/MJBhJuuxM3?$CQB is no “top banana” in the fruit biz $$ $SPY?Mar 10, 2014

Market Impact

  • Corporate Cash Pushes Further Into Corporate Bonds?http://t.co/Vk9PGzrItp?Corporate finance gets urge 2b a profit center @ wrong moment $$?Mar 14, 2014
  • Bio-finance? Why high-frequency trading makes stocks flock like birds?http://t.co/UB6jzwgjla?Reasonable defense of HFT H/T: @matt_levine $$?Mar 14, 2014
  • ETFs Get $41B Erasing Stock Withdrawals on Economy?http://t.co/l1hrnCWuel?This is y I advocate low turnover strategies $$ sell low, buy high?Mar 13, 2014
  • BlackRock Junk ETFs Push Buyers to Dark Corners?http://t.co/vjydZFBFwG?Same problem exists w/index bonds not in ETFs; high short interest $$?Mar 13, 2014
  • A man and his signals @reformedbroker?http://t.co/12SiH3ZkCp?No 1 has a set of signals that can be relied upon in all market environments $$?Mar 13, 2014
  • Wall Street and Casinos…Are They Similar??http://t.co/MYNALbXAJm?@howardlindzon tells us 2b prepared, understand mkts & not blame ump $$?Mar 13, 2014
  • Activist Investors Put Bondholders in Crossfire?http://t.co/k1BdJx1gR6?Investment grade corps offer little2no protection frm negative M&A $$?Mar 13, 2014
  • How Market Tops Get Made?http://t.co/Saa7j6zkCQ?Good piece by @Ritholtz on technicals of market tops. For dessert: http://t.co/VIGN6jhACy $$?Mar 12, 2014
  • Stock Market Surge Bypasses Most Americans, Poll Shows?http://t.co/IJ0S2rRx8x?People don’t get stocks; worse, they think they get housing $$?Mar 12, 2014
  • Chart of the Day: No Profits, No Problem??http://t.co/HpYPLqoOKP?IPO quality is down, & many private companies want to IPO. IP-uh-oh $$ $SPY?Mar 12, 2014
  • Bull Market Rivals ?90s at Half Valuation as Demand Broadens?http://t.co/YzXZDj9HlK?Profit margins were a lot lower & corp yields higher $$?Mar 10, 2014
  • Still Corporate Cash Everywhere?http://t.co/gseGZd38Th?How much $$ is encumbered? More derivatives today, which induces some calc bias $SPY?Mar 10, 2014

 

US Politics & Policy

  • Regulators Size Up Wall Street, With Worry?http://t.co/aQolfRq0Y4?Allowing big banks to fail, while protecting depositors is a solution $$?Mar 14, 2014
  • Senate Investigation of Bush-Era Torture Erupts Into Constitutional Crisis?http://t.co/qkqkAGiP9Y?Obama-era also; what he tell CIA 2 do? $$?Mar 13, 2014
  • CFPB targets “zombie” foreclosures after Reuters report?http://t.co/RohgKncAnm?What happens when an owner walks away & bank doesn’t f/c $$?Mar 13, 2014
  • How the NSA Plans to Infect ‘Millions’ of Computers with Malware?http://t.co/N72lYfxhr9?Another reason to end the existence of NSA $$ #nonsa?Mar 13, 2014
  • Raskin Confirmed by Senate as US Treasury?s No. 2 Official?http://t.co/TvwMcqj6eI?Maybe she’ll do as much at Tsy as she did at the Fed $$?Mar 12, 2014
  • ObamaCare’s Secret Mandate Exemption?http://t.co/s6OCOdwU83?HHS quietly repeals the individual purchase rule for two more years $$ $SPY $TLT?Mar 12, 2014

Central Banking

  • Fed Sends $79.6B in Profit to Treasury?http://t.co/W313rKFj2k?That profit is taken from the pockets of savers, it is not like manna $$ $TLT?Mar 14, 2014
  • Fed Nominees Vow To Fight for Recovery?http://t.co/KjdmHILaCV?Stanley Fischer & 2 blanks in the gun; really unimpressed w/shuffle Tsy/Fed $$?Mar 13, 2014
  • Yellen Job One Is Redoing Guidance Without Roiling Markets?http://t.co/2Hu8ALqIwW?Unlikely, her own work established current verbiage $$?Mar 12, 2014

?

Economics

  • Your Job Taught to Machines Puts Half US Work at Risk?http://t.co/a0WSKAEIom?W/o labor-saving innovation we wouldn’t b so well off $$ $SPY?Mar 12, 2014
  • Global Debt Exceeds $100T as Governments Binge, BIS Says?http://t.co/cDgYwRUI7A?When large amts of securities get issued -> underperform $$?Mar 10, 2014
  • Where’s Economics When We Need It??http://t.co/3SMaboCeG6?Games played by obscure mathematicians explaining a world that does not exist $$?Mar 10, 2014
  • Will Housing Bloom Again This Spring?http://t.co/KEHLTIKesD?There r2 many investors looking to make $$ in housing; makes further gains hard?Mar 10, 2014

Other

  • Want a Lasting Relationship? Give Up Sex [before marriage]?http://t.co/nxSBVl2QB2?Interesting piece that supports traditional morality $$?Mar 13, 2014
  • Vanishing Planes Since 1948?http://t.co/2mSC2NGByA?Interesting lost planes graphic @BloombergNews | Rare, but more common than expected $$?Mar 13, 2014
  • The Risk Behind Buffett’s Advice?http://t.co/LE6EGqinq2?Asset allocation driven by valuation & time horizon. Don’t B&H if you need the $$?Mar 10, 2014
  • Morgan Stanley, Goldman Said to Swap Fees for Deal Credit?http://t.co/dH1FwKNEsr?$$ less valuable 2 investment banks than pride $GS $MS $SPY?Mar 10, 2014

Wrong

  • Wrong: US to Be Energy Self-Sufficient by 2035: $BP?http://t.co/hr8TTFBpge?Many don’t notice how quickly production tails off w/new wells $$?Mar 13, 2014
  • Wrong: Repo Fire-Sale Plan Said Within Reach After Fed Sounds Alarm?http://t.co/Kzbgp20yRG?These r just band-aid solutions $$ $NLY $TLT $SPY?Mar 12, 2014

Retweets, Replies & Comments

  • Here’s to Martin Rimes @hitmarktrading, my 9,000th Twitter follower; thanks to all who follow me. $$?Mar 13, 2014
  • @Money_in_Stereo I’m writing an article about it tonight at Aleph Blog. This was last night’s article:?http://t.co/bjvqvgXRc5?$$ $BRK.B?Mar 13, 2014
  • @Money_in_Stereo Did anyone respond to you when you asked about the Harney Investment Trust $BRK.B ??Mar 13, 2014

 

On the Structure of Berkshire Hathaway, Part 2, the Harney Investment Trust

On the Structure of Berkshire Hathaway, Part 2, the Harney Investment Trust

Posted on by David Merkel

In Omaha, there is Farnam Street. ?Among value investors, it is well-known, because the small main office of Berkshire Hathaway [BRK] is located there. ?Less well known is Harney Street, but from an insurance standpoint it is important, because Berkshire Hathaway’s largest insurance subsidiary, National Indemnity, is located there. ?One of the major assets of National Indemnity is the Harney Investment Trust, of which National Indemnity is the sole beneficiary.

Before I go further, I want to say there is a lot I don’t know about what I am going to write. ?Let me tell you what sources I have looked at:

  • SEC filings of companies where the Harney Investment Trust was a greater than 5% shareholder.
  • Legal documents from Bankruptcies and other corporate legal events where Harney Investment Trust was a party.
  • All of the statutory filings for Berkshire Hathaway’s primary insurance companies in 2012.
  • All of National Indemnity’s statutory filings on assets 2002-2013.
  • All of National Indemity’s statutory audits, 2002-2012.

Now, if you read through BRK’s filings to the SEC, you won’t find many mentions of the Harney Investment Trust. ?You have to read the insurance regulatory documents to find it, and even if you do that, you will still be puzzled. ?Why?

  • Over the last 12 years, the National Association of Insurance Commissioners does not require “Other Assets” on Schedule BA to provide enough data so that an external user can make the change in book value or market value make sense. ?It has gotten better over time, but it is still not enough. ?You want to have enough data such that it explains the change in market and book value to the nearest thousand dollars.
  • There are a few errors that are obvious. ?Some easy calculations don’t add. ?Current year starting values are not the same as last year’s ending values.
  • A few numbers between the statutory filings and audits don’t agree.

Now, some of that is due to bad regulation. ?The data reported for schedule BA assets could be streamlined such that it reports the change in the balance sheet for each asset on a book and fair market value basis.

But more of it is due to BRK’s lack of willingness to discuss/mention the Harney Investment Trust. ?I did a lot of digging on this, and found ?little that was definitive. ?One seemingly intelligent opinion I found here. ?I will quote the most relevant portion from “globalfinancepartners”:

Regarding the large surplus at Berkshire – it is largely because many subsidiaries are owned inside the insurance companies – especially within National Indemnity.? 100% of the stock of BNSF, for example, valued at BRK’s cost of $34 Billion – is owned by National Indemnity and counts towards the statutory surplus.? Also, National Indemnity owns 100% of the shares of GEICO.? Then in addition there are the securities, of course.

GEICO, in turn, owns 100% of the shares of Clayton, McLane, TTI, as well the marketable securities.

I’ll attach an NAIC filing if you really want to geek out.? But unfortunately, the mystery stock Buffett has been accumulating and receiving confidential status on through the SEC is hidden like always inside the “Harney Investment Trust” – Buffett’s go-to vehicle for keeping stock trading hidden from regulatory filings.? (Harney Street is in Omaha)

He gets it, mostly, and concludes that Buffett uses the Harney Investment Trust to hide his buying and selling of positions. ?Assets inside the Trust do not get reported one-by-one on the insurance Schedule D.

Now, before I close, I want to share the data that I have harvested from the Statutory statements, and make a few more comments.

Year

2001

2002

2003

2004

2005
Cost ?? 8,063,249,239 ?? 6,098,184,425 ??? 4,345,049,427 ????? 7,566,419,887
Addl Investment ????? 4,314,851,219
Fair Value ?? 10,532,124,694
Book ?? 9,814,864,000 ?? 9,325,481,908 ?? 8,326,636,998 ??? 5,326,049,532 ????? 9,524,818,329
Change ???? (220,350,768) ?????? 859,931,290 ? (1,141,017,994) ????? 1,958,398,441
Accretion
OTTI
FX Change
Inv Income ????????? 455,078,969
Book Sold ?? 5,405,086,442 ?? 4,640,112,416 ??? 2,934,268,712 ????? 1,121,718,176
Change ?????????? (40,084,139)
Consideration ?? 6,156,977,208 ?? 5,492,507,843 ?? ?3,827,449,032 ????? 1,561,718,363
Gain ?????? 751,890,766 ?????? 852,395,427 ???????? 893,180,320 ????????? 399,916,048
income
% Assets

25.77%

18.33%

10.45%

15.36%
Am Cost ?? 8,355,067,000 ?? 8,063,249,000 ?? 6,098,184,000 ??? 4,345,049,000 ????? 7,566,420,000
URGC ?? 1,459,797,000 ?? 1,711,427,000 ?? 3,810,157,000 ??? 2,316,272,000 ????? 2,965,705,000
URCL ????????????????????????????????? – ?????? 144,894,000 ????????????????????????????????? – ?????????????????????????????????? – ???????????????????????????????????? –
Fair Value ?? 9,814,864,000 ?? 9,629,782,000 ?? 9,908,341,000 ??? 6,661,321,000 ?? 10,532,125,000
Comments Disagreeing figs

 

Year

2006

2007

2008

2009
Cost ????? 6,964,633,697 ?? 20,139,079,483 ????? 5,921,482,114 ????? 5,786,018,179
Addl Investment ????????? 982,768,239 ?? 15,783,905,450 ????? 9,781,668,840 ?? 10,865,269,974
Fair Value ?? 12,117,706,779 ?? 21,921,621,265 ????? 4,923,093,676 ????? 6,769,046,868
Book ?? 11,123,440,646 ?? 21,921,621,265 ????? 4,801,843,191 ????? 5,800,502,260
Change ????? 3,098,256,653 ????? 1,751,436,622 ??? (2,840,908,667) ????? 1,108,867,879
Accretion ????????? 119,595,243 ????????? 197,707,597
OTTI ????????? 288,188,143 ????? 2,590,146,282
FX Change ?????????? (57,873,620) ???????????? 36,966,246
Inv Income ????? 1,261,755,231 ????????? 663,463,512 ????????? 987,469,687 ????????? 826,207,723
Book Sold ?? ???1,746,959,239 ????? 2,653,395,647 ?? 24,830,673,311 ????? 8,645,957,509
Change ??????? (100,447,051) ????????????? (3,398,147) ???????????? 37,662,286
Consideration ????? 1,999,993,027 ????? 6,522,527,452 ?? 24,010,303,351 ????? 9,017,341,154
Gain ????????? 353,480,839 ????? 3,869,131,805 ????????? 179,640,040 ????????? 371,383,645
income ??????????????? 3,658,670 ???????????? 62,505,008
% Assets

16.56%

29.56%

7.78%

7.39%
Am Cost ????? 6,964,634,000 ?? 20,139,079,000 ????? 5,921,482,000 ????? 5,786,018,000
URGC ????? 5,153,073,000 ????? 1,782,542,000 ???????????????????????????????????? – ????????? 983,029,000
URCL ????????????????????????? ???????????- ???????????????????????????????????? – ????????? 998,388,000 ???????????????????????????????????? –
Fair Value ?? 12,117,707,000 ?? 21,921,621,000 ????? 4,923,094,000 ????? 6,769,047,000
Comments Bought out other trusts Cleaned House
Year

2010

2011

2012

2013
Cost ????? 9,457,498,340 ????? 7,464,877,852 ?? 7,064,639,865 ?? 5,004,510,446
Addl Investment ????? 7,068,414,613 ?? 12,784,563,299 ?? 4,186,877,510 ?? 3,254,233,606
Fair Value ?? 11,700,226,848 ????? 7,807,366,099 ?? 9,066,610,408 ?? 7,675,070,719
Book ?? 10,720,330,531 ????? 7,450,894,712 ?? 8,417,129,742 ?? 7,511,081,043
Change ????? 1,271,863,576 ??? (1,276,652,476) ?? 1,332,026,027 ?? 1,163,420,948
Accretion ???????????? 17,914,824 ?????????? (25,309,149) ???????????? 2,759,586 ???????????? 2,810,400
OTTI ????????? 476,659,635 ????????? 190,142,457 ?? ????115,680,863
FX Change ????????????? (5,766,223) ?????????????????? (911,734) ???????????? 1,296,067 ????????????????? 659,774
Inv Income ????????? 554,369,500 ????????? 719,996,080 ?????? 389,469,312 ?????? 403,093,171
Book Sold ????? 2,944,738,747 ?? 14,566,437,847 ?? 4,479,185,215 ?? 5,214,644,823
Change ??????????????? 7,728,019 ??????????????? 4,705,665 ???????????? 4,970,996 ???? (102,528,623)
Consideration ????? 3,576,396,272 ? ?14,738,706,689 ?? 4,833,798,698 ?? 5,785,003,373
Gain ????????? 631,657,525 ????????? 141,268,842 ?????? 354,613,478 ?????? 570,358,551
income ???????????? 76,920,680 ???????????? 25,137,655 ????????? 11,091,687 ?????? 118,147,838
% Assets

9.60%

6.45%

6.59%
Am Cost ????? 9,457,498,000 ????? 7,464,878,000 ?? 7,064,640,000
URGC ????? 2,343,171,000 ????????? 866,984,000 ?? 2,083,717,000
URCL ????????? 100,442,000 ????????? 524,226,000 ????????? 81,747,000
Fair Value ?? 11,700,227,000 ????? 7,807,636,000 ?? 9,066,610,000

Notes: OTTI: other than temporary impairments. ?URCG: Unrealized Capital Gains. URCL: Unrealized Capital Losses. ?Other categories are hard to define, though I am sure the NAIC has definitions, though they don’t give complete changes in balance sheets.

Another thing that I could not make to match from the statutory statements was the securities that went in and out of the trust. ?Aside from some Treasury bonds ?in 2002, here are all of the reported transactions where securities moved from National Indemnity to the Trust, and vice-versa.

Year Action Ticker Shares Value Consideration Capital Gain (loss)

2003

 In MTB ???????? 927,760 ????????????? 3,655,241

2003

 In WFC ???? 6,138,800 ???????? 127,795,056

2003

 In AXP ???? 5,308,500 ???????? 101,902,002

2003

 In MCO ?? 16,140,300 ???????? 340,631,841

2003

 Poof LVLT ?? 32,691,065 ???????? 100,000,000

2004

 In TMK ???????? 872,200 ?????????? 20,268,837

2004

 In HRB ?? 14,350,600 ???????? 222,546,836

2004

 In CDO ???? 1,195,274 ????????????????????????????? 1

2004

 In COST ???? 5,254,000 ???????? 146,595,428

2004

 In GCI ???? 3,447,600 ?????????? 81,873,173

2004

 In MLI ???? 1,361,900 ?????????? 30,408,193

2004

 In SEE ???? 1,113,300 ?????????? 32,102,292

2004

 In USG ???? 6,500,000 ?????????? 37,180,000

2005

 Out TMK ???????? 872,200 ?????????? 20,268,837 ???????? 49,826,080 ?????????????? 29,557,243

2005

 Out HRB ?? 14,350,600 ???????? 222,546,836 ?????? 703,179,400 ???????????? 480,632,564

2005

 Out CDO ???? 1,195,274 ????????????????????????????? 1 ???????? 26,666,563 ?????????????? 26,666,562

2005

 Out COST ???? 5,254,000 ???????? 146,595,428 ?????? 254,346,140 ???????????? 107,750,712

2005

 Out GCI ???? 3,447,600 ?????????? 81,873,173 ?????? 281,668,800 ???????????? 199,795,627

2005

 Out MLI ???? 1,361,900 ?????????? 30,408,193 ???????? 43,853,180 ?????????????? 13,444,987

2005

 Out SEE ???? 1,113,300 ?????????? 32,102,292 ???????? 59,305,491 ?????????????? 27,203,199

2005

 Out USG ???? 6,500,000 ?????????? 37,180,000 ?????? 261,755,000 ???????????? 224,575,000

2008

 In USB ?? 20,768,728 ???????? 657,202,698

2008

 In WFC ?? 52,372,788 ???? 1,819,017,267

2008

 In COP ?? 71,896,273 ?? ??5,878,643,401

2008

 In COST ???? 5,264,000 ???????? 146,595,428

2008

 In KFT ?? 89,222,400 ???? 2,957,096,963

2008

 In PG ?? 17,200,318 ???? 1,026,726,674

2008

 In USG ?? 10,102,918 ??????? ?202,419,056

2008

 In WMT ?? 18,998,300 ???????? 901,731,797

2008

 Out PG ?? 20,000,000 ???? 1,193,846,154 ?? 1,468,400,000 ?????????? (274,553,846)

2009

 In COP ?? 29,711,330 ???? 1,163,495,683

2009

 In MTB ???????????? 6,300 ???????????????? 447,467

2009

 In PG ?? 14,328,093 ???????? 855,276,936

2009

 In TMK ???? 1,656,900 ?????????? 60,572,017

2009

 In WMT ?? 14,892,842 ???????? 746,046,432

2009

 In WFC ?? 21,030,680 ???????? 473,941,080

2009

 In GSK ???? 1,510,500 ?????????? 78,918,016

2009

 In PKX ???? 1,087,000 ?????????? 44,260,228

2009

 In SNY ???? 2,896,133 ???????? 119,233,280

2009

 Out COP ?? 71,896,273 ???? 5,690,321,498 ?? 3,724,226,941 ???????? 1,966,094,557

2009

 Out MCO ?? 15,000,000 ???????? 163,880,137 ?????? 284,850,000 ?????????? (120,969,863)

2009

 Out PG ? ?26,000,000 ???? 1,552,000,000 ?? 1,607,320,000 ???????????? (55,320,000)

2010

 In JNJ ?? 13,274,736 ???????? 851,173,066

2010

 Out COP ?? 25,227,450 ???????? 987,906,942 ?? 1,288,365,871 ?????????? (300,458,929)

2010

 Out KFT ?? 57,684,645 ???? 1,885,271,843 ?? 1,567,868,651 ???????????? 317,403,192

2010

 Out MTB ???? 4,680,322 ?????????? 36,930,716 ?????? 216,105,603 ???????????? 179,174,887

2010

 Out PG ?? 15,000,000 ???????? 895,384,615 ?????? 909,450,000 ?????????????? 14,065,385

2011

 In COP ?? 21,109,637 ???????? 826,653,385

2011

 In GCI ???? 1,740,231 ?????????? 13,921,848

2011

 In IBM ?? 63,905,931 ?? 10,856,339,550

2011

 In MTB ???? 4,671,245 ?????????? 38,003,193

2011

 In PG ?? 12,669,252 ???????? 756,256,889

2011

 In WFC ?? 28,446,437 ???????? 718,140,133

2011

 Out JNJ ?? 12,951,761 ??? ?????829,897,088 ?????? 801,466,418 ?????????????? 28,830,670

2012

 In WFC ?? 32,872,641 ???? 1,090,916,624

2012

 Out PG ?? 29,754,036 ???? 1,776,087,072 ?? 1,984,891,742 ???????????? 208,804,670

In means assets came into National Indemnity, and out means the reverse. ?Poof means something came into National Indemnity, and left in the same calendar year.

Notably, in 2008, Buffett had most of the assets exit the trust into National Indemnity, when they were in a position of unrealized capital loss. ?I don’t fully understand the tax and capital effects here, but it seems that Buffett found it to his advantage to move assets out of the trust, and into National Indemnity once the assets were unrealized capital losses.

I think the guy I quoted is correct. ?Buffett uses the Harney Investment Trust to hide his acquisitions and dispositions of stock. ?The NAIC should end this, and make Schedule BA assets that are easily separable appear on Schedule D, where they belong. ?Schedule BA should be for assets that are not publicly traded. ?Partnerships with assets that would fit on Schedule D should ?be on Schedule D.

Summary

Buffett tries to take an ethical stance in investing, and makes many statements about the way investing ought to be done. ?Using a trust to avoid disclosure of holdings and transactions is not in the spirit of GAAP or statutory accounting/disclosures. ? This practice should be ended. ?Warren, step up your game before you have to and end the Harney Investment Trust. ?I write this as a fan who owns BRK/B shares.

And, to my dedicated readers, if you have more data, or a better means of analysis of the data I have gathered, by all means offer your help. ?Thanks, David

Full disclosure: long BRK/B for clients and me

On the Structure of Berkshire Hathaway

On the Structure of Berkshire Hathaway

Posted on by David Merkel

Berkshire Hathaway [BRK] is a unique company. ?You have a property-casualty insurance giant owning many businesses directly through insurance subsidiaries, including huge businesses like a Class 1 Railroad — BNSF.

Yes, National Indemnity owns BNSF in entire, and many other businesses as well. ?I thought the pre-crisis org chart of AIG was complex — because of the many industries that it covers, BRK is far more complex. ? In the 2012 statutory statements, it runs for 22 pages. ?Let me list the top-level subsidiaries, and any significant lower level subsidiaries they own.

  1. Affordable Housing Partners (common for reducing taxes w/ section 42 housing)
  2. Albecca (Larson-Juhl)
  3. AU Holding Company (Applied Underwriters
  4. Ben Bridge Corporation
  5. Benjamin Moore
  6. Berkshire Hathaway Credit Corp (BH Media — all the little newspapers)
  7. Berkshire Hathaway Finance Corp
  8. BH Columbia Inc (Columbia Insurance, Medical Protective Corp [which owns Lubrizol debt])
  9. BH Housing LLC
  10. BH Shoe Holdings, Inc.
  11. BH-IMC Holdings B.V. (“Iscar”)
  12. BHSF (SF = Scott Fetzer)
  13. Blue Chip Stamps, Inc. ?(Really, still around?)
  14. Borsheim Jewelry Company
  15. Brookwood Insurance Company
  16. Business Wire, Inc.
  17. Central States of Omaha Companies, Inc.
  18. CORT Business Services Corp
  19. CTB International Corp.
  20. Cypress Insurance Company
  21. Forest River, Inc.
  22. Fruit of the Loom, Inc.
  23. Garan, Inc.
  24. Gateway Underwriters Agency
  25. General Re Corporation (seems to own much of Fruit of the Loom)
  26. Helzberg’s Diamond Shops
  27. International Dairy Queen
  28. Johns Manville Corp
  29. Jordan’s Furniture
  30. Justin Brands (Acme Brick)
  31. Marmon Holdings
  32. MidAmerican Energy Holdings (CalEnergy, HomeServices of America, Magma Power, NV Energy, Pacificorp)
  33. MiTek Industries
  34. MS Property
  35. National Fire & Marine Insurance Company
  36. National Indemnity (Flightsafety, BNSF, CLAL, GEICO, Clayton Homes, McLane, TTI)
  37. National Liability & Fire Insurance Company
  38. Nebraska Furniture Mart
  39. NetJets, Inc.
  40. Northern States Agency, Inc.
  41. OTC Worldwide Holdings (Oriental Trading Company)
  42. Precision Steel Warehouse, Inc.
  43. R. C. Willey Home Furnishings
  44. Richline Group, Inc.
  45. See’s Candy Shops
  46. Shaw Industries Group
  47. Star Furniture Company
  48. The Buffalo News, Inc.
  49. The Fechheimer Brothers Company
  50. The Lubrizol Corp
  51. The Pampered Chef, Lrd.
  52. US Investment Corporation
  53. Wesco-Financial Insurance Company
  54. XTRA Corp

BRK is huge, and Buffett prefers owning whole companies to portions of companies, because then the entire free cash flow is available to him, not just the dividends.

The first question to answer is why does Buffett have some industrial companies inside his insurers, and some not? ?That has to do with risk-based capital. ?P&C insurers have to put up capital equal to 22.5% on equity of affiliated insurers, and 15% on non-affiliated common stocks, and 20% on Schedule BA investments that are similar to stocks. ?These are more liberal than the standards for life companies, which ?have a 30% charge on stocks. ? (Which doesn’t make sense, because life insurers have longer balance sheets, and have a better ability to hold equities, but I digress…)

But even if they have to put up capital to own the companies, BRK has a negative cost of capital inside its insurers, because they make underwriting profits. ?What a business — make money on insurance, and on businesses owned by the insurance subsidiary.

One more thing about BRK’s insurance subsidiaries — in general, because they have so much asset risk, they don’t write as much insurance as other companies of their size would.

Tomorrow, I will write part 2 on this, regarding the one anomaly I found going through BRK’s statutory books, the Harney Investment Trust. ?Till then.

Full disclosure: long BRK/B for clients and me

Why I Don’t Write a Newsletter

Why I Don’t Write a Newsletter

Posted on by David Merkel

At various points over the last 20 years, various friends have encouraged me to write a newsletter. ? I have resisted these requests, because in general, I don’t have respect for newsletter writers.

If you’ve got great ideas, invest in them, and start a firm to do so for others. ?Don’t hide behind the virtual sham of “this is only entertainment.” ?I’ve been blogging for seven years, and I am not trying to entertain but to educate. ?I don’t give financial advice because I don’t know who I am speaking to; everything is general, so what I write may be applicable to some readers, but certainly not all readers.

Second, since I have created my own firm, I owe a duty to my clients that they get my best insights, implicitly or explicitly. ?Implicitly: I no longer mention what my holdings are, unless I write about them. ?At present, the sharpest reader who is not a client knows 20% of my equity portfolio at best. ?Explicitly, I write to my clients once a quarter, and tell them what I am thinking, and why I have taken the actions that I have in their portfolios.

It is simpler for me from an ethics and compliance standpoint to keep public and private information separate. ?It gives my clients the focus they deserve, and allows me to write on a wide amount of topics of interest to many people, without doing damage to either side. ?As always, if I have a position in something I write about, I will disclose it.

The Rules, Part LXI (The End… of the Past)

The Rules, Part LXI (The End… of the Past)

Posted on by David Merkel

Rule: every rule has exceptions, including this one

In the long-run, and with hindsight, most actions of the market make sense. ?Sadly, we live in the short run, and our lives may only see one to 1.5 full macro-cycles of the market in our lives. ?We live in a haze, and wonder what useful economic and financial rules are persistently valid?

We live in a tension between imitation and thought, between momentum and valuation, between crowds and lonely reasoning, between short-term thinking and long-term thinking.

It would be nice to be like Buffett, who has no constraint on his time horizon, managing to the infinite horizon, because he has so much that setbacks would mean little to him. ?But most of us have retirements to fund, college expenses, a mortgage, and many other things that make us far more subject to risk.

Does valuation matter? ?You bet it does. ?When will it matter next? ?Uh, we can’t answer that. ?When we come up with a good measure of that, people begin using it, and the system changes.

My personal asset allocation for most of my life has been 75% risk assets/25% cash. ?Especially now, when bond yields are so low, I don’t see a lot of reason to extend the maturities of my bond portfolio, aside from a small position in ultra-long Treasuries, which is a hedge against deflation.

Investment reasoning is a struggle between the short-term and the long-term. ?The short-term gets the news day-by-day. ?The long term silently gains value.

If you invest long enough, you will have more than your share of situations where you say, “I don’t get this.” ?It can happen on the bull or bear sides of the market, and you may eventually be proved right, but how did you do while you were waiting?

Thus, uncertainty.

Is there a permanent return premium to investing in equities? ?I think so, but it is smaller than most imagine, particularly if compared against BBB/Baa bonds.

I’m not saying there are no rules. ?Far from it, why did I write this series?! ?What I am saying is that we have to have a firm understanding of the time horizon over which the “rules” will work, and an understanding of market valuations, sensing when valuations are high amid a surging market, and when valuations are low amid a plunging market. ?There are times to resist the trends, and times to embrace the trends.

The rules that I embrace and write about are useful. ?They reduce risk and enhance return. ?I once said to Jim Cramer before I started writing at RealMoney that the rules work 65% of the time, they don’t work 30% of the time, and 5% of the time, the opposite of the rules works. ?This is important to grasp, because any set of tools used to analyze the market will be limited — there is no perfect set of rules that can anticipate everything. ?You should expect disappointment, and even embarrassment with some degree of frequency. ?That’s the way of the market even for the best of us.

Hey, Buffett bought investment banks, textiles, shoes and airlines at the wrong times. ?But we remember the baseball players who had seasons that were better than .400, and Buffett is an example of that. ?In general, he made errors, but he rarely compounded them. ?His successes he compounded, and then some.

The rule I stated above is meant to be a paradox. ?In general, I am a long-term oriented, valuation-driven investor who seeks to maximize total return over the long haul, with significant efforts to avoid risk. ?Do I always succeed? ?No. ?Do I make significant mistakes? ?Yes. ?Have my winners more than paid for my losers over the 20+ years I have been an active investor? Yes, yes, and then some.

But this isn’t about me. ?Every investor will have days where they will have their head in their hands, like I did managing the huge corporate bond portfolio in September 2002, where I said to the high yield manager one evening as we were leaving work, “This can’t keep going on like like this, right? ?We’re close to this burning out, no?

He was a great aid to my learning, an optimist who embraced risk when it paid to do so. ?At the time, he agreed with me, but told me that you can never tell how bad it could get.

As it was, that was near the bottom, and the pains that we felt were those of the market shaking out the crud to reveal what had long lasting value. ?Or at least, value for a time, because?the modus operandi of the Fed became inflating a financial/housing bubble. ?That would not work in the long run, but it would work for a time. ?After that, I worked at a place that assumed that it would fail very soon, and was shocked at how far the financial excesses would eventually run. ?I was the one reluctant semi-bull in a bear shop that would eventually be right, but we had to survive through 4+ years of increasing leverage, waiting for the moment when the leverage had gone too far, and then some.

Being a moderate risk-taker who respects risk is a good way to approach the markets. ?I have learned from such men, and that is what I aim for in my investing. ?That means I lag when things are crazy, and that is fine with me. ?I don’t play for the last nickel — that nickel may cost many bucks. ?Respect the markets, and realize that they aren’t here to serve you; they exist to allocate capital to the wise over the long run. ?In the process, some will try to profit via imitation — it’s a simple strategy, and time honored, but when too many people imitate, rather than think, bad things happen.

The End, for Now

This post is the end of a long series, and I thank those who have read me through the series. ?I think there is a lot of wisdom here, but markets play havoc ?with wisdom in the short run, even if it wins in the long run. ?If I find something particularly profound, I will add to this series, but aside from one or two posts, all of the “rules” were generated prior to 2003. ?Thus, this is the end of the series.

The Rules, Part LX

The Rules, Part LX

Posted on by David Merkel

Rapid upward moves in volatility almost always presage a bounce rally.

Again, I am scraping the bottom of the barrel, but this is a common aspect of markets. ?When things get tough, scaredy-cats buy put options. ?That pushes up option implied volatilities. ?The same doesn’t happen when prices are rising, because that happens slower. ?Prices fall twice as fast as they rise in the stock market.

Emotions play a big role with options, and many do not use them rationally. ?Rather than using them when the market is rising in order to hedge, more commonly they hedge after the market has fallen.

As implied volatility rises, the ability to make money from hedging falls, as the cost of insurance goes up. ?As a result, hedging peters out, and the market will be receptive to positive news, given that most who want to hedge have hedged. ?Their pseudo-selling is over, and a bounce rally will happen.

Volatility tends to mean-revert, and as the reversion from high levels of volatility happens, the value of stocks rise. ?People buy equities as fears dissipate.

Volatility, both actual and implied, are tools to have in your arsenal to help you understand when markets might be overvalued (low volatility) or undervalued (very high volatility). ?Use this knowledge to guide your portfolio positioning. ?At present, it is more reliable then many other measures of the market.

Next time, I end this series. ?Till then.

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