Are some Baby Boomers retiring because the current value of their assets is high?  This article from Bloomberg gives an ambivalent answer to the question.  Personally, I don’t know the answer to that question, but I can answer a related question: In the current market environment, where interest rates are low and stock valuations are high, should Baby Boomers accelerate their retirements?

The answer is no.  Here’s why: in retirement, you aren’t earning income from wages.  You need income to be able to pay for expenses.  If interest rates are low and stock valuations are high, you won’t be able to create much income relative to your assets.

It’s like owning a long bond that you intend to buy and hold for the income.  Do you care that interest rates have fallen, and the value of your bond is above where you bought it?  No.  It doesn’t give you any more income.  If you sold it, where would you reinvest to get more income at equivalent risk?

Let me digress: rather than looking at asset values, look at anticipated cash flow streams.  Have you grown you anticipated cash flow stream?  In a bull market, many look like geniuses, but if it is only due to a rise in valuations, it means that the cash flow streams are unchanged.

I realize this is a harder way to look at the markets, but for those that have managed the interest rate risk at life insurers, this is the way the best do it.  Have you created a higher income rate over the funding horizon?  That is true improvement of the economic position.

Don’t merely look at the current value of your assets.  That is an illusion of the true value in terms of income.  Think of it this way.  Say that you have surpassed your prior peak assets of 2007 recently in 2014.  Now look at the income you could have purchased in 2007 (use the long bond as a proxy — 5%), versus what you could buy today — 3.4%.  The ability to generate income is reduced by 30%+.

You might argue that the long bond is the wrong proxy — too long, too safe.  I would argue that the safety is necessary.  If you want to take more risks in fixed income, go ahead, but that is an option.  As for length, the length is close to what is needed, but if you used 20-year bonds, the argument would not change.

Final Notes

You might think you have a lot of money, but how much income can it generate?  Are you protected against inflation? Deflation? Credit risk?  Don’t assume because the asset balance is high that you are necessarily better off, because you might not be able to earn as much income off your assets.

One of the challenges in investing is understanding whether stocks are really earning above expectations or not.  Many companies, especially the large ones have their adjusted or modified GAAP earnings.  I can sympathize with the companies if the adjustments make the adjusted earnings more like free cash flow.  But if not, I disagree.

GAAP accounting is very good, better than IFRS, but not perfect. There are two uses for earnings figures, and they are different, because they serve different time periods.

When analyzing quarterly earnings, heed the adjusted earnings figure, but review that calculation to see that is is on the same basis as it was over the last year.  Shenanigans are often played here.

Second, look over a 3-, 5-, and 10-year periods: see how much actual earnings lagged behind management estimates.    Yes, there are temporary fluctuations in earnings.  But when they repeat again and again, it indicates that management is sloppy.  This is structural and not sporadic.

Don’t invest in companies that regularly have significant one-time disappointments.  What is regular should be treated as regular.  Companies that regularly have to adjust earnings higher then GAAP deserve lower valuations.

Here’s another way of thinking about it: writedowns usually reflect the past, indicating that past profitability wasn’t so high.  If writedowns come frequently, it means that management has made bad/liberal accounting decisions.  This could be a stock to avoid.

Thus in the short run, look at adjusted earnings, but critically.  In the long run, look at unadjusted earnings, because managements should be responsible for their long-term errors.

This was a two part article that was published at RealMoney July 19-20, 2004:


Two changes have taken place in the corporate bond market in recent years. The first change deals with credit default swaps, which I’ll discuss in today’s column. In Part 2 I’ll talk about how corporate bonds are analyzed differently now.

Surviving the Loss of a Major Class of Investor

There used to be a tendency for Wall Street to hold a supply of corporate bonds to sell to the buy side. That changed when credit default swaps were, or CDS, developed. A credit default swap is a transaction where one party buys protection against the default of a corporate credit from another party. The party selling protection receives a constant payment over the life of the transaction so long as the corporate credit does not default.

These swaps were developed in the mid-1990s, but they remained somewhat tangential to investment banks until the negative side of the credit cycle hit in 2000-2002. Many banks did a huge business in CDS, but they traded cash bonds and CDS separately. Typically, the cash bond side of the house was net long corporate bonds, and the CDS side was typically flat credit risk. From late 2001 through 2002, a major change rippled through the “bulge bracket” firms on Wall Street. They got the bright idea to trade cash bonds and CDS together as a group.

This had several desirable outcomes:

  • It enabled them to hold a larger inventory of corporate bonds with less risk.
  • It enabled them to be flat the corporate bond market in a period of severe stress. (However, it must be noted that most of those that instituted programs like this had the trough of the corporate bond market.)
  • It allowed them to trade more rationally. There were new trades that could be done by comparing the cash bond market and CDS market, going long one and short the other. (Note: Here’s how to make money on corporate trading desks: You have more flow in the market than most people you trade with. When clients offer you mispriced trades in your favor, you trade with them and then buy or sell the offsetting positions in the intradealer market at a fair price. With CDS, you have more options for laying off the risk.)

This had the unfortunate effect of removing a seemingly natural buyer from the corporate bond market at a time when the corporate bond market could least afford it. It is my guess that that was part of the reason why the corporate bond market bottomed out in October of 2002, rather than July of 2002. Pressure on the corporate bond market from CDS-related selling did not abate until mid-November of 2002.

As a result, there is only one major buyer of long-term corporate credit risk left in the U.S. economy: life insurance companies. Pension funds play a role in this market, as do foreign institutional buyers. So when corporate bonds do badly or well, life insurance companies are disproportionately affected.

In one sense, we are in a brave new world for both life insurance companies and the corporate bond market because the life insurance industry alone is not big enough to purchase all of the corporate bonds outstanding. Perhaps foreign institutions have filled the gap at present; if so, it will be interesting to see whether foreign capital is as patient as the life insurance industry if we have another downturn in the credit markets.

An Additional Implication of CDS

CDS unify the debt capital structure of debt-issuing companies. In the old days, companies that borrowed money from banks, or issued debt, did so in marketplaces that were separately priced. That separation allowed corporations a greater degree of wiggle room when financial times got tough. Even if the bond market temporarily shut down after a company was downgraded to junk, typically banks would still lend to them, even if the terms were more onerous.

But with the advent of CDS, the banks might lend, but they will lay all the risk on the CDS market. As more risk gets laid off, the credit default swap spreads rise. As the credit default swap spreads rise, an arbitrage opportunity appears against cash bonds.

This leads the corporate bond market default in tandem with rising credit default swaps spreads. Finally, because of arbitrage between equity prices, equity volatility, corporate bond spreads and credit default swap spreads, even a dislocation in the equity markets can lead to trouble in the debt markets and vice versa.

Here is an example of how the world has changed. In late 2000, Xerox (XRX) was under threat of downgrade from both ratings agencies. A downgrade from either agency would make Xerox unable to sell commercial paper, which it needed to finance its deteriorating business. The company tried to issue more commercial paper, but the auction failed, which forced it to exit the commercial paper market. To make up for the cash flow shortfall, Xerox went to its banks to tap its CP backup credit lines. The banks, distressed that what was previously considered free money for them was actually going to be put to use, went to hedge their risks in the CDS market as the CP backup lines got drawn down. The massive buying demand for Xerox CDS led the CDS spreads to widen, which spread into the corporate bond market through arbitrage and eventually led the price of Xerox common equity downward. This happened in a matter of a few days, although the effects rippled for weeks afterward.

Thus, in a panic situation, every market that provides capital to corporations fights against the corporations in a unified manner. This is very different from how the markets behaved 10 years ago. The implication for equity investors is that if you’re buying the equity of debt-issuing corporations, you must be aware that in a crisis they will be more volatile than they were in the past.

Since the bottom of corporate bond market in the 2002, corporations have enjoyed stronger profits and free cash flow. Many corporations have deleveraged. This would be reason alone for corporate spreads to tighten. But there is another factor at play here that is less known outside of the corporate market.

Two Methods of Analysis

There are two distinctly different ways to analyze corporate bonds. The first way is the old standard, which relies on fundamental analysis of a company’s financial statements. The second way relies on contingent claims theory (options theory, Merton’s model) and primarily uses market-oriented variables like stock prices and option volatility.

The basic idea behind the latter method is that the unsecured debt of a firm can be viewed as having sold a put option to the equity owners. In an insolvency, the most the equity owners can lose is their investment. The unsecured bondholders (in a simple two-asset-class capital structure) are the new “de facto” equity holders of the firm. That equity interest is most often worth far less than the original debt. Recoveries are usually 40% or so of the original principal.

Under contingent claims theory, spreads should narrow when equity prices rise, and when implied volatility of equity options falls. Both of these make the implied put option of the equity holders less valuable. Equity holders do not want to give the bondholders a firm that is worth more, or more stable.

So what’s the point? Over the last seven years, more and more managers of corporate credit risk use contingent claims models. Some use them exclusively; others use them in tandem with traditional models. They have a big enough influence on the corporate bond market that they often drive the level of spreads.

Because of this, the decline in implied volatility for the indices and individual companies has been a major factor in the spread compression that has happened. I would say that the decline in implied volatility, and deleveraging, has had a larger impact on spreads than improved profitability has.

Wider Implications for the Markets

Contingent claims models are not perfect, but they are quite good. To ignore them is foolish, but understanding their weaknesses is helpful.

Contingent claims models have a tendency to overestimate the risk of default with corporations that are overleveraged but have a long maturity debt structure. In many of these cases, the indebted corporation has a great deal of “breathing room” and often can maneuver its way out of the situation. This can offer real opportunities for buy-and-hold investors because they can buy the debt or equity at depressed levels and hold it through the apparent crisis. Doing this requires careful fundamental analysis, so if you invest in any of these situations, make sure you do your homework thoroughly.

Finally, the combination of contingent claims theory and the existence of CDS can produce other anomalies. It becomes theoretically possible to hedge CDS against common equity. Some hedge funds do this. They analyze bank debt, corporate bonds, convertible bonds, preferred and common stocks, options, warrants and other financing instruments, to find the cheapest aspect of a company’s credit structure and buy it, and find the richest aspect and sell it.

The full set of implications for the asset markets from this is unknown, partly because funds that do this are small relative to the markets as a whole. If the hedge funds that did this were too large for the markets, it would create too many feedback loops that have not yet been tested, which would have a tendency to amplify price moves in a crisis.

I can’t tell where such a crisis might lurk. The markets are relatively optimistic now. But being aware that these feedback loops could exist, can give you an edge in a crisis. The main upshot is this: Having a strong balance sheet is worth more today than it was in the past. It’s one of many reasons why I continue to focus on higher-quality companies in my equity investing.

I wrote the following article for RealMoney in August 2005.  I don’t like handing out individual stock ideas.  I would rather teach people how to think about stocks and other assets, because my individual ideas will be wrong 30% of the time, and I will garner a lot of complaints from them.  I will get few thanks from the 70% I got right.  The ratio corresponds to that which Jesus had healing the lepers.

That said, those that invested in this portfolio for two years did well.  Okay, read on:


I’m not crazy about giving individual stock ideas on RealMoney because all investing is best viewed in a portfolio context. Individual stock ideas are important, but I believe portfolio construction and management are more important.

Too many investors are looking for the next hot company when they should really be looking for a consistent theory of how to produce reliable returns while minimizing downside risk.

In my column Evolution of an Investment Style, I tried to describe how I achieve above-average returns while trying to squeeze out risk. This is not an easy process, but it is achievable if you think about investing in the same way an intelligent businessman thinks about his own firm.

That’s what my seven rules from that column are all about.

One of the first things you’ll notice is that there doesn’t seem to be any rhyme or reason to the order in which the stocks are listed. There is a logic here, but the order is based on the timing of initial purchases. Stocks that I have held the longest are on top, and stocks that I have bought for the first time most recently are at the bottom.

This helps me see on a day-to-day and week-to-week basis, which group of ideas are doing well. If my newest are doing well, there may be some mean-reversion happening in valuations.

If my oldest are doing well, there may be a bit of momentum happening for those that have already reverted to the mean. Because I tend to make shifts to the portfolio quarterly in groups of four or so stocks, I can see themes working out as I look at performance in the order that stocks were purchased.

The Current Portfolio

Listed below are the stocks in my portfolio. They are roughly equal-weighted.


Value With a Twist
David Merkel’s current holdings
NameAug. 10 CloseP/EYieldMarket CapP/E (This Year)P/BP/S
Cemex (CX:NYSE)46.946.992.5116.808.981.831.45
Dycom (DY:NYSE)23.5021.081.1520.982.011.13
Cytec (CYT:NYSE)48.2514.870.832.2214.261.811.18
Ameron (AMN:NYSE)37.2521.082.140.3210.351.140.49
Allstate (ALL:NYSE)58.0411.622.0438.799.331.741.13
Unilever PLC (UL:NYSE)41.1919.403.5166.3613.186.901.32
Liz Claiborne (LIZ:NYSE)41.8014.180.544.5713.712.430.94
Fresh Del Monte (FDP:NYSE)25.4610.803.911.4710.971.370.46
Montpelier (MRH:NYSE)34.2711.
PartnerRe (PRE:NYSE)62.927.432.263.478.841.000.84
ConocoPhillips (COP:NYSE)65.649.662.0791.398.422.000.71
SPX Corp. (SPW:NYSE)45.363.752.223.4117.431.210.76
Canadian National Railway (CNI:NYSE)67.4416.431.2618.5715.362.443.23
Petro Canada (PCZ:NYSE)79.4218.950.7420.8312.132.781.67
Stone Energy (SGY:NYSE)53.719.631.447.861.512.34
Barclays PLC (BCS:NYSE ADR)42.3912.674.2268.3911.542.202.85
Valero Energy (VLO:NYSE)90.7710.740.4923.3010.142.920.37
Toyota (TM:NYSE ADS)78.4211.931.24128.1011.121.530.75
Sappi (SPP:NYSE ADS)10.8851.922.782.4690.001.130.50
Apache (APA:NYSE)71.9311.090.4623.619.462.483.60
Premcor (PCO:NYSE)81.059.800.087.249.912.750.38
Ryerson Tull (RT:NYSE)19.376.051.280.495.131.050.10
Jones Apparel (JNY:NYSE)29.0313.141.793.4412.101.310.70
Neenah Paper (NP:NYSE)31.4520.090.930.4620.092.400.63
Johnson Controls (JCI:NYSE)57.4612.391.7011.0312.831.910.39
Japan Smaller Capitalization Fund (JOF:NYSE)11.815.200.1950.000.98108.19
Pfizer (PFE:NYSE)26.3920.043.43196.2013.392.923.70
Sara Lee (SLE:NYSE)20.0213.313.8315.7613.514.610.80
Repsol (REP:NYSE)29.6114.952.1936.158.982.000.80
Premium Standard (PORK:Nasdaq)14.766.700.410.469.071.100.40
Anglo American (AAUK:Nasdaq ADR)26.7211.682.6239.6210.321.591.53
ABN AMRO (ABN:NYSE)24.7311.547.5241.2810.251.781.61
Gold Kist (GKIS:Nasdaq)18.938.600.977.862.460.90
Dana (DCN:NYSE)15.0111.733.122.2612.920.980.24
Source: David Merkel, Yahoo!


This Portfolio Is Weird

Even though I manage this portfolio the same way that a “long-only” mutual fund manager would, because my portfolio is diversified by country and capitalization, it doesn’t fit any of the neat classifications common to mutual funds. I’m not running a mutual fund for which I’m anxious to gather assets, so this doesn’t bother me. Given that, I will now describe the way the portfolio breaks down by country, capitalization, sector and industry.


Sector Mix
The makeup of this portfolio defies easy categorization
Source: David Merkel

A notable characteristic of the portfolio is that 34% of it is non-U.S. Even adding back the two Bermuda reinsurers (which only trade in the U.S.), the percentage foreign is 29%. This is high enough that it would be hard to call this a domestic fund, but low enough that it can’t be an international or global fund. Why do it this way? Because I believe it offers the best returns to a U.S. investor. I try to buy stocks that operate in stable parts of the world, with reasonable legal systems. I consider information, war and expropriation risks. When something outside the U.S. seems too cheap, I buy it, but I don’t force myself to stay inside or outside of the U.S.

My approach to market capitalization is not as idiosyncratic. I am “all capitalization,” which is done by a number of mutual funds. I am probably more large-cap now than I have been in years. Small-caps generally don’t offer the valuation discount that I like to see when buying something off of the beaten path. Mid-caps I normally like best, because they typically have the stability of large-caps, but still have enough potential to grow, like some small-caps do. At present, many large-caps seem quite cheap, so I have more of them than normal.

The most important thing to look for in market capitalization is rule No. 4 from the column I mentioned above: “Purchase companies appropriately sized to serve their market niches.” Some businesses need scale in order to be profitable. Other businesses favor the entrance of smaller competitors following a niche strategy. “Is the business the right size in order to prosper?” is a question that intelligent investors ask.

Sector/Industry Mix

Looking at both the sector and industry mix, Jim Cramer would probably gong me in his radio show’s “Am I Diversified?” segment. Well, no, I’m not diversified, at least not by sector and industry. I can hear the comments: Where’s the tech and telecom? Pfizer is not enough for health care. Only one utility, and that one’s in an emerging market? You’re too overweight in materials and energy. Agriculture has been a loser for years. You’re joking, right?

I’ve always run an undiversified portfolio, because intelligent sector rotation can add value. Industries tend to trend in the short run and revert to the mean over the intermediate term. I try to analyze where the pricing power of industries is as I evaluate companies for investment. There are two things that get me primed for purchase:

  • Things are abysmal and no one wants to invest there. (Think of auto parts.)
  • Or, stock prices have not caught up to the industry pricing cycle. (Think of energy.)

That’s how I view it. I want to be in industries that are underrated, whether that’s due to a bruising bear market in an industry, or because of an abundance of skepticism in the face of improving fundamentals.

Valuation Parameters

The summary statistics of my portfolio are shown in the table below.


The Numbers at a Glance
CategoryMedian Value
P/E last year11.7x
P/E this year11.0x
P/E next year10.4x
Source: David Merkel

You can tell that my portfolio broadly fits into the “traditional value” style. I like my modified form of Graham and Dodd, with tweaks from Marty Whitman and a number of other notable value investors. That said, it’s my unique synthesis, and it has paid off for me in performance. Buying them cheap is critical to both good performance and risk control.

You might adopt my style or you might not; it takes some effort to do well with it. But the important thing is thinking through your portfolio management process to make sure that it’s fundamentally sound, businesslike, intelligently contrarian and something that fits into the way you live your life. Life is broader than investing, and management techniques must be small enough in time use for them to be a part of a broader, well-balanced life. You have my best wishes as you work out your own investment management style.


Full disclosure: still long VLO, IBA, JOF


  • China Slowdown Deepens This isn’t a bad thing if China is giving up on forced industrialization through borrowing $$ May 17, 2014
  • Carnage on China Roads Shows Dark Side of Electric Bikes Going 25MPH in crowded conditions w/limited control, ouch $$ May 17, 2014
  • The Golf Boom in China Illegal 2build new courses, so they start as health clubs that have golf as a therapy $$ $FXI May 17, 2014
  • Chinese Bad Loans Rise Most Since 2005 as Economy Slows Will the Chinese Govt allow failure or do large bailouts? $$ May 17, 2014
  • China Central Bank Calls for Faster Home Lending in Slump China asks their banks 2b more aggressive in lending $$ 🙁 May 15, 2014
  • US Is No. 1, China Is So Yesterday A little over the top, but correct, the US has many strengths that PPP can’t c $$ May 14, 2014
  • Xi Says China Must Adapt to ‘New Normal’ of Slower Growth Maybe, just maybe, China is serious raising consumption $$ May 12, 2014
  • Goldman to Citigroup Miss World’s Worst Selloff in China Long-term, this is a good thing. Short-term will b bumpy $$ May 14, 2014


Market Dynamics

  • Fooled by IRRs (Yale, Schwarzman’s Cases) With private equity, IRRs overstate returns received $$ May 17, 2014
  • Miller Wagers Gundlach’s Bearish Housing Position Loses Y Miller lost so badly during the crisis, no debt fear $$ May 17, 2014
  • Young, tech-savvy investors entrusting their portfolios 2 ‘robo advisors’ | Depends on how good underlying model is $$ May 17, 2014
  • From two secondaries, Cramer sees only one opportunity Secondary IPOs validate levels & show real demand 4an asset $$ May 17, 2014
  • Do Alternative Investments Belong in Most Individuals’ Portfolios? No. 2 much illiquidity, opaqueness & high fees $$ May 17, 2014
  • US Stocks Decline as Russell 2000 Nears Correction R2K down ~10% now from 3/18 high close $IWM $SPY $$ $IWN $IWO May 15, 2014
  • Why retail investors almost always get burned Retail $$ chases performance, and institutions aren’t much better $$ May 14, 2014
  • The Retirement Fund That People Set, Forget and Regret Target date funds usually ignore mkt over- & under-pricing $$ May 13, 2014
  • A New Ruling on IRA Rollovers Abuse of IRA rollovers leads to a tougher interpretation of regs; transfers r fine $$ May 13, 2014
  • The Problem with AAII Screens Explaining the seemingly high returns from the Piotroski screen –> 2few stock pass $$ May 13, 2014
  • Low Yields, The Same Risks, and Rising Leverage listen to @DavidSchawel he is intelligent. Low yields r a warning $$ May 13, 2014
  • Hated Stocks Unlock Market as Analysts Prove No Guide to Gains Choppy, trendless, themeless, wandering, not so bad $$ May 12, 2014
  • In Gundlach’s `No Normal’ World, U.S. Treasuries Just Can’t Lose Long liabilities need income in a low rate world $$ May 12, 2014
  • America’s Retirement Delusion @Ritholtz explains y most people r deluded over retirement; the math is inexorable $$ May 12, 2014


Rest of the World

  • Portugal Laden With $293B Debt Exits Bailout Plan Third-highest level of Debt/GDP in the EU; what if trouble comes $$ May 17, 2014
  • Japanese Hotshots Become Moms, Hit Dead End; Abe Weighs Foreign Maids to Help Cheat kids of high-quality attention $$ May 17, 2014
  • NASA Asked How to Keep Space Station Going Without Russia A cost of a world that stops co-operating $$ #peacedividend May 17, 2014
  • Modi-Led Bloc Wins Biggest India Mandate in Three Decades Deregulate, deregulate, & after that, deregulate $$ $SPY May 17, 2014
  • Today’s Good News From Japan Is Terrible New taxes will slow economy, while inflation squeezes real incomes $$ $FXY May 17, 2014
  • Global Growth Worries Climb Once deleveraging is complete, growth will resume, but govts would rather lever more $$ May 17, 2014
  • Goodbye, Crisis, as Bankers Start Lending in Portugal What has survived is in better shape, way to go $$ May 15, 2014
  • Putin Emboldened on Instability Arc by EU Defense Divide What does the EU want 2b if it grows up? $$ $MACRO $FXE May 15, 2014
  • Asian Junk Left Behind as Defaults Expose Cracks Hi debt levels, falling real estate prices, defaults -> yields up $$ May 14, 2014
  • Scots Seen Slipping Away Makes U.K. Seek Silver Bullet How much UK debt will Scotland take & how large a tax rise $$ May 14, 2014
  • Former BOJ Policy Maker Sees Japan Inflation Dilemma Japan is a bug in search of a windshield; inflation no friend $$ May 14, 2014
  • Wives Revolt as India Election Booze Leaves Trail of Widows Males get bribed w/alcohol 2 sell their votes. Some OD $$ May 12, 2014
  • Will The Last Businessman To Leave France Turn Out The Lights? W/French businesses being acquired, what’s left? $$ May 13, 2014


Companies & Industries

  • Jill Abramson, Arthur Sulzberger, and the New York Times: What Went Wrong? She goofed through poor salary research $$ May 17, 2014
  • New York Times Internal Report Painted Dire Digital Picture $NYT figures out they r becoming less relevant $$ #doh May 17, 2014
  • Bakken Crude Is Highly Volatile, Oil Study Shows Should b a way 2 extract & sell valuable ethane, propane & butane $$ May 15, 2014
  • Lehman a Gift That Keeps Giving for Paulson to King Street A rising tide lifts all boats, flotsam and jetsam too $$ May 14, 2014
  • Yes, we’re in a tech bubble. Here’s how I know it Adam Lashinsky shares his qualitative signs for concern $$ $XLK May 14, 2014
  • Where’s the Fertilizer? Farmers Grow Worried Increased us of rail 2deliver oil snarls grain & fertilizer shipments $$ May 14, 2014



  • Congratulations to Class of 2014, Most Indebted Ever Student debts r growing, but not the salaries of graduates $$ May 17, 2014
  • Why America’s Middle-Class Housing Crunch Is Here 2 Stay Affordability has fallen in almost every major metro area $$ May 17, 2014
  • Big Banks Said to Improve Loan Servicing Under Mortgage Accord Interesting 2c some better debtor treatment emerge $$ May 15, 2014


US Politics & Policy

  • Detroit Creditors Seek to Defend Pension Debt in Lawsuit Detroit attempts 2cheat pensioners & FGIC, & not sell art $$ May 17, 2014
  • More Detroits Are on the Way Even as pension bombs tick, cities and states still borrow far beyond their means. $$ May 17, 2014
  • Huszar: Geithner Drove Me From NY Fed Nuanced thought on Geithner’s strengths &weaknesses; my thoughts in comments $$ May 15, 2014
  • FCC Net-Neutrality Plan Sparks Response Before Release Paid deals, few paid deals, or no favoritism of web traffic $$ May 15, 2014
  • Income Tax Yo-Yo Hits US States Budgets should b set assuming zero taxes from capital gains and housing sales $$ TLT May 15, 2014
  • How Hoenig, Norton Wield Influence on FDIC Board They hold intelligent positions & try 2 get most of them accepted $$ May 14, 2014
  • Fannie, Freddie Regulator Signals Broad Shift in Housing Policy & A bad idea that won’t die $$ May 13, 2014
  • Book Review: ‘Stress Test’ by Timothy Geithner Didn’t foresee mortgage crisis coming or its severity $$ $TLT $IEF May 12, 2014
  • Rahm Emanuel Faces New Test With Chicago Pension Crisis Inexorable pension math forces hard decisions & fights $$ May 12, 2014


US Economy

  • Why It’s So Hard to Get a Job @vpostrel provides some analysis on the skills mismatch. Employers would rather wait $$ May 15, 2014
  • Producer price gain offers cautionary note on inflation Remember, inflation expectations r “well contained” $$ $TLT May 15, 2014
  • US Consumer Prices Rise at Strongest Rate in Nearly a Year Remember, inflation expectations are “well contained” $$ May 15, 2014
  • Income Inequality Is Higher In Democratic Districts Than Republican Ones Wealthier districts tend 2b more unequal $$ May 13, 2014
  • America on the Move Becomes Stay-Home Nation for Young Millennials move < , delay HH formation, buying homes, jobs $$ May 12, 2014



  • Meet the Italian Who Beat Google to Web Search — and Gave It Away Meet man who inspired Larry Page &Google $$ $GOOG May 17, 2014
  • The Problem for Sports Parents: Overspending Note to parents: Sunk costs are sunk. Think it through b4 u spend $$ May 14, 2014
  • Inside Google’s Driverless Car: The Unused Kill Button What it’s like to ride in one of the driverless cars $$ $GOOG May 14, 2014



  • Wrong: Bring Back the Girls—Quietly In foreign conflicts, let the rest of the world grow up & handle it themselves $$ May 17, 2014
  • Wrong:Mortgages Should Be Easier to Get Didn’t learn from the last crisis; 2 much mtge debt makes housing unstable $$ May 15, 2014
  • Wrong: Yes, the World Needs More MBAs. Here’s Why We would get more improvement by fixing elementary schools $$ $TLT May 14, 2014


 Retweets, Replies & Comments

  • RT @DavidSchawel: “Average yields on CCC & below debt worldwide fell to 8.58% this week, the same investors were getting 3 years ago on BB … May 17, 2014
  • RT @matt_levine: I know it’s journalism and stuff, but I’m really glad my job isn’t doxxing smart helpful anonymous working finance people … May 15, 2014
  • “A better article would provide enough analysis 2say what the ETFs were doing w/the derivatives.” — David_Merkel $$ May 14, 2014
  • @felixsalmon I really doubt this, as does Charlie Munger. May 13, 2014


In the fourth quarter of 2011, I decided that I needed to analyze the 13F filings of major investors who I thought were bright.  The first stage was looking at track records, and then finding the 13F filings.  Some investment management companies  make them difficult to find.  And, prior to three quarters ago, formatting issues allowed managers to make it a lot more difficult to compare 13F data across managers.

But now data must be submitted in a uniform format, using extensible markup language [XML].  That can be fed into Excel with little effort, and much of the prior data scrubbing goes away.  That data scrubbing took an extra day at least.

That said, the central challenge for someone that does not have a Bloomberg terminal is converting the CUSIP numbers [Committee on Uniform Securities Identification Procedures numbers] into ticker symbols.  Those numbers are owned by the American Banking Association, and they charge a pretty penny to use them.  I asked the folks at AAII [American Association of Individual Investors] to include a CUSIP field  in their deluxe stock screening package, and they said something like, “Are you kidding?  Do you know what the American Bankers Association charges for it?!”

When I started, I asked my bright, then 12-year old daughter to build up our own CUSIP to Ticker database.  She worked for many hours, producing a significant database for which I paid her well.  Since that time, I have maintained that database.

After I download via XML all of the manager reports that I want to follow, I sort out all of the CUSIPs I have never seen before, and find their tickers.

What used to take a week now takes a little more than a day in total, start to finish.

One thing that I do differently than some others in analyzing 13F filings is that I am interested in what percentage of the market capitalization the positions represent, and how large the net increase in positions is relative to market capitalization.

After that I look at three things:

  1. What are the largest holdings as a group as a whole as a percentage of market cap,
  2. What are the largest net increases in holdings as a group as a whole as a percentage of market cap, and
  3. What ideas are new, that no one invested in last quarter, and two or more invested in this quarter?

Now I am not saying that I have the formula right, but this feels right to me.  I invite readers to suggest their own ways of screening through 13Fs to determine the most worthy investment ideas.

But before I leave for the evening, another boon: here are the tickers generated by my 13F methods this quarter:


After the last few articles, you know almost all of the companies that I am considering investing in versus my current portfolio.  Have look as you like, and maybe a few of them are good investment ideas.

I try to avoid investments where the upside is limited, but the downside is unlimited.  That’s the way I feel about junk bonds now.  Have junk yields been lower before?  No, we have eclipsed the time in 2013 when the junk market was in a yield frenzy, until Bernanke uttered the word “taper.”

There are a lot of desperate retirees seeking income, assuming it is free, and not merely a return of capital.  There are a lot of desperate people seeking certainty in investing and do not realize that dividends are a handmaiden of value, and not value itself.

There are a lot of desperate pension plans looking to make up for lost time, and hoping against hope, buying dividend paying and growth stocks, high-yield bonds, alternatives like hedge funds, private equity, etc., at the wrong time.

Those are the things you should buy when stocks are cheap and people are scared to death.  You sell them when people are confident, and valuations are high.

Valuations are high; not nosebleed high as in 2000, but high as in comparable to the peak in 2007.  Could things go higher?  Yes, but you are playing for pennies and risking dollars in the process.  Those with a value and quality discipline will likely fare better in the process, but markets are messy, and what actually happens will be a surprise.

Thus I would encourage you to consider the credit quality of your stocks and bonds.  What kind of shock could they withstand?  When yields are low, like they are now, the system is less resilient to credit crises.  Be aware, and be on your guard.


Today I start my quarterly analysis of my portfolio.  I do it once per quarter to take the emotion out of it and make it businesslike.

But in-between analyses, I read.  I read a lot of stuff, and occasionally I see ideas where I say, “That looks like a good idea!”  After that, I record the ticker symbol and throw away the reason why it seemed good.

Why do I do it this way?  Several reasons:

1) Quick decisions are rarely good ones.  Lots of people have slick pitches.  Far better to wait a while, and analyze the opportunity coldly, and compare it against other ideas.

2) If I buy this, what should I sell?  Not that you have to sell but it is a good exercise to make you improve the portfolio.  It might indeed be a good idea, but you may have better ideas still in your current portfolio.

3) I need to analyze all opportunities through the same prism, and I need to understand them myself, not just what someone else told me.  If I don’t understand why I am buying, I will not understand when to sell.

The truth is, the need for urgency in investing is overrated.  If an idea is good today, it will likely be good three months from now.  Few investment ideas move linearly, and many ideas seem to fail before succeeding.  Most companies that I have averaged down on have proven to be successes.

So take your time, analyze dispassionately, and compare new possibilities versus existing positions.  And don’t trade much.  It takes time for most investment these to work out.  So choose a small number of new ideas to enter your portfolio, while selling a similar number of old ideas.

I don’t normally do this, and I might not do it in the future, but here are the tickers for the companies that looked like a good idea over the last three months:


As with anything I write, do your own “due diligence.”  But thanks for reading me.  I appreciate all of my readers.

Tuesday, a subsidiary of Eurohold Group, Euroins Insurance Group, announced a $3.75 bid for Tower Group.  I think it is bogus.  Here’s why:

  • At the price they are paying, they are offering more than their net worth to buy Tower Group $215MM vs $190MM.
  • They would pay a 2x+ premium over book to buy Tower when they trade at ~70% of book.
  • They have no overlapping lines, geographically.  It would be cheaper for Eurohold to buy a Bermuda shell and poach some talent, if what they want to do is diversify.
  • TWGP isn’t even worth the $2.50 that ACP Re is offering.
  • The language in the “offer” is weaker than that of many “letters of intent” I have read, much less a binding offer.

Now, let me take one step back, and say that the numbers I calculated above derive from documents written in Bulgarian that I have translated mechanically.  I may have made mistakes.

Also, a fool and his money are soon parted.  If Eurohold is foolish, a bid could be made where economics doesn’t matter.  After all of my dealings with foreign insurers, I have seen many ill-thought-out deals.

Kudos to the guy who sold near $3 on Tuesday.  He got the best outcome out of this sordid mess.  Opposite for the one that bought.

As for me, I have no position.  I rarely short, and there is no significant margin of safety in owning TWGP.  The odds of the operating subsidiaries as a group having not enough surplus to exceed the relevant company action level risk based capital  for the group as a whole is not high, but is not zero.  That is the one condition that can break the $2.50 deal with ACP Re.

Now let’s see how the first quarter earnings come in.  That will say a lot.

As an aside, the bonds of Tower Group offer about as much upside, and less downside than the equity does, if the ACP Re deal is the only real deal.


Yield is an illusion, whether it comes from stocks, REITs, preferred stocks, bonds, loans, limited partnerships, etc.  Yield from investments is not the same as being a farmer with chickens, where each day you can collect eggs, enjoy or sell them, and your net worth is not affected by harvesting the eggs.

I say this because one has to consider the enterprise paying the dividends, interest, or distributions.  What are the odds that the enterprise might have to scale back or eliminate dividends or distributions?  What are the odds that the enterprise might default on interest payments?

I have said it, and I will say it again: focus on the health and growth of the enterprises, and not on the dividends (and buybacks).  The ’70s had many people buying stocks with high yields, dividends often exceeding what earnings could deliver.

Some naively say, “Dividends don’t lie.”  Well yes, the money you receive is yours, but is the company as healthy after the dividend?  Will they be able to keep it up?  Often that is not the case.

In an era of financial repression, where the Fed punishes savers who deserve a better return, many reach to try to get a higher income off of investments.  In the process they end up taking a lot of risk that their income streams will be cut through dividend decreases, and outright defaults on interest payments.

Income payments rely on the health of the entities making payments.  This means that an intelligent income investor acts like a value investor, and looks for overall prosperity of the enterprise as security for the payments and growth in payments he would like to receive.

Now dividends and stock buybacks do signal the willingness of management to hand assets back to shareholders and maximize short-term returns to shareholders.  Even debt finance, with an unwillingness to issue more equity is usually a sign of a management team that is shareholder oriented.  But both of these findings rely on the idea that the management team has not overextended itself, such that they risk insolvency, cutting the dividend, or reducing the buyback.

Broader investment variables to indicate growth in the value of the enterprise have more punch than the shareholder income measures.  Look at earnings, book value, growth in book value, cash flow from operations, and free cash flow instead.  And with industrials, sales per share is often the best indicator, particularly in a market like the present one where sales growth is anemic.

Okay, look at the shareholder income-based measures if you must, but analyze:

  • The payout ratio — are they paying out more to shareholders than they are earning?  What if earnings decline?  Will they maintain the payouts?
  • Times interest earned — how secure are the interest payments relative to earnings?
  • How likely are they to safely raise the payouts to equity?  Growth in dividends is often more important the the level of dividends.  The best performing REITs have had lower payouts that grew more rapidly.

Guard the return of your money, rather than seek a high return on your money.  When the  credit cycle turns negative, and it will turn negative, it always does, management teams that have been too aggressive will get punished.  Try to avoid the punishment.

I write this as an equity manager that has an above average yield on investments, but the yield stems from low price-to-earnings, -sales, -cash flow, -free cash flow and -book.  15% of my companies don’t pay a dividend, and I don’t care.  If the management teams have good places to reinvest money to grow value, that is the best place of all to be.  Buffett loves investing excess cash if he can find highly productive places to do so.

With all that said, analyze companies for growth in value, safety, and prudent use of free cash flow.  If income is a part of capital discipline, well good, but be aware of the risks in an adverse economic scenario.  When the tide goes out, we find out who has been swimming naked.