Author: David Merkel
David J. Merkel, CFA, FSA, is a leading commentator at the excellent investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited David to write for the site, and write he does -- on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, and more. His specialty is looking at the interlinkages in the markets in order to understand individual markets better. David is also presently a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. He also manages the internal profit sharing and charitable endowment monies of the firm. Prior to joining Hovde in 2003, Merkel managed corporate bonds for Dwight Asset Management. In 1998, he joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. His background as a life actuary has given David a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that David will deal with in this blog. Merkel holds bachelor's and master's degrees from Johns Hopkins University. In his spare time, he takes care of his eight children with his wonderful wife Ruth.

Sorted Weekly Tweets

Picture Credit: David Merkel, with an assist from the YouImagine AI image generator || Even logos need a vacation every now and then

Investing

  • Hedge funds gave Discord, Stripe, SpaceX and other startups billions. A Bloomberg News analysis shows what they may be worth https://t.co/vBOZSoqyIJ  Far better to write them down, so as to keep an air of honesty. Jan 07, 2023
  • Berkshire Hathaway Could Face a Big Tax Hit if the Bull Market Resumes https://t.co/TIZsdztH9T  This is a proposal that I support: tax the change in unrealized capital gains. In the first year, tax unrealized capital gains. For private equity, an EBITDA tax Jan 07, 2023
  • ARK’s Cathie Wood Isn’t Backing Down. She Explains Exactly Why. https://t.co/7hsvVaV8Ea  An amateur who got lucky for a while, who throws money at companies that generally can’t produce positive free cash flow to reward shareholders. Jan 07, 2023
  • How private markets became an escape from reality https://t.co/ouOZMxC7JT  ‘Investor Cliff Asness wrote recently of the “mind blowing” possibility that investors now knowingly accept lower returns “for the privilege of not being told the prices”.’ Jan 07, 2023
  • Silicon Valley staff rush to offload start-up shares as valuations plummet https://t.co/T6hxfFBzJt  Watch for more deals where a big investor buys in at the last round price, but with additional goodies atached. Jan 07, 2023
  • The Fed needs to jack rates up by 10% right now https://t.co/DbWnztkWNw  “But we’re sure that the good folk at Andreessen Horowitz, Sequoia and Founders Fund have done exhaustive due diligence and been disciplined in their capital allocation.” Jan 07, 2023
  • A tried-and-true investing strategy just turned in one of its worst years ever. But is the strategy dead? Not even close, says @jasonzweigwsj. https://t.co/jWP36ra4DM  80/20 is best for the long haul. 60/40 does about as well as 100/0 but with less volatility Jan 06, 2023
  • If you receive a windfall, should you pay down debt or save for the future? https://t.co/X82JnL6Wp8  It may be a good idea if you have a long time horizon. Valuations are *still* not cheap yet. There is more downside likely after the FOMC stops raising rates. Jan 05, 2023

Politics

  • Kevin McCarthy’s torturous bid for House speaker exemplifies the dysfunctional state of the Republican Party heading into the 2024 presidential race https://t.co/X3BIIk5cRq  Be bold. Want centrist politics? Ban political parties and primaries. Jan 07, 2023
  • South Carolina’s congressional maps will be redrawn after a federal court ruled that the House district lines intentionally split Black neighborhoods https://t.co/iePGQNglOT  District boundaries should be chosen to minimize the length of internal boundaries Jan 06, 2023
  • Why can’t Kevin McCarthy get the votes he needs, and what happens until the standoff is resolved? Here are answers https://t.co/eExsSCCvpZ  Well, who knows? Maybe nothing gets done by Congress, and the government shuts down. The Russians invade Alaska, & the Chinese take Taiwan Jan 05, 2023
  • Representatives Matt Gaetz and Andy Harris, and even a freshman GOP House member, stand to gain from their votes for Kevin McCarthy for speaker https://t.co/QXtkZIUXJD  Somewhat piggish here, problem of a small majority… perhaps the “Freedom Caucus” could do a deal with the Dems Jan 04, 2023
  • Directors who often have little financial expertise are looking after the retirement funds of US public servants. They’re proving to be no match for a system that’s exploded in size and complexity https://t.co/vXZiUcPc33  We do our best to keep investment expertise off the boards. Jan 04, 2023
  • I applied to serve on the Maryland & Howard County Pension Boards as a citizen representative. I am more than a generalist investor; I am an investment actuary. I understand it all. Of course they didn’t choose me. Politics. https://t.co/9FP9JeS9vp  Jan 04, 2023

Science

  • The phenomenon behind California’s double-whammy drought and storms has a name: “hydroclimate whiplash” https://t.co/Z8yUafaHwu  Climate change is getting stretched pretty thin to explain every unusual bit of weather. Jan 08, 2023
  • US Army’s Flow Battery Could Change Military Power https://t.co/malEss9iyc  If this actually works, it would be significant for intermittent power sources Jan 07, 2023
  • Improved Solid-State Batteries for Electric Vehicles Are On The Way https://t.co/gkKCcEKDIt  Still has to be developed to scale, but this could be promising Jan 07, 2023
  • San Francisco is in the path of one of the worst rainstorms yet in a season that has likely left behind $1 billion in damages and losses across California https://t.co/GSDxXdfpTe  At least this will good for the farmers Jan 07, 2023
  • Meet Tree Energy Solutions, a green-hydrogen startup looking to provide low-emission fuels to European companies amid the energy crisis https://t.co/8JCKHUqBe3  This does not make sense. Most projects in this vein are trying to turn NG into hydrogen. Jan 04, 2023
  • Is my study useless? Why researchers need methodological review boards https://t.co/nDKAEgFS2s  It would also help if they reviewed the data & statistical analysis in advance, so that it will be “set in stone” and not arbitrarily modified to get a “significant” result Jan 03, 2023

Companies

  • How Amazon grew an awkward side project into AWS, a behemoth that’s now 4 times bigger than its original shopping business https://t.co/eAg7FtrYkh  Long read, worth it. How an internal project to standardize $AMZN programming became a business for others needing computer services Jan 07, 2023
  • Why Banks Are Losing the War Against Fintechs https://t.co/6NUII7cwNH  This article is really about cultural differences between bankers and programmers. It would pay the banks to teach programmers about banking, then listen to their suggestions once they have learned Jan 05, 2023
  • Southwest’s Biggest Mistake Was Forgetting Its Own Culture https://t.co/6yHLAXawM6  This was coming for a while. On a $LUV flight over a year ago, the crew was openly complaining about the long hours and unpredictability of scheduling. Jan 04, 2023
  • About that $4bn BREIT deal https://t.co/KoBvPE6FCj  You have an opportunity to exit the troubled BREIT. Take the exit, and feed the losses to $BX, the University of CA, and those who are too slow to act. Jan 04, 2023
  • Bank regulators say holding cryptocurrencies is likely inconsistent with safe banking practices https://t.co/lt7wvzuZwv  “Regulators say holding cryptocurrencies is likely inconsistent with safe banking practices.” Keep the two systems separate. Same way we don’t allow FX mismatch Jan 04, 2023

Economics

  • What makes the least sense in Chinese economic policy is trying to maintain residential real estate prices at such high levels, virtually requiring huge amounts of debt to support the prices. Housing is important, but it can’t truly be 70% of the assets of the nation. #3redlines Jan 07, 2023
  • The Fed needs to stop raising rates https://t.co/eFgO1Oc1ti  I used to accuse Bill Gross of “talking his book” when he was at PIMCO, but in this case, I think he hit the nail on the head. Jan 04, 2023
  • Japan’s new benchmark 10-year note brings a fresh headache for the nation’s central bank in its battle against bond bears https://t.co/GtnWVv45eF  Japan risks a situation where something may break. Better to let the 10-yr float. Jan 06, 2023

Financing

  • Wall Street wants capital rules eased to unblock $22tn Treasury market https://t.co/VyNaOGhrr7  This could make sense. Treasuries and cash reserves hit the supplemental leverage ratios disproportionate to their actual riskiness Jan 07, 2023
  • The deal was unusual because of its timing and purpose. Most banks and borrowers were holding off on bringing new deals after a rocky year https://t.co/lYIn3LYbPU  Dividend deals are usually bad investments. Do they think the credit bear cycle is over? Jan 06, 2023
  • “There’s a durable arbitrage built into AAA CLOs. There’s a regulatory arbitrage,” said Sycamore Tree’s Okada. “You’re floating rate, you’re AAA. I’m pounding the table on that trade.” https://t.co/Bpp20OM083  And that will work until it doesn’t Jan 06, 2023

Odds & Ends

  • If you’re looking to earn some extra income, these are the most profitable side hustles https://t.co/A3VDHLIjVu  Useful article Jan 07, 2023
  • Extra pharmacy certification requirements put an unnecessary stigma on abortion medication https://t.co/hPZ4FkO6Tx  Yes, “safe” medicine that kills an unborn child Jan 06, 2023
  • Walgreens plans to seek certification to dispense pills that can induce an abortion, part of a new program through the US FDA to broaden access to the medication https://t.co/VnIunu2BfK  I will be selling my CVS shares. FD: + $CVS Jan 06, 2023
  • The Patriarch Behind Vladimir Putin by @tunkuv https://t.co/hltSakx8fR  This is believable, given the long-term fractious relationship between the Russian and Ukrainian Orthodox Churches. But both are empty ritualism. Jan 04, 2023
  • Pope Francis has been the leader of the Catholic Church for almost 10 years, but he has only been the sole pope in the Vatican since Saturday https://t.co/TxW06Raa9c  Bergoglio is a relativist, similar to a liberal protestant with few absolutes Jan 04, 2023
  • The moves partly stem from a growing consensus among many who work in education that disruptive behavior often reflects underlying mental-health issues such as anxiety, depression and trauma https://t.co/KRbLENCvxW  In-school suspension is effective. So is expulsion. Jan 04, 2023
  • Sam Bankman-Fried has said Alameda prospered until it was tripped up in a crypto crash. Its troubles were much deeper than that. https://t.co/7JrH5fxqnH  Hindsight is 20-20, even for things with a lot of red flags. Jan 04, 2023

Sorted Weekly Tweets

Picture Credit: David Merkel, with an assist from the YouImagine AI image generator || I’m giving this another try

Dear Readers,

I know I don’t write as much as I used to. I typically write when I motivated by a given topic, and that’s just not coming as much to me now. But I still tweet on Twitter. I did sorted weekly tweets from 2012 to 2014, then I stopped tweeting as much for a while, and so discontinued them.

I can think of three good reasons to try this again:

  1. Readers can see the most interesting articles that I have been reading, and can see some of my thoughts about them.
  2. It may give me an idea for a blog post when I see them categorized.
  3. In the past, some people have asked me to try this again

So, here is the first episode of this go-round of “Sorted Weekly Tweets.”

Credit Trends

  • The worst year for equity bulls since 2008 will also be remembered as one when the predominant investment strategies veered from one another by the most in 21 years https://t.co/BWG0OaRZok  2022 key: “immunize yourself from interest-rate sensitivity.” 2023 key: reduce credit risk Dec 31, 2022
  • Despite performance, corporate issues OneMain Financial to raise $460.5 million https://t.co/wszreQ7DXr  Though terms of the securitization offer more structural protection than prior, underlying asset quality looks poor. Credit deterioration on the low end. Dec 31, 2022
  • Predictions for 2023: Car Prices Fall as Dealers Suffer https://t.co/glne5aK761  There are a lot of good charts and analysis here. Should be good deals on used cars around mid-year 2023, if you have cash… Dec 31, 2022
  • Consumer ABS experts: Keep an eye on employment amid rate policy, inflation https://t.co/cCv1vsPkPP  Early signs of weakness on the low end of credit Dec 31, 2022
  • Multiple stress points are emerging in credit markets after years of excess. With cheap money becoming a thing of the past, this may just be the start https://t.co/SqGbFUu5wR  Recently issued loans, with weak covenants, became the financing of choice for many weak companies Dec 28, 2022
  • Still one place to get a good deal on an auto loan: Credit unions, which have been offering some of the lowest rates around, undercutting banks and other lenders https://t.co/kDiPkbSfPy  They don’t pay taxes; gives more flexibility. Can cut deposit interest if defaults spike Dec 28, 2022

Politics

  • Trump’s tax returns released, launching fresh scrutiny of his finances https://t.co/q9B3s71DTG  If it becomes a question of fraud for assets Trump wrote down in the past to generate losses, his tax returns prior to the seven-year limit could be audited also, particularly 2009. Dec 30, 2022
  • Brazil President-elect Luiz Inacio Lula da Silva has selected a senator and former Petrobras official to lead the country’s state-controlled oil giant https://t.co/Bc9PRFoPDi  Sounds like a disaster that will come back to bite Lula. Another unforced error, like Europe & China Dec 30, 2022
  • Weeks before the government approved a wind farm off Rhode Island, US scientists warned it could jeopardize the area’s iconic cod https://t.co/Ent7FU1qFK  Environmentalists arguing with environmentalists Dec 30, 2022
  • 10 Ways Secure 2.0, Part of Spending Bill, Changes Retirement Planning https://t.co/45p2tW2xzT  Marginal ideas at best Dec 27, 2022
  • Going Boldly: The Retirement Savings for Americans Act 2022 https://t.co/HkIDtzSrlq  This will do less good than most imagine. Many poor people need the money to live now. They will not use this. Dec 27, 2022
  • Inside TurboTax’s 20-Year Fight to Stop Americans From Filing Their Taxes for Free https://t.co/Fa0tWhAzNA  & Intuit spends millions lobbying amid accusations of deceptive TurboTax advertising https://t.co/UZ378WSCa7  $INTU is annoying, especially paying annually for Quicken Dec 24, 2022
  • Intuit collects as much as $1.6Bn in annual income from its TurboTax products, and ProPublica & OpenSecrets find that $INTU has spent >$10Mn lobbying Congress to keep the IRS from simplifying taxes (which would undercut the need to purchase TurboTax). https://t.co/iLHl9qJqk3  Dec 24, 2022
  • The Sordid Saga of Hunter Biden’s Laptop https://t.co/VeY2ynEWSW  “The most invasive data breach imaginable is a political scandal Democrats can’t just wish away.” Very long, and sadly, we will likely hear a lot more about this. Dec 24, 2022
  • The Surreal Case of a C.I.A. Hacker’s Revenge https://t.co/g6Z8kIovAN  This is indeed surreal, and quite long. Who watches over the watchers? Dec 24, 2022
  • I golfed a full course of congressional districts in 84 strokes – 11 strokes over par! Tee off in @washingtonpost’s Gerrymander Invitational: https://t.co/pbmw1nZSvv  I live in MD’s 3rd district, likely the most gerrymandered in the country. It is hole 9, par 26 on this course Dec 24, 2022
  • “Isn’t administrative complexity a problem for the government to solve, not a bunch of unelected do-gooders?” @AnnieLowrey writes: https://t.co/N8T8Q6OUIy  Cool idea. I am concerned that in dealing with the government, poor people are disadvantaged by legal & regulatory complexity Dec 24, 2022

Cryptocurrencies

  • Opportunities Around GBTC – Valkyrie https://t.co/fkPmSuOPzR  Why should Grayscale voluntarily give up its profits? Dec 30, 2022
  • Has Sam Bankman-Fried finally managed to make accounting class sexy? https://t.co/miOiI5y865  No, but he has shown its necessity. Also, the “run on the bank” at FTX would have happened even if CZ hadn’t taken action. That said, when will Binance have its run? Dec 30, 2022
  • MicroStrategy shares hit the lowest since 2020 after the enterprise-software firm, the largest corporate buyer of Bitcoin, disclosed its first ever sale of the token https://t.co/XVVczgL629  $MSTR is just levered Bitcoin. Goes broke in 2025 as 2028 secured notes accelerate. Dec 30, 2022
  • Criminal charges against a trader who swiped $100M from a DeFi platform show that even as crypto remains largely unregulated, it offers no shield against prosecution over alleged fraud https://t.co/gUtpv4I4fF  I think the plaintiffs have the better argument. Dec 30, 2022

Markets

  • Cash holdings at U.S. state government pension funds dropped to the lowest level since the financial crisis https://t.co/xBk8rGpJhh  Many of these funds are desperate: looking for higher returns to bail out the underfunding, taking on risks they don’t grasp including illiquidity Dec 30, 2022
  • Tech-heavy hedge funds had a banner year in 2020, but that was the last of the good times https://t.co/zXBkkzK66a  In general long-only management is less risky than hedge funds, and over a full market cycle provide better returns Dec 30, 2022
  • After the worst year for global stocks in more than a decade, & a rout in bonds that’s unmatched this century, some investors aren’t going to take anything for granted in 2023 https://t.co/4i6ExvYesP  In the past, few took account of war, contagion, expropriation, sovereign crises Dec 28, 2022
  • Home prices fell 0.5% in October compared with the previous month, as higher mortgage interest rates continue to weigh on home-buying demand https://t.co/cUEtw52Ppd  Leading indicator on inflation and growth Dec 28, 2022

Stocks

  • Wall Street’s best and brightest got inflation all wrong this year, leaving them & their clients exposed to the full brunt of an epic market collapse. Now, they have to adjust to a new era https://t.co/7Y4AcgaLWd  Stock valuations are still top decile by the equity share model Dec 30, 2022
  • US automobile industry; Final Sales of 2022 and Trends for 2023 https://t.co/p2THEFWRXZ  Of the top 10 new car sellers: 1) 9 had their stock price fall. Exception: Subaru. 2) 8 sold fewer cars than 2021. Exceptions: Tesla and GM. In general, I prefer owning auto part makers. Dec 30, 2022
  • @MikePTraffic @retheauditors As a value investor, I could not see how Border’s would survive vs $AMZN. It was weakly capitalized, and had to carry a lot of inventory. I agree with your point about management loving their business, and understanding the economics thereof. There is no generic business. Dec 30, 2022
  • Used Tesla prices are plummeting four times faster than other cars https://t.co/GEKnx91fIg  Calling Elon Musk! Time to focus on your main business! Dec 30, 2022
  • VanEck is the latest asset manager to liquidate Russia ETFs nearly a year into Vladimir Putin’s invasion of Ukraine https://t.co/44trdYkzRf  Isn’t it: 1) Convert ADRs to local Russian shares 2) Deposit Russian shares with a Russian broker 3) Sell them on a Russian exchange? Dec 29, 2022
  • 4) Convert rubles to dollars. 5) Wire dollars to the custodial account in the US. 6) Distribute pro-rata to shareholders https://t.co/De3NJTMy2y  Dec 30, 2022
  • Silicon Valley staff rush to offload start-up shares as valuations plummet https://t.co/T6hxfFB1TV  Too much money chased too little profit in the past. Now liquidity is needed. Who will provide it, and at what price? Dec 29, 2022

Economics

  • After a turbulent year, signs are emerging that wage inequality may be starting to reverse https://t.co/lTdjd4aOVi  Unlikely. Technology aids those who are intelligent, and doesn’t help those who aren’t. Dec 30, 2022
  • David A. Shaywitz reviews “Escape From Model Land” by Erica Thompson https://t.co/522DtNmOMl  Send a copy to the Fed Dec 29, 2022
  • We Aren’t Ready for a Financial Crisis https://t.co/u5to9iTDqY  We grew faster when we had less debt, public and private, and ran balanced budgets. Dec 24, 2022

Central Banking

  • The central bank horror story https://t.co/HBpCjxDEWJ  May not be so bad. Swaps in aggregate net to zero, but there are winners & losers. If the losers run out of money while margining, the winners may lose as well. Dec 30, 2022
  • The Bank of Japan announced a third day of unscheduled bond purchases as it fights back against speculation it’s moving toward ending its super-accommodative monetary policy https://t.co/TFZ322s70j  Rippling across global bond markets, creating lots of Yen deposit liabilities Dec 30, 2022
  • The long Australian boom shielded the central bank. That’s changing, for the better https://t.co/IG9Yba411h  Just set up a currency board, and end your misery. Dec 30, 2022
  • Global debt markets extended an end-of year selloff Wednesday, prompting additional bond purchases from the Bank of Japan https://t.co/9TEV4yBfWO  Say goodbye to negative yields. Hope we never go there again. Dec 29, 2022

China

  • Rural residents worry for elderly as COVID rips across China https://t.co/m38cO0ORAO It would have been better if the CCP had given two months warning so people could get vaccinated prior to dropping the COVID zero policy. But the CCP couldn’t be thoughtful Dec 30, 2022
  • China’s unprecedented assault on its housing market has left would-be home buyers asking if it was all worth it https://t.co/BJyH7vsZvf  The real estate situation in China is even worse than Japan’s in 1989. Crackup, or three lost decades? Dec 29, 2022
  • A growing number of affluent Chinese are coming to Japan to live, in an indication of social and political tensions back home https://t.co/MHst0tbhLe  I find this fascinating given the past antipathy between Chinese & Japanese. Dec 28, 2022

Global

  • Billionaire Adani Says India Will Add $1 Trillion to GDP Every 12-18 Months https://t.co/FAbMGwkyV5  Not likely. When this overindebted conglomerateur flames out it will be stunning. Dec 29, 2022
  • Putin Wants Fealty, and He’s Found It in Africa https://t.co/rdCmko1vD7  The Central African Republic has always been among the most corrupt nations in the world. Should this be surprising? Dec 28, 2022
  • In Record Numbers, Venezuelans Risk a Deadly Trek to the U.S. Border https://t.co/bgoGTQNV9a  This is dated, but I had not heard about this. You have to be pretty desperate to take on a trip like this. Thanks a lot, Chavez & Maduro, for ruining Venezuela. Dec 24, 2022

Science

  • Unlike Covid shots, vaccines for cancer need to be customized for each individual, writes @lisamjarvis https://t.co/rDIed7BhJn Looks promising, but there is a long way to go. $MRK $MRNA FD: + $MRK for clients and me Dec 31, 2022
  • Our investigation traces plastic recycling from US households to a city in India where the items are burnt for energy https://t.co/jdtBUxjxbr  I’m surprised that you would not expect this. People have to live. Global warming is just a theory. We need 100 years to make it a fact. Dec 28, 2022
  • The deep freeze that blanketed most of the US temporarily plunged millions into darkness, and laid bare just how vulnerable the electric grid has become to a full-on catastrophe https://t.co/VYidNKPC8Q  I would not assume this won’t revert. Weather often has decadal streaks Dec 28, 2022
  • These Prenatal Tests Are Usually Wrong When Warning of Rare Disorders https://t.co/kSGzVgjj8R  This is a practical example of how the misuse of statistics by scientists (ignoring false positives) harms patients. Aside from common diseases, it is better not to get your baby tested Dec 24, 2022

Odds & Ends

  • Explaining the baby formula shortage. Mapping abortion access after the end of Roe v. Wade. Breaking down the FTX collapse. Here’s how we used data and graphics to tell 2022’s most important stories https://t.co/8I4bdgJzdB  Beautiful graphics on an artistic page that is clunky Dec 29, 2022
  • As travel springs back and even China dismantles the last remaining Covid curbs, one stark truth is beginning to emerge — the world is running desperately short of planes https://t.co/rhJjRDk6Xx  I missed this. Thought the planes in the desert could be easily restarted, but no Dec 28, 2022
  • You can fix most of your tech problems with these simple troubleshooting tricks from @nicnguyen https://t.co/nBpr4Cv02I  I knew about these, but it is very good and simple advice. Off and on. Disconnect and reconnect. Uninstall and reinstall. Clear Cache. Delete Cookies. Dec 28, 2022
  • @TasteAtlas The last battle in the manga “Food Wars” was to make a dish that no one has ever seen before using elements of the five great cuisines of our world. What was their list of five? Chinese, Indian, French, Italian, and Turkish. A reasonable list. Dec 28, 2022
  • Twitterati are looking for their next destination. https://t.co/MmUw4w4J9F  Then again, there may be some out from Twitter, but Twitter stays large enough to remain dominant over things that are trying to be like Twitter. Elon may bail on the investment, but Twitter will survive Dec 28, 2022
  • How Telegram Became the Anti-Facebook https://t.co/6l5kFll3GO  Utterly long, but fascinating. There will always be demand for unfiltered social networks, and governments will fight that. Dec 24, 2022
  • These three brothers scammed their investors out of $233Mn. Then they lived like kings https://t.co/W7J0nv3hmj  There is never anything easy about investing, especially if aiming for high returns. Safety can be controlled, mostly. Avoid people who advertise easy high returns Dec 24, 2022
  • The Precarious Future of Sanibel Island https://t.co/XFmkZrwWWk  I went to beautiful Sanibel as a boy. Time & chance happen to all men and places. “Old Town” Ellicott City has been badly flooded twice in the last decade. Twice rebuilt, but the cost was high, & higher for Sanibel Dec 24, 2022
  • @VIXandMore I get it. Hope you are doing well, Bill. I write less than I used to, but I am still writing. Dec 24, 2022

Talk is Cheap, but Money Talks

Photo Credit: Inhabitat || What is wealth, but concentrated efforts from the past organized by a man?

I’ve written on this topic many times, and I summarized my thoughts in this piece, Understanding Investment Consensus. Journalists and investors are often cavalier regarding how the market is positioned versus a given issue. Just because journalists and bloggers talk about something that is a possible crisis, that does not mean that investors have acted on those opinions.

Think of our last two major crises, the Great Financial Crisis (2008) and the Dot-Com Bubble (2000). Were there many people warning about those events in advance? Yes, there were many who did so. Did institutional investors react to these correct predictions? No, they didn’t. Why?

First, institutional investors have been trained not to time the market. Thus they tune out what they view as noise. Second, indexing and pseudo-indexing dominate the markets. Pseudo-indexing is the asset managers who are benchmarked against the market as a whole. All of them hug the indexes on average. There are generally few asset managers that are willing to be unique.

Most of the market is passive investing when aggregated, which leaves more opportunity for those that are willing to take chances on a portfolio that is not index-like in the slightest.

There is a real advantage at present to managers who are willing to run value portfolios that are distinct — not like the indexes, and willing to tolerate a lot of deviation versus the indexes.

It is not a Bad Time to Retire

Picture credit: Kevin Trotman || In general, it is probably best to put off retirement as long as you can…

I’ve seen a number of articles suggesting that it is a bad time to retire at present, because the market value of portfolios has declined. I’m here to tell you that the opposite is true.

Picture Credit: Aleph Blog. Who else would do a graph this lame?

Why did I pick these three dates to show you the US Treasury Yield Curve? On 1/3/2022, the stock market hit its high point. On 11/7/2022, pessimism about FOMC policy hit its high point. 12/13/2022 is now, leaving aside the rally in long Treasuries after the FOMC announcement on 12/14/2022.

Yes, asset values on a mark-to-market basis have declined by around 15%. But the yield you can obtain from those asset has doubled! You are not in a worse position to retire. You have a greater expectation of income now if you converted your assets to a bond ladder.

And I can tell you that the yield that you can get from a bond ladder has more than doubled since the beginning of 2022. So even if your assets have declined by 15% or so, the income you can receive now from bonds is far greater then before. You can even throw in some TIPS for inflation protection, and still have more income.

What’s that, you say? Why not stocks that pay growing dividends? Why the focus on default free bonds?

I start with Treasury securities because they are the backbone of the fixed income market. Everything else prices off of them.

Most dividend-paying common stocks yield less than Treasury securities now. That said, one way to compare a stock with growing dividends is to look at its current yield, and add to it half of your estimate of how fast stockholders’ equity per share is growing. If you were perfectly accurate, you would not cut it in half, you would add in the whole percentage growth in equity. This would assume that management is reinvesting the equity at high returns on equity, or planning on paying it out to shareholders at a more rapid rate.

Income opportunities are much higher now than in the yield-starved 2010s. Do you want income in retirement? It is on offer now.

The Value of a CFA Charter: Ethics

Picture Credit: Marco Verch Professional Photographer || Being a financial analyst is being a competent generalist in business

Let me tell you why I am writing this, roughly three years later than I said I would. It started with a post I entitled Limits. The post itself is not why I am writing this, but in the the comments there was great criticism of the CFA Institute. They asked me what I thought of the criticisms and I said I would write about it.

I suspect no one will like this post. I will mention that I served on the board of the Baltimore CFA Society for 12 years, serving nine years as its Secretary, and two years as its programs chair. I am grateful that I earned my CFA credential in 1996, which enabled me to transition from being a life actuary, to being an investment actuary, to being a a financial analyst with actuarial skills.

Four weeks ago, I gave a talk at the Baltimore CFA Society’s Charter Award Dinner. The title of the talk was “The Value of Ethics –The Value of a CFA Charter.” The main point of my talk was that the uniqueness of the CFA Charter did not stem from the “Body of Knowledge” imparted in the exams, but rather from the emphasis on ethics. The men who created the “National Federation of Financial Analysts Societies” in 1947 wanted financial analysts to be competent and ethical. After all, the Great Depression soured many people on investing, considering all of the unsavory tactics that many speculators used.

So what made me decide to write this tonight? My friend Tom Brakke made the following post at LinkedIn. He laments the decline in the teaching of the “Body of Knowledge” at the CFA Institute. I agree with him. The leadership of the CFA Institute seems weak to me, and gives in to political and cultural trends. Two examples: first, adding cryptocurrency to the “body of knowledge,” when it has no intrinsic value. Second, adding ESG to the body of knowledge, when it is ill-defined, useless, and not in the interests of those served by fiduciaries.

What should the CFA Institute do with respect to the “Body of Knowledge?” Investment knowledge is not a monopoly of the CFA Institute. You can get the same knowledge through many different sources. For me, I learned 90%+ of my investment knowledge before I took my first CFA exam. That’s why they were so easy for me. Many CFA Charterholders don’t like me saying the exams are easy, but I will say, “Have you taken an actuarial exam? There is no comparison.” Even the penultimate president of the CFA Institute said to me, “They have an amazing qualification process.” (Something like that…)

What should the CFA Institute do to create its “Body of Knowledge?” Choose the most compact and important knowledge that an intelligent investor needs to know, and then pursue it in a written exam format, not using computers. Why written? Because investing requires the ability to be able to write. The Society of Actuaries made a similar mistake when it eliminated their English exam, which turned their candidates into math nerds who often could not understand qualitative features in insurance. Actuaries once were CEOs of insurance companies, and that is rare now.

Does the CFA Institute’s Body of Knowledge need reform? Definitely. Clear out the crud, and make more room for the basics. Also, emphasize ethics, because that is what differentiates CFA Charterholders from other investment workers.

But Back to the Original Reason for Writing this

So what of people who pass the CFA exams, get a job, stop paying their CFA dues, and say that they passed the CFA exams, but not explicitly calling themselves CFA Charterholders? Are they cheating the system?

Yes, they are cheating the system, and if the CFA Institute had an ounce of courage, they would take them to court, saying that they agreed to the CFA Institute’s standards when they took the exams and received the Charter. If they are not doing so now, they can’t say they passed the exams. It might be true, but it is an obfuscation to have some benefit of a CFA Charter while not continuing to hold to its code of ethics. If you are not subject to the CFA Code of Ethics, you should not be allowed to mention that you were once a CFA.

The same is true for me. I never say that I am a Fellow in the Society of Actuaries, though I passed all of the exams and was inducted. I haven’t paid dues for over a decade, nor have I done their continuing education (that was the bigger issue). Do I still know their body of knowledge? I was a leader in asset-liability management inside life insurers, and I would still be a leader there.

To close this article, I would simply say to those who have dropped their CFA charters, but still try to benefit from them: pay the money and observe the code of ethics. Be a real CFA Charterholder. We are the ones that are supposed to be cleaning up the financial industry. This is our ethical obligation that you agreed to when you received your CFA Charter. Don’t be a cheapskate, and don’t be unethical by avoiding the duties that you accepted when you took the CFA exams.

An Analogy for Some Facets of Crypto

Picture Credit: Kent Schimke || Ah, the downward spiral of cryptocurrency assets!

What I am writing was sparked by what is happening with FTX, which reminded me of promoted penny stocks. Now, before I go on to that, let me mention what the results were regarding the promoted penny stocks that I wrote articles about the last one of which was written a little less than seven years ago. I only wrote about promoted penny stocks when I personally received a promotion, whether by snail mail or email.

Of the 32 stocks I wrote about, how many failed in entire? Twenty-four. How many have a market cap over $1 million? Three. How many actually appreciated in price from the time I wrote the article? One, Barfresh [BRFH], which was the only one the I said seemed legitimate.

Penny stocks are less of a problem today as a result of the efforts of Seeking Alpha, and to a far lesser extent me. But now we have a new problem — cryptocurrencies that are not widely traded.

FTX had several cryptocurrencies which they held on their balance sheet where they held a huge amount of the cryptocurrency relative to the float, or trading volume. This included FTT and Serum, among others. If FTX sold those cryptocurrencies in size to raise US Dollars, the price would quickly go to something near zero.

The same is true of promoted penny stocks. If they did a large issuance of stock, the price would quickly go to something near zero. (Far better to do a rights offering.) Instead, they quietly deal stock in small amounts at a discount to the market price to pay for services, goods, etc. Promoted penny stocks are the only investment class where the statement of shareholder equity is the most important statement.

As such, FTX using the value of the last trade, overvalues their holdings of worthless crypto. It is actually more valuable for them not to trade, than to swamp the market. That said, what will happen when they are forced to liquidate? (Think of Luna and Terra.)

You could structure the accounting for assets on the balance sheet at entrance value, current value, or exit value. Each has its implications — success, survival, and failure, respectively. Unless we decide to have multiple balance sheets and income statements, which I have suggested in the past, but will never take place, a single balance sheet will never represent reality — survival is probably the best overall option, and that is close to what GAAP does, with its many imperfections.

As such, please realize that most unaudited intermediaries of cryptocurrencies are likely insolvent. It is time to liquidate and go back to US Dollars, prone as they are to inflation. Remember, if you are slow, you may end up with nothing.

Unstable Value Funds (VII)

Picture Credit: Boston Public Library || When total systemic leverage is so high, you can’t tell what might go wrong

Because of the fall in interest rates since the last post, the risks have declined with Stable Value Funds. That said, the FOMC still sounds hawkish, even though the yield curve is inverted. The FOMC needs fewer macroeconomists, and more economic historians. They are deluded by the bad models of the last fifty-five years, which lack any credibility outside of the sterility of academia.

Here are the two equations that I left out of the last piece. How to calculate the premium/discount of a stable value fund:

How to calculate the annualized yield to maturity:

Here are the definitions:

BV: Book value — the accrued value of the stable value fund assets so far.

MV: Market Value — the market value of the assets now, if we are able to liquidate the assets at current prices.

AYTM: Annualized Yield to Maturity — the annualized rate that the assets are yielding at current market prices. Note that if you have the SEC Yield, that is the Semiannual yield to maturity, sometimes called the bond-equivalent yield [YTM]. To convert YTM to AYTM:((1 + YTM/2)^2) -1 = AYTM.

D: Effective Duration — The first derivative of Market Value with respect to AYTM. For those that have not taken Calculus, or have forgotten what that means, it measures the sensitivity of market value to small moves in the AYTM. A bigger D means the market value changes more than a smaller D. (And always remember, as interest rates rise, the value of all ordinary bonds goes down.

It is called effective duration, because on a present value basis it measures the weighted average time at which you can expect to receive the cash flows, typically measured in years.

CR: Credited Rate — Though all of these values are artificial in some sense (channeling my best Matt Levine), this one is the most artificial. It means this: in the past the book value accrued to its current value. Now, over the length of time expressed by the Effective Duration, what should the current credited rate be in order for the book and market value to converge? The credited rate is a figure that is like a “heat-seeking” missile, always adjusting (monthly or quarterly) to new conditions as the book value chases the market value. When book value is above market value, the credited rate slows down relative to the AYTM. When the book value is below the market value, the credited rate speeds up relative to the AYTM.

Unstable Value Funds (VI)

As my reader who prompted the last post wrote:

I’m trying to get my head around the implications of the lower MV/BV ratios, but I’m not sure I completely understand the how the crediting rate mechanism works with respect to inflows and outflows.

As I understand it, when MV/BV is less than one, inflows are going bring it closer to par and outflows will further decrease it (assuming outflows are at BV), yes? There are not separate calculations for different plans or different participants, correct?  I feel like this may not be a big concern under more typical market conditions, but with MV/BV so low people’s crediting rates are going into look a lot less competitive relative to the returns available with other conservative options and there is more incentive to do as you describe and take the short-term risk in a non-competing fund. Plans leaving is one thing, but a significant participant lead outflow would be much harder to manage, wouldn’t it?

Also, you mention duration longer than 5 being potentially worrisome, but isn’t possible that funds may extend duration early next year as a way of simultaneously goosing the crediting rate and positioning to recoup some losses in anticipation of a Fed pivot? But if rates go higher than expected….

Private email to me

She is a bright lady; she understands it perfectly. Given the recent lower inflation estimates, maybe everything works out easily. But will the FOMC understand that and stop raising the Fed funds rate? Given their desire to appear bold, I think the answer is no. And so I repeat my advice from my last post:

It is not a bad idea now for most participants to move your stable value assets to a balanced fund for 30 days, then move that to a short-to-intermediate term bond fund. You will escape the low-yielding and possibly defaulting stable value fund. You will also earn more from the bond fund.

Remember, there is no FDIC for stable value funds. Watch out for your own best interests while most people don’t notice.

Feasible Defeasance

Photo Credit: gelbachdesigns || Pay less to pay off your debt.

For some people/entities with home/commercial mortgages, for the first time in a while, it is possible to invest in US Treasuries at rates higher than the rate on your mortgage. Now there are complexities around this, but let me give an example of how this might work. I’m affiliated with a group that owns a building worth $3.5 million, with a first mortgage loan of $470K @ 3.8% AEY [Annual Equivalent Yield], and a second mortgage loan of $270K @ 3.6% AEY. The first mortgage loan has a balloon payment in June 2028, and the second mortgage fully amortizes, and pays off in November 2035.

When interest rates were low, our best use of surplus cash was to pay down the first mortgage. But now it would be better to buy the 1.25% Treasury note maturing 5/31/2028, presently yielding around 3.93% BEY [Bond Equivalent Yield — AEY ~4%]. This isn’t a large advantage, but when I thought of writing this article 2 weeks ago, prior to the recent CPI number, the yield gap was considerably more compelling.

Now, we may still get a higher inflation surprise over the next few months, unsettling the bond market. Or, hawkish FOMC members may continue to blather that rates have to go a lot higher, raising yields on short-to-intermediate Treasury Notes. (Knut Wicksell had it right with his simplistic rules [yield curve slope], rather than the FOMC with their complex models and fear of the media. [We must be manly men!]) There may be better opportunities in the near future.

My main point for this short piece is to get people to think more broadly about how to find opportunities with interest rates.

Another idea would be for those with residential mortgage loans to buy participations a FNMA or FHLMC pool with similar characteristics to your loan. Why prepay your 3% loan when you can buy a participation in loans like yours at a yield of 6%?

I realize that I am glossing over a lot of things here, but this is simply to suggest that your behavior in higher interest rate environments should be different from that in lower interest rate environments.

Unstable Value Funds (VI)

Photo Credit: Ruin Raider || It is important to recognize the limitations of any system. Don’t overestimate what is possible.

Well, the last installment in this series was 2009. I ran a Guaranteed Investment Contract [GIC] desk at Provident Mutual from 1992-1997. I also managed our internal stable value funds for our pension line of business. This was during a period where increasingly Stable Value Funds were being replaced by bonds and bond funds being wrapped by a type of derivative that would allow for “benefit responsive payments,” called a “wrap contract.”

Now, I know I lost most of you with the last paragraph. Definitions:

Guaranteed Investment Contract: A group annuity issued by a life insurance company. It is like a bond, paying principal and interest until it matures. But it is more secure than most bonds because it is an insurance liability, which has a higher bankruptcy priority than a bond issued by the insurance company. Also, a GIC will pay money out sooner if there is a need to pay “benefit responsive payments.” Absent default, the value of a GIC never falls. Its value accrues like a savings account, because it is an annuity from a life insurer.

Benefit Responsive Payments: In Defined Contribution Pension Plans (401k, 403b, 457, etc.), if a participant dies, gets disabled, leaves his current employer, gets served with a QDRO [Qualified Domestic Relations Order — child support, alimony], exchanges funds in the stable value fund for noncompeting funds (funds that are not short-to-intermediate fixed income), etc., then the GIC may pay benefits out early at book value.

Stable Value Funds: Funds that buy investments that absent default, only appreciate, and thus act like a savings account, but with much better yields. Those can be insurance contracts (rare now), or bonds wrapped by “wrap agreements.”

Wrap Agreements: Derivative instruments that receive money if benefit responsive payments occur and the market value of the wrapped bonds is higher than the book value, and pay money if benefit responsive payments occur and the market value of the wrapped bonds is lower than the book value. The objective is that benefit responsive payments go to the beneficiary at book value, and no one else in the Stable Value Fund is affected.

Why am I Writing This?

I received an email from a lady working at a major investment bank, asking me where she could find independent commentary regarding stable value funds, because most of the commentary is produced by the stable value fund managers themselves. Why is that so? Stable Value Funds are complex beasts. Typically only insiders understand them. She was wondering how the funds were doing given the rapid increase in interest rates. This is the toughest scenario for stable value funds.

The Math

Let’s define terms first.

BV: Book value — the accrued value of the stable value fund assets so far.

MV: Market Value — the market value of the assets now, if we are able to liquidate the assets at current prices.

AYTM: Annualized Yield to Maturity — the annualized rate that the assets are yielding at current market prices. Note that if you have the SEC Yield, that is the Semiannual yield to maturity, sometimes called the bond-equivalent yield [YTM]. To convert YTM to AYTM:((1 + YTM/2)^2) -1 = AYTM.

D: Effective Duration — The first derivative of Market Value with respect to AYTM. For those that have not taken Calculus, or have forgotten what that means, it measures the sensitivity of market value to small moves in the AYTM. A bigger D means the market value changes more than a smaller D. (And always remember, as interest rates rise, the value of all ordinary bonds goes down.

It is called effective duration, because on a present value basis it measures the weighted average time at which you can expect to receive the cash flows, typically measured in years.

CR: Credited Rate — Though all of these values are artificial in some sense (channeling my best Matt Levine), this one is the most artificial. It means this: in the past the book value accrued to its current value. Now, over the length of time expressed by the Effective Duration, what should the current credited rate be in order for the book and market value to converge? The credited rate is a figure that is like a “heat-seeking” missile, always adjusting (monthly or quarterly) to new conditions as the book value chases the market value. When book value is above market value, the credited rate slows down relative to the AYTM. When the book value is below the market value, the credited rate speeds up relative to the AYTM.

So what’s the issue here?

Interest rates have risen rapidly, after dwelling at low rates for a long time. Back when I was developing a stable value product in 1996, I knew this was the disaster scenario for stable value. More than most actuaries at the time, I had realistic interest rate scenario models the reflected the true volatility of interest rates. I would create 10,000 full yield curve scenarios over a 10 year period, then analyze the ones where the stable value fund failed. Failures occurred in the scenarios where short rates rose rapidly.

Wait. How can a stable value fund fail? If the credited rate drops below zero, practically it has failed. The fund sponsor will credit zero in such a situation, but it will face the problem of participants exiting to non-competing options, worsening the problem. The stable value fund may not be able to return book value to its participants.

But this isn’t bad for everyone, at least not yet

I don’t think everyone needs to worry, though. The edge cases, those who have taken too much risk at the wrong time should worry. for the worst-managed funds, there is some risk of a “run-on-the fund.”

I did a little digging around the large stable value managers, at least among those who publish all their data publicly. I’m not naming names, I have my own liability risk here. There are a number of insurance companies running their stable value plans at durations higher than 5, and their ratio of market value to book value is near 85%. If you are in such a situation, move your stable value assets to a balanced fund for 30 days, then move that to a short-to-intermediate term bond fund. You will escape the low-yielding and possibly defaulting stable value fund. You will also earn more from the bond fund.

At present, most stable value funds have a market value to book value is between 91-95%. If you are in a fund like that, don’t worry, unless a panic happens because of the funds running at long durations. Then do the same shuffle that I suggest: move your stable value assets to a balanced fund for 30 days, then move that to a short-to-intermediate term bond fund. You will escape the low-yielding and possibly defaulting stable value fund. You will also earn more from the bond fund.

Other Issues

There is also the risk of stretching for yield. Though the bond managers who manage fixed-income portfolios for stable value funds are generally conservative, when rates are low, many bond managers take chances that don’t work out. As such if the YTM/AYTM of the asset manager seems aggressive, maybe pare back. (If it is more than 1.5% above Treasuries, consider leaving.) If something seems too good to be true, it very well may be too good to be true.

Conclusion

Say what you will about Stable Value Funds, they are more opaque than other investments. As such, they deserve more scrutiny. It is not a bad idea now for most participants to move your stable value assets to a balanced fund for 30 days, then move that to a short-to-intermediate term bond fund. You will escape the low-yielding and possibly defaulting stable value fund. You will also earn more from the bond fund.

I don’t think most people have to do this, but it is not a bad strategy for all. Take your opportunity and move stable value money to a balanced fund. Then if you don’t like the volatility, move to a short-to-intermediate term bond fund.

Estimating Future Stock Returns, June 2022 Update

Graph Credit: Aleph Blog || How do you feel about 3.00%/year nominal returns over the next 10 years? That’s less yield than the 10-year T-note

Stocks always beat bonds. Stocks always beat bonds. Stocks always beat bonds. Stocks always beat bonds.

Quite a mantra. And for those with a long time horizon, this is true. What I am telling you this evening is if you want that to work for you, your time horizon should be greater than ten years. With the ten-year T-note yielding 3.41%, the S&P 500 at 3946 indicates likely nominal returns of 3.00%/year over the next ten years. Though the bond market has had a lousy year, many of the times I wrote about this over the last few years, the S&P 500 had return expectations in line with a 10-year single-A corporate bond. When the market indicates returns lower than a 10-year T-note, it is still quite expensive (95th percentile).

As the end of December 2021 was near the recent highs, so the end of June 2022 was near the recent lows, projecting a nominal 3.32%/year return for the S&P 500 over the next ten years. The weak rally of the last eleven weeks has reduced future returns to 3.00%.

So what to do? For me, not much. I have always kept my asset allocation around 70% risky, 30% safe. I am near that now, and don’t feel the need to panic. I like the stocks that I own for me and my clients. We are up this year. All that said, I haven’t had a good year prior to this since 2013. Versus the broad market, my performance has been poor as value has lagged, and I am more value-y than most value managers.

Graph Credit: Aleph Blog
Graph Credit: Aleph Blog
Graph Credit: Aleph Blog

The histogram above attempts to show scenarios when likely returns per year were within 1% of where they are now. Positive returns are expected with a considerable left tail.

So What Might Happen?

My view here is that the Fed will overshoot in tightening, leading the stock market to new lows in this bear market. Ray Dalio has said something like this. Looking at the ’70s or the Great Financial Crisis are not what I would look at. My best analogy here is the dot-com bubble.

I remember from that era how many people said that Fed policy was irrelevant to growth stocks. When the yield curve inverts, those who finance long assets with short-term debt blow up. During the dot-com bubble, that was mostly tech firms. The banks were mostly not affected. That is true today, as the banks are in good shape.

So expect:

  • The yield curve to get more inverted
  • Stocks to fall, especially growth stocks
  • Real GDP will decline
  • Commodities will suffer
  • The Fed will panic, and loosen in 2023

That’s all for now. I have been going through a hard period in my life, thus I have not been posting much.

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