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I’m Not in This for Love

Friday, April 11th, 2014

Much as I appreciate those who like what I write at this blog, I don’t write to be loved.  I don’t write to be hated, either.  I am sensitive to what people think of me, but not to the degree that it changes what I write.

I may have nonconsensus views on:

  • The Federal Reserve
  • Gold
  • Social Security & Medicare (and their cousins around the globe)
  • The current Bull Market in Stocks and Corporate Bonds
  • Long Treasuries
  • and more…..

But I write what I write to disclose the truth.  I am an active equity manager, but I encourage people to use passive investing via index funds, unless they can find a manager who can reliably obtain outperformance.

I don’t blog for economic advantage.  If I wanted to do that, I could channel a wide variety of ideas on investing that are popular, but I know are marginal at best in terms of effectiveness.

Some friends of mine have told me, “Why don’t you write about companies that you own, or companies that look attractive to you?”

I’ve been burned by doing that.  For every ten that you get right, you get the same response from every one you get wrong.  As with most of the web, the complainers dominate.  That’s why I don’t trot out many individual stock ideas.  It’s not that I don’t have them, but I only share them as a group, not as a single idea, most of the time.


I’m here to tell the truth, even if it cuts against my own short-term economic interests.  Most of the time, I adjust my portfolio so that it is ready for everything, but sometimes I delay, because I know that changes in the market usually happen slowly.

I do not write to be popular.  I write to change the consensus, unlikely as that will be.  Finance is a perverse area of life where fear and greed take over.  And with academics, they have these lame models that are fit for Vulcans (maybe) but not humans (and certainly not Ferengi).

We need new models that reflect the fear-greed cycle, and make valuation a significant input in risk assessments.

I’m not in this for love; I only want to change the way that we view investment decisions.

This May Be Gold, But It Is Not Golden

Sunday, February 16th, 2014

I’ve done a number of articles on dollar-weighted returns in mutual funds.  There are rare cases where the shareholder base is smart, usually in value funds, where the shareholders add more money on declines, and lighten up when things are going too well.

Tonight’s target is the Gold ETF SPDR Gold Shares [GLD].  As with most volatile mutual funds, people tend to get greedy or panic.  They chase performance.  Consider this list of inflows and outflows from GLD. Cash flows are assumed to occur at mid-period.


Cash Flow































Versus a buy-and-hold investor, the average holder gives up almost 3% of returns via market mistiming.  Technicians may talk down buy and hold, but buy and hold usually outperforms the average trader.  This is similar to what my friend Josh Brown talks about in his article Flows Don’t Follow Value, They Follow Performance.  Very few investors are rational businessmen, estimating likely returns over their funding horizon.  Rather they chase past success, and flee past failures.

Such has been true of the SPDR Gold Shares ETF.  Say what you will about the cheapness of large ETFs, people will still misuse them.  They will buy late in a bull phase, and sell late in a bear phase.

And so I say to all: Guard your emotions.  Be forward-looking.  Analyze likely value five years out.  Don’t make snap decisions out of regret.  Think about risk control before you buy shares, bonds, whatever.

Now, as a personal aside, it took me around eight years to learn to control my emotions.  Over the last 20 years, I have made at most a handful of errors reacting to bad market events.  I learned to analyze rather than panic back in the 90s.  It doesn’t mean that I am always right, but it does mean that I act.  I almost never react.

As for GLD, be wary about paper gold.  Is it really fully collateralized by audited gold in a warehouse?  There are lots of promises of gold being traded, but how much physical gold could you have delivered to you, should you want it?

That’s all for now.  Be careful in all of your investing; it is easy to err.

Sorted Weekly Tweets

Saturday, February 15th, 2014

Market Impact


  • Companies Squeeze 401K Plans From Facebook to JPMorgan This should not surprise, many companies shrink labor costs $$ Feb 15, 2014
  • Wells Fargo edges back into subprime as US mortgage market thaws Isn’t a problem now, problem comes w/imitators $$ Feb 15, 2014
  • Homebuyers Get Break as Loan Rates Defy Fed Tapering Housing & general economy weakened, so mortgage rates fell $$ Feb 13, 2014
  • Pension politics @felixsalmon points out how defined benefit plans r in general better 4 workers. Mind the PBGC $$ Feb 13, 2014
  • Colleges Raise Record $33.8B Exceeding US Peak in 2009 Donations always follow creation of unrealized cap gains $$ Feb 12, 2014
  • Some Lines Say Maybe the Stock Market Will Go Down @matt_levine correctly criticizes the 1928-9 $SPY graph overlay $$ Feb 13, 2014
  • 1929 Stock Market Crash Chart Is Garbage Unequal left & right scales make the relationship look tighter than it is $$ Feb 12, 2014
  •  When to Ignore the Investment Experts “When all the experts &forecasts agree — something else is going 2 happen.” $$ Feb 11, 2014
  • Comparing Economic Recoveries In 1984-2006, growth was borrowed from future by increasing debt levels-> #payback $$ Feb 11, 2014
  • Aluminum Lines Still Trouble the London Metal Exchange Aluminum inventories will b a prob, til short intrates rise $$ Feb 11, 2014
  • Top Anecdotal Signs of a Market Bubble Good piece, like one of mine: Watch the credit cycle $$ Feb 11, 2014
  • Ten Stocks to Own During a Market Correction Good list. I own a few of them. $$ Feb 11, 2014
  • Does trend-chasing explain financial markets? Partly. Difference between investment IRR and total return is big $$ Feb 10, 2014
  • “Security. Safety. Stability.” from @reformedbroker Gold is useful at certain points, but only when it is hated $$ Feb 10, 2014
  • Flows Don’t Follow Value, They Follow Performance @reformedbroker wrote this little gem. Learn & internalize it $$ Feb 10, 2014
  • Long Term Charts 2: Western Markets Since The Middle Ages Interesting charts from very messy data at Zero Hedge $$ Feb 10, 2014
  • Most Expensive Place to Find Out Who You Are @jasonzweigwsj : Your reaction 2 minor crisis shows yr risk tolerance $$ Feb 10, 2014


Companies & Industries


  • AIG Takes $832 Million Charge on Death Bets as Hedge Funds Gain Life settlements should b illegal $$ $MET $AIG $PRU Feb 14, 2014
  • To Stop the Coffee Apocalypse, Starbucks Buys a Farm $SBUX helps create a variety of rust resistant Arabica trees $$ Feb 13, 2014
  • Former BlackRock Manager Finds Billions on Rice Energy Few investment mgrs have operating talent; Daniel Rice does $$ Feb 13, 2014
  • Buffett’s Pal Munger Heads a Very Weird Company Growth of $DJCO thru investing leads 2 # of growing pains & 13F $$ Feb 13, 2014
  • Here’s Why the Biggest Cable Company in the Country Thinks It Can Get Bigger Feds tolerant of cable re antitrust $$ Feb 13, 2014
  • Why AOL ended up spending millions on ‘distressed babies’ $AOL chose 2b in healthcare biz 4 its employees & lost $$ Feb 13, 2014
  • 3 High-Yielders To Buy On The Pullback In total $SNH issues more stock than it pays in divs. Divs -> cap losses $$ Feb 13, 2014
  • Who is John Thompson? A look at Microsoft’s new chairman May have right stuff to protect new CEO from meddling $$ Feb 10, 2014


US Politics & Policy


  • Runaway Drones Map Land, Film ‘Wolf,’ Knock Down People, FAA Gives Chase Drones r here 2 stay; time license them $$ Feb 15, 2014
  • Teacher Tenure Put to the Test in California Lawsuit Tenure has outlived its usefulness; older teachers can b lazy $$ Feb 15, 2014
  • Lincoln’s Foreign Policy in Today’s World Kept England & France from joining Civil War; otherwise pragmatic $$ $SPY Feb 15, 2014
  • What Would Lincoln Do? A clever man w/principles, who did not cease to be pragmatic pursuing 1 main goal – Union $$ Feb 15, 2014
  • Harvard Professor Attacking Google Thrives as Web Sheriff At some point, lack of disclosure will blow up on him $$ Feb 14, 2014
  • The $2.2B Bird-Scorching Solar Project Get used 2 idea: almost every form of energy imposes environmental costs $$ Feb 13, 2014
  • Obamacare Damage-Control Teams Seek to Calm Complaints Things r tough when u r trying to avoid media embarrassment $$ Feb 13, 2014
  • Billionaire Musk Gets Brownsville to Pay for SpaceX Like a football owner bargaining 2 get taxpayers buy a stadium $$ Feb 13, 2014
  • Snowden Swiped Password From NSA Coworker & it cost him his job. Snowden denies it; NSA is Not Saying Anything $$ Feb 13, 2014
  • Puerto Rico Legislators Amend Bill Calling for Bank-Deposit Shift Provincial govt’s attempt 2raid cookie jar stopd $$ Feb 13, 2014
  • Obamacare Will, in Fact, Encourage Employers to Cut Jobs As the employer mandate comes into force, jobs will b cut $$ Feb 12, 2014
  • Tea Party Scorns Republicans as House Lifts Debt Ceiling t-party can b “pure” as Dems raise ceiling w/few GOP $$ $TLT Feb 12, 2014
  • A Lame Duckish Calm Falls Over the Capital Parties in DC act as if the next event is the November elections $$ $TLT Feb 12, 2014
  • Obama Rewrites ObamaCare Another day, another lawless exemption, once again for business; WSJ bangs populist drum $$ Feb 11, 2014
  • The US Senate Again Insists on USPS Saturday Mail Delivery 2 timid; end Wednesday & Saturday delivery $$ $UPS $FDX Feb 11, 2014
  • US firms ‘paid effective tax rate of 2.2% in 2011’ More than a tax haven, Ireland helps insurers shave reserves $$ Feb 11, 2014
  • No Honeymoon for Janet Yellen QE withdrawal will bite, & what will become of all the deposits? $$ Feb 11, 2014
  • Please Hold Your Bernanke Applause Remember, when Greenspan left, he was viewed as a success, same as BB now $$ $TLT Feb 11, 2014
  • Sounding the Tax Alarm, to Little Applause IRS stiffs whistleblowers who often lose employability 4 being a tipper $$ Feb 10, 2014


Rest of the World


  • Putin is Playing a Game of His Own Not so fast. Russia has significant resources & influence in Eastern H’sphere $$ Feb 15, 2014
  • Boy’s Life Hanging on 8-Hour Trip Shows Why Venezuelans Protest Socialism is like a cancer that spreads til death $$ Feb 14, 2014
  • Let’s Watch Venezuela Destroy Itself Logical extreme of Socialism falls apart; pity that Chavez never lived 2c it $$ Feb 14, 2014
  • Chinese Join Winklevosses in L.A. Luxury Home Hedges Amazing what the wealthy will pay 4a fancy foreign retreat $$ Feb 14, 2014
  • Next crisis won’t come from the emerging markets Argues France, Germany, Britain, Australia & Canada-> 2 much debt $$ Feb 13, 2014
  • Mister Donut, Pan Am and Friendster Found Alive and Well Old brands never die, they just move overseas & make $$ $SPY Feb 13, 2014
  • Bank of England points to 2015 rate rise, blurs guidance More precision than 1 can know; the world is messy $$ $FXB Feb 13, 2014
  • Italy Pays Record Low to Sell 3-Year Debt at Auction Let the leverage build for the next crisis $$ Feb 13, 2014
  • Fink to Mobius Touting Emerging Stocks Fails to Stem Outflow A time 2 nibble, not a time 2 gulp $$ $EEM Be wary Feb 13, 2014
  • Greek Truckers Show Plight as Groceries Show Up Frozen Freeing up the labor market will work as attitudes change $$ Feb 13, 2014
  • Tunisians Bolt Doors Even After New Constitution Passed Constitutions cannot create cultural change; asks 2 much $$ Feb 13, 2014
  • Israel Desalination Shows California Not to Fear Drought When resources r tight there are incentives 2 create tech $$ Feb 13, 2014
  • London Walkie Talkie Owners to Shield Car-Melting Beam Reflective parabolic curve of building melts cars @ a spot $$ Feb 12, 2014
  • Rouhani Seeks Economic Fix as Iran Commemorates Revolution Will have to get the agreement of unelected true rulers $$ Feb 11, 2014
  • Argentina to Replace Bogus Inflation Index to Mend IMF Ties Argentina tries 2 find cheapest way out of this mess $$ Feb 11, 2014
  • Who Should Pay for Trusts that Go Bust? If China is smart, protect depositors, but let banks & WMP holders fail $$ Feb 11, 2014
  • Iceland Girds for Fight as Suit Targets Half $14B GDP Icelandic taxpayer will refuse the bill; UK will b stiffed $$ Feb 11, 2014
  • Mobius Says Emerging-Market Rout Near End as Valuations Lure I dunno, a 4% earnings yield premium seems small $$ $EEM Feb 11, 2014
  • Rehabilitating Portugal Long; Argues that a Greek-style bailout should b done, or Portugal will eventually default $$ Feb 11, 2014
  • Iranian TV Shows Rare Broadcast of Band Playing Music Christianity has always been easier on music than Islam $$ Feb 11, 2014


Work Trends


  • Sheep-Shearing Wells Fargo Banker Bridges US Income Gap Sells coffeemakers too; many in US work multiple jobs $$ $TLT Feb 13, 2014
  • Workers Shed Caution, in a Healthy Sign for Labor Market When workers r willing 2 quit, labor mkt is healthy $$ $TLT Feb 11, 2014




  • A Little Valentine’s Day Straight Talk Sage counsel 2 younger women if they want to get married: start early $$ Feb 15, 2014
  • The Sex Question Readers Want Answered Most Even Long-Married Happy Couples Ask, ‘How Can We Have Sex More Often?’ $$ Feb 11, 2014
  • Ten Ways You’re Probably Leaving Money on the Table Simple list of ways to save money for avg upper-middle class $$ Feb 11, 2014
  • Why Mom’s Time Is Different From Dad’s Time Husbands, u can win if u reduce chaos for your overburdened wives $$ Feb 11, 2014




  • US Scores Fusion-Power Breakthrough Bad news is Tritium very expensive @ $100K per gram; takes much energy 2 make $$ Feb 13, 2014
  • If Ocean Heat Pump Switches On, Expect to Feel It Speculative; we don’t understand climate or hurricanes well $$ Feb 11, 2014
  • Who is Steven Reisman? Meet Hip-Hop VIPs’ Favorite Lawyer, The Man With The $2 Bills Weird. Very, very weird $$ $SPY Feb 11, 2014
  • What Really Happened to Flappy Bird? Beware the success u wish 4? Also: Still a puzzle $$ $SPY Feb 11, 2014


Wrong, etc.


  • Skeptical: Blackstone-Fueled Single-Family Home Boom Lifts Chicago In past hi levels of investor ownership bearish $$ Feb 15, 2014
  • Wrong: Pros Panic, Retail Investors Stay Cool on Emerging Markets Too short a period time to judge $$ Feb 14, 2014
  • Wrong: Social norms: The indignity of no work New technologies will create new jobs & make the whole world better $$ Feb 13, 2014
  • Wrong: Warren Buffett is laughing at you for selling Poorly thought-out piece glues 2unrelated ideas together $$ $EEM Feb 13, 2014
  • Wrong: The #1 High-Yield Investment Of America’s Elite Spammy article that talks about REITs as if they r a secret $$ Feb 11, 2014


Replies, Retweets & Comments


  • 10 miles west of Baltimore, MD, we got ~15 inches of snow over the last last 2 days. #snow #weather #pax $$ Feb 14, 2014
  • “I made this comment six months ago:… & then, I tipped the SEC. …” — David_Merkel $$ $DJCO Feb 13, 2014
  • “Administrative Services Only” plus individual stop loss protection is in general the smart way2…” — David_Merkel $$ Feb 13, 2014
  • “This is a common confusion in statistics — you can have a high correlation and a low beta. Second…” — Merkel $$ Feb 13, 2014
  • RT @Pawelmorski: Scary parallel my foot. Feb 12, 2014
  • @davidgaffen that would only be a temporary fix. I wrote this 3.5 yrs ago on the topic: The internet eats USPS Feb 11, 2014
  • @quakkelaar I miss you too. If you are ever near Baltimore/DC, let me know; we can get together, brother. Last few years have been hard Feb 11, 2014
  • RT @ReformedBroker: Please explain how the wording of this investment advertisement on the Washington Post site could be legal:… Feb 10, 2014
  • ‘ @quakkelaar Hail old friend. Yes, same old mistakes, b/c those wishing to retire are making the money sweat, until it rebels on them $$ Feb 09, 2014


An Expensive Kind of Insurance

Thursday, February 6th, 2014

Strategy One: “Consistent Losses, with Occasional Big Gains when the Market is Stressed”

Strategy Two: “Consistent Gains, with Total Wipe-out Risk When Market is Highly Stressed”

How do these two strategies sound to you?  Not too appealing?  I would agree with that.  The second of those strategies was featured in an article at recently — Inverse VIX Fund Gets Record Cash on Calm Market Bet.  And though the initial graph confused me, because it was the graph for the exchange traded note VXX, which benefits when the VIX spikes, the article was mostly about the inverse VIX exchange traded note XIV.

Why would someone pursue the second strategy?  Most of the time, it makes money, and since January 2011 we haven’t a horrendous market event like the one from August 2008 through February 2009, it makes money.

I would encourage you to look at the decline in the second half of 2011, where it fell 75% when the VIX briefly burped up to around 50.  But given the amazing comeback as volatility abated, the lesson that some investors drew was this: “Volatility Spike? Time to buy XIV!”  And that explains the article linked above.

You might remember a recent book review of mine — Rule Based Investing.  In that review, I made the point that those that sell insurance on financial contracts tend to win, but it is a volatile game with the possibility of total loss.  To give another example from the recent financial crisis: most of the financial and mortgage insurers in existence prior to 2007 are gone.  Let me put it simply: though financial risks can be insured, the risks are so volatile that they should not be insured.  You are just one colossal failure away from death, and that colossal failure will tend to come when everyone is certain that it can’t come.

But what of the first strategy?  How has it done?

Wow!  Look at the returns over the last few weeks!  Rather, look at a strategy that consistently loses money because it rolls futures contracts for the VIX where the futures curve is upward-sloping almost all the time, leading to buy high, sell low.

Does it pay off in a crisis?  Yes.  Can you use it tactically?  Yes.  Can you hold it and make money?  No.

Back to the second strategy.  People are putting money into XIV because they “know” that implied volatility always mean-reverts, and so they will make easy money after a volatility spike.  But what if they arrive too early, and volatility spikes far higher than expected?  Worse yet, what if Credit Suisse goes belly-up in the volatility?  After all, it is an exchange-traded note where owners of XIV are lending money to Credit Suisse.

Back to Basics

Do I play in these markets?  No.

Do I understand them?  Mostly, but I can’t claim to be the best at this.

What if I try both strategies at the same time?  You will lose.  You are short fees and trading frictions.

What if I short both strategies at the same time?  Uncertain. It comes down to whether you can hold the shorts over the long term without getting “bought in” or panic when one side of the trade runs the wrong way.

Recently, someone pinged me to speak to CFA Institute, Baltimore, where he wanted to talk about “not all correlations of risky assets go to one in a crisis” and pointed to volatility investing as the way to improve asset allocation.  Sigh.  I’m inclined to say that “you can’t teach a Sneech.”

I favor simplicity in investing, and think that many exchange traded products will harm investors on average because the investors do not understand the underlying economics of what they own, while Wall Street uses them as a cheap way to hedge their risk exposures.

There may be some value to speculators in using “investments” like strategy one for a few days at a time.  But holding for any long time is poison.  Worse, if you are accidentally right, and the world comes to an end — this is an exchange-traded note, and the bank you lent to will be broke.  That will also kill strategy two.

So, my advice to you is this: avoid either side of this trade.  Stick with simple investments that do not invest in futures or options.  Complexity is the enemy of the average investor.  I can understand these investments and they don’t work for me.  You should avoid them too.

PS — before I close, let me mention:

Good article in both places.

Book Review: The Safe Investor

Wednesday, January 29th, 2014


This is a special book.  It’s special because it explains investment concept in simple language, and tries to give average people an ability to understand how the markets work.

The author shares from his life experiences, where not everything turned out right.  With bonds in the 1970s, what was ordinarily a safe investment turned into “Certificates of Confiscation,” as inflation and interest rates rose.

The author is careful to point out the difference between fake diversification and true diversification.  False diversification has a large number of positions that are related, like owning many tech stocks from 1998-2003, or many financial and housing stocks 2005-2009.

True diversification means there is not some hidden factor that can affect your whole portfolio.  The author argues that we need a broad array of investments in the portfolio to diversify results, reducing volatility, so that the investment program can continue  until the target is reached.

Th author also argues  that investors need to dig into the guts of what they are investing in.  Who is the custodian?  Are my assets safe from commingling with the assets of others?  (Think of MF Global or Madoff.)  Is there any factor that could cause a substantial fraction of my assets to be significantly impaired?  As an example, what if you live to an old age?  Will you outlive your assets?  For most Baby Boomers, that is a significant risk that is under-appreciated.

The author, who managed two significant asset management firms in his career, encourages readers to do detailed checks on any active managers they hire (like me).  Analyze their methods, their incentives, their character, and more.  Passive investing does away with many of those questions, but still you have to set up an asset allocation.

As for active managers, they often buy and sell to make it look like they are doing something for clients, when frequently less activity would be in the best interests of clients.  Active management often works better at lower turnover rates.

Investment performance analysis has its own pathologies.  There is the need to buy an outperforming fund.  Why buy a fund that has done poorly?  An investor could ask two questions: 1) is the manager just benefiting from the current cycle, or are his picks good aside from that? 2) Has the manager gotten so large in that strategy that there is no place to place money to achieve an above average return.

The author also notes a strategy that many rich employ: hold safe assets and risky assets, but not the stuff in-between.  Few have made their wealth on the stuff in-between.  Preferred stock has made no one rich, nor investment-grade corporate bonds.  Junk bonds when carefully chosen may be an exception.

Now, that said, I think the author is too optimistic on emerging markets.  As in the current mini-crisis, many of them have immature financial systems, and are mis-financed.  Long assets are being financed by short loans.  This can goose growth in the short-run, but not in the long run.  I think that emerging markets have a place in portfolios, but smaller than the author implies.

Three Pockets

The author posits three pockets for assets — a large one for savings (don’t lose this), a medium one for investing (moderate risk), and a small one for trading (high risk).  He is trying to channel male actions in a good way.  You want to gamble?  Gamble with a small amount of money.  Keep the main body of your assets in ordinary hands that you do not touch.  Set it, and mostly, forget it.

This is an interesting way to try to get people to take limited risks, and have most of the portfolio be safe or have limited risks.

Passive vs Active

The author does not take a stark position on this, but points people toward passive funds if active fees are too high, and track records do not validate good investment choices.  That is how I feel about my own investing.  If I can’t outperform, I don’t want you investing with me.  The book’s position is only invest with active investors that have an edge.  That is more common with smaller cap stocks, international investing and junk bonds.

When to Adjust Portfolios to Reduce Risk from Aging

This book has risk positions lasting longer than most books, and generally, I think that is right, unless markets have gone to such high levels that intelligent investors should lighten up.  I think we are in one of those moments now.  Walk, don’t run, to reduce risk assets, and don’t go all the way, just lighten up.  I rarely make big moves, and the book would not advocate tactical big moves either.

I thought the book’s chapters on choosing advisors were well-written.  It gives you adequate ways to check out financial advisors like me, and those much larger than me.


The summaries at the end of each chapter are very useful.  I can endorse almost everything in the book.  Just be more careful about emerging markets than the book is, they have a lot of risk embedded at present.


None, aside from what what previously mentioned.

Who would benefit from this book: Most amateur investors could benefit from this great book.  If you want to, you can buy it here: The Safe Investor: How to Make Your Money Grow in a Volatile Global Economy.

Full disclosure: The PR people offered me a book, and I accepted it.  I am glad that I did.

If you enter Amazon through my site, and you buy anything, I get a small commission.  This is my main source of blog revenue.  I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip.  Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book.  Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.  Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.  Whether you buy at Amazon directly or enter via my site, your prices don’t change.


Risks, not Risk, Again

Wednesday, December 18th, 2013

One of the most important things I am here to teach readers is that there is no such generic concept as risk.  There are risks, and they must be handled separately.  Generic measures of risk such as standard deviation of returns, beta, etc. are unstable.  This was driven home to me when I heard a presentation from endowment investment advisors, where they talked about their models, and how the models translated current economic statistics into investment decisions.

I’m sorry, but the models can not be that good.  The financial markets are only weakly related to the real economy in the short-run, though the tie gets strong in the long-run.

Economies are unstable; get used to it.  The concept of equilibrium is also not useful, and it holds economics in thrall, because it makes the math work, even though equilibrium never occurs.

It is far better to look at your investment in an oil refiner and ask “What are the possibilities for where crack spreads will be a year from now,” than to look at the beta, correlations to anything, standard deviations, etc.  The coefficients aren’t stable.

Many advisors would rather follow a false certainty, than have to think for themselves, and have to deal with the complexity of the markets.

I am a quantitative analyst, and a very good one.  That is why I pay attention to the limitations of models, and the possibility that past data might be special, and not so relevant to the present.  It is far better that you pick over your portfolios, and ask what risks they are subject to, than to look at standardized risk measurements that describe the past or present.

Be forward looking.  What can go wrong?  Analyze each company.  Find the three most pertinent risks — read the 10-K if you are having a hard time.  See if you think the risks are worth taking.

But be assured of this.  Merely by looking at market price derived variables for stocks, you won’t learn anything valuable about the risks of what you own, or might own.  You need to think like a businessman, a sole owner, and ask whether the risks can be ably faced.

To the Consultants

Your models are garbage.  You need to review your managers at the holdings level, or you are doing no good at all.  All of the aggregate statistics hide the instability.  Far better to understand the qualitative methods of managers, and analyze whether they have a durable competitive advantage or not.

That may not seem so scientific, but science is put to bad ends in areas where there is no good science.

If I were hiring managers, I would spend a lot of time on process and people, and ignore a lot of other items.


Mathematics is of limited use in analyzing investments and investment managers.  It is far better to look for those that have good business sense, and invest with them.

When to Worry — An Asset-Liability Management Perspective on Financial Macroeconomics

Friday, December 13th, 2013

At the end of the day, the world is net flat.  Every asset is owned 100%; every liability is someone else’s asset.

If everything is 100% owned, why are there ever crises?  Financial companies owning illiquid assets financed by short, liquid liabilities.  Liquidity crises are credit crises; a company going through a liquidity crisis did not do sufficient stress testing to realize that they were weakly financed.

Crises are never accidents, aside from things like Hurricane Katrina and Superstorm Sandy.  And guess what?  How many insurers failed from those two events?  None.

Crises happen because things are inverted.  Under ordinary circumstances, prudence dictates that long-term assets be financed by equity or long-term debt.  Before a crisis, long-term assets are owned with short-term debt, and wealthy guys like Buffett and Klarman hold cash and shun long-term assets.  That’s inverted.  Those that should not be bearing risk are bearing risk, and those the could bear risk aren’t.  Why?  Because the prices on risk assets are high, and smart investors lighten the boat as the envious buy into momentum at the end of a doomed rally.  Ben Graham’s weighing machine takes over from the voting machine.

So what are reasons to worry?  Here are a dozen, not in any order:

  • The combined balance sheets of investment banks grow, and the complexity of their assets rises.
  • The repo market grows, as less liquid assets are financed by very liquid liabilities.
  • Poor-to-middle class people begin taking risk by buying homes, or speculating in stocks.  These people have weak liability structures, because they live paycheck to paycheck.
  • Mortgage finance moves to ARMs or even more exotic loans.
  • Downpayments on homes get low.
  • Rich hold more cash while the poor and middle-class borrow.  The rich can take losses — they have long time horizons.  When they play defense, it is a time to be concerned.
  • In a given sector there has been a large increase in debt, and there are concerns over ability to repay.
  • Shadow banking has increased dramatically.
  • Financial commercial paper issuance has increased dramatically.
  • People rely on certain large financial firms to not default, even if they have taken on too much credit risk relative to their capital.  (Think of Fannie and Freddie.)
  • Increased financial complexity makes everything opaque.  Bad things happen in the dark.
  • The credit cycle gets long in the tooth, and credit spreads/yields tighten to levels that are far too low for the risk taken on.

Now, I leave aside pure macroeconomic concerns like the possibility that the Fed might face a greater problem with stagflation than it did in the ’70s.  When long illiquid assets are financed by short liabilities, all sorts of bad things can happen.  Keep your eyes open.  Hey, aren’t Buffett and Klarman letting cash levels rise?

What is Liquidity? (Part V)

Friday, December 6th, 2013

Here are the predecessor posts in this series:

This series has been very irregular.  But it does include the first real post at this blog.  It is something that I think about frequently, and my best summary for what liquidity means is:

What does it cost to enter or exit fixed commitments?

Tonight I want to take a slightly different approach, and talk about two aspects of liquidity: assets and liabilities.

On the liability side, we can look at publicly traded assets and say that they are liquid, though many may only be fungible.  When I was a bond manager there were some trades that took days or weeks to set up.  Some were public bonds coming to market that were complex, others were asset- and mortgage-backed bonds that took some time to research.  Some were pure privates where you were trading the whole chunk or nothing — it was not far distant from being a bank.

With many investments, there is a liability structure.  Yearly, quarterly, monthly, daily liquidity.  Funds are locked up for three or five years.  Funds are locked up until assets are liquidated, and you might be paid in kind, not cash.

The ability to get cash is an important aspect of liquidity.  But so is the ability to preserve value, and that is the asset side of the question.  After all, liquidity means that you have assets that preserve value, such that you can liquidate and spend it.

From an asset standpoint, stocks are liquid as far as trading goes, but not liquid in terms of preserving value in the short-to-intermediate run.  Equity is illiquid, whether public or private.  It offers no protection of value.  Think of it this way: if you were going to buy a house in a few months, would you invest your down payment in stocks?  It would not be wise to do that.

There are various ways of owning equities, and other investments.  It is more important to understand the riskiness of the assets, than the shell in which the assets are held.  The shell may offer liquidity at intervals, but that has no effect on the underlying value of the assets.

Thus I will say it it is far more important to focus on the value of the assets, than on when cash will be released to you.  As one of my bosses said to me:

Liquidity follows quality.  The better the asset is, the more liquid it becomes.

As a result, those wanting to do best in investment management should keep a supply of short-to-intermediate high-quality debt as the performance of risk assets may vary considerably, which will affect the ability to achieve fixed commitments.

Liquidity is the ability to preserve value for near-term spending.  Thus both asset and liability aspects of investments have to be considered when considering liquidity — it is not only ability to liquidate, but to receive value back in real terms.

Book Review: Retirement GPS

Wednesday, December 4th, 2013


This book encourages you to invest most of your savings abroad, away from the imperfect but good protections offered by US law.  I wrote a piece on this idea a few years ago that pointed out the problems with this idea.  (Note to those reading this at, Google “Aleph In Defense of Home Bias” and you will find my article.)

Now don’t get me wrong — I invest in foreign companies.  One-third of the assets that I run are invested abroad, in both developed and emerging markets.  International investment is good, but it is not a panacea.  There is no inherent advantage to investing abroad versus investing in the US.  Even if emerging markets are growing more rapidly, that doesn’t mean they are better to buy. because valuations are higher, and government policies are more fickle.

This book is rather facile about problems in emerging markets.  Problems with Brazil led me to sell my stocks when Dilma Rousseff was elected President.  Lula promoted markets, Dilma did not.

I found this book to be long on cliches, and short on sharp ideas.  If you try to take the advice as an amateur, you will have a hard time doing it.  If you decide to hire an advisor other then the authors, you won’t get what the book offers.  Thus I can tell you that the book is merely a marketing pitch for their services, and so I tell you to avoid it.


Already expressed, though I would also add that the book didn’t feel right.  Too casual in the way that it treated topics.

Who would benefit from this book: Few would benefit from the book; the theory is flawed.  If you want to, you can buy it here: Retirement GPS: How to Navigate Your Way to A Secure Financial Future with Global Investing.

Full disclosure: The publisher sent me the book after asking me if I wanted it.

If you enter Amazon through my site, and you buy anything, I get a small commission.  This is my main source of blog revenue.  I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip.  Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book.  Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.  Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.  Whether you buy at Amazon directly or enter via my site, your prices don’t change.

Book Review: Code Red

Saturday, November 30th, 2013

Code Red

This is a tough book to review.  It is correct in analysis of what went wrong, but overpromises in what its main goal is — protecting assets before the next financial crisis.

Let me take a step back, and describe the structure of the book.  A major goal of neoclassical macroeconomics is to try to eliminate the business cycle, and end up with smooth growth that minimizes unemployment.

As a result, central bankers, since they have a freer hand than politicians, as they are appointed, not elected, act to try to stimulate demand by lower interest rates.  They did that from 1982 to 2008, until they came to the bottom rung of their ladder, and realized they could go no further.

Thus “Code Red” — a situation that is an emergency.  Many central banks felt they needed to act in an emergency to create liquidity to pump up economies with significant financial bankruptcies.

Would it work?  When the central bankers started, all they had was theory, and  Japan.  Japan had tried out their theory, and it did them no good.

The academics argued that Japan did not do it right, and sadly, one was the Chairman of the Fed.  Would that Bernanke had done his Ph.D. dissertation on another unrelated topic.  Some historical accidents are real killers, and this was one.  (As an aside: always be wary of academic researchers that have a lot invested in an idea.  They cease to be neutral, and cause contrary data to be ignored, because you can always find a method to twist the data.)

Anyway, that is the first and longer part of the book explaining how bankrupt. untested theories led us to a situation where debt levels are high with governments, and central banks are ultra-loose.  In such a situation, nations will try to weaken their currencies to gain a nominal advantage over other nations, so that they can export more.  Eventually, it could lead to a currency war of competitive devaluations, or worse, a trade war of competing tariffs.

If central banks cooperate with their governments, they can repress people financially, making the rate that they can invest in with safety to be lower than the inflation rate.  The authors believe that governments will try to do that and eventually fail, because credit creation will eventually lead to significant inflation.

One virtue of the book is that it shows that economists with influence over policy don’t know what they are doing, but make a bold show of it.  Particularly telling is Bernanke on page 135 saying the Fed can mop up excess liquidity at the right time, and he is 100% confident of that.  The Fed has never succeeded at that before, so who is he kidding?

The second half of the book deals with how to protect your assets — half is generous here, because it is 25% of the book.  It goes over the permanent portfolio idea of Harry Browne, and then a series of non-solutions in Chapter 10, essentially arguing that diversification is called for.

Chapter 11 argues for inflation protection through buying shares of companies that have moats, such as:

  • Valuable Intellectual Property
  • Benefit from strong network effects
  • Are low cost producers
  • Have lock-in, and customers can’t switch easily
  • Natural monopolies and monopolies of market niches

These are good ideas, in my opinion, but difficult to continually implement.  The book gives companies that presently fit the ideas of the authors, but updating it, and knowing how to trade it is tough.  We’ve been through eras like the early ’70s, where companies like this have cratered, so this strategy does not come without the possibility where it becomes too popular, and gets abandoned.

Chapter 12 goes through commodities and gold, and is bearish on them, arguing that the commodities supercycle is dead, and that gold is tied to real interest rates.

In short, the second half of the book is thin.  If you are looking for protection, maybe the book should have said, there aren’t a lot of great ways to seek protection against the monstrous economic policies of the developed world and China, but that wouldn’t have sold many books.


I disagree with the first chapter that we had to have bailouts.  The government could have protected regulated subsidiaries of the banks, and derivative counterparties, and let the holding companies fail.  I also disagree that we had to have abnormal monetary policy to stem the crisis — so long as there is a positive yield curve, there is stimulus, but once you get down near zero, perverse effects kick in.

The rest of my disagreements are already expressed.  To summarize: the first half of the book is good, but the second half is thin gruel if you want to protect your assets.

Who would benefit from this book: If you want to understand the causes of the crisis this is a great book to buy.  For protection of your assets, it will give you a few ideas, but no solution.  If you want to, you can buy it here: Code Red: How to Protect Your Savings From the Coming Crisis.

Full disclosure: I asked the publisher for a copy of the book, and he sent one.

If you enter Amazon through my site, and you buy anything, I get a small commission.  This is my main source of blog revenue.  I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip.  Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book.  Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.  Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.  Whether you buy at Amazon directly or enter via my site, your prices don’t change.


David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures.

Also, though David runs Aleph Investments, LLC, this blog is not a part of that business. This blog exists to educate investors, and give something back. It is not intended as advertisement for Aleph Investments; David is not soliciting business through it. When David, or a client of David's has an interest in a security mentioned, full disclosure will be given, as has been past practice for all that David does on the web. Disclosure is the breakfast of champions.

Additionally, David may occasionally write about accounting, actuarial, insurance, and tax topics, but nothing written here, at RealMoney, or anywhere else is meant to be formal "advice" in those areas. Consult a reputable professional in those areas to get personal, tailored advice that meets the specialized needs that David can have no knowledge of.

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