I’m going to go in reverse order here. These were my best investments in the Broad Market Portfolio over the past 7.7 years measured by total dollars gained. After this post, I should have one or two more to wrap up the series, to try to explain why I think my methods work, and flesh out the lessons that I have learned. I am a generalist, but if I have a core skill, I think it is being a portfolio manager, especially regarding risk control, though as I have admitted, I have had some real losers.

Drumroll, and here goes:

10) Anglo American plc

When I bought it originally, it was the cheapest of the diversified miners.  I wanted some base metal mining exposure, because I felt it was an industry trend that was underdiscounted.  The metal prices were ahead of the stock prices.  (And, I wish I had never sold Cleveland Cliffs… then again, for many of the names on this post, I wish I had never sold a share, but discipline in risk taking gives you the confidence to take risks.)

The trading of this one was simple — one rebalancing buy in 2006 during a small metals panic, but aside from that, the thesis was perfect, and I kept selling as the price kept rising.  As is common for me with big gainers in my taxable account, I gave away the last bit to charity.  If you are charitable, giving away appreciated stock is a wonderful way to do it, and the Fidelity Charitable Gift Trust makes it sooooo easy.

9) Ameron International

You ever heard of Ameron International?  I’m not sure to this day where I first heard of it.  For much of the time that I owned it, it was one of the larger stocks with no analytical coverage.  Ameron International  is a multinational manufacturer of engineered products and materials for the chemical, industrial, energy, transportation and infrastructure markets.

Anyway, I bought some, and then Chris Edmonds, who at that time wrote for RealMoney, separately picked it for one of his Holiday Portfolios.  I e-mailed my hearty assent.

Ameron didn’t do much for the first three years that I owned it, but I kept clipping the dividend, and doing rebalancing trades, while the internal value of the business grew.  Finally, some institutional investor(s) realized what a gem this company is, and the price exploded.  I gave the final slug to charity.  Would that I had held on, but I have had other good stocks since then.

8 ) SPX Corp

SPX Corp is a diversified industrial corporation that fell on hard times.  I looked at it as a turnaround, with global growth as a tailwind that would eventually drive the stock up.  In the fall of 2004, I felt pretty dumb about my purchases, but I persevered, thinking that there was value to be unlocked through intelligent management.

Many companies that I own have significant declines for no good economic reason.  SPX was one of them.  It is difficult to tell apart those that will disappoint versus those that will persevere, but my experience is that more of mine persevere than fail.

Again, another company that in hindsight it would have been better not to sell, but it was outside my valuation boundaries, and as I would say along with Lord Rothschild, “I always sell too soon.”

7) Helmerich & Payne

I still own Helmerich & Payne, and have sold once more in May.  As the oil price kept going higher, I looked for related entities that had not gone crazy and would benefit from the higher prices.  HP was one of them.  (And, as I wanted to say to my pal Cody Willard — “Hey, Cody, I own HP, but it’s the right HP.”)

Contract drilling is a great place to be, when oil prices are so high.  During the rise in energy prices, I moved more of my exposure into services, because even if oil would not be found, still those that were aiding the attempt to find it would get paid.

6) Cemex SA

Cemex is the company that I have held the longest.  I have long been a fan of the cement industry, because it is the cheap way to facilitate global growth, and catch up on delayed infrastructure investment in the US.  My first article for RealMoney was on the cement industry, and I owned three companies in it at that time, a massive overweight that paid off.

It was not a popular idea to buy Cemex when I did.  They had problems with derivatives and mis-hedging in recent memory, but the stock was cheap enough that I thought it was worth the risk.  For the next year it got cheaper, and I bought more.  Most investors would have assumed that they had gotten it wrong, and bailed out.  That’s not my way.

As you can see, though the price of Cemex rose, it rose in a volatile way, and my rebalancing discipline captured a lot of extra value in the process.  I still own Cemex, and still think that it is cheap, and that management is pretty bright.  I’m getting close to another rebalancing sale.  This is a gift that keeps on giving.

5) Valero Energy

I own Valero today, but I sold out of it in entirety in 2005.  I also owned Premcor during the best part of the run, and through the acquisition by Valero.  At the end, I sold some and gave the rest away.  If I added Valero and Premcor together, they would be my #1 gainer.

When I bought Valero, I felt that refining was in short supply, and would get rewarded.  I don’t expect to be right that fast, but it is gratifying when it happens.

Now, after Hurricane Katrina, I felt that the price rises were overdone for refining stocks, so I sold, and gave the rest away.

4) Lyondell Chemical

Lyondell was an idea that I grabbed from that grand old man, John Neff.  He is a humble guy, so you won’t hear him tooting his horn.  My idea was that they owned half of a refinery with Citgo, and the rest of their business I was getting for the price of the refinery.

As it was, Venezuela needed cash because of the self-aggrandizing goals of Chavez, and they sold their half of the refinery cheaply to Lyondell.  There was some confusion in the process and the rating agencies had their doubts, but Lyondell managed it well, until selling out to Basell, a Russian company.  I gave the remainder away to charity.

3) Conoco Phillips

I have owned Conoco for a long time.  It is my second longest holding, and it has rewarded me well.  It looked cheap when I bought it, and on an earnings basis, it doesn’t look much different now.  I have had a few rebalancing buys, but on the whole, the mix of exploration and refining has done admirably.

2) Plum Creek Timber

There is a small complexity in this investment.  When Plum Creek bought The Timber Company [TGP], I swapped my holdings of Plum Creek for the Timber Company.  When the deal closed, I had more Plum Creek shares.  Even after that, to mid-2002, I bought more Plum Creek, making it a triple-weight in my portfolio.  I felt that timber assets were undervalued, and I was happy to clip dividends while the market caught up with me.

In late 2004, I began the process of scaling out of the position, moving from a triple weight to a double, single, and then zero weight.  I like the management of Plum Creek, but there are price levels that I can’t pay, and I must sell.

1) Companhia de Saneamento Basico do Estado de Sao Paulo — SABESP

What a company; this was an idea from Cramer (yes).  I have long believed the thesis that potable water is scarce, and that companies that facilitate fresh water will be rewarded.  SABESP is one of the few companies that was cheap enough to buy in 2005, and remains so today.  Demand for water remains high, particularly in Sao Paulo, Brazil.  I have sold many times, but not bought because there haven’t been any pullbacks; what a happy problem to have.

So, there are my top ten.  They are a mix of:

• Get the right industry.
• Get a bright management team.
• Don’t panic over small setbacks.  Buy more.

It is worth noting that the top 11 companies that I have owned covered all of my losses.  The gains have been bigger than my losses by a wide margin , and I have had three gains for every loss.  In my next post or two, I will wrap up this series, and try to explain underlying ideas that helped me do so well.

Full disclosure: long SBS COP HP VLO CX

Okay, same drill as my pieces for my worst losses, but this time I chose the ten most average investments of mine in terms of dollars earned. Remember, one of my key disciplines is rebalancing.

Honeywell

Honeywell was short and simple.  I felt it was out of favor, and I bought some.  Six months later, I had cheaper stocks to buy, so Honeywell was gone.

Stone Energy

Stone Energy was a weird one.  As you will note, the initial purchase and final sale prices aren’t that much different.  Interim trading made a difference to the total return.

The stock popped after hurricane Katrina, and sagged quickly thereafter on an audit of proven reserves that came up light.  The rebalancing discipline was a big help here.

Dow Chemical

Dow Chemical has two stories.  First, dividends are valuable.  Second, rebalancing adds value.  Dow was a cheap stock that did not get respect, but I still made decent money off of its gyrations, and dividends.

Universal American Financial Corporation

This one is too early to tell.  I still own it.  Sometimes investments make significant money out of the gate.  That is not often, in my experience.  This is a little individual and group healthcare company that has gotten smashed over the merger integration.  That is a relatively stable business, but small healthcare players have been harmed in  the past.  Insider buying here is a plus.

Aspen Insurance Holdings

Aspen was a relatively cheap reinsurer.  I bought some and sold a chunk into a runup, and sold the rest as I concluded that I had better places to put money.

Summary of Part I

• Rebalance your portfolio regularly to fixed weights.
• Dividends matter.
• Buy cheap.

If done consistently, these principles will raise your overall return, and reduce overall risk.  Pretty good performance from a bunch of average stocks.

Full disclosure: long UAM

I sympathize with Bill Miller; no one likes to have a losing streak.  That said, by my calculations, he is now behind the S&P 500 over the last ten years.

I want to offer a simple explanation as to why Bill Miller has done so poorly recently.  First, he has bought growth companies — companies where the valuation is critically dependent on future earnings growth.  Think of Amazon (a success) or Yahoo (a failure).  Second, he avoided cyclical companies that benefit from global economic growth, that is, energy and basic materials.

Bill Miller did well in the era where he used simpler valuation metrics, before he moved onto metrics that demanded more from future growth of earnings.  Since that time, he has underperformed, and deservedly so.  He has neglected the core idea of value investing, which is the margin of safety.  By buying companies that will get crushed if growth targets are not met, he has invited his own troubles.

And, for someone who prizes deep thinking, I’m afraid he missed the forest for the trees.  (Tsst… MM is a bright guy, I like reading him, but what does he really add?)  Better to spend a little time looking at the world, and adjust the investing accordingly, than to insist that a bunch of US-centric growth companies will outperform.  Cyclical growth is real growth in this environment.

I hope Bill Miller turns it around because many friends of mine are part of the Baltimore money management community.  As Legg Mason shrinks, so do opportunities here.  But to turn it around, it means a return to down and dirty value investing, and an eye toward analyzing what sectors will do best from a global context.

If you ask me what is more fundamental to me — am I an economist or and an investor? I will tell you that I am an investor. At present for my work I am putting together a pitch book for my company detailing my value investing for potential clients. In the process of doing that, I decided to analyze all of my investments over the past 7+ years, in an effort to find some stories that are representative of my money management methods (both good and bad).

In order to get those stories, I had to download and clean all of my transactions over the past 7+ years, and then calculate the internal rate of return on each stock that I bought over the period. I still haven’t written the stories, and would appreciate advice from readers as to which stocks to use.

As I did my analysis, I learned a few things:

• Over the 7+ years, I have owned 186 stocks.
• Slightly more than 75% of my investments have been profitable.
• My average holding period has been 503 days.
• I have hit some home runs, and hit into triple plays.
• My top 11 gains pay for all of my losers.
• My cumulative profits comprise more than two-thirds of my assets.

Holding Period

Now, on this graph, the days are averages, so zero represents 0-50 days, 100 represents 50-150 days, etc. As you can see, I occasionally trade (though usually not intentionally) , but most of the time I invest.

Internal Rates of Return
What is an internal rate of return [IRR]? It is the constant rate one earns on an investment from start to finish. It is a way of averaging out all of the cash flows, and annualizing the result, so that it can be compared against other investments. Here is a histogram of the internal rates of return on my investments:

But, IRRs can be misleading.  A small gain/loss in a short period of time can result in large absolute IRRs.  That’s why I decided to create the imperfect concept of the pseudo-cumulative return.  Suppose you earned the IRR over the full length of the investment?  What would the cumulative return be?

Now, those who have followed me for a while know that my rebalancing discipline forces me to buy or sell after large moves.  The pseudo-cumulative return usually overstates my return, because I sold on the way up, and bought on the way down.

The above graph, tough as it is to interpret, gives a reasonable idea of how my investments have worked.  Most of my investments last for a few years, some more, some less.  I have tended to make money pretty regularly, but I have had some real stinkers.  I’ll pick up on that theme in my next post on Monday.

One of the dangers of being a generalist is that you get spread too thin.  Another is that you overplay your abilities.  I probably did a little of both in my recent post on ETNs (and blogging while tired).  The fine folks at Index Universe took umbrage at my post, and for good reason.  I wrote a sloppy post without enough research.

Here’s what I intended, even though it came out wrong.  I liked the post that came from Index Universe, because it highlighted an issue with ETNs that I had been talking about for two years — you have a significant credit risk there.  In the two years since I wrote the piece that I cited in my article, I have read dozens of articles on ETNs, and not one of them mentioned credit risk.  So, I was glad that someone had taken up my point. Or, at least, I thought it was my point.

Now, how was I to know that some writers at Index Universe had already written on the issue of credit risk?  I read pretty broadly, but I can’t dig for everything.  Also, they took it as a poke/jab; that was not my intent.  I don’t think that way, and I genuinely like Index Universe, even though I don’t read it daily.

I offered my apologies at their site, and I offer my apologies to readers here.  I apologize for my mistakes; I am not like some writers on the web that can never be wrong.

One final note: I have been dealing with credit issues since 1992 in the insurance, mortgage bond, and corporate bond businesses.  My experience is very relevant here.  You would be amazed at the panoply of products resembling ETNs that got trotted out since the mid-1980s, though I ran into them in the 1990s.

In any case, hail Index Universe, and investors remember, ETNs carry credit risk.

I thought Felix Salmon did an excellent job on this post regarding economics blogging. His correspondent proposes standards for and a reward to be handed out to the best bloggers. Felix declines. I decline as well, which I will detail later. There are already ways for financial bloggers to be distinguished against one another:

• What’s the Alexa, Technorati, and Quantcast rankings of your site?
• Do journalists call you to talk about financial issues? (Happens to me a lot.) Do you get mentioned in the paper? (Uh, not so much… the copy editors leave me on the cutting room floor…)
• If someone Googles a given term, where do you show up?
• How many hits do you get per day? How many subscribe to your RSS feed? E-mail feed? Seeking Alpha? Other?
• Do you get mentioned by Abnormal Returns? The Kirk Report? Other linkfests?

The thing is, the web is a very competitive environment, with a lot of bright people. Switching on the web is easier newspapers or magazines.

But why do I blog? Let me answer that with a different question, “Why did/do I write for RealMoney?” Well, it’s not for the money, though I would earn more if I submitted my articles to RealMoney rather than placing them at my blog. I like explaining concepts to people and seeing the light go on. I like hearing that someone made a better investment decision because of my educational writings. I also enjoy the challenge of trying to tease out conclusions from dirty data, using an approach that is eclectic.

Oh, and the money? Sorry, not much there. Though my blog costs me $200/year, it makes roughly $1000/year. The $800/year of profit is not enough to compensate me for my time; given the time required, I’m not sure what would be enough. I don’t do it for the money; I do it for the audience. (I would make more if I submitted it all to RealMoney, but then the audience would not be as wide, and I would not be building my brand.)

Now some bloggers are anonymous. I will mention Equity Private and Accrued Interest. Both know their stuff, and they aren’t pulling anyone’s chains. If someone writes anonymously, and does not know their stuff, their readership will not grow, because it will become known through the comments at the blog — it will not appeal to the intelligent commenters that help build an audience.

Blogging is in many ways tougher than being a young journalist. A blogger starts with no audience, whereas a young journalist has an audience from the publication. The young journalist will be guided in what to write about by his superiors, and will automatically get edited. The blogger has to figure out what he can adequately say, and whether anyone really wants to read him. The young journalist will have discipline imposed on him, whereas most successful bloggers have to develop their own discipline — one consistent with their posting style and frequency. Blog audiences decay rapidly with lack of attention, and there is a lot of competition to be heard. Journalists succeed or fail as a group, and the individual journalist does not have a lot of effect on that.

That last point should be changed to when journalistic organizations succeed or fail, the journalists inside tag along. Their competition does not primarily come from bloggers, but from Craigslist (classified ads), Google (targeted advertising), Ebay (targeted consumer to consumer sales), and Monster (Job ads and applicants), which dries up the real revenue streams. Plus, the younger demographic does not as easily pay for print subscriptions.

One other note — many popular bloggers realize that they could become a lot more popular if they head off in a sensationalistic direction, and a few do, with some cost to the truth. They do their readers little service. What I have stared down is that I could write only about stock investing ideas, and my site would be more popular. But those are far less certain than what I write about. I feel comfortable talking about my portfolio, which is over at Stockpickr.com, but individual ideas, particularly the controversial ones, have a lower probability of being correct.

Blogging is easier than being a journalist if you don’t care about being read. Anyone can go to Blogger or Typepad (among others), and start a blog in minutes. It is those bloggers who have something significant to say who will end up with an audience. I thank my audience that reads me regularly; I only hope that I can continue to be worthy of your time.

PS — I recently submitted my blog to Blogged.com, and the editor did not think that much of my blog. If you have a strong opinion about me, positive or negative, perhaps you could write a review. Again, thanks.

Every now and then, my hyperactive mind runs the film of the Federal Reserve changing its policy, and an unexpected chain of events happens, triggering a war a long way away. Sound farfetched?  US monetary policy with its unending bias toward stimulus, since we are the global reserve currency (for now), pushes inflation out into the countries that lend to us and into the commodity markets as well.  (What do you expect from a negative real interest rate?)  This has political impacts as the prices for energy, food , and related goods rise.

Nigeria is a basket case because of the light sweet crude buried there.  Venezuela gets its share of troubles because nationalized oil gives extra power to their government.  Same for Russia, though the politics are different.  Now there might be a movement for autonomy in the part of Bolivia where the natural gas is located.  I sometimes think that Iran will have internal difficulties once their oil production falls to the degree that they can no longer subsidize their populace.

These are some of the difficulties driven in part by rising energy prices.  Now, even in the US rising energy prices pinch.  Summer travel will be less (though I will still take my family to the 50th anniversary of my parents — I expect to spend at least $600 on gas… cheaper than plane fare.)

Now, some allege that the energy markets are being manipulated.  It is impossible to manipulate a resource market successfully over a long period.  The Hunt Brothers learned that on the silver market, and OPEC learned that in the mid-80s on energy.  Our government should not worry about the energy market getting manipulated.  It can’t be done over the intermediate-term.  Here’s one (of many) reasons why: when the price rises, new sources of supply show up, even the recovery of marginal amounts of energy in places where it was too expensive to extract.

Food and energy inflation are linked in several ways:

• A growing global middle class creates demand for both.
• Rising input costs, such as energy and fertilizer push up the costs of growing food.
• We grow crops for their energy content.  That has spillover effects on crops that are displaced.
• There are even spillover effects in China, and other countries that are feeling the pinch.

Rationing of rice and other staples is happening globally, even in the US to a limited degree.  Personally, I think it will lead to higher prices still and a lot more planting (on land previously considered marginal) for food, not energy purposes.

There are other spillover effects in the US, whether it is pricing/portions in restaurants, or the general rise in price for meats that may come.  Remember the meat shortage in the 70s? (Ugh, I am dating myself…)  First grain prices rose.  Then, ranchers culled their herds/flocks.  Meat prices fell. (That may be where we are now.)  Once the excess meat was purchased, meat prices rose as well, creating the “meat shortage.”

My endgame for the foolishness for the past 20 years has resembled a repeat of the 1970s, minus country music, truckers being cool, disco, etc.  It will have its difficulties; just be grateful to God that you don’t live in Nigeria, or any other place that is coming under stress that is eve n more severe.

Just a quick note on how my equity investing is doing — in April I was slightly ahead of the S&P 500, and year-to-date, things are quite good. This is not to say that I haven’t had my share of failures… Deerfield Capital, YRC Worldwide, Jones Apparel, National Atlantic, and Vishay Intertechnology have hurt. But in a portfolio of 35 stocks, even large percentage whacks get evened out if the stock picking on the remainder has been good enough. And, for me it has, though the successes are not as notable as the failures.

As an investor, I am a singles hitter, but my average is high, and strikeouts low. I have my failures, but the eight rules, which are my risk controllers and return generators, protect me. At least it seems that way for the last 7.7 years, but I know enough that even if the principles are right, they are no guarantee for the next day, year, or decade. “The markets always find a new way to make a fool out of you,” and so I encourage caution in investing. Risk control wins the game in the long run, not bold moves.

So, I keep plugging on, adapting to what I think the market will reward in the future, and ignoring the past for the most part.

Full disclosure: long VSH YRCW NAHC JNY

The books keep rolling in; I keep reviewing. Given that I am a generalist, perhaps this is a good task for me. Before I start for the evening, though, because I know the material relatively well, I skimmed the book, and read the parts that I thought were the most critical.

The Religious War Over Indexing

Passive investors are often passionate investors when it comes to what they think is right and wrong. For market cap or float-weighted indexers:

• The market is efficient!
• Keep expenses low!
• Don’t trade fund positions!
• Fundholders buy and hold!
• Tax efficiency!
• Weight by market cap or float!

For fundamental indexers:

• The market is inefficient (in specific gameable ways).
• Keep expenses relatively low.
• Adjust internal fund positions as valuations change!
• Fundholders buy and hold!
• Relative tax efficiency!
• Weight by fundamental value!

Some of the arguments in Journals like the Financial Analysts Jounrnal have been heated. The two sides believe in their positions passionately.

For purposes of this review, I’m going to call the first group classical indexers, and the second group fundamental indexers. The first group asks the following question: “How can I get the average return out of a class of publicly buyable assets?” The answer is easy. Buy the same fraction of shares of every member of the class of assets. The neat part about this answer, is everyone can do it. The entirety of shares could be owned in such a manner. Aside from buyouts and replacements for companies bought out, the turnover is non-existent. Net new cash replicates existing positions.

The fundamental indexer asks a different question, namely: “What common accounting (or other) variables, relatively standard across companies, are indicators of the likely future value of the firm? Let’s set up a portfolio that weights the positions by the estimated future values.” Estimates of future value get updated periodically and the weights change as well, so there is more trading.

Now, not all fundamental indexers are the same. They have different proxies for value — dividend yield, earnings yield, sales, book value, cash flow, free cash flow, etc. They will come to different answers. Even with the different answers, not everyone could fundamentally index, because at some point the member of the asset class with the highest ratio of fundamental weight as a ratio of float weight will be bought up in entire. No one else would be able to replicate the fundamental weightings.

So, why all of the fuss? Well, in tests going back to 1962, the particular method of fundamental indexing that the authors use would beat the S&P 500 by 2%/year. That’s worth the fuss. Now, I have kind of a middle position on this. I think that fundamental indexing is superior to classic indexing, so long as it is not overdone as a strategy. Fundamental indexing is just another form of enhanced indexing, tilting the portfolio to value, and smaller cap, both of which tend to lead to outperformance. It also allows for sector and company-level rebalancing changes from valuation changes, which also aids outperformance. In one sense fundamental weighting reminds me of Tobin’s Q — it is an attempt to back into replacement cost. Buy more of the assets with low market to replacement cost ratios.

But to me, it is a form of enhanced indexing rather than indexing, because everyone can’t do it. Fundamental Indexing will change valuations in the marketplace as it becomes a bigger strategy, wiping out some of its advantages. The same is not true of classic indexing, which just buys a fixed fraction of a total asset class.

Though the book is about fundamental indexing, and the intellectual and market battle versus classic indexing, there are many other topics touched on in the book, including:

• Asset Allocation — best done with forward looking estimates of earnings yields (another case of if everyone did this, it wouldn’t work.. but everyone doesn’t do it. Ask Jeremy Grantham…)
• The difference to investors between dollar vs time weighted returns by equity style and sector. (Value and Large lose less to bad trading on the part of fund investors… in general, the more volatile, the more fund investors lose from bad market timing.)
• A small section on assumptions behind the Capital Asset Pricing Model, and how none of them are true. (Trying to show that a cap-weighted portfolio would not be optimal…)
• And a section on how future returns from stocks are likely to be lower than what we have experienced over the last half century.

One more note: I finally got how fundamental weighting might work with bonds, though it is not explained well in the book. Weight the bond holdings toward what your own models think they should be worth one year from now. That’s not the way the book explains it, but it is how I think it could be reasonably implemented.

The Verdict

I recommend the book.  The authors are Bob Arnott, Jason Hsu, and John West. At 260 pages of main text, and a lot of graphs, it is a reasonable read. The tone is occasionally strident toward classic indexing, which to me is still a good strategy, just not as good as fundamental indexing. (It sounds like Bob wrote most of the book from a tone standpoint… but I could be wrong.)

Who should buy this book? Academics interested in the debate, and buyers of indexed equity products should buy the book. It is well-written, and ably sets forth the case for fundamental indexing.

Full disclosure: If you buy anything from Amazon after entering Amazon through any link on my leftbar, I get a small commission. It is my version of the tip jar, and it does not increase your costs at all.

1) I think Ambac is dreaming if they think they will maintain their AAA ratings. Aside from the real deterioration in their capital position, they now face stronger competition. Buffett got the AAA without the usual five-year delay because he has one of the few remaining natural AAAs behind him at Berky. (Political pressure doesn’t hurt either… many municipalities want credit enhancement that they believe is worth something.)

2) I read through the documents from the Senate hearings on the rating agencies, and my quick conclusion is that there won’t be a lot of change, particularly on such a technical topic in an election year. And, in my opinion, it would be difficult to change the system from its current configuration, and still have securitization go on. Now, maybe securitization should be banned; after all, it offers an illusion of liquidity liquidity in good times, but not in bad times, for underlying assets that are fungible, but not liquid.

3) I am not a fan of Fair Value Accounting. But if we’re going to do it, let’s do it right, as I suggested to an IASB commissioner several years ago. Have two balance sheets and two income statements. One set would be fair value, and the other amortized cost. It would not be any more work than we are doing now.

4) Now, some bankers are up in arms over fair value, and I’m afraid I can’t sympathize. If you’re going to invest in or borrow using complex instruments that amortized cost accounting can’t deal with, you should expect the accounting regulations to change.

5) Just because you can classify assets or liabilities as level 3 doesn’t mean the market will give full credibility to your model. Accounting uncertainty always receives lower valuations. It as if the market says, :These assets will have to prove themselves through their cash flows, we can’t capitalize earnings here. The same applies to the temporary gains from revaluing corporate liabilities down because of credit stress. If the creditworthiness recovers, though gains will be reversed, and good analysts should lower their future earnings estimates when bond spreads widen, to the degree that present gains are taken.

6) The student loan market is interesting, with so many lenders dropping out. This is one area where the auction-rate securities market initially hurt matters when it blew up, but there was a feature that said that the auction rate bonds could not receive more than the student lenders were receiving. So, after rates blew out for a little while, now some the auction rate bonds are receiving zero (for a while).

7) After yesterday’s post, I mused about how much the high yield market has come back, and with few defaults, aside from those that should have been dead anyway. With liquidiity low at some firms, there will be more to come. Personally, I expect spreads to eclipse their recent wides as things get worse, but enjoy the bear market rally for now.

Many munis are still cheap, but the “stupid cheap” money has been made. Lighten up a little if you went to maximum overweight.

9) What’s the Big Money smoking? They certainly are optimistic in this Barron’s piece. One thing that I can find to support them is insider buying, which is high relative to selling at present. And, even ahead of the recent run, hedge funds (and many mutual funds) had been getting more conservative. Guess they had to buy the rally. On the other side, there is a sort of leakage from DB plans, as many of them allocate more to hedge funds and private equity.

10) Does large private equity fund size lead to bad decision making? I would think so. Larger deals are more scarce, and so added urgency comes when they are available. Negotiating for such deals is more intense, and the winner often suffers the winner’s curse of having overbid.

11) I am not a believer in the shorts being able to manipulate the markets as much as some would say. It’s easier to manipulate on the long side. Here is a good post at Ultimi Barbarorum on the topic.

12) Financials are the largest sector in the S&P 500.  Perhaps not for long… they may shrink below the size of the Tech sector at current rates, or, Energy could grow to be the largest.  Nothing would make me more skittish about my energy longs.  The largest sector always seems to get hit the hardest, whether Financials today, or Tech in 2000, or Energy in the mid-90s.