I get asked to participate in surveys, and frequently, I look at the surveys and think, “You’re wasting everyone’s time here. Some people grade everything harshly, some people grade everything easily. Many people keep their responses within a restricted band, other go for the poles.  Besides, you’re asking too many questions.  Few people have that many strong opinions.”

What I am going to suggest here applies to questions like, “How can we improve our marketing, service, or operations?” I used this technique several times to improve the marketing at an insurance company that I worked for. Here is the core of the idea: if you want to elicit accurate opinions on surveys — use a constraint.

When I survey people, I do a one question initial survey to ask what the issues are that they care about. It is just a brainstorm to identify issues. Then I follow with a one-question survey that lists all of the issues, and then I say: “Pretend you are the marketing director, and that you have a budget of $100,000. How would you divide up the budget?”

Placing a budget constraint on their answers forces respondents to optimize. It also standardizes, so you don’t have to adjust for optimists and pessimists. It’s a very simple question, so answers are sharp. And, if someone feels very strongly about just one item, they can express that. Plus, it values the time of those you are surveying, so they are more willing to answer; you get almost 100% completion.

Anyway, this method has worked well for me. If you try it, and it works well for you, or doesn’t, let me know.

There is one fundamental rule on the idea generation process to get across to new retail investors:

Buy what you have researched.  Don’t buy what your friends are buying, or even worse, what someone is trying to sell you.

(For those with access to RealMoney.com, you could review my Using Investment Advice series.)

The point here is to become capable of doing the basic research necessary to make reasonable decisions.  You don’t have to make great decisions in order to succeed.  You do have to avoid making major errors, which requires a degree of skepticism toward the opinions of your non-expert friends, and modest hostility toward those selling investment products.

What led to this article was a eight-page glossy advertisement from a publication that I do not deign to name (I worry about lawsuits), about a company called GTX Corp [GTXO].  Now, maybe I need to refresh my free subscription to the direct mail preference service, which really cuts down on the amount of junk mail that I receive.

GTX Corp is an example of a company with a high valuation, and uncertain prospects.  There is no provision for adverse deviation.  It trades on the Bulletin Board, and here is its business:

GTX Corporation integrates global positioning system (GPS) technology into consumer electronics devices.  The technology allows for real-time oversight of loved ones.

Now, why don’t I like this company, aside from the advertisement that did not mention valuation, balance sheet strength, or any other risk factors?

• It trades at a high ratio of book, and trailing earnings don’t exist.
• It was created out of a merger with a failed mining company.
• Its recent financing this month offered equity interests far cheaper than the current market price.
• Their auditor is not a major auditing firm.
• Give the auditor credit though, they did not give them a “going concern” opinion, but instead expressed doubts.
• The stock is on the Nasdaq’s Threshold Securities list, so finding shares to short is problematic.
• Major shareholders are doing a secondary offering.
• The advertiser was paid $186,000 to do the ad by a third party.

I have no idea how good their GPS technology might be, but there are too many risk factors here to make me even consider a long position.

I am not here to beat on GTX Corp.  I am using them, and the guy who advertised them as an example.

• The advertisement had all manner of positive things to say about the technology and what it could do.  That’s fine, but what has it done?  Why doesn’t this corporation have significant revenues?
• Why does the ad use the scam language “as featured on” and “as seen in,” naming prominent publications and channels, when all he likely did was buy some slack advertisements at a late hour, or in regional editions?
• The ad compares the company to Garmin and other successful companies.
• The ad uses a bunch of emotive problems that the technology could solve.
• The ad puts forth a target price of $12 without any justification.

Buyer beware, and don’t listen to strangers giving you advice.  Cultivate networks of knowledgeable friends who are trustworthy, and avoid getting taken for a ride by slick-talking (writing) hucksters who pitch clever ideas to you.  Do your work, and buy cheap, boring ideas like I do.

Take some low single-A or high-BBB rated debt, lever it up 15 times.  If spreads back up, lever up more, and buy more at the higher spreads, and hope spreads don’t continue to rapidly widen, such that you have to break the deal and realize the losses.  If spreads tighten enough, de-lever, and declare victory.  That is a great bull market strategy to make money in investment grade credit, but it is not a high quality strategy.

If I created a Collateralized Debt Obligation [CDO] out of similar instruments, with what would be light leverage of 15 times, and it had just two tranches — 94% senior, 6% junior, the senior obligations would get a AAA (probably), but the junior obligations would be rated BB or so — just my back-of-the-envelope guess, but consistent with my experience.

But for Constant proportion debt obligations [CPDOs], they were not rated BB but AAA, because the dynamic portfolio management would allow the structure to survive modest bear markets in credit.  Unfortunately, when a lot of parties lever up credit, the historical statistics on how the credit markets behave at lower leverage levels don’t apply.  The odds of a sharp self-reinforcing bear market in credit rise.

So, it is not a surprise that I was an early bear on CPDO structures.  Here’s a summary piece on what I wrote, and when I wrote it.

Now today it gets revealed in the Financial Times that Moody’s had a mistake in their ratings model for CPDOs that allowed them to offer ratings equivalent to those of S&P.  Needless to say, this is getting a lot of coverage today, from:

• Reuters — nice fact summary
• Felix Salmon at Market Movers
• FT Alphaville
• Creditflux (another early skeptic)
• Naked Capitalism
• Calculated Risk

There are conflicts of interest in the way that ratings agencies get paid by the issuers, and the CPDO debacle highlights them.  I don’t think you can create a system where the users of ratings carry the full weight of the ratings process.  The issuers have the concentrated interest in a way buyers do not.

But maybe there is a way to re-align matters.  What if the ratings agencies received half of their fee by receiving interests in the juniormost class?  (For non-structured deals, make that a subordinated interest strip.)  My, but I think that subordination levels would rise.  Also, I think the ratings agencies would become more generally cautious.

From my angle, though, the CPDO debacle is more egregious than other rating failures, because the agencies deviated from their normal way of rating debt, seemingly just to make more money.  Well, they made the money, but how much is a reputation for quality ratings worth?  In the long run, the CPDO deals will be net losers for Moody’s and S&P, and a net win for skeptics like Fitch and Dominion.

Okay, here is the S&P 500 over the past year:

We haven’t quite made it back to the highs made in July or October. But the VIX has normalized:

And the spread between A2/P2 commercial paper and the two-year Treasury has narrowed as well. Normalcy has returned to the lending markets?

Well, sort of. The question remains as to what happens when the Fed ends their new lending programs, that is, if they can end them. As with many government programs, they take on a life of their own, and they are difficult to end. If the Fed can’t end the new facilities, can they really say that they have ended the crises?

As for market sentiment, consider this graph:

This is a knockoff of the oscillator that Cramer cites. How accurate is it? Over +/- 500, Cramer comments that there are extreme readings. But as for now we are near zero — this indicator tells us nothing here.

So, what am I saying? We have rallied a great deal, and a lot of fear has come out of the markets, but we still have not eclipsed the highs of July or October. My sense is that we will muddle from here and not do much on net for the next three months. Fear has ended too quickly.

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

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.

As I sit here, my taxes are done, all except for one K-1 that is very late, to put it mildly.  My taxes are complex, but my rule is that I do my own taxes.  If I can’t figure out the code, then I am probably doing something that I don’t understand the full economics behind it, and I should avoid it as a result.  Besides, it keeps me up with trends in the tax code that I might not truly grasp.  Surprises this year included the form for HSAs, and a credit  for promoting domestic production.  I also learned some of the intricacies in accounting for the sale of S corporation stock.  Not fun, but I learned something, and that is good.

It does motivate me to write a piece on tax reform, though.  I don’t fit neatly on the political spectrum: I’m a libertarian on economics, and a conservative on social policy (though conservative really isn’t the right word). Tax reform means different things to different people; let’s consider what it means to conservatives and liberals.

What does tax reform mean to conservatives?

• Eliminate the estate tax
• Eliminate the double taxation of dividends
• Eliminate the marriage penalty (actually should be a goal of liberals, and not conservatives, but hey…)
• Flatten the tax rate structure
• Preferentially tax income classes that aid in capital formation
• More taxation at the state level, less at the federal level
• Carve out exceptions for political allies that support your broad agenda

What does tax reform mean to liberals?

• Roll back the Bush tax cuts
• Keep the estate tax
• Increase the progressivity of tax rates
• More taxation at the federal level, less at the state level
• Preferentially tax wage income at lower rates
• Carve out exceptions for political allies that support your broad agenda

To me, both of them miss a dimension of the problem.  The main problem is how we define income, not the rate at which we tax income.  Both liberals and conservatives support areas in the tax code that allow for deferral of taxation.  To me, that is a core problem in the tax code.  Taxation should be roughly proportionate to the good that a taxpayer is deriving from society.  As a proxy for that, it should be proportional to his increase in net worth, whether the increase in net worth is liquid or not.

I will use Warren Buffett as my example.  Because he rarely sells stock, his taxes are deferred both personally, and at Berkshire Hathaway.  His net worth keeps going up, and the Treasury doesn’t get a piece of it.  Then he has the nerve to show up on Capitol Hill in favor of the estate tax, a tax of which his estate will pay little, because he has given most of it away.

My view is that people should be taxed like traders, on the increase in their net worth, at the same rate, regardless of where the income comes from.  Taxes would be paid on a mark-to-market basis.  There would be no more tax deferral IRAs or 401(k)s, and even pension earnings would get taxed inside DB plans.  Life insurance and annuities would lose their tax breaks.  Even charitable endowments would be taxed.  Private equity would get taxed off of “phantom income” at a 15% compounded rate, i.e., a private equity fund with $100 million in equity would have to pay taxes on $15 million of phantom income, at the fund if 15% distributions are not made to shareholders.  Truing up would occur at the dissolution of the fund.

Another key component here would be that there would be no separate tax accounting basis — the IRS would use GAAP.  What you report, is what you get taxed on, with the exception that firms that are heavily indebted to avoid paying taxes would get taxed on phantom income, the same as private equity.  Also, all like-kind exchanges would be taxed.  Even real estate would follow the property assessor, and income taxation would occur on the increase.

Then eliminate all deductions, conservative and liberal ones, and you have a tax code that can operate at a low rate because the entire increase of wealth in the economy is being taxed, without exceptions.  Oh, and since the income has been taxed all of the way up, the estate tax is no longer needed.  It was needed when wealthy people could shelter their increasing net worth from taxation.

Objections to this Outlandish Proposal

• Would you really allow investment losses to reduce someone’s income to zero, or below?  Yes, though there would have to be some safeguards against people who disguise their hobbies to be businesses.
• This will kill investment; the economy won’t grow without tax deferral!  Nonsense.  Most tax deferral incentives don’t change the amount of investment, but just the forms that the investments go into.
• Without tax deferral, people won’t buy life insurance, annuities, and corporations won’t provide pensions.  To some degree, yes, but after the shock wears off people will invest for maximum advantage again, and with an eye toward what is best, not what is tax-favored.  With my proposal, I don’t care if people have pensions or savings.  It’s all the same.  Life insurance and annuities will be bought for risk reduction reasons, not tax reasons.
• This will kill private equity!  It won’t.  It may shrink it a little, but there are many advantage to private equity aside from deferral of taxation.
• But phantom income will require illiquid investments to retain liquidity for taxes, or require equity holders to fund taxes.  Guilty as  charged.  It changes the business model to that degree.
• This discriminates against the poor in favor of the rich.  No, it discriminates against the clever rich, who shield the increase in their net worth from taxation.  Taxes delayed often become taxes avoided in entire.  Poor people should pay some taxes.  They benefit from society a little, and taxes would give them greater interest in voting.
• If there’s no deduction/credit for JKL, then JKL will disappear.  Good, or, maybe I should say, yes, there will be a decrease, but if it is valuable, it will find its own level.
• This proposal is incomplete!  You haven’t considered a lot of other areas.  No doubt; there would be a lot to do here, should it ever see the light of day.  Let John McCain be a real straight-talking maverick, and adopt a proposal like this.  He could be a real conservative, while offending all of the “conservatives.”

I harbor no illusions here.  We have the tax code that we deserve.  Don’t blame the IRS.  Don’t blame the President or Congress.  Blame those who elected them, and those who failed to vote.  The politicians offer us favors from our own money, and we thank them for it, by re-electing them.  I know that my views of tax reform will never be enacted because it steps on too many feet.  Can you imagine how many accountants, attorneys and actuaries would be unemployed by this?  If they fought hard against TRA ‘86, just imagine how they would fight against this.  The politicians like fostering the illusion that they create our prosperity, when in reality, they take a share of it.  A proposal like this, that makes taxation more immediate, and more transparent, would make people more concerned about where their taxes go, because they would feel it more acutely.

And then, after all of this, we should move election day to April 15th.  Let the voters feel acutely what the politicians have decided for raising revenue, and they will render a better verdict.

When I was younger, twenty years younger, I subscribed to the WSJ, Forbes and Barrons.  Though I am retaining my subscription to the WSJ (my wife wants it for one of my older sons), I am letting my subscriptions to Forbes and Barrons lapse.  What good that they do, I can get online.  (I will probably keep my Barrons Online, but dump WSJ Online.)

I just don’t get enough from Forbes to justify reading it anymore.  Their lists are a convenient way to fill space, and the advertising to articles ratio is high.  I like Barron’s, but I can read it online.  As for the Wall Street Journal Online, it may already be free.

I learned a lot from all of these publications when I was younger, but time is shorter now, and I get more information from online sources at present.