Category: Macroeconomics

The Great Garbage Post

The Great Garbage Post

Posted on by David Merkel

Perhaps for blogging, I should not do this. My editors at RealMoney told me that they liked my “Notes and Comments” posts in the Columnist Conversation, but they wished that I could give it a greater title. Titles are meant to give a common theme. Often with my “Miscellaneous Notes” posts, there is no common theme. Unlike other writers at RealMoney, I cover a lot more ground. I like to think of myself as a generalist in investing. I know at least a little about most topics.

Now, I have to be careful not to overestimate what I know, but the advantage that I have in being a generalist is that I can sometimes see interlinkages among the markets that generalists miss. Anyway, onto my unrelated comments…

1) So many arguments over at RealMoney over what market capitalization is better, small or large? Personally, I like midcaps, but market capitalization is largely a fallout of my processes. If one group of capitalizations looks cheap, I’ll will predominantly be buying them, subject to my rule #4, “Purchase companies appropriately sized to serve their market niches.” Analyze the competitive position. Sometimes scale matters, and sometimes it doesn’t.

2) My oscillator says to me that the market is now overbought. We can rise further from here, but the market needs to digest its gains. We should not see a rapid rise from here over the next two weeks, and we might see a pullback.

3) My, but the dollar has been weak. Good thing I have enough international bonds to support my balanced mandates. I am long the Yen, Swissie, and Loony.

4) Sold a little Tsakos today, just to rebalance after the nice run. Cleared out of Fresh Del Monte. Cash flow looks weak. Suggestions for a replacement candidate are solicited.
5) Roger Nusbaum is an underrated columnist at RealMoney in my opinion. Today, he had a great article dealing with understanding strategy. He asked the following two questions:

  • If you had to pick one overriding philosophy for your investment management, what would it be?
  • If you had to pick four of your strategies or tactics to accomplish this philosophy, what would they be?

Good questions that will focus anyone’s investment efforts.

6) In the “Good News is Bad News” department, there is an article from the WSJ describing how the SEC may eliminate the FASB by allowing US companies to ditch GAAP, and optionally use international accounting standards [IFRS]. If it happens, this is just the first move. Eventually all companies will follow an international standard, that is, if Congress in its infinite wisdom can restrain itself from meddling in the management of accounting. The private sector does well enough, thank you. Please limit your scope to tax accounting (or not).

7) Also from the WSJ, an article on how employers are grabbing back control of 401(k) plans. Good idea, since most people don’t know how to save or invest. But why not go all the way, and set up a defined benefit plan or a trustee-directed defined contribution plan? The latter idea is cheap to do; we have one at my current employer. Expenses are close to nil, because I mange the money in-house. Even with an external manager, it would be cheap.Would there be people who complain, saying they want more freedom? Of course, but they are the exception, not the rule, and of those who complain, maybe one in five can do better than an index fund over the long haul. I am for paternalism here; most ordinary people can’t save and invest wisely. Someone must do it for them.

8) Finally, the “hooey alert.” The concept of using custom indexes to analyze outperformance smacks of the inanity of “returns-based style analysis.” I wrote extensively on this topic in the mid-90s. Anytime one uses constrained optimization to calculate a benchmark using a bunch of equity indexes, the result is often spurious, because the indexes are highly correlated. Most differentiation between them is typically the overinterpretation of a random difference between the indexes. Typically, these calculations predict well in the past, but predict the future badly.

That’s all for now.

Full Disclosure: long TNP FXY FXF FXC

International Diversification

International Diversification

Posted on by David Merkel

The Wall Street Journal had two bits on international diversification: a poll, and an article. Both were good as far as they went, but the past outperformance of international over domestic stocks doesn’t help us analyze which will be better in the future. That macro question is hard, particularly because once a streak gets long, it gets more touchy to be long. But let’s look at a “micro” angle on foreign investing.

 

One of the reasons to invest abroad is to diversify currency risk. Let’s pretend for a moment that we know the dollar is going down over the next few years. What stocks would I buy? I would buy foreign companies that import US goods (costs are getting cheaper), foreign companies that are purely local (earnings stream rising in dollar terms), and US companies that export (sales should rise as the dollar falls).

 

Now let’s pretend for a moment that we know the dollar is going up over the next few years. What stocks would I buy? I would buy foreign companies that export goods to the US (sales should rise as the dollar rises), US companies that are purely local (earnings stream rising in foreign currency terms), and US companies that import (costs are getting cheaper).

 

All that said, foreign investing is more complex because of:

  • Expropriation risk
  • Different accounting standards
  • Often less disclosure
  • Poor corporate governance (US investors don’t know how good they have it, or on the negative side, SOX chases foreign firms away from US listings.)
  • Inability to get fair redress in the courts
  • Language issues
  • Foreign trading costs if not listed in the US.
  • War
  • Exchange controls

 

As for me, I am mainly country-indifferent in investing. I agree with John Templeton, who said something to the effect of: “Buy the cheapest companies in a given industry.” I do look for the “rule of law,” though. Just as when we buy shares in a company, we check to see how they treat outside passive minority shareholders, with foreign firms, we have to go a step further, and ask how the country treats foreign outside passive minority shareholders.

 

With bonds the issue is simpler, because it boils down to yield, currency and repayment issues. The challenge there is to understand what will drive the relative forward interest rate policy between countries. In the intermediate term, it is better to invest in currencies where the central bank is tightening, particularly if there are any “surprise” tightenings.

 

I believe in international diversification; in general it is a good thing. But it should not be done blindly; investors should consider the factors that I have mentioned above, if not more factors.

An Interesting Post from NPR Marketplace

An Interesting Post from NPR Marketplace

Posted on by David Merkel

We haven’t had foreclosure on a wide scale since securitization became common. Some municipalities are trying to figure out who truly owns a house in foreclosure if the loan was securitized. I would think that the trustees were the legal owners on behalf of the junior certificate holders, with the servicer acting in behalf of the trustee.

The radio show NPR Marketplace had an interesting piece on this phenomenon. When a city is dealing with a mass of abandoned buildings, they want to know who owns them, so that they can be protected, and blight avoided.
In this era of securitization, finding the owner after foreclosure is not simple. Listen to the piece, and consider the effects on our markets and society.

Too Many Vultures, Too Little Carrion

Too Many Vultures, Too Little Carrion

Posted on by David Merkel

I had a cc post over at RealMoney called Too Many Vultures, Too Little Carrion . The idea was that there’s too much money ready to rescue dud assets at present. Yesterday, Cramer had his own blog entry suggesting that the absorption of subprime assets at relatively high prices implied that the depositary financial sector is a sound place to invest. I disagree. In the early phases of any secular change, there are market players who snap up distressed assets, and later they find out that they could have gotten a better bargain had they waited.

The good sale prices for subprime portfolios is not a sign of strength, but a sign that there is a lot of vulture capital looking for deals. The true problems will surface when the vulture capital gets burned through or scared away.

Pity the Poor Investment Grade Corporate Bond Manager

Pity the Poor Investment Grade Corporate Bond Manager

Posted on by David Merkel

When I was an investment grade corporate bond manager (2001-2003), my analysts would come to me and explain the credit metrics of the company whose bond we might buy. Now, that was a period of great stress in the credit markets. Often my analysts would stress that the low enterprise value to EBITDA ratio would help protect us, and it did.

Fast forward to 2006-2007. Companies with low enterprise value to EBITDA ratios are being taken private, and the corporate bonds with no change-of-control covenants are being downgraded to junk, because of the additional senior bank debt subordinating the old corporate bonds.

This is another situation where the manager wants Goldilocks. Not too hot, lest it be taken private. Not too cold, lest it default. It’s a tough situation to be in, and if I were managing a bond portfolio, I would move to higher quality with corporate bonds (not much yield give-up), while buying junk-rated corporate loans, so long as they have protective covenants.

It’s a tough situation. Clients want yield and safety, and the trade-off is tough. The best a corporate bond manager can do is to play it safe with spreads so tight, and wait for a better day to take credit risk.

Worth the Fuss

Worth the Fuss

Posted on by David Merkel

I would like to draw your attention to this free Wall Street Journal article on Dan Fuss of Loomis Sayles. Dan Fuss is a fundamental genius in bond investing, and anything you hear about him is worth reading. Largely because of his reasoning, I own a decent slug of Canadian bonds for my balanced mandates.

I will contrast him with the better known Bill Gross of PIMCO. PIMCO is largely a quantitative shop, implicitly writing out-of-the-money calls against their fixed income positions to generate incremental income. Dan Fuss makes big investments on what he believes the world will be like 3-5 years out. His view of the world has been uncanny for several decades. No surprise that he has been the best in bond management over the long haul.

What I Have Been Doing Lately

What I Have Been Doing Lately

Posted on by David Merkel

Recently I have had rebalancing trades, selling a little Dorel Indsutries and Sappi. Also, I swapped Sonic Automotive for Group 1 Automotive early on Tuesday. I was able to enjoy two unexpected sell-side upgrades. It’s not supposed to work this well, but it is nice when it does.

On another note, from a piece by Lloyd Byrne of Morgan Stanley, in 2006 only 73% of oil production was replaced by new reserves for companies that they follow. This is just another reason why I am overweight energy. The replacement ratio has fallen for the last four years.

Finally, if you subscribe to RealMoney, be sure to read Jim Griffin’s post, Fed-Watchers Have Blinders On. I have been contending that the housing lending crisis is serious but will not derail the economy on is own. With the decline in the dollar, it is no surprise that our exporters are seeing some growth. Funny that few notice that. I guess we are used to being importers only….

Full disclosure: long GPI DIIB SPP

The Pips Are Squeaking

The Pips Are Squeaking

Posted on by David Merkel

Around the world, broad measures of money are moving higher as goods price inflation moves higher.? China and India come to mind here.? Economic liberalization has brought benefits for both the nations that liberalized, and those that trade with them.

As such, tightening measures by developing country central banks are to be expected.? As an example consider this article by Andy Mukherjee of Bloomberg.? There’s a lot of excess credit out there, and central banks are half-heartedly trying to extinguish it.

Goods price inflation is moving higher globally, and global short rates are rising as a result.? When do we hit the tipping point, and what nations/sectors will have the worst of it once deflation or stagflation takes hold?? I’m not sure, but those that are running a current account surplus should do better.

Update on Indicators, Part 2

Update on Indicators, Part 2

Posted on by David Merkel

I should mention that Assurant has been added to the S&P 500. Could not happen to a more deserving company; they are truly innovators in the insurance industry.

And now, more on indicators, bullish, bearish, and otherwise:

Bullish

  1. Low quality stocks outperformed in the first quarter, according to Merrill Lynch. That’s bullish in the short run, but not the intermediate term.
  2. LBO volume and private equity volume continue unabated.

Bearish

  1. Economy feels like stagflation-lite. Low positive growth, and rising inflation.
  2. Inflation is rising globally, particularly in India and China.
  3. Mortgage interest payments in the US are a record high (since 1989) compared to Disposable Personal Income.
  4. Corporate credit metrics are deteriorating for both junk and high grade corporate debt, but are not critical yet.
  5. Equity REITs seem to be rolling over.

That’s all for now. Tomorrow is another day.
Full Disclosure: long AIZ

Update on Indicators

Update on Indicators

Posted on by David Merkel

Usually I look at my indicators at the beginning of a month. If I look at them more frequently, the changes are too small, and I don’t get the signal. In no particular order, here are my thoughts, both Bullish and Bearish:

Bullish

  1. Contrary to what the bear in Barron’s said this weekend, the chart for the Merger Fund is bullish. They paid a dividend at year end, and the current chart shows that arbs are making money, which is bullish.
  2. ECRI’s indicators are forecasting growth up, and inflation down.
  3. Both emerging market stocks an bonds have bounced back well.
  4. Earnings yields are still high relative to Treasuries, though if profit margins mean-revert, this argument is hooey.
  5. ISI Group’s broadline retailer’s survey is showing some life.
  6. Securitization of subprime loans, and CDOs containing tranches of subprime deals rated less than AA, are not getting done. These assets are getting sold to financial intermediaries that have adequate balance sheets to fund them.

Bearish

  1. From Alan Abelson’s column in Barron’s this weekend, Henry Kauffman uses a concept akin to my “bicycle stability versus table stability” to discuss liquidity. The former is access to credit, while the latter is excess high quality assets that are readily salable.
  2. Imposing tariffs on China is a real dumbkopf move. Eventually that will bite into the capital flow that keeps our interest rates so low, in addition to decreasing the benefits from the global division of labor.
  3. M3 is falling, and significantly. The banks are pulling back from landing, and credit availability is shrinking. My M3 proxy is the total liabilities of the banking system. Works very well.
  4. Fed funds continues to miss on the high side, since the FOMC meeting. The monetary base has gone flat, and there has been only one permanent open market operation this year, on 2/26.
  5. Financial stocks are lagging the market.
  6. The yield curve is still flat.
  7. Equity REITs don’t yield enough relative to Treasuries.
  8. Housing prices are falling nationwide.
  9. Asset price changes are increasingly in two camps: safe and risky. Correlations within the two camps are high and positive. Correlations of the two camps are very negative.
  10. Inflation remains high over the Fed’s comfort zone.

Neutral, or You Call It

  1. Implied volatilities have bounced up, but are still low.
  2. Corporate bond spreads have bounced up, but are still low.
  3. Implied 5 year inflation, five years forward, has been in a channel between 2.2% and 2.8% for the last four years.
  4. TED spreads are higher, but still low.
  5. The swap curve gained slope after the recent mini-crisis.
  6. The FOMC tightened less this time relative to prior times, if the measure is inflation versus the Fed funds rate.

That’s all for now. The two biggest bits of news are the tariffs on Chinese goods, and the decline in my M3 proxy. Bearish items both.

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