The Aleph Blog

Reaching For Yield

15 months ago I wrote a piece called Expensive High Yield – II.  High yield is still expensive.  I won’t post all of the regressions, but I have re-run them.  The results are largely the same as before.  Yields are low, and spreads are overly tight for everything except CCC bonds.

Much of this is the result of the Fed’s low fed funds rate and quantitative easing, which forces investors to take more risk.  Another aspect is the strong equity market.

Also, CCC bonds offering opportunity may not adjust for the loosening of covenant protections.  There is a tendency for investors to try to maintain yield levels while letting quality & covenants sag.  In a low interest environment, with more and more people retiring, there is a growing desire for the simplicity of yield.

My conclusion last time was this:

All of the corporate bond market is expensive relative to history, perhaps excluding CCC bonds.  That doesn’t mean it can’t get more expensive, particularly if stocks continue to move upward.   But this won’t last for more than two years; the signs of speculation are here, and that should make us cautious.

As a result, I am investing my bond strategy cautiously now.  What little yield I get comes from emerging market sovereigns.  Credit risk from corporates is small.

Well, I blew it with emerging markets; what a kick in the teeth.  I would have been better off in high yield.  As it is, for me and my bond clients, the strategy is Fire and Ice.  20% long Treasuries for deflation, 80% short credit instruments for inflation.  So far, so good.

Be wary in this environment.  So many are reaching for yield amid a weak economy with yields that are low relative to past trends.  But also be aware that a rising stock market can support the corporate bond market.  That has worked for the last two years, but it can’t work forever.

Sorted Weekly Tweets

Rest of the World

  • Putin’s Rejection of the West, in Writing ”Russia must be viewed as a unique and original civilization…” $$ $MACRO Apr 05, 2014
  • Japan Working Women Face Tax Blow as Their Numbers Swell Govt’s like women working o/s home: can tax their output $$ Apr 05, 2014
  • China Leverage Seen Rising Through 2016 It’s relatively worse than advertised, debts r private, bank & muni $$ Apr 03, 2014
  • China Unsated by US Ham Means More Food Deals If China is rebalancing to consumption, expect large food imports $$ Apr 03, 2014
  • Rajan Offers No Solace as Developers Fight Rut Rising rates put pressure on Indian businessmen $$ Apr 03, 2014
  • CHINA IS IMPORTING GOLD SECRETLY USING MILITARY CHANNELS @JamesGRickards new book is coming out in a few days $$ $GLD Apr 01, 2014
  • How rumour sparked panic and three-day bank run in Chinese city All it took was a rumor that went viral $$ $FXI $SPY Apr 01, 2014
  • Foreign Policy Legacy of Obama Administration in European Hands U don’t want Europeans 2question the value of NATO $$ Apr 01, 2014
  • Chinese Private Sector Debt China’s ratio of private debt to GDP is higher than the US & EU $$ Apr 01, 2014
  • Poor Coordination Led to Flawed Search for Missing Malaysia Airlines Flight 370 Maybe, but would have been hard $$ Apr 01, 2014
  • South Sudan Ethnic Hatred Drives Rebel Leader’s White Army Read the last sentence & u will c y this war persists $$ Apr 01, 2014
  • She’s lost 3 sons in the war & is adamant should continue. “The war will not be stopped until we kill all Dinka, including the children,” $$ Apr 01, 2014
  • China Burns Speculators as $5.5B Lost on Yuan Bets Real market goes more than 1 way, doles out punishment 2losers $$ Apr 01, 2014
  • Almost 10,000 Divorces Each Day in China’s Breakup Boom Driven by increasing economics & greater freedom 2 do so $$ Apr 01, 2014
  • Dashed Ikea Dreams Show Decades Lost to Bribery in Ukraine Corruption & denial of propty rights keep nations poor $$ Apr 01, 2014
  • China’s $14.5B Test China seizes $14.5B assets from family, associates of ex-security chief $$ Apr 01, 2014
  • China Lake Saved From Stink Leaves Fiscal Cleanup for Li Ability 2 service municipal debt is a problem 4 China $$ Apr 01, 2014

US Politics & Policy

  • A Catastrophe Like No Other Peggy Noonan: The president tries to put a good face on ObamaCare $$ #unforcederror $TLT Apr 05, 2014
  • Janet Yellen’s Human Message Gets Clouded Truth is monetary policy is weak w/respect to unemployment $$ Change regs Apr 03, 2014
  • Yelp Reviews Brew Fight Over Free Speech, Fairness Free speech doesn’t mean u can say anything, libel is a crime $$ Apr 03, 2014
  • Democrats Bet on Technology Instead of Paying Down Debts Dems put lack of $$ where mouth is, b/c debts don’t matter Apr 01, 2014
  • Constitutional conundrum: Michigan demand 4a balanced budget could trigger amendment convention States take power? $$ Apr 01, 2014
  • The House Republican Mess GOP leadership held unannounced voice vote on a one-year unfunded “doc fix” 4 Medicare $$ Apr 01, 2014
  • What Is a Patent Troll? Congress, Courts Try to Find Out Should not be able to patent ideas, many ways 2 implement $$ Apr 01, 2014
  • Controversial FHA payoff rule to end At closings, FHA required one month’s interest from sellers who prepaid mtge $$ Apr 01, 2014
  • Supreme Court skeptical of computer-based patents Multiple ways 2 achieve same results w/computer code $$ $MSFT $GOOG Apr 01, 2014
  • Yellen Assures Markets on Interest Rates In the short-run, monetary looseness helps, in the long-run it hurts $$ $TLT Apr 01, 2014
  • GOP Sees a New Path for Senate Through Iowa Looking at the data, the GOP will have a hard time taking the Senate $$ Apr 01, 2014            

Market Impact

  • Buying Bonds in Sellers’ World: Prepare to Fail If u r a life insurer, don’t want 2 give up income from prem bonds $$ Apr 05, 2014
  • Emerging markets ETFs take off in March and June Bear market rallies r short & sharp, watch monetary tightening $$ Apr 03, 2014
  • Investors Clamor for Risky Debt Offerings High yield isn’t so high anymore, & income starvation leads ppl astray $$ Apr 03, 2014
  • Gross Worst as Volatility Spikes in Fund Bad idea to move to 5s just as Yellen began to speak unguardedly $$ #taper Apr 03, 2014
  • Forget the lottery. Time for the Billionaire ETF? Kind of a follow the 13Fs of the wealthy fund, could do worse $$ Apr 03, 2014
  • Vanguard Beats BlackRock Winning Most ETF Money This Year Low fees, sticky clients, tracks index well, low fees $$ Apr 01, 2014
  • Andreesen On How To Kill Stock Market Personal pet peeve is how Sarbox killed off sponsored listings of fgn firms $$ Apr 01, 2014
  • Activists Beat S&P 500 in 48% Gain for Shareholders Cool interactive graphic $$ $SPY Apr 01, 2014
  • Investors Picking Fights Enhance Value as Stocks Beat S&P 500 Problem: avg investors can’t find those stocks early $$ Apr 01, 2014
  • Biggest ETF Flow From US Debt Since ’10 on Growth Optimism Funny how long Tsys haven’t tanked yet $$ $TLT Apr 01, 2014
  • So Far, So Meh @ReformedBroker tells us to expect a boring year when all is done with lots of jolts inbetween $$ $SPY Apr 01, 2014
  • Flows Don’t Follow Value, They Follow Performance @reformedbroker tells u small investors r always late & lose $$ Apr 01, 2014  

High Frequency Trading (Boo!)

  • Michael Lewis Feels No Shame as Book Curdles Tempers Must admit, I lost respect 4 him on this last media circus $$ Apr 05, 2014
  • High-Frequency Trading May Be Too Efficient @matt_levine explains the effect of HFT, who gets hurt, who doesn’t $$ Apr 03, 2014
  • High-Frequency Traders Chase Currencies as Stock Volume Recedes Ponder how HFT can b good 1 place & bad in others $$ Apr 03, 2014
  • What Michael Lewis Gets Wrong About High-Frequency Trading He gets quite a bit wrong; this is a good summary $$ Apr 03, 2014
  • An Adaptation From ‘Flash Boys: A Wall Street Revolt,’ by Michael Lewis Tells story creating a fair stock exchange $$ Apr 01, 2014  

Marvel Comics Movies

  • Kevin Feige, Marvel’s Superhero at Running Movie Franchises Great article. Explains the strategic aspects well $$ Apr 05, 2014
  • Comic Wars: How Two Tycoons Battled Over the Marvel Comics Empire–And Both Lost Provides backstory for Marvel $$ Apr 05, 2014  

Companies & Industries

  • Energy Future Talks Pit Billionaires Against Billionaires & the IRS, who is owed billions, creditors want 2 stiff $$ Apr 03, 2014
  • Old Math Casts Doubt on Accuracy of Oil Reserve Estimates Life of fracked wells is a lot shorter than conventional $$ Apr 03, 2014
  • New $GOOG Shares Hit Market as Founders Cement Grip With Split Won’t hurt much, just don’t issue2many C shs $$ $GOOGL Apr 03, 2014
  • The Argument for $75 Oil Should Be $95 Oil W/weak global econ, oil should b falling but it is not; new equilibrium $$ Apr 01, 2014  


  • Loans Are Finally Easier to Get If this persists for 6 months, start watching consumer price inflation $$ Apr 03, 2014
  • Jules Kroll’s KBRA Out to Disrupt Cozy Ratings Agency Business Starts in area of greatest failure: securitizations $$ Apr 03, 2014
  • So U Think You’re Smarter Than A CIA Agent Good Judgment project finds bright ppl who predict better than experts $$ Apr 03, 2014
  • Do We Hate Female Bosses? Never had one, so I don’t know. ;) $$ Apr 03, 2014
  • How Americans Meet Their Spouses Fewer people meet their spouses @ work, more meet them over the internet than b4 $$ Apr 01, 2014
  • US Airports Are Off the Chart @Ritholtz shows how lack of infrastructural investment hurts the US $$ $SPY $TLT Apr 01, 2014
  • Millennials Mired in Wealth Gap as Older Americans Gain If u had lots of debts & few assets going into 2008, ouch $$ Apr 01, 2014  


  • 2hard: US Seeks Changes to ‘Skewed’ Data in UN Climate Draft Models r 2complex 2produce any sort of accuracy $$ $SPY Apr 05, 2014
  • Wrong: Investment strategies you’d be foolish to ignore – Pros Many of these might work in the short-run, not L-T $$ Apr 03, 2014
  • Wrong: Schwab: HFT a cancer that needs to be stopped It’s more complex than that; improves mkts in some ways $$ $SPY Apr 03, 2014
  • Wrong: Christine Lagarde: global economic growth is still too slow Aside frm degegulation govts can’t affct growth $$ Apr 03, 2014
  • Wrong: This Ratio Reveals The Market’s Top Bargains Makes rookie error of applying FCF 2 financials, can’t b done $$ Apr 03, 2014
  • Wrong: The Modern View of the Stock Market Value of MPT is that it sidelines smart people who would b competitors $$ Apr 01, 2014
  • Meh: Flight 370 Search Gains Vessel With Black Box-Detector Late 2 arrive; can’t probe more than 1 mile deep $$ $BA Apr 01, 2014
  • Maybe: Home Sales in US Poised to Surge With Spring Maybe if prices come down this might happen, few moveup buyers $$ Apr 01, 2014
  • Very Wrong: When You Really Look, Financial Quicksand Turns Into Oligarchical BS Claims Govt debt doesn’t matter $$ Apr 01, 2014  

Comments, Replies, and Retweets

  • @charlie_simpson Marry young, have children, a recipe for happiness that fights loneliness — true for men as well. Apr 02, 2014
  • @insidermonkey @jimcramer @katsuyama Stupid argument. Read & learn $$ Apr 02, 2014
  • . @dpinsen seems he just wants it 2 stop. Also notes Darfur attacked once again & $$ $SPY $TLT Apr 01, 2014
  • @dpinsen I’m not backing the Ukraine in NATO — only caution. NATO should be bold or silent, but not in-between, counting the costs. $$ Mar 30, 2014

Best of the Aleph Blog, Part 24

These articles appeared between November 2012 and January 2013:

On Time Horizons

Investment advice without a time horizon is not investment advice.

This Election Will Solve Nothing

So far that is true of the 2012 elections.


We need to add “None of the Above” as an electoral choice in all elections.

Eliminating the Rating Agencies, Part 2

Eliminating the Rating Agencies, Part 3

Where I propose a great idea, and then realize that I am wrong.

The Rules, Part XXXV

Stability only comes to markets in a self-reinforcing mode, from buy and hold (and sell and sit on cash) investors who act at the turning points.

The Rules, Part XXXVI

It almost never makes sense to play for the last 5% of something; it costs too much. Getting 90-95% is relatively easy; grasping for the last 5-10% usually results in losing some of the 90-95%.

Charlie Brown the Retail Investor

Where Lucy represents Wall Street, the football is returns, and Charlie Brown is the Retail Investor. Aaauuuggh!

On Hucksters

Why to be careful when promised results seem too good, and they get delayed, or worse.

Bombing Baby BDC Bonds

Avoid bonds with few protective covenants, unless the borrower is very strong.

On Math Education

Why current efforts to change Math Education will fail.  Pedagogy peaked in the ’50s, and has been declining since then.

On Human Fertility, Part 2

On the continuing decline in human fertility across the globe.

If you Want to be Well-off in Life

Simple advice on how to be better off.  Warning: it requires discipline.

Young People Should Favor Low Discount Rates

If we had assumed lower discount rates in the past, we wouldn’t have the problems we do now.  (And maybe DB pensions would have died sooner.)

Problems in Life Insurance

On why we should be concerned about life insurance accounting.

Investing In P&C Insurers

On why analyzing P&C insurers boils down to analyzing management teams.

Selling Options Cheaply (Did You Know?)

Naive bond investors often take on risks that they did not anticipate.

Book Review: The Snowball, Part One

Book Review: The Snowball, Part Two

Book Review: The Snowball, Part Three

Book Review: The Snowball, Part Four

Book Review: The Snowball, Epilogue

My review of the most comprehensive book on the life of Warren Buffett.

On Watchlists

How I met one of the Superinvestors of Graham-and -Doddsville, and how I generate investment ideas.

Why do Value Investors Like to Index?

How I admitted to not having  a correct perspective on value indexing.

Evaluating Regulated Financials

Why regulated financials are different from other stocks, and how to analyze them.

Locking in a Smaller Loss

Why people are willing to lock in a loss against inflation, because of bad monetary policy.

Why I Sold the Long End

Great timing.

The Evaluation of Common Stocks

Value investing is still powerful, but the competition is a lot tougher.

The Order of Battle in Financial Planning for Ordinary Folks

The basics of personal finance

Sorting Through the News

How to use my free news screener to cut through the news flow, and eliminate noise.

On Financial Blogging

So why do we spend the time at this?

Matching Assets and Liabilities Personally

How to manage investments to fit your own need for cash in the future.

Penny Wise, Pound Foolish

How short-sighted, incompetent managers destroy value.

Expensive High Yield – II

No such thing as a bad trade , only an early trade… high yield prices moved higher from here.

2012 Financial Report of the US Government

Chronicling the financial promises made by the Federal Government

On Insurance Investing, Part 1

On Insurance Investing, Part 2

On Insurance Investing, Part 3

The first three parts of my 7-part series on how to understand this complex group of sub-industries.

How to Become Super-Rich?

Even Buffett didn’t get super-rich by only investing his own money.  He had to invest the money of others as well.  The super-rich form corporations and grow them; they build institutions bigger than themselves.

The Product that Never saw the Light of Day

On the Variable Annuity product that would simply be a tax scam.  Later I would learn that product exists now, just not in the form I proposed 8 years earlier when it didn’t exist.

Best of the Aleph Blog, Part 23

Before I start this evening, I would like to explain some of the reasons for these “Best of the Aleph Blog” articles.  I write these no closer than one year after an article was written, so that I can have a more dispassionate assessment of how good they were.  I write these for the following reasons:

  • Some people want a quick introduction to the way I think.
  • Some publishers on the web want additional copy, and I let them republish some of my best pieces.
  • One day I may bundle a bunch of them together, rewrite them to improve clarity, and integrate them to create a set of books on different topics.
  • One of my editors at RealMoney once shared with me that I was one of the few authors there whose articles got re-read, or read after a significant time had passed.  This is meant to be mostly “timeless” stuff.
  • New readers might be interested in older stuff.
  • I enjoy re-reading my older pieces, and sometimes it stimulates updates, and new ideas.

Anyway, onto this issue of the “Best of the Aleph Blog.”  These articles appeared between August 2012 and October 2012:

On Credit Scores

Why credit scores are important; make sure you guard yours.

Retail Investors and the Stock Market

On the pathologies of being an amateur investor when there are those who will take advantage of you, and you might sabotage yourself as well.

On the Poway School District

Goes through the details of how a school district outside San Diego mortgaged the future of the next generation who will live there, if any will live there.

Using Investment Advice, Part I

Using Investment Advice, Part II

Using Investment Advice, Part III

Using Investment Advice, Part IV

A series of articles inspired by what I wrote at RealMoney, encouraging people to be careful about listening to advice in the media on stocks, including those recommended by Cramer.

The Future Belongs to Those with Patience

On why patience and discipline are required for good investing.

What Caused the Crisis?

A retrospective, if somewhat controversial.

On the International Business Machines Industrial Average

Replace the DJIA with a new cap-weighted index of the 30 largest capitalization stocks.

How Warren Buffett is Different from Most Investors, Part 1

How Warren Buffett is Different from Most Investors, Part 2

You have to understand Buffett the businessman to understand Buffett the investor.

Volatility Analogy

How an interview I messed up led to an interesting way to explain volatility.

Spot the Gerrymander

Eventually we need to eliminate gerrymandering — hey, maybe we can do that at the future Constitutional Convention.

Reforming Public School Testing

Creating exams where you can’t study for the test; you can only study.

Carrying Capacity

Governments imagine that they can shape outcomes, and in the short-run, they can.  In the long-run, the real productivity of the economy matters, and only those that can make it without government help will make it.  Whatever government policy may try to achieve, eventually the economy reverts to what would happen naturally without incentives.  There is a natural carrying capacity for most activities, and efforts to change that usually fail.

Actuaries Versus Quants

On why Actuaries are much better than Quants

Neoclassical vs Austrian Economics

Applying math to economics has been a loser.  Who has a consistently good macroeconomic model?  No one that I know.  Estimates of future GDP growth and inflation are regularly wrong, and no one calls turning points well.

The Dilemma of Adding Yield

A quick summary of risk in bonds, and why additional yield is often not rewarded.

The Dilemma of Adding Yield, Redux

On working out the pricing between discount, premium, and par bonds.

Too Much Investment

Investment is a good thing, overinvestment is a bad thing.

Got Cash? (Part 2)

On Buffett and others carrying cash to give themselves flexibility.

Set it and Forget it

On what uneducated investors should do.

Forest Fires and Central Banking

Short piece pointing out that small crises are needed to prevent huge crises.

Match Assets and Liabilities

Total Return Versus Long Liabilities

Cash flow matching has often been sneered at as an investment policy.  I explain why such a view is naive, not sophisticated, and definitely wrong.

The Rules, Part XXXIV

“Once something is used for hedging purposes, it becomes useless for predictive purposes.”

Why I LOVE Blogging

On the downsides of blogging, and why they aren’t so bad.

Higher Taxes, Inflation, Default (Choose One)

Coming to a country near you, and soon!

On the Virtue of Hard Questions for Young Analysts

How young analysts toughen up through hard competitions.

Dealing in Fractions of Sense

On how to reform High Frequency Trading

Yield is the Last Refuge of Scoundrels

Far from offering high price appreciation, it is far easier to cheat many people by offering a high yield, because average people look for ways to stretch their limited resources with a tight budget.

The Stock Market Is Rigged! The Stock Market Is Not Rigged!

After the announcement of Michael Lewis new book (which I don’t have a copy of, and I am not asking for one), together with a variety of interviews, he declared that the stock market is rigged.  This is a convenient finding that will gladden the hearts of many who have tried the markets and lost.  The trouble is, there are ways in which the market is rigged, and ways in which it is not.  There are ways to avoid much of the rigging, if are knowledgeable, disciplined and in control of your emotions.

Let’s start with a story.  My oldest son was an intern at a hedge fund that I worked at during a summer of high school.  He sat in with analysts, portfolio managers, and our trader.  He remarked to me, “The trading part seems like a lot of fun.”  I said to him, “Jason is a skilled trader, is good at discerning market conditions, and is able to trade our positions without divulging too much of what we want to do especially when stocks aren’t liquid.”

Another story: When I was a bond manager, and had to trade my portfolio (this is pre-TRACE where actual pricing data was scarce to anyone except the brokers who could see the inter-dealer market prices) realizing that the big brokers knew more than me, the regional brokers did not, and the little specialty brokers knew their niche at most, and nothing else.  I got very good at sniffing out potential trades, to the point where a number of my brokers would run ideas past me.  Most would not fly, a few would.

I learned that I had to be careful what I said and how I said it, because this was a voice-to-voice market, and not electronic.  Markets change when new information arrives.  I remember how delicate I had to be when I owned 35% of an illiquid bond that we liked, and I needed to sell it down without spooking the market.  I did it by telling the potential buyers that I really liked the bond, had no reason to sell it, but that I was a businessman, and would be willing to part with a few (million) bonds at a slightly higher price, more at a higher price, and a significant amount (20% of the issue) at a price that discounted most of the excess value of the bonds.  The bids came in, and I got the significant amount price, and  at a much higher price than had been previously seen for the bonds.

Now if I had done a “market order,” and said to a broker, “Sell half of the block at the current price,” I would have gotten a much lower price.  That would have signaled desperation.

Another thing from voice-to-voice trading, I would tell my brokers what I was doing with the proceeds of a sale.  I did not want them to think I had any special information that they did not have.  ”We need to raise cash to pay benefits.”  ”I see a class of bonds that are really cheap, and I need liquidity to do so.”  When I said those things, they were true, but it was like showing four cards of my poker hand, and hiding the fifth, the most critical card.

Information changes markets.  The reason that I mention bond trading, even though my target is stock trading, is that it was a *far* more rigged market because it was dealer-driven, and voice-to-voice.  It was far easier to lose to more skilled brokers, than trading stocks online today.

Now, Michael Lewis alleges that the market is rigged because there are clever high-frequency traders who trade quickly when they get significant information.  What information?  Market orders.  Market orders scream, “I gotta buy/sell the stock NOW!”  Motivated buyer, motivated seller?  That can change a market, if briefly.

Time for embarrassment.  I learned this one the hard way.  I was doing microcap value 1993-1998, with some significant success, but one day I slipped, and entered a market order for 1x the daily volume of a stock.  The stock’s price doubled before the order was fully filled, and then sank back down to very near where it was before I bought it.  To add insult to injury, the company was eventually a “take-under,” where control shareholders bought it out at a price even below that.

Don’t use market orders.  If people stopped using market orders, much of the advantage of high frequency trading would go away.  Use limit orders, and wait for your price, at the risk of the trade getting away from you in the short run.

Also, use orders that disguise your size and price you are willing to buy/sell at.  Reserve and discretionary orders are useful weapons to disguise your intent.  Also, get a low cost broker that charges commissions on a per share basis, and break up your trades into smaller chunks that are more easily digestible by the market.

But while trading is a large portion of the stock market reason to exist, it does not comprehend the true value of stocks.  There is a saying, and it is true: you don’t make money when you trade; you make money while you wait.

The stock market will not make any more value than the cash flows that get distributed by the businesses comprised there.  Some individuals may prosper from momentum trading, but it is at the expense of other investors, not the company.

The waiting game is not rigged.  As companies make money, and reinvest/distribute it wisely, value is built.  This is Ben Graham’s “weighing machine” versus the trading market’s “voting machine.”  In the short-run, trading dominates.  In the long-run, corporate value generation (or lack thereof) dominates.

Never Bring a Knife to a Gunfight

But there is away that the market is significantly rigged, but it is lodged in human nature, and not lodged in nefarious fellows who pick off little bits of value off market orders (a trifling amount of the value gained for longer-term investors).  Most of the people who believe the market is rigged are those who haven’t studied the market enough and thought it would be easy.  It’s not easy; and if you think that it is easy, you will be skinned.

Much money for less skilled investors gets lost as a result of buying near peaks (greed, or late imitation), and selling near bottoms (fear, or  capital preservation).  If you don’t have skill, far better to buy and hold, with a moderate asset allocation to stocks, thus moderating volatility, and moderating fear and greed in the process.

Have healthy respect for your competition.  Even the best investment organizations know that their edge in the market is limited.  Few pursue every possible advantage; the best understand this is a game where you win by applying your limited advantage where it is strongest, and stay neutral or out where there is no advantage.

Though professionals may be somewhat prone to many of the same pathologies as retail investors, and have the further disadvantage of putting a lot of money to work, still, the professionals apply basic principles day after day, and make the market the hard-to-get-an-advantage place that it is.


So is the market rigged?  It depends who you are.  If you understand your limitations, do your due diligence, and control your emotions, then no, the markets are not rigged.

If you naively presume that you can make money in the markets without adequate study, discipline, experience, etc., eventually the markets will seem rigged.

And if you are a short-term trader, the high frequency traders have eliminated a lot of the low hanging fruit.  The high frequency traders are a reason for even traders to lengthen their time horizons, and use trading tools that disguise their efforts.

For me, the markets are not rigged.  They are highly competitive.  I keep applying my edge, realizing that I don’t know it all, and focusing on investments where my differential knowledge may make a difference.

My summary is this: the markets are not rigged.  They not efficient; we don’t know what that means.  The markets are highly competitive, and that makes them tough.

PS — with thanks to my friend Josh Brown, whose clever piece made me decide to write this.  My conclusion is a little different, but at base I think we agree.

Book Review: Treasure Islands


Tax havens exist to lower taxes and regulations on corporations and wealthy individuals.  But doing this involves significant complicated legal and accounting work.  The average person could not benefit because the fixed costs are high.  You need to have a lot of assets to benefit from tax havens.

So why do the wealthy governments of the world tolerate tax havens?  Why don’t they “use NATO to blockade these places, and tell them to end their tax-avoidance-facilitation policies, or else.”  Sadly, the wealthy have disproportionate power over politicians, and the majority of politicians are wealthy.  They like the system as it is.  You can make the tax code as progressive as you like; you will not end up taxing the intelligent wealthy much more.

This book confronts transfer pricing, where profits get shifted to low-tax countries by clever accountants.  Very difficult to police.

The is an amusing section in the middle of the book about the City of London Corporation, which has unique rights in the UK.  It is the home of most financial activity n London, and is mostly unaccountable to the UK.

In general, I believe that taxation should be the same regardless of the structure of the entity being taxed, its location, etc.  To that end, I think that corporations should be taxed on their global income as expressed to its owners.  Or, don’t tax corporations, but make all taxation like limited partnerships, and tax the individuals that own them.

There are other possible solutions.  There can be limits on corporate structure.  Israel limits subsidiaries such that the depth from the holding company cannot exceed two.  There could be consolidation and/or non-recognition of  subsidiaries in tax havens.

Additional Resources

Longreads article

Book website (those reading at Amazon, come to Aleph Blog to get links)


The book makes its last chapter about how tax havens helped cause the financial crisis, but it makes a very weak case.  Individuals and Banks overlevered themselves as asset prices rose, creating a bubble — not much different than the 1920s.  Tax havens played little role, even if they aided securitization in a few ways.

The book argues for capital controls, but those controls often create incentives for greater corruption.

My main problem with the book is that it does not offer any workable solutions to the problems.  My secondary problem is that the problem is not so much with the tax havens, which we could easily marginalize, but with the politicians, who do not do the hard work of seeing that taxation takes place, regardless of the corporate form or location.

Who would benefit from this book: You have to be willing to endure complex arguments to benefit from this book.  If you want to, you can buy it here: Treasure Islands: Uncovering the Damage of Offshore Banking and Tax Havens.

Full disclosure: I borrowed it at my library.

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.

Sorted Weekly Tweets

Rest of the World


  • Malaysia Plane Traced in Inmarsat Engineer London Huddle How they managed to figure out the area of the crash $$ $SPY Mar 30, 2014
  • UK Pension Revolution Putting Long-Term Bonds at Risk Need 2 match liabs drives demand 4 long bonds, lowers yields $$ Mar 30, 2014
  • Putin Has Exposed NATO’s Weakness US & NATO Europe willing to agree upon? What r they willing 2 risk? Be careful $$ Mar 30, 2014
  • China Said to Expand Property Survey Amid Oversupply Concern Will b difficult 2 end overinvestment by fiat $$ Mar 30, 2014
  • Chinese Pigs Eating Soybeans Cut US Supply to 1965 Low Chinese demand 4 pork drives demand 4 US Soybeans $$ Mar 30, 2014
  • Lira Fate Tied to Real Assets as Hot Money Flees In countries where inflation is a threat, invest in property $$ Mar 30, 2014
  • Business not ipso facto criminal: Tendency of presuming it guilty without proof is damaging India’s economy $$ Mar 30, 2014
  • Mr. Putin’s Revealing Speech Defender of Orthodox civilization as he sees it pushes back against encroahing NATO $$ Mar 30, 2014
  • Russian Forces on Border Stir Concern as Crimea Annexed Threats of more economic sanctions will not deter Putin $$ Mar 23, 2014
  • What the West Can Learn From Putin’s Other Neighbors Don’t make promises that u won’t keep; Putin is not scared $$ Mar 22, 2014


Financial Sector


  • So what is today’s nonbank business model? Legalized extortion done to “protect consumers,” objective is political $$ Mar 30, 2014
  • Wall Street Banks Cut Out of Prized Commercial Mortgages $MET $PRU originate commercial mortgages 2 fund own liabs $$ Mar 30, 2014
  • SEC Is Probing Dealings by Banks and Companies in Loan Securities Current CLO issuance drives loan issuance $$ $BKLN Mar 30, 2014
  • Pimco Chases BlackRock in ETFs as Money Returns to Bonds Amazing how people follow anything w/positive momentum $$ Mar 30, 2014
  • And if banks start lending aggressively, it will b time to radically shrink asset maturities in bond portfolios, velocity will b rising $$ Mar 30, 2014
  • Banks Lending Like It’s 2007 Belied by $10T Hoard But they aren’t lending heavy yet, if they do FOMC has 2tighten $$ Mar 30, 2014
  • Scandal-Hit British Banks Turn to ‘Weirdy Beardy’ ”Why do you exist?” “Who r u?” Pondering existence bugs bankers $$ Mar 30, 2014
  • Josh Rosner: The Wrong Remedy for Fannie and Freddie Better to wind them up & get Govt out of the Mtge mkts $$ Mar 30, 2014
  • Iowa’s Friendlier Watchdogs Lead Insurer Pack to Des Moines Iowa DOI will regret embracing complexity, gtee funds2 $$ Mar 30, 2014


Market Impact


  • Which will win? $BRK.B or $IWM ? 3views: & & BRK will beat smallcaps $$ Mar 30, 2014
  • Americans Can’t Retire When Bill Gross Sees Repression Investments eventually reflect the underlying cash flows $$ Mar 30, 2014
  • Financial scars linger: 1/3 of investors wary of stocks Have 2 wait 4 these people 2 come & put in the top $$ $SPY Mar 30, 2014
  • 1999 Buffett: stocks can’t possibly meet public’s expectations. Internet? Notes how few got rich in auto &aviation $$ Mar 30, 2014
  • Declining Pension Benefits Leave Workers Uneasy Difficult 2 fund high benefits when interest rates r so low $$ $TLT Mar 30, 2014
  • Google Traders See Opportunity in Confusion on New Shares New nonvoting shares may allow 4 some arbitrage plays $$ Mar 30, 2014
  • Attention Suckers: Please Send Us Your Money @Ritholtz comments how the JOBS Act weakened investor protections $$ Mar 30, 2014


US Housing


  • High Prices Partly to Blame for Slow New Home Sales When markets near their peak, frequently volumes drop off $$ $LEN Mar 30, 2014
  • Time might be ripe for boomers to sell their homes and move on Sell them 2whom & @ what price? Lack move-up buyers $$ Mar 30, 2014
  • Finding a House That Won’t Destroy You Buy a house u can afford even under stressed conditions, reduce risk $$ Mar 30, 2014


US Politics, Policy & Economics


  • Florida’s Scott Travels on Corporate Tab as Lobbyists Tag Along Governors increasingly use corporate $$ 2fund trips Mar 30, 2014
  • IRS Takes a Position on Bitcoin: It’s Property Thus any trading of bitcoins involves capital gains &losses $$ $BTCUSD Mar 30, 2014
  • Google, EBay and the Roots of Collusion Some don’t want to annoy companies that r complementary 2their biz goals $$ Mar 30, 2014
  • The Individual Mandate Goes Poof Barack Obama undoes what House GOP would like 2undo, just not permanently totally $$ Mar 30, 2014
  • Global Warming Will Not Cost the Earth, Leaked IPCC Report Admits Will b interesting 2c how gets spun by bothsides $$ Mar 30, 2014
  • Economists: Rising interest rates are the biggest threat to recovery More evidence that rates will stay low $TLT $$ Mar 24, 2014
  • Kocherlakota: Don’t raise rates to head off possible crisis There may come a time when you will have no choice $$ Mar 22, 2014



  • Advice for a Happy Life by Charles Murray Marry young & someone similar 2u, don’t try2get rich, Groundhog Day $$ $SPY Mar 30, 2014
  • Why Runners Can’t Eat Whatever They Want Studies Show Heart Risks to Devil-May-Care Diets—No Matter How Much U Run $$ Mar 30, 2014
  • Speed Reading Returns Apps and Classes Help People Adapt 2Reading on Their Phones | More content 2 read everywhere $$ Mar 30, 2014
  • The book Scientology tried to ban Read about the *real* L. Ron Hubbard, from a book Church of Scientology hates $$ Mar 30, 2014



  • Wrong: Not Voting Should Not Be a Choice Seems fundamental that no one should b forced to vote; it’s a protest $$ Mar 30, 2014
  • Wrong: Japan Is Doomed Unless It Learns to Love Inflation More “hair of the dog that bit you solutions” $$ $JPY $JOF Mar 30, 2014
  • Wrong: Digital v human: the new debate We’ve seen transformational technologies b4, takes a while 4 new jobs 2show $$ Mar 30, 2014
  • Wrong: Fed’s Bullard: Yellen’s ‘6 Months’ Comment Doesn’t Represent Change in Policy Stance Could have fooled me $$ Mar 22, 2014


Notes, Comments, Reples & Retweets

  • RT @ReformedBroker: In November 1999, Buffett wrote this op-ed for Fortune on why he doesn’t bet on innovation. @pmarca @hblodget http://t… Mar 27, 2014
  • RT @felixsalmon: “This means Bitcoins are not fungible, and that makes it unworkable as a currency.” cc @pmarca @bar… Mar 27, 2014
  • RT @journalistjosh: Crowdfunding emptor: Attention Suckers: Please Send Us Your Money via @BloombergView Mar 27, 2014
  • We enjoyed having @susanweiner speak to us at the #CFA Institute – Baltimore; we can all benefit from learning to write more engagingly $$ Mar 26, 2014
  • ‘ @PlanMaestro Yes, I remember that piece and the series that followed it $$ Capital efficient Mar 26, 2014


Classic: Choosing an Insurance Company?

This was published in the “Ask Our Pros” column at RealMoney.  I don’t know when, and I don’t have the actual question, but looking at my answer, I think I know what was asked.

I’ve been cheated in the past by insurance companies.  How can I choose an insurance company that won’t cheat me?

This is a question after my own heart.  I worked in the life insurance business as an actuary for 17 years, serving in almost every area that life insurance companies have.

Life insurance agents and products have a bad reputation in the financial press.  Much of that bad reputation is deserved.  Products are often sold that pay agents well, but do not meet the needs of clients.  Agents influence the flow of information between the company and policyholder, and sometimes tell different stories to each side.

The life insurance industry has tried over the years to control the sales process better, so that only suitable products get sold.  Regulators have demanded it, industry groups want a better reputation, and individual companies have learned that writing bad business is unprofitable.  There are regulatory rules, industry conduct codes, etc.  It is difficult to root out bad apples among agents, which can flit from company to company; companies with bad records tend to get disciplined by the regulators and the courts.

Life insurance and annuities are products that are generally sold, not bought, excluding fancy tax reduction schemes used by high net worth individuals.  Typically, though, they get sold to people who will not plan for their own financial well-being, and would not save, invest, and protect their families on their own.  It is an expensive way to invest, but it is better than not investing at all.

There is a need for agent-sold financial products to help those that will not plan for themselves.  This provides a real service, though never as good as what an intelligent investor would do for himself, if he had the time to research everything out.

Disability and health insurance often get a bad rap over claims payment practices, often deservedly so.  Part of the reason for that is that people don’t want to pay the full price of these products; companies respond with lower priced products and get more hard-nosed about claims.  Part of the research that any person should do about an insurance company is their claims payment practices.  State insurance commissioners keep a record of which companies get complaints, and which do not.  Insurance fraud further pushes up costs, and makes companies scrutinize claims more.  Trial lawyers further push up costs by making medical malpractice expensive through exorbitant tort claims.

Auto and home insurance usually don’t draw the same level of complaints as the above areas.  There are some companies that try to be too sharp about claims practices; this is something to watch out for in any insurance company.  Auto insurance (or the equivalent) is mandatory; mortgage companies require home insurance.  The market is regulated, and usually highly competitive.

Another area of complaint is private mortgage insurance [PMI].  PMI benefits the lender, but is paid for by the homeowner.  The benefit to the homeowner is that he can buy a home, and not make a down payment of at least 20%.  The lenders require PMI when the ratio of the first mortgage to the appraised home value is greater than 80%.  New laws require PMI to go away when the ratio drops below 78%.  Homeowners can petition the lender when the ratio is at 80%.  (The lender will probably require a new appraisal.)

Now all this said, insurance companies have had a lower return on equity in the past 20 years than all other companies on average.  Insurance companies don’t make all that much money.  So where does the money go?  1) Agents.  2) Benefit payments.  3) Home office expenses.  Investment income usually subsidizes insurance companies; they lose money on underwriting on average, and when the pricing cycle is weak, they lose substantial amounts.  Since the inception of health insurance, the insurance industry may have lost money in aggregate.

In Summary:

  • Plan your investment and protection needs yourself, or find a trusted advisor to help you.  Investment knowledge pays its own dividends.
  • Study a company’s claims paying practices before buying.
  • Review expense and surrender charges and other contract terms.
  • Choose an insurance company off its reputation, and not price only.

Classic: Know Your Debt Crises: This Too Shall Pass

The following was published at RealMoney on August 6th, 2007:

Editor’s Summary

The illiquid debt instruments at the heart of the current crisis are subject to regime shifts.

  •  We’re in a periodic repricing of illiquid debt instruments.
  • Look for the time when the bulk of the losses will be reconciled.
  • Stick with the companies that have strong balance sheets.

I appreciated Cramer’s piece Friday morning, which picks up on many themes that I have articulated for the last four years here on RealMoney.  Here are a few:

  • Hedge fund-of-funds demand smooth returns that are higher than that which a moderate quality short-term fixed-income fund can deliver.
  • This leads to the creation of hedge funds that seek yield through arbitrage strategies.
  • And the creation of hedge funds that seek yield through buying risky debts, unlevered.
  • And the creation of hedge funds that seek yield through buying less risky debts, levered.
  • And the creation of hedge funds that seek yield through buying risky debts, levered.

In the short run, yield-seeking strategies work.  If a lot of players pursue them, they work extra-well for a time, as late entrants to the trade push up the returns for early entrants, with greater demand for scarce, illiquid securities with extra yield.  Pricing grids are a necessity for such securities, because the individual securities don’t have liquid secondary markets.  The pressure of demand raises the value not only of the securities being bought, but also of those securities that are like them.  (Smart managers begin to exit then.)

I’ve been through regime shifts in the markets for collateralized debt obligations (CDOs), asset-backed securities (ABS), residential-backed securities (RMBS) and commercial mortgage-backed securities (CMBS).  Something shifts at the back of the chain that forces everything to reprice.  For example:

1989-1994: After the real estate boom of the mid-1980s, many banks, savings & loans and insurance companies get loose in their lending standards and real estate investment, leading to a crisis when rent growth can’t keep up with financing terms; defaults ensue, killing off a great number of S&Ls, some major insurance companies and a passel of medium and small banks.

Late 1991-early 1993: The adjustable-rate mortgage market, fueled by demand from ARM funds, overbids for ARMs in an effort to provide a high floating rate yield.  As the FOMC loosens monetary policy, higher than expected prepayments force losses onto the ARM funds

Late 1993-late 1994: The FOMC threatens to, and does, start raising interest rates, which throws the residential mortgage-backed market into crisis.

Mid-1998-mid-1999: Long Term Capital Management blows up, forcing all manner of exotic ABS, CMBS and RMBS into the market for bids.  The bids back up, until the entire market reprices and then tightens in the space of one year.

1998-1999: Home equity ABS blow up, as defaults threaten to, and then do, emerge at levels far higher than anticipated.  Almost no originators survive.

1999-2001: Cruddy high-yield bonds reveal their true value as defaults threaten to, and then do, emerge.

2002-2003: The manufactured-housing ABS market blows up, as originators don’t take initial losses but roll borrowers over into new loans that reduce payments and extend payment terms, technically keeping the loans current.  The system collapses when the buildup of bad debts and repossessed homes becomes too great to roll over.

(Of the existing large securitization markets, only the CMBS market so far has not faced a real crisis, partly due to the influence of the B-piece buyers cartel: six or so firms that buy the junk-rated debt of deals and enforce credit quality standards on the individual loans by kicking out poorly underwritten loans.  But who knows?  Even that could be overwhelmed under the right circumstances.)

In each of these situations, there was a boom-bust cycle.  The markets did not adjust slowly and evenly to changing conditions; the transitions between “boom” pricing, and “bust” pricing were swift.  This is the nature of markets, particularly when enough debt is employed to amplify the process.

There is no conspiracy necessary to make the shift happen (though often the media will make it seem like there was one); the bubble pops when the financing proves insufficient to carry the assets.  After the bubble pops, it becomes a question of what the underlying assets can be liquidated for, allocating losses mercilessly according to the loan documents and bankruptcy priority.

Today the crises are nonprime lending, leveraged buyouts and other high-yield debt and over-leverage in the CDO market.  These will get worked out, as all other crises do, handing losses to those who speculated unwisely and allowing those who financed properly to prosper on the other side of the crisis.

As you invest, look for the time when more than half of the losses will be reconciled.  That will be near the bottom for homebuilders and housing finance.

That time may not come for another two years or so, but there will be money to be made once the crisis is mostly reconciled.  Just stick with the companies that have strong balance sheets.

Return to Tower Group

A while ago, I wrote a piece on Tower Group after its stock price imploded, before it went down more, and attracted an acquisition offer from entities affiliated with the main owner of AmTrust Financial Services for $3/share.  Here’s another letter, from a different respective reader:

Hello, David:

I’ve been a longtime reader of your columns (back to RealMoney) and have a lot of respect for your opinion as an investor and analyst, particularly your insights into insurance companies.

Merger arb has been a (small) part of my toolkit for the last 15 years but haven’t yet seen an insurance merger quite as complicated as TWGP’s acquisition by ACP Re and AFSI.  With an 8% discount to the offer price and about 4 weeks until the shareholder meeting, this one looks intriguing.

There’s a (wordy) analysis of the deal terms here: .

A couple of specific questions about the deal, if you feel inclined to respond:

1.  Does Karfunkel’s potential conflict of interest in selling the part of TWGP he doesn’t want (commercial, personal) to the publicly traded company he chairs (AFSI) raise enough of a red flag that regulators may intervene?

2.  Are the NOLs owned by TWGP usable by ACP if there is a reverse takeover (TWGP the surviving entity) under Bermuda law?

3.  Does the price at which Karfunkel is selling the pieces to public entities using mostly public shareholders’ money raise any red flags to you?

As I said, I respect and enjoy your work and hopefully you enjoy it enough to continue.

First I will handle the questions.  Then I will hand out a few opinions.

On question 1, the answer is not likely.   The regulators will disallow any situation where an acquisition would significantly impair the ratio of capital to required capital to bear risk [RBC].  Now, shareholders could be another matter.  In this acquisition, two public companies that the Karfunkel families control are buying up the renewal rights to Tower Group Commercial Lines business (AmTrust Financial – AFSI), and Personal Lines business – (National General Holdings Corp - NGHC, which recently went public).

With renewal rights, the AFSI & NGHC acquire the assets and the right to renew existing business at terms mutually acceptable to clients & companies, but they do not acquire anything that pertains to claims from business existing prior to the deal.  In return, they pay money to ACP Re, Karkunkel’s private company owned by his grantor trust.

On question 2, the answer is not likely.  When Argonaut bought out PXRE in a reverse merger, the NOLs were disallowed.  Now, I’m not a tax expert, so maybe someone reeeeally clever can fox their way around this, but to me the answer is no.

On question 3, the answer is I don’t know.  The public companies that he controls have the advantage that they aren’t taking on much risk in a renewal rights transaction.  Whether they are paying the right price or not depends heavily on whether the reserving for claims at the Tower Group entities is overstated or understated.  Prior under-reserving may not have been fully corrected.  With smaller companies near bankruptcy, like Tower Group, there is the risk of death via many cuts.

That brings me to my main insight.  Though there are no financing contingencies to this deal, ACP Re can walk away with no penalty if it merely wants to do so.  If they find a material adverse change, the deal can die, and TWGP will have to pay ACP Re a breakup fee.

Like Fairfax Financial’s offer to buy Blackberry, Prem Watsa had the equivalent of a “free look.”  Tower Group is desperate enough that they gave a “free look” to the Karfunkels and their allied companies.  The deal is not a lock, and a lot depends on what is written when the late 10-K is finally filed.

Why delay the 10-K?  My best guess is trying to get the claim reserves right.  After having to revise reserves twice before, the odds of further revisions are significant.  You have to understand that claim reserves for P&C companies are not a science, particularly for long-tailed lines, and Tower Group was overly aggressive in those lines.

But delay in filing the 10-K is not a positive sign.  If you have confidence in the actuarial analysis of reserves, why delay the filing?  Every other aspect of a P&C insurance company can be calculated within a few weeks of the year’s end.  No mysteries, except for the reserves.

So, if ACP Re concludes that the likely claim payments from the legacy business are likely to be larger than the net amount they are paying for the legacy business ($67 million), ACP Re can walk away, with no breakup fee.  In that scenario Tower Group could head to bankruptcy.

So, when I consider the arbitrage opportunities available by buying Tower Group common stock, I would pass.  As a rule, I don’t short, though I would be tempted to do so here.  Tower Group is a very complex company for its size, and as such, I have less confidence in its financials.  Complexity in financial companies creates inflexibility, which can lead to trouble when regulators deny moving cash from one company to another, which might lead to default on debts.

Avoid this situation, and all of the companies involved.  Buffett has his “Too Hard” pile.  This one is too hard, because no one can know the claims that will be paid from aggressively written legacy business.

Full disclosure: no positions in the companies mentioned



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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