It was late 1993, and I knew that we could make a lot of money if I sold floating-rate Guaranteed Investment Contracts.  Let me quote an earlier piece:

My goal as an actuarial businessman was to make profits with modest risk for my ultimate owners, who were the mutual policyholders.  Once I faced a situation where there might be easy profits — writing floating rate GICs.  So, I went to my models and tried to figure out how we could make money safely while our interest rates would shift every three months.  I came to the conclusion that there was no safe way to do so, and so I walked into the office of my boss and told him so.  He surprised me by supporting my thesis, and in his usual back-of-the-envelope way, explained to me in a few minutes why it had to be so.

A few weeks later, he informed me that an actuary from Goldman Sachs (yes), would be dropping by to tell about one of their new derivative contracts that would enable us to write floating rate GICs profitably.  The meeting day came, and I validated the expectations of my boss.  The year was 1993.  I asked the actuary from Goldman what happens if the yield curve inverts.  He answered honestly, “This strategy blows up when the yield curve inverts.”  Score a small victory for me.  I gave myself points for avoiding trendy bad ideas.  Over the next twelve months, two major insurers and one investment bank would announce billion-dollar blowups from following that strategy.

After the blowups, I went back to the buyers of floating-rate GICs, and asked them if they would accept a lower spread over LIBOR.  The response was a firm “no.”  So much for that market.

Those few players in that market had mispriced the risk.  Is it any surprise that they got a lot of volume?

Here’s another example:

Two years after that, I was at the Society of Actuaries annual meeting, where I met a well-known actuary who had worked inside the corporate actuarial area of the Equitable during the critical years.  I.e., he watched and analyzed the assets and the liabilities as they arose.  The conversation went something like this:

David: What was it like working inside the Equitable during that period of fast growth?

Corporate Actuary: It was amazing.  It took everything we could do to stay on top of it, and still we fell behind.

D: Didn’t you think that perhaps you were offering guaranteed rates that were too attractive?

C: We wondered about it, but with money coming in, everyone felt great about the growth.  We simply had to find ways to productively deploy all of the cash flow.

D: But wait.  Didn’t the investment department have a difficult time investing all of the proceeds?  With that much money coming in, the likelihood of making severe errors would be high.

C: Were you a bug on the wall at our meetings?  Yes, that is exactly what happened.  The money came in faster than we could invest it prudently.

D: Wow.  I thought that was what happened, but it amazes me to hear it confirmed.

They offered free options, and surprise, investors took them up on them.  They couldn’t make enough to fund the promises, and undertook a risky strategy in the late 80s that I called “double or nothing.”  The strategy failed, and they almost went broke, except that AXA bought them, pumped in a little capital, and then the real estate market turned.

What’s my point here?  Twofold: one, rapid growth in financial institutions is rarely a good thing; it usually means that an error has been made.  Two, there is a barrier in many financial decisions, where responsible parties are loath to cry foul until it is way past obvious, because the cost of being wrong is high.

Long Term Capital Management became large relative to the markets that they “arbitraged.”  Anytime you can feel yourself moving the market, it is time to stop.

There was a correlation crisis in the CDO market in 2005.  For those with access to RealMoney, I wrote about it here.  Some quants with clever ideas, much like the current JPM fiasco, thought that they could hedge mezzanine against subordinated.  True when the trade is small, wrong when the trade is big.

Beyond that, we have the brain-dead example of AIG.  They dominated the market for AAA subprime mortgage insurance.  It was free money, until it wasn’t.  If you have a large share of a market where there are no barriers to entry, you should stop and ask why you are the only smart one.

The problem with becoming large relative to the market, is that you begin distorting the price signals of the market.  If you have a large long position and the price starts to fall, it is easy to justify purchases, because your internal model indicates that it is cheap.  But every model has weaknesses, consider the examples listed above.  Anytime you get a large fraction of the market’s volume, you should stop, and re-evaluate.  You’re probably doing something wrong.

Markets by their nature invite diversity, and do not admit anyone to dominate them except under abnormal circumstances.

So, if you find yourself growing large relative to your market, calm down, and re-evaluate your positions, before they get large enough to bite you.

There will be elderly poor.  Look at page 26 of this PDF.  I interpret those that don’t know or declined as being well below $50K in assets.  That means 60% of those reaching “retirement age” will have less than two years income stored up.

That said I feel more sorry for younger workers who have to pay high amounts into Social Security/Medicare, and they will not get out of program what they put in.  There’s a longish article here, excerpting from a recently released book on the topic.  In general, the older you are, the sweeter the deal was for those who received payments from Social Security, at least until 2026 when benefits will be cut by 25%, or taxes raised.

What this means is that in aggregate, Americans don’t save enough, particularly the Baby Boomers, of which I am one, but not a negligent one.

We are heading for elderly poverty/work for a large portion of Americans.  I suspect that many older people will continue to work, solving their problem but taking jobs from those who are younger.

This should be no surprise.  Incomes should be declining for lower skilled people in the US, because there are more people who can do that work abroad.  My advice to all readers is to make sure you cannot be obsoleted by foreigners.

One more note: don’t expect the asset markets to bail you out.  Returns to financial assets will do poorly as so many begin to sell them to pay for living expenses, whether directly as individuals, or indirectly as defined benefit plans pay retirement benefits.

This is on top of the problem that when high-quality long interest rates are so low, it is typically a bad time to try to make money in financial assets, because returns on risky assets are typically only 0-2% percent higher than the yield on long BBB/Baa debt over the long run.

All for now…

May is a tough month for me, because I have to submit reports for the nonprofits that I work with, and this year is worse, because I have a moderate injury that I need  to see a doctor about, but can’t until next week, because of the schedule.

But I do want to say a few things about the JP Morgan news.  First, JP Morgan should be broken up, whether state by state, or by Federal reserve district, with an investment bank spun off as well.

Second, after we have been through 2008, why do we care about a piddling $2Billion+ loss?  JP Morgan’s balance sheet can handle far more than that, and come back kicking.

Third, there are a lot of people who are mindlessly asking for the reinstatement of Glass-Stegall, without realizing that the repeal had little to do with the crisis.  Most of the losses at banks sprang from bad lending on residential mortgages, not trading.  Also, if regulators had been more fastidious about asset quality and leverage, it also might not have happened, but who dares to oppose a boom?

My point of view is that states are better at regulating financials than the federal government.  It is far harder to co-opt 50 regulators than one.

Decentralized government, where power is limited, is far harder to corrupt than centralized governments like India, China, Russia, Greece, etc.

Fourth, when a bank engages in a complex trade, and is a large portion of the market, it is asking for trouble.  Companies have problems when they become the market for financial promises.  Markets work well when there are a large number of players, with no one dominating.  Financial markets with a dominant player have a problem because it becomes difficult for the dominant player to discern the right price.  They don’t want to set it too low, because it makes their own financials look bad.  That skewed incentive can harm economic truth, and the company as well.

Being a monopolist or an oligopolist is not as easy as the textbooks would say, at least for long-term transactions.  When there is no free market to validate your pricing against, how does an oligopolist come up with an economic price?  It can’t do so.

We get on shaky ground when anyone becomes dominant in a market of promises.  Initially the accounting is flexible enough that losses do not occur on bad lending, but eventually the bad/negative net cash flows crush the firm.  This is why I never invest in novel financial companies.

This is a confusing time:

• Lousy fiscal policy — way too much borrowing by the government
• Lousy monetary policy — way too much expansion of the monetary base, and for little good reason, and funding the deficits of the government as a result…
• Negative real interest rates on Treasuries 15 years out; that is financial repression, and that can’t happen without the Treasury and Fed conspiring to do so.
• Low equity market valuations, but only because profit margins are abnormally high.  There are reasons to think that profit margins will not mean-revert this time, because the increase in the global capitalist labor pool is depressing wages.  Wages may remain low for a longer time than many expect.  Sorry to the laborers, but there are more of you than the globe can accommodate.  Thus I remain agnostic on high profit margins; let’s revisit the issue when wage rates rise.

Personally, I think that the fiscal multiplier is negative.  Spend money on government projects, many of which do not build value for the economy, and the economy grows slower or shrinks.

We would do better with austerity.  The economy would grow faster with a balanced budget, and a sense that government was not out of control.  Shrinking the bureaucracy and its rules, would allow the economy to grow faster.  Delegate more responsibilities to the states, particularly regulation of financial companies.  Relatively few insurers fail, which are state-regulated.  Many banks fail, which are federally regulated.  It is far easier to co-opt a single federal regulator than many state regulators.  Best yet, split all of the too big to fail banks into 51 entities, divided into the states and DC.  No more interstate branching — that’s the real problem, not Glass-Steagall.

Limiting banking to states keeps it small, Glass-Steagall tinkers at the edges, but if banks are kept small by limiting their size by states, like insurers, they won’t become systemic problems.  Simple, huh?

Much like the AT&T breakup, I think a breakup of interstate banking would be good for the US economy.  It would unleash competition in financial services, and would eliminate systemic risk in the financial economy.  And once banking regulation is returned to the states, like insurance, we can eliminate the Fed, which has been a poor regulator of banks, and a bad manager of monetary policy.  Go back to a gold standard, or at worst a currency board.  Get money out of the hands of the government, who diverts much of the economics back to themselves.

I appreciate Eddy Elfenbein.  He comes up with ideas that make me say, “Huh. Interesting.  Let’s test that.”  His recent article, World’s Simplest Stock Valuation Measure, put forth the idea that:

Growth Rate/2 + 8 = PE Ratio

Cool, reminds me of my 1993 formula for value investing:

Price per share < Tangible Book per share + 5 * EPS

Eddy’s idea is that you can buy a company that isn’t growing or shrinking earnings at a PE of 8, or alternatively, a E/P (earnings yield) of 12.5%.  In a weird environment like this, it means an earnings yield that is more than 9% over the long bond is a good purchase.  I like that idea, it offers a good reward for taking risk.

But as the growth rate rises, you can expand the PE multiple by half of the anticipated growth rate.  So, a company anticipated to grow at a 10% rate would warrant a PE multiple of 13, a 20% rate 18, etc.  I like his formula, because it is conservative.  It seeks growth at a reasonable price.  It will not overpay for high growth rates.

But now let’s test this statistically to see what validity it presently has.  I ran a regression on Current year expected PEs versus expected 3-5 year growth rates.  I excluded all companies with fewer than two analysts putting forth growth estimates.  Here were the results:

Significant results statistically, but what a low R-squared.  Just shows us all how complex the market really is.  Look at this graph to see it as it is:

There really doesn’t seem to be much of a relationship.  But Eddy’s formula is conservative versus the estimates.  His formula invests in no-growth  companies  at an earnings yield of 12.5%, the market does so at an earnings yield of 8.4%.  His formula increases the PE multiple at a 50% rate as earnings increases, but the market does so at a 69% rate.

Good for Eddy, and any that follow him.  His method builds in a margin of safety, which is a key to all good investing.

Before I close I would like to offer the 20 most mispriced companies, both positively and negatively.  Just be aware that the markets are complex, and this valuation method is simple, and most likely wrong… but it can provide a jumping-off point for due diligence.

Potential Buys

Potential Sells

That’s all for now.

Eurozone

• Danske Bank’s Patience With Moody’s Evaporates http://t.co/eGbf3kV5 Questions over willingness of Denmark to provide support in a crisis. May 11, 2012
• CIC Stops Buying Europe Government Debt on Crisis Concern http://t.co/dljk9Tau Overblown; China will return to funding the Eurozone $$ May 10, 2012
• Greeks May Hold $510 Billion Trump Card in Renegotiation http://t.co/P7U4LSpG Depends on how well Core EZone banks have divested Greece $$ May 10, 2012
• Spanish Banks Erode Creditors With ECB Loans http://t.co/HaEx3bgT Better collateral highly encumbered; Unsec debts implicitly subord 2 ECB May 10, 2012
• Greece Euro-Exit Debate Goes Public http://t.co/0xOgsa7G Core Eurozone wrestles w/how to kick Greece out, even though they can’t. $$ May 10, 2012
• How a Radical Greek Rescue Plan Fell Short http://t.co/Ds0589IG Greece is failing as a culture due2 corruption; no rescue would work $$ May 10, 2012
• Denmark’s Banks Endure Writedown Shock Delaying Recovery http://t.co/A2Vdpymn Good sign on Denmark; take pain early -> in good shape $$ May 10, 2012
• Greek Election Surprise Rejects ‘Barbarism’ of Bailout Austerity http://t.co/oX0nt5SF Growth is magic, magic I tell u! Just invoke it! $$ May 08, 2012
• Merkozy End Means Franco-German Gulf; Greek Voters Rebel http://t.co/iCd0Cs6l Loss of Sarkozy may not b bad, but Greek paralysis will b $$ May 08, 2012
• Francois Hollande has ten weeks to avert a French bond crisis http://t.co/3SEAWJB5 When few adults r in the room the children run wild $$ May 08, 2012
• Challenge to Austerity, And Germany, Is Sharpened http://t.co/BWbgQJ85 The odds have risen that Germany will leave the Eurozone $$ May 08, 2012
• Obvious but it needs 2b said $$ RT @Hawk100Clemens: Mauldin tells #CFA12 every monetary union in history has failed. May 07, 2012
• France faces 40pc house price slump http://t.co/nPuMaVnJ If French banks have trouble now, just wait until the bad mortgage debt hits $$ May 06, 2012

JP Morgan

• What Beached the London Whale? Credit Indices http://t.co/JKFxfaMb Crosshedging long credit risk by buying protection on an index? $$ May 11, 2012
• J.P. Morgan Trades In Its Crown http://t.co/QUJ6hmoA That goes for firms and CEOs as well: $JPM and Jamie Dimon will not get free passes May 11, 2012
• Drew Built 30-Yr JPMorgan Career Embracing Risk http://t.co/uocyyVC1 Lifetime 2build reputation; few years 2destroy it; revealed: 1 day $$ May 11, 2012
• And the best way to reduce risk is to lower leverage & raise cash $$ RT @marydchilds: “The best way to hedge something is to get rid of it.” May 11, 2012

Facebook

• Facebook Co-Founder Saverin Gives Up U.S. Citizenship Before IPO http://t.co/kL1VQYXU Cuts down on the tax bill; discount prior 2 IPO $$ May 11, 2012
• Facebook IPO Said to Get Weaker-Than-Forecast Demand http://t.co/ktK5Bgun $FB faces slowing revenue growth, order books 4 IPO go slack $$ May 11, 2012

Miscellaneous

• Google’s Brin Makes Strides in Hunt for Parkinson’s Cure http://t.co/YvL4LUNA He may get it one day; his Mother already has Parkinson’s $$ May 11, 2012
• And also for those who call vegetables “veggies?” RT @jasonWSJ: Can we impose a $40 fine on dudes who refer to sandwiches as “sammies”? May 10, 2012
• Firefox browser group irked with Microsoft, Windows 8 http://t.co/tBZ9GFuw Only Internet Explorer runs on Windows 8; expect some lawsuits $$ May 10, 2012
• Aluminum Buyers in Japan to Pay Record Fee on Supply Drop http://t.co/7AVU1knI Smelting capacity reduced, China buys more, Japan pays up May 10, 2012
• @RobTheStreet A lot depends on the definition of marriage, Would you allow people to marry inanimate objects, animals, or multiple parties? May 09, 2012
• Brookstone to sell Lilliputian portable power chargers, this year http://t.co/FnSvdfOw Impressive technology if it works. $$ May 08, 2012
• Economy Reshapes Wisconsin Recall Vote http://t.co/G0OetHhV My wife and father were forced in2 unions by collectivist brutes. Go Walker! May 08, 2012
• Father’s Shadow as Transit Leader Hard to Evade for Shuster http://t.co/0FAZUqd4 Bud Shuster is a jerk, forcing us through Breezewood $$ May 08, 2012
• Kellogg’s Kashi Targeted as Web Food Fighting Escalates http://t.co/BNhf5294 We need 2 send a lot of people back 4 science reeducation May 08, 2012

Rest of the World

• Sony, Panasonic Fall to 30-Year Lows as TV Losses Mount http://t.co/Euo37RLQ Sold Panasonic after reviewing uneconomic “green” agenda $$ May 11, 2012
• Kim Jong Un Bashes ‘Pathetic’ North Korea Fun Park http://t.co/gb4S9HBc He should know; he lived outside NK, where there is real fun $$ May 10, 2012
• Sukhoi SuperJet Disappears During Indonesia Demo Flight http://t.co/0JrxAkAw Another sign of degraded Russian abilities in aerospace $$ May 10, 2012
• Bad H/L: Shooting to Kill Pirates Risks Blackwater Moment http://t.co/laW55VEo Correct H/L: Hiring Armed Guards protects cargoes &crews $$ May 10, 2012
• Drug-Defying Germs From India Speed Post-Antibiotic Era http://t.co/XGeno5mf Long. Scariest article of the day; wash your hands w/soap $$ May 08, 2012
• Israel Pyramid Rules Turn Insurers Into Buyout Targets http://t.co/4tXBqehx Interesting:

Israel is limiting holding company levels to 3 $$ May 10, 2012

• UK Pay Protests Oust Aviva Chief http://t.co/WKVdmQGM I remember when they overpaid for Amerus Life in the US; sign of bad management $$ May 10, 2012

Energy

• RT @merrillmatter: @AlephBlog Methinks we’ll need to see some epic blowouts in natgas space (ha ha) before supply/demand can come back i … May 10, 2012
• Chesapeake Deals Carry $1.4 Billion in Undisclosed Liability http://t.co/UFohsseZ $CHK May b worth a look when things stop getting worse May 10, 2012
• When the Exxon way stops working http://t.co/BgN2zLO6 $XOM learns 2b more cooperative w/foreign countries where it wants 2 explore 4 oil $$ May 08, 2012
• Argentina Taps Ex-Schlumberger Executive Galuccio to Run YPF http://t.co/j5P1oyoS Possibly a good choice to run the purloined company $$ May 08, 2012

Fixed Income

• Still time to make money in Treasury bonds http://t.co/ABl43gzM The depressionary bull case 4 long T-bonds; D. Rosenberg & Lacy Hunt $$ May 10, 2012
• Why Emerging Market Corporate Bond ETFs are Hot http://t.co/tWvz0sif High USD yield, but be wary. Laws governing creditor rights vary $$ May 10, 2012
• In other words, the 30-year Tsy sold well today b/c some seek Depression insurance & others hedge convexity or immunize long liabilities $$ May 10, 2012
• Treasuries Pare Losses as Europe Concern Aids Sale http://t.co/C7jytF08 Investors make sure they get income 4 30-yrs & $$ back when old May 10, 2012
• S&P Warns Of $46T Perfect Credit Storm http://t.co/jZTbvy42 If companies have adequate cash flows from operations, this is not an issue. May 10, 2012

Canada

• In Canada, Alternate Currency Keeps Traction With Fans http://t.co/ePyXRH1f Paper Money, Issued by Canadian Tire, Is Popular Way 2Pay $$ May 11, 2012
• Revisit after their housing bubble pops RT @vgmac: There is a lot of love for Canada’s banking system here at the Chicago Fed conferences $$ May 10, 2012
• @vgmac Then again, at the first Treasury/blogger summit I told them they should imitate the Canadian regulators and central bankers. #canada May 10, 2012
• Canada Housing Bubble Concern Shown in Insurer Query http://t.co/kGHcqgDE Should the Canadian govt try2exit the mortgage insurance biz? $$ May 10, 2012
• CMHC Says Capital Levels “Double” OSFI Requirements http://t.co/R4p5TuBO F&F also had capital far higher than their disaster level $$ May 08, 2012

Cisco Systems

• Cisco shares drop on tech spending worries http://t.co/06maBaX4 Global economic weakness feeds into tech firms that sell much abroad $$ May 10, 2012
• @ampressman Cramer said something like, “It’s not a growth company if they have to talk about the economy, weather, industry factors, etc.” May 10, 2012
• @ampressman $AAPL is a growth company, at least for now, $CSCO was a growth company somewhere in the last 15 years… May 10, 2012

Delta Air Lines

• Buy Delta Air Lines: Trainer Refinery Purchase & Improving Financials Will Lift The Stock http://t.co/W7YeEmgb Poorly reasoned thesis $$ May 08, 2012
• Remember when $DD bot Conoco? There would b synergies in petrochemicals. $DD bot it at the peak, spit it out at the bottom $$ #limitscope May 08, 2012
• $DAL substitutes risk in jet fuel pricing 4 risks in crude oil, gasoline, heating oil prices, & operational risk in a biz it doesn’t know $$ May 08, 2012
• @The_Analyst Agreed, though enough capacity has come out of the industry through mergers that they might finally c some pricing power $$ May 08, 2012

US Housing

• 5 Pitfalls of Home Refinancing http://t.co/ZxGUF3HM Longer maturity, Closing costs, Contract terms, Hidden fees, Appraisals $$ May 10, 2012
• Look Who’s Pushing Homeowners Off the Foreclosure Cliff http://t.co/T6CBkUAt Mtge docs exist to protect the lender’s property interest $$ May 08, 2012
• RE: @bloombergview Read any mortgage contract; it exists to protect the rights of lenders, including protecting the m… http://t.co/ob9eIcBt May 08, 2012
• No Repeating Slowdown Seen by U.S. With Banks to Housing http://t.co/A0LNwrjh While hi % of mtges r underwater, finl stress will remain $$ May 08, 2012
• Pimco Housing Bear Kiesel Says It’s Time to Start Buying http://t.co/f3zaBNZA He assumes dark supply will hang on for higher prices. $$ May 06, 2012

US Regulation

• Maybe to be perfectly fair, the government releases the data on a website at midnight ET, long before the US markets … http://t.co/9Zqniljs May 10, 2012
• A Jury of Peers for Broker Disputes http://t.co/5Ly14oKJ The playing field may be more even now; odds r still stacked against investors May 10, 2012
• Congress Seeks Postal Overhaul While Making It Impossible http://t.co/lvcEBxmw The real danger is after reduction, PS is less relevant $$ May 10, 2012
• US Millionaires Told Go Away as Tax Evasion Rule Looms http://t.co/Tx6lr1Bl Fewer foreign banks will accept accts w/US citizens/firms $$ May 10, 2012

Berkshire Hathaway

• Biggest Buffett Targets Seen Spanning Deere to Henkel http://t.co/dLbp9pic Muses about what Buffett would buy 2 eclipse BNSF $$ May 08, 2012
• +1 RT @Kevin_Holloway: Good read on possibilities of recent $BRK.B purchases among some other gd thoughts by @AlephBlog http://t.co/xkN8SlXu May 08, 2012
• Deep in the Insurance Weeds at Berkshire Hathaway http://t.co/GkH9oWBo This helps explain the life reinsurance losses at $BRKB. LTC $$ May 08, 2012
• Buffett understands tech. But he searches for revenue streams that can’t easily be obsoleted. $AAPL & $GOOG could be … http://t.co/VyOnKUTy May 07, 2012

Market Dynamics

• World’s Simplest Stock Valuation Measure http://t.co/OvmQTmHs Growth Rate/2 + 8 = PE Ratio; @eddyelfenbein & his conservative PE formula $$ May 10, 2012
• Dole Food Breakup Seen Bearing Fruit With 58% Return http://t.co/C4SvaNvw Can $DOLE become a high margin biz, & pay down debt? $$ May 10, 2012

Financial Sector

• What about front-running? $$ RT @abnormalreturns: @MebFaber: Nail in the Mutual Fund Coffin (NAV Based ETF Trading) http://t.co/SZ3CbIY3 May 08, 2012
• BTW, for those holding dividend funds, back in 1994, stock managers following a yield strategy got crushed. $$ #annushorribilisforbonds May 08, 2012
• The Dangers of Dividend Funds http://t.co/5WSdEFwN Dividend funds may b safer than other stock funds, r still stock funds w/real risk $$ May 08, 2012
• True 4 many $$ RT @ReformedBroker: “Daddy, what do you do at your job?” http://t.co/mxrcVyhm May 08, 2012
• BofA’s New Black-Belt Data Chief Targets Blinding Gaps http://t.co/P60yhtAk Merger integration didn’t happen in $BAC ‘s IT areas $$ #mess May 08, 2012
• Billion-Dollar Traders Quit Wall Street for Hedge Funds http://t.co/2yFJ2JXr Volcker Rule reducing dealer-driven market liquidity $$ May 08, 2012
• Flash-Crash Story Looks More Like a Fairy Tale http://t.co/0mBQDGKZ Still a mystery; but4any self-feeding panic, players leaning wrong way May 08, 2012
• Almost Half of Finance Graduates Seek New Jobs, PwC Says http://t.co/YUuH9KJl The bubble in financial jobs has popped, decamp 2 other inds May 08, 2012
• “Where is Everybody?” http://t.co/7YPOcMUb Little retail participation is bullish; it means that only the relatively smart $$ is playing May 08, 2012
• 50 Ways to Restore Trust in the Investment Industry http://t.co/VHhllKyp The CFA Institute gathers opinions from members on cleaning up $$ May 08, 2012
• RE: @bloombergview Equity is more expensive than other types of bank capital; raising the cost of capital means fewer… http://t.co/qPvVygll May 07, 2012
• Heat’s on Triparty Repos http://t.co/7Jk7DrTS Fed Is Pressing Big Players to Reduce Exposures to $1.7 Trillion Market $$ May 06, 2012

Company Specific

• How Hewlett-Packard lost its way http://t.co/pA683e3H Very long & ugly article about board & mgmt dysfunction @ $HPQ. FD: +$HPQ 4 me&clients May 08, 2012
• A Real Concern For Apple’s Stock: Telecom Carriers Threaten to Kill Subsidies on Phones http://t.co/JlQwSDAq Interesting thesis $$ May 08, 2012
• AMR Said to Seek More Overseas Flights as Suitor Circles http://t.co/eUHdHju4 $LCC wins more backing, could allow filing another plan $$ May 08, 2012

Politics

• Exodus From Tiburon to Texarkana Is Exaggerated http://t.co/nsyd3QjF Truth is, people & firms r sticky, until they finally get fed up! $$ May 10, 2012
• If we do not discipline ourselves, the bond market will discipline us $$ RT @carney: Why the left will keeping winning. http://t.co/kJcfgEt4 May 08, 2012
• Too bad, we need a better opponent to Obama $$ RT @BloombergNews: Breaking: Santorum Endorses Former Rival Romney as Republican Nominee May 08, 2012
• Don’t Worry (About GDP), Be Happy http://t.co/BaSDMbTM GDP approximates economic growth; more subjective progress measures r ridiculous May 08, 2012
• @justinwolfers Last thing we need on the Fed is another neoclassical Ph. D. economist. Let’s try some brainy generalists, value investors $$ May 07, 2012
• @GaelicTorus @justinwolfers All I am saying is value investors understand how the economy works better than neoclassical economists do $$ May 07, 2012
• Disabled Americans Shrink Size of U.S. Labor Force http://t.co/NX6ZzCjK I still resent former neighbor on SSD, putting Xmas lights on roof May 06, 2012
• But are they ending with an accrual basis surplus, not just a cash surplus? That’s the question. http://t.co/uGa7WX14 May 06, 2012

This book is written by one of the foremost stock investors in emerging markets, Mark Mobius.  This is a short book that has little to no math in it, and few graphs.  It can be read in 2-3 hours.

The edge that this book will give you is understanding the limitations of emerging market investing.  What are those limitations?

1) Emerging markets are volatile, and dependent on the overall health of the developed economies.  Companies in emerging markets often export to the developed nations.  Emerging market governments often gear their monetary policy to aid their exporters, which forces them to absorb the loose or tight monetary policy of the developed nations.

2) Emerging markets often lack legal safeguards on property rights that developed markets take for granted.  Remember that there is a difference between “rule of law” (governments are subject to a constitution), and “rule by law.” (governments make laws to enforce their will on everyone else)

3) Accounting methods may be less well-developed.  Typically this leads to valuation discounts, until the accounting is deemed as trustworthy as in the developed nations.

4) Corporate governance can be weak, with insiders getting significantly more benefits than shareholders.  Getting to know whether the board & management are honest, and acting for the good of all is critical.

5) Frontier emerging markets offer a lot of potential for profit, but they have all of the above problems, and much larger.  When there are few foreign investors in a market, safeguards are few.  Ask who registers the shares, and you may find that no one does, or the company does, so how can you prove you are the owner.

6) As a result, one must insist on a large margin of safety when investing in emerging markets.  That involves a good balance sheet, cheap valuation, and growth potential.

7) Emerging market investing is a hybrid — look at the country, the industry, and the company itself.  To buy, you have to have some confidence in most/all of them.

Opportunities are often best after a large pullback in the nation’s stock index.  Buy the strongest most liquid names after a crisis.  They will come back.

9) Privatizations are often good opportunities to buy; the company will do much better once there is a profit motive.

10) Banks are mirrors of the local economy; they lead the market down and up.  Anything affecting the economy in specific affects the banks, because usually bond markets are not active.

11) To be long emerging market stocks, you have to be an optimist.  It is similar to being a high-yield bond manager.  Investment grade bond managers are paid to be pessimists; there is little to no upside.  High yield managers have some upside that they play for; they are always more optimistic.  So it is for emerging market stock managers — there is a lot of upside to play for , so they have to be optimists.

12) As such, investing in emerging markets takes a lot of work to do it well.  And if you read the book, you might think by the end that you don’t have enough information to do it on your own, and I think you would be right.

Think for a moment about all of the scandals over Chinese reverse mergers with US shell companies — and these are listed in the US!  What hope does a US investor have of investing in emerging markets at a distance?  Accounting differences, disclosure differences, legal rights can be different… it could be a full time job.

This is why you need a manager of an open-end or closed-end mutual fund, or at least an exchange-traded fund [ETF] to invest in.  Mark Mobius explains how difficult it is to do it yourself, without saying that bluntly to you as I am doing.  Personally, I would encourage investing in a broad fund that can go anywhere, and not a country-specific fund, unless you have a very strong view of why a particular market will do well.

I recommend this book so that you can learn, but I think at the end, you won’t do much with it, except buy a mutual fund or an ETF.

Quibbles

This is a “little book.”  As such, you only get a taste.  If you want a full meal from Mr. Mobius, you might get this book: Passport to Profits: Why the Next Investment Windfalls Will be Found Abroad and How to Grab Your Share.

Who would benefit from this book:People who want an introduction to emerging market investing, including the market cycles would benefit from this book.  If you want to, you can buy the book here: The Little Book of Emerging Markets: How To Make Money in the Worlds Fastest Growing Markets (Little Books. Big Profits).

Full disclosure: This book was sent to me without my asking for it.

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

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

I want to call attention to News at Yahoo Finance.  I have used Yahoo Finance for 15 years and have found it valuable.  As time has gone on, Yahoo has added low value news sources like Seeking Alpha, Motley Fool, and Zacks.  These are websites that if I could eliminate them, it would be done already.

News at Yahoo Finance is the best free source of finance news that I know of.  If there is a better source of free finance news, please let me know.

My main gripe with Yahoo Finance is that it allows for considerable customization of the news feed, but excludes certain providers, such as:

• Bloomberg
• CNBC
• CNNMoney.com
• Financial Times
• Fortune
• Fox Business
• Investor’s Business Daily
• Morningstar
• Motley Fool
• Seeking Alpha
• The Daily Ticker
• The Wall Street Journal
• Wall St. Cheat Sheet
• Zacks

I have written Yahoo Finance about this issue three times but have not gotten any help from them.  Maybe they get a lot of revenue from those that I don’t want to see.  If that is true, let them tell shareholders about it, and us as well.

The three entities I would like to block occupy 25% of my news feed.  Yahoo, do you think you can allow me to block them?  It makes reading your news feed a lot harder.

PS — yes, it says you can block Motley Fool, and I have unchecked that box, but I still get them.

This stretches from August 2010 to October 2010:

The Education of a Corporate Bond Manager, Part VII

On the value of credit analysts.

The Education of a Corporate Bond Manager, Part VIII

On price discovery in dealer markets, and auctions gone wrong.  I never knew that I could haggle so well.

The Education of a Corporate Bond Manager, Part IX

On the vagaries of bulge-bracket brokers, and how a good reputation helps on Wall Street.

The Education of a Corporate Bond Manager, Part X

On how we almost did a CDO, and how it fell apart.  Also, how to make money in the bond market when you reach the risk limits.

The Education of a Corporate Bond Manager, Part XI

On my biggest mistakes in managing bonds.  Also, on aggressive life insurance managements.

The Education of a Corporate Bond Manager, Part XII (The End)

On bond technical analysis, and how to deal with a rapidly growing client.   Also, the end of my time as a bond manager, and the parties that came as a result.   Oh, and putting your subordinates first.

Queasing over Quantitative Easing

Queasing over Quantitative Easing, Redux

Queasing over Quantitative Easing, Part III

Queasing over Quantitative Easing, Part IV

Queasing over Quantitative Easing, Part V

Queasing over Quantitative Easing, Part VI

The problems with the Fed’s seemingly “free lunch”strategy.  Pushes up asset prices and commodity prices, benefiting the rich versus the poor.

The Economic Geography of Publicly-Traded Companies in the United States by Sector

The Economic Geography of Publicly-Traded Companies in the United States by Sector (II)

Shows what US states have diversified vs concentrated economies by sector, and what states dominate each sector.

Portfolio Rule One

Industries are under-analyzed, relative to the market on the whole, and relative to individual companies. Spend time trying to find good companies with strong balance sheets in industries with lousy pricing power, and cheap companies in good industries, where the trends are not fully discounted.

Portfolio Rule Two

Purchase equities that are cheap relative to other names in the industry. Depending on the industry, this can mean low P/E, low P/B, low P/S, low P/CFO, low P/FCF, or low EV/EBITDA.

Portfolio Rule Three

Stick with higher quality companies for a given industry.

Portfolio Rule Four

Purchase companies appropriately sized to serve their market niches.

Portfolio Rule Five

Analyze financial statements to avoid companies that misuse generally accepted accounting principles and overstate earnings.

Portfolio Rule Six

Analyze the use of cash flow by management, to avoid companies that invest or buy back their stock when it dilutes value, and purchase those that enhance value through intelligent buybacks and investment.

Portfolio Rule Seven

Of Investment Earnings Assumptions and Century Bonds

If we could turn back the clock 65 or so years and set up a more conservative method of accounting for pension liabilities, we would be much better off today.

Who Dares Oppose a Boom?

This piece won a small prize, and in turn, I received three speaking engagements.

Fairness Versus Economics

Fairness Versus Economics (2)

People care more about fairness than improving their own economic/social position.

Earnings Estimates as a Control Mechanism, Flawed as they are

Earnings Estimates as a Control Mechanism, Flawed as they are, Redux

Earnings estimates have their problems, but they exist to give us a flawed method of estimating the future performance of companies.

-==-=-=-=-=–=-=

That’s all for now.  Never thought I would do so many long series when I started blogging.

Before I start this evening, if you like my reviews generally, please go to Amazon and tell them that my reviews are helpful.  From this link, it does not take long to do so.  Thanks.

This was one of those books that grew on me.  The author, the well-known John Mauldin, strings together a bunch of ideas originated by others.  That’s not much different than what Tadas Viskanta does at Abnormal Returns.  He brings us the best ideas that he has culled from others.  That is a significant piece of work that should not be denigrated by others.

The beginning of the the book is consumed with 12-20 year market cycles.  There are times when investing in risky assets where you face headwinds and tailwinds. The headwinds and tailwinds are driven by valuation, often expressed through Q-ratio, CAPE, or Michael Alexander’s Price-to-Resources ratio, out of which the book makes a lot (link here for an example).  It’s a Price-to-Adjusted Book value ratio as I see it.

Regardless of the method, if you buy in at high valuations, the wind is in your face, and you are not likely to earn much.  The opposite is true for low valuations, but at the valuation trough, everyone is disgusted, and few are willing to buy.

So it takes a strong stomach and mind to follow a method like this.  Strong stomach, because when it is time to buy one will fear that the money will be lost.  Strong mind, because near valuation peaks people will tell you that you are nuts to leave the party — it’s just getting started.

But what if a decent sized portion of institutional money did this?  The cycles would go away, or be muted.  That’s not likely to happen in my opinion: some men may change, but you can’t change mankind.  Emotions of fear and greed dominate over clear thinking.

The book touches on many other topics:

• Why strategies go in and out of favor
• Why to be skeptical of those who give investment advice (including Mauldin & me)
• That the growth rate of the economy eventually limits the growth rate of any company.
• The effect of demographics on the markets
• Why chasing performance doesn’t work.
• Why most newsletter writers strategies could never be as good as they state, or they manage money in tiny niches.
• How to detect value in stocks.
• How to use bonds and commodities in asset allocation.

I say “touches on” because in line with its title, it is a “little book.”  You are only getting a taste of what an intelligent investor who hires other managers to manage money for clients thinks.  This is especially true as you go through the section on value investing, which does not get much beyond dividend yield, dividend growth, and price-to-book (common equity).

As such, this book will not be a complete answer to any investor wanting to learn about the markets.  It introduces basic concepts in ways that most ordinary people could learn.  Reading time should be less than two hours.  One more thing, the book has very little in the way of math.

I appreciated the short summaries at the end of each chapter.  If someone wanted to get the gist of the book, they could read all of the short summaries in about 10 minutes, and then they would have the skeletal ideas of the book, allowing them to read all or part of the book with greater understanding.

Quibbles

The book could have used an index.

Who would benefit from this book:People who want an introduction to investing, including long-term market cycles would benefit from this book.  It would be of modest help to experienced investors who understand market cycles.  If you want to, you can buy the book here: The Little Book of Bull’s Eye Investing: Finding Value, Generating Absolute Returns, and Controlling Risk in Turbulent Markets (Little Books. Big Profits).

Full disclosure: This book was sent to me without my asking for it.

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

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