Deerfield Triarc Revisited

Deerfield Triarc Revisited

I am basically at breakeven, and above my tough rebalancing buy in August.?? I bought lower as well.? My view is that Deerfield returns to book value ($13) or above, because the market for prime and AAA whole-loan mortgage backed securities is improving.

It would not surprise me to hear that repo margins return to prior levels, which would benefit Deerfield Triarc.? The market for low risk mortgage collateral has returned.

There is disagreement over whether the merger with the asset manager is a good thing or not.? I favor the merger, because I think CDOs have a future.? That said, if it happens or not, I won’t be harmed much.


My view is this: at 73% of book, there is significant value to obtain here.? The company is not going broke.? I will only sell my full stake when the company trades over book.

Full disclosure: long DFR

Cut-throat Anagrams

Cut-throat Anagrams

A dear friend of mine introduced me to this game, which I play with my kids every now and then. All you need is a set of Scrabble tiles. You place all of the tiles face down, and swirl them around. The dealer (ordinarily the best player, so it distracts him), flips one tile at a time. When enough tiles are flipped to create a word of at least three letters, the first player to name the word claims it, and takes it for himself.


Play continues, with more tiles flipped, but there are two choices now for the tiles that are face up. You can use the tiles to create new words, or combine them with existing words of yours, or words of your opponents. Suppose your opponent has the word “ham,” and there are an “s” and an “e” on the board. The player that calls out “shame” claims the tiles from “ham” and creates the word “shame” in his field. Stealing the words of opponents is often more effective than creating new words, though there is a balance to be maintained. It is also wise to boost the letters in your own words, which makes them harder to steal. Additional note: the letter orders can be rearranged. If “gun” and “one” have been claimed by players, and there is a “d” on the board, a player could take the two words for the word “dungeon.”

Play ends two minutes after the last tile is flipped. Additional rules:

  • No proper nouns
  • No foreign words, unless they are in common use in English discourse.
  • Appeal to an unabridged dictionary is permitted for words in dispute.
  • Blanks are wild cards, but the first time a blank is played, it stays that letter for the remainder of the game.


Scoring: each word gets points equal to the number of letters minus two.

Benefits of the game: children learn to think along multiple lines of strategy and structure words in ways that they don’t commonly consider. It is a real mind-stretcher. An aside: this is a game where speed of thought helps but is not determinative. Having a large vocabulary helps, which benefits the grownups.

Nine Points on the International Scene

Nine Points on the International Scene

1) In an open economy, you can control your exchange rate or your interest rates, but not both.? The first time I learned that was late 1986, when the Dollar crashed, then the bond market crashed (May 1987), then the stock market crashed(October 1987).? This article from Morgan Stanley goes over the same idea.? Pay attention to the investment? implications at the end, though Hong Kong may have already rallied enough.

For a more bearish view, many Asian economies are facing the choice of slowing their economies, or importing inflation from the US. My sense is that we are in an uptrend for inflation globally.? Few central banks are truly pursuing sound currencies.

2)? Europe is no monolith here.? Managing the ECB is some trick, because money is political, and there is monetary union without political union.? The Swiss Central Bank continues to tighten, while the Bank of England effectively loosens, because of the recent panic there, involving Northern Rock.

3) One of my favorite observations about technical analysis is that slow moves tend to persist, while fast moves tend to mean-revert.? Well, the US dollar is having a grinding, slow adjustment downward. ? To me, that is just another indicator that the decline will persist.

4) Will the Saudis drop the dollar peg?? Maybe.? Given the current inflation rate there, I would suspect that they, and other Persian Gulf nations, will move to a currency basket approach that has a high US Dollar weighting.? That will allow themselves the flexibility to make further adjustments that allows them to arrest inflation.? That will lead to further declines in the dollar against other currencies.

5) What makes a currency attractive?? GDP growth and high real (inflation-adjusted) interest rates.? The US has neither of those now.

6) An old dear friend of mine, Roy Hallowell, had two merciful rules: a) We all make mistakes.? We ALL make mistakes. b) Most of them are like the rest of them.? Such is Goldman Sachs Global Alpha.? They played too much on the carry trade and got burned, among other bad trades.

7) I am not a bear on emerging markets as a group.? There are some running bad monetary and fiscal policies that I would avoid (Latvia, Iceland, Bulgaria, Turkey, and Romania are examples).? But in general, many of the emerging markets are not dependent on US conditions to the same degree that they were before.? Many are in better shape to face volatility than the US.


8)? Given the fall in the implied volatility of the yen, the yen carry trade is coming back.? The carry trade works best when implied volatilities are low, because the cost of protection against adverse moves is modest.? But, if low interest currencies persist in tightening, the carry trade could be a bad bet.? My thought : Japan is not tightening anytime soon, and? the carry trade continues there.? Switzerland goes the other way.

9) China is different.? So what’s happening?

That’s all on this topic for now.

Ten Notes on Our Funky Federal Reserve

Ten Notes on Our Funky Federal Reserve

1) Fed chatter has gotten a little quieter, so maybe it is time for an update.? Let me begin by saying in an era of detailed press releases from the Fed, many analysts spend more time parsing phrases than looking at the quantitative guts of monetary policy.? This article from Mish, which cites this article from Gary North is close to my views, in that they are looking at what is happening to the critical variables of the money supply.

 

2) For another example, Look at the discount window.? That has faded as a factor over the past two weeks.? You have to dig into Dow Jones Newswires just to hear about this.? The discount window is back to being a non-entity.

 

3) Review his book.? Cite his article.? Though I think the FOMC will loosen more, I agree that it should not be loosening.? The Fed will overstimulate healthy areas of the economy, while sick areas get little additional credit; that’s how fiat monetary policy works.? (Maybe I should review James Grant’s The Trouble With Prosperity?)

 

4)? I may not vote for him, but I like Ron Paul.? He is one of the few economically literate members of Congress. Thus I enjoyed his question to Ben Bernanke.? I favor a sound dollar, and risk in our system.? It keeps us honest.? Without that, risk taking gets out of control.

 

5) Now, onto the chattering Fed Governors.? Consider Donald Kohn, a genuinely bright guy trying to spin the idea that the Fed is not to blame for residential real estate speculation.? He argues that much of the speculation occurred while the FOMC was tightening.? Sorry, but the speculation only cut of when the FOMC got rates above a threshold that deterred speculation because positive carry from borrowing to buy real estate disappeared, which finally happened in September of 2005, when the FOMC was still tightening.

 

Or, consider Fed Governor Frederic Mishkin, who thinks that troubles in the economy from housing can be ameliorated by proactive FOMC policy.? If his view is dominating the Fed, then my prediction of 3% fed funds sometime in 2008 is reasonable.

 

But no review of Fed Governor chatter would be complete without the obligatory, “Don’t expect more rate cuts.”? They don’t want their policy moves to be impotent, so they verbally lean against what they are planning on doing.? This maximizes surprise, which adds punch to policy moves.

 

6)? Consider foreign central banks for a moment.? I’ll probably write more about this tomorrow, but a loosening Fed presents them with a problem.? Do they let their currencies appreciate, slowing economic growth, or do they import inflation from the US by cutting rates in tandem?? Tough decision, but I would take the growth slowdown.

 

7) What central bank has had a rougher time than the Fed?? The Bank of England.? When push came to shove, they indicated that they would bail out a large portion of the UK banking system.? Northern Rock financed a large part of their assets via the Bank of England during their crisis.? This just sets up the system for greater moral hazard in the future.

 

8) Now the CP market is returning to health; almost all of the questionable CP has been refinanced by other means.? Now, money market funds are better off than they were one month ago, but all of the issues are not through yet.? Some money market funds contain commercial paper financing subprime CDOs.? Now, the odds are that the big fund sponsors would never let the ir funds break the buck.? They would eat the loss.? That’s not a certainty though so be aware.

 

9) This article is the one place where the Fed lists most of the Large Complex Banking Organizations [LCBOs — pages 32-33].? Some suggest that this is the “too big to fail list,” though by now, it is quite dated.? On the bright side, it correlates highly with asset size, so maybe a list of the 20 largest bank holding companies in the US would serve as well.

 

10) We end with Goodhart’s Law, which states that “any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes.”? My way of saying it is that trying to control a system changes the system.? The application here is that when the Fed tries to affect the shape of the yield curve by FOMC policy, it eventually stops working.

Book Review: Active Value Investing

Book Review: Active Value Investing

Book: Active Value InvestingA note before I begin. When I do book reviews at this website, I have read the whole thing, even if I might skim some sections. In this case, I read all of it without skimming. It is a very good book on value investing. His objective is to teach you how to make money in range bound markets. Now I hadn’t thought of value investing in that way before, but it makes sense to me. If the average dollar invested in the stock market isn’t going anywhere, how can you make money? It was easy from 1982 to 2000, but what about relatively stale periods like the last seven years? During periods like that, security selection is paramount, as is willingness to adjust your portfolio to accommodate new cheap areas of the market.


He has a three part system for stock evaluation — Quality, Valuation, and Growth. He spends most of his effort on valuation, and provides the reader with a detailed and disciplined way of coming up with what P/E a stock deserves. I am not going to adopt it for myself; I already have my own methods, but someone looking for a rigorous way to value public companies could do worse than the author’s methods. (Note: this is not a full endorsement of his valuation methodology. I’d have to do a lot more work to get there. It’s credible and reasonable; it looks fair, but requires the user to make relative judgments about the character of the company being analyzed.) The methods require thought and work, but none of the formulas require anything more than grade school math, unless you want to try discounted cash flow analysis.


Other key concepts get covered in the book as well: margin of safety (and how to calculate it), buy discipline, sell discipline, contrarianism, and diversification (not too little, not too much). The idea is to not lose much when an idea goes wrong, and make money when the price of an undervalued stock returns to fair value, and sometimes overshoots it. His view on risk is similar to mine: don’t overdiversify, buy quality companies trading at a discount, sell them when they are fairly valued, or when the deteriorating fundamentals no longer justify the price. His view on international investing is similar to mine: go anywhere, but be aware of the risks.


On the whole, I found his methods to be similar to mine. Here are the differences:

  1. His portfolio is more concentrated than mine. 20 stocks vs 35.
  2. I have a more explicit rebalancing strategy.
  3. He focuses more on growth than I do… maybe I could learn something there.
  4. I spend more time on industry selection and pricing power.
  5. I don’t use P/E as my primary metric.
  6. I spend more time looking for ideas that are better than my current portfolio, and doing explicit swap transactions to keep my portfolio focused on value.
  7. I may be wrong here, but I think I spend more time on accounting and free cash flow issues.


That said, I like Vitaliy Katsenelson’s processes and can heartily recommend this book to my readers. His book is a fine addition to the world of value investing. If you want to buy it, you may do so below. Full disclosure: I get a small cut of the proceeds from Amazon if you use the link below.

Oh, and here is the book’s website.