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The broad market fund was up 85 basis points this week, against a disappointing 25 bp loss for the S&P. My balanced mandates were up 40 basis points, also good. In general, my cyclical and foreign names outperformed.


On the insurance side, Conseco reported that it would be taking some middling charges — the reaction in the stock market was muted. My own estimate of reserve insufficiencies is higher than what they took, so if this cleans it all up, this is a net plus. I’m still waiting to hear back from Conseco IR, so I can’t really tell what is going on yet. From my recent conversation with James Prieur, the CEO, I think the company is on the right track; the only real question is how bad the old long term care [LTC] block is.

Lincoln National increased its buyback today. I appreciate the shareholder-friendly actions of many insurers. Rather than being hyper-competitive, many companies are returning capital in the soft part of the pricing cycle, and that is the right thing to do.

Long LNC CNO

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Insurance stocks are tricky for several reasons. There are probably more unique accounting rules for insurance, then any other industry. Why? The cost of goods sold is not known at the issuance of a policy. Every dollar into an insurance company is equal, but every promise made is not equal. Over time, estimates of cost become more accurate, but with long-tailed lines the progress is often fitful at best.

Life reserving is a science (please ignore the new funky investment derivatives inside some policies). Short-tailed P&C reserving is close to a science. Long-tailed P&C reserving is an art, and a dark art. I’m not sure that even the internal actuaries reserving the long-tailed lines can be that comfortable with the accuracy of the reserves.

This is why it pays to stick with conservative and competent managements that have shown that they can manage the soft part of the cycle. I may miss some speculative gains managing this way, but for the most part, I will miss out on the losses. To give you further insight into my philosophy, here’s a presentation that I gave to the Southeastern Actuaries Club. (I am available for other speaking engagements if I can show my employer a business purpose.)

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  1. The Broad Market Portfolio made 30 basis points yesterday, amid a rally in some cyclicals. Names that worked for me included Tsakos Energy Navigation [TNP], Royal Bank of Scotland [RBSPF], and Lafarge SA [LR]. Industrias Bachoco SA lagged, but after yesterday’s great performance, who can complain? Energy names did okay, but less well than the commodity; this may be part of a correction for the recent energy equity outperformance.

  2. I think Cramer has it wrong on railroad mergers. The great demand in rail is for traffic to go East-West, not North-South. If the antitrust authorities allowed it, it would make sense for Union Pacific and Norfolk Southern to merge, as well as Burlington Northern and CSX. That would offer far more value than what he proposes.

long RBSPF ABN BCS IBA TNP LR

by ·Comments Off on Insurance Notes

1. Hartford increases its buyback authorization by a billion dollars. Well good. Like Allstate, they are oozing free cash flow in this environment, and don’t have as many reinvestment opportunities; they ought to be returning cash to shareholders, but cautiously, buying only on dips.

2. How do you lower personal lines insurance premiums, if you are a state regulator? Oddly, the answer is to not panic and create mandates for insurers in the state, but to allow free entry and exit for the insurers. Premium rate filings should either not be required, or be “file and use.” If a regulator does that, the insurers will trust the regulator, and there will be no lack of insurance companies seeking business in the state. Premium rates will fall.

Immature regulators place demands on insurance companies (leaving aside fraud issues). Mature regulators focus on fraud, and let the market do its work.

Long ALL HIG

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  1. The broad market portfolio was up yesterday against a mixed market. Big movers included:
  • Industrias Bachoco [IBA], which acquired a smaller rival Mexican chicken producer for cash.
  • ABN Amro [ABN], which might break up into smaller pieces. Excellent idea!
  • and Valero Energy [VLO], the largest refiner in the US.
  • Also Cemex [CX] and Grupo Casa Saba [SAB]… the Mexican market is hot.
  1. Howard Simons is one of my favorite columnists over at RealMoney. Yesterday he had a mea culpa over an article he wrote on equity REITs. If Howard needs to do a mea culpa, I guess that I do as well. I’ve thought that they were overvalued for some time, though not enough so to short them. Howard ended his article with, “At some point, the price of REITs will rise to a point where they no longer make sense. We have yet to see firm technical signs of higher prices being rejected, though, so we must conclude the uptrend remains intact for now.”
    I agree that we should honor the momentum; that said, I don’t think there is much farther that equity REITs can run; the yields are at a record low versus the 2-year Treasury yield.

  2. I wish Jim Griffin posted more at RealMoney. I really enjoy his weekly posts. I think he is dead right on his post yesterday where he thought the demise of the carry trade was the biggest global risk. That’s why I am moving my bond positions to lower yielding currencies.

Also, he commented, “Is there a law of conservation of risk? Perhaps there should be, one analogous to the laws of conservation of matter and energy, which Einstein assures us can be neither created nor destroyed. It is pushing the point to declare a scientific law, but, akin to the transference between the states of energy and matter, when risk is seen to be suppressed in the macro economy, it tends to be transferred into financial markets.”

There is such a law. Risk can’t be eliminated from the system, except to the extent that parties for one reason or another naturally want the opposite side of a trade. The best example I can think of is the swap market, where some parties naturally want floating, and others want fixed.

  1. Not to dis James Cramer, but the Fed doesn’t care about mortgage REITs. It only cares about depositary institutions under their purview. If a mortgage REIT goes bust, it just means that a non-bank lender is gone, thus strengthening the Fed’s hold on monetary policy.

Long VLO SAB CX IBA ABN

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I have resisted writing this for some time, but there are certain points in the bond market where yield is poisonous.  I have a rule of thumb that says when spread relationships get too tight, give up yield to gain possible capital gains in the future.  That’s why I made the post at RealMoney late yesterday.  When everyone is grasping for yield, that is the time to avoid it, and aim for capital gains.  That is what I am doing now.

by ·Comments Off on A Modest Proposal Concerning The Satellite Radio Merger

I have a simple solution for what the government should do regarding the Sirius and XM Satellite radio merger. Just have them give up one of the licenses, which the FCC will re-auction.

I can even guess who the likely buyer will be: Google. I can see it now: Google buys it to create the Google Satellite Data Network (using half the bandwidth), while creating satellite radio channels by aggregating terrestrial radio stations that use the web, plus podcast stations. What’s more, it will be free, though one will happily listen to Google’s creative ads. This is a deal where everyone can win, except perhaps the two that are merging. Such a deal!

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I would have loved to have owned Assurant (and several other insurance names, like Prudential and MetLife) over the last several years, but I could not do so because I there are limitations on the stocks that I can own in my personal account. I pick insurance stocks for the hedge funds that I work for. I can’t personally buy if the stock is within 10% of the price that I recommend the funds to buy. I can’t sell until the last share held by the funds is sold.

This has held back performance on my broad market portfolio. Value managers always own financials. So what financials do I own now? Allstate, but I bought it prior to coming to the hedge funds, and ABN Amro, Barclays plc, Royal Bank of Scotland, and Deerfield Triarc. I offered each one to the hedge funds and they passed (excluding Allstate). I’ve made good money on all of them.

I would also add that I would buy HCC Insurance in this environment, though the funds I work for have passed on it. It would be politically ugly for me to get clearance to buy it, but I pass it on to my readers as a well run, high quality insurer trading at a cheap price.

I do have a few other restrictions that I should mention. For the good of the firm that I work for, I can’t mention companies that we are short without permission from the legal area. Also, I don’t mention companies that we own until we have built our initial position. Also, I usually don’t discuss microcaps that we own, but I’m willing to discuss any company that readers bring up, and my firm’s 13F is a matter of record. Finally, for now, I can’t talk about Scottish Re, which was my major mistake in 2006.
Beyond that, I can talk about almost anything. Let’s get the conversation started.Disclosure: the funds that I work for are long Assurant, Prudential, MetLife, and a teensy amount of SCT.  I am presently long DFR, ABN, RBSPF, and BCS.

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Many market commentators, myself included, have been talking about the amazing amount of liquidity in the markets. Caroline Baum wrote a piece recently asking what liquidity really was, and she did not draw any real conclusion, in my opinion. For someone as smart as Caroline Baum to not come to a conclusion, means the concept must be pretty tough.

Last week’s copy of The Economist took another stab at it, and here is the critical quotation:

Helpfully, Martin Barnes, of BCA Research, an economic research firm, has laid out three ways of looking at liquidity. The first has to do with overall monetary conditions: money supply, official interest rates and the price of credit. The second is the state of balance sheets—the share of money, or things that can be exchanged for it in a hurry, in the assets of firms, households and financial institutions. The third, financial-market liquidity, is close to the textbook definition: the ability to buy and sell securities without triggering big changes in prices.

Pretty good, but it could be better. These are correlated phenomena. Times of high liquidity exist when parties are willing to take on fixed commitments for seemingly low rewards. Credit spreads are tight. Credit is growing more rapidly than the monetary base. Banks are willing to lend at relatively low spreads over Treasuries. Same for corporate bond investors. And, if you are trying to generate income by selling options, it almost doesn’t matter what market you are trading. Implied volatilities are low, so you realize less premium, while giving up flexibility (or, liquidity).

The demographics of the developed world favor saving over spending, given the given the graying of the Baby Boomers. Given that the excess credit is heading for the financial markets, and not to the goods markets, we are getting asset price inflation, but not goods price inflation. Spreads tighten, implied volatilities drop, and companies get bought out of the public markets, and get levered up in the private markets. The excess of credit also lowers the costs of carrying assets, which in turn leads to more trading, and bid/ask spreads tighten.

In short, what we are faced with is a situation where there is increasing leverage among market intermediaries in order to earn high returns off of assets with low unlevered returns. This cannot persist indefinitely, and when it reverses, the markets will be ugly. This is why you should insist on high quality stocks and bonds in this market environment. When the willingness to take risk diminishes, the low quality stuff will get killed.

by ·Comments Off on Welcome to The Aleph Blog!

Thanks for coming to the Aleph Blog. This is a work in progress, and suggestions are solicited for both style and content.

The Aleph Blog derives its name in two ways: first, Aleph is the Hebrew equivalent of the Greek Alpha. Alpha is what is desired out of investment managers — outperformance versus a client’s benchmark. I have my methods for doing so that I have described over at RealMoney, and will continue here at my blog. Second is that the Hebrew letter Aleph corresponds to the word for “Ox.” Well, what’s more bullish than an Ox?

I look forward to communicating with my readers, and building this site into something that a lot of people can learn from and enjoy.

Sincerely,

David