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Archive for May, 2008

Book Review: While America Aged

Saturday, May 31st, 2008

Where were you while America aged? ;) I’ve been following the issues in this book written by Roger Lowenstein for over 20 years. As an actuary (but not a pension actuary) and a financial analyst, I have written about the issues involved since 1992.

Roger Lowenstein motivates the issues surrounding pensions by telling three stories, those of General Motors, the New York City Subway, and the City of San Diego. He captures the essence of why we have pension problems in a way that anyone can appreciate. I sum it up this way: promises today, payments far in the future. Get through the present difficulty, at the price of mortgaging the future.

If you repeat that recipe often enough, you get into a tough spot, as GM is in today. Give GM credit though, a lesser firm would have declared bankruptcy long before now, and shed its pension liabilities to the Pension Benefit Guaranty Corporation [PBGC].

Given the softness of funding requirements for pension liabilities, the easy road for corporations and municipalities has been to skimp on funding pensions, leaving a bigger problem for others to solve 10+ years later. As for municipalities, review my recent post here.

Now, why didn’t the US Government insist on stricter funding standards for pension plans? Because of pushback from corporations and municipalities. The US Government hoped that their funding methods for corporations would encourage the creation of pension plans, and that corporations would be good corporate citizens, and not play it to the edge.

As for municipalities, which are not subject to ERISA, as corporations are, the government assumed that they would act in their best long-term interests. Alas, but governments are run by men, not angels.

I found each of the three stories in the book to be interesting and instructive. They are tales of people aiming at short-term results, while letting the future suffer. In the case of the NYC Subways, the plan sponsors finally fought back. With GM, they accomodated until they were nearly dead. With San Diego, they compromised until it cost them their bond rating, and many people involved got sent to jail.

As any good author would, the book offers a few solutions at the end, but it recognizes as I do, that we are pretty late in this game — there are no “good” solutions. There are solutions that may aid future generations. An example is making municipalities subject to the funding requirements of ERISA. I agree, and add that we should apply that to Federal DB [defined benefit] plans, and Social Security too. This could be our own Sovereign wealth fund, investing overseas for the good of US retirees. (What, there is no money available to do that? What a shock.)

I would also add that the funding requirements specified in ERISA are weak. The standards for life insurance reserving are stronger. The weak standards were there to encourage the creation of DB plans. Well, you can encourage creation, but maintenance is another thing.

A certain level of overfunding is need in good times, hopefully, with discipline not to increase benefits. That overfunding is hard to achieve, because the IRS discouraged overfunding above a certain level, because it did not want companies to shelter income from taxation by contributing to the DB pension plans.

Now, I have also reviewed the book Pension Dumping. Which one is better? For the average reader, While America Aged motivates the topic better, but if you want to dig into some of the deeper issues, Pension Dumping does more.

Full disclosure: If you enter Amazon through a link on my site and buy something, I get a small commission. This is my version of the “tip jar.” Thanks to all who support me.

PS — In some ways, the actuarial profession comes out with a black eye in books like this, and I would say that it is deserved. I don’t believe in professions, per se. Self-regulating guilds/industries are a fool’s bargain. There are no guilds/industries where if you can’t explain it to a bunch of average folks, there should be no cause for discipline from society at large. What stinks to me, is that there is no hint of discipline to any of the actuaries, and other third party consultants from the actions that they took to support the actions of politicians and corporations where they bent and broke pension funding rules. The ABCD? What a joke.

A Good Month — A Good Year, so far

Saturday, May 31st, 2008

Of the 35 stocks in my portfolio, only 4 lost money for me in May: Magna International, Group 1 Automotive, Reinsurance Group of America, and Hartford Insurance.  My largest gainer, OfficeMax, paid for all of the losses and then some.

I am only market-weight in energy, so that was not what drove my month.  Almost everything worked in May: company selection, industry selection, etc.  My other big gainers were: Charlotte Russe, Helmerich & Payne, Japan Smaller Capitalization Fund, and Ensco International.  I have often said that I am a singles hitter in investing — this month is a perfect example of that.

Now, looking at the year to date, I am not in double digits yet, but I am getting close — I am only 3.6% below my peak unit value on 7/19/07.  My win/loss ratio is messier: 15 losses against 32 wins.  It takes the top 5 wins to wipe out all of the losses.  The top 5: National Atlantic, Cimarex, Helmerich & Payne, Arkansas Best, and Ensco International.  Energy, Trucking, and a lousy insurance company that undershot late in 2007.

The main losers: Deerfield Triarc (ouch), Valero, Royal Bank of Scotland, Avnet, and Deutsche Bank.

I much prefer talking about my portfolio than individual stock ideas, because I think people are easily misled if you offer a lot of single stock ideas.  I have usually refused to do that here; I am not in the business of touting stocks.  I do like my management methods, though, and I like writing about those ideas.  If I can make my readers to be erudite thinkers about investing; I have done my job.

So, with that, onto the rest of 2007.  I don’t believe in sitting on a lead — I am always trying to do better, so let’s see how I fail or succeed at that in the remainder of 2007.

PS — When I have audited figures, I will be more precise.  You can see my portfolio, for now, at Stockpickr.com.

Full disclosure: long VLO AVT NAHC XEC HP ESV MGA GPI RGA HIG OMX CHIC JOF

Industry Ranks

Saturday, May 31st, 2008

Time for another dose of my industry ranks.  Here’s the list, complete with the ideas that are most attractive for me to investigate:

Remember, this uses the Value Line Industries, and it can be used in Value mode (green industries), or Momo mode (Red industries)  I look to buy from the green list, but I have a tendency to let companies that I own that are on the red list hang around.  Momentum tends to persist in the short run, and I have usually trimmed exposure due to my rebalancing discipline.

My next reshaping is not until early July, but I expect that it will be a doozy, because I will redeploy proceeds from National Atlantic, as well as a new slug of cash that I have received.  I’m running at 12% cash now, but if you count in National Atlantic, it is more like 18%.  That has to come down, so in a month or so, I will have to deploy cash.  I’m looking for a downdraft to do it in, but those don’t always come on schedule.

Full disclosure: long NAHC

Accepting Defeat

Saturday, May 31st, 2008

Part of being a good investor is recognizing when you have lost, so that you can cut your losses, or focus on what can win in the future. Today, I recognize my loss on National Atlantic. Why today? After talking with a friend who knows more than me about appraisal rights in this situation, in New Jersey, in cash deals there are no appraisal rights allowed, unless specifically granted in the corporate charter. Here is an example from a NJ bank deal.

Ugh. It shouldn’t be this way, but it is. Maybe someone with deep pockets could sue NAHC and its board and management, jointly and severally for fraud, but those pockets aren’t mine. So, I look forward to the merger vote. I will vote my 0.15% of the shares “against,” but I realize the NAHC management plus the arbs hold enough shares to win. Personally, I really dislike the disinformation that they have written in their definitive proxy regarding runoff; they paint a scenario that does not ring true with my knowledge of the insurance business.

$6.25/share — It could be worse, right? No, probably not. :(

Full disclosure: long NAHC

A Quick Run Through a few of my Indicators

Friday, May 30th, 2008

After this article, I plan on doing a run through some longer-dated thoughts of mine — I figure when things are relatively quiet, it is time to start thinking about the bigger picture.

Quiet? Are things quiet now? Well, sorta… we still have problems:

  • We still have an oversupply of houses.
  • Investment banks are still overlevered in their swap books.
  • Commercial property prices are beginning to fall, and that will have negative effects on the equityholders, and those who finance them.
  • Though there is no logical replacement for the US Dollar as the global reserve currency, the US is gaming the system, passing inflation through to the rest of the world. Maybe the world doesn’t need a reserve currency. In any case, there are a lot of annoyed central bankers looking to drop their peg to the US dollar at a convenient time that doesn’t hurt their home economies badly.
  • We are still waiting for the junk issuance from 2004-2006 to start defaulting in size.
  • Our retiree healthcare cost crisis is coming in five years, and will last for two decades.
  • The pension crisis comes in the next 5-10 years, and will last for two decades.
  • Most of the demographic crises will cover the developed world.

But as for now, the news flow is light, and nothing is presently cratering. Consider the short-term lending markets:

This graph shows the difference between yields on A2/P2 commercial paper and the 2-year Treasury. What this says is that a BBB company can borrow unsecured for a month at 2.7%. Not bad. Now look at the Treasury-Eurodollar [TED] spread:

Things have improved. The TED spread is down to 0.78%. To me, normal is 60 bp or lower. The question still remains as to what happens when the Fed begins withdrawing its new lending facilities.  As it stands now, they seem to be increasing them further.  (I don’t get it.)

In the midst of this, the Fed has not increased the monetary base in a loosening cycle. The last permanent injection of funds was 5/3/07, long before they started to cut rates. What growth in credit has come from a loosening of the leverage policy toward the banks.

As you can see, we have hit levels of total liabilities of the banking system versus the monetary base of the Federal reserve that we haven’t seen since the early 80s. (I need to multiply that graph by 1000 to show that the multiple is 11x. Oops.)

But, my proxy for bank profitability on new money shows that if you can borrow at 12 month US LIBOR, and lend to fund Fannie Mae 30-year mortgage passthroughs, you can make good money now.

What of Fed funds policy? The market is expecting a 25bp hike in December. I think they are dreaming, but if you are going to bet, you have to know the line.


What of inflation expectations? Above is my 5-years forward 5-year inflation graph. The expectations of inflation are low, at least as far as institutional investors are concerned, even as the measure of inflation underlying TIPS rolls ahead at 4% or so.

At least the yield curve has resumed a normal shape, as noted before, that will be good for the banks in the long run.

Now, since mid-March, global long rates have bottomed.  I use 10-year swap rates here because they are more comparable than government bond rates.  From my viewpoint, this is due to an increase in expected nominal growth for the Gross World Product.  I can’t tell whether that is coming through inflation or real growth, but I am guessing at mainly inflation.

So, after all of this, where do I stand?

  • We still have problems to work through. (See top list above.)
  • The short term lending markets have largely normalized.  So has the yield curve.
  • The economy may not be in recession.  Then again, it is probably close to the line.
  • Long-term implied inflation measures are quiet amid a jump in global inflation measures.
  • Global long rates are rising.
  • If the banks can lend, they can make decent money on new loans.
  • The Fed is still trying to be “too cute,” solving problems through unorthodox means.  Hey, for now it is good, but who can tell what the long term effects will be.  I am still a skeptic here.  Until they unwind the new lending schemes, and return to a clean balance sheet, the game is not over.

One Way to do a Good Survey

Thursday, May 29th, 2008

I get asked to participate in surveys, and frequently, I look at the surveys and think, “You’re wasting everyone’s time here. Some people grade everything harshly, some people grade everything easily. Many people keep their responses within a restricted band, other go for the poles.  Besides, you’re asking too many questions.  Few people have that many strong opinions.”

What I am going to suggest here applies to questions like, “How can we improve our marketing, service, or operations?” I used this technique several times to improve the marketing at an insurance company that I worked for. Here is the core of the idea: if you want to elicit accurate opinions on surveys — use a constraint.

When I survey people, I do a one question initial survey to ask what the issues are that they care about. It is just a brainstorm to identify issues. Then I follow with a one-question survey that lists all of the issues, and then I say: “Pretend you are the marketing director, and that you have a budget of $100,000. How would you divide up the budget?”

Placing a budget constraint on their answers forces respondents to optimize. It also standardizes, so you don’t have to adjust for optimists and pessimists. It’s a very simple question, so answers are sharp. And, if someone feels very strongly about just one item, they can express that. Plus, it values the time of those you are surveying, so they are more willing to answer; you get almost 100% completion.

Anyway, this method has worked well for me. If you try it, and it works well for you, or doesn’t, let me know.

The Dollar and Inflation

Thursday, May 29th, 2008

What can a possible crisis in Vietnam tell us about the US Dollar? Or rumors of currency stress in in nations in the Persian Gulf? That loose US monetary policy is rippling out, and affecting the countries with fixed (or dirty-fixed) exchange rates. These countries face a challenge — float their currencies, or revalue the significantly higher, and send their export economies into the cellar, or, keep importing inflation from the US.

Inflation is a global problem today, and many countries are ignoring it, because in the short run, economic growth is better. Because the US Dollar is the global reserve currency, it can get away with a lot of excess borrowing, given that there aren’t any countries capable of taking the place of the US as the reserve currency, yet.

Going BATS over Yahoo Finance

Thursday, May 29th, 2008

I’ve used Yahoo Finance since 1997, I think.  What a great resource.  Today, they announced the return of free real-time quotes.  Nice, though I went through three phases in my reaction.  The first was, “Yes, the whole real-time market.” The second was, “What, just an ECN?”  The third was, “Okay, they trade 9% of all shares traded… that’s not ideal, but that’s pretty good.”

Now, how could Yahoo improve this?  At present, the ECN real-time quotes are only available on single stock quotes.  Create a view where they can be applied to portfolios, and things gets a lot better.  Let those quotes stream, and you have an amazing service.

An Annual Warning on Annuity Salesmen

Thursday, May 29th, 2008

Beware financial companies that grow rapidly. Beware if you are an investor; beware if you are a consumer; beware if you are a regulator. Fast growth usually means at least one of the following is wrong:

  • The accounting, whether regulatory or GAAP
  • Consumer disclosures

I write this evening, because of this long article from Bloomberg on a division of Aegon, namely, World Financial Group. In this case, I don’t know about any accounting difficulties, but the disclosures to consumers are lacking.

The founder of ICH Corp, once said something to the effect of, “Insurance is a great business. You issue promises, and people send you money.” Thankfully, ICH is no longer among us.

Now, I don’t like the annuity business, and I advise my friends only to buy them if they have maxed out all their other ways of saving on a tax deferred basis. Have you maxed out your 401(k)? Your Roth or non-deductible IRA? If you have, and still want tax deferral, a deferred annuity could be useful. Consider getting one from Vanguard, because the fees from everyone else are dreadfully high.

Beyond that, product design is complex for annuities, and people don’t understand their annuities well. In general, I think that small investors are best served through simplicity, and the various variable and equity-indexed annuities don’t pass that test. Aside from that, the insurance industry uses complexity to hide fees.

Now, I have worked for three aggressive life insurers in my time. They wrote annuities like crazy. I know what the sales culture is like from the inside: very focused on getting a product that is easy to sell, and then selling like mad. I’ve also been on the legal committee at one of those insurers, and it is not fun.

My advice remains — buy what you determine to buy, not what someone is trying to sell you. Call for a “time out” at minimum with salesman, and if he will not assent to that, show him the door. Get your network of intelligent friends together, and analyze it if the salesman is willing to wait.

Buyer beware. Unless you have complex tax-avoidance needs, stick to simple insurance products.

Why Watching Bankruptcies Can Help Stock Performance

Wednesday, May 28th, 2008

This is a bit dated, but bear with me. Last week, Jevic Transportation closed down. It looks like it is liquidating. On the next day, trucking stocks fell as a result. Are things tough in the trucking industry? You bet. Volumes are low, and fuel costs are high.

Now, Jevic wasn’t that big, but if I see a few more large-ish Truckers disappear, I will move to a major overweight in trucking stocks. Why? Pricing power will return to the remaining trucking firms, and after a time, the stocks will rebound. That’s what happened to steel in 2002. I owned Nucor, and did quite well, though, I sold too soon.

When my next reshaping comes up, I will toss some of the highest quality trucking stocks into the mix. The idea is that if the industry weakens further, they will remain among the survivors, but if pricing power comes back, I will make more than adequate profits.

-==–=-=-==-=-=–==-=-

Now, if you have read me for a while, you know I like to rotate sectors within a value discipline. I do well at it. But who is the best of them all? Ken Heebner. Now, that’s a guy I would love to learn from. I deliberately don’t let sector rotation become the whole strategy because I am trying to limit risk. I also don’t trade like a maniac, because I can’t do that well. But I do more than adequately, and all of us could learn from the expertise of Ken Heebner. Unlike Peter Lynch, who was totally bottoms up, there are real advantages that come through analyzing the economy, particularly individual industries. But, if most investors ignore economics, or, if they only focus on broad macroeconomics, that’s fine with me. I will focus on the economics of industries, and that will help me invest well.

Disclaimer


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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