July 2012 – Page 3 – The Aleph Blog

New Highs, New Lows, Yield Greed

Posted on 12 July 201212 July 2012 by David Merkel

When I read this post by Ivan Hoff, I decided to look at the new high and new lows lists, which I never do now, but used to do regularly back in the days when I read a paper Wall Street Journal every day.? Now our philosophies for doing so differ.? He is looking for buy high, sell higher, and I am looking for misunderstood companies that are first safe, then cheap.

So after the close, I copied the new highs and new lows for the NYSE, NASDAQ, and Amex as a group.? There were 203 highs and 89 lows.

But then I noticed something funny: a large number (53) of the new highs came from preferred stock, hybrid debt, and bonds — yieldy stuff.? With the lows, there was some weird stuff, but 7 companies had rights and warrants, hitting new lows, and one new muni bond fund, NKGD, which was just noise.

Then I looked at the industries that they were in, mostly to separate out the ETPs and CEFs from everything else.? Here are the tables:

New Highs

	Values
Row Labels	Sum of mktcap	Count of ticker
0715 – Insurance (Property & Casualty)	205,242	2
0524 – Tobacco	97,162	2
0803 – Biotechnology & Drugs	62,010	8
0521 – Personal & Household Products	40,837	2
0963 – Retail (Specialty Non-Apparel)	38,396	1
1203 – Electric Utilities	20,944	7
0515 – Food Processing	17,571	1
0721 – Misc. Financial Services	15,158	57
0115 – Forestry & Wood Products	11,980	1
0727 – Regional Banks	6,434	22
0806 – Healthcare Facilities	5,358	3
1209 – Water Utilities	4,356	2
1106 – Airline	3,595	2
1206 – Natural Gas Utilities	3,363	2
0812 – Medical Equipment & Supplies	3,209	4
0957 – Retail (Grocery)	2,472	3
0951 – Retail (Department & Discount)	2,356	1
1018 – Computer Services	2,039	1
1024 – Electronic Instruments & Controls	1,790	1
0612 – Oil Well Services & Equipment	1,335	1
0730 – S&Ls/Savings Banks	1,290	9
0915 – Communications Services	1,007	2
1036 – Software & Programming	832	2
0718 – Investment Services	548	2
0209 – Construction – Supplies and Fixtures	494	2
0712 – Insurance (Miscellaneous)	347	1
0942 – Restaurants	333	1
0703 – Consumer Financial Services	322	2
1033 – Semiconductors	316	1
0421 – Furniture & Fixtures	120	1
0909 – Business Services	33	1
1003 – Communications Equipment	31	1
0133 – Paper & Paper Products	17	1
0912 – Casinos & Gaming	0	1
Grand Total	551,295	150

Exclude Misc Fin Svcs	536,137	93

New Lows

	Values
Row Labels	Sum of mktcap	Count of ticker
0118 – Gold & Silver	41,488	9
1036 – Software & Programming	16,268	7
1003 – Communications Equipment	14,856	7
0515 – Food Processing	12,732	2
1033 – Semiconductors	10,351	2
1109 – Misc. Transportation	8,131	1
0206 – Construction & Agricultural Machinery	5,849	1
0948 – Retail (Catalog & Mail Order)	5,451	1
0951 – Retail (Department & Discount)	4,837	1
0603 – Coal	4,479	2
0424 – Jewelry & Silverware	4,243	1
0103 – Chemical Manufacturing	3,933	3
0203 – Aerospace and Defense	2,995	1
1018 – Computer Services	2,851	3
0218 – Misc. Capital Goods	2,300	2
0924 – Personal Services	2,292	1
0927 – Printing & Publishing	2,043	1
0124 – Metal Mining	2,024	2
0721 – Misc. Financial Services	1,903	2
0215 – Construction Services	1,802	1
0939 – Rental & Leasing	1,760	1
0915 – Communications Services	1,616	1
0418 – Footwear	1,439	1
1024 – Electronic Instruments & Controls	1,384	2
0909 – Business Services	1,223	1
0812 – Medical Equipment & Supplies	1,077	5
0612 – Oil Well Services & Equipment	1,075	1
0918 – Hotels & Motels	937	1
0969 – Schools	836	1
0609 – Oil & Gas Operations	820	1
0933 – Real Estate Operations	731	1
0415 – Auto & Truck Parts	703	2
0127 – Misc. Fabricated Products	693	2
1021 – Computer Storage Devices	512	2
0966 – Retail (Technology)	418	1
0703 – Consumer Financial Services	195	1
0806 – Healthcare Facilities	64	1
0727 – Regional Banks	61	1
0803 – Biotechnology & Drugs	54	2
0930 – Printing Services	6	1
0942 – Restaurants	5	1
0421 – Furniture & Fixtures	4	1
Grand Total	166,437	81

Exclude Misc Fin Svcs	164,534	79

By the time you are done separating out the passive vehicles, because one is miscategorized in the new highs, you have for regular stocks 92 highs versus 79 lows.? The market cap spread favors the highs because of Berkshire Hathaway, Altria, Amgen, Target, Kimberly Clark, Reynolds American, and H.J. Heinz.? The only large company among the lows was Barrick Gold.

I should add that all of the ETPs and CEFs making new highs were all fixed income funds.? ALL!

Then I looked at the yields of the common stocks that were making new highs and new lows.? For new highs, 35 out of 92 (38%) have yields over 2%.? For new lows, 10 out of 79 (13%) have yields over 2%.

This is a market that is driven by yield and safety/non-cyclicality.? The new highs are predominantly in stable industries, and the new lows in cyclical industries.

I’ve said it before, but I’ll say it again, yield is not real.? It is a residual of a larger economic process.? If you own a bond, preferred stock, or common stock that pays dividends, your future well-being relies on the economic success of that company.? With stocks, that connection is direct, with bonds it means avoiding default.? Other securities face similar limits.? Yields cease to exist when companies fail; chasing yield as a main strategy will fail, because fund shareholders will give up during the hard times when capital gets marked down, and sell.

Though the portfolio that I manage for clients has an above average dividend yield, I do not look for dividend yields; I look for solid companies, and the dividend yields find me.? (Buybacks too.)? I do not reach for yield.? There are many investors that are reaching for yield in this environment, and I think they will eventually get burned.

So be wary over yield.? It may not pop for a year or two; it might pop tomorrow.? I identify risks, and risks typically don’t come with dates.? Just be wary.? When everyone is scrambling for yield, it is probably best to not aim for a yieldy portfolio.

PS — note all the banks and S&Ls on the new highs list, and they are almost all small firms.

Full Disclosure: long AMGN

Finding Meaningful Work in a Complex World

Posted on 10 July 2012 by David Merkel

This post isn’t for everyone.? My target is mostly college students, and parents with children who are getting close to adulthood.? Others may benefit from it, because we all have younger friends that we want to help.

What to study in college?? Do I even need college? What sort of job should I work for, or what kind of business should I create?? These are big questions, but I want you to view them through a different lens: where are there needs?? What can I do to solve the needs of others, that people/institutions would be willing to pay for?? Then: which of those things would I enjoy doing?

The last question is the least important.? Yes, we all want to do something we think is cool.? “Do what you love, and you will never work a day in your life.”? That’s nice work if you can get it, but often there is no one to pay for what you love.? Some will be creative and create their own gig.? That’s rare for most people, but is worth pursuing if you are finding paid demand for the human needs that you meet.

Some needs are simple, like public order.? I have one child who wants to be a policeman, and is presently a favorite of his advisors in the local police explorer post.? He has a well-defined path to a career he will like; an associates’ degree will help him, and later a bachelor’s degree if needed.

Other needs are more complex, like education.? Kids will always need to be educated.? I have one child who can take a room full of small children and make them behave; she has the “knack.”? You can’t teach the “knack.”? Maybe you can develop it if you are the oldest of eight kids.? Even with lesser intellectual gifts, she will be a more effective teacher because education with young kids requires classroom control more than brilliance.? (As an aside, if we want to reform the schools, my solution is to end teacher credentialing.? What teachers get taught in college positively harms their ability to educate.? After that, we need to move back to a basic curriculum and avoid fads.? Where I live, parents are pulling their kids out of the public schools for private and home schooling, because of fads that try to impose a pedagogy that does not work.? As I sometimes say, “It is dangerous to have unaccountable idealists in important positions.”)

I have another child pursuing biochemistry.? Seems to be a real growth area, with a lot of applications.? Bright kid, will go far.

Then I have two ninth graders.? One is interested in industrial work using computers; that’s promising growth area.? The other wants to be my assistant one day and is reading basic books on investing, and asks me questions.

Enough about my family — I think it is wise for young people to consider the needs/desires of others first when they are looking at their life’s work.? Perhaps the summary question should be: “What do other people need that I would like to do?”? “Do I need more training to do that?”? And for parents, spend time with your kids describing occupations, telling them what other people do.

It’s a complex world, and it is likely to get more complex — the division of labor is widening, not shrinking across nations.? On the bright side, this reduces the probability of war.? As business interests get spread over multiple nations, the politics of war get messy.

Let me summarize it this way: the concept of “follow your bliss” is inherently selfish, and there is no reason why it should be rewarded.? But the idea of meeting the needs of others is significant and good.? It is humble, and would that more of us brought humility to our callings.

Value comes through serving others. That is a humble route to prosperity.

My Two Cents on Two Promoted Penny Stocks

Posted on 10 July 2012 by David Merkel

Via Tadas Viskanta of Abnormal Returns, Zestinvest.com approached me regarding and intriguing promoted stock, Implant Sciences [IMSC].? Read his article, he will say more about it than I will.

From my angle, this is another low revenue, negative net worth, negative earnings stock, which I think every sane investor should avoid.? But there are a few interesting aspects to the scam:

There is the outside possibility that their services will be bought by an arm of the US Government, in an effort against terrorism.
It is being touted by Gene Marcial at Forbes, and at other blogs of his.? Gene Marcial has a financial interest in CPreports.com, which gets paid to publish favorable research on companies.
It is being touted by Ray Dirks, which disappoints me.? I always thought better of him, given his early contest regarding insider trading? in the Equities Funding scandal, which he successfully contested to the Supreme Court.? (And as a kid of 13, I sent away for his research on low P/E stocks!? What a guy! Maybe.)

This is a company that is likely to be taken over by its lender in three months, leaving the equity with zero, or nearly that.? The company is so deep in debt that I suspect their lenders will not get paid in full either.

-==–=-==–=-=-=–=-=-=-=-=-==-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-

Onto my second promoted penny stock, Luxeyard.? Wait, first the promoted penny stock scorecard:

Ticker	Date of Article	Price @ Article	Price @ 7/9/12	Decline
GTXO	5/27/2008	2.45	0.03	-98.78%
BONZ	10/22/2009	0.35	0.0171	-95.11%
BONU	10/22/2009	0.89	0.065	-92.70%
UTOG	3/30/2011	1.55	0.07	-95.48%
OBJE	4/29/2011	2.9	0.045	-98.45%
LSTG	10/5/2011	1.12	0.152	-86.43%
AERN	10/5/2011	0.077	0.0011	-98.57%
IRYS	3/15/2012	0.261	0.13	-50.19%
NVMN	3/22/2012	1.47	1.46	-0.68%
STVF	3/28/2012	3.24	0.435	-86.57%
CRCL	5/1/2012	2.22	0.67	-69.82%
ORYN	5/30/2012	0.93	0.6	-35.48%
BRFH	5/30/2012	1.16	0.57	-50.86%
LUXR	6/12/2012	1.59	0.35	-77.99%

Aside from very deep out-of-the-money options, I can’t think of anything that does so badly.? Back to Luxeyard.? How did it lose 78% in less then a month?? Go back to my original post:

NBT Equities Research and/or its publisher, ChangeWave, Inc., dba NBT Communications has received $35,000 and been pledged 75,000 shares of rule 144 common shares in LuxeYard to assist in the writing of this advertisement.

Next Media LLC paid $1,500,000 to marketing vendors to pay for all the costs of creating and distributing this report, including printing and postage, in an effort to build investor awareness.

Next Media LLC was paid by non-affiliate shareholders who fully intend to sell their shares into this advertising campaign.

Duuuuuhhhh.? They have plainly told you that they will fleece you.? Few are so bald in their designs.? Why didn’t you listen?? This offering more than doubles the float, on a company that is worthless anyway.? This is just a way for insiders to profit or minimize losses.

So it is no surprise that the stock has fallen so much, notable as it is to fall so quickly.? But this was eminently avoidable.? Remember the Indian saying: “Lie down with dogs; wake up with fleas.”

Grow Embedded Value

Posted on 7 July 20128 July 2012 by David Merkel

One of my rules of thumb in equity investing is that if I buy companies trading below tangible book value,? with earnings yields over 10%, it is difficult to lose value, and the odds favor gaining value.

But there are some caveats:

Analyze the balance sheet, highly indebted companies are not to be trusted, but that varies by industry.
Longer dated assets, like property, plant & equipment should be discounted.
Banks and REITs must be scrutinized carefully, because of their weak liability structures.
Foreign companies need extra scrutiny, because the disclosures are often not as good.? This goes triple for Chinese companies.
Make sure you are not investing in a “buggy whip” industry, particularly in the era of the internet.? How can your company be disrupted?

The idea is a simple one.? Buy companies below their tangible book value when they have good earnings, and good earnings prospects. Over a long enough period of time, the growth in tangible book value will help drive growth in the stock price.

For companies with over $100 million in market capitalization, here are the companies that fit this description:

company	ticker	img_desc	country	exchg_desc	P / TB	P / E	Expected P/E	Mkt cap	LT Debt/ Equity
AerCap Holdings N.V.	AER	0939 – Rental & Leasing	Netherlands	N – New York	0.66	7.6	5.2	1524.4	263.6
Aircastle Limited	AYR	0939 – Rental & Leasing	United States	N – New York	0.64	8.4	8.1	931.2	202.1
American International Group,	AIG	0715 – Insurance (Property & Casualty)	United States	N – New York	0.55	2.9	9.8	56637	73.6
Anworth Mortgage Asset Corpora	ANH	0933 – Real Estate Operations	United States	N – New York	0.94	7.8	7.9	917.8	3.8
Assurant, Inc.	AIZ	0709 – Insurance (Life)	United States	N – New York	0.74	5.7	6	2992.7	19.6
AXA (ADR)	AXAHY	0709 – Insurance (Life)	France	O – Over the counter	0.88	7.6	5.8	29204.3	21.5
Axis Capital Holdings Limited	AXS	0715 – Insurance (Property & Casualty)	Bermuda	N – New York	0.86	8.3	8.8	4325.9	19.3
AXT, Inc.	AXTI	1033 – Semiconductors	United States	M – Nasdaq	0.94	7.5	9.9	129	2.8
Banco Bilbao Vizcaya Argentari	BBVA	0724 – Money Center Banks	Spain	N – New York	0.9	8.7	6	34554.8	250.4
Barclays PLC (ADR)	BCS	0727 – Regional Banks	United Kingdom	N – New York	0.42	6.9	3.6	31291.9	44.7
Callon Petroleum Company	CPE	0609 – Oil & Gas Operations	United States	N – New York	0.86	1.7	5.8	171.6	62.6
Chimera Investment Corporation	CIM	0703 – Consumer Financial Services	United States	N – New York	0.73	4.6	5.3	2434.6	59.2
China Gerui Adv Mtals Grp Ltd	CHOP	0121 – Iron & Steel	China	M – Nasdaq	0.55	2.3	1.7	157.4	0
China Zenix Auto International	ZX	0415 – Auto & Truck Parts	China	N – New York	0.49	1.8	1.4	127.3	0
Citigroup Inc.	C	0724 – Money Center Banks	United States	N – New York	0.53	7.4	5.8	77291.7	165.3
Corning Incorporated	GLW	1024 – Electronic Instruments & Controls	United States	N – New York	0.95	8	8.4	19410	14.7
Crexus Investment Corp	CXS	0933 – Real Estate Operations	United States	N – New York	0.85	6.6	9.4	779.2	0
Deutsche Bank AG (USA)	DB	0727 – Regional Banks	Germany	N – New York	0.65	7.6	4.7	31543.1	318.7
GeoEye Inc.	GEOY	0909 – Business Services	United States	M – Nasdaq	0.8	7.3	8.7	358.5	97.6
Hardinge Inc.	HDNG	0218 – Misc. Capital Goods	United States	M – Nasdaq	0.74	8	7.4	105.1	4.3
Homex Development Corp. (ADR)	HXM	0215 – Construction Services	Mexico	N – New York	0.91	8.6	5.5	846.4	85.4
Ingles Markets, Incorporated	IMKTA	0957 – Retail (Grocery)	United States	M – Nasdaq	0.91	9.9	8.2	400	183.1
Ingram Micro Inc.	IM	1006 – Computer Hardware	United States	N – New York	0.77	9.6	7.6	2591.2	8.7
Jinpan International Limited	JST	1024 – Electronic Instruments & Controls	China	M – Nasdaq	0.85	5.3	4.7	132	0.8
Kelly Services, Inc.	KELYA	0909 – Business Services	United States	M – Nasdaq	0.77	6.4	7.4	462.9	0
KeyCorp	KEY	0727 – Regional Banks	United States	N – New York	0.83	8.4	9.5	7339.2	90.7
KKR Financial Holdings LLC	KFN	0718 – Investment Services	United States	N – New York	0.89	5.1	4.7	1557.4	0
Knightsbridge Tankers Limited	VLCCF	1118 – Water Transportation	Bermuda	M – Nasdaq	0.61	6.9	9.4	215.2	42
KT Corporation (ADR)	KT	0915 – Communications Services	South Korea	N – New York	0.89	9	7	7041.3	72.6
Le Gaga Holdings Ltd ADR	GAGA	0509 – Crops	Hong Kong	M – Nasdaq	0.89	8.1	4.1	200.3	5.3
Lihua International Inc	LIWA	0127 – Misc. Fabricated Products	China	M – Nasdaq	0.7	3.1	2.1	161.3	0
LUKOIL (ADR)	LUKOY	0606 – Oil & Gas – Integrated	Russia	O – Over the counter	0.68	4.2	4	47753.8	10.4
Mechel OAO (ADR)	MTL	0124 – Metal Mining	Russia	N – New York	0.8	4.6	3.5	3322.6	139.6
Metlife Inc	MET	0709 – Insurance (Life)	United States	N – New York	0.69	5.7	5.4	32402.5	45.3
Mizuho Financial Group Inc. (A	MFG	0727 – Regional Banks	Japan	N – New York	0.9	3.5	8.5	40165.5	236.3
Navios Maritime Holdings Inc.	NM	1118 – Water Transportation	Greece	N – New York	0.53	4.6	7.6	350.3	131.3
Newfield Exploration Co.	NFX	0609 – Oil & Gas Operations	United States	N – New York	0.98	5.9	8.8	3943.1	72.2
Olympic Steel, Inc.	ZEUS	0127 – Misc. Fabricated Products	United States	M – Nasdaq	0.86	8.8	6.4	181.8	95.4
Orbotech Ltd.	ORBK	1033 – Semiconductors	Israel	M – Nasdaq	0.78	6.3	9.7	329.7	13.1
Patterson-UTI Energy, Inc.	PTEN	0612 – Oil Well Services & Equipment	United States	M – Nasdaq	0.93	6.6	8.3	2276.5	18.7
Petroleo Brasileiro SA (ADR)	PBR	0606 – Oil & Gas – Integrated	Brazil	N – New York	0.9	6.8	6.3	126006.1	43.5
Phoenix Companies, Inc., The	PNX	0709 – Insurance (Life)	United States	N – New York	0.21	3.6	3.7	203.5	45
Popular, Inc.	BPOP	0727 – Regional Banks	Puerto Rico	M – Nasdaq	0.52	8.9	6.1	1664	47.1
Protective Life Corp.	PL	0709 – Insurance (Life)	United States	N – New York	0.7	7.2	8	2557	53
Reinsurance Group of America I	RGA	0706 – Insurance (Accident & Health)	United States	N – New York	0.68	7.8	7.2	4059.3	34.9
Republic Bancorp, Inc. KY	RBCAA	0727 – Regional Banks	United States	M – Nasdaq	0.94	4.7	8.7	489.6	7.7
REX American Resources Corp	REX	0103 – Chemical Manufacturing	United States	N – New York	0.65	7.8	6.8	163.9	41
Royal Caribbean Cruises Ltd.	RCL	1118 – Water Transportation	United States	N – New York	0.71	9.7	9.5	5542.1	91.9
Societe Generale SA (ADR)	SCGLY	0724 – Money Center Banks	France	O – Over the counter	0.29	5.8	3.8	16945.2	20.7
StanCorp Financial Group, Inc.	SFG	0706 – Insurance (Accident & Health)	United States	N – New York	0.84	2.5	8.7	1676.1	14.8
StealthGas Inc.	GASS	1118 – Water Transportation	Greece	M – Nasdaq	0.38	8.5	5	122.1	98.5
Symetra Financial Corporation	SYA	0709 – Insurance (Life)	United States	N – New York	0.47	7.8	8.5	1494.6	0
Tech Data Corp	TECD	1006 – Computer Hardware	United States	M – Nasdaq	0.96	9.8	8	1918.9	2.9
Ternium S.A. (ADR)	TX	0121 – Iron & Steel	Luxembourg	N – New York	0.81	8.3	5.8	3993.4	26.2
Thompson Creek Metals Company,	TC	0124 – Metal Mining	United States	N – New York	0.33	3.5	5.7	563.9	20.8
Transportadora de Gas del Sur	TGS	0609 – Oil & Gas Operations	Argentina	N – New York	0.43	5.6	7.5	191.7	80.6
TravelCenters of America LLC	TA	0963 – Retail (Specialty Non-Apparel)	United States	A – American	0.51	4	3.7	145	31.9
Triple-S Management Corp.	GTS	0806 – Healthcare Facilities	Puerto Rico	N – New York	0.76	9.4	8.6	510.6	18.2
Unit Corporation	UNT	0612 – Oil Well Services & Equipment	United States	N – New York	0.94	8.7	9	1819.7	15.8
Valero Energy Corporation	VLO	0609 – Oil & Gas Operations	United States	N – New York	0.86	9.1	5.6	13578.5	40.5
Vishay Intertechnology	VSH	1033 – Semiconductors	United States	N – New York	0.97	7.7	7.1	1433.8	23.4
Woori Finance Holdings Co., Lt	WF	0727 – Regional Banks	South Korea	N – New York	0.57	4.5	4.8	8482.1	0
Xinyuan Real Estate Co., Ltd.	XIN	0215 – Construction Services	China	N – New York	0.33	2	2.1	215.1	8.8
Yongye International Inc	YONG	0103 – Chemical Manufacturing	China	M – Nasdaq	0.55	1.9	1.3	163.7	2.8
ZHONGPIN INC.	HOGS	0515 – Food Processing	China	M – Nasdaq	0.89	6.6	5.5	371.9	18.1
Zuoan Fashion Ltd (ADR)	ZA	0403 – Apparel/Accessories	China	N – New York	0.6	2.4	1.8	102.1	0

Full disclosure: long AIZ, PBR, RGA, SFG, VLO

PS — be wary of Chinese companies, I mean it…? Also, use the Ctrl-Minus key to view this in entire.

The Failure of Government-Provided Prosperity

Posted on 7 July 2012 by David Merkel

If I had one bit of advice to reach the ears of Barack Obama, Mitt Romney, and Ben Bernanke, it would be this: stop the illusion that you have any significant control over the US economy.? Government is designed for justice, and does not do well when trying to promote prosperity.? At most, economically, the government can set ground rules that reduce the probability of fraud.

As it is, at present, the US still has an over-indebted economy, and as a result, will grow slowly, because businesses and individuals in danger of default do not spend freely.

Politicians claim that they can being prosperity, but they rarely do that.? I’m not talking about marginal tax rates, or monetary policy, which offer transitory relief, but changes in regulations.? The economy as a whole would do a lot better if marginal regulation were reduced.? That would be a help, but few politicians in either party want to reduce the power of the government.

Prosperity exists aside from the government.? Yes, in the short-run the government can tweak the economy to grow faster, but at the price of the situation we are now in, where nothing works.? Far better for the government to focus on things it can do well: defense, internal security, public health, etc.? But it does not do well with macroeconomic management, so it should give up on that, run balanced budgets, and replace the Fed with a currency board.

At that point, we would have predictable policy, and businessmen might be willing to take more risk and grow the economy.? Unsustainable policies cause producers and consumers to pull back.

At best, in economics governments set ground rules to reduce fraud.? Beyond that, governments reduce the flexibility of economies, and reduce growth.? Socialistic governments produce dependency cultures that inhibit work, initiative, and growth.

Do not look to the government for prosperity.? Governments are umpires; Umpires allow for good games, but they aren’t the ones playing the games and creating the excitement.? Governments can never make us prosperous; if government action were what made us well off, the Soviet Union would be dictating term s to the world today.

Sorted Weekly Tweets

Posted on 6 July 2012 by David Merkel

LIBOR

Commented on The Economist | The LIBOR scandal: The rotten heart of finance $$ LIBOR may not be as rotten as advertised http://t.co/GfXH4hRq Jul 06, 2012
LIBOR scandal: The rotten heart of finance http://t.co/g2RBmaNy Proving actual damages will b tough; don’t think this will amount2much $$ Jul 05, 2012
Libor, central banks and financial stability http://t.co/9DBCcZaK The degree of damage from Libor-fixing is arguable; more analysis2come Jul 04, 2012
LIBOR: Everything You Want to Know, but were Afraid to Ask http://t.co/eYwKF68v Good summary article. $$ Jul 04, 2012

Eurozone

Europe Recalls Hamilton as Desperation Turns on the Debt http://t.co/K8RvS9dP Time running out; will EZone pull together or fly apart $$ Jul 07, 2012
This Is A Fantastic Presentation On Why ‘Germany Is Riskier Than You Think’ http://t.co/UPcEg8yS Cost: Support Euro < Abandon Euro $$ Jul 04, 2012
France Signals More Austerity http://t.co/gCiXPLKl Fascinating:Hollande may b delivering more conservative fiscal policy than Sarkozy $$ Jul 03, 2012

US Politics

Obama Fails to Gain as Unemployment Stuck Since March http://t.co/vX87x6vQ W/policy unsustainable, business owners reluctant 2 hire $$ Jul 06, 2012
Cities Consider Seizing Mortgages http://t.co/V9CKARiC Abuse of eminent domain will not hold up in court. Theft by another name. $$ Jul 05, 2012
How Stockton went broke: A 15-year spending binge http://t.co/VGy6fWv7 Offered enhanced employee benefits, which required no cash outlay $$ Jul 05, 2012
Thx 4 sharing this; worth the read $$ RT @LaurenLaCapra: How Stockton went broke: A 15-year spending binge | Reuters http://t.co/LK9VKq4q Jul 05, 2012
Yes, there is a free-market alternative to Obamacare http://t.co/gOpygz04 Support high deductible insurance, even if govt has2do it4the poor Jul 04, 2012
Who Is John…Allison? A Randian, Libertarian Business Icon Takes Over the Cato Institute http://t.co/Bms310O7 Met him @ #CMC29. Nice guy Jul 04, 2012
Debt Forgiveness Would Revive the Economy http://t.co/D5lkF7b6 @JamesGRickards argues this, as I have elsewhere: http://t.co/LdeYyBkh $$ Jul 03, 2012

Financial Markets

Big Board’s New Dark-Pool Ammo: Sub-Penny Quotes http://t.co/FgvZ7ebD I agree w/the guy quoted @ end; A step in the wrong direction $$ Jul 06, 2012
The High-Frequency Conspiracy http://t.co/iOs8buSu HFT and the market makers / specialists work together to extract $$ from stock traders. Jul 04, 2012
@TraderNewsFeed I don’t share that view; I think the GSEs deserve some blame, the Fed a lot of blame, & invt banks a lot of blame, but… $$ Jul 04, 2012
@TraderNewsFeed Pt 2, the investors deserve blame as well. U can’t have a derivative hedge without a yield hog seeking additional income $$ Jul 04, 2012
Tail Risk and Hedge Fund Returns http://t.co/uqcs0Bcg ht: @PragCapitalist As I have argued B4, hedge funds as a whole r short volatility $$ Jul 04, 2012
Blackstone Makes Foray Into Houses for Rent http://t.co/UaRvTRqE Economics of managing a lot of single family houses is difficult $$ Jul 04, 2012
Ex-JPMorgan Trader Feldstein Wins in Betting Against Bank http://t.co/pSfwA1xd This is a good example of how frenemies act on Wall Street Jul 04, 2012
The Changing Face of U.S. Equity Ownership http://t.co/aqQXXVFF Individuals own less, Institutions more; Graph: http://t.co/gb7M6RgY Jul 04, 2012
Stocks for Bond Lovers http://t.co/nzNrE6RA If dividends grow rapidly, a rising income stream beats bonds, if market value persists $$ Jul 04, 2012
Pimco’s Bond King Regains Investor Favor http://t.co/MwSZ8hUu Owning long Treasuries is too fashionable, think I have2sell $TLT FD: +TLT Jul 04, 2012
“There is a high correlation between stocks & anticipated inflation. $$ http://t.co/mKr4SFcn Aleph Blog article: http://t.co/MWBP9Ib7 Jul 03, 2012
Pimco?s El-Erian Says US, Emerging Markets R Top Investments http://t.co/LwbYAIzs EM r in good shape, US better than other big nations $$ Jul 03, 2012

China

For CFAs: China?s Fragile Foundations http://t.co/jwf1IJJB Fraser Howie of CLSA Asia-Pacific explains the economic weaknesses of China $$ Jul 05, 2012
China?s New Rules May Curb Credit Growth http://t.co/KQcRe9uQ Loosen with one hand; tighten w/the other. Now that’s a monetary policy $$ Jul 05, 2012
BRICs Priced for Economic Meltdown http://t.co/wTf6nRp9 It is the lack of “rule of law” that makes them cheap, not possible slump $$ Jul 04, 2012
Jim Chanos ?China Makes Greece and Spain Look Like Child?s Play? http://t.co/GA2woEwn Chanos is an accounting expert; sniffs out failures $$ Jul 03, 2012

Miscellaneous

Good for about 45 minutes as well, eh? $$ RT @BloombergNews: Central banks deliver 45-minute salvo as growth weakens http://t.co/MzlnAUXQ Jul 05, 2012
A New Market for Schools http://t.co/HbMuSfcK Be wary; costs of the degree including foregone wages may not be worth it. $$ Jul 05, 2012
The Green Mountain saga: a cup of joe to go http://t.co/uUPtr1Ht Once again, revenue policies take center stage for accounting quality $$ Jul 04, 2012
Loeb’s Third Point fund moves into Chesapeake http://t.co/3yYeKOhq The plot thickens, as a group of activist investors gathers $$ Jul 04, 2012
Contra: Carlyle Bets Big on U.S. Energy http://t.co/0bT7y1LM This does not look like a big bet to me. $$ Jul 04, 2012
Been experimenting with a spreadsheet that takes @yahoofinance news, and weeds out the chaff, I like it; improves quality, takes work $$ Jul 03, 2012
DNA Mapping of Alzheimer?s Patients Gives Deep Dive View http://t.co/L5M0ATIN May be promising, but not every disease is gene-based $$ Jul 03, 2012

Comments

“It will be very difficult to prove actual damages in these cases. I don’t think this will amount to much.” http://t.co/BP18Tw8D $$ Jul 05, 2012
“Organic growth is one of the toughest tasks in business, and also the most valuable.” ? David_Merkel http://t.co/T2MMseVx $$ $BLK Jul 05, 2012
“W/all of that liquidity, they can buy a bigger string to push on.” ? David_Merkel http://t.co/N0EOuYnB $$ http://t.co/P456cjMP Jul 05, 2012
“It’s lousy fiscal policy to subsidize things in oversupply, like homes and banks. No spillover?” ? David_Merkel http://t.co/AItUK466 $$ Jul 05, 2012
On second thought, thanks to all of my Twitter followers. I am honored that you want to listen to me & I will do my best to serve you $$ Jul 05, 2012
Many thanks to @Clarityspring, my 5,000th Twitter follower; never thought I would enjoy Twitter so much! Jul 05, 2012
Quirky, but interesting. http://t.co/RZSAG652 Jul 04, 2012
RE: @TheStreet_News I think all orders should be good for at least one second. Until them, I will use discretionary r? http://t.co/dxvv58RA Jul 03, 2012
“What a fragmented market: top 10 have ~45%. Not much of a story here. Next. $$” ? David_Merkel http://t.co/nChBIcF2 $JPM $BAC $C $DBK $BARC Jul 02, 2012
“Only one way to lower healthcare costs: move back to a first-party payer system. Individuals decide?” ? David_Merkel http://t.co/lGZaDFJW Jul 02, 2012
“Difficult proposition: choke the economy to achieve an uncertain environmental benefit.” ? David_Merkel http://t.co/ngsN5VdG $$ Jul 02, 2012

An Analysis of Three-Month LIBOR 2005-2008

Posted on 6 July 20126 July 2012 by David Merkel

I downloaded the data for LIBOR over the period 2005-2008, and decided to run regressions of the 3-month rates submitted from each bank versus 3-month LIBOR, since I think it is the most commonly used.? Here are the results:

Note the inverse relationship between the willingness to be above the consensus, and the willingness to move with the consensus.

Those that were above the LIBOR rate were in general less willing to adjust to changes in LIBOR whereas those below were more willing to adjust.? This could all be an artifact of being in a declining interest rate environment.

Also note that JP Morgan was below the LIBOR consensus by more than Barclays was above it.? Why is JP Morgan escaping criticism if Barclays is getting it?

Let’s look at the residuals from the regressions over the whole period:

As you can see, we had the great moderation in effect from 2005 through mid-2007. Everything was placid; central banking could not err, even as it erred by providing too much liquidity.? Financial companies could not err either.

There are three periods here: the great moderation, the SIV/correlation crisis in the third quarter of 2007, and the bank solvency crisis in the second half of 2008.? Let’s look at them closer up.

SIV/Correlation crisis, residual bank yields in percent:

Now, in the above graph which covers July 2007 vs 2008, same graph as above, just expanded for better viewing, you can see at the left the orderliness of the past.? Deviations from normal LIBOR behavior are 1-2 basis points; the banks in the middle generally agree about where LIBOR should be on any given day, and those that are in the tails are excluded from the calculation.

But the deviations are small, relatively speaking from what the banks commonly did — +/- 0.05% usually, and almost never higher than +/- 0.10%.? You can note that in 2008 JPM and Barclays get closer together.? JPM is ~5 basis points higher than its normal practice, and Barclays is ~5 lower, but given that on average Barclays was 7 basis points over LIBOR, and JPM 12 bp under LIBOR, that cuts the gap in half in that era.

But now lets take a walk on the wild side:

Banking Solvency crisis, residual bank yields in percent:

In mid-September, as the failures cascade, the submissions for LIBOR lose regularity.? Some go high, like Barclays, HBOS, Credit Suisse, and BTMU.? Others go low, like WestLB, Rabobank, JP Morgan, HSBC, Lloyds and Citi.? Most of these don’t make it into the LIBOR calculation, because they are outliers.? Sizes of the deviations are ~10x the size of what they were during the SIV/Correlation crisis.

By mid-November, semi-normalcy turns, though JP Morgan is lower than their normal practice, and Barclays starts higher, and ends the year lower than their normal practice.

The Correlation Matrix

So, if I were hunting for a conspiracy to fix LIBOR, I would look for clusters of high positive correlations, which are dark green in the correlation matrix above.? Starting with Barclays, I get BTMU, Credit Suisse, HBOS, Norinchuckin, and RBS, maybe Deutsche.? With BTMU, I get Barclays, Credit Suisse, HBOS, Norinchuckin, and RBS, maybe Deutsche.? With HBOS, I get Barclays, BTMU, Credit Suisse, but none of the rest.? By the time I am done, I have an informal group that seems to act together: Barclays, BTMU, Credit Suisse, HBOS, Norinchuckin, and RBS.

Maybe there is another cluster.? Starting with Citi, I have HSBC, JP Morgan, Lloyds, and Rabobank.? Yes, upon further inspection, that’s the second and only other cluster, which means we can ignore for now Bank of America, Deutsche, RBC, UBS, and WestLB.

Here’s my punchline: go back to my table at the top.? The first group, Barclays, BTMU, Credit Suisse, HBOS, Norinchuckin, and RBS are high LIBOR submitters (along with Deutsche, who is close to being a part of the group).? The second group, Citi, HSBC, JP Morgan, Lloyds, and Rabobank are low LIBOR submitters.? (Weaker ties may exist with Bank of America and RBC.)

My initial diagnosis is this: whether formally or informally, you have two groups of banks submitting rates for LIBOR.? One group is trying to pull LIBOR up, the other is trying to pull LIBOR down.? Statistically, if I add up their intercept terms from the first table, they both sum to 0.23%, one positive, the other negative.? Even if LIBOR were a simple average, which it is not, this is a colossal game of tug of war, with two equal teams.

As it is, LIBOR excludes the outliers, and calculates an average off of those that remain.? It’s a difficult measure to manipulate.? There may have been attempts to manipulate LIBOR, and even two groups of banks trying to pull LIBOR their own way, but successful systemic manipulation of LIBOR is unlikely in my opinion.

But if you disagree, here are the two clusters of banks, pursue their collusions:

Coalition to pull LIBOR up

Barclays
BTMU
Credit Suisse
HBOS
Norinchuckin
RBS

Coalition to pull LIBOR down

Citi
HSBC
JP Morgan
Lloyds
Rabobank

Start with Barclays and JP Morgan, they are the outliers, and if there is collusion, they are the likely leaders.

On Aviva, Six Years Later

Posted on 5 July 2012 by David Merkel

I note this article about Aviva plc.? I took grief from Amerus Group’s IR department during the merger six years ago for my commentary at RealMoney.? Here is an example of my writing that theStreet,com made public.? Thanks, TSCM.

Like many foreign acquirers of US life insurers, the bids were too aggressive, and Aviva paid far too much for Amerus Group.? Overpaying for US life companies, particularly for newcomers to the US is not uncommon; Old Mutual did even worse with F&G Life back in 2001.? (And if you like, look at the amount of capital they pumped in, before selling it to Harbinger Group for a 90% loss. Ouch, Ouch, OUCH!!!)

So Aviva is not the worst, but has done badly.? Would that they had listened to intelligent advisors, instead of destroying value via the Amerus purchase.? The price is down 60%+ since then.

On Internal Indexes, like LIBOR

Posted on 5 July 2012 by David Merkel

When I was a life actuary, following the deferred annuity market, the concept of market-value-adjusted annuities arose.? Annuity values could react like bonds to:

An external index rate, or,
An internal index, driven off of the new money rate for annuities

Now, the internal index sounds soft, but it is not so.? Yes, you can lower your new money rate but reserves grow on indexed products.? You can raise your rates, but reserves will shrink.? It’s not perfect here, but the internal index will work over the long haul.

So when I look at LIBOR and potential manipulation, I don’t see a lot of reason for concern.

When bond deals are priced, the relative yield is what is priced; it does not matter what the benchmark is, roughly the same overall yield would have been obtained.? Spreads are a way of expressing the excess yield over equivalent maturity government or AA bank (swap/LIBOR) yields.? They are a result of the process, not a driver of the process.

If 3-month LIBOR were replaced by the on-the-run 3-month Treasury yield, new deals would be priced, and the spreads would be higher by the TED (EuroDollar – Treasury) yield spread.

When I was a bond manager, dealer desks would often try to sell or buy bonds off of unusual benchmarks.? I would always make the necessary adjustments to calculate the option adjusted spread over interpolated swap rates, with further adjustments for the degree of premium or discount to par.? (Note: A premium bond carries extra credit risk because if it defaults, the most you can recover is par.? Opposite for discount bonds.? There is a mathematical method for calculating the amount of yield tradeoff between premium/par/discount bonds, even in the absence of a credit default swap [CDS] market.? You assume that the spread over swap is the CDS premium, and calculate the annual cost of insuring the premium to par.? Deduct that from the current spread, and you have the hypothetical true par spread.? Once you have that, you can make rational swap trades.)

What I am trying to say is that benchmarks/indexes aren’t all powerful.? Bright bond investors look past them, and analyze the economics of the situation.? Same for intelligent borrowers; they know that LIBOR rises during times of financial stress.? If you are a floating rate investor/borrower, you ought to analyze the rate that your investment/loan is tied to.

Many commentators with knowledge of the situation think that lawsuits regarding LIBOR will amount to little (one, two).? Yes, there may have been some manipulation in a micro-sense for some banks, but in terms of having a big effect on many, I don’t think that is possible.? There might be some degree to which borrowers benefited and savers/lenders lost.? That’s a tough case to press on any side.? Courts favor borrowers, and they benefited from any manipulation.

In closing, I don’t think much will come from the “LIBOR scandal” the same way that nothing will come from the “rating agencies scandal.” Both are examples of summarizing information/opinions that investors can use at their own risk.? They are not fiduciaries; those who use the information do so at their own risk.

On Power Outages

Posted on 3 July 2012 by David Merkel

I want to toss out an idea for comment regarding power outages.? In the present storm, my power was restored within two days.? The? last time in August/September 2o11, it took almost seven days.

When large disasters occur, utilities bid for the services of power crews that are out of the area.? There should be some incentive to make them bid aggressively for additional power crews.

Here is my incentive:

Those not restored in 3 full days get one month of free electricity.
Those not restored in 5 full days get three months of free electricity.
Those not restored in 7 full days get one year of free electricity.

The idea is threefold:

The utilities pay in their own product, thus softening the blow on them.
As time progresses, the costs/inconveniences mount for those without power; this gives companies an incentive to bid for power crews, because the longer people are without power, the greater the future revenue loss.
The results of the penalty get delivered to those most inconvenienced, and in a way that is fitting — you might even have some people smiling as they sit in the dark, knowing that their reward builds exponentially as they wait.

I like this idea, because it is a minimalist way of giving incentives to the utilities to restore service.? In both this disaster and the one last August/September, my local utility said, “We are doing all that we can.”? Nonsense.? Other utilities were more aggressive in bidding for power crews.

Comments are welcome.? This idea is just a rough stab, but I think it would go a long way toward restoring equity to those that are most inconvenienced be power outages.

PS — As an aside, as the internet has become more important in the lives of people, and even more the mobile internet, it is fascinating to watch how people seek out opportunities to charge up or log in as the crisis progresses, much as they would seek out ice, nonperishable food, and other necessities as the crisis progresses.