April 2014 – Page 2 – The Aleph Blog

Sorted Weekly Tweets

Posted on 18 April 2014 by David Merkel

Stocks & Industries

Invest In Stubs, Spin-Offs And Liquidations For Alternative Returns?http://t.co/ccezep0K9Y?Cites a Gabelli article http://t.co/xTrqEfmQeq $$?Apr 19, 2014
Real Estate Management Better Than Owning Real Estate??http://t.co/IFaDLiwTRa?Sometimes yes, sometimes no. Definitely adds more leverage $$?Apr 19, 2014
Wells Fargo Securities Lending Lawsuit Ends in Settlement?http://t.co/w3lSY4Cw8D?Low margin business that can go badly wrong in a crisis $$?Apr 19, 2014
Makani, a $GOOG subsidiary makes an airborne wind turbine that dramaticlly increases power generation efficiency?http://t.co/0Fug49o7gC?$$?Apr 18, 2014
Google to Buy Titan Aerospace as Web Giants Battle for Air Superiority?http://t.co/HjJ8wKtnjM?Makes me think $GOOG has 2much $$ 2spend?Apr 18, 2014
Profit Tastes Like Chicken in Hunt for Cheaper US Meat?http://t.co/drgQbwEiKR?With recent rise in beef & pork prices people substitute $$?Apr 18, 2014
Roads Versus Rail:The Big Battle Over Public Transportation?http://t.co/ydBxEglexC?Makes case that American will own fewer cars in future $$?Apr 18, 2014
Barclays Ups $LNC To Buy, Says $MET , $PRU Are Undervalued – Stocks To Watch?http://t.co/c7yNaVZqdp?Stock Market sensitive insurance cos $$?Apr 18, 2014
Bidding War Looming for Aspen? Analysts Say Don?t Count On It?http://t.co/iMotqyAgHv?Offer 4 $AHL looks pretty full 2me, dont look4more $$?Apr 18, 2014
Biggest LBO Demise Poised to Put Oncor in Play?http://t.co/d30djwOa5M?Buffett is unlikely 2 enter into bidding in a competitive sale $$?Apr 18, 2014
Target of Naked Short Sellers Is Angry, Confused?http://t.co/I3ZZDn5JNp?@matt_lavine takes on imaginary naked shorting in $LPHI $$?Apr 18, 2014
Radioactive Waste Is North Dakota’s New Shale Problem?http://t.co/BiMkO0ZdgK?Significant amounts of low level radiation from radium $$?Apr 18, 2014
The death of mortgage lending?http://t.co/u8uQBvZCuS?Loan yields must rise in order to compensate for higher required capital at banks $$?Apr 19, 2014
Kochs? Flood Insurance Opposition Becomes Campaign Issue?http://t.co/b1iuvoVhZK?1 of the few businesses the Kochs’ aren’t in is insurance $$?Apr 18, 2014
Office Markets Strengthen Where Tech, Energy Jobs Are?http://t.co/sESuHUeAVr?Helps explain the spottiness of commercial RE prices $$ $CMBS?Apr 18, 2014
Labor Shortage Threatens to Bust the Shale Boom?http://t.co/R1TctaTelD?Can’t find a job? Consider learning to weld; monotonous but pays $$?Apr 18, 2014
Koch Brothers Net Worth Tops $100B as TV Warfare Escalates?http://t.co/XgH0M6CNIR?Almost as wealthy as extended Walton family $$ $WMT $SPY?Apr 18, 2014
Big Banks Ramp Up Business Lending?http://t.co/83dMAPIQia?Signs of life spotted in big corporations, but r they just buying back stock? $$?Apr 18, 2014
How Can Yahoo Be Worth Less Than Zero??http://t.co/sr3owwkyNE?@matt_levine argues a breakup of $YHOO makes sense even if core biz loses $$?Apr 18, 2014
Wal-Mart Undercuts Rivals With New U.S. Money Transfer Service?http://t.co/a4vq0HYALi?Useful if u need 2 transfer $$ inside the US $WMT $SPY?Apr 18, 2014
How Chick-fil-A Spent $50M to Change Its Grilled Chicken?http://t.co/Q9kpXoSIbF?The marinade matters, but the grill design was the key $$?Apr 15, 2014
Small US Colleges Battle Death Spiral as Enrollment Drops?http://t.co/nHRhO4Gc1R?Too much capacity & affordability is a problem $$ $APOL?Apr 14, 2014

Outside the US

China GDP Gauge Seen Showing Deeper Slowdown?http://t.co/ntIxxdXcpO?If China increases consumption GDP growth will fall faster still $$ $FXI?Apr 18, 2014
Housing Trouble Grows in China?http://t.co/Z4tKUuqLFd?Overbuilding by Real-Estate Developers Leaves Smaller Cities W/Glut of Apartments $$?Apr 18, 2014
Suddenly, Europe Is Taking a Harder Line on Russia Sanctions?http://t.co/MnzxvMP3pe?Nations can solidify when they face a common threat $$?Apr 18, 2014
Las Bambas Copper Mine Purchase Shows China’s Still in the Hunt for Commodities?http://t.co/h1cqGERGCu?China may not b changing much $$?Apr 18, 2014
Forgetting How to Speak Russian?http://t.co/D0UwT6unki?Among former Soviet republics knowing Russian is less important for business $$?Apr 18, 2014
The Middle East War on Christians?http://t.co/BW1NwCAXuH?Israeli Ambassador 2 UN argues Israel is tolerant of Christians, not like some $$?Apr 18, 2014
Britons Struggle to Save for Home Down Payments as Prices Surge?http://t.co/M6vH0vDlDs?Space is constrained in London & foreigners buy $$?Apr 18, 2014
US Said to Warn Money Managers of More Russia Sanctions?http://t.co/rB8AUQTsnc?Putin knows Iran survived worse sanctions; Russia tougher $$?Apr 18, 2014
China Sentences Four Activists on Disturbing Public Order Charge?http://t.co/Tx95rrhWsb?Mostly, US has rule of law, China has rule by law $$?Apr 18, 2014
US govt isn’t perfect, but in principle the govt is subject to the Constitution & laws, & not merely able 2 use law 2 enforce its will $$?Apr 18, 2014
Frontier Fund Buyers Find It Pays To Look Under The Hood?http://t.co/JQ6khwYllJ?2much $$ is being thrown @ frontier mkts; crowded trade $FM?Apr 18, 2014
Why iShares? ?FM? Is About To Get Better?http://t.co/4FiqlfW0YS?Diversifies out of Middle East, but frontier market vals r stretched $$ $FM?Apr 18, 2014
Putin’s 21-Year Quest to Be Russian Guardian Began in Estonia?http://t.co/5oelLBHCmN?Father was betrayed by Estonians in WWI, almost died $$?Apr 15, 2014

Market Dynamics & Fundamentals

Bridgewater Founder Says 85 Percent Of Pensions will Go Bankrupt?http://t.co/YknEmyGgfJ?9% pension returns required, 4% is most likely $$?Apr 19, 2014
The Fitch Fundamentals Index Dashboard?http://t.co/OzI6KWUFfs?Interesting little utility 4 understanding where we are in the credit cycle $$?Apr 19, 2014
Rich Start-Ups Go Back for Another Helping?http://t.co/ZbFbpLVgmM?When capital is plentiful, bad decisions get made. expected returns low $$?Apr 18, 2014
Stumbling S&P 500 Reaches Worst Stretch of Election Cycle?http://t.co/zgJTynu2od?Interesting timing, wonder whether past is prologue? $$?Apr 18, 2014
How a 56-Year-Old Engineer?s $45K Loss Spurred SEC Probe?http://t.co/3HfdH2aqxK?Always read the risk factors in the prospectus or 10K $$?Apr 18, 2014
High-Speed Traders Said to Be Subpoenaed in NY Probe?http://t.co/2qxmrxeVd7?What level of technology is legitimate 2 gain an advantage? $$?Apr 18, 2014
Nuggets of Corporate Governance Wisdom From Charlie Munger?http://t.co/gMFIE9jlRM?Also c this paper: http://t.co/033v0bgdYr $$ $BRK.B $SPY?Apr 18, 2014
Global stock rally: World market cap reached record high in March, &is $2.4T above pre-recession, pre-crisis level?http://t.co/iMq0IoBhch?$$?Apr 18, 2014
Speed?the only HFT advantage? Not so fast?Flash?Boyshttp://www.cnbc.com/id/101586488?Algorithms may also be an advantage w/price patterns $$?Apr 18, 2014
Investor Alert – Exchange-Traded Notes?Avoid Unpleasant Surprises?http://t.co/NqhUr2whsJ?A helpful reminder 2b wary of exotic ETNs $$ $SPY?Apr 18, 2014
Americans Sold on Real Estate as Best Long-Term Investment?http://t.co/La4UROU0ie?Helps explain y retail investors lose on average $$ $GLD?Apr 18, 2014
Destroying Smart Beta 2: Ground Rules?http://t.co/uecYqZLCEe?Smart beta is a trendy but vapid concept, factors should be part of alpha $$?Apr 18, 2014
Gross Loses to Goldman in Hot Bond Strategy as Pimco Lags?http://t.co/VWv7UC72bS?Series of bad bets makes Pimco a laggard as AUM flees $$?Apr 15, 2014
Trillion-Dollar Firms Dominating Bonds Prompting Probes?http://t.co/RXZNkNwtFs?Concentrated markets can lead to bond pricing distortions $$?Apr 15, 2014

US Politics & Policy

What’s the Matter With Illinois??http://t.co/wmDiyWDN1e?They r the exemplary state for shortsightedness & corruption $$?Apr 19, 2014
Heartbleed Hackers Steal Encryption Keys in Threat Test?http://t.co/dYfezfXe8A?>6 people were able to extract private key of a website $$?Apr 19, 2014
Elijah Cummings, W/IRS, Targeted Tea Party Group True The Vote?http://t.co/TE5A1zTM0y?I live in his gerrymandered district; kick him out $$?Apr 18, 2014
Yellen Lays Groundwork for Rules on Short-Term Credit Markets?http://t.co/z03MWlpsqI?Fed doesn’t regulate the banks well, y try 4 more? $$?Apr 18, 2014
Schooling on a ‘Debit Card’?http://t.co/wwixbB0pqy?Arizona created a program so that special needs kids can get specialized schooling $$?Apr 18, 2014
IRS Among Agencies Using License Plate-Tracking Vendor?http://t.co/HTs5aEMNtK?Howard County Police use it & catch people 4 old crimes $$?Apr 18, 2014
Wealth Effect Failing to Move Wealthy to Spend?http://t.co/R3vfD5i94J?Wealth effect, if it exists, is small, FOMC is pursuing illusions $$?Apr 18, 2014
NSA Said 2 Exploit Heartbleed Bug for Intelligence for Years?http://t.co/9XvcLX9ZTE?NSA quietly knows security vulnerabilities; uses them $$?Apr 15, 2014
The Wall Street second-chances rule: scandal makes the rich grow stronger?http://t.co/8HhscWJjMN?What does not kill us makes us stronger? $$?Apr 14, 2014

Practical

How well do you know your insurance policy??http://t.co/szp3G8H4kN?Know what is covered & what isn’t, how much is covered & options $$?Apr 19, 2014
Attention Shoppers: Fruit and Vegetable Prices Are Rising?http://t.co/MMdPOLry9A?As are meat prices & most food prices $$ #agflation?Apr 18, 2014
How to start investing?http://t.co/yGyziE8Tac?Good advice from a credible source $$?Apr 18, 2014

Other

El Nino Signs Detected, Presaging Global Weather Change?http://t.co/D1uDLS9aJ0?El Nino exists 2 give us something 2 blame when frustrated $$?Apr 18, 2014
More People Pick Elimination Diets to Discover Food Sensitivities?http://t.co/ftQkzs3PxP?Fad and Science of Not Eating Entire Food Groups $$?Apr 18, 2014
SAT Adopts Real-World Questions and Jettisons Obscure Words?http://t.co/Mspw9EG3OV?In 2016, changes from intelligence to achievement test $$?Apr 18, 2014
Scientists Make First Embryo Clones From Adults?http://t.co/e5qlwyiWwj?Cloned cells 2create early-stage embryos, matching DNA tissue $$?Apr 18, 2014

Comments, Replies & Retweets

RT @howardlindzon: Funds still paying up (I say silly overpay) for private over public, this is spooking IPO ‘s for sure?http://t.co/mclSd9??Apr 15, 2014

The Good ETF, Part 2 (sort of)

Posted on 18 April 2014 by David Merkel

About 4.5 years ago, I wrote a short piece called?The Good ETF. ?I’ll quote the summary:

Good ETFs are:

Small compared to the pool that they fish in

Follow broad themes

Do not rely on irreplicable assets

Storable, they do not require a ?roll? or some replication strategy.

Not affected by unexpected credit events.

Liquid in terms of what they repesent, and liquid it what they hold.

The last one is a good summary.? There are many ETFs that are Closed-end funds in disguise.? An ETF with liquid assets, following a theme that many will want to follow will never disappear, and will have a price that tracks its NAV.

Though I said ETFs, I really meant ETPs, which included Exchange Traded Notes, and other structures. ?I remain concerned that people get deluded by the idea that if it trades as a stock, it will behave like a stock, or a spot commodity, or an index.

What triggered this article was reading the following article:?How a 56-Year-Old Engineer?s $45,000 Loss Spurred SEC Probe. ?Quoting from the beginning of the article:

Jeff Steckbeck?didn’t?read the prospectus. He?didn’t?realize the price was inflated. He?didn’t?even know the security he?read?about?online was something other than an exchange-traded fund.

The 56-year-old civil engineer ultimately lost $45,000 on the wrong end of a?volatility?bet, or about 80 percent of his investment, after a?Credit Suisse Group AG (CSGN)?note known as TVIX crashed a week after he bought it in March 2012 and never recovered. Now Steckbeck says he wishes he?d been aware of the perils of bank securities known as exchange-traded notes that use derivatives to mimic assets from natural gas to stocks.

?In theory, everybody?s supposed to read everything right to the bottom line and you take all the risks associated with it if you don?t,? he said this month by phone from Lebanon,?Pennsylvania. ?But in reality, you gotta trust that these people are operating within what they generally say, you know??

No, you don’t have to trust people blindly. ?Reagan said, “Trust, but verify.” ?Anytime you enter into a contract, you need to know the major features of the contract, or have trusted expert advisers who do know, and assure you that things are fine.

After all, these are financial markets. ?In any business deal, you may run into someone who offers you something that sounds attractive until you read the fine print. ?You need to read the fine print.? Now, fraud can be alleged to those who actively dissuade people from reading the fine print, but not to those who offer the prospectus where all of the risks are disclosed. ?Again, quoting from the article:

Some fail to adequately explain that banks can bet against the very notes they?re selling or suspend new offerings or take other actions that can affect their value, according to the letter.

[snip]

?My experience with ETN prospectuses is that they?re very clear about the fees and the risks and the transparency,? Styrcula said. ?Any investor who invests without reading the prospectus does so at his or her own peril, and that?s the way it should be.?

[snip]

The offering documents for the VelocityShares Daily 2x?VIX (VIX)?Short Term ETN, the TVIX, says on the first page that the security is intended for ?sophisticated investors.? The note ?is likely to be close to zero after 20 years and we do not intend or expect any investor to hold the ETNs from inception to maturity,? according to the prospectus.

While Steckbeck said a supervisor at Clermont Wealth Strategies advised him against investing in TVIX in February 2012, he bought 4,000 shares the next month from his self-managed brokerage account. The adviser, whom Steckbeck declined to name,?didn’t?say that the price had become unmoored from the index it was supposed to track.

David Campbell, president of Clermont Wealth Strategies, declined to comment.

Steckbeck, who found the TVIX on the Yahoo Finance website, doesn?t have time to comb through dozens of pages every time he makes an investment, he said.

?Engineers — we?re not dumb,? said Steckbeck, who founded his own consulting company in 1990. ?We?re good with math, good with numbers. We read and understand stuff fairly quickly, but we also have our jobs to perform. We can?t sit there and read prospectuses all day.?

If you are investing, you need to read prospectuses. ?No ifs, ands, or buts. ?I’m sorry, Mr. Steckbeck, you’re not dumb, but you are foolish. ?Being bright with math and science is not enough for investing if you can’t be bothered to read the legal documents for the complex contract/security that you bought. ?I read every prospectus for every security that I buy if it is unusual. ?I read prospectuses and 10-Ks for many simple securities like stocks — the managements must “spill the beans” in the “risk factors” because if they don’t, and something bad happens that they didn’t talk about, they will be sued.

In general I am not a fan of a “liberal arts” education. ?I am a fan of math and science. ?But truly, I want both. ?We homeschool, and our eight kids are “all arounds.” ?They aren’t all smart, but they tend to be equal with verbal and quantitative reasoning. ?Truly bright people are good with both math and language. ?Final quotation from the article:

?The whole point of making these things exchange-traded was to make them accessible to retail investors,? said?Colbrin Wright, assistant professor at?Brigham Young University?in Provo,?Utah, who has written academic articles on the indicative values of ETNs. ?The majority of ETNs are overpriced, and about a third of them are statistically significant in their overpricing.?

So, I contacted Colby Wright, and we had a short e-mail exchange, where he pointed me to the paper that he co-wrote. ?Interesting paper, and it makes me want to do more research to see how great ETN prices can be versus their net asset values [NAVs]. ?That said, end of the paper errs when it concludes:

We assert that the frequent and persistent negative WDFDs [DM: NAV premiums] that appear to be driven by?uninformed return chasing investors would not exist to the conspicuous degree that we observe if ETNs?offered a more investor-driven and fluid system for share creation. We believe the system for share?creation is ineffective in mitigating the asymmetric mispricing investigated in our study. Hence, we?recommend that ETN issuers reformulate the share creation system related to their securities.?Specifically, we recommend the ETN share creation process be structured to mirror that of ETFs. At a?minimum, the share creation process should be initiated by investors, rather than by the ETN issuers?themselves, as we believe profit-motivated investors will be more diligent and responsive in creating?ETN shares when severe mispricing arises.

Here’s the problem: ETNs are debt, not equity. ?To have the same share creation system means that the debtor must be willing to take on what could be an unlimited amount of debt. ?In most cases, that doesn’t work.

So I come back to where I started. ?Be skeptical of complexity in exchange traded products. ?Avoid complexity. ?Complexity works in favor of the one offering the deal, not the one accepting the deal. ?I have only bought one structured note in my life, and that was one that I was allowed to structure. ?As Buffett once said (something like this), “My terms, your price.”

To close, here are four valuable articles on this topic:

So avoid complexity in investing. ?Do due diligence in all investing, and more when the investments are complex. ?I am astounded at how much money has been lost in exchange traded investments that are designed to lose money over the long term. ?You might be able to avoid it, but someone has to hold every “asset,” so losses will come to those who hold investments long term that were designed to last for a day.

On Approximate Valuation Methods

Posted on 17 April 2014 by David Merkel

The growth of corporations is always constrained by something. ?The trick is figuring out what the “something” is. ?Tonight, I am here to simplify it for you.

Financial businesses that are regulated

We value these via book value or tangible book value. ?Capital levels constrain business growth, so look at the return on equity to help modify what the proper valuation level should be. ?Book value and return on equity are what govern.

Non-financial?businesses that are regulated, such as utilities?

Look to the rate base that the regulators use. ?Book value might be a good substitute, but look to see how companies might invest to increase their “rate base.” ?Market Cap as a ratio to what the regulators allow profits on would be ideal.

Unregulated businesses that are mature

These are governed by sales per share, calculating the price-to-sales ratio. ?In general, it is wise to buy these when the P/S ratios are low, and sell them when they are high.

Unregulated businesses that are not mature

This is the complex part of valuation, but in this case the PEG Ratio makes sense. ?Companies that grow their earnings rapidly can justify high P/E multiples, but in general they need to grow earnings more rapidly than their P/E ratio expressed in percentage terms.

I don’t invest in many immature businesses, so this is not so relevant to me. ?I look for places where businesses are neglected, and I buy, while selling businesses that are more then fully valued.

Summary

Think about compounding. ? Ask what will best compound the growth of your capital. ?I suspect that it will resemble what I have written here. ?Focus on compounding and ignore Modern Portfolio Theory. ?Compounding is real business. ?MPT is fakery from men who could not build a business.

Peterson’s Guide to Financial Blog Commenters

Posted on 16 April 2014 by David Merkel

I’ve been blogging for over seven years… this is just an experiment, and unlikely to be repeated. ?Here goes:

Have you ever read through comment streams on major financial news and blogging websites? ?Or the Message Boards at Yahoo? ?It is often ugly, bitter, and uninformed. ?That’s why I am bringing to you the?Peterson’s Guide to Financial Blog Commenters! ?Let’s have a look at the zoo:

The Insult Masters

There are many who can’t argue the details of an article, so it saves time and face to insult the author or other commenters. ?These are all too common, and make life dreary for serious thinkers.

The Person with a Little Insight

There are well-meaning and knowledgeable commenters, and they are a breath of fresh air compared to most of those who comment. ?Would that we had more of them. ?More often found in places where authors don’t write offensively.

The Person with a Lot of Insight

This is rare, but occasionally you get commenters that know more than the writer, or at least are on a par. ?If you spot them in the wild, take a snapshot of them, and send it in to the Aleph Blog. ?I appreciate great wisdom wherever it is found. ?Usually found as blogs that take a studious and serious tone.

Cult Members / Victimhood

The internet has many nooks and crannies, more than a mountain of English muffins. ?Let me point out a few with respect to cults & victimhood:

Cults

Bitcoin
Xenophobia
Guns

Victimhood

Bush
Obama
1%
Bankers
Government
Big Biz & Big Government
The Purple Party (I.e. “there ain’t a dime’s worth of difference between the Republican and Democrat parties.” George Wallace)
Jews — Really? ?We haven’t gotten past this? ?Anti-Semitism is so 20th Century.

Partisan Hacks

You know how the world works, and you talk down to the unwashed who don’t agree. ?Though they may deprecate religion, they are as bad as the worst of the religious in not listening to the views of the other side — after all, they have the knowledge that few do.

Too Much Time on Your Hands

I don’t know why some people leave incredibly long comments at a website or blog. ?It would be far better for them to start their own blog where they can showcase their work, and put it forth positively, rather than merely reacting.

The Writer is a Shill

There are some commenters that exist only to push a view for which they are compensated. ?Be wary of those who stridently comment in areas where there is some financial advantage to do so.

Pushes Pet Issue

Much like the cult members and victims, there are those that will push their pet issue, because that is a main goal of theirs.

Tells Sob Story

Cute kid, huh? ?But some people use comment threads to grieve over their story where they allege they were abused by powerful corporations, governments, etc.

Joker

Some just make jokes about the article or comments, and this is perhaps the most common of all… after all, who doesn’t like a good joke? ?Unless, of course, you are the target…

Pot Shots

There are many who go for quick hits on authors or commenters. ?After all, in an anonymous culture, there is no cost to being insulting or rude. ?So take a pot shot, right?

Ranters

Like those that have to much time on their hands, those that rant have a lot to say, and you are entitled to all of it.

Pedant

Finally, the least valuable — those that insist on points of grammar, when the sense of the communication is easily known.

Summary

My main point here is that most who comment on financial websites and blogs should not do it, or they should change, so that they comment in such a way that they elevate the discussion above the analogy of a common brawl. ?Do unto others as you would have others do unto you. ?Aim for the good of others, rather than putdowns. ?It’s that simple.

On a Concentrated Bond Market

Posted on 14 April 2014 by David Merkel

There have been a few articles recently on the underperformance of Pimco, and on the increasing concentration on the buy side of the bond market. ?There is danger here for large active managers and their clients.

Two years ago, I wrote a piece called?Don?t Become the Market. ?Though the piece doesn’t talk about it, I wrote it partly to explain the “London Whale” problem of JP Morgan. ?Anytime you become big relative to a market that you use, your own actions affect the prices of the market. ?This means that a market dominated by a firm or set of firms pursuing a similar strategy will no longer be able to rely on prices as a reasonable guide in assessing risk.

Smaller players, who can trade without affecting prices, can still make their estimates of risk at current prices, and they can trade against larger players. ?Though there are initially economies of scale, once you get big enough as an active investment manager, the diseconomies of scale kick in.

It is relatively easy to outperform when you are a small manager. ?But when you get big as an active manager, you begin to find that you can’t find so many good investable ideas. ?Now, if you were a passive manager like Vanguard, you wouldn’t have to worry — just own an even slice of everything, and complain that you don’t get a decent allocation on bond IPOs.

Because of this, I tend to use smaller managers for money that is not passively managed. ?The smaller the manager, the more he can take advantage of off-the-beaten-track ideas. ?If he is a trader (unlike me), being small is an advantage if he has skill.

There is an exception to this, and it is for institutions that buy and hold fixed income obligations. ?In that case, holding 50% of the issue is not a problem if you’ve done your credit work right. ?You have no intention of selling, and you will bear the few losses that you take. ?If a large manager acts like that, it can work so long as its financing cannot run, and the defaults are not overwhelming.

My advice to readers is to use lesser-known and smaller investors if doing active investing. ?If they have a a good record, use them. ?You can benefit with them as they grow.

Sorted Weekly Tweets

Posted on 12 April 2014 by David Merkel

US Policy & Politics?

Nearly Half of Dodd-Frank Rules Still Unwritten?http://t.co/TwzSawT298?Experiment of regulation by study committees continues albeit slow $$?Apr 12, 2014
Banks Given Two Extra Years to Fully Comply With Volcker Rule http://t.co/XVfO9CKMm7?Banks prefer abolition; Fed offers a delay $$ #more??Apr 12, 2014
How Big Banks Created a Fed to Serve Their Own Interests?http://t.co/tUlNYE3px5?Fed almost always ends up being a shill 4 the banks $$ $XLF?Apr 12, 2014
Angry students snap photos of lunches, tell Michelle Obama: ‘You call this a [expletive] lunch?’?http://t.co/PY4gfa90oI?Food Nazis r mean $$?Apr 12, 2014
On equal pay for women, Obama challenges GOP to ‘join us in this the 21st century’ http://t.co/wthQJKwsOO?White House has own disparities $$?Apr 12, 2014
When the Messenger Is Worth Shooting?http://t.co/GGuAxpkizc?Fewer & fewer people think teaching financial literacy 2 avg ppl works $$ $SPY?Apr 12, 2014
Republicans should be friendly to markets, not to business?http://t.co/YXEWNr9MEh?Big business excellent at co-opt laws 4 their own good $$?Apr 12, 2014
Maybe a Gender Pay Gap Is OK?http://t.co/2rtYIZ6MFo?This argumentation isn’t new; economists have been making this argument since the 70s $$?Apr 12, 2014
The Best SEC Money Can Buy?http://t.co/wbwBB0CYd4?@ritholtz on Jim Kidney’s excellent retirement speech on the SEC which is worth reading $$?Apr 12, 2014
Food Price Shock, 2014 Edition?http://t.co/u79xlrwK1I?Note that the last time this happened, wars & other pains hit developing world $$?Apr 12, 2014

Market Impact

Hedge Fund Industry Growing With Pensions To Thank?http://t.co/RF2FTh3YsD?Probably a mistake as hedge funds tend not 2b good w/volatility $$?Apr 12, 2014
Hedge Funds Unwind As Growth To Value Rotation Intensifies?http://t.co/XoK1RFKiAg?As growth stocks correct, hedge funds chase performance $$?Apr 12, 2014
How Money Managers Fight Their Emotions and Sometimes Lose http://t.co/J0KH06m12P Too Bold? Not bold enough? Tough 2strike right balance $$?Apr 12, 2014
The Buys You Can?t Make Yourself?http://t.co/0swRNG0Eyo?@reformedbroker points out the value of @MebFaber ‘s global value ETF $GVAL $$?Apr 12, 2014
Humble Student of the Markets: A quant lesson from a technician http://t.co/svQilIRW4m Useful way to understand indicators & mkt regimes $$?Apr 12, 2014
2014 crash will be worse than 1987’s: Marc Faber?http://t.co/Guil41sSvP?Bold w/respect to timing &severity of the next crisis, prob wrong $$?Apr 12, 2014
Do ‘rising rate’ ETFs really protect investors??http://t.co/tcx2p4qtuc?I would b wary here; additional yield often carries hidden risks $$?Apr 12, 2014

Rest of the World

Kuroda Seen Brewing Yen-Weakening Surprise Action?http://t.co/fVpFvwEiJz?Don’t b shocked if the BOJ does yet more to weaken the yen $FXY $$?Apr 12, 2014
This is the bank to watch for a Chinese credit implosion?http://t.co/sKL9NPruZz?Minsheng is an aggressive lender 2the most dodgy credits $$?Apr 12, 2014
China?s steelmakers have branched out into shadow banking?which is funny since they owe $484B?http://t.co/Z1IzHBJJ7G?Brief stmt of prob $$?Apr 12, 2014
China Pizza Passion Has Fonterra Riding Mozzarella Wave?http://t.co/J4605GnGK4?Pizza is so different than traditional Chinese food $$ $YUM?Apr 12, 2014
Ukraine?s Rust Belt Faces Ruin as Putin Threatens Imports?http://t.co/7BYk6ULy3t?Russia has more ec influence on Ukraine thn US on Russia $$?Apr 12, 2014
Saudi Banks Reject Algosaibi Meeting on $5.9B Default?http://t.co/6eZwowBlZW?Islamic finance struggles w/debt that isn’t debt but is debt $$?Apr 12, 2014
Lavender-Filled Teddy Bears From Tasmania Are a Big Hit in China http://t.co/ubhWoUSnQz?Bobbie Bear touches the hearts of Chinese ladies $$?Apr 12, 2014
Top economists warn Germany that EMU crisis as dangerous as ever http://t.co/gsqrbZ5ox0?Overall & banking leverage still higher than safe $$?Apr 12, 2014
Fracking’s hottest year in China?http://t.co/5xVoKK6K0d?China finds gas & tight oil in their shale formations. Who knew? $$ $FXI $XLE?Apr 12, 2014

Companies & Industries

Time Inc. to Raise $1.4B in Debt for Spinoff?http://t.co/8QUGvyKhrv?I would b careful here; levering up old media not a recipe 4 success $$?Apr 12, 2014
Vox Takes Melding of Journalism and Technology to a New Level http://t.co/YdMuuu0ZQC?Vox Media creates a content mgmt system 4 journalism $$?Apr 12, 2014
Trailer Parks Lure Wall Street Investors Looking for Double-Wide Returns http://t.co/zym4OmSDP5?Poor people have a hard time moving $$?Apr 12, 2014

Other

Stay-at-Home Moms Rise in Reversal of Modern Family Trend http://t.co/sCBErpTIhk?Children deserve attention to help them grow up $$ $SPY?Apr 12, 2014
More Moms Staying Home, Reversing Decadeslong Decline?http://t.co/w7bnhw8tQd?Value in efforts 2 produce better children w/more parenting $$?Apr 12, 2014
Font War: Inside the Design World’s $20M Divorce?http://t.co/4YpYf1x5UN?Not clearly spelling out a partnership agreement: font of trouble $$?Apr 12, 2014
Windows XP Goes Dark; Will Hackers Be Lurking??http://t.co/GPBJKpzdhf?XP has been debugged; odds of significant holes are low $$?Apr 12, 2014
After Heartbleed Bug, A Race to Plug Internet Hole?http://t.co/HCBfcHBl5O?A significant part of internet affecting privacy had a hole $$?Apr 12, 2014
Global solar dominance in sight as science trumps fossil fuels?http://t.co/BZOdAVwYbA?Can capture 31% of sun’s energy with a 111V Solar Cell?Apr 12, 2014
At Gross’s Pimco, El-Erian Says ‘Different Styles’ Stopped Working Well Together http://t.co/vRqPfRA67m?Oil & water eventually separated $$?Apr 12, 2014

Wrong

Unsafe: Greece Plans to Issue Long-Term Bond on Wednesday?http://t.co/X4gnld481q?Lust 4 yield guides the behavior of debt investors $$?Apr 12, 2014
Misleading: Oklahoma Swamped by Surge in Earthquakes Near Fracking http://t.co/nHfPIWys3q?All quakes r little which avoids big quakes $$?Apr 12, 2014
Wrong: Are Safer Cars Worth the Money??http://t.co/1N0Y9aklJb?Misapplies benefit-cost analysis; may b cheaper ways 2 save more lives $$ $F?Apr 12, 2014

Retweets, Replies & Comments

‘ @foxjust Nice going; EEBS is breaktakingly honest with respect to earnings manipulation. cc: @jciesielski $$?Apr 12, 2014
RT @ReformedBroker: Reminder: The Fed?s own economic forecasts are basically worse than your dog?s.?http://t.co/uLYirMA5zB?Apr 09, 2014

On Rising Rate Funds, or, Who Remembers ARM Funds in the Early ’90s?

Posted on 12 April 2014 by David Merkel

In the early 90s, there were not many investment actuaries. ?One of the Holy Grail ideas of the early-to-mid ’90s was creating floating rate funds with yield so that floating rate Guaranteed Investment Contracts could be profitably written. ?I chronicled my efforts there in this article.

One avenue that I went down and rejected was ARM [Adjustable Rate Mortgage] funds. ?There was a minor craze for them in the early-to-mid ’90s, and there were not enough ARMs issued to meet the demand for high floating rates. ?As such, the prices for blocks of ARMs rose above par, sometimes significantly.

One truism of buying mortgages at a premium in the ’90s was that the ability to refinance got sharper and sharper. ?Those willing to buy mortgage securities above par usually took losses as rates fell.

Thus when I read articles about rising rate ETFs, which either invest short-term, or short the bond market synthetically or actually, I think “we’ve been here before.” ?It is difficult to gain incremental yield on short duration instruments without taking on risks like:

Credit, including weak covenants
Structure (another form of credit & illiquidity)
Negative optionality

So be wary here. ?Pay more attention to the return of your principal than the return on the principal.

I?m Not in This for Love

Posted on 11 April 2014 by David Merkel

Much as I appreciate those who like what I write at this blog, I don’t write to be loved. ?I don’t write to be hated, either. ?I am sensitive to what people think of me, but not to the degree that it changes what I write.

I may have nonconsensus views on:

The Federal Reserve
Gold
Social Security & Medicare (and their cousins around the globe)
The current Bull Market in Stocks and Corporate Bonds
Long Treasuries
and more…..

But I write what I write to disclose the truth. ?I am an active equity manager, but I encourage people to use passive investing via index funds, unless they can find a manager who can reliably obtain outperformance.

I don’t blog for economic advantage. ?If I wanted to do that, I could channel a wide variety of ideas on investing that are popular, but I know are marginal at best in terms of effectiveness.

Some friends of mine have told me, “Why don’t you write about companies that you own, or companies that look attractive to you?”

I’ve been burned by doing that. ?For every ten that you get right, you get the same response from every one you get wrong. ?As with most of the web, the complainers dominate. ?That’s why I don’t trot out many individual stock ideas. ?It’s not that I don’t have them, but I only share them as a group, not as a single idea, most of the time.

Summary

I’m here to tell the truth, even if it cuts against my own short-term economic interests. ?Most of the time, I adjust my portfolio so that it is ready for everything, but sometimes I delay, because I know that changes in the market usually happen slowly.

I do not write to be popular. ?I write to change the consensus, unlikely as that will be. ?Finance is a perverse area of life where fear and greed take over. ?And with academics, they have these lame models that are fit for Vulcans (maybe) but not humans (and certainly not Ferengi).

We need new models that reflect the fear-greed cycle, and make valuation a significant input in risk assessments.

I’m not in this for love; I only want to change the way that we view investment decisions.

To Live off of, and Die from, the Equity Premium and Alpha

Posted on 10 April 2014 by David Merkel

I’m working on my taxes. ?I’m not in a good mood. ?Okay, writing that made me chuckle, because I am usually in a good mood.

Let me divide my working life into four segments:

1986-1998: Actuary — reasonably well paid, and significantly underpaid compared to the value I delivered.
1998-2007 — Investment risk manager, Mortgage bond manager, Corporate bond manager, and Senior Analyst at a long/short hedge fund. ?Paid well for my efforts, and the ?rewards to clients were far more than what I was paid.
2007-2010 — Almost no pay, as I deal with home issues, provide research to a small minority broker-dealer, and try to gain institutional asset management clients. ?Living off of assets from earlier days.
2010-2014 — Living off of asset income as I slowly build a retail and small institutional client base for my value investing.

The last two periods are the most interesting in a way, because I was drawing more income from investments than I was from any other source. ?Even during my time at the hedge fund, I made more money from my own investing every year than I was paid, and I was paid well. ?That said the mid-2000s were a hot time, particularly if you made the right calls on a growing global economy.

My net worth today is roughly where it was at the peak of the markets in 2007, despite my low wage income. ?I have been bailed out by the returns of the equity market and my alpha.

This is not a comfortable place to be, because general equity returns are not predictable, and alpha, though I have had it for years, is not predictable either. ?That said, my client base has been growing, and in another year or so, my practice should support my family even if the markets don’t do well.

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Though I just told a story about me, the real story isn’t about me. ?Think of all of the people who are trying to manage their lump sum in retirement. ?They are relying on strong equity markets; they are hoping for alpha. ?They are not ready for setbacks.

Unless you are seriously wealthy, when you are not receiving reliable income from a wage-like source, you can feel like you are in a weak position. I have felt that on occasion, but in general ?I have not worried.

I write this because equity outperformance over bonds will likely be limited over the next ten years. ?I peg equities at about a 5%/year average nominal return, with a diversified portfolio of bonds at around 2-3%/year. ?Also the ability to add alpha is limited, because alpha is zero in total, and are you smart enough to find the managers that can do it?

In desperate times desperate men do desperate things. ?Low interest rates are leading many to speculate more than they ordinarily would. ?Equity allocations go higher. ?Allocations to “alternatives” go higher. ?People start using nonguaranteed income vehicles as if they had the structural protections of bonds.

As I always say, be careful. ?Those trying to manage a lump sum for income in retirement are playing a dangerous game where if you try to draw more than 3.5%/year with regularity will prove challenging, because that is playing at the boundary of what the assets can deliver, and leaves little room for an adverse scenario. ?Be careful.

Book Review: Letters to a Young Analyst

Posted on 8 April 2014 by David Merkel

We need to spend more time thinking about the big picture issues in investing. ?Why do we do what we do? ?How do we structure our firm to get the best out of the talented people that we employ? ?Where do we really have a sustainable competitive advantage?

This slim volume has much advice in these areas, but focuses on how young analysts can make themselves valuable to the firms that they work for.

In addition to the advice of Tom Brakke, you get the advice of 12+ analysts, many of whom I respect, explaining the “nuts and bolts” of good analysis to young analysts. ?I was on of the twelve, and judging from the other comments, there are many who remember what it was like to be young and grasping for help. ?What would we have done differently, given our acquired knowledge? ?This book is meant to give young and amateur investors a leg up.

The end of the book gives a wealth of resources on how the young analyst can learn. ?In this era, it’s almost more of a question of excluding pervasive bad content.

This is a great book for young analysts, and serious amateur stockpickers. ?If you are interested, you can buy it here.

Unlike most of my book reviews, there is no way for me to profit off of this one, not that I ever profit much off of my book reviews. ?If you buy it, I encourage you to study it, because many older investors have given their best to aid young analysts.