2014 – Page 2 – The Aleph Blog

Is This Legit?

Posted on 12 November 2014 by David Merkel

Photo Credit: .SilentMode || Doubts that the deal is legitimate?

I’ve written a lot about financial fraud at Aleph Blog. ?I try to encourage people to be skeptical, because it is genuinely rare when a deal is exceptionally good for an average person. ?Most of the time in life, you are doing pretty well if you are getting a fair deal, particularly when it comes to financial matters. ?Most people selling financial products know more about the product than the?prospective buyer.

Thus, Aleph Blog has written about a wide number of deals that are bad, and those that are outright fraudulent. ?(At the end of this article, there will be a sample of articles that I have written.) ?Not that anyone appointed me, but I regard this as one of my sub-missions, in writing this blog. ?Cleaning up the investment world should be a goal of many legitimate investors, because the cleaner things are, the better the culture of trust will be for legitimate financial products.

Now, Aleph Blog does this service on two bases: free and paid. ?Free is for the simple stuff. ?If you write an e-mail to me asking “Is this legit?” and it is simple enough for me to give a quick answer through a blog post, I will likely (but not certainly) write a post on it, or point you to one I have written. ?I may even answer the companion question, “Is it a smart thing to do?” ?Most of what I do here will fall into the free category.

The complex stuff is another matter. ?I have done analyses like these for prior employers, and on a freelance basis for wealthy individuals and corporations. ?Examples have included:

Analyzing whether the Permanent Portfolio idea works or not (and other investing theory questions).
Analyzing a complex tax avoidance deal that involved insurance, securitization, and other factors.
Analyzing whether a private business deal looks legitimate.
Analyzing whether a securitization deal looks legitimate.
Analyzing complex bonds or other securities for value.
Giving a second opinion on an investment question.
Giving a second opinion on a new investment product.
Giving a second opinion on a financial plan.

I like an occasional complex project because it keeps my skills sharp. ?I am a good financial modeler, and though I did not go to the finals the last two years in the Modeloff competition, I placed well in the first round the last two years, and in the second round in 2013 was in the top half, and though I qualified, this year I could not compete in the second round due to a schedule conflict (presbytery meeting).

If a project does not fit my expertise, I will turn it down. ?Why waste your?time and mine? ?If I don’t have slack time, I will turn it down — my investment clients come first. ?But if you have an interesting project that you think might fit me, email me, and let’s talk. ?I am willing to sign confidentiality agreements, and not publish the results if need be.

Beyond that, let’s make the financial world better, and eliminate as many scams as we can.

Articles

On the ?770? Account?– using life insurance as an asset accumulation tool — generally a bad idea. ?(Gets a lot of hits a my blog regularly), also?Using Life Insurance Products to Fund Long-Term Needs
Why Are We The Lucky Ones??– on some private securitizations and collateralized loans that never saw the light of day due to my due diligence.
My continuing articles on promoted stocks
The Madoff series ? A New Appreciation for the Plumbing, Book Review: No One Would Listen, Book Review: The Club No One Wanted To Join, Book Review: How To Smell a Rat, Book Review: The Wizard of Lies, Enduring Ponzi
On Con Men?– on a sketchy business plan
On Con Men, Advanced Edition?– various sorts of?financial products that are usually not good deals
On Hucksters?– business ideas that were “too good to be true”
Get a Piece of the Schlock?– On “Rich Dad”
Selling Options Cheaply (Did You Know?)?– on structured notes, and other dodgy bonds
On Avoiding Con Men?– being wary of passive income streams generally
Book Review: The Big Con?– a review of the con men of yesteryear with applications to today
Permanent Asset Allocation?– on the Permanent Portfolio idea — I have more unpublished behind this.
Bombing Baby BDC Bonds?– even though the deal has gone well so far, the protections are weak, and the bonds are illiquid
The Art of Extracting Large Commissions From Investors?– legitimate financial products that you should usually avoid
Protect Your Older Family & Friends?– scams that prey on the elderly

Hey, thanks for reading… 😉 and play it safe, please.

Book Review: Bad Paper

Posted on 11 November 2014 by David Merkel

This book has two significant types of insights: on people and on market failure.? It does well with both of them, but spends most of its time on the former, because it is more interesting.? That said, the second set is more important, and is buried in a few places in the second half of the book.

With people, this book answers the following questions:

Why does this book largely take place in Buffalo, NY? Because entrepreneurs got started there, and found it easy to acquire talent there.
Why does the industry employ a lot of ex-convicts? There are some crossover benefits to having been through the rough-and-tumble of street life that gives an edge in dealing with desperate people who have bad debts.
Is there an ethical code for debt collectors? Well, yes, sort of.? Kind of like ?the code? from the movie Repo Man ? don?t tell debtors they are in legal trouble, don?t threaten, treat them with kindness, don?t buy debt where you don?t have a clear chain of title, don?t sell lists of debts to collect where the debtors have already been verbally flogged.
Do all debt collectors follow the code? Well, no, and that is one place where the book gets interesting, as various debt collectors look for edges so that they can make money off of debts that creditors have given up on.? There *is* honor among thieves, and be careful if you cross anyone powerful or desperate enough.
Can?t you use the legal system to try to recover money on the debts? Well, only at the end, and even then it is difficult, because if the debtor asks for evidence on the debt that is being collected, the debt collector usually doesn?t have it, and the case will be dismissed.? It is best for collectors to come to settlements out of court.

The book follows around debt collectors and those associated with them, a colorful bunch, who see their see their opportunities flow and ebb as the financial crisis first produces a lot of bad debts to work on, and they mine that ore until the yields get poor.? Some of these people you will gain sympathy for, as they are trying to make a buck ethically.? Others will turn you off with their conduct.

As for market failure issues, you might wonder why the credit card companies and other creditors don?t pursue the debtors themselves.? Why do they sell the right to collect on unsecured debts at such deep discounts to the face value of the debts? [Pennies on the dollar, or less?]

The creditors don?t want to make the effort to dig up the necessary data to make the case in court a slam-dunk.? It would not pay for them to do so in most cases given the large number of cases to pursue, and the relatively small amounts that would be recovered.? That?s why the debts are sold at a discount.

Some debts don?t get removed from databases when payments are made to close them out, and as such some debt collectors try to collect on debts that were once in default, but paid off in a compromise.? This could be remedied if there were a comprehensive database of all debts, but the costs of creating and updating such a database would likely be prohibitive.

Finally, you might ask where the regulators are in all of this.? Between the States and the Feds, they try to clip the worst aspects of debt collection, but they are stretched thin.? This means that for many people, the optimal strategy is not to pay on defaulted unsecured debts, and challenge them if they take you to court.

Quibbles

Lots of foul language, but you?re dealing with the lowest rungs of society, so what do you expect?

Summary / Who Would Benefit from this Book

This is a good book if you want to understand the unsecured debt collection business. ?If you have friends who are troubled by debt collectors, it might be worth a purchase, and lend the book to them. ?If you still want to buy it, you can buy it here:?Bad Paper: Chasing Debt from Wall Street to the Underworld.

Full disclosure:?I?received a?copy from the author?s PR flack.

If you enter Amazon through my site, and you buy anything, I get a small commission.? This is my main source of blog revenue.? I prefer this to a ?tip jar? because I want you to get something you want, rather than merely giving me a tip.? Book reviews take time, particularly with the reading, which most book reviewers don?t do in full, and I typically do. (When I don?t, I mention that I scanned the book.? Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.? Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.? Whether you buy at Amazon directly or enter via my site, your prices don?t change.

Revenue Misses Can Be Good

Posted on 8 November 20149 November 2014 by David Merkel

Photo Credit: Phineas Jones || Beyond the destruction, honesty?

Few like revenue misses, but let me point out a few?significant things that investors should care about:

If a company misses revenue estimates around 50% of the time, that can be an indicator that it doesn’t play around with revenue recognition, which is probably the most common way of shading accounting results. ?Honest accounting is worth a lot in the long-run, even if the market won’t pay up for it in the short-run.
If a company beats revenue estimates nearly all the time, do a little digging into revenue recognition policies. ?Have they changed? ?It may be that the company is hitting on all cylinders, but that is difficult to keep up for a long time. ?How do accounts receivable look?
If a company misses revenue estimates nearly all the time, take a look at what they are saying about their marketing, and analyze the industry and competition. ?If it is due to the industry, that might not be so bad if you are getting the company’s shares at a cheap valuation. ?If it is due to other reasons, it might be time to look elsewhere…
If you are late in the company’s product pricing cycle, and competitors are overly aggressive, good companies may take a step back and emphasize profitable business over volume, if fixed costs aren’t too high. ?In a pricing war, analyze who has the capability of living through it — maybe it is time to avoid the sector, or simply own the strongest company there, as you wait for capacity to rationalize.

Regardless, it can be a good exercise to look at the current asset accruals of the non-financial companies that you own to see if they look high, because of the higher odds of an earnings disappointment if those accruals are too aggressive. ?If you need a summary statistic to look at, perhaps use normalized operating accruals or the days outstanding in the cash conversion cycle for receivables plus?inventories?minus payables as a fraction of revenues.

That’s all for now.

Problems in Simulating Investment Returns

Posted on 6 November 2014 by David Merkel

Photo Credit: Hans and Carolyn || Do you have the right building blocks for your model?

Simulating hypothetical future investment returns can be important for investors trying to make decisions regarding the riskiness of various investing strategies. ?The trouble is that it is difficult to do right, and I rarely see it done right. ?Here are some of the trouble spots:

1) You need to get the correlations right across assets. ?Equity returns need to move largely but not totally together, and the same for credit spreads and equity volatility.

2) You need to model bonds from a yield standpoint and turn the yield changes into price changes. ?That keeps the markets realistic, avoiding series of price changes which would imply that yields would go too high or below zero.?Yield curves also need ways of getting too steep or too inverted.

3) You need to add in some momentum and weak mean reversion for asset prices. ?Streaks happen more frequently than pure randomness. ?Also, over the long haul returns are somewhat predictable, which brings up:

4) Valuations. ?The mean reversion component of the models needs to reflect valuations, such that risky assets rarely get “stupid cheap” or stratospheric.

5) Crises need to be modeled, with differing correlations during crisis and non-crisis times.

6) Risky asset markets need to rise much more frequently than they fall, and the rises should be slower than the falls.

7) Foreign currencies, if modeled, have to be consistent with each other, and consistent with the interest rate modeling.

Anyway, those are some of the ideas that realistic simulation models need to follow, and sadly, few if any follow them all.

Stay Calm

Posted on 5 November 2014 by David Merkel

Photo Credit: Moyan Brenn || Relax, you know less than you think... — Photo Credit: Moyan Brenn || Relax, you know less than you think…

So, the Republicans swamped the Democrats in the midterm elections.

Big deal.

The differences between the varying wings of the Purple Party are smaller than you think. ?What’s more, their willingness to magnify those differences and do little as a result is a high probability outcome.

Add in that the Republicans don’t have a coherent set of policies as a group. Will the t-party and Establishment wings of the GOP come to a meeting of the minds? (Democrats may insert easy cheap joke here.) ?Even if they do, who will take the blame when Obama vetoes their bills? ?They aren’t called the “stupid party” for nothing. ?They have a peculiar knack for snatching defeat from the jaws of victory, and letting their less presentable members define them.

Even if in theory, the markets do better from Republicans, in practice the reverse seems to be true. ?But the track record has so few data points that statistical credibility is low.

And, if there is something to the Republicans being in power moving the markets, how would you know if it wasn’t anticipated in the recent run-up of prices? ?Many parties may have bought into the concept of greater prosperity as result of the then-forthcoming elections. ?The time to buy?the rumor is gone. ?The time to sell the news may be here.

The same applies to the presidential cycle. ?Many argue that we are heading into a good time for the markets in the third and fourth year of a presidential term. ?Too many are arguing this in my opinion, and even if there is some real impact from presidential terms, perhaps the market is anticipating this as well. ?After all, the bad part of the presidential cycle looked pretty good this time around.

Add in that again we are working with the law of small numbers — the presidential cycle could just be due to?randomness. ?Some part of the presidential cycle had to look better. ?Is it so much better than any other subset could have been?

The same thing applies to the argument I am seeing trotted around that we are coming into the best six months?of the year. ?Cue the comments on the law of small numbers and randomness. ?Even if there is a structural reason like tax-based selling, might it have been anticipated this time around? ?Markets tend to anticipate. ?Some six month period had to be best… but is it due to randomness?

Going back to politics, I would point out that few significant things change in politics off of party affiliation. ?How many states have their budgets balanced on an accrual basis, taking into account the need to spread out the cost of infrastructure projects, and?pensions funded assuming a realistic 5% earnings assumption on assets, together with fully funded accrual accounts? ?None. ?All of the states put off paying for the accruals of what should be current expenses.

We’ve talked about entitlement reform, but action never happens, except further expansion, as under Bush, Jr. ?Will we see GSE reform, or will Congress continue to use the GSEs for their own ends? ?Will there ever be significant cuts in defense? ?Will we ever see truly balanced budgets on an accrual basis?

Beyond that, consider the Fed, the Supreme Court, and the bureaucracy generally… they don’t change rapidly, if at all. ?Admittedly, the Supreme Court has been more activist over the recent past… so maybe I am wrong there.

And truly, Congress changes only at the edges. ?The grand majority?of the same faces will be there, only the majority and committee assignments shift. ?That may not mean much.

But do we want lots of change? ?Individually, many of us do, but if you add us all together, it often nets to something near zero. ?Perhaps most of us are happy with that, given the alternative that those of us with the opposite views might impose them on the rest of us.

I leave you with this: don’t make too much out of the election results, the presidential cycle, the “sell in May and go away” phenomenon, etc. ?The world is complex, with many people trying to anticipate market reactions. ?Untangling them is close to impossible, so stay calm, and pursue the ordinary strategies that you always do. ?For me, I will continue my value investing.

Back to RT Boom/Bust

Posted on 1 November 20141 November 2014 by David Merkel

On Thursday, November 23rd, I was recorded to be on RT Boom/Bust. The first half of it played that day, and the video of it is below:

We covered a lot of ground in a short amount of time. ?Here are the topics, with articles of mine that flesh out my thoughts in more detail (if any):

The falling price of crude oil.
Whether it is a great time to be in stocks (I give a mixed answer), see comment near bottom of this article on actual versus implied volatility.
On the Permanent Portfolio concept?(also here)
On Buffett’s stock holdings not doing so well, versus those of some hedge funds and value managers (On how Buffett has changed over the years — also here)
On the use of free cash flow for organic growth, dividends, and buybacks? (also here?[includes a mention of IBM] and here)

The second half of it played today on October 31st, and the video of it is below:

Here we talked about the following:

The rally in Long Treasuries
A few investment ideas (Russia, Brazil, LUKOIL, Ensco, Navient, and SABESP)
Using dividend paying stocks as a bond substitute for income?(also here)

I really appreciated being on the show. ?Hope you enjoy the videos. ?Thinking fast is a challenge, and you can often see me trying to gather my thoughts.

My thanks to Erin, the producer Ed Harrison, and their segment producer, Bianca.

Full disclosure: long LUKOY, ESV, NAVI and SBS for clients and me

Redacted Version of the October 2014 FOMC Statement

Posted on 29 October 2014 by David Merkel

September 2014	October 2014	Comments
Information received since the Federal Open Market Committee met in July suggests that economic activity is expanding at a moderate pace.	Information received since the Federal Open Market Committee met in September suggests that economic activity is expanding at a moderate pace.	No change. This is another overestimate by the FOMC.
On balance, labor market conditions improved somewhat further; however, the unemployment rate is little changed and a range of labor market indicators suggests that there remains significant underutilization of labor resources.	Labor market conditions improved somewhat further, with solid job gains and a lower unemployment rate. On balance, a range of labor market indicators suggests that underutilization of labor resources is gradually diminishing.	Shades their view of labor use up.? More people working some amount of time, but many discouraged workers, part-time workers, lower paid positions, etc.
Household spending appears to be rising moderately and business fixed investment is advancing, while the recovery in the housing sector remains slow.	Household spending is rising moderately and business fixed investment is advancing, while the recovery in the housing sector remains slow.	Shades up household spending a little.
Fiscal policy is restraining economic growth, although the extent of restraint is diminishing.		Finally dropped this bogus statement.
Inflation has been running below the Committee’s longer-run objective. Longer-term inflation expectations have remained stable.	Inflation has continued to run below the Committee’s longer-run objective. Market-based measures of inflation compensation have declined somewhat; survey-based measures of longer-term inflation expectations have remained stable.	Shades their forward view of inflation down.? TIPS are showing slightly lower inflation expectations since the last meeting. 5y forward 5y inflation implied from TIPS is near 2.35%, down 0.18% from September.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.	Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.	No change. Any time they mention the ?statutory mandate,? it is to excuse bad policy.
The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators and inflation moving toward levels the Committee judges consistent with its dual mandate.	The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators and inflation moving toward levels the Committee judges consistent with its dual mandate.	No change.? They can?t truly affect the labor markets in any effective way.
The Committee sees the risks to the outlook for economic activity and the labor market as nearly balanced and judges that the likelihood of inflation running persistently below 2 percent has diminished somewhat since early this year.	The Committee sees the risks to the outlook for economic activity and the labor market as nearly balanced. Although inflation in the near term will likely be held down by lower energy prices and other factors, the Committee judges that the likelihood of inflation running persistently below 2 percent has diminished somewhat since early this year.	CPI is at 1.7% now, yoy.? They shade up their view down on inflation?s amount and persistence.
The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions.	The Committee judges that there has been a substantial improvement in the outlook for the labor market since the inception of its current asset purchase program.	No change.
In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in October, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $5 billion per month rather than $10 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $10 billion per month rather than $15 billion per month.	Moreover, the Committee continues to see sufficient underlying strength in the broader economy to support ongoing progress toward maximum employment in a context of price stability. Accordingly, the Committee decided to conclude its asset purchase program this month.	Finally ends QE, for now.
The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction.	The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction.	No change
The Committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate.	This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.	Maintains reinvestment of long-term securities, which does little to hold interest rates down, assuming that is a desirable goal.
The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability.		Finally ends a useless paragraph.
If incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will end its current program of asset purchases at its next meeting.		Deletes sentence
However, asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases.		Deletes sentence
To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate.? In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.	To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.	Highly accommodative monetary policy is gone ? but a super-low Fed funds rate remains.? Policy normalizes, sort of, but no real change.
The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.	The Committee anticipates, based on its current assessment, that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program this month, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.	No change.? Its standards for raising Fed funds are arbitrary.
	However, if incoming information indicates faster progress toward the Committee’s employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated. Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated.	Tells us what we already knew.
When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.	When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.	No change.
The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.	The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.	No change.
Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Stanley Fischer; Narayana Kocherlakota; Loretta J. Mester; Jerome H. Powell; and Daniel K. Tarullo.	Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Stanley Fischer; Richard W. Fisher; Loretta J. Mester; Charles I. Plosser; Jerome H. Powell; and Daniel K. Tarullo.	Fisher and Plosser dissent.? Finally some with a little courage.
Voting against the action were Richard W. Fisher and Charles I. Plosser. President Fisher believed that the continued strengthening of the real economy, improved outlook for labor utilization and for general price stability, and continued signs of financial market excess, will likely warrant an earlier reduction in monetary accommodation than is suggested by the Committee’s stated forward guidance. President Plosser objected to the guidance indicating that it likely will be appropriate to maintain the current target range for the federal funds rate for “a considerable time after the asset purchase program ends,” because such language is time dependent and does not reflect the considerable economic progress that has been made toward the Committee’s goals.	Voting against the action was Narayana Kocherlakota, who believed that, in light of continued sluggishness in the inflation outlook and the recent slide in market-based measures of longer-term inflation expectations, the Committee should commit to keeping the current target range for the federal funds rate at least until the one-to-two-year ahead inflation outlook has returned to 2 percent and should continue the asset purchase program at its current level.	Send Mr. Kocherlakota a chill pill, and ask him to review how badly the FOMC forecasts, and how little effectiveness monetary policy has had for the good in the US.? He just wants to create another bubble, along with the rest of the doves.

Comments

Pretty much a nothing-burger. Few significant changes, if any.? Yes, QE ends, but who didn?t expect that?
Despite lower unemployment levels, labor market conditions are still pretty punk. Much of the unemployment rate improvement comes more from discouraged workers, and part-time workers.? Wage growth is weak also.
Equities flat and long bonds rise. Commodity prices are down.? The FOMC says that any future change to policy is contingent on almost everything.
Don?t know they keep an optimistic view of GDP growth, especially amid falling monetary velocity.
The FOMC chops some ?dead wood? out of its statement. Brief communication is clear communication.? If a sentence doesn?t change often, remove it.
In the past I have said, ?When [holding down longer-term rates on the highest-quality debt] doesn?t work, what will they do? I have to imagine that they are wondering whether QE works at all, given the recent rise and fall in long rates.? The Fed is playing with forces bigger than themselves, and it isn?t dawning on them yet.
The key variables on Fed Policy are capacity utilization, labor market indicators, inflation trends, and inflation expectations. As a result, the FOMC ain?t moving rates up, absent improvement in labor market indicators, much higher inflation, or a US Dollar crisis.

Book Review: Berkshire Beyond Buffett

Posted on 29 October 2014 by David Merkel

It’s time to change what Warren Buffett supposedly said about his mentors:

“I’m 85% Ben Graham, and 15% Phil Fisher.”

For those who don’t know, Ben Graham is regarded to be the father of value investing, and Phil Fisher the father of growth investing. ?Trouble is, Warren Buffett changed in his career such that this is no longer accurate. ?Most of Buffett’s economic activity does not stem from buying and selling?portions of public companies, but by buying and managing whole companies. ?Buffett is the manager of a conglomerate that uses insurance reserves as a funding vehicle.

As a result, this would be more accurate about the modern Buffett:

Buffett is?70% Henry Singleton,?15% Ben Graham, and 15% Phil Fisher.

Henry Singleton was the CEO of Teledyne, a very successful conglomerate, and one of the few to do well over a long period of time. ?It is very difficult to manage a conglomerate, but Teledyne survived for around 40 years, and was very profitable. ?Buffett thought highly of Singleton as a allocator?of capital, though the conglomerate that Buffett created is very different than Teledyne.

Tonight, I am reviewing a book that describes Buffett as a manager of a special conglomerate called Berkshire Hathaway [BRK] — Berkshire Beyond Buffett. ?This Buffett book is different, because it deals with the guts of how Buffett created BRK the company, and not the typical and misleading Buffett as a value investor.

Before I go on, here are three articles that could prove useful for background:

Buffett?s Career in Less Than 1000 Words, and
The Forever Fund?– deals with the Burlington Northern Acquisition, and Buffett’s efforts to create a firm that will thrive long after he is gone.
On the Structure of Berkshire Hathaway?– describes how the insurance enterprises, particularly National Indemnity, own and fund many of the industrial subsidiaries.

The main point of Berkshire Beyond Buffett is that Buffett has created a company that operates without his detailed oversight. ?As a result, when Buffett dies, BRK should be able to continue on without him and do well. ?The author attributes that to the ethical values that Buffett has?selected for when acquiring companies. ?He manages to cram those values into an acronym BERKSHIRE.

I won’t spoil the acronym, but it boils down to a few key ideas:

Do you have subsidiary managers who are competent, ethical, and love nothing better than running the business? ?Do they act as if they are the sole proprietors?of the business, and act only to maximize its long-term value consistent with its corporate culture? ?These are the ideal managers of BRK subsidiaries.
Acquiring such companies often comes about because a founder or significant builder of the company is getting old, and there are family, succession, taxation, funding or other issues that being a part of BRK would solve, allowing the management team to focus on running the business.
Do the businesses have sustainable competitive advantages in markets that are likely to be relevant several generations from now?

The beauty of a company coming under the Berkshire umbrella is that Buffett leaves the culture alone, and so long as the company is producing its profits well, he continues to leave them alone. ?Thus, the one selling a company to Buffett gets the benefit of knowing that the people and culture of the company will not change. ?In exchange, Buffett does not pay top dollar, but gets deals done faster than almost anyone else.

This is a very good book, and its greatest strength is that it talks about Berkshire Hathaway the company as built by Buffett to endure. ?If you want to understand?Buffett’s corporate strategy, it is described ably here.

Quibbles

Now, my three ideas above?*might* have been a better way to organize the book, rather than the hokey BERKSHIRE. ?Also, a lot more could have been done with the insurance enterprises of BRK, which are a critical aspect of how the company owns and finances many of the other subsidiaries.

But will BRK do so well without Buffett? ?Yes, his loyal son Howard will guard the culture. ?The Board is loyal to the ethos that Buffett has created. ?Ted Weschler and Todd Combs will continue to invest the public money. ?The all-star subsidiary managers will soldier on, at least in the short-run.

But will the new CEO be the person that “you don’t want to disappoint,” as some subsidiary managers think of Buffett? ?As a result, how will BRK deal with underperformers? ?What new structures will they set up? ?Tracy Britt Cool is smart, but will BRK need many like her, and how will they be organized?

Will he be a great capital allocator? ?Will he maintain the “hands off” policy toward the culture of subsidiaries, or will the day come when some centralization takes place to save money?

Will Buffett’s replacement be equally intuitive with respect to acquisition prices, and sustainable competitive advantage?

Buffett’s not perfect — he has had his share of errors with textiles, shoe companies, airlines, Energy Future, and a variety of other investments, but his record will be tough to match, even if replaced by a team of clever people. ?Say what you will, but teams are not as decisive as a single manager, and that may be a future liability of BRK.

Summary / Who Would Benefit from this Book

Most people will not benefit from this book if they are looking for a way to make more money in their life. ?There are no magic ways to apply the insights of the book for quick gains. ?Also, readers are unlikely to use Buffett’s “hands off” methods in building their own conglomerate. ?But readers will benefit because they will get to consider the building of the BRK enterprise from the basic principles involved. ?There will be?indirect benefits as they analyze other business situations, perhaps using BRK as a counterexample — a different way to acquire and run a large enterprise.

But as for getting any direct benefit from the book? There’s probably not much, but you will understand business better at the end. ?If you still want to buy it, you can buy it here:?Berkshire Beyond Buffett: The Enduring Value of Values.

Full disclosure:?I?received a?copy from the author?s PR flack.

Full Disclosure: long BRK/B for clients and myself

Waiting to Buy

Posted on 28 October 2014 by David Merkel

Photo Credit: Brett Davies || Waiting, but to what end?

When I worked in the investment department of a number of life insurers, every now and then I would hear one of the portfolio managers say, “We know that the rating agencies are going to downgrade the bonds of XYZ Corp, but?we like the story. ?We’re just waiting until after the downgrade, and then we will buy, because they will be cheaper then.”

And, sometimes it would work. ?Other times, nothing would happen at the downgrade, and they would buy at the same price. ?But more interesting and frequent were the times when the bonds would rally after the downgrade, which would make the portfolio managers wince and say, “Guess everyone else was waiting to buy also.”

Now, there was a point in time where the corporate bond market was more strictly segmented, and getting downgraded, if was severe enough, would mean there was a class of holders that would become forced sellers, and thus it paid to wait for downgrades. ?But as with many market inefficiencies, a combination of specialists focusing on the inefficiency and greater flexibility on the part of former forced sellers made it disappear, or at least, make it unpredictable.

But so what? ?Bonds are dull, right? ?Well, no, but most think so. ?What about stocks? ?What if you want to buy a stock that you think is going to rise, but you are waiting for a pullback in order to buy?

In order to to get this one right, you have to get multiple things right:

The stock is a good buy long term, and not enough parties know it
The stock is short-term overbought by flexible money
Other longer-term buyers aren’t willing to buy it at the current level and down to the level where you would like to buy.
The correction doesn’t make quantitative managers panic, sell, and the price overshoots your level.

Maybe the last one isn’t so bad — no such thing as a bad trade, only an early trade, if the stock is good long term?

That’s one reason why I do two things:

I tend to buy the things I like now. ?I don’t wait. ?Timing is not a core skill of mine, or of most investors — if you are mostly right, go with it.
I pursue multiple ideas at the same time. ?If I have multiple ideas to put new money into, the probability is greater that I get a good deal on the one that I choose.

The same idea would?apply to waiting to sell. ?Maybe you think it is fully valued, but will have one more good quarterly earnings number, and somehow the rest of the world doesn’t know also.

Hint: do it now. ?If you are truly uncertain, do half. ?It’s tough enough to get one thing right. ?Getting short-term timing right verges on the impossible. ?Better to act on your strongest long-term sense of value than trying to get the short-run perfect. ?You will do best in the long run that way.

Risk Tolerance — The Ability to Deal with Loss

Posted on 25 October 201426 October 2014 by David Merkel

No one knows their financial “risk tolerance” outside of the context of losing money. ?Part of the trouble is that risk and return are often described in the same breath as if they are inseparable, when they are more weakly related than most think, and certainly not linear.

Surveys, no matter how well-intentioned or -designed do not typically grasp the asymmetry of gain and loss. ?People feel losses much more acutely than gains, and are far more likely to change their behavior after losses. ?Can’t tell you how many times I have had people say to me, “I’m never buying stock again,” after 2000-2 and 2008-9.

Nothing can prepare you for the event of loss except prior losses. ?Those who have made it through losing money have coping strategies ranging from diversification to rebalancing to benign neglect, etc. ?The best look at it as a cost of doing business, and try to view it together with all other investment decisions made — there will always be losses, but were there gains as well, and more of them over the long haul?

Risk is best faced in prospect, and not retrospect: ask?yourself if?the current assets that you hold offer fair compensation for the risks that they have. ?Are they building value even if the market is not reflecting it yet?

I’m going to be starting a new irregular series at Aleph Blog, where I go through my past tax returns and pull out all of the blunders over the past 25 years. ?I hope it will be instructive to my readers in many ways, but perhaps the most important of those ways is that you have to get up and fight again if you have been knocked down. ?Don’t give up! ?If you leave the game, it is typically at the time prior to gains. ?Rather, ask whether what you are doing now is the right thing to do on a looking forward basis. ?The past is gone, and the only time to affect the future is now.

So look for the new series, and appreciate my packrat tendencies that I still have the records for these matters. ?Hopefully it will be fun, and particularly instructive for younger readers because I was young once too, and I started in this game as an amateur. ?I made a lot of mistakes, but I did not compound my mistakes by leaving the game.