Personal Finance – Page 16

Using Investment Advice, Part IV

Posted on 18 August 2012 by David Merkel

My last point on investment advice is to think long-term and treat it as a business.? You are trying to buy underpriced cash flow streams.

Because it is a business, you must focus on the long term, and downplay short cycle information.? Don’t let the media scare you or make you greedy.? There are bumps and jolts in all investing.? Keep your eyes on the long term.? Always ask yourself when reading news, “What is the long-term effect on profitability?”? Often good companies have bad quarters or years.? The same is true of bad companies having good years.? Look at the long-term profitability, and downplay the short-term noise.

By short-term noise, I largely mean the media.? That includes the web, and those that tout stocks on a short-run basis. There are several problems here:

1) Media investment advice (and that from Wall Street as well) is biased toward buying.? Articles will give you a list of stocks to buy either generally, or in a given industry.? The biggest problem is that they won’t generally follow up on their recommendations, nor will they tell you what the time horizon is for the recommendation, or what catalyst should lead you to sell.

2) You will not see many articles offering a list of stocks to sell.? There are several reasons for this: a) most readers have some cash, which they could use to buy stock.? Most readers do not own the stocks that one might suggest to sell, so unless readers are enterprising enough to sell short, which even fewer are willing to do, your article is of little value to the average person. b) Do you want the possibility of a lawsuit?? Unlikely, but could happen. c) If you rely on advertising, do you want the reputation of shooting companies down?

There is an even bigger reason behind this: the world is designed to be 100% long.? That is the norm.? Shorting is a side-bet.? Even holding cash is a side bet, trusting in the veracity of a central bank that mostly has claims on the taxation power of the government.

3) Most people in the media are not investors.? As journalists, they have to be neutral.? At least there has to be significant disclosure of interests.? Readers should ask themselves, “What does this writer know that I don’t?? Who disagrees with him?”? In good investment shops, they have a process where they challenge opinions.? Rarely do you see that in the media, where two parties present opposite opinions.

4) Even when professionals go on the air or on the web, be skeptical.? (This includes me.)? They may have an interest to mention stocks that are close to their “Sell” level, but they will not mention companies that they are currently acquiring.? Hey, I went through that when writing for RealMoney.? I could write about things only once we had our full position on.? It is normal for firms to not allow their employees to write, ever.? It is second most normal to allow them to write only when the firm’s interests are not affected.

5) There’s no measurement process, no feedback when people give investment advice in the media.? They seem more credible when they are on the Web, TV, Radio, but does that really make them more competent?? It does make them more marketable.

6) Investing is best when it is businesslike.? Good opinions take a lot of time to form within investment firms.? If anyone can do the “lightning round,” Cramer can.? But good investing isn’t typically snap decisions, so we should not give a lot of credence to anyone’s off-the-cuff remarks.

7) Remember, few people writing/speaking on investments are doing you favors.? They have their agenda.? Some make it clearer, like me, and others don’t.? Be aware, you are your own best defender.

8 ) Few writers will urge caution on asset allocation because it is a boring topic, and besides articles on bonds don’t sell.? People read advice that excites, not that which preserves safety, at least not to the same degree.

9) One last note, good value investing is usually boring.? There may be some interesting tales, but who will be good/talented enough to do all of the research and spill it for free?? There are uses for such a person that pay more.

This probably ends my series on Investment Advice, but feel free to send questions, ideas, etc.? Thanks for reading this.

Using Investment Advice, Part III

Posted on 16 August 201216 August 2012 by David Merkel

The next aspect of using investment advice is understanding your own capabilities.? It comes down to what you understand, and what you have time for.

Some investment advice requires constant attention, even assuming that it is right.? Does your job afford you that flexibility?? If it doesn’t, you need to look to longer-term strategies.

There was a period in my life when I did small company deal arbitrage.? More profitable, more volatility, more blowups.? It took a lot of time to do the daily research.? I really felt I was cheating my family in that era.? Value investing does not take nearly that amount of time.

Do you know enough about the investment advice that you can be an intelligent amateur critic?? You don’t have to be an expert but to follow the strategies of others, you have to be intelligent to the point where you can differentiate between strategies that work and those that don’t.

What, that’s a tall order?? Really, it depends on your time horizon.? Value investing will deliver over a decade-long horizon.? Momentum investing will deliver most of the time, so long as too many people aren’t following it.? Value has the advantage that adjustments are infrequent, that’s not true with momentum.

Beyond those two primal strategies, I’m not sure what else works, aside from indexing.? Indexing has its own issue: as long as money is flowing into indexing, indexing tends to outperform.? This is less obvious with stocks, but if you have ever been a bond manager, index bonds trade special (expensive).? They have lower yields because there is a class of investors that has to own them.? If the money flow ever reverses, indexing will not do well.

You are your own best defender.? No one can protect yourself more than you can.? That is why it pays to be skeptical of unusual claims of investing expertise.? If they were really that good, they would invest for themselves, and not solicit outside investors.

After all, in this modern era, if anyone has an infallible investment method and limited capital, they will do best by setting up a hedge fund.? Those who proclaim to you that they have methods that border on miraculous should be questioned closely, because in investing, there are no miracles — only cash flows, and the market’s anticipation of future cash flows.

Now, there are some things with investment advisors that can give you some comfort.? Smaller managers tend to do better, because they haven’t reached the boundary of how much money their ideas can accommodate.? Beyond that, in my opinion, managers that don’t beg for business do better as well, they aren’t spending time on the marketing; they are managing.? Also, managers with a clean revenue model “fee only” aid investors.? The costs are clear from day one, and there are no conflicts of interest.

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Taking it back a step, can you critique yourself?? Where have your biggest successes and losses come from?? It might be good to keep a journal, so you can see if your successes stemmed from things you foresaw, or were accidental, and if your losses stemmed from neglect of discipline in following your ideas, or whether the idea itself was wrong.

My personal conviction is that most investors lack patience.? That’s why we sell at the bottom, and buy at the top.? But to be a patient investor requires strong balance sheets, because bad things do occur, and we want to avoid a permanent impairment of capital.

Do you know your weaknesses?? It took me 10 years to wash fear out of my system.? Greed wasn’t a problem.

Understand yourself, and learn self-control.? Don’t compare a stock to where it was, compare it to where you estimate it should be, once you are realistic.

More in Part IV

Using Investment Advice, Part II

Posted on 15 August 201215 August 2012 by David Merkel

Part two is understanding the advice.? A large part of the problem is that many aspects of the advice are unsaid.? For example, with a “buy” recommendation:

What time horizon does this recommendation require?
How likely is it that this investment will succeed?
What risk factors could cause the investment to fail?
How will this advice get updated?
Have prior investors benefited from this advice?
What is the benchmark for the advice?

Time horizon is important, even if it were handled approximately, e.g, “six months to two years.”? Should you buy for the earnings release and sell thereafter, or is this a company going through a multi-year shift?

The likelihood of success is subjective, but still important.? It helps if analysts/touts would clarify how certain they are of success, st least in vague terms.

Listing the risk factors is important.? Analysts do less of this than do companies in their prospectuses/10Ks.? These are important, and it would be valuable for analysts to see if there are any risk factors not listed, or emphasize the importance of key risk factors.

Knowing how frequently the advice will be updated aids the investors — it helps them understand how much help they will get, or whether after the recommendation, they are on their own.

It helps to know whether the adviser has any real talent or not.? Does he just opine, or is his own money on the line?? Has he succeeded in the past?

Finally, the benchmark is of utmost importance.? Buy! Why, what will it do better than?? Is it a relatively good stock?? Is it a relatively good stock in its industry?? Is it a relatively good bond?? Is it just going to do better than cash?? You need to understand the comparison that the analyst is making in order to say the stock is a buy.

More in Part III

What Insurance do Actuaries Buy?

Posted on 14 August 2012 by David Merkel

A reader asked me the following:

?When I know that you are trained as an actuary it got me curious. They say that actuary assess the risks of insurance products to find value for consumers, at the same time evaluate the probable risks of the product.

?What kind of insurance does an actuary actually buy for his and his family? Insurance are often sold with economic bias so what better way to know then find out from people that use actual data and determined it through quantifiable methods.

?I heard that actuaries often buy only term life insurance only and that investment linked and limited whole life policies do not make sense. At the same time, it would seem that the way you can claim critical illness is such that most of the time you can claim it, you are almost very disabled or near death. In such a scenario wouldnt [sic] a pure death and tpd [sic] term life be suffice?

This is my opinion, given my dealings among actuaries.? I could be wrong.? Actuaries avoid complexity in insurance products.? Why?? In general, complex products hide high profit margins.? Products that are easy to analyze, like term life insurance, are competitive, and profit margins are low.

The same is true for savings products, like deferred annuities.? Actuaries tend to buy simple products that cover basic needs.

Also, they tend to use insurance as catastrophe cover, because they know that having insurance companies pay on a lot of small claims is expensive on average.

There is an exception to all of this.? If you are so rich as to need to stiff the taxman, buying cash value insurance policies can make a lot of sense.? In that case, wealthy actuaries with clever tax advisors buy cash value life insurance.? Death benefits do not pass through the estate.

Actuaries are generally conservative, and avoid insurance products that are not easily analyzed.? That should be true of most insurance buyers.

Using Investment Advice, Part I

Posted on 13 August 2012 by David Merkel

If you have a subscription at RealMoney, you should read these articles:

Using Investment Advice, Part 1
Using Investment Advice, Part 2
Using Investment Advice, Part 3
Tread Warily on Media Stock Tips

I didn’t say it at the time, but I wrote those with Cramer in mind.? This was not that I did not like Cramer, hey, he gave me my start in investment writing, my blog would not exist without that start, but that what he said in the mass media often did not include enough data to allow an investor to manage his/her portfolio.? I will explain why here.? (Note, this is true of many investment gurus, not just Cramer.? Cramer takes more abuse because he is so visible.)

Part one is understanding yourself.? What are you good at? What do you understand?? What do you have time to do?

If your work is demanding, ignore services that require quick responses in order to work.? If you don’t understand bonds or commodities, you probably should avoid advice on those, unless they update you regularly on prior recommendations, and provide a track record on recommendations. When younger people ask me about investing, the first question I ask is how much time they have to put into it.? If they don’t have time for it, I push them toward Vanguard and indexing.? Save time, get a slightly better-than average result.

It is also not wise to follow any sort of instructions on investing that you do not understand.? If you want the wisdom of the investor, ask to have a portfolio that mirrors his — I mean, if you have implicit trust in someone, make sure that your interests are aligned.? After all, that is how it is from my clients, they have copies of my portfolios and get the same results, less fees.

If you follow instructions that you do not understand, it is as if you believe in magic.? You are flying blind, but won’t admit it.

Let’s take a different tack: when you read or hear investment advice, how often do they tell you when to take the opposite action?? I.e., buy here, sell there.? Sell here, buy there.? That is rare.

And this is a reason why I rarely write about individual stocks.? I’m not going to update you, and that is true of most investment writers.? Also, when you get one right, you get one praise.? If you get one wrong, you get fifteen kicks.

Using investment advice boils down to understanding what one is intelligently capable of acting on.? You are responsible for educating yourself so that you are capable of evaluating investment advice.? If you don’t do it, no one else will, and you will only have yourself to blame.

More in part II

Book Review: Moods and Markets

Posted on 11 August 201213 August 2012 by David Merkel

To my readers: this is the second time I have written this review. When I pushed the “publish” button earlier this evening, WordPress ate the document. That’s never happened before, so I did not have a backup. As a result, this review is entirely different than the prior one, and I did it using DragonDictate, so it may sound a little more colloquial than other reviews of mine. Let me know what you think, and if you like my reviews please vote them up at Amazon. As always, whether you agree or not, thanks for being a reader of mine.

This book is about the questions every investor wants answers to:

Why do I tend to get into and out of the market at the wrong times?
Why are professionals prone to the exact same problems?
Why do financial crises happen?
Is there a way to approximately measure where we are in the overall market cycle?

The author has a theory that he calls “Horizon Preference.” Think of it this way: when the market is near bottom, market players have very short time horizons for investment. They hide in cash. More than that, they choose very generic investments; they stay close to home and keep things simple. Fear drives them back to what they know always works in the very short run, which means any opportunity for gain is lost.

At such a time, only the most risk tolerant and experienced remain holding risky assets. Valuations are low. The party is over, the young have left, and the old guys are cleaning up the room. If you look in a financial newspaper, or out on the web, the headlines you read are pervasively negative. But at a true bottom, you’ll see that things have stopped getting worse.

Then optimism begins. It’s a fitful at first. It is two steps forward and one step back, before it becomes three steps forward and one step back, before it becomes an unrelentingly good trend. But as this happens, moods, headlines, move from disbelief, to doubt, to wonder, to optimism, and to greed. As this happens, market players expand their horizons. They are willing to take on new risks, with new instruments, and in new places. They are willing to pay remarkably higher prices for risky assets. This happens with individual investors, professional investors, bankers make loans, regulators, accountants who have to make the numbers for management, etc.

At the top everything is wondrous. Nothing can go wrong. At the top, the attitude is “We are going to make a lot of money.??It?s as if money is free, and anyone can make it in the markets now. Everyone can be rich, just invest in the market. All of the neophytes are playing in the market. The experienced professionals who have seen a few market cycles have begun to edge out of the market, if not raise significant cash. Risk control is derided as a way of losing money. Real heavy hitters don’t need risk control.

All of the discretionary cash is applied to the markets. Various forms of leverage are applied to personal investments, real estate, and business investments. Because everyone knows things are going to go well, they figure they may as well play it to the hilt.

But at the top, things stop getting better. Then pessimism begins.? It’s a fitful at first. It is two steps back and one step forward, before it becomes three steps back and one step forward, before it becomes an unrelentingly bad trend.? Sadly, during the phase of pessimism, things move down about twice as fast as they went up. It’s frightening, and it should be. Bear markets tend to persist until the bad ideas and investments of the up cycle are liquidated, unless the government steps in to arrest the fall.

The planning horizons of businessmen and investors shrink, as do valuations, until we hit the bottom, and the cycle starts again.

What I have described to you is the basic framework of the book. The author then applies that framework to the housing bubble, the possible higher education bubble, changes to accounting frameworks as rising preferences change, and where we are today in the markets. He gives a tour of the various phenomena inside corporations that take place at different points in the cycle. Optimism breeds complexity, lack of risk management, concept stocks, big projects, and a lot of credit. Pessimism breeds simplicity, renewed risk management, and bankruptcies.

This book will give you a feel for what part of the market cycle we’re in, and how you can profit from it. It is not math intensive; the book has no equations. There are a lot of graphs, but they are simple to understand.

Quibbles

In one sense, this book is about the credit cycle, and how it affects all risky assets. But it is couched in the language of how moods change of market participants, which then drives the market. My view of the matter is slightly different. I see market players making estimates of their future well-being, and as that estimate changes, so do their moods change, and the prices of risky assets. I don’t think this is a big difference from what the author is saying, so I heartily endorse this book.

Who would benefit from this book:?? Inexperienced investors would definitely benefit from this book. Experienced investors who are having a hard time with the unpredictability of the market of late would also benefit.? If you want to, you can buy it here: Moods and Markets: A New Way to Invest in Good Times and in Bad (Minyanville Media).

Full disclosure:?I got this book in a weird way. I don’t know the author, but we have a mutual friend, and he suggested to the publisher that he send me a copy of the book. That’s how I got it.

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.

Sorted Weekly Tweets

Posted on 10 August 2012 by David Merkel

Life Insurance Secondary Guarantees

Hartford Mulls Client Buyouts to Cut Risk Buffett Called Ungodly http://t.co/Nv4jRlUC Advice: don’t take the Variable Annuity buyouts $$ Aug 10, 2012
The original: Buffett Says Insurers Took ‘Ungodly Amount of Risk’ http://t.co/pXfXv8ME Warren Buffett again is prescient cc: @PlanMaestro $$ Aug 10, 2012
@PlanMaestro Thanks4 flagging this. Together w/companies scaling back gtees 4 new prods, the buyout offers show the probs in the life biz $$ Aug 10, 2012
@PlanMaestro I am not in favor of peer review. Actuaries call themselves a “profession,” but they really technicians. Aug 09, 2012
@PlanMaestro Regulators not crazy for this, because they can’t understand it, & almost makes the companies self-regulating. Peer Review? $$ Aug 09, 2012
@PlanMaestro But actuaries are trying to get regulators to cmove to a Canadian-style principle based approach. In Actuaries we Trust! $$ + Aug 09, 2012
@PlanMaestro But the devil is in the details, and GAAP reserving does not always reflect antiselection. Stat tries to do that, but + $$ Aug 09, 2012
@PlanMaestro But you’re right, the 10Ks do contain approximate partial sensitivity data on economic value for most important variables $$ Aug 09, 2012
@PlanMaestro In 1999, I saw a VA that guaranteed 7% minimum return if held till death or annuitization $$ Aug 09, 2012
@PlanMaestro I said “Wow, how do you guarantee the better of 5%/yr and performance of the underlying 4 just 2.25%?” $$ Aug 09, 2012
@PlanMaestro I have a friend who is a $PRU agent. One day he showed me his hottest-selling VA product, and ask me how I liked it. $$ + Aug 09, 2012
@PlanMaestro Acctg can get really screwy if you hedge NPV or FMV; gets really noisy because the results pile up in the current year $$ Aug 09, 2012
@PlanMaestro hedging long-dated options, w/complex contingencies built into them. Do you hedge next few years, or NPV sensitivity? $$ + Aug 09, 2012
@PlanMaestro I was an ALM actuary for many years, typically we hedged partial durations; fixed income hedging is easy, what’s hard is $$ + Aug 09, 2012
@PlanMaestro many exposures are impossible to hedge b/c the contracts r long-term, and hedge instruments r usually far shorter $$ Aug 09, 2012
@PlanMaestro That’s one of my concerns about the life industry; secondary guarantees r virtually impossible to reserve, getting big now $$ Aug 09, 2012

Insurance Industry

@ReformedBroker Good post, same thing happens with young life insurance agents to a degree http://t.co/LbMyo48G $$ Aug 10, 2012
@Bonfire_Sherman P&C – P/TB vs ROTE, adjusted 4 business mix, reserve life & conservatism, mgmt quality, U/W cycle, never premiums $$ Aug 09, 2012
@Bonfire_Sherman Most of it is change in required capital. Life actuaries typically calculate “distibutable earnings” reflting stat & RBC $$ Aug 09, 2012
Anytime anyone talks about Financial Cos & tells u about Free Cash Flow, ask how they did the calc. C if they mention chg in req capital $$ Aug 09, 2012
Wrong: 3 Life Insurance Stocks Undervalued By Levered Free Cash Flows http://t.co/gF5HYRZb GAAP financials don’t have data4 FCF calcs $$ Aug 09, 2012
Aviva profits fall as it cuts the value of its US unit http://t.co/t816IjAZ Amerus IR was annoyed @ me 4saying the orignal deal expensive $$ Aug 09, 2012
@PlanMaestro HIG is next on my list Aug 09, 2012
@PlanMaestro Thanks, I know where to get them, but I have enough GNW on my plate for now, I took me two weeks to write my AIG piece. $$ Aug 09, 2012
@PlanMaestro Have not looked at HIG, after I am done with GNW may take a look. If u r looking at stat acctg, look @ pg 5 indiv annuities $$ Aug 09, 2012
@PlanMaestro That’s the thing, like AIG prior to the crisis, and Scottish Re, they are capital constrained; things have 2go right 4 them $$ Aug 09, 2012
@PlanMaestro & not so sure about the rest if investing for more than five years. $$ Aug 09, 2012
@PlanMaestro Aye, agreed. Oddly, my interest stemmed from a reader who asked me if I would invest in GNW bonds. Yes 4 GIC-MTNs + Aug 09, 2012
@PlanMaestro I’m going to write a broad piece about it, but follow it up, with a narrow piece focusing on the specific problems. $$ Aug 09, 2012
@PlanMaestro Intercompany surplus notes and preferred stock too. Aug 09, 2012
@PlanMaestro There’s a ton. Underreserving, capital stacking, capital interlacing, intercompany reinsurance, & I’ve ony been looking 2 hours Aug 09, 2012
@Bonfire_Sherman Good guess, I need to look at the life co stmts someday, esp. page 5 for Indiv annuities Aug 09, 2012
Ding! We have a winner! RT @RennieScinto: @AlephBlog gnw? Aug 09, 2012
I’m a fun guy, looking @ statutory statements of a major US insurer, though AIG in 2008 looked worse, this company doesn’t look good $$ Who? Aug 09, 2012
Online Dating for Homes Stumps Insurers http://t.co/R2fmztPa Y not have both deposit $$ w/the insurer plus a premium payment? #wouldwork Aug 08, 2012
Regulators Probe ‘Captives’ http://t.co/xbXQ5aYO How to bend life insurance reserves. Catch my comment: http://t.co/9WQWYZ3W $$ Aug 06, 2012
Berkshire Trims Municipal-Debt Bet http://t.co/9zhhbdtD Meredith Whitney, no. Buffett, yes. But even he is only selectively reducing $$ Aug 05, 2012

Poway School District

Article near issuance of Poway School District CAB http://t.co/kxAWCNxT Letter from CA AG: http://t.co/UiZM0j3K cc: @munilass @jamessaft $$ Aug 06, 2012
@jamessaft I’m not a muni expert like @munilass, but no, I would try to find another way to refinance prior debts. $$ Aug 06, 2012
Ideal buyer4the preceding bond would b Buffett, or a P&C company w/long-tail liabilities. Prospectus 4 wonks only http://t.co/nIKJvJje $$ Aug 06, 2012
Where Borrowing $105 Million Will Cost $1 Billion: Poway Schools http://t.co/IPaABoXY Paying 7.6% IRR at a duration of 25. Astounding! $$ Aug 06, 2012
@munilass Also, I found the prospectus here: http://t.co/nIKJvJje Last Q: Do county tax levies into a sinking fund ever fail to work? $$ Aug 06, 2012
@munilass I get the holder taxes now. Poway was structured as a series of zero coupon notes, followed by 2 series of long lottery bonds $$ Aug 06, 2012
@munilass Used to be an asset-liability manager, so I look for that. 1 question: do you know how holders are taxed on a deal like that? Aug 06, 2012
@munilass This is just a crude estimate, but the IRR on the Poway deal is around 7.7%, and is nonrefinancable. Duration estimate 25 years $$ Aug 06, 2012

Rest of the World

China Export Growth Slides as World Recovery Slows http://t.co/u4YEUPQB China sneezes & the world catches a cold? no, important anyway $$ Aug 10, 2012
India?s Biggest Corporate Loss Shows Singh?s Dilemma on Deficit http://t.co/6xl7lsZD Force oil company to lose $$, eventually lose oil co. Aug 10, 2012
Housewives With Frying Pans Protest Japan Tax Hike as Debt Soars http://t.co/z3aeqjEv Taxes to double; can’t keep borrowing 4ever $$ Aug 10, 2012
Virus found in Mideast can spy on finance transactions http://t.co/V2GgyjpV Can spy on financial transactions, email & social networking $$ Aug 09, 2012
Toronto Condo ?Roller Coaster? Peaks as Flaherty Acts http://t.co/c6sJ0CqE Is Canadian housing a basketball (sss) or a bubble (pop)? $$ Aug 08, 2012
Iran?s Big Crisis: The Price of Chicken http://t.co/WXlUIIdL Describes some the economic difficulties of Iran under sanctions $$ Aug 08, 2012
Article makes a good point. The industries where China has overcapacity are power-intensive & are shrinking. Simple. http://t.co/IzyV0Bxe Aug 08, 2012
China’s answer to subprime bets: the “Golden Elephant” http://t.co/MP7LviwT Illiquid investments touting high returns w/lousy business $$ Aug 07, 2012
RE: Things are getting less equal in the US, because we allow more freedom here.? Globally, things are getting more e? http://t.co/WeGEEJF9 Aug 07, 2012
Presidential candidate up by 15%+ in August will win. If merely ahead, 9 times out of 12 he will win the Presidency http://t.co/soCj7Kf9 Aug 08, 2012
Swiss Banks Face Slow Death as Taxman Chases Assets http://t.co/13I9NkiQ Life’s tough when u can no longer help people cheat the taxman $$ Aug 06, 2012
Germany has the most to lose from a meltdown http://t.co/9JTwRfii Basically encourages an inflationary “solution.” Prob won’t work $$ Aug 06, 2012
If policymakers are worried about this, they are worried about the wrong thing. EU does not have that big… http://t.co/eCBlZg5I Aug 06, 2012
Summary: greater structural unity, mutualization of sovereign debts and a weak euro $$ Tough order for the… http://t.co/KN9pc0Pt Aug 06, 2012
Rogoff Sees World Wishing It?s America Year After S&P Downgrade http://t.co/MpStm7ww Relative flexibility pays off $$ Aug 06, 2012

Fixed Income

Lending in the offshore markets developed because of bad regulations here. It is outside US control & we should not m? http://t.co/C8y9rVFw Aug 10, 2012
In hunt for yield, hybrids flourish anew http://t.co/GCugG6A6 Credit rally revsup ppl grab yield in exchange 4 higher poss loss severity $$ Aug 09, 2012
Please, no $$ RT @CapitalCityIFR: In hunt for yield, hybrids flourish anew http://t.co/ZWbdRRl5 Aug 09, 2012
For a bad 30-yr Tsy auction, nice rally since then $$ Aug 09, 2012
A Greek banker, the Shah and the birth of Libor http://t.co/ibvVs9mE ht: @alea_ Started w/a loan 2 the Shah. Inauspicious start 4a big # $$ Aug 09, 2012
Definitely a weak auction, surprised long end not selling off $$ RT @ritholtz: 30 yr bond auction weak as well http://t.co/1gU89HMb $$ Aug 09, 2012
“Credit default swaps are easily manipulated. Rather, watch the bond market; it’s much bigger. $$” ? David_Merkel http://t.co/tESmTJsK Aug 09, 2012

Politics

The Neocon War Against Robert Zoellick http://t.co/vZreHf1n If Romney wins, pragmatic Zoellick could be influential on foreign policy $$ Aug 11, 2012
Christie Does Tenure http://t.co/J8krPlim Tenure is one of those sacred cows that hides the intellectually weak from consequences $$ Aug 10, 2012
In New York City, Microsoft Really Is Watching You http://t.co/trNOkU2d Interesting partnership w/NYC & $MSFT Civil liberties? $$ Aug 09, 2012
Postal Service $1 Million-an-Hour Loss Puts Abyss in View http://t.co/FVXMn5Di Raise stamp prices & costs 2 $FDX & $UPS $$ #simple Aug 09, 2012
Here’s The Real Reason The Feds Are Furious At The NY Regulator Going After Standard Chartered http://t.co/OmpwBILH Made Feds look dumb $$ Aug 08, 2012
RE: @bloombergview Dream, the Republicans will block this because it favors blue states over Red. $$ http://www.bloom? http://t.co/jT7EmSS0 Aug 08, 2012
I think it is a fair tradeoff to lose 2% of GDP in 2013 in order to get the economy growing. I agree with… http://t.co/mwuvnogX Aug 07, 2012
The Numbers Inside a Hot-Button Issue http://t.co/Fwois4YN Something to make everyone unhappy. Me: Don’t focus on rates, but deferral $$ Aug 07, 2012

Pensions & Endowments

State Pensions Get High Fees, Low Profits-Study http://t.co/3LRIL23c Add to that the lack of adequate funding &you have a serious crisis $$ Aug 10, 2012
Cornell, MIT Scale Back Aid Even as Endowments Rise http://t.co/WUoWDLLB Endowments provide less when rates r low, future cashflows smallr Aug 10, 2012
Defined contribution assets hit all-time high despite conservative shift http://t.co/7s9Stabd Amazing 2c bond alloc rising w/low rates $$ Aug 06, 2012
U can say that again $$ RT @e_d_sanders: @AlephBlog now this is an issue I know something about. Public pensions for execs are a nightmare Aug 05, 2012
Police Chief?s $204,000 Pension Shows How Cities Crashed http://t.co/ZorpuSjX Sloppy pension negotiating leads2 L-T cash flow crises. $$ Aug 05, 2012

Energy

Let the market decide.? If people want to pay a lot for gas, let them.? Why is Obama discouraging consumer spending? http://t.co/VT8xCyU0 Aug 10, 2012
Refiners Awash in Shale Oil Offer 10 Times Exxon Returns http://t.co/IIw9xXlb Buy cheap shale oil, ship to coasts, refine, sell & make $$ Aug 10, 2012
Louisiana sinkhole roils local natural gas network http://t.co/IkZxHLAs Now, who could have seen that coming? Risk is pervasive. $$ #sloorp Aug 09, 2012
Coal stocks typically have a lot of debt, beware $$ RT @MKTWBurton: Don?t mine this coal stock – Chuck Jaffe – http://t.co/nCQWfYzQ Aug 09, 2012

Other

Passed 10,000 tweets today. I quit Twitter after my first month, but came back to it after I saw its usefulness. Thanks 4 reading me $$ Aug 10, 2012
Heavy rain in Baltimore w/sleet and sunshine. Really weird weather. Sleet is neat, is hard to beat & will repeat, to make me tweet. $$ #ugh Aug 09, 2012
After Moods & Markets, Bailout is my next book to review. http://t.co/zkioUQ5N Aug 09, 2012
5 Questions Great Job Candidates Ask http://t.co/JpnpVWtu Questions show initiative, intelligence, & give u good jump pts 2 sell yrself $$ Aug 09, 2012
Novel Cure for Ailing Hearts http://t.co/RAiv4FYj Nanotech combines w/vascular endothelial growth factor to grow new heart muscle $$ Aug 09, 2012
Wrong: Business Is Booming in Empirical Economics http://t.co/aTNu4qfu U might get cute papers out of it, but nothing that generalizes $$ Aug 07, 2012

Companies

Yahoo Reviewing Business Strategy, Alibaba Proceeds; Shares Tumble http://t.co/ikk3dpeC Marissa Mayer has plans, & they require $$ Aug 09, 2012
Why Honda?s New Accord Looks Like the Old One http://t.co/6Ez8uL5i FD: + $HMC Designers tire of their designs long b4 users do $$ Aug 09, 2012
The WARN Act dilemma http://t.co/ilbxFsXD Defense, Fiscal cliff, DOL Guidance Letter saying ignore WARN act on 11/1, & elections $$ Aug 09, 2012
Hewlett-Packard?s Whitman Dismantles Hurd-Era Empire http://t.co/ySeeVM9w FD: + $HPQ She seems 2b evaluating each biz separately $$ #good Aug 09, 2012
The New York Times Is About to Say Goodbye to About,com http://t.co/frzrVlUq gives more details on the lossesv$$ Aug 08, 2012
New York Times Shares Rise on Deal to Sell About,com http://t.co/k5GarxXV Amazing how much $NYT lost on it, capital losses, neg income $$ Aug 08, 2012
Judge in Google, Oracle case seeks names of paid reporters, bloggers http://t.co/7vhmK5N3 Fascinating 4bloggers 2b paid $$ by corps quietly Aug 08, 2012
I do not get how http://t.co/ROsNYak3 could be worth $270M. What’s the revenue model? Ads? $$ http://t.co/n1ddWxvU Aug 08, 2012
Wrong: The PC looks like it’s dying http://t.co/IqeVAbi6 Like most tech, when it matures, it finds & stays there. Think of “dead” radio $$ Aug 07, 2012
Amazon Is No Wal-Mart…Yet http://t.co/cmEjPHHu Relatively neutral article on $AMZN by Martin Sosnoff; prob: treats AMZN as retailer $$ Aug 07, 2012
Why FedEx and UPS Want the Postal Service to Survive http://t.co/MAaCfOXQ Solution: raise stamp prices, and prices to $FDX and $UPS $$ #easy Aug 05, 2012

Monetary Policy

Fisher Says More Stimulus May Overburden Central Banks http://t.co/5ZMlKO5G 3-time winner of coveted “FOMC loose cannon award” speaks $$ Aug 08, 2012
Economic Musings – Fed eyeing a new kind of twist? http://t.co/aUezU2XE $$ Extending duration in MBS; creating larger losses later $$ Aug 08, 2012
RE: @bondtrader83 That’s not all that much different than the 1st Twist. It’s duration extension in MBS. Wait till ra? http://t.co/PrMHBSGh Aug 08, 2012
How about quantitative easing for the people? http://t.co/inHK9NF2 Would work better than current QE/Twist etc, but this frightens me. $$ Aug 08, 2012
Wrong: Bernanke to Economists: More Philosophy, Please http://t.co/9638QlHo Been down this road; utility theory doesn’t explain mankind $$ Aug 07, 2012

Housing & Related

Public-Housing Parking Lots Make Everyone Poorer http://t.co/2gensCd8 Set rates to achieve 15% vacancy; Rather than lots, have garages $$ Aug 08, 2012
Home Prices Climb as Supply Dwindles http://t.co/hMoZBsNZ Good news for the low end of the market, high end will take time $$ Aug 08, 2012
Fannie Mae profits rolled into rainy day fund http://t.co/bDWphSuE Good for Fannie & Freddie preferred, not worth anything 4 the common $$ Aug 08, 2012

Financial Companies & Markets

NYSE in talks with SEC to settle data probe http://t.co/FkxBtlbz Wow, faster data feeds 4 some special clients; level the playing field $$ Aug 09, 2012
Are Diamonds an ETF?s Best Friend? http://t.co/RHbSghCw Bad things happen when you take something illiquid and try to make it liquid $$ Aug 08, 2012
Richest Family Offices Seeing Fastest Growth as Firms Oust Banks http://t.co/NqY9650P UberWealthy get $$ talent; tax savings >> costs Aug 07, 2012
4 ETF Lessons From Knight http://t.co/st6wbNgR Lead Market Makers matter, Markets Work, Settlement Works, Illiquid ETFs Need Helpers $$ Aug 06, 2012
Other problem: active etf gives away trading information it might rather not divulge, leading to front-running. $$ http://t.co/q4XXZwRv Aug 06, 2012
A Tale of Two Fund Giants: American Funds vs Vanguard http://t.co/46rFsL9e Key advantage for Vanguard was embracing ETFs early $$ Aug 06, 2012

Repos

Banks? Liquidity Hinges on Risky Assets http://t.co/45Iw5Dz9 Repo lending is subject2runs during credit panics which depress collateral $$ Aug 08, 2012
Good one $$ RT @pdacosta: Watch out for the grim repo-er RT @cate_long Banks? liquidity hinges on risky assets http://t.co/9lk0GjA0 Aug 08, 2012
The danger of repo http://t.co/mZDG9Ocb Repo is weak financing in crisis; 3-mo T-bills would b a better index 4 Tsy floating rate notes $$ Aug 06, 2012

The Equity Premium

That would get the advantage of stocks over high quality bonds down to ~1-2%/year. Outperforms with a *lot* of noise $$ Aug 11, 2012
Bill Gross Is Wrong About Stocks: GMO http://t.co/c6gJwfUB Truth inbetween; have GMO adjust 4 $$ -weighted returns, not time-weighted Aug 11, 2012
Bonds for the Long Run http://t.co/MmkoYk3U @ritholtz nails it. Advantage of stocks over bonds is ~1%/yr over the long haul. Limited data $$ Aug 10, 2012

Comments

@LDrogen After reading this, I have more certainty that airbnb has already worked out some of the bugs http://t.co/Xx3ztVZv $$ Aug 10, 2012
@LDrogen Fine, Leigh, I hope it works. When single party lending gave way to securitization, it was unstoppable, until lending stds died. $$ Aug 10, 2012
RE: @ldrogen Multiple party economic dealings have their issues.? Consider: http://t.co/Z2rRNeTS? http://t.co/gCrEYzX2 Aug 10, 2012
‘ @TheOneDave In a word: depletion. Costs are rising to incremental barrels of oil, and ounces of gold. $$ Aug 09, 2012
@PlanMaestro $CLD LTD/E ~89%, take a look at $HNRG Hallador Energy. I’m not looking @ coal names until I see a few go BK, like steel 2002 $$ Aug 09, 2012
@PragCapitalist Depends on slope of demand curve 4 Tsys. Compare it2the former on-the-run. Jump of 6 bps high for that spot on the curve $$ Aug 08, 2012
@groditi Effective Yield series. Was trying to show that junk yields don’t compress as much when HQ-yields are low. Would have liked OAY $$ Aug 08, 2012
@PragCapitalist If it gets enough assets to survive $$ Aug 08, 2012
@footnoted …and maybe adjs for a year, but large writeoffs mean that prior earnings were overstated; testifies to bad mgmt quality $$ Aug 08, 2012
@footnoted That’s one reason why I tell investors to look at LT growth in BV + Divs rather than op income. I accept adjustments 4 a qtr + $$ Aug 08, 2012
RE: @bloombergview The single period cost to fix might be small, the continuous transfer cost would be considerably l? http://t.co/9gyFVvh4 Aug 08, 2012
RE: @bloombergview When games change from two players to three players, things get messy if no single player has most? http://t.co/TU09OZml Aug 08, 2012
Most pessimistic he’s been on China debts RT @groditi: Wow. I’m used to Pettis’ Euro-pessimism, but he’s not holding back here. U MAD, PROF? Aug 07, 2012
Always a great read RT @groditi: yaaaaaay new Pettis! Aug 07, 2012
@AnaCapMgmt Ain’t true. The foolish models of economists do not take into account political realities, and when inflation runs, no ammo. $$ Aug 05, 2012
@LisaCNBC Ask him how confident he is in India’s power grid. After that, the water supply. $$ Aug 05, 2012
‘ @pvitha Gold moves inversely to real interest rates, a.k.a. cost of carry, that’s all I know. $$ Aug 06, 2012
‘ @WTOP Romney shouldn’t worry about the Fed; they are out of ammo. QE is a joke, as is Operation Twist, and forward fed funds guidance. $$ Aug 05, 2012
+1 I like to say that 🙂 RT @BarbarianCap: “there are more debt claims than resources to pay them at par” Aug 05, 2012

Retail Investors and the Stock Market

Posted on 7 August 2012 by David Merkel

I’ve seen a spate of articles lately on retail investors abandoning the stock market. Here’s a sampling:

Cult Figures — Bill Gross
Stock bulls have a beef with Bill Gross — Jonathan Burton
Why Are Investors Fleeing Equities? Hint: It?s Not the Computers — Andrew Ross Sorkin
Small investors vs high-speed traders — Felix Salmon
AMERICAN IDLE: FIVE REASONS WE HATE THE STOCK MARKET — Josh Brown

I chose these because I think they add to the discussion.? In general, I think there are a decent number of retail investors, that have left the markets, or reduced their exposure.

But I saw this back in 2002, when I saw many friends leave the stock market because of the losses they were taking.? Several said to me, “I am going to invest in what I know — I’m sticking with real estate.”? I winced and stuck with stocks, and had phenomenal performance in 2003.? I paid off my mortgage, and considered selling my house in 2005, but I realized for me, a house is not an investment — it’s a place to live.

After 2008, more people concluded the stock market was rigged.? Why?? Because they lost money, and that couldn’t be their fault.? Sorry, but retail investors, and many professionals too, give way to fear and greed, and chase trends.? They are not invested at the bottom, because they are too scared.? They are invested at the top, because it is the “thing to do if you want to make money.”

Call my point 1 this: People who don’t understand investing buy and sell at the wrong times.? They panic and get greedy.

Point 2: People don’t get that returns are lumpy.? They happen in spurts, over months, years, decades.? This is the big problem with financial planners — they assume smooth returns that will assure a retirement.? Sorry, but market moves in regimes, and is not easily predictable.? There are a few two decade periods where the market goes nowhere.? They are not anomalies; the value of companies are catching up to their prices.

Point 3: The estimates of equity outperformance sold by consultants, financial planners and naive journalists exaggerate the reality.? Here’s the reality: equities perform maybe 1% better than Baa/BBB bonds, particularly when you analyze the investments on a dollar-weighted basis.

Point 4: Everyone loves a winner.? People were spoiled by the returns of the 80s and 90s, and that validated in their minds the idea that more stocks are better; the projections of the financial planners are conservative; equities always beat bonds.

Point 5: Most ignore long-term valuation metrics, whether professionals or retail.? Whether it is the:

Q-Ratio
CAPE
Price-to-Resources Ratio
Whatever John Hussman has cooked up
Eddy Elfenbein’s view the stock market as a bond measure

they say roughly the same thing at present: equities are overvalued long-term.? Short-term is another matter: P/Es aren’t that high and momentum is running.? But how short is your horizon?? This makes sense if you are willing to play for months, not years.

Point 6: Professionals changed too.? In this market environment many professionals have started to trade more, as if we don’t trade too much already, and I think this is the wrong response.? As professionals, we need to do due diligence, and pick stocks we can be happy with for some time.? High frequency trading affects those who are not clever at trading.? Those who are clever disguise their trades making them look small like retail.

Point 7: But regardless of who holds stocks, they are still held by some entity.? They don’t disappear.? They move from weak hands to strong hands.? The trouble for retail investors is that they are weak hands on average.? They can’t handle disappointment, versus value investors who buy when there is disappointment.

Yes, I understand the frustration of average investors who do not do well; you are novices in a complex market.? Maybe you should just buy BBB bonds.? With the abnormal economic policies of our government, it is difficult to make any decision.

Personally I don’t think that retail investors are abnormally disappointed at present.? This is just market noise — we face overvaluation, but positive momentum.

Me?? I keep owning undervalued companies for myself and clients.

On Credit Scores

Posted on 5 August 2012 by David Merkel

To give credit where credit is due, this post was triggered by an article at SmartMoney, 10 Things Credit Scores Won’t Say.

In 1996, I got a call from a recruiter suggesting there was a real opportunity with the Philadelphia-based corporation Advanta.? They were looking for an actuary with investment knowledge that could help them in their joint venture with The Progressive to use credit scores in underwriting auto insurance.? Since I was local, and known to be a “nontraditional actuary” with some degree of talent, and my situation at Provident Mutual was deteriorating because of a management change, I accepted the interview.

Being a life actuary, I didn’t know much about P&C insurance, but my career had been one of growth.? I may not know everything there is to know about a given topic, but I learn rapidly, and bring allied knowledge to the table that others may not possess.? The interview was interesting.? If you are a life actuary, you don’t expect interviews like Advanta. Credit cards were reaching their apex, and some clever people were trying to figure out other ways to apply the data from individuals using credit cards.? I ended up being Advanta’s “second choice.”? Bad for them, good for me.? Two years later, I would join the St. Paul’s Investment department in Baltimore.

The key idea was that credit scores were highly predictive regarding personal insurance losses, particularly when combined with traditional underwriting metrics.? The idea was a surprise to me when I first ran into it, but it quickly made sense to me.? Let me explain.

Honoring agreements that you have entered into is an important indicator of your personality.? Those who do not repay are on average less moral than those that repay.? Those that are net creditors on average made efforts that net debtors did not.

Credit scores are important.? In a specific way, they measure your willingness to keep your word.? Anytime you enter into a debt contract, you make a promise to repay.? If you fulfill your promise to repay, you impress others as one of good moral character.? If you don’t repay, it is vice-versa, you appear to be of low moral character.? (Note: I am excluding those that got hoodwinked by lenders that defrauded borrowers in a variety of ways.? That said, if you can be hoodwinked, that says something else about you, and that may have an impact on your creditworthiness as well.)

Now, before I continue, these concepts work on average, and not always in particular.? I have helped some at the edge of society with gifts and loans.? In some cases there is a cascade of bad events that the most intelligent would have a hard time facing.? Being wise helps, but there are some situations that would tax the soul of anyone, and be difficult to claim that they were blameworthy; it’s just the way things happened.

That said, that concept of a “credit score” traveled rapidly to insurance, because moral character is highly correlated with how a person drives.? People who are sloppy with their debts tend to be sloppy with their driving.? As with everything in this post, this is only a general tendency.? It applies on average, it does not always apply.

Some US states were offended at P&C companies using credit scores, and so the companies moved to use “insurance scores,” which were little different from what they aimed to replace.? The insurance companies took the disaggregated data behind the credit scores, did a little more research, and discovered which variables were most predictive of insurance claims, in concert with their own data.

The same is true for many other uses of credit data.? Different parties want different aspects of the underlying data.? Whether it is employers, lessors, lenders, insurers, etc., in an impersonal world, where there are fewer shared ethical values than in the past, economic actors rely on semi-public data to get comfortable about who they are dealing with.

Two final notes:

1) It’s easier to go down than up with credit scores.? But that is similar to many things in life.? One big mistake can undo a hundred lesser things done well.

2) Those who pay off debts rapidly are rewarded with discounts, as many companies want to avoid bad debts.? You might remember my piece, Build the Buffer.? Be wise, and have enough cash around to get discounts over those that pay things monthly/quarterly.

I am happily debt-free aside from paying off the debts regularly on my few credit cards.? The simple truth is that living within your own means, and having enough of a buffer to deal with minor crises is the best place to be.

Forget Your Cost Basis

Posted on 31 July 2012 by David Merkel

All good investment decision-making is forward looking.? Whether you are buying or selling, it doesn’t matter where prices have been in the past.

Now, that said, price and volume charts may occasionally indicate where there is support or resistance.? That might be worthy of consideration in the short-run.? When I was an institutional bond manager, competing against few others, but larger others, that was more important.? Not sure it is so important when competitors are smaller.

My main concern is that investors focus forward.? Use your best data. and estimate future advantage.? Be aware of mean reversion, so don’t let mere changes in price affect your opinion.? Always aim for the best possible future return.

We win and lose constantly in the market.? Don’t let past successes delude you, they may be historical accidents. Instead, focus forward to try to see what opportunities and threats are in front of you.

There were two hard things I had to learn when I was a corporate bond manager: 1) learning to sell lower than my original sell. 2) Learning to buy higher than my original buy.? That meant I had to forget my original cost basis, and try to estimate the best forward value that I could.

That is a tough place to be, but it is rational.? Always look forward, and estimate where you will have the best outcomes going forward.? You will get superior results from doing that.