Category: Portfolio Management

Logical Links

Logical Links

This should be a short post this evening, because I am tired.? Always be skeptical of analyses that reason like this: A will lead to B, B will lead to C, C will lead to D, D will lead to E, E will lead to F, which is a (horrible disaster / incredible success).

Causality is problematic.? Things don’t always move the way we would expect, because the system is more complex and robust than most anticipate.? There’s more than one way to skin the cat.? Also, we often get spurious correlations, which fools amplify noise into signals.? Correlation is not causation.

Also, there are expectation effects that vary over time.? Sometimes a market effect that commonly occurs has been overinvested in, it is true usually, but overpriced for now.? Example BBB bonds out perform in the long haul, but in May of 2002 as spreads were crashing in, it was right for me to throw those bonds out the window for AAA, AA, and A-rated bonds for what was a small yield give-up.

When you reason about investing, write out the chain of causality, and recognize that things that are certain are less than certain.? The more links, the less likely the whole argument is.

It is better to keep things simple, and avoid extended reasoning.? Most good investing involves simple judgments on broad issues — try to get the big things right, and the little things will follow.? You can do well in investing by avoiding situations that are highly levered; yes there are some big gains with high leverage, but there are more big losses.

So keep things simple, invest simply, focusing on relative value and income.

The Best of the Aleph Blog, Part 16

The Best of the Aleph Blog, Part 16

I try to do “The Best of the? Aleph Blog” pieces between 1-2 years after original publication.? Why?? It gives time for reflection, time for series to complete, time for me to be proven wrong/right, etc.? I would have preferred that readers do this job for me, so that I could be neutral, but I realized that I am the one that has the most concentrated interest in doing this, so that is why I do this.? The main benefit for me in doing this is when I submit free content to “Wall Street All Stars,” I know what I think is good stuff, and I utter a few words to explain how my wisdom has proven right, or fell on its face.

This episode covers the era of November 2010 through January 2011.

On Investment Modeling, Part 1

On Investment Modeling, Part 2

On Investment Modeling, Part 3

On Investment Modeling, Part 4

Investment modeling is tough, you omit some bits of reality, and deny other bits of reality.? In this four-part series, I try to explain how difficult good modeling is, and how to make it better.

Flavors of Insurance, Part I

Flavors of Insurance, Part II (Life)

Flavors of Insurance, Part III (Personal Lines)

Flavors of Insurance, Part IV (Commercial)

Flavors of Insurance, Part V (Reinsurance)

Flavors of Insurance, Part VI (Brokers)

Flavors of Insurance, Part VII (Health)

Flavors of Insurance, Part VIII (Financial)

Flavors of Insurance, Part IX (Title)

Flavors of Insurance, Part X (Conglomerates)

Flavors of Insurance, Part XI (Banks and the Insurance Business)

Flavors of Insurance, Part XII (Summary ? The End)

This was a unique series where I tried to bring my expertise to bear on a complex industry.? I wrote the original piece in 2003, and it never got published.? I used OCR to scan it and one of my brighter children to edit it, so you have my original text, plus my commentary in 2010, pointing out where I was right and wrong.

Time to Grow Up

I am an advocate for a brainy libertarianism that reflects the intelligence embedded in the Bible, coming form the Creator Himself.? I do not back what the t-party has to say, whose positions reflect personal selfishness.

Nonidentical Twins: Solvency and Liquidity (III)

Now, when a government is overleveraged, but interest rates are low, the situation is potentially unstable.? A rise in rates could tip the scales.? Market actors would conclude that they can?t survive at rates high than a certain threshold, so sell the debt now, in case rates would get so high.? That action forces rates higher, leading to a self-reinforcing panic.

Sometimes this happens in advance of a debt refinancing, leading some politicians and bureaucrats to say the forever bogus phrase, ?This is not a solvency crisis, this is a liquidity crisis.?? Sorry, if you play near the cliff, don?t complain if you happen to fall off.

Liquidity crises do not happen to governments with low debt levels.? Liquidity crises are solvency crises during the panic phase, before they are revealed to be solvency crises alone.

The Value of Fair Accounting

Why fair value accounting has value to investors.? This should be a “duh” moment, because everyone should understand this.

2010 Financial Report of the US Government

My annual post on the topic, describing the deterioration of the situation.

A Portrait of Maryland?s Public Companies

I explain why Maryland, my adopted homestate, has the mix of publicly traded companies that it does.

Why We Don?t Need the Fed

We would do better with a commodity standard, and even a gold standard.? The Fed hoodwinks us with its pretended efforts to maintain value.? I genuinely mean that we could do better without the Fed.? Put James Grant and Steven Hanke in charge of our monetary policy, and we will do well

On Human Fertility

A controversial topic, but fertility rates are falling more rapidly than the demographers expect. Why? It is politically correct to say that the planet is running out of resources, a bogus idea, but often stated.? As it is, because of changes in the way that women and men view their roles, fewer children will be born.

And as for a guy who has sired three children, and adopted five (far more difficult), I would simply say that we are better off with more children in homes that care about the results of how children turn out.

Sorted Weekly Tweets

Sorted Weekly Tweets

US State Economics

 

  • State Politicians and the Public Pension Cookie Jar http://t.co/NLyWlK2X Politicians don’t cut public pensions b/c they pad own pensions $$ Jun 09, 2012
  • North Las Vegas Crisis Shows Fragility of Nevada Economy http://t.co/sCnrcmRk Moral laxity of Vegas invites elements that lead2trouble $$ Jun 09, 2012
  • Wrong: What Scott Walker can teach Barack Obama http://t.co/lpO5hETn When Walker campaigned he did not know he would have a majority in +1/2 Jun 06, 2012
  • both houses of the legislature. He seized the opportunity & did something bold in order to fix Wisconsin’s finances. Result: Survives recall Jun 06, 2012

 

US Fiscal Policy

 

  • U.S. House May Split Up Package of Expired Tax Breaks http://t.co/hXcmb1Ec Good idea; let each tax break stand on its own &b abolished. $$ Jun 09, 2012
  • True Capitalists Are Pro-Market, Not Pro-Business http://t.co/HVQjkfk2 Get business special interests out of tax code & govt subsidies $$ Jun 08, 2012
  • Senate Dealmaker Baucus Turns to Rewrite of US Tax Code http://t.co/naa2hePj Baucus is going to try to gore everyone equally, maybe? $$ Jun 08, 2012
  • RT @TheOneDave: True capitalists are pro-market rather than pro-business, according to Yale’s Stephen Carter: http://t.co/vQQ64YDa via @ … Jun 08, 2012
  • Americans Cling to Jobs as U.S. Workforce Dynamism Fades http://t.co/acaAmcGm Inverted Mtge, 2 earners, ec uncertainty reduce flexibility $$ Jun 08, 2012
  • Teachers Unions Have a Popularity Problem http://t.co/QGqzD8Ys Pct of electorate backing rights of teachers 2 collectively bargain falls $$ Jun 05, 2012
  • Monetary Aid Coming as Wal-Mart Helps Housing http://t.co/pBBoiRH6 Mixed Bag: QE3, Youth unemployment & being near a WalMart boosts home $$ Jun 04, 2012
  • U.S. Multinationals Lobby to Alter Tax Rules They Sought http://t.co/7maKR41m Would be better to eliminate, & raise taxes on divs & CGs $$ Jun 04, 2012

 

US Mortgages & Real Estate

 

  • Mortgage Rates Hit New Low, 30-Year Drops to 3.67% http://t.co/BLQGkosE Because housing is not recovering, mtge rates continue to fall $$ Jun 08, 2012
  • FHA Turns to Investors as Losses Continue to Rise http://t.co/c73e01TU US Govt messes up another lending guarantee area. They always do $$ Jun 08, 2012

 

Asia

 

  • Strong Yen Won?t Survive Japan?s Fiscal Cliff http://t.co/e7P6RyFl Shilling argues that Japan will suffer as it ages & sells govt debt $$ Jun 09, 2012
  • Ikea to Consider India Entry, Plans More China Stores http://t.co/lfrvVgTY Many difficulties setting up biz in overregulated India $$ Jun 08, 2012
  • Japan Confronts Flight to Quality With Brutal Yen http://t.co/bWj62zo3 Wondering when the “flight to quality” may no longer benefit Japan $$ Jun 07, 2012
  • China Cuts Interest Rates for First Time Since 2008 http://t.co/7bIbIdUd Unlikely to do much to stimulate, not much demand 4 loans now $$ Jun 07, 2012
  • Bad News Piles Up for China’s Economy http://t.co/coT0mfgf Repeated cycles of malinvestment are finally hitting tipping point of failure $$ Jun 07, 2012
  • Keep tight stops RT @mercenaryjack: Contrarian buy signal $USDJPY RT Japan Confronts Flight to Quality With Brutal Yen http://t.co/D98ax8rH Jun 07, 2012
  • Japan?s Debt Sustains a Deflationary Depression http://t.co/6sUCexpl As Japan ages & shrinks, will be hard 4 it to maintain economy $$ Jun 05, 2012
  • Bob Fu: The Pastor of China’s Underground Railroad http://t.co/1HXIypo5 Fascinating tale of life in China & influencing China from outside Jun 04, 2012

 

?Politics

?

  • Brown Challenged Over Dodd-Frank http://t.co/UsRpt5tf Scott Brown best chance at election: pro-business moderate; paint Warren extremist $$ Jun 08, 2012
  • What’s Changed After Wisconsin http://t.co/rTa0vaWi Don’t normally link2 Peggy Noonan, but the last line was quite a stinger. Jun 08, 2012
  • “Because Bill Clinton loves politics, he hates losers. Maybe he just can’t resist sticking it to them a little, when he gets a chance.” $$ + Jun 08, 2012
  • Romney Executive Style Forged in Faith He Rarely Mentions http://t.co/SOOSDnwI He has 2b quiet; there is no upside explaining Mormonism $$ Jun 08, 2012
  • Hollande Gets Crisis-Protection Tips From Business-Friendly Lyon http://t.co/4emjSYXn Interesting piece; Lyon businessmen guide Socialism $$ Jun 08, 2012
  • Walker Bets on Brats to Heal Wisconsin as Praise Pours In http://t.co/9Kto2qIA Smart move on Walker’s part after a bitter election fight $$ Jun 08, 2012
  • Chavez Losing Grip on ?Benjamin? as U.S. Dollars Sought http://t.co/YQ9aLNTp Thier’s law in action in Venezuela http://t.co/mNNp2KzJ $$ Jun 08, 2012
  • Congressman to Bernanke: Take QE3 Off the Table http://t.co/QpQnU0BZ I’m sorry, but the Fed doesn’t listen 2 Congress; they’re above that $$ Jun 07, 2012
  • Bernanke Cites Risks, but Doesn’t Signal Action http://t.co/Ew9Nc2K8 Bernanke is a dove, but does not like to telegraph views, only leak $$ Jun 07, 2012
  • French, Greek Unemployment Rise http://t.co/vKfvrwWY Highest jobless rate in France in a decade and a record unemployment rate in Greece $$ Jun 07, 2012
  • Hollande Deficit Vow Lures Investors to French Debt http://t.co/25CZUhHS I’ll believe it when I c it. What taxes rise & programs cut? $$ Jun 07, 2012
  • Merkel Allies Signal Progress on Fund to Pool Debts http://t.co/p8UGaOXr Don’t see how this works economically or politically long-term $$ Jun 07, 2012
  • RE: @bloombergview Bloomberg’s regulation fails one basic test: “I’d like two sodas, please.”? Very dumb, and he went? http://t.co/GphkCClc Jun 07, 2012

?? Student Loans Held by the Federal Government http://t.co/IsW6eywX When the govt enters a lending business, it typically creates a bubble $$ Jun 06, 2012

?? Obama’s Debt Boom http://t.co/OsPykK3q $$ borrowed & misspent produces no growth; same 4 QE which inflates goods and Hi-Qual asset prices $$ Jun 06, 2012

  • Wisconsin Voters Head to Polls in Recall Election http://t.co/9pNJvCsL <2% of WI voters uncertain. Most divisive election I can recall.. $$ Jun 05, 2012
  • Recall Stirs Passion in a Purple State http://t.co/2NsLiisy I think Wisconsin would b more civil if it weren’t recall election $$ #civilwar Jun 04, 2012

 

Energy

 

  • Oil Heads for Longest Weekly Losing Streak in 13 Years http://t.co/Gx0wPKr4 After oil bubble popped in 2008, we went down to $50, not now $$ Jun 09, 2012
  • Oil Tankers Squeezed as Rates Drop to Lowest Since ?97 http://t.co/dXFAzMw4 Could go lower; what will the bondholders do w/the boats? $$ 😀 Jun 05, 2012
  • Romney Aversion to Wind-Power Aid Alienating Republicans http://t.co/V7yp3lHE Good. End *all* energy subsidies, especially ethanol. $$ Jun 05, 2012

 

Bond Markets

 

  • Investors Bail on Junk Bonds http://t.co/Iwk1URn2 This is still early, & we lack notable defaults necessary to have a full-scale panic $$ Jun 09, 2012
  • A Safe Haven in ‘Cat’ Bonds http://t.co/MbXh1KLB Every fixed income subclass eventually underwrites crud in a mania; still waiting here $$ Jun 07, 2012
  • MF Global and the Risks Looming in the Repo Market http://t.co/AD8XXOGh Should have been a red flag to see Corzine change the core biz $$ Jun 07, 2012
  • The TIPS curve has become inverted http://t.co/DN0ZHsbY CPI inflation expectation falling in near term; may justify some dumb move by Fed $$ Jun 06, 2012
  • Thought experiment: What if PIMCO Hi Inc $PHK 70% prem2NAV did a rights offering giving each share a tradable right 2 buy a share @ par? $$ Jun 05, 2012
  • Quirks of High-Yield ETFs http://t.co/voVBkmvr Good article; I will follow up w/a piece comparing time- & $$ -weighted returns of bond ETFs Jun 04, 2012
  • In all of the bond furor of last week, anyone else notice that the real yield on the on-the-run 20-yr TIPS went negative? I didn’t either $$ Jun 04, 2012

 

Eurozone

 

  • I like to think that I am pretty imaginative, so, wow! $$ RT @betandbetter: @AlephBlog and the reality of France is worst than u CAN imagine Jun 07, 2012
  • The rise and fall of European banking http://t.co/94t9dzk2 Lenders retreat within own borders to minimize losses in breakup scenario $$ Jun 07, 2012
  • 4 reasons why the euro will survive http://t.co/PcDpsERP Too painful, Votersr risk-averse, euro is innovative?? & ECB can handle troubles $$ Jun 07, 2012
  • Spanish, French Borrowing Costs Diverge http://t.co/X2XfTUem Spain had to cut the size of its auction to make it succeed $$ Jun 07, 2012
  • My Self-Esteem a Mess Is Refrain for Spain?s Unemployed http://t.co/sV7l8Gbq When the economy turns down many other problems occur $$ Jun 07, 2012
  • Germany Grapples With Role in Rescue http://t.co/dvkQXL38 Will the rest of Eurozone embrace the idea of a Federal Europe? Open question. $$ Jun 06, 2012
  • Maybe the solution is to send unemployed Greek, Portugese, Spanish, Italian & Irish workers to Germany, there is low unemployment there $$ Jun 06, 2012
  • “It has brought untold suffering to Europe” http://t.co/JDvp91eq Interview w/Felix Zuluaf, translated from German, regarding the Eurozone $$ Jun 05, 2012
  • @JackHBarnes @japhychron Maybe define a euro as exchangeable into fixed %s of subcurrencies, and let the subcurrencies trade; learn new wgts Jun 05, 2012
  • RT @JackHBarnes: How hard would it be to relaunch sub currencys at the N.C.B level, but have a quote vs the Euro as a whole? Dynamic int … Jun 05, 2012
  • Spain Warns Market Access Being Shut http://t.co/tkr6No7s Spain auctions 2-yr, 4-yr & 10-yr bonds on 6/7, which will tell us a lot. $$ Jun 05, 2012
  • Germany refuses Eurobonds: http://t.co/RLqELufX Germany would accept eurobonds if full fiscal/banking unification http://t.co/qXcrvsXh $$ Jun 04, 2012
  • Portugal Props Up Three Banks http://t.co/xJOpX1yP The Eurozone must either centralize, or break into smaller compeatible units $$ Jun 04, 2012

 

Companies

?

  • Intel Can?t Break TV?s Bundles http://t.co/4RUtMAPi Difficult 2encourage a la carte pricing for television shows; few incentives FD: + $INTC Jun 08, 2012
  • Pushing the PRAM: when chips just can’t get any smaller http://t.co/G7Tcd6hg Fascinating technologies 4 future shrinkage of storage & NAND $$ Jun 08, 2012
  • Could value investors be the reason a stock’s cheap? http://t.co/xAMVjAqx No, cheap stock is y value investors show; we don’t make it cheap Jun 08, 2012
  • Big Customers Are Taking Longer to Pay http://t.co/7JS1Nov0 Causes everyone to seek longer financing terms; not a good sign $$ Jun 07, 2012
  • The (very) bullish case for the American auto market http://t.co/ukPi2GUj Premature to forecast a boom here; credit is not that good $$ Jun 05, 2012
  • JPMorgan Faces $4.2B Trading Loss, ISI Forecasts http://t.co/0FPsl5bR $JPM looks cheap here, but is it safe here? Almost tempted 2 buy $$ Jun 05, 2012
  • Hedges Gone Awry Set Back Chesapeake http://t.co/Kw7gUpOD How many times does a hedger lose $$ speculating? Usually once, the last time 😉 Jun 04, 2012

 

Monetary Policy

 

  • Rely on BB2provide dovish $$ policy RT @cabaum1 Bernanke says nothing without committing to anything http://t.co/qCV9J5SF via @BloombergView Jun 07, 2012
  • Why Everyone Still Wants Dollars http://t.co/9QbDkaxl $$ hegemony will stop when neomercantilistic nations stop subsidizing exporters via FX Jun 07, 2012
  • Pimco?s Home-Loan Wager Seen as Prescient on QE3 Odds http://t.co/gr8BmHOr Key Q: if QE3, what will the Fed buy? Tsys, Agys, Mtges, other $$ Jun 07, 2012
  • @ampressman Monetary policy has not been run properly since Volcker left. $$ Jun 06, 2012
  • RE: @bloombergview Where is your proof that QE works? A stupid idea thought up by ivory tower economists. Rubbish. http://t.co/Wgzpx01I Jun 06, 2012
  • @GaelicTorus Sorry, disagree. Fiat monetary policy is constrained by the total resources/productivity of an economy @ a given price level $$ Jun 06, 2012
  • Bill Gross: Global monetary system may be fatally flawed http://t.co/Hm2kIEFD System doesn’t work well if savers don’t earn more than CPI $$ Jun 06, 2012

 

Economics

 

  • Behind every model is an analogy; behind every datum is history; marry the 2, you have a story. Math obscures, doesn’t reveal econ truth $$ Jun 07, 2012
  • Wrong: What If Speed Traders Competed on Price? http://t.co/jZm0dlOs Moves to lower the tick size have always led to more games, not less $$ Jun 07, 2012
  • Are Economics PhDs Learning the Wrong Thing? http://t.co/oT5oH9eK If more Economics depts taught philosophy & history would help fix Econ $$ Jun 07, 2012

 

Resources

 

  • Gold Bugs Defy Bear-Market Threat With Soros Buying http://t.co/Q3g6xOwS Gold does well when real interest rates fall, & vice-versa $$ Jun 06, 2012
  • Exhausting the Earth’s Resources? Not So Fast http://t.co/OZlc0GS5 It will b a long time b4 mining asteroids will b economic. $$ Jun 05, 2012
  • Next Frontier: Mining the Ocean Floor http://t.co/o7DAp8Oi After years of discussing it, it is finally happening, w/Glencore buying ores $$ Jun 05, 2012

 

Miscellaneous

 

  • Wall Street to Muppets: Thanks for the Love http://t.co/d0KLKPYF Blunt opening: “The dumb money is back.” Equity mutual funds get $$ inflows Jun 06, 2012
  • 10 Things Law Schools Won’t Tell You http://t.co/l5NcIHBd Most of it boils down to oversupply, high training costs, low quality, job lies $$ Jun 06, 2012
  • Bristol Immune Drug Success in Cancer May Spur Industry Race http://t.co/kivy3JgW Promising therapy awakens immune system 2fight cancer $$ Jun 05, 2012
  • NRA-Backed Law Spells Out When Indianans May Open Fire on Police http://t.co/8v922BB2 Law will likely not last long; few corrupt cops $$ Jun 05, 2012
  • AIG Chief Sees Retirement Age as High as 80 After Crisis http://t.co/VF0thYCp A bit of a tin ear as he relaxes at his Croatian villa $$ Jun 04, 2012
  • IPads on a Plane Let Scoot Save Fuel by Shedding TV Tons http://t.co/50POpeO2 Never realized the entertainment system weighed so much $$ Jun 04, 2012
  • Q: What Is New and Scary? A: The Revised GMAT http://t.co/Z0LR8dq4 Nu requires test-takers2read & sort complex charts & analyze much data $$ Jun 04, 2012
  • Iran and Israel Can Agree on This: Rita Jahanforuz Totally Rocks http://t.co/83HxNwsx Jewish Star Remakes Persian Oldies; Fans in Tehran $$ Jun 04, 2012
  • European Project Trips China Builder http://t.co/7jtu1Q5M Long tale of woe in Poland from accepting lowball bid from Chinese construction co Jun 04, 2012
  • Good time had by all $$ MT @interfluidity: a mexican lunch in ellicott city with @interfluidity makes for a delightful afternoon. Jun 04, 2012
Getting Crowded

Getting Crowded

Note: there is a vote going on at http://list.ly/list/1HO-top-100-investment-blogs? regarding the best investment blogs.? Whether you vote for me or not, I encourage you to vote up blogs you like.? I voted for 12 or so blogs, I didn’t just vote for myself.? Recommend other blogs if you see fit.

PS — If anyone wants to nominate me for Who do you think is a big thinker in finance? I would be honored, but I understand if otherwise.? I voted for many who were there already.

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

It took me a while to come over to the views of Lacy Hunt, Van Hoisington, and Gary Shilling, but with the addition of Bill Gross, Mizuho Securities, and Jason Zweig, I am beginning to feel crowded.? When abnormal theories begin to get embraced I get concerned that the cycle is changing and that the theory will fail because more people believe it.? In the short-run, it means the long end of the yield curve will rally, in the long run, macroeconomic forces will dominate.

Will long rates continue to fall?? Probably.? Will they stay low??? They might stay low for a few years, but if the US government takes actions that reduce regulation, the economy will grow, banks will lend, and rates will rise.? But if Obama is re-elected, regulations will increase, businesses will not grow, banks will have no reason to lend, and we will remain in this morass.

Note: I am planning on voting for a third party, I don’t care for Romney.? Romney would be far better for the economy than Obama, but economics does not figure into my voting; I look for the man who can best lead us ethically, and that is almost never the Republican or the Democrat.

 

Strong Hands

Strong Hands

When I started writing this blog, my Major Article List was a big thing to me.? I wrote some pretty good things at RealMoney.com, and I wanted to have a record of the best of that.? I only wish I had done the same thing for my Columnist Conversation comments, because many of them were far better than most articles at RealMoney.? Give TST credit, they would frequently take my best comments, and turn them into posts, and pay me for them.? They did not have to do that.

But, I would love to republish many of my best timeless posts here.? I offer a deal to RealMoney: In exchange for being able to republish old posts and comments of mine here, I will offer you new posts of mine, or the best of my old posts at my blog, so long as they are timeless.

Regardless, when I was at RealMoney, I wrote a series that dealt with the motives of various investors as it stemmed from their balance sheets.? For those that have access to RealMoney, here are the articles (note: I wrote different titles than what was used):

Managing Liability Affects Stocks, Pt. 1
Separating Weak Holders From the Strong
Get to Know the Holders? Hands, Part 1
Get to Know the Holders? Hands, Part 2

The main idea is this: There are a wide variety of investors, and they have differing abilities to hold assets.? Why should investors have differing abilities to hold assets?? And why should that matter?

When will you need the cash?? That should be a central question for every investment adviser, dictating asset allocation.? This is basic asset-liability management.? This gets neglected in investing more often than most imagine.

  1. Mutual funds know that money will be pulled if they underperform.? This forces them to be more short-term in investing.? An exception can be closed-end funds, since they have captive capital, so long as the discount to NAV doesn’t get too great, and they attract activist investors.
  2. Same thing for hedge funds; they tend to be volatility-averse on average; and their investors may be technically more sophisticated than mutual fund investors, in practice, they make the same mistake of chasing performance.
  3. Average individual investors chase trends; that is very short-term.
  4. ETPs react to the market.? Indexed investing amplifies a market as it grows, and muffles a market as it shrinks.
  5. Endowments can resist short-term underperformance for a few years, then the trustees get antsy.
  6. Same thing for Defined Benefit [DB] pension plans, but more so.
  7. Most banks and insurers have short liability structures so they can’t allocate that much to long duration assets like stocks and esoteric illiquid assets.? Life insurers could invest there, but the risk-based capital regulations make it unworkable.? That leaves P&C insurers writing long-tailed business; many of them are value investors, and use the long-duration liabilities (as Buffett calls it “float”) to invest in a wide number of cheap assets where it may take a while for value to be realized.
  8. Trusts, limited partnerships, etc., hinge on how much leverage they employ and how often the terms of the leverage shift, as well as any limitations on when capital must be distributed.? Sometimes that’s not obvious, as in the failure of many mortgage REITs when the repo haircuts got boosted in the midst of the financial crisis, leading to forced selling, as they did not have enough capital to post as margin against all the assets that they held.? The forced selling led to falling prices for mortgages, which led to further increases in the repo haircut, which created a self-reinforcing spiral until a new class of investors held many of the mortgages, and many mortgage REITs were bankrupt or broken.

With respect to institutional investors, my experience is the more of the investment is done internally, the more patient the capital tends to be.? Perhaps that’s the illusion of control, but I tend to think that investors have more trust in their own reasoning than in the reasoning of external managers.

The longer the time that you can invest and wait for returns, on average, the more aggressive you can be in investing.? The investor that can “Buy-and-hold” can take on the most difficult situations if there is a sufficient discount in the price to make the wait worthwhile, and avenues that allow for change to be encouraged.

So, when I think of how my investment is affected by those that invest alongside me, I divide them up this way:

  • Strong Hands — long liability structures, excess capital, experienced, patient, never compelled to do anything; they can live with short-term losses.
  • Weak Hands — no balance sheet or short liability structures, have to make a certain return each year, less experience, leveraged; they can’t live with short-term losses.

When I go through 13F filings, I note the quirkiness of the assets held, and often held for a long time.? Almost all of the 13Fs that I track I would classify as strong hands.? They don’t care about the next quarter; they are thinking about the next 3-5 years.? They care about the growing underlying value of the businesses; they wouldn’t care if stock market was only open one day per month.? Some, like Seth Klarman, do little on the long side when opportunities are not compelling.? Like underwriters at well-run insurers, when an insurance market is nuts, you stop writing business, and spend time improving your skills.

So for my own investing this past period after I finished my 13F analysis, I took the companies that had:

  • The 100 largest increases in my 13F investors
  • The 100 largest increases in cash invested as a fraction of market cap
  • The 100 with the greatest number of my 13F investors
  • and the 100 largest positions as a fraction of market cap,

and put them in as competitors in my ranking system, against my current portfolio.? Because of redundancy, it was about 320 companies in all.? I think it was a good exercise, because it made me think about a bunch of companies that I would otherwise never consider.? Anyway, the process is complete, and the equity portfolios have some promising new names with good prospects, and fellow shareholders that are for the most part “strong hands.”

On the Facebook IPO

On the Facebook IPO

If you are a manager of corporate bonds, you get to learn the speculation cycle.? New IPOs may close in weeks if things are cold, and close in minutes if things are hot.

When things are hot in bonds, eventually the syndicate (“Wall Street”) decides that it is time to test the bullishness of buyers.? At such a time, they extend the time of the offering, and either lower the yield spread (raise the price), or increase the size of the deal.

When I was a corporate bond manager, if a deal was upsized by a large amount during a period while the market was hot, I would not buy.? Tough decision, but cutting against the grain is usually a good thing.? My brokers marveled that I was not participating in these large “benchmark” deals.? More often then not, they failed, and I smiled on the sidelines.? The brokers “stuffed” the ignorant buy-side that was all too willing to take risk.? Typically after that, corporate investors were more careful.

I don’t know the right value for Facebook, and I don’t think anyone does.? Too much of the value depends on future decisions, competitor actions, and economic conditions.? Valuing stocks where the positive cash flows are far out into the future is tough, should the cash flows materialize.

The last IPO I bought was Assurant [AIZ] where I was buying the company for <90% of book value,? and 9x earnings.? I’m a value buyer, so I buy companies where prospects are not fairly calculated by the market, but I avoid new issues where the price is outlandish.

Look, Wall Street works on two levels: distribute paper at a slight discount price, until buyers take it for granted and bid aggressively, leading to a mini-crisis, like it is for Facebook now.

Did Wall Street get the best price for Facebook’s current shareholders at the IPO? Probably yes.

Was that the right price? For recent investors, the answer is no.? But in any IPO process there were a wide number of ways to protect themselves:

1) Don’t participate in IPOs. When general valuations in the market? are high, IPO valuations are higher.

2) Avoid buying IPOs in hot sectors, they are often overvalued.? Only go for IPOs in sectors no one cares about, like insurance, where I offer you Assurant [AIZ} and Safety Insurance [SAFT], among others.? (I don’t suppose it helps you to learn that insurers return better than almost any other industry?? Didn’t think so… because it is a boring yet complicated business.? Even Buffett said about Assurant — “too complicated,” and he is one of the greatest insurance executives of all time.)

3) Avoid IPOs where the deal size is upsized.? When a deal is upsized that often means the underwriters are taking advantage of demand, which diminishes the likelihood of any short-term outperformance.? For this point, in the bond market, I would cut my bid, unless I really liked the credit, together with my analyst.

4) Avoid IPOs where the price talk is raised, which also limits the likelihood of any short-term outperformance.? Same thing as a bond manager, I would drop out out if the new yield did not meet my yield needs.

5) Buy IPOs when they are forced to occur and are hated, like my experience with the Prudential “C” bonds, and most mutual insurer conversions.? IPOs are like the market on steroids, you want to avoid them when things a hot, but they are interesting when things are cold.? After all, who wants to IPO when things are cold?? There are occasional situations where legal matters force a company to go public, and that can be an interesting time to be an opportunistic buyer.

6) Avid IPOs where the valuation is stretched.? It may be a great business concept, but can it grow into that fancy valuation?? Unlike Dr. Damodaran, I don’t go in for fancy reasoning that justifies high valuations.? Most investors are better off avoiding high valuation situations, and focus on more down-to-earth types of businesses.? (My recent purchases include: Crude Oil Refining & Transport, Integrated Oil Major, two basic technology companies with forward P/Es under 10, a specialty retailer that is the strongest in its category, and two insurers, one that is a holding company, and one that is a hedge fund.)

7) Finally, avoid IPOs where those that know nothing about investing are interested.? Facebook is a perfect example here, with a large number of users who love the company, but have little idea of how profits are made, or how they will grow.

IPOs are tough, I think tougher than ordinary investing, so? avoid them unless you have an edge that justifies participation.? Be tough on yourself here — what is your edge?? Share it with a friend who has expertise, and see if he agrees with you.? This is not easy stuff, it only seems easy when the market is running hot, and that is a bad place to be when it goes cold.

 

 

Full disclosure: long AIZ, for me and clients

Book Review: The Big Win

Book Review: The Big Win

I enjoyed reading this book, but I have some issues with it.? First, let me say what I liked:

1) The author chose? a number of different investors to make his point.? They weren’t all outside passive minority investors like most of us are.? There were many that invested in whole companies, or, they were the company, and invested in incredible ventures.

2) He points out a number of significant successes and how they occurred, for seven investors.

3) He points out commonalities in? the processes in the first two chapters and the epilogue.

4) He is a sharp observer of investment processes.? He knows the game, as I do.

What I did not like:

1) Big successes are like snowflakes — no two are alike.? There was little to unify the successes of the book.?? Readers deserve a more unified theory of what leads to success.

2) The Chapter on Jimmy Rogers was weak.? Aside from what he did with Soros, there is no indication that he has made significant money since then.? No “Big Win” was recorded in the book.

3) With a few of the “Big Win” investors, it was difficult to tell whether they really had a “big win” or a moderate win.? Some of the stories had nothing dramatic behind them.

4) There was little to integrate the disparate investors, despite the chapters that attempted it.

Though I liked the book, I found nothing compelling to make me love the book.? I have read better books in this area.

Quibbles

Already expressed.

Who would benefit from this book:?? If you like a mostly unrelated set of investors that will not teach you an integrated set of ideas, you will find it here.? If you want to, you can buy the book here: The Big Win: Learning from the Legends to Become a More Successful Investor.

Full disclosure: The PR flack asked me if I wanted the book, and was kind enough to send me the prior book also, which I thought wouldbe the better of the two.

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.

 

Aim for the Middle

Aim for the Middle

“Ya gotta take more risk to get more return.”? That’s the street language version of what is commonly trotted out, but it is only half true.

The truth is that moderate risk taking outperforms taking no risk or taking high risks.? This is true in bonds.? BBB bonds return best of all — they are the middle of credit risk.? There is no native group that wants to own them exclusively.? Higher-rated bonds do next best, and junk bonds do worse still on average.

Think of it this way: Those that invest in cash get a low return.? But those that invest in high-risk growth companies also get a low return, on average.? Those that take moderate risk have the best potential of making money.? That is why I focus on investors that take moderate risk relative to their peers.

Moderate risk taking does best on average, at least as far as public capital goes.?? Private capital may have more control and expertise, and can take more risk as a result.? In general, the less control and expertise, the less risk should be taken. With private equity, this is one of the tough truths: Private capital can change matters if it is large enough. Then it has to deal with changing the management of the business.? Public equity does not get there, except in rare cases.

That is a major reason why moderate risk-taking wins on average. In one sense, it is why low volatility investing and value investing work.? You are putting your money at risk, but you are doing so with a margin of safety.? Part of making money is survival; if you don’t survive round one, you won’t make money in round two and the rounds that follow.

That’s why swinging for the fences with stocks doesn’t work.? You get too many strikeouts, and few home runs.? Personally, I try to be a singles hitter in investing.? It’s doable, both intellectually and financially.

This applies to asset allocation as well. 60/40 stocks/bonds does as well as 100% stocks, and with less volatility.? 80/20 stocks/bonds did best the last time I tested — perhaps the true ratio is 70/30 given the outperformance of bonds over stocks over the last decade, but I am reluctant to think so because over the long haul, the best a bond can do is pay its coupon and return the principal.? Even in the case of premium calls, you get your principal back at what is typically an unfavorable time to reinvest.

Another reason to aim for the middle is that you will not get jolted hard during downdrafts, and be tempted to trade out at the maximum point of pain, or, buy in near the peak when the bulls are running their last lap.? A lot of money gets lost that way.

It’s also a reason to hang onto some slack cash or other safe assets, like high-quality noncallable bonds lacking weird features.? It may diminish returns in the short run, but it allows you to stay in the game of investing.? Too many people give up at the wrong time — many friends that I had that gave up on stocks in late 2002 – early 2003, deciding to focus on “what they knew”: residential real estate.? Another group gave up on stocks late 2008 – early 2009, with no place to go with their cash.

Realistic expectations are needed as well.? If you earn more than the growth rate of GDP plus a few percent, count yourself blessed and realize that it is very hard to do that consistently over the long-term.

So aim for the middle: take moderate risks, diversify, be realistic, and adjust your portfolio slowly as conditions change.? Then you can stay in the game, and compound your returns.

Book Review: The Billion Dollar Mistake

Book Review: The Billion Dollar Mistake

Note to readers: I appreciate votes at Amazon.com if you like my reviews, and you can vote here.

We learn more from failures than successes.? With failures, it is easy to observe the cause in hindsight and realize that we neglected a key principle in investing.? With successes, the reasons vary, and it is much harder to generalize.

In the book, most of the failures stem from failing to consider implicit or explicit debt on investments.? I am a sympathetic critic here, because most of my own failures in investing stem from the same flaw.

The two exceptions are the Leon Cooperman and the Madoff investors, where the problem was fraud.? Fraud is tough, and there are ways to reduce the odds of being snared by it — I have written about that at my blog.? It is impossible to eliminate.

But there are some defenses, look for free cash flow, and check the normalized operating accruals.? Scams tend to increase accruals, and no have free cash flow.

High levels of debt are always dangerous; best for amateur and most professional investors to avoid the situations.? If you can do this, you will eliminate most large portfolio failures.

Strengths of the Book

The book considers a wide range of investors.? It has Wealthy Dudes, Hedge Fund Managers, Private Equity Managers, Mutual Fund Managers, Corporations, Individual Investors, and CEOs.? The book considers both passive and active investors, and that is a real strength.? The author aimed for generality in investing when he wrote this.? He could have focused on a single area, but he didn’t.

Quibbles

In dealing with Geoff Grant, the author shows that he does not understand asset-backed securities that well.? What happened there was that they did not understand portfolio margining, and that they could be forced to sell under tough conditions, which is a potential asset-liability mismatch.

With respect to Chris Davis and AIG, it is clear that Davis was relying on historical performance which would no longer prospectively be true.? Complexity in accounting is almost always punished.? Ask Mr. Buffett as to why he keeps his reserves conservative.

Who would benefit from this book:?? With the above caveats, I recommend this book.? We learn more from failures than successes; and you could learn a lot from this book.? If you want to, you can buy the book here: The Billion Dollar Mistake: Learning the Art of Investing Through the Missteps of Legendary Investors.

Full disclosure: I asked the PR flack for the book when she asked me to review his latest book, which I am still reading.

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.

 

391 Auctions

391 Auctions

Jason Zweig of the Wall Street Journal has an interesting piece up called Could Computers Protect the Market From Computers?? I appreciate Jason, he writes a lot of intelligent stuff, and had the guts to revise one of my favorite books, “The Intelligent Investor.”

We are talking about positive feedback loops, where computers amplify the actions of humans demanding action now.? Computers, for all of their strengths, are rules based, and we the humans feed them the rules, or the information that allows them to react to data as they emerge.? The rules may be very complex, but they are rules, and do not allow for humans to modify the computer’s reaction to the market on-the-fly.

I’m skeptical that we can stop unusual things from happening resulting from computers trading rapidly by having other computers monitor it.? First, stocks are volatile, and news can break that leads to significant rallies/declines.? Second, part of the difficulty from the “flash crash” was computers getting out of sync with one another.? We can’t guarantee that the regulatory computers might not fall behind the trading computers, and what might happen if the “right” action to slow trading emerges slowly.

Third, one has to recognize that you should only have regulations that are understood easily by participants, and accepted, or else the rules will face a lot of lobbying pushback.

I think that there is little to no gain to the market as a whole from sub-second trading speeds.? I think we could slow down the market, and force a more rational market than what we currently have, by limiting the ability to cancel orders — all orders must be good for at least one second.

Markets need good rules and structure to work well.? Rather than having shadowy computer overlords, which only academics could like, craft a rule that says, “One auction per second.”? Or create a central order book and eliminate alternative venues for execution.? The cost listed in the article is cheap.? I’m agnostic on what the best solution is, but to me, the best solution involves slowing things down, so that information does not cause cascades off of short-term signals.

Even simple rules like, “Stop trading for any company that has dropped/risen by more than 5% on the day for 30 minutes,” would be preferable to any guidance from computers that is less clear.

Rather than using computers and complex reasoning, we need simple rules to slow things down, or…who cares, let errors happen.? I made money on the day of the “flash crash” by buying shares of a company that was solid but temporarily depressed.? Teach people not to use market orders or they could get harmed.

This is the market, after all, and if you are “bellying up to the bar,” you should be ready for the fact that you are outgunned.? You are likely not smarter than all of the resources being deployed against you by hedge funds, high frequency traders, etc.? Secondary markets in equities exist to provide flexibility to holders of the equities, most of whom hold their stocks every day, with only a small fraction trading.? Trading is a sideshow to value creation, which happens in the companies, not the exchanges.

Which makes me take step back and mention that Buffett wouldn’t care if the exchanges were closed for a year, because he buys solid companies.? Suppose for a moment, I had written an article called 391 Auctions, where I would suggest that the markets have one auction each minute, and that all orders must last until the end of the minute, with no cancellations.? (After I wrote, this I changed the article title, so I did do it.)

With 391 auctions per day, who couldn’t think that we were providing enough opportunity for price discovery each day?? Slow things down, and ignore those arguing for technical efficiency versus those arguing for rational markets that allow people to make reasonable decisions in real time.? One auction per minute?? Could work well — watch the bids and asks line up, once per minute.

Markets need structure to work well.? This could be one way of doing it; I am open to other ideas, but letting the computers attempt to do it opaquely seems like a loser to me.? Slowing things down seems like a winner, because secondary trading is a sideshow to the real value creation that happens inside the companies.

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