Category: Portfolio Management

Seven Notes

Seven Notes

Posted on by David Merkel

First, I have some blog news:? my hosting provider made me delete 7000 spammers out of my user database.? That left me with 200+ users.? Inadvertently, in the process, around 70 bona fide users with surnames starting with the letters J-Z got deleted.? So, if you got deleted, and have to re-register, my apologies.? I tried to be careful, but made an error when matching databases.

Second, MetLife should not have to undergo the stress tests that banks do.? Banks borrow short and lend long; they are inherently unstable.? Insurance companies generally match assets and liabilities, and are stable.? The only insurer of consequence to fail in the crisis was AIG, and it was because of derivatives and securities lending issues, areas that other insurance companies do not touch, or handle differently.

Third, why does an institutional investor use an investment bank?

When I was a corporate bond manager, we used everyone.? We wanted access to deals, and if you don’t deal with all of the majors, you are shut out.? Of course every manager deals with Goldman Sachs even if they don’t trust them.? The big guys know this and keep their brokers at arm’s length.

If you are a reporter, that is why managers will not speak on record.? If the syndicate desks on Wall Street don’t like you, they won’t give you good allocations on contested deals.

Bond managers are wise to use Goldman.? They are wiser to realize that Goldman does not act in their interests, and so, be cautious.? And to the degree that you are a smart manager, you can lessen your dependence on the big guys, and work with the hungry second tier, who know that money can be made by implementing the ideas of smart investors, so find ways to buy cheap bonds for smart investors from dumb investors, and sell rich bonds from smart investors to dumb investors.? After all, brokers only make money when assets are bought or sold.

There are few friends on Wall Street.? Big institutions know that, retail investors should learn that.? But the guy who resigned from Goldman should be aware that not all clients were muppets.? Firms I was with would avoid derivatives unless we were the ones structuring them.? If we have control, derivatives are good.? If we don’t have control, derivatives are bad.? Control is good….

You should always be thinking that those who you deal with may not be acting in your interest, and often, it is because of forces beyond their control.? I was pinned with $10MM face of Teleglobe bonds and the main broker dealing in them held (unknown to me at the time) $100MM+ of the bonds.? My efforts to sell the bonds failed because the broker had a larger position, and there was no active market.

Fourth, just because you live in America, it doesn’t mean you should get a high wage.? Particularly for manufacturing wages are declining, and why shouldn’t they decline, because productivity is not rapidly advancing.? It’s like my article on comparable worth.? Most Americans are going to have to get used to being poorer, because there are many others who can do what they do for less.? And, that partly explains the 1% vs 99% argument, because as the rest of the world grows, and the US doesn’t, it has impact on those in the US that earn too much relative to their productivity.

Fifth, imagine for a moment that you are in charge of an organization that is going to play a baseball game against the winners of the World Series.? You can choose any people to be players that have not been employed in MLB for the last five years.? How well do you think you will do?

Duh. You know you are going to lose.? Well, the same thing applies for those that are arguing that the 99% can dominate the 1%.? Short of Soviet tyranny, it won’t work.? The 1%, should it really exist as a stable organization, is too smart, and will beat the 99% nine times out of ten.

We talk a lot about democracy, though our government thwarts it when it can.? Government typically boils down to aristocracy — the rich rule, and it can’t be otherwise, unless we want Communism, like China under Mao.? In the Eurozone, under the “socialism,” the wealthy happily rule.? Only societies that are wiling to destroy wealth are willing to deny power to the wealthy.? And China is a great example here, as the wealthy increasingly dominate their government, to a greater degree than is true in the US.

Money talks, losers walk, and I never give money to politicians; it is all too corrupt.? Just realize that the deck is stacked against you.? Money finds a way to win in the process eventually.

Sixth, California will suffer for making retiree healthcare unchangeable.? Retiree healthcare in its present form is not affordable by almost everyone.? Why destroy your state by making? promises that can’t be upheld?

Seventh, after you read this, explain why you might trust Chinese statistics.? I reminds me of AIG where bad news had a hard time traveling to the top.

 

Sorted Weekly Tweets

Sorted Weekly Tweets

Posted on by David Merkel

Central Banking

 

  • Norway Faces Housing Bubble as Krone Steals Policy Agenda http://t.co/15hzb0So By cheapening the currency Norway gets an asset bubble $$ Mar 17, 2012
  • Unintended Consequences http://t.co/eLrKtCJc Sprott suggests that the financial system has a chemical dependency on the Central Banks. $$ Mar 17, 2012
  • Is the bond market tightening for the Fed? http://t.co/iRSerA8X The bond market is larger than the Fed; they can’t control the curve $$ Mar 17, 2012
  • Germany Turns Up Pressure on ECB http://t.co/w2yyfvU1 Difficult to see how the liquidity drains out of the ECB ~3 years from now $$ Mar 13, 2012
  • China central bank news conference on policy, yuan http://t.co/w8cy5K1Z & http://t.co/XcIFAbvb Japan buys Yuan, don’t think it means much Mar 13, 2012
  • Bond market certainly did not like the FOMC statement. “Don’t worry about energy prices, we got it all under control.” $$ #fuelinginfltion Mar 13, 2012

 

Investment Banking

 

  • Why banks will continue to rip off clients http://t.co/oTT9fd2i Conflicts on Wall Street, especially at $GS. Big guys know that. So what? Mar 17, 2012
  • Goldman Sachs?s long history of duping its clients http://t.co/2sXmKl0D Tells the story of how $GS foxed its way out of Penn Central CP $$ Mar 17, 2012
  • The CMBS maturity wall is here http://t.co/GrcEm1KO I remember buying CMBS deals 11-12 years ago. Bullet loans weak if can’t refinance $$ Mar 17, 2012
  • Goldman Roiled by Op-Ed Loses $2.2B for Shareholders http://t.co/yz0f0oLy A passing matter; of course IBs have conflicts of interest #duh Mar 17, 2012

 

China

 

  • Bo?s Ides of March http://t.co/mnKFU8Zx Not so much a move to the right as a statement against being flashy and self-promoting $$ Mar 17, 2012
  • Chinese Economy Already in ?Hard Landing,? JPMorgan?s Mowat Says http://t.co/kwFW2Ty6 Cyclical industries will produce less in China 2012. Mar 17, 2012
  • China’s official admission of slowing commerce activities http://t.co/br7H4D2o When a long trend changes, often moves further than expected Mar 17, 2012
  • China’s fixed asset investment growth moderating http://t.co/CEl5mZTc “Growth in real estate and manufacturing projects remains steady.” $$ Mar 13, 2012
  • GMO: Something’s Fishy in China http://t.co/DO8v4w8p Goes through the 10 signs of a bubble; finds that Chinese economy has most of them $$ Mar 13, 2012
  • US and Europe Move on China Minerals http://t.co/xyGsdkDq WTO ruled against China in January, pressing similar case 17 rare-earth metals Mar 13, 2012
  • Another call for an end to China driven industrial commodities “super-cycle” http://t.co/VAd5gR0D Investment is way too high & unproductive Mar 13, 2012

 

Rest of the World

?

  • Sarkozy?s Yield Drop at Risk With Hollande Victory http://t.co/ti25ozdq Surprise, if Hollande cares for poor in France, E-Zone suffers $$ Mar 17, 2012
  • Saudi Arabia Lifts Curtain on Diplomacy as Syria Killings Spur King to Act http://t.co/H8g8D5nG Favors 85% Sunnis over ruling 15% Alawites Mar 13, 2012
  • How about those Japanese net-net’s? http://t.co/SAZEcofy Making money in very ill-known small companies in Japan $$ Mar 13, 2012
  • The Islamic World’s Quiet Revolution http://t.co/ChNksuFm They’re having fewer children, which I already noted here: http://t.co/KnOGFeOA $$ Mar 13, 2012
  • Portugal Yield at 13% Says Greek Deal Not Unique http://t.co/bPBconfk After Greece, the next places to watch are Portugal & Spain. $$ Mar 13, 2012
  • Iran-Israel History Suggests a Different Future http://t.co/M1IzxuuB I never knew that Israel sold weapons to Iran in the ’80s. $$ Mar 13, 2012

?

Financial Sector

?

  • MetLife CEO’s Stress Test http://t.co/YaVV4GMp $MET doesn’t deserve to be treated as a systemically risky firm. Long liabilities protect Mar 17, 2012
  • Assurant Falls as California Seeks Rate Cuts http://t.co/d0OcDS09 FD: long $AIZ; this is overrated; ability of the commissioner limited $$ Mar 17, 2012
  • Felix Salmon At Columbia Journalism School: Don’t Blame Journalists For Failing To Prevent Financial Crisis http://t.co/0LrCwisB true, but Mar 13, 2012
  • Journalists, even if they understood what was going on in the finl mkts would face a tough time writing warnings in the midst of boom $$ Mar 13, 2012
  • US Government Agencies Comparing Notes On Algo Feeds http://t.co/15oAxpn9 Little speed advantages w/econ data can lead to big profits #SEC Mar 13, 2012
  • Marketview:Point of Reference http://t.co/Xlp5jczH “4 the 1st time this yr I can feel the true bullish sentiment among the investing public” Mar 13, 2012
  • Banks foreclosing on churches in record numbers http://t.co/fR3Ro9CJ Frankly, I am surprised that banks lend to some churches. $$ Mar 13, 2012
  • Banks Buy Treasuries at Seven Times Pace in 2011 http://t.co/SDKsJIUB What else to do with all the excess liquidity & weak borrowing $$ Mar 13, 2012

 

US Government-Related

 

  • Pension Benefit Costs Cut by Record 43 States, Study Says http://t.co/B8ZRg4gZ State take actions to reduce benefits to active employees Mar 17, 2012
  • Best Treasury Forecaster Says 10-Year Yield to Drop From Highs http://t.co/ma8YoN4u Don’t be too sure about Treasury rates rising $$ Mar 17, 2012
  • International Demand for U.S. Assets Rises http://t.co/FwdXqrWH As the E-Zone gets worse, demand for US debt improves. $$ Mar 17, 2012

 

Investing

 

  • Temporary Hedges eventually force Deleveraging http://t.co/0jVSWRzw On Energy Future Holdings, & why predicting the future is tough $$ Mar 17, 2012
  • Cyclicals persistent underperformance http://t.co/KkJ2q05p Cyclicals started underperforming in August. Relatively they never recovered. $$ Mar 17, 2012
  • Magnetic Fields http://t.co/S6VYIe5Y Good post. This graph is worth a look: http://t.co/EBhPh6ZN May help explain recent lost decade $$ Mar 13, 2012
  • Stock Compensation, Tax Law, Financial Reporting and Facebook’s IPO http://t.co/ULyVLNkr Future dilution may pressure $FB shares $$ Mar 13, 2012
  • A Value Investor’s Take on Shorting http://t.co/cZYueqGH Tactical discipline, not structural, b/c market can go nuts. Can help hedge $$ Mar 13, 2012

 

Miscellaneous

 

  • Considering Bankruptcy? Head to the Mall http://t.co/UvgEArMj Legal services offered for simple situations in mall locations. $$ Mar 13, 2012

 

Book Review: Pandora’s Risk

Book Review: Pandora’s Risk

Posted on by David Merkel

This is two books in one, and very well done.? The main part of the book explains risk and uncertainty in general terms, such that most people can understand it.? But for those that can deal with complex math, the latter part of the book offers a lot of additional firepower.

Risk is a tough subject because history only vaguely informs you as to how bad things can get.? Past is not prologue.? There are two possibilities, the past contains and event that was so horrible that it can never happen again, or, the past does not tell you how bad things can be.

Market observers took the first view, that the Great Depression could not repeat.? As a result, few prepared for a situation where there was too much debt, and insufficient ability to service it.

The subtitle of the book is rightly “Uncertainty at the Core of Finance.” Not risk, but uncertainty.? The distinct is important, because risks are things that we know some things about the possible economic outcomes, and can control them to a degree.? Uncertainty is where we don’t really understand the dimensions of the outcomes, and have little if any control.

There is fundamental uncertainty to the simplest aspect of finance, money.? Money seems stable enough in the short-run, but every now and then it fails due to hyperinflation, or the slow steady failure in the store of value sense of moderate inflation over long periods.

Wealth itself is uncertain.? Even if you own it free and clear, there’s no way to tell what it will be exchangeable for next year, much less further out.? There are a lot of people who thought they knew what their homes were worth 5-7 years ago that are decidedly disappointed.

Government debt is uncertain, as governments think they can always roll it over, but political and other obstacles can lead to a refusal to pay when debt service becomes high relative to tax revenues.

Banking is uncertain, mainly because of borrowing short to lend long.? If banks limited themselves to facilitating transactions, a lot of the uncertainty would go away.? Banks would be a lot smaller, less profitable, and there would be fewer of them, and the economy would be more stable.? (Entities with longer liability structures, like pension plans, endowments, and life insurers would become the new source of lending. More would be financed through equity.)

Credit is uncertain.? During boom times, corporate bonds behave independently, and diversification evens out results.? As a result, corporate credit seems safer than it really is, and marginal ideas get to borrow.? During bust times, far more corporate debt defaults than would be expected — there’s almost no such thing as an average year.? It’s either feast or famine.

There are things that can be done to try to mitigate uncertainty: credit ratings, or any scoring system for assets, lending at a more senior level, and Value-at-Risk.? Also using more robust assumptions on possible outcomes, which would lead to smaller position sizes, less leverage, or more cash.

The book has a real strength in showing how the the assumption of normally-distributed risks fails dramatically in many cases, and offers alternatives that would work better.? Trouble is, once you realize how volatile the world really is, a lot of strategies either don’t work, or need to be scaled back.

The book praises actuaries as risk managers, with their ethic codes and stress tests, as opposed to quants with Value-at-Risk and no ethics code.? Banks and Wall Street would be better off in the long run hiring actuaries, who think about risk more holistically, and getting rid of the quants in their risk control departments.? Same for the regulators who evaluate banks.

There are other controversial ideas here: is it possible that the strong economic growth of the past is an anomaly?? Is it possible that growth for nations, and the world as a whole follows S-curves, like products and companies?

This is an ambitious book, and I like it a lot because it is willing to cross boundaries and apply the principles in one? area to another that seemingly should not receive it.? I liked it a lot, and would recommend it to many.

Quibbles

On page 17, he thinks of currency as a put option, but I think of it as 0% overnight commercial paper.? On page 37, he confuses Moses and Joseph, having Moses predict the 7 good followed by 7 bad years, when it was Joseph who did that.

Who would benefit from this book: Every financial regulator should have this book.? Every academic burdened by the lies of Modern Portfolio Theory should get this book.? Anyone who fancies himself to be a risk manager should have this book.? Finally, if you want to understand why financial markets are inherently uncertain, this book will teach you well.? If you want to, you can buy it here: Pandora’s Risk: Uncertainty at the Core of Finance (Columbia Business School Publishing).

Full disclosure: The publisher asked if I wanted the book.? I said ?yes? and he sent it to me.

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.

An Advanced Penny Stock Scam

An Advanced Penny Stock Scam

Posted on by David Merkel

Don’t buy what someone wants to sell you.? Buy what you have researched, and know that it is what you want to buy, because it is valuable.

I have an irregular series on penny stocks, largely off of advertisements mailed to me, or things found on the web.? Every promoted penny stock I have run into has done badly.

Now for all of my prior penny stocks that I have been written about, all have done horribly.

Today’s gem is iTrackr [IRYS], which the advertiser says is the “Groupon Killer,” complete with a cover page that has a dinosaur labeled “Groupon,” being hit by meteors labeled “iTrackr” and “IRYS.”? Now, this time I got a full 16-page shiny brochure, which had quotes on iTrackr from two notable publications, but in 2006 & 2007, long before Groupon was prominent… and iTrackr did not gain in profitability since then, rather, it had larger and larger losses.

In five-point (or so) type, near the back of the brochure, there is the disclaimer.? I scan it with OCR so that you can read it at a normal size:

Disclaimer:

The xxx Newsletter and/or its publisher, Author Inc., dba blablabla.com did not receive any direct compensation (other than future subscription revenues, the amount of which is not known at this time) with respect to the publication of this Advertisement. Author Inc. has received ten thousand dollars in cash compensation to assist in the writing of this advertisement. BHB Marketing paid eight hundred thousand dollars to marketing vendors to pay for all the costs of creating and distributing this report, including printing and postage, in an effort to build investor awareness. BHB Marketing was paid by non- affiliate shareholders who intend to sell their shares.

?This publication does not provide an analysis of a company’s financial position. iTrackr Systems, Inc.’s financial position and all other information regarding iTrackr Systems, Inc. should be verified with the company. Information about many publicly traded companies and other investor resources can be found at the Securities and Exchange Commission’s website at www.sec.gov. Investing in securities is speculative and carries risk. It is recommended that any investment in any security should be made only after consulting with your investment advisor and only after reviewing all publicly available information, including the financial statements of the company. This mailing piece is not intended to be, nor should it be construed as, an offer to sell or a solicitation of an offer to buy securities, nor should it be construed as the provision of any investment-related advice or services tailored to any particular individual’s financial situation or investment objective(s). The xxx Newsletter is a bona fide publication of general and regular circulation offering impersonalized investment-related research to readers and/or prospective readers and is not an investment adviser. As such, it relies upon the “publisher’s exclusion” as provided under Section 202(a) (11) of the Investment Advisers Act of 1940 and corresponding state securities laws. The xxx Newsletter is not a registered broker dealer. Staff members of The xxx Newsletter and its affiliates may hold positions in investments mentioned herein, and may buy or sell their interests on the open market at anytime. The xxx Newsletter presents information in this report believed to be reliable, but its accuracy cannot be guaranteed. Additionally, it includes forward-looking statements and information within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including statements regarding expected growth of the featured company. Any statements that express or involve discussions with respect to predictions, expectation, beliefs, plans, projections, objectives, goods, assumptions or future events or performance may be forward-looking statements. The forward-looking statements contained herein (which include all statements other than historical information) involve significant uncertainties. Factors that could cause actual results to differ from the results or implied in forward-looking statements include the size and growth of the market for the Company’s products, the Company’s ability to fund its capital requirements in the near term and in the long term, pricing pressures for the Company’s products and services, the Company’s ability to obtain needed resources, and the local, regional and global markets. Forward-looking statements are based on expectations, estimates and projections at the time the statements are made that involve a number of risks and uncertainties that could cause actual results or events to differ materially from those presently anticipated. Past performance does not guarantee future results.

Emphasis mine. I wanted to split and highlight the juicy stuff.

Now, let’s think about the math of the scam: they pay the author $10,000 to sell his limited credibility to pump a penny stock.? They put $800,000 into the production and mailing of the glossy brochure.? But the market cap of the company is only $6.7 million.? They think the advertisement will create a lasting 12%+ rise in the stock that they can sell into.? Pump-and-dump.? Proclaim a biased story in big print; offer retractions in small print.

No surprise to me, this company has negative earnings (which are getting worse) and a growing negative tangible net worth.? For fun let’s look at the risk disclosures from the 10-K:

  • Because there is doubt about our ability to continue as a going concern, an investor may lose all of his investment in our company.? [Oh yeah, the auditors don’t believe in us.]
  • iTrackr has a history of losses and may not be able to generate sufficient net revenue from its business in the future to achieve or sustain profitability.
  • iTrackr?s cash on hand and anticipated near term sales may be insufficient to fund operations for the next 12 months.
  • If iTrackr is unable to fund its operations and capital expenditures, iTrackr may not be able to continue to develop and market its products and services which would have a material adverse effect on its business.
  • iTrackr is dependent upon key personnel whose loss may adversely impact iTrackr?s business.
  • iTrackr?s management systems and personnel may not be sufficient to effectively manage its growth.
  • If we are not competitive in the market for online sales, marketing and customer service solutions, or online consumer services our business could be harmed.
  • We are dependent on technology systems and third-party content that are beyond our control.
  • Our services are subject to payment-related risks.
  • We may be liable if third parties misappropriate personal information belonging to our clients? Internet users.
  • Our products and services may infringe upon intellectual property rights of third parties and any infringement could require us to incur substantial costs and may distract our management.
  • Technological or other defects could disrupt or negatively impact our services, which could harm our business and reputation.
  • Our promotion and marketing of our websites may not result in generation of significant revenue which may cause our business to fail.
  • Unauthorized disclosure of sensitive or confidential client and customer data, whether through breach of our computer systems or otherwise, could expose us to protracted and costly litigation and cause us to lose clients which may result in our going out of business and for you to lose your investment.
  • Competition in the social networking, online marketing and e-commerce industry is intense and our competitors have greater financial resources and development capabilities than we have, and we may not have the resources necessary to successfully compete with them.
  • Our services may become obsolete and unmarketable if we are unable to respond adequately to rapidly changing technology and customer demands.
  • The loss of our executive officers or directors, could adversely affect our business.
  • Our Controls and Procedures may not prevent misstatements.
  • Our Financial Statements for the year ended December 31, 2009 and the quarterly periods ended March 31, 2010 and June 30, 2010 were Restated as a Result of a Re-Audit by our New Independent Accountant Which was Necessitated Due to Revocation of our Former Auditor?s Public Company Accounting Oversight Board (?PCAOB?) Registration.
  • There will be a substantial number of shares of iTrackr?s common stock available for sale in the future that may be dilutive to its current stockholders and may cause a decrease in the market price of its common stock.
  • Our common stock is considered ?a penny stock? and may be difficult to sell.
  • iTrackr may be unable to receive a listing of its securities on NASDAQ or another national securities exchange, and this may make it more difficult for its stockholders to sell their securities.
  • One stockholder owns a majority of our common stock and may act, or prevent certain types of corporate actions, to the detriment of other stockholders.
  • If we issue additional shares of common stock in the future this may result in dilution to our existing stockholders.
  • There is currently no market for trading our common stock, and when such a market does develop, the trading price of our common stock may be volatile, with the result that an investor may not be able to sell any shares acquired at a price equal to or greater than the price paid by the investor.
  • The trading price of iTrackr?s common stock is likely to be volatile, and you might not be able to sell your shares at or above the public offering price.
  • The concentration of iTrackr?s capital stock ownership with insiders will likely limit your ability to influence corporate matters.
  • The Company does not expect to pay any cash dividends for the foreseeable future.

Not too optimistic, as you can see, and one looking through the financials would note that they are running out of cash.

Do the large holders think that they will dupe enough people to buy their shares from them, and at advantageous prices?? Hmm… maybe any price above zero is an advantageous price.? As with many promoted penny stocks, it usually looks like a future zero.

Even if the scam is legal, I don’t get how the math works.? They really think they will get a sustained 12%+ rise in the stock, adequate to turn over the entire capitalization of the company into the hand of suckers?

Which makes this double-dumb.? When even the scammers don’t make money, it is one really dumb scam.

Main lesson: don’t buy promoted stocks, and particularly not penny stocks.

PS — Why did the advisor decide to write this?? Was he that desperate for money?? If I were one who bought newsletters, I would not be impressed with the lousy analysis here.
The Best of the Aleph Blog, Part 14

The Best of the Aleph Blog, Part 14

Posted on by David Merkel

This period of the Aleph Blog covers May through July of 2010.? The one big series that I started in that era was “The Education of a Corporate Bond Manager” series.? The idea was to describe how a neophyte was thrust into an unusual position and thrived, after some difficulties.

The Education of a Corporate Bond Manager, Part I

How I learned the basics, and survived 9/11.

The Education of a Corporate Bond Manager, Part II

How I learned to trade bonds, and engage in intelligent price discovery.

The Education of a Corporate Bond Manager, Part III

What is the new issue bond allocation process like, and what games get played around it?

The Education of a Corporate Bond Manager, Part IV

On the games that can be played in dealing with brokers.

The Education of a Corporate Bond Manager, Part V

On selling hot sectors, and dealing with the dirty details of unusual bonds.

The Education of a Corporate Bond Manager, Part VI

On dealing with ignorant clients, and taking out-of-consensus risks.

Then there was the continuation of “The Rules” series:

The Rules, Part XIII, subpart A

On the biases the come from yield-seeking.

The Rules, Part XIII, subpart B

Repeat after me, “Yield is not free.”

The Rules, Part XIII, subpart C

Reaching for yield always has risks, but the penalties are most intense at the top of the cycle, when credit spreads are tight, and the Fed?s loosening cycle is nearing its end.? It is at that point that a good bond manager tosses as much risk as he can overboard without bringing yield so low that his client screams.

The Rules, Part XV

Securitization segments a security into liquid and illiquid components.

The Rules, Part XVI

“Governments are smaller than markets; markets are smaller than cultures.“

A fundamental rule of mine, but one with a lot of punch.

The Rules, Part XVII

On the differences between panics and booms.

The Journal of Failed Finance Research

Much research fails quietly, but other researchers don’t learn about the dead ends.? Better that they should learn of the failures, and avoid the dead ends.

How I Minimize Taxes on my Stock Investing

Sell low tax cost lots and donate appreciated stock to charities.

Place Political Limits on Overly Compliant Central Banks

Gives a simple rule to control central banks so that they avoid the present troubles.

Yield, the Oldest Scam in the Books

Yes, offering yield is the oldest way to trick people into handing over their money.

A Summary of my Writings on Analyzing Insurance Stocks

A good place to get started if one wants to get up to speed on insurance stocks, but there is a lot there.

Economics is Hard; the Bad Assumptions of Economists Makes it Harder

Going over Kartik Athreya?s letter criticizing nonprofessional economics bloggers.? Why the math behind macroeconomics and microeconomics doesn’t work.

Why Are We The Lucky Ones?

When you are a part of a small broker-dealer, all manner of harebrained deals get offered to you.? This explores three of them.? Note: management did not ask my opinion on the fourth deal, and that is a large part of why they no longer exist.

One more note: the guy who was going to pledge $5 million of stock in example 2 for a $1 million loan?? The stock is worth $7,000 today.

Watch the State of the States

The economics of the states tells us a lot more about the national health because they can’t print money to buy national debts.? (Though they can can raid accrual accounts…)

We Might Be Dead In The Long-Run, But What Do We Leave Our Children?

My view is that neoclassical economists are wrong.? Aggregate demand has failed for four reasons:

  1. Overleveraged consumers will not readily buy.
  2. Citizens of overleveraged governments will not readily spend, for fear of what may come later from the taxman, or from fear of future unemployment.
  3. Aggregate demand is mean-reverting.? It overshot because of the buildup of debt, and is now in the process of returning to more sustainable levels.? The same is true of private debt levels, which are being reduced to levels that will allow consumers to buy more freely once again.
  4. When the financial system is in trouble, people get skittish.

The Market Goes to the Dogs, Which Chase Their Tail Risk

Complex and expensive hedging solutions, many of which embed some credit risk, can be less effective than lowering leverage, and (horrors) holding some cash.

Fishing at a Paradox. No Toil, No Thrift, No Fish, No Paradox.

This one had its detractors, because I believe the paradox of thrift is wrong.? Too much aggregation, and it does not allow the dynamism of the economy to adjust over time, even from severe conditions.

Sorted Weekly Tweets

Sorted Weekly Tweets

Posted on by David Merkel

Here’s the news of the past week:

US Economy

 

  • How the Government Lies About the Real Inflation Rate http://t.co/g6E4KxV5 I agree inf is understated, but by 1-2%, not 6-8%/yr $$ Mar 09, 2012
  • Tax Hunt Pushes Global Wealthy Into Offshore Trusts for Children in US http://t.co/l53hjFH1 Many clever ways 2cheat the taxman #thinkahead Mar 07, 2012
  • How Much Do Income Taxes Affect Our Behavior? http://t.co/mADKt7a7 Answer: not much, but people favor lower marginal tax rates anyway $$ Mar 07, 2012
  • On Politics, Social Security and Spine http://t.co/N8O1Eu6h @brucekrasting on the Disability Income Trust & what it implies 4 politics $$ Mar 07, 2012
  • Why Young People Might (Eventually) Like to Buy a House http://t.co/yC9FX7H5 On the low end, this makes sense at present. $$ Mar 06, 2012
  • Getting Ready to Buy a House http://t.co/6aqzzPmI Megan McArdle notes how low down payments r still prevalent; system not clean @ present $$ Mar 06, 2012
  • Warren Buffett vs. the profiteers of doom http://t.co/02XgQ9tB Unless the US fails in entire, Buffett will be right & the scaremongers wrong Mar 06, 2012
  • NACM credit managers’ index trade credit increase http://t.co/LUdFkYTZ Businesses r more confident in extending credit; coincident indicator Mar 04, 2012
  • @DavidSchawel Then they are having materially better performance than the FHA; I still think housing prices have further to fall on hi end Mar 04, 2012
  • Your Share of Fannie, Freddie Losses: $1,300 http://t.co/h9KdR5d3 Even considering what they are paying the US in dividends, they lose. $$ Mar 03, 2012

?

Federal Reserve

  • @GonzaloLiraSPG Borrow, not print. Fed becomes huge hedge fund 2 arb risky debt spreads. Not in favor of this, but it is happening in small Mar 09, 2012
  • Thought experiment: What would happen if the Fed borrowed enough money to buy up all of the MBS, CMBS, ABS, Agys, Corps, Munis, etc? $$ Mar 09, 2012
  • What the Fed is Considering Doing in Layman’s Terms http://t.co/dXZTMXL2 Levering up, taking more risk in an effort to reduce long yields $$ Mar 09, 2012
  • Bernanke Seen Accepting Faster Inflation as Fed Seeks to Boost Employment http://t.co/AyixImcf Fed is asymmetric, only fights unemployment Mar 08, 2012
  • http://t.co/DR8SLua2 NY Fed never buys the on-the-run and near the run nominal bonds, does the opposite for TIPS, pushes up implied CPI $$ Mar 07, 2012
  • Fed?s Money Monopoly Endangers Liberty and Peace http://t.co/TGhcvm8O Unsound money encourage governments 2b graspy & warlike $$ Mar 07, 2012
  • Central bank policy driving corporate spreads http://t.co/YvV1djQb When the Fed offers cheap financing, risk asset flourish $$ Mar 06, 2012
  • Woodlands congressman battling Federal Reserve’s power http://t.co/iUiwTimH Inflation only, expand role of Regional Feds; Fisher likes it $$ Mar 04, 2012
  • The eventual unwinding of QE: why it?s ignored and what it could mean http://t.co/BPRMaGaU The Fed will be reluctant 2 shrink the Bal Sht $$ Mar 03, 2012

 

Eurozone

 

  • Draghi Lays Groundwork for ECB Stimulus Exit as Inflation Takes Spotlight http://t.co/0y5znzjH So u can’t get inflation thru debt growth? Mar 09, 2012
  • Bond And CDS Arbitrage Opportunities? http://t.co/uRDRh59G Sov CDS “cheap” 2 bonds b/c of a lack of trust in the default trigger $$ Mar 09, 2012
  • Portugal. Boo! http://t.co/ZED0TWOx Mar 09, 2012
  • Draghi Headache: Inflation Heating Up in Europe http://t.co/RQqvvOiC Draghi raised the 2012 forecasts for inflation to 2.1%-2.7% $$ Mar 08, 2012
  • Rift Grows Between Germany’s Bundesbank and ECB http://t.co/trwAlyWm Wise Buba will take pain where ECB wil not. Follow this it will destroy Mar 08, 2012
  • Goldman?s Secret Greece Loan Reveals Sinners http://t.co/eMzOvs2X When u conspire 2b shady, u work w/the shady, who will cheat u2 $GS $$ Mar 07, 2012
  • French-German Border Shapes More Than Territoryhttp://nyti.ms/zDuqpi Culture matters. Policy matters. Similar people yield different results Mar 06, 2012
  • Everyone Loves Mario http://t.co/2sDYYNXh Draghi is popular at present, but this will not end well, b/c bank dependence on the ECB will tell Mar 04, 2012
  • The optimistic view of Europe http://t.co/xtsVrfrY Rogoff argues that these are the birth pangs of the USE: the United States of Europe $$ Mar 04, 2012
  • IMF Set to Curb Funds for Greece http://t.co/XvNhtAcm IMF has 2 much exposure to EZ-fringe; could it b global system hit peak debt? $$ Mar 04, 2012

?

Economics

 

  • An interesting model of asset bubbles http://t.co/cHcFGHht Follows the debt-fueled model of asset bubbles, with momentum tossed in $$ Mar 09, 2012
  • Model Thinking Notes I from Stanford Class http://t.co/qHD0UCzt Those applying models to political questions predict better than others $$ Mar 09, 2012
  • Investors Crave a Taste of the Island http://t.co/fjWsoVDR Amazing how reducing deficits and cleaning up finances can bring growth $$ Mar 09, 2012
  • Cicero quote of the week http://t.co/Y1e6KKYL The budget should b balanced, the Treasury should b refilled, public debt should b reduced… Mar 08, 2012
  • Kindleberger?s Universal Bubble and Crash Scenario http://t.co/Og2VYsX8 We are overindebted, should we be surprised that we face a crisis? Mar 08, 2012
  • After 3 years, we?re all hooked on free money http://t.co/oKRDzSPD Low base rates are creating a new kind of inflation, sad but true $$ Mar 08, 2012

 

China

 

  • Contra: China Inflation May Provide Room for Stimulus http://t.co/Qds1uBwx That is, if you can believe the Chinese inflation statistics $$ Mar 09, 2012
  • Asian banks may b bust; tiger still bites http://t.co/2mW40PMJ Economic consultancy Lombard Street warned China is financial house of cards Mar 08, 2012
  • According to Credit Suisse, the global commodity demand has peaked http://t.co/GNXsHZwL China cannot increase its demand further $$ Mar 08, 2012
  • China Life Discount Swells on World Growth Woes http://t.co/Jl27DtCk I still don’t get China Life and its business model; avoid b careful Mar 08, 2012
  • China needs to enhance ability to win ‘local wars’, Premier says http://t.co/THUVeHVe Dominance of the South China Sea is desired $$ Mar 07, 2012
  • China?s State of the Union http://t.co/D2E2yaH0 China has fewer options by the day. GDP is shrinking because much production is worthless $$ Mar 04, 2012
  • +1 $$ RT @The_Analyst: @AlephBlog ha, newsflash: people whose livlihood depends on strong real estate market say market is strong… Mar 04, 2012
  • End of The World not nigh, say developers http://t.co/JTDwPtT3 A lot of cross-currents in Chinese property markets, suspect trouble $$ Mar 04, 2012
  • China?s Politics in Rare Bloom http://t.co/kmDFW8ou A rare season where the hidden politics of China become publicly visible $$ Mar 04, 2012

 

Miscellaneous

 

  • ‘Internet-in-a-Suitcase’: The Web Technology That Wants You to Be Free http://t.co/UXTNOHDo Not live yet, but coming 2a revolution near u Mar 09, 2012
  • Wal-Mart Therapy Tried as Pentagon Copes With Traumatized Troops http://t.co/7YIU2yqJ long $WMT | PTSD? Trips 2 WMT may help, really. $$ Mar 08, 2012
  • US public schools sell empty classroom seats abroad http://t.co/qTuefNqV Solves a tough problem 4 rural districts w/falling enrollment $$ Mar 08, 2012
  • US Top Destination for Christian, Buddhist Immigrants, Study Says http://t.co/gZW6T62o Interesting commentary on religion & migration $$ Mar 08, 2012
  • The Confucius quote is a lot like Hillel’s “Do not do unto others what you would not hav… http://t.co/XplJNuew Mar 07, 2012
  • RE: @dcrothers This is too important to be left to preschools only. Mothers and fathers must take an active role in t? http://t.co/4je2nZj2 Mar 06, 2012

 

Markets

 

  • Insurers to re-examine risk, capital structure in 2012 – PwC http://t.co/1Cl8bTc1 Low ins co valuations begets low interest for M&A $$ Mar 09, 2012
  • Contra: Apollo Wants to ?Be the New Bank? in 2012, Co-Founder Rowan Says http://t.co/HjfMo5xx Might work in short-run; dangerous idea $$ Mar 09, 2012
  • Tactical asset allocation — Another ripoff http://t.co/NVCwvCCQ During bear markets, TAA gains temporary cache as market timing $$ Mar 08, 2012
  • Think Twice, Even Thrice, Before Trading http://t.co/618YZMAB Most of the time, trading leads to losses, people like the illusion of control Mar 08, 2012
  • Trade to improve your portfolio http://t.co/fINnnvh1 Features thoughts of those who agree. When will average people listen to the good guys? Mar 08, 2012
  • The mystery of the vanishing stock trader http://t.co/y0jvQ6F8 Volume is disappearing in Canada. That’s probably healthy; buy Canada $$ Mar 07, 2012
  • @CflGator My simple solution to all of that is that only hedgers may initiate trades, speculators may not trade with speculators. $$ Mar 07, 2012
  • Contra: Managed money goes LONG oil http://t.co/SartTMgC In mid-2008, there weren’t as many speculative longs & the price was far higher $$ Mar 07, 2012
  • Companies Float Up to $20 Billion in Bonds http://t.co/CJTnGiTE If that much is getting digested easily, maybe the corp rally continues Mar 07, 2012
  • @lcsonka39 @hedgefundinvest I did use the words “if” and “maybe.” I am far enough away that I’m not sure, but I have been through that b4 $$ Mar 07, 2012
  • US Insurers Face $2 Billion in Claims From Tornadoes, Risk Modeler Says http://t.co/N6vW1uIn I would expect a rough weather year $$ Mar 07, 2012
  • IBM?s Watson Computer Gets Wall Street Job http://t.co/qP2mlQDZ Bloodless. Soulless. Brilliant. Ultimate Risk Manager or Disaster Creator Mar 07, 2012
  • Judge: Jefferson County Chapter 9 Case Can Continue http://t.co/MGn2sDTD Remember Ch 9 only gives breathing room, Empee benes relief $$ Mar 06, 2012
  • Do You Need to Buy Big Oil Stocks? http://t.co/FlPMNBXN Arends: As fuel prices soar (again), it may make sense to invest where you spend Mar 06, 2012
  • How To Make Financial Content http://t.co/NRLLm00B Funny takes from @reformedbroker on how various news organizations write their copy $$ Mar 06, 2012
  • Demographic trends will depress portfolio returns, this researcher warns http://t.co/yDXh8J8C Arnott makes u look at the real economy $$ Mar 06, 2012
  • Stocks Cheaper Than Any U.S. Peak in 23 Years http://t.co/wZAnn7Ij Key Q: what will profit margins do? Only will 2 use capital is scarce Mar 06, 2012
  • Milwaukee?s Home-Grown Managers Shun Fads http://t.co/oSzOOjMh My hometown. People there are rational and not given to fads. $$ Mar 06, 2012
  • Dan Zwirn, the Man Who Fell to Earth http://t.co/NmgWpqRm Grew hedge fund fast, inadequate operational support, scandal, business dies $$ Mar 04, 2012

 

International (rest of the world)

 

  • One Year Later, Japan City Sees Light?in a Long Tunnel http://t.co/3JfbCqWG Too much $$ being tossed at too few people in short-run Mar 09, 2012
  • Australian vs Canadian property http://t.co/7Q3pdBP1 Argues that Canada is in trouble, Australia in worse shape but a better economy for now Mar 07, 2012
  • Faros Trading: Yen to Weaken http://t.co/cSAp3Fra & http://t.co/aJkOCcXQ Idea that the yen may weaken is gaining traction $$ Mar 06, 2012
  • Canadian envoy to Iceland sparks loonie controversy http://t.co/QZfE9Kvi Hey, I would link to the loonie if I could, smart idea $$ Mar 06, 2012
  • BRIC Investors Losing as Statists Forgo Earnings http://t.co/kuntGmOJ Worrisome trend, but political influence on firms tends 2b cyclical Mar 04, 2012
  • Why Japan Is Looking Good http://t.co/trw811WG Argues that QE weakens the yen, leading to better corp performance of f low valuation $$ Mar 04, 2012
  • London Is Eating New York?s Lunch http://t.co/UBEFijF7 London has a greater share of international transactions; New York too regulated $$ Mar 04, 2012

 

Politics

 

  • Romney campaign says losing nomination would take ‘act of God’ http://t.co/Q0VS1qRV Whom God would destroy, he first makes proud #hubris $$ Mar 07, 2012
  • Paralyzed Kids Employ Florida Lobbyists With Millions at Stake http://t.co/fmS5UIHu When there r damage caps, pleading 4 special exceptions Mar 07, 2012
  • Hoping for a deadlocked convention that turns to Huckabee, or someone like him http://t.co/OCRBjpXF Mar 03, 2012
  • @Nonrelatedsense I do not trust Romney, Santorum, or Gingrich. They change positions too easily. I may not like everything about Huckabee+ Mar 04, 2012
  • @Nonrelatedsense or Ron Paul, but they don’t shift their views as much. Huckabee would be acceptable to both wings of the GOP. $$ Mar 04, 2012
Peak Government Debt

Peak Government Debt

Posted on by David Merkel

We’re in an interesting situation where most developed country governments are borrowing at a rapid rate, and their central banks are financing it.? Public old age retirement and health plans are underfunded.? Most major developed countries can’t grow rapidly, and there’s really nothing that can be done about it — competition from cheaper labor in developing countries is forcing developed country wages down.? We can’t grow out of the debt.

We wait for the tipping point.? When will investor sentiment change from believing debts will be paid in equivalent purchasing power, to believing that they will not get paid back in equivalent purchasing power terms?

Greece is past the tipping point.? Other nations in Europe teeter.? Is Japan nearing such a point?? They rejoice to see the Yen weakening as the BOJ finances the government deficit.? Be careful what you wish for, Japan — what is good in small, can become self-reinforcing if lenders lose confidence in the Japanese government.

Part of the trouble is with central banks repressing savers, deficits are considerably lower than they otherwise would be because short bond yields are low.? If rates rose, deficits would begin to rise gradually but distinctly in proportion to the maturity structure of the country.? That’s the tipping point.? There are only two states with an unstable equilibrium between them — government debt is trusted, and government debt is not trusted.

Now there is no simple answer here — how will the government react?

  • Raise taxes dramatically?
  • Cut spending dramatically?? Tell seniors that Medicare will no longer do what it used to?
  • Inflate the currency?
  • Default?? (Can make sense when a country does not need access to the debt markets.)
  • Try to drive a debt reduction deal, like Greece has done, and Argentina sorta did.

Each situation has a different best investment.? That’s a boon to governments, or disaster would have happened already.? Doubt as to policy blunts the rush to panic.? There may be worry but they don’t know what to do.

One more note: when one nation passes the tipping point, the question will be raised on other nations.? Imagine a world where many developed nations default on their debts.? There would be few certainties and silver and gold would likely become new currencies.

These are just some musings of mine; all sorts of kooky things could happen, but the pressure to use the five reactions listed above will be considerable globally.? Prepare as best you can; this one isn’t easy.

Buy-and-Hold Can?t Die, Redux

Buy-and-Hold Can?t Die, Redux

Posted on by David Merkel

When I wrote my piece last night, I did not write it to say one ought to buy and never sell.? In investing, I encourage the concept that one must look to relative valuations and trade assets that are worth less for those that are worth more.? In doing so, one maintains exposure to the overall risk of the markets, but shifts to more promising areas.

But what if valuations get so strained that future returns from most risk assets are tepid?? At that point, buy-and-hold turns into sell-and-wait.? It’s like being a bond manager — if the excess returns are small from taking additional risk, you don’t take additional risk.

I tend to turn over my portfolio once every three years.? That to me is a good tradeoff between holding for a long time and recognizing that opportunity changes over time.? But my trading is driven by analyzing relative opportunity, selling what I think are lower future cash flow streams for larger cash flow streams.? Do I have a crystal ball to tell me which is better?? No, just business judgment.? As Buffett says, “I am a better businessman because I am an investor, and I am a better investor because I am a businessman.”

My business judgment has done well for me over my career, but I don’t pretend that it is infallible, because I make significant mistakes.? Humility is an asset to the investor, because we don’t always know the right course.? That said, let diversification handle uncertainty, and within risky assets trade away less promising assets for those with more promise.

A reader wrote me, one who works for a prestigious university and he said:

Since 1926, the minimum inflation-adjusted total return of the S&P 500 (or its predecessor index) has been over 4%, annualized, over every 40-year rolling period.? For 20-year periods, the returns are typically either high (say 9%) or low (say 2%).? Thus, the buy-and-hold investor is best off with the 4-decade hold time.? Fortunately, 40 years matches the typical work life of a person, so workers ought to be shoveling retirement money into equities, and leaving there when they retire, if history is any guide.

?Your thoughts?

Yes, so long as your government holds together, over longer periods of time we do better.? But the tough part for retirees is “What is my situation like when I retire?? Yes, I built up a pot of assets, but what will that buy in terms of continuing income, and will that do well against declining purchasing power?”

There is no magic bullet.? I try to solve this by shifting industries over time, aiming at the most promising current opportunities, but not leaving the market in entire.? I limit cash to 20% of the portfolio when valuations are strained for he market as a whole.

Back to the question, yes, I think most people should buy-and-hold, if they can’t analyze the asset markets.? That’s like the Biblical proverb that a fool is counted wise if he is silent.? But for businessmen/investors there are often relative opportunities to do better.? Analyze those opportunities and take the best of them.

Yes, have some exposure to risky assets for your career, but vary the amount of exposure, and where it goes relative to likely opportunity.

I appreciated Jonathan Burton’s piece Speed kills, but so does complacency.? Like me, he is trying to strike a balance between hyper-trading and permafrost.

My mother is a good example here, though she does things differently than I do.? She holds stocks for a decade or so on average, and analyzes to see whether they have long-term prospects.?? She buys, holds, and occasionally adjusts.? She spends more time painting, for which she has a degree of reputation.? She beats average asset mangers regularly.

The main idea should be one of relative value: trade to improve.? Look at the underlying cash flow streams if you can, and trade smaller for larger.

Here’s one more tool to help you.? When the amount of money into an asset goes parabolic, it time to leave.? It is rare that large amounts of additional money will yield excess returns.? This simply admits that there are times when it is wise to reduce exposure to risky assets.? just as bond managers look at yield spreads to commit capital, so should investors in risky assets aim for a margin of safety in what they invest.

As a final note, buy-and-hold is a fundamental strategy in investing.? It presumes that you spent the time analyzing whether this asset was undervalued.? If it becomes overvalued, it does not mean you should hold it.? Always look for better relative value.? In the end that leads to better portfolio performance.

Buy-and-Hold Can’t Die

Buy-and-Hold Can’t Die

Posted on by David Merkel

There’s this mistaken idea trotting around in the popular media, which usually only shows its face in bear or sideways markets: buy-and-hold investing is dead. This is wrong in several ways:

1) The average investor is horrible at market timing.? They buy high and sell low.? The more volatile the asset subclass the more pronounced this behavior is.? I have witnessed this personally while analyzing the return differences for Bill Miller, Bruce Berkowitz, and the S&P 500 Spider.? There is a profound difference between the returns that a buy-and-hold investor receives, and that which the average investor receives.? The buy-and-hold investor almost always does better; the only exception that may exist are value investors who have learned to resist price trends, painful as that may be.

2) The assets of the market are far less volatile than those that trade them.? Bonds are issued, the grand majority of them mature (pay off).? Stocks are issued, and they pay dividends, get bought out, fail, spin off another company, etc.? Trading activity usually far exceeds the need for financing assets; it becomes a game unto itself, and a zero-to-negative-sum game at that.? When you are playing a game that is overall negative-sum, i.e., the brokers suck cash out of the game proportionate to trading, the better players look for quality assets, and trade less.

3) When a sustained bull market arrives, the other mistake will show up, “Buy-and-hold is the only way to go.”? Risky assets have periods of protracted increases in valuation.? Certainty in the continuation of the process grows as it gets closer to the end of the cycle, when the cash flows of the assets cannot support the cash flows of those who borrowed to buy them.

4) Longer-term investors are often the key to a turnaround in the price of an asset.? Asset prices bottom when longer-term investors see value, and buy-and-hold, waiting out the volatility.? Asset prices crest when long-term investors decide to sell-and-wait, because the prospective returns to a buy-and-hold investor are poor.

This is why the perspective of a value investor can be valuable in approaching markets… are you willing to do a cold hard analysis of the likely cash flows?? You know that it gets harder to maintain high returns on equity [ROEs] as time goes on, and the same for low ROEs — new management arrives, and there is mean-reversion.

Conclusion

Yes, there are clever traders, but by necessity they are few in the market ecosystem, and repeatability is uncertain.? There are far more dumb traders, and repeatability is only limited by their declining capital.? Then there are the value-oriented infrequent traders.? They do best, but second to them are those that buy-and-hold.

In general, the economy rewards those who bear risk over long periods of time.? Thus buy-and-hold does well, usually, over long periods of time.? That time period may be 30-40 years, and may not do well with respect to your retirement date, so take caution, and don’t trust in long-term investing as if it is the force of gravity.? It is more akin to one who realizes the bean farming has become unpopular, and so, he decides to plant beans.? It might not work immediately, but it stands a better chance of working than those who are chasing the current farming fad.

At the Local Investment Research Challenge

At the Local Investment Research Challenge

Posted on by David Merkel

Yesterday I was a judge (one of five) for the Washington/Baltimore Investment Research Challenge.? Five teams from local colleges participated to analyze a prominent local company, Under Armour.? (My kids love the stuff, I hate to pay the price.)

I have to say that I admire all of the young men and women who presented to us.? It takes a lot of guts to present to people 30 years older then you.? The experience differential is considerable.

One practical difference is that the students apply many methods from Modern Portfolio Theory that are roundly ignored by most investment managers.? Few investment managers apply Discounted Cash Flows [DCF], because it is too flexible, with too many parameters that are hard to calculate.? Some apply reverse DCF, attempting to estimate the rate of return of companies at their current price… same problems exist, though the comparability of results is simpler.

My advice to future contestants would be to spend more time on qualitative issues, and less on quantitative.? Regarding quantitative issues, I would encourage abandoning DCF in favor of simpler valuation methodologies.

Also, I would discourage using regression unless you really understand what it means.? It’s easy to teach people to use advanced statistical methods, but tough to teach them the limitations of where the methods get abused, or don’t work.? As I have often said, I rarely see advanced statistics used properly by Wall Street, and yesterday was no exception.

But all that said, there are a lot of bright people entering the talent pool for investing; for investment firms in a given region, going to an event like this could be a good recruiting tool.

PS — make sure you understand the liability structure in full, also…

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