Speculation – Page 14 – The Aleph Blog

Book Review: The Malign Hand of the Markets

Posted on 17 July 2012 by David Merkel

When I first saw the book, and read the introduction, my heart sank and I said to myself, “I doubt I will like this one.”

I was wrong, very wrong, and liked the book more and more as I read it.? The author is a professor of Psychology, Biology and Neurobiology, and is writing about economics.? Those who have read me for some time know that I favor ecological analogies to explain economics, rather than the pseudo-physics that most neoclassical economists employ.? I am beginning to think that non-economists have a better chance of understanding economics than most economists do, because they are free from the indoctrination that comes in the early economics classes where they teach you to assume away all reality, and assume that all men are maximizers of utility or profits, and that the world is radically simple, when it is really very messy.

To the Book

Sorry to be verbose, but I found the author’s approach to be refreshing.? Men are economically rational, but what do we mean by rational?? To some, being rational means imitating what seems good.? “My neighbor is making lots of money speculating in real estate, I will do this also.”? Or rationality can mean something higher, “Real Estate prices are getting far beyond the prices that rentals could justify, I think I will sell my house and rent.”? The difference is the degree of analysis, and the willingness to think about the system as a whole.

The book also highlights why free markets and democracy do not necessarily go together.? There is pressure from the moneyed to affect the democratic process, and there is pressure from the less-well-off to vote money to themselves from the public purse.

The book takes on the concept of economic efficiency, and shows that it leads to instability, as I have argued.? Stable economic systems have slack.? Stable systems do not optimize to the hilt.

He describes the process where more and more loans were provided to the housing market, leading to a bubble.? The bubble involved some sideshows, like CDOs, where Collateralized Debt Obligation buyers provided cheap capital that purchased risky pieces of residential mortgage loans.

Economists like to talk about equilibrium, because that allows them to publish their complex math papers, but economies are big on variation, things are far more volatile than theory can admit.

He takes a dim view of central banking but does not see how we can get rid of it.? The politics are too strong, and the aversion to gold too great.? He lays most of the blame for the bubble and bust at the feet of the Fed, which is right.

He finds Keynes to be a bright guy but with many unrealistic assumptions, and too much aggregation.? The simplification of the economy is too great, and the models don’t work.

Unlike many other books, he offers solutions, and I think they are reasonable.? He inveighs against insurance where the risk is voluntarily takes on.? We should not backstop voluntary risks, nor should we allow people to speculate on the losses of others, as I have argued elsewhere.

He also argues that the Dodd-Frank bill will largely be ineffective because it does not set rules. You can have rules or scrutiny.? We have used scrutiny in the past for financial regulation and it has not worked, because the regulators were wimps.? Over the last 30 years, they have mostly been wimps.

Rules have value, and insurance regulation has been more rules-based, which helps to account for its success.? Principles-based approaches allow a minority to bend the principles, leading to financial failure.

Particularly the Fed has been lax in financial oversight, as they are the overall regulator, and they have not been tough on the regulators that they oversee.

Naive faith in economic efficiency leads many to neglect the need to regulate banks tightly.? It is far better to set rules that provide negative feedback to banks that are taking too much risk, and negative feedback to those who borrow from or lend to other banks, which increases systemic risk.

At the end, he offers four rules that I will summarize:

Limit the monetary policy discretion of the Fed. (Yes!)
No bailouts.
Insurance products that have the possibility of positive feedback should be banned.
Investment Banks should be partnerships, and commercial banks should be limited from investment banking business.

I am in hearty agreement with all of this.? He adds one further proposal that suggests taxing investment banks on the riskiness of their books; if that can be properly achieved that is a worthy idea.

Quibbles

None.? Great book.

Who would benefit from this book:?? Anyone who wants to understand economics and the crisis better would benefit from this book.? If you want to, you can buy it here: The Malign Hand of the Markets: The Insidious Forces on Wall Street that are Destroying Financial Markets ? and What We Can Do About it.

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.

My Two Cents on Two Promoted Penny Stocks

Posted on 10 July 2012 by David Merkel

Via Tadas Viskanta of Abnormal Returns, Zestinvest.com approached me regarding and intriguing promoted stock, Implant Sciences [IMSC].? Read his article, he will say more about it than I will.

From my angle, this is another low revenue, negative net worth, negative earnings stock, which I think every sane investor should avoid.? But there are a few interesting aspects to the scam:

There is the outside possibility that their services will be bought by an arm of the US Government, in an effort against terrorism.
It is being touted by Gene Marcial at Forbes, and at other blogs of his.? Gene Marcial has a financial interest in CPreports.com, which gets paid to publish favorable research on companies.
It is being touted by Ray Dirks, which disappoints me.? I always thought better of him, given his early contest regarding insider trading? in the Equities Funding scandal, which he successfully contested to the Supreme Court.? (And as a kid of 13, I sent away for his research on low P/E stocks!? What a guy! Maybe.)

This is a company that is likely to be taken over by its lender in three months, leaving the equity with zero, or nearly that.? The company is so deep in debt that I suspect their lenders will not get paid in full either.

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Onto my second promoted penny stock, Luxeyard.? Wait, first the promoted penny stock scorecard:

Ticker	Date of Article	Price @ Article	Price @ 7/9/12	Decline
GTXO	5/27/2008	2.45	0.03	-98.78%
BONZ	10/22/2009	0.35	0.0171	-95.11%
BONU	10/22/2009	0.89	0.065	-92.70%
UTOG	3/30/2011	1.55	0.07	-95.48%
OBJE	4/29/2011	2.9	0.045	-98.45%
LSTG	10/5/2011	1.12	0.152	-86.43%
AERN	10/5/2011	0.077	0.0011	-98.57%
IRYS	3/15/2012	0.261	0.13	-50.19%
NVMN	3/22/2012	1.47	1.46	-0.68%
STVF	3/28/2012	3.24	0.435	-86.57%
CRCL	5/1/2012	2.22	0.67	-69.82%
ORYN	5/30/2012	0.93	0.6	-35.48%
BRFH	5/30/2012	1.16	0.57	-50.86%
LUXR	6/12/2012	1.59	0.35	-77.99%

Aside from very deep out-of-the-money options, I can’t think of anything that does so badly.? Back to Luxeyard.? How did it lose 78% in less then a month?? Go back to my original post:

NBT Equities Research and/or its publisher, ChangeWave, Inc., dba NBT Communications has received $35,000 and been pledged 75,000 shares of rule 144 common shares in LuxeYard to assist in the writing of this advertisement.

Next Media LLC paid $1,500,000 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.

Next Media LLC was paid by non-affiliate shareholders who fully intend to sell their shares into this advertising campaign.

Duuuuuhhhh.? They have plainly told you that they will fleece you.? Few are so bald in their designs.? Why didn’t you listen?? This offering more than doubles the float, on a company that is worthless anyway.? This is just a way for insiders to profit or minimize losses.

So it is no surprise that the stock has fallen so much, notable as it is to fall so quickly.? But this was eminently avoidable.? Remember the Indian saying: “Lie down with dogs; wake up with fleas.”

Redacted Version of the June 2012 FOMC Statement

Posted on 20 June 2012 by David Merkel

Comments

Operation Twist is extended for six months, but there is no amount set for it.? Looks like an oversight, then again, they may not have a lot of bonds three years and shorter to sell.
The changes are significant, because in the space of one meeting, they went from things are good to things are bad.? They shaded down their views on GDP growth, employment, inflation, and household spending.
In my opinion, I don?t think holding down longer-term rates on the highest-quality debt will have any impact on lower quality debts, which is where most of the economy finances itself.
Also, the reinvestment in Agency MBS should have limited impact because so many owners are inverted, or ineligible for financing backed by the GSEs, and implicitly the government, even with the recently announced refinancing changes.
The key variables on Fed Policy are capacity utilization, unemployment, inflation trends, and inflation expectations.? As a result, the FOMC ain?t moving rates up, absent increases in employment, or a US Dollar crisis.? Labor employment is the key metric.
Do they want the yield on 30 year TIPS to go negative?? Looks that way.
GDP growth is not improving much if at all, and the unemployment rate improvement comes more from discouraged workers.? Inflation has moderated, but whether it will stay that way is another question.

Questions for Dr. Bernanke:

Is it possible that you don?t really know what would have worked to solve the Great Depression, and you are just committing an entirely new error that will result in a larger problem for us later?
Why do think extending the period of accommodation by a little more than two years will have any significant effect on the economy, aside from stock and bond prices?
Discouraged workers are a large factor in the falling unemployment rate. Why do you think the economy is doing well?
Couldn?t increased unemployment be structural, after all, there is a lot more competition from labor in emerging markets?
Why do you think that holding down longer-term rates on the highest-quality debt will have any impact on lower quality debts, which is where most of the economy finances itself?
Why will reinvestment in Agency MBS help the economy significantly?? Doesn?t that only help solvent borrowers on the low end of housing, who don?t really need the help?
Isn?t stagflation a possibility here?? I mean, no one expected it in the ?70s either.
Could we end up with another debt bubble from keeping short rates so low?
If the Fed ever does shrink its balance sheet, what effect will it have on the banks?

Best of the Aleph Blog, Part 17

Posted on 19 June 2012 by David Merkel

These articles appeared between February and April 2011:

On the Percentage of Market Cap held by Domestic Stock ETFs

Implications

Domestic stock ETFs tend to pick more volatile stocks.

Domestic stock ETFs tend to pick stocks held by major institutions.

Domestic stock ETFs tend to pick stocks less held by insiders.? (They tend to be more boring.)

Goes Down Double-Speed

Bear markets move at 1.9x the rate of bull markets. (double speed)

Consider the Boom in the Bust; Consider the Bust in the Boom

We would all be better off if policymakers thought at least half a cycle ahead in the credit cycle. Sadly, they are linear thinkers, and would be better off working at the county landfill, if they qualified for such authority.

Critical Analysis of Buffett?s Annual Letter

Critical Analysis of Buffett?s Annual Report

Analyzes Berkshire Hathaway in 2011.? Points at the growth in debt at BRK, and concentration risk in the subsidiaries.

Musings on Yield

Why you should not use yield as a criterion for investment.

On the Usefulness of Yield Spreads

So what does this tell us?

There is a credit factor that effects yields, and the effect on Baa bonds is roughly 1.5x that of Aaa bonds.

As Treasury yields get lower, Baa bond yields rise at roughly 45% of the rate.? There is the nominal yield need ? even Baa bonds tend to need a certain nominal yield, particularly for 20+ year bonds.

Present yield levels are fair for long Baa bonds, to the extent that Moody?s measures them accurately.

On Con Men

So avoid complex investments.? Particularly avoid investments that you don?t understand.? At minimum, find a competent friend, or some neutral party that will look at the deal.? If you can?t find such a friend/party, don?t do the deal.? The friend is important, because he does not want you to come to harm, or lose you as a friend if things go bad.

Three Years from Now

There are real advantages to managing for the intermediate term.

Responding to a Bright Reader

Why I started a bond product.

Things are not as good as they look

Analyzing economic statistics when they don’t sound right.

Limits: Models, Governments, and Central Banks

Most writers say the governments and central banks are all-powerful.? I disagree, and I try to explain why.

Regarding David Sokol

Regarding David Sokol, Redux

Regarding David Sokol, Part 3

Regarding David Sokol, Part 4

The growing sentiment, though ahead of the crowd, that David Sokol should leave Berkshire Hathaway.

Everything Old is New Again in Bonds

On unconstrained mandates and managing for total returns with bonds.

When I was Young

What I went through in investing in my younger days.? Taught me a lot.

When Everything is Strong

When Everything is Strong, Redux

When the only thing weak is high quality bonds, what do you do?

It Would Have Happened Already, Redux

What do you do when all you hear are consensus opinions?

Little Revenues, Large Losses, Negative Net Worth

Posted on 12 June 2012 by David Merkel

You can guess that I am talking about promoted penny stocks.? From now on, whenever I write about this, I will update this table:

Ticker	Date of Article	Price @ Article	Price @ 6/12/12	Decline
GTXO	5/27/2008	2.45	0.0395	-98.4%
BONZ	10/22/2009	0.35	0.018	-94.9%
BONU	10/22/2009	0.89	0.0799	-91.0%
UTOG	3/30/2011	1.55	0.07	-95.5%
OBJE	4/29/2011	2.90	0.04	-98.6%
LSTG	10/5/2011	1.12	0.1525	-86.4%
AERN	10/5/2011	0.0770	0.0014	-98.2%
IRYS	3/15/2012	0.261	0.16	-38.7%
NVMN	3/22/2012	1.47	1.3	-11.6%
STVF	3/28/2012	3.24	0.46	-85.8%
CRCL	5/1/2012	2.22	1.12	-49.5%
ORYN	5/30/2012	0.93	0.75	-19.4%
BRFH	5/30/2012	1.16	0.765	-34.1%

Personally, I find the consistent losses to be impressive.? All of the companies that I wrote about more than three months ago have losses greater than 86%.

Tonight’s loser is Luxeyard [LUXR].? I got this sorry excuse for research today. Six months ago the company, was called Top Gear, Inc., was based in Israel, and had the goal of becoming a leading kosher food certification organization.? As a result of an acquisition of Luxeyard, and spinout of the kosher food certification efforts, the company is a website for selling luxury goods.

Well, at least the disclaimer tells some truth this time:

NBT Equities Research and/or its publisher, ChangeWave, Inc., dba NBT Communications has received $35,000 and been pledged 75,000 shares of rule 144 common shares in LuxeYard to assist in the writing of this advertisement.

Next Media LLC paid $1,500,000 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.

Next Media LLC was paid by non-affiliate shareholders who fully intend to sell their shares into this advertising campaign.

Prior holders of Top Gear, and those who sold Luxeyard to them have paid the research liar to bull up the price so that they can sell into it.? Those who buy Luxeyard are dumb; really, really dumb.

Anytime a third party promotes a stock to you, and it is not a normal Wall Street “We provide research so that we can do IPOs and get trading volume,” avoid it.? All of these promotions are scams.? They don’t make money.? Average investors lose, even those that think they can play the speculation game.

Again, I ask why promotions like this are legal.? If the disclaimer is small type (this one was 7.5 points), and the regular type encouraging investment is 12+ points, I think the disclaimer should not be valid, and the author, publisher, and backers should be subject to lawsuits, that they forfeit their ill-gotten gains.

Getting Crowded

Posted on 9 June 2012 by David Merkel

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.

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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.

On the Facebook IPO

Posted on 7 June 2012 by David Merkel

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

Pennies from Hell

Posted on 31 May 2012 by David Merkel

I had lunch with Eddy Elfenbein today, and we had a great time together.? After all of the time that we have e-mailed, linked, etc., it was great to make the acquaintance.

Before I start tonight’s post, that makes me want to say this: if you are a blogger that likes me, and you are traveling to the Baltimore/DC area, email me, and let’s get together.? Even if you are marginal on me, try me, and if I accept I will buy lunch.

Many of us as bloggers do a service for the investment community; I have sometimes said that we are the conscience of Wall Street.? Well, tonight’s post is another post to warn people away from a class of investments that almost always loses money: promoted stocks / penny stocks.

As I looked through my archives, I was surprised at how many promoted penny stock I have written about — there were eleven.? Not what I intended when I started this blog, but I go where I think I am needed.? So, what has the performance been of the promoted penny stocks since I wrote about them?

Ticker	Date of Article	Price @ Article	Price @ 5/30/12	Decline
GTXO	5/27/2008	2.45	0.04	-98.4%
BONZ	10/22/2009	0.35	0.02	-94.3%
BONU	10/22/2009	0.89	0.10	-88.8%
UTOG	3/30/2011	1.55	0.05	-96.8%
OBJE	4/29/2011	2.90	0.05	-98.3%
LSTG	10/5/2011	1.12	0.15	-86.6%
AERN	10/5/2011	0.0770	0.0016	-97.9%
IRYS	3/15/2012	0.261	0.160	-38.7%
NVMN	3/22/2012	1.47	1.35	-8.2%
STVF	3/28/2012	3.24	0.53	-83.6%
CRCL	5/1/2012	2.22	1.34	-39.6%

Can I say “Ouch?!”? This is almost as bad as the dot-com bubble, except there are no successes to give the illusion that if you pick them right, you will do fine.

But today, after coming home from lunch, I went to the mailbox and found three (THREE!!) penny stock scams in my mail, two from the same promoter.? I could be wrong, but I think the frequency of penny stock scams is increasing, perhaps out of desperation for some people to make money.

One of the promotions was Circle Star, which I have mentioned before, though this was through a different promoter, and you can see the promotion here.? The writer received $75,000 for his efforts.? Enough said.

Then there was Oryon Technologies [ORYN], Inc.? This company that masquerades as a technology and apparel company, was a mining company three months ago.? It has never earned a dollar of revenue.? Enough said.

The last one was Barfresh Food Group, Inc. [BRFH]? Smoothies as a patentable investment idea is ridiculous.? But at least the disclaimer on this one is honest:

Do not invest in this company unless you can afford to possibly lose your entire investment. NBT Equities Research and/or its publisher, ChangeWave, Inc., dba NBT Communications has received thirty five thousand dollars and been pledged seventy-five thousand shares of rule 144 common shares in Barfresh Food Group Inc. to assist in the writing of this advertisement. Primo Strategies LLC paid one million three 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.

and

Primo Strategies LLC was paid by non-affiliate shareholders who fully intend to sell without notice their shares into this advertising/market awareness campaign, including selling into increased volume and share price that may result from this campaign. The non-affiliate shareholders may also purchase shares without notice at any time before, during or after this campaign. A non-affiliate shareholder acted as advisor to Primo Strategies LLC in this market awareness campaign, including providing outside research, materials and information to outside writers to compile written materials as part of this campaign.

and

Third Party/Agency Disclaimer: Content of this message is published by NBT Equities Research, LLC and/or its publisher, ChangeWave, Inc. and sent to select email lists through various marketing agencies to provide readers with information on selected publicly traded companies. Winning Media is managing a total budget of $250,000 for this and other advertisements in an effort to build industry and investor awareness. The $250,000 budget was provided to Winning Media by MarketByte LLC, a shareholder of Barfresh Food Group, Inc. MarketByte LLC reserves the right to buy and/or sell shares of Barfresh Food Group, Inc. at any time. This should be viewed as a potential conflict of interest.

This company has received revenues, but has not earned profits, and has a negative net worth as well.? It was a company searching to buy movie scripts, and realized that smoothies were a better business.? Go figure.? In general, companies that make big shifts in industrial direction are usually horrible companies.

Think about this Differently

Suppose for a moment you did have a great idea that could revolutionize a given business.? Would you:

Try to grow the business using only your own capital, and that of friends and family, and a limited number of? angel investors, until you realize that institutional capital and knowledge is needed to take this to the next level, i.e., venture capitalists.? Advertise where needed, but don’t give potential competitors too much of an idea that you are out there.
Take over a rotted shell of a public company, and use its broken balance sheet to attempt to grow.? Exchange unpayable loans for increased equity stakes for the lenders, diluting yourself.? When their stakes get big enough they engage some third parties to do a pump-and-dump.? Some bozo writes the copy, another bozo distributes it.

No credible idea would come public via method 2, they would work through venture capitalists.? So I would tell you without hesitation that there is never a reason to buy a promoted penny stock.? The large holders are the only ones with sufficient economic interest to promote a pump & dump, and they are likely the ones behind the bozos doing the promoting.

One Public Policy Recommendation

We need to codify something here, that if a brochure says in 12 point type: “Call your broker today to discuss how large a position in Circle Star Energy Corp [CRCL] you can comfortably own,”? (This was in the written brochure and not on the web, as far as I have seen.) then any disclaimer in a smaller, or less readable typeface is not valid in court.? This is an implicit form of fraud, and I believe that the writers and distributors of this drivel, as well as those that paid them should be able to be successfully prosecuted for fraud.

One last thing, to the guys who write these “analyses” that display incredible certainty and opportunity in large type, and then say that this is not really an investment analysis in tiny unreadable type — how can you look at yourselves in the mirror when you are such liars and cowards?

Book Review: The Billion Dollar Mistake

Posted on 29 May 2012 by David Merkel

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.

Book Review: The Alpha Masters

Posted on 21 May 201221 May 2012 by David Merkel

This book has just been released.? I got an early copy.? The book is interesting enough that I would like to do a Q&A with the author, and I have contacted the PR flack to do so.

To the review:

Would you like to understand the mindsets of a variety of successful hedge fund managers?? This book will give that to you, but there is a catch: you will also learn how these managers developed, and this is a big plus.

Most of the managers went through rigorous experiences that made them far more effective at evaluating risk and return potentials.?? Have you been through anything similar to that?? If not, you might read this very interesting set of accounts, but then realize that you don’t have the personality/skills necessary to replicate what they have done.? Don’t feel bad, most people don’t have that.

A large part of what makes hedge fund managers successful is their willingness to limit their activity to areas where they have genuine expertise.? They gain insight beyond most into areas where they are experts in discerning value.

This book does not give you a formula for how to make money; instead, it gives you lessons in the characters of those that have made a lot of money for themselves and their clients.? What are they like?

Among their many attributes, they are:

Driven/competitive — though I have known my share of failures in investing that have that attribute.
Lifelong learners, like Buffett and Munger — though I have known some really bright people who know a lot about investing/finance who add little to an investment process.
Opportunistic — they recognize what their best opportunities are, and pursue them to the exclusion of others.
Focused — they develop an edge, and try to be “best in class,” whether in mathematics of the markets, understanding the legal rights of different types of securities, understanding industry dynamics, accounting nuances, etc.
Patient — if opportunities are not promising, don’t do much.? It’s like being an intelligent underwriter — when your competitors are giving away the store, don’t write business, spend time sharpening your skills.? Study what could go wrong, and see if there is a way to take advantage of the situation.
Team-builders — They develop talented teams/cultures and motivate them to excellence.
Sensible — They know when to be doggedly persistent, and know when to admit defeat.

Now, no hedge fund manager has all of these, but the best have most of them.

Contents

The book covers nine managers/firms:

Ray Dalio — Bridgewater
Pierre LaGrange & Tim Wong — MAN Group / AHL
John Paulson — Paulson & Co.
Marc Lasry and Sonia Gardner — Avenue Capital Group
David Tepper — Appaloosa Management
William A. Ackman — Pershing Square Capital Management
Daniel Loeb — Third Point
James Chanos — Kynikos Associates LP
Boaz Weinstein, Saba Capital Management

About the Author

Her name is Maneet Ahuja, and is a producer for CNBC, specializing in covering hedge funds.? That’s how she gained the contacts in order to write the book.? Business Insider did a profile on her, and you can find it here.

Quibbles

The book needs something to tie it together and give it depth, otherwise the book is only “Meet these nine nifty hedge fund managers that I have gotten to know.”? That’s a serious deficiency; even a single chapter at the front or back would have enriched the book, making it more general and cohesive.

I also think there would have been better choices for those that wrote the foreword (Mohamed El-Erian) and the afterword (Myron Scholes).? The former is an accomplished investor, but is not an expert on hedge funds.? Myron Scholes is an accomplished academic, has worked for hedge funds, but is still not an expert on them.

Who would benefit from this book: If you want to learn about what type of people these nine hedge fund managers are, and read anecdotes about some of their best and worst trades, this would be a book you would enjoy.? If you want to, you can buy the book here: The Alpha Masters: Unlocking the Genius of the World’s Top Hedge Funds.

Full disclosure: The book was sent to me out of the blue; did not ask for it.

April 2012	June 2012	Comments
Information received since the Federal Open Market Committee met in March suggests that the economy has been expanding moderately.	Information received since the Federal Open Market Committee met in April suggests that the economy has been expanding moderately this year.	?This year? makes it more of a historical statement, and shades the GDP view down.
Labor market conditions have improved in recent months; the unemployment rate has declined but remains elevated.	However, growth in employment has slowed in recent months, and the unemployment rate remains elevated.	Shades labor employment down.? Still thinks there is growth in employment rate.
Household spending and business fixed investment have continued to advance. Despite some signs of improvement, the housing sector remains depressed.	Business fixed investment has continued to advance. Household spending appears to be rising at a somewhat slower pace than earlier in the year. Despite some signs of improvement, the housing sector remains depressed.	Shades down household spending.
Inflation has picked up somewhat, mainly reflecting higher prices of crude oil and gasoline. However, longer-term inflation expectations have remained stable.	Inflation has declined, mainly reflecting lower prices of crude oil and gasoline, and longer-term inflation expectations have remained stable.	Shades down ?their view of inflation. TIPS are showing virtually unchanged inflation expectations since the last meeting. (5y forward 5y inflation implied from TIPS.)
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.	Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.	No change.
The Committee expects economic growth to remain moderate over coming quarters and then to pick up gradually. Consequently, the Committee anticipates that the unemployment rate will decline gradually toward levels that it judges to be consistent with its dual mandate.	The Committee expects economic growth to remain moderate over coming quarters and then to pick up very gradually. Consequently, the Committee anticipates that the unemployment rate will decline only slowly toward levels that it judges to be consistent with its dual mandate.	Shades down its views of future GDP growth.
Strains in global financial markets continue to pose significant downside risks to the economic outlook.	Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook.	No real change.
The increase in oil and gasoline prices earlier this year is expected to affect inflation only temporarily, and the Committee anticipates that subsequently inflation will run at or below the rate that it judges most consistent with its dual mandate.	The Committee anticipates that inflation over the medium term will run at or below the rate that it judges most consistent with its dual mandate.	Declares victory in their view on energy prices.
To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee expects to maintain a highly accommodative stance for monetary policy.	To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee expects to maintain a highly accommodative stance for monetary policy.	No change.
In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.	In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.	No change.
The Committee also decided to continue its program to extend the average maturity of its holdings of securities as announced in September.	The Committee also decided to continue through the end of the year its program to extend the average maturity of its holdings of securities. Specifically, the Committee intends to purchase Treasury securities with remaining maturities of 6 years to 30 years at the current pace and to sell or redeem an equal amount of Treasury securities with remaining maturities of approximately 3 years or less. This continuation of the maturity extension program should put downward pressure on longer-term interest rates and help to make broader financial conditions more accommodative.	Extends Operation Twist for six months.? Doesn?t say how much.
The Committee is maintaining its existing policies of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction.	The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities.	I guess the renewal of Operation Twist changes the language here.
The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate to promote a stronger economic recovery in a context of price stability.	The Committee is prepared to take further action as appropriate to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Dennis P. Lockhart; Sandra Pianalto; Sarah Bloom Raskin; Daniel K. Tarullo; John C. Williams; and Janet L. Yellen.	Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Dennis P. Lockhart; Sandra Pianalto; Jerome H. Powell; Sarah Bloom Raskin; Jeremy C. Stein; Daniel K. Tarullo; John C. Williams; and Janet L. Yellen.	Adds in the two new doves; can?t have enough groupthink.
Voting against the action was Jeffrey M. Lacker, who does not anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate through late 2014.	Voting against the action was Jeffrey M. Lacker, who opposed continuation of the maturity extension program.	Does this mean Lacker is on board with policy accommodation through 2014?? Don?t think so, but maybe a reporter should ask.