Wednesday, December 31, 2008

Geoff Colvin on Charlie Rose

Malcolm Gladwell on Charlie Rose

"Cassandra" - If You Can't Tell Who The Sucker Is....

Thumbing through the sell-side research from their multitudes of Strategists, I notice some recurring phrases, small and innocuous as they may be, that trouble me. Time and again, they repeat, in various contexts, the mantras: "when things return to normal", "when markets return to normal", and "when x, y or z normalizes" with "normal" implied to be that which has been common over the past decade-or-so in respect of liquidity, leverage, asset prices, equity risk premiums, speculative activity, growth. Mulling this over, I wonder to myself: "is this not just the perfect "recency bias" example, defined by wikipedia as "a cognitive bias that results from disproportionate salience of recent stimuli or observations"? For as I consider what precisely is meant by "normal", it seems to me that there is a reasonable good chance insofar as this IS "The Big One" (as Bridgewater Associates precsiently termed it nearly a year ago) that all these things - debt, leverage, consumption vs. income, relative asset prices - are ALREADY returning to normal, and the strategists, demonstrating the old poker joke about "if you look around the table and you don't know who the sucker is, its you....", simply haven't yet fathomed the appropriate interval frame of the normality to which things are returning towards.
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Money & Emotions - Chris Davis Interview

Short (8 minute) interview with Chris Davis: HERE.
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Friday, December 26, 2008

Why we are, as we are

As the 150th anniversary of the publication of “On The Origin of Species” approaches, the moment has come to ask how Darwin’s insights can be used profitably by policymakers

For a Darwinian, life is about two things: survival and reproduction. Of the two, the second is the more significant. To put it crudely, the only Darwinian point of survival is reproduction. As a consequence, much of daily existence is about showing off, subtly or starkly, in ways that attract members of the opposite sex and intimidate those of the same sex. In humans—unlike, say, peafowl, where only the cocks have the flashy tails, or deer, where only the stags have the chunky antlers—both sexes engage in this. Men do it more than women, but you need look no further than Ascot race course on Gold Cup day to see that women do it too. Status and hierarchy matter. And in modern society, status is mediated by money.

Status, though, is always relative: it is linked to money because it drives the desire to make more of the stuff in order to outdo the competition. This is the ultimate engine of economic growth. Since status is a moving target, there is no such thing as enough money.

The relative nature of status explains the paradox observed in 1974 by an economist called Richard Easterlin that, while rich people are happier than poor people within a country, average happiness does not increase as that country gets richer. This has been disputed recently. But if it withstands scrutiny it means the free-market argument—that because economic growth makes everybody better off, it does not matter that some are more better off than others—does not stand up, at least if “better off” is measured in terms of happiness. What actually matters, Darwinism suggests, is that a free society allows people to rise through the hierarchy by their own efforts: the American dream, if you like.
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The hope this analysis brings, though, is that there is nothing particularly special about biologically based brands such as skin colour. If other brands of group membership can be strengthened, the traditional ones may diminish, even if they do not disappear completely. If this theory of race is correct (and more research is certainly needed), it indicates a strong prescription: policies that encourage groups to retain their identity within a society will cause trouble, but those that encourage cultural integration will smooth things over.
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A Darwinian analysis thus sheds light on a number of pressing questions. There are others. The rise of metabolic syndrome (obesity plus high blood-pressure equals diabetes plus heart disease) seems to Darwinists the consequence of people trying to sate appetites for sugar and fat that evolution put no brakes on because they were so rare in the natural world.

Pretending young adults are children so that they can be educated en masse in schools is another area ripe for investigation. And the refusal of people to adhere to the patterns of behaviour prescribed for them by classical economics has already spun off a field called behavioural economics that often has Darwinian thinking at its roots.

No one is suggesting Darwinism has all the answers to social questions. Indeed, with some, such as the role of hierarchies, it suggests there is no definitive answer at all—itself an important conclusion. What is extraordinary, though, is how rarely an evolutionary analysis is part of the process of policymaking. To draw an analogy, it is like trying to fix a car without properly understanding how it works: not impossible, but as likely as not to result in a breakdown or a crash. Perhaps, after a century and a half, it is time not just to recognise but also to understand that human beings are evolved creatures. To know thyself is, after all, the beginning of wisdom.

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Related books:

The Origin of Species

Mean Genes
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Tuesday, December 23, 2008

Is the Medicine Worse Than the Illness? - By James Grant

Barely nudging Mr. Madoff out of the top of the news was the Federal Reserve's announcement last Tuesday that it intends to debase its own paper money. The year just ending has been a time of confusion as much as it has been of loss. But here, at least, was the bright beam of clarity. Specifically, the Fed pledged to print dollars in unlimited volume and to trim its funds rate, if necessary, all the way to zero. Nor would it rest on its laurels even at an interest rate low enough to drive the creditor class back to work. It would, on the contrary, "continue to consider ways of using its balance sheet to further support credit markets and economic activity."

Wall Street that day did handsprings. Even government securities prices raced higher, as if, somehow, Treasury bonds were not denominated in the currency with which the Fed had announced its intention to paper the face of the earth. Economic commentators praised the central bank's determination to fight deflation -- that is, to reinstate inflation. All hands, including President-elect Obama, seemed to agree that wholesale money-printing was the answer to the nation's prayers.

One market, only, registered a protest. The Fed's declaration of inflationary intent knocked the dollar for a loop against gold and foreign currencies. In many different languages and from many time zones came the question, "Tell me, again, now that the dollar yields so little, why do we own it?"

It was on Oct. 6, 1979, that then-Fed Chairman Paul A. Volcker vowed to print less money to bring down inflation. So doing, he closed one monetary era and opened another. With Tuesday's promise to print much more money, the Federal Reserve of Ben S. Bernanke has opened its own new era. Whether Mr. Bernanke's policy of debasement will lead to as happy an outcome as that which crowned the Volcker anti-inflation initiative is, however, doubtful. Whatever the road to riches might be paved with, it isn't little green pieces of paper stamped "legal tender."

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Yes, today's policy makers allow, there are risks to "creating" a trillion or so of new currency every few months, but that is tomorrow's worry. On today's agenda is a deflationary abyss. Frostbite victims tend not to dwell on the summertime perils of heatstroke.

But the seasons of finance are unpredictable. Prescience is rare enough in the private sector. It is almost unheard of in Washington. The credit troubles took the Fed unawares. So, likely, will the outbreak of the next inflation. Already the stars are aligned for a doozy. Not only the Fed, but also the other leading central banks are frantically ramping up money production. Simultaneously, miners and oil producers are ramping down commodity production -- as is, for instance, is Rio Tinto, the heavily encumbered mining giant, which the other day disclosed 14,000 layoffs and a $5 billion cutback in capital expenditure. Come the economic recovery, resource producers will certainly increase output. But it is far less certain that, once the cycle turns, the central banks will punctually tighten.

The public has been slow to anger in this costliest and scariest of post World War II financial crises. Wall Street and the debt ratings agencies have come in for well-deserved castigation. But pointing fingers rarely find the Federal Reserve, whose low, low interest rates helped to set house prices levitating in the first place.

After Mr. Bernanke gets a good night's sleep, he should be called to account for once again cutting interest rates at the expense of the long-suffering (and possibly hungry) savers. He should be asked to explain how the central-banking methods of the paper-dollar era represent any improvement, either in practice or theory, over the rigor, elegance, simplicity and predictability of the gold standard. He should be directed to read aloud the text of critique by Elihu Root and explain where, if at all, the old gentleman went wrong. Finally, he should be directed to put himself into the shoes of a foreign holder of U.S. dollars. "Tell us, Mr. Bernanke," a congressman might consider asking him, "if you had the choice, would you hold dollars? And may I remind you, Mr. Chairman, that you are under oath?"

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Related books:

Mr. Market Miscalculates: The Bubble Years and Beyond

The Mystery of Banking

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And for those worried about inflation, you may want to consider TIPS.

Bill Gates on Charlie Rose

Thursday, December 18, 2008

Howard Marks Memo: Volatility + Leverage = Dynamite

One of my favorite adages concerns the six-foot-tall man who drowned crossing the stream that was five feet deep on average. It’s not enough to survive in the investment world on average; you have to survive every moment. The unusual turbulence of the last two years – and especially the last three months – made it possible for that six-foot-tall man to drown in a stream that was two feet deep on average. Should the possibility of today’s events have been anticipated? It’s hard to say it should have been. And yet, it’s incumbent upon investors to prepare for adversity. The juxtaposition of these sentences introduces an interesting conundrum.

Consider these tales from the front lines:

* There had never been a national decline in home prices, but now the Case-Shiller index is down 26% from its peak in July 2006, according to the Financial Times of November 29.

* In my twenty-nine previous years with high yield bonds, including four when more than 10% of all outstanding bonds defaulted, the index’s worst yearly decline was 7%. But in 2008, it’s down 30% (even though the last-twelve-months’ default rate is only about 3%).

* Performing bank loans never traded much below par in the past, and holders received very substantial recoveries on any that defaulted. Now, even though there have been few defaults, the price of the average loan is in the 60s.

The headlines are full of entities that have seen massive losses, and perhaps meltdowns, because they bought assets using leverage. Going back to the diagrams on pages 4-5, these investors put on leverage that might have been appropriate with moderate-volatility assets and ran into the greatest volatility ever seen. It’s easy to say they made a mistake. But is it reasonable to expect them to have girded for unique events?

If every portfolio was required to be able to withstand declines on the scale we’ve witnessed this year, it’s possible no leverage would ever be used. Is that a reasonable reaction? (In fact, it’s possible that no one would ever invest in these asset classes, even on an unlevered basis.)

In all aspects of our lives, we base our decisions on what we think probably will happen. And, in turn, we base that to a great extent on what usually happened in the past. We expect results to be close to the norm (A) most of the time, but we know it’s not unusual to see outcomes that are better or worse (B). Although we should bear in mind that, once in a while, a result will be outside the usual range (C), we tend to forget about the potential for outliers. And importantly, as illustrated by recent events, we rarely consider outcomes that have happened only once a century . . . or never (D).


Enlightenment man

A FORMER vice-president, Al Gore, and one of the co-founders of Google, Larry Page, were already seated on the stage of Google’s “Zeitgeist” conference, an exclusive gathering for the intelligentsia, but the third chair was still empty. After a few minutes, Sergey Brin, the other founder of the world’s biggest internet company, joined them. Messrs Gore and Page gave him the floor, because Mr Brin had something important to say.

The global “thought leaders” in the audience at Zeitgeist had just spent two days talking about solving the world’s biggest problems by applying the Enlightenment values of reason and science that Google espouses. But Mr Brin, usually a very private man, opened with an uncharacteristically personal story. He talked about his mother, Eugenia, a Jewish-Russian immigrant and a former computer engineer at NASA, and her suffering from Parkinson’s disease.

The reason was that Mr Brin had recently discovered that he has inherited from his mother a mutation of a gene called LRRK2 that appears to predispose carriers to familial Parkinson’s. Thus Mr Brin, at the age of 35, had found out that he had a high statistical chance—between 20% and 80%, depending on the study—of developing Parkinson’s himself. To the surprise of many in the audience, this did not seem to bother him.

One member of the audience asked whether ignorance was not bliss in such matters, since knowledge would only lead to a life spent worrying. Mr Brin looked genuinely puzzled. First of all, he began, who’s talking about worrying? His discovery was merely a statistical insight, and Mr Brin, a wizard at mathematics, uses statistics without fretting about them. More importantly, he went on, his knowledge means that he can now take measures to ward off the disease. Exercise helps, as does smoking, apparently—although Mr Brin, to laughter, denied taking up cigarettes (a vice of his father’s).

But Mr Brin was making a much bigger point. Isn’t knowledge always good, and certainly always better than ignorance? Armed with it, Mr Brin is now in a position to fund and encourage research into this gene in particular, and Parkinson’s in general. He is likely to contact other bearers of the gene. In effect, Mr Brin regards his mutation of LRRK2 as a bug in his personal code, and thus as no different from the bugs in computer code that Google’s engineers fix every day. By helping himself, he can therefore help others as well. He considers himself lucky.

The moment in some ways sums up Mr Brin’s approach to life. Like Mr Page, he has a vision, as Google’s motto puts it, of making all the world’s information “universally accessible and useful”. Very soon after the two cooked up their new engine for web searches, in the late 1990s at Stanford University, they began thinking about information that is today beyond the web. Their vast project to digitise books has been the most controversial so far, prompting a lawsuit from a group of publishers in 2005 that was resolved in October. But Messrs Brin and Page have always taken a special interest in the sort of information that most people hold dearest: that about their health.
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Wednesday, December 17, 2008

Harvard Business School Interview with Seth Klarman

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Tuesday, December 16, 2008

Stock picks from the experts

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Richard Branson's 2007 talk with TED's Chris Anderson










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Wednesday, December 10, 2008

Little logic to bond world amid current risk phobias - By Jim Grant

"There are no bad bonds, only bad prices," the traders used to say. They should say it again, only louder. In the spring of 1984, long-dated Treasuries went begging at yields of nearly 14 per cent in the context of an inflation rate of just 4 per cent. Those, too, were fearful times, the recollected horror being the great inflation of the 1970s. Inflation was ineradicable, the bondphobes said. Now a new generation of creditors espouses the opposite proposition. Deflation is baked in the cake, they say.
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The truth is that no investment asset is inherently safe. Risk or safety is an attribute of price. At the right price, a lowly convertible bond is a safer proposition than an exalted Treasury. Watching the government securities market zoom, many mistake price action for price.

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In their magnum opus, Security Analysis, Benjamin Graham and David L. Dodd advise that "bonds should be bought on their ability to withstand depression". They wrote that in 1934. So far is that rule from being honoured by today's financiers that not a few bonds - and boxcars full of mortgages - could hardly withstand prosperity. Two urgent questions present themselves. One: does something far worse than recession loom? Two: does that certain something definitely spell much lower interest rates?
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In corporate debt and mortgages, anomalies and non sequiturs abound. They are especially prevalent in convertible bonds. More so than even the average stressed-out fund manager, convertible arbitrageurs have been through the mill. It was they - and almost they alone - who owned convertibles. Now many of these folk must sell them.
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Few buyers are presenting themselves, however, though extraordinary bargains keep popping up. Thus, at the end of October, a Medtronic convertible bond with a 1.5 per cent coupon with the debt maturing in April 2011 briefly traded at 80.75. This was a price to yield 10.6 per cent, an adjusted spread of 1,600 basis points over the Treasury curve (adjusted, that is, for the value of the options embedded in the convert, notably the option to exchange it for common stock at the stipulated rate). Contrary to what such a yield might imply, A1/AA minus rated Medtronic, the world's top manufacturer of medical devices for the treatment of heart disease, spinal injuries and diabetes, is no early candidate for insolvency. Almost every day brings comparable examples of risks not borne by people who, in this time of crisis, have come to define risk as "anything not guaranteed by Uncle Sam".
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"Risk-free return" is the standard tag attached to the government's solemn obligations. An investor I know, repulsed by prevailing government yields, has a timelier description - "return-free risk".

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Related books:
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Security Analysis: Sixth Edition
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Mr. Market Miscalculates: The Bubble Years and Beyond
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Tuesday, December 9, 2008

A Bargain Hunter Stands Tall

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Related previous posts:
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Bystanders to this financial crime were many - By Nassim Nicholas Taleb and Pablo Triana

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Yet a method heavily grounded on those same quantitative and theoretical principles, called Value at Risk, continued to be widely used. It was this that was to blame for the crisis. Listening to us, risk management practitioners would often agree on every point. But they elected to take part in the system and to play bystanders. They tried to explain away their decision to partake in the vast diffusion of responsibility: “Lehman Brothers and Morgan Stanley use the model” or “it is on the CFA exam” or, the most potent argument, “modern finance and portfolio theory got Nobels”. Indeed, the same Nobel economists who helped blow up the system at least once, Professors Scholes and Merton, could be seen lecturing us on risk management, to the ire of one of the authors of this article. Most poignantly, the police itself may have participated in the murder. The regulators were using the same arguments. They, too, were responsible.
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Related previous posts:
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Wednesday, December 3, 2008

The Manual of Ideas

There's a new publication out called The Manual of Ideas. The editor, John Mihaljevic, was kind enough to send me the inaugural issue and give me permission to share the login information with Value Investing World readers. So, here it is:
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username: moi
password: moi
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Tuesday, December 2, 2008

Warren Buffett's 4 Market Call Articles

Whitney Tilson compiled the four articles Mr. Buffett has written about the market's valuation over the years (Bullish in 1974, 1979, and 2008; Bearish in 1999) and posted them HERE. Warren got the first 3 right. Time will tell if he was also right in 2008 (I wouldn't bet against him).
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