Friday, July 30, 2010

Wednesday, July 28, 2010

Khan Academy

From Bill Gates’ Twitter account:

I’ve been spending time watching some of the courses on – many of which are quite good. More coming on GatesNotes...

Description: The Khan Academy is a not-for-profit organization with the mission of providing a high quality education to anyone, anywhere.


Related link: GatesNotes

Monday, July 26, 2010

James Montier: Is Austerity the Road to Ruin?

John Mauldin: Some Thoughts on Deflation

The debate over whether we are in for inflation or deflation was alive and well at the Agora Symposium in Vancouver this week. It seems that not everyone is ready to join the deflation-first, then-inflation camp I am currently resident in. So in this week’s letter we look at some of the causes of deflation, the elements of deflation, if you will, and see if they are in ascendancy. For equity investors, this is an important question because, historically, periods of deflation have not been kind to stock markets. Let’s come at this week’s letter from the side, and see if we can sneak up on some answers.

Hussman Weekly Market Comment: Betting on a Bubble, Bracing for a Fall

The financial markets are in a bit of a fight here between technicals and fundamentals. On a technical basis, a variety of widely-followed trendlines, moving average crossings, and resistance areas converge on the 1100 area for the S&P 500. Market internals have also firmed somewhat during the rally in recent weeks, suggesting that investors are eager to re-establish a speculative tone to the market. At the same time, fundamentals are bearing down hard on the market. We continue to observe a clear deterioration in leading indicators of economic activity.

Over the short-term, my impression is that the technicals may hold sway for a bit. The economic data points simply do not come out every day, and to the extent that economic news is not perfectly uniform in its implications, the eagerness of investors to speculate can easily dominate briefly. We established enough contingent call options at lower levels that we've now got about 1% of assets in roughly at-the-money index calls - a modest "anti-hedge" that removes any concern we might have about a frantic short-squeeze if the S&P 500 moves materially above 1100. At the same time, the historical evidence suggests that fundamentals have ultimately trumped technicals when we've observed similar warnings from economic indicators in the past. My impression is that the economic cold water could hit investors very abruptly, so that gains achieved over several weeks may be suddenly erased in a matter of a few days.

My basic concerns are the same here. Investors who will need to fund specific expenses within a short number of years - retirement needs, tuition, health care, home purchases etc - should not be relying on a continued market advance. If your life plans would be significantly derailed by a major market decline, get out. In contrast, if you are pursuing a disciplined, long-term investment strategy, and you know from your own experience of the past decade that you are diversified enough to ride out periodic losses without abandoning that strategy, ignore my views (and those of everyone else) and stick to your discipline.

Much of my research last week was spent working with our various measures of valuation. While the extent of implied overvaluation on our best measures does have a range of variation, that range runs between about 25%-40% overvalued. We certainly know of many valuation indicators that suggest that stocks are "cheap" here. Unfortunately, they don't demonstrate any reliability in historical tests. It is almost mind-numbing to observe how many analysts confidently make valuation claims about the market on CNBC, evidently without ever having done any historical research. If you don't require evidence, you can say anything you want.


"Well, then the Fed would lose money there"

Last week, Ben Bernanke appeared before Congress for his regular Humphrey-Hawkins testimony. For most of that testimony, it fascinated me that every time the Bernanke said that the Fed has taken no losses on its operations, there was absolutely no remark that the reason the Fed has not lost money is that the Treasury, directly (Fannie, Freddie) or indirectly (AIG) has made the liabilities held by the Fed whole.

From that perspective, the critical part of Bernanke's testimony was the following exchange with New Jersey Congressman Scott Garrett of the House Financial Services Committee. Importantly, Bernanke concedes that by placing two-thirds of its balance sheet into the liabilities of insolvent agencies (Fannie Mae and Freddie Mac), now under conservatorship, the Fed is essentially relying on Congress to make these institutions whole at taxpayer expense. The Fed has put the public on the hook to bail out the GSEs.

Friday, July 23, 2010

"We are What We Choose"

Remarks by Jeff Bezos, as delivered to the Class of 2010 at Princeton - May 30, 2010

As a kid, I spent my summers with my grandparents on their ranch in Texas. I helped fix windmills, vaccinate cattle, and do other chores. We also watched soap operas every afternoon, especially "Days of our Lives." My grandparents belonged to a Caravan Club, a group of Airstream trailer owners who travel together around the U.S. and Canada. And every few summers, we'd join the caravan. We'd hitch up the Airstream trailer to my grandfather's car, and off we'd go, in a line with 300 other Airstream adventurers. I loved and worshipped my grandparents and I really looked forward to these trips. On one particular trip, I was about 10 years old. I was rolling around in the big bench seat in the back of the car. My grandfather was driving. And my grandmother had the passenger seat. She smoked throughout these trips, and I hated the smell.

At that age, I'd take any excuse to make estimates and do minor arithmetic. I'd calculate our gas mileage -- figure out useless statistics on things like grocery spending. I'd been hearing an ad campaign about smoking. I can't remember the details, but basically the ad said, every puff of a cigarette takes some number of minutes off of your life: I think it might have been two minutes per puff. At any rate, I decided to do the math for my grandmother. I estimated the number of cigarettes per days, estimated the number of puffs per cigarette and so on. When I was satisfied that I'd come up with a reasonable number, I poked my head into the front of the car, tapped my grandmother on the shoulder, and proudly proclaimed, "At two minutes per puff, you've taken nine years off your life!"

I have a vivid memory of what happened, and it was not what I expected. I expected to be applauded for my cleverness and arithmetic skills. "Jeff, you're so smart. You had to have made some tricky estimates, figure out the number of minutes in a year and do some division." That's not what happened. Instead, my grandmother burst into tears. I sat in the backseat and did not know what to do. While my grandmother sat crying, my grandfather, who had been driving in silence, pulled over onto the shoulder of the highway. He got out of the car and came around and opened my door and waited for me to follow. Was I in trouble? My grandfather was a highly intelligent, quiet man. He had never said a harsh word to me, and maybe this was to be the first time? Or maybe he would ask that I get back in the car and apologize to my grandmother. I had no experience in this realm with my grandparents and no way to gauge what the consequences might be. We stopped beside the trailer. My grandfather looked at me, and after a bit of silence, he gently and calmly said, "Jeff, one day you'll understand that it's harder to be kind than clever."

What I want to talk to you about today is the difference between gifts and choices. Cleverness is a gift, kindness is a choice. Gifts are easy -- they're given after all. Choices can be hard. You can seduce yourself with your gifts if you're not careful, and if you do, it'll probably be to the detriment of your choices.


Related previous post:'s Jeff Bezos – Interviews

Wednesday, July 21, 2010

Howard Marks Memo: It’s Greek to Me

Experience shows how radically markets fluctuate between seeing the proverbial glass half full and seeing it half empty. Rather than achieve a happy medium, sometimes the markets focus exclusively on good news (as during the twelve months through April) and sometimes exclusively on bad. Greece kicked off a turn to the negative in late April, which was exacerbated by the Gulf oil spill and rising concern over the possibility of an economic double dip. On May 8, after Greece’s troubles blossomed, The New York Times quoted Bill Gross as saying, “Up until last week there was this confidence that nothing could upset the apple cart as long as the economy and jobs growth was positive. Now, fear is back in play.”

Just a few months ago, no one seemed to have a problem with nations that ran chronic deficits and continuously increased their debt. Then investors changed their mind – as they tend to do – and today they take a dim view of these practices. Government solvency is considered a critical issue. Here’s how guest contributor and hedge fund analyst Andrew Marks (also my son) sums up current sentiment:

Sovereign debt has become like fiat currency, as it is supported only by people’s willingness to believe in other people’s willingness to refinance it. The debt of an issuer with no plan to repay and no underlying way to meet maturities other than through refinancing sounds eerily like a subprime mortgage.

Markets are safer when fear balances greed, and when worry about losing money balances worry about missing opportunity. We don’t like it when fear rears its head and stocks drop, but certainly that creates a healthier environment in which to be a holder, and one which should offer better buying opportunities. Over the first part of this year it was easy to say prices had gotten ahead of fundamentals; all things being equal, that now seems less true.

The current positives for investors include moderate valuations, rising corporate earnings and the likelihood we’re already in a recovery. On the other hand, I continue to feel consumers are too traumatized to resume spending strongly, and I see unpleasant and rarely contemplated long-term possibilities including those discussed above. In particular, conservatism, austerity and increased savings are good for economic units individually but bad for a stagnant overall economy. Bottom line: anyone who invests today in a pro-risk fashion out of belief in the recovery must be confident he’ll be agile enough to take profits before the long-term realities set in.

I’ve had a heck of a time pulling together all of these ideas, and I’ve found it even harder to come up with anything like answers. But I hope the discussion has been helpful, and that you’ll think about the questions I’ve raised and encourage others to do so as well. I don’t enjoy feeling like a worrywart, but I doubt my concerns are unfounded, and I can’t imagine silence would be preferable.

Ricardo Semler Lecture: Leading by Omission


Monday, July 19, 2010

In Defense of Difference and The Science of Resilience

Found via Simoleon Sense.

Resilience theory, and the nascent field of resilience science associated with it, begins with the basic premise that human and natural systems act as strongly coupled, integrated systems. These so-called “social-ecological” systems are understood to be in constant flux and highly unpredictable. And unlike standard ecological theory, which holds that nature responds to gradual changes in a correspondingly steady fashion, resilience thinking holds that systems often respond to stochastic events — things like storms or fires — with dramatic shifts into completely different states from which it is difficult, if not impossible, to recover. Numerous studies of rangelands, coral reefs, forests, lakes, and even human political systems show this to be true: A clear lake, for instance, seems hardly affected by fertilizer runoff until a critical threshold is passed, at which point the pond abruptly turns murky. A reef dominated by hard coral can, in the aftermath of a hurricane, flip into a state dominated by algae. A democratic nation stricken by drought, disease, or stock market crashes can descend into political chaos.

It’s the ability of a system — whether a tide pool or township — to withstand environmental flux without collapsing into a qualitatively different state that is formally defined as “resilience.” And that is where diversity enters the equation. The more biologically and culturally variegated a system is, the more buffered, or resilient, it is against disturbance. Take the Caribbean Sea, where a wide variety of fish once kept algae on the coral reef in check. Because of overfishing in recent years, these grazers gradually gave way to sea urchins, which continued to keep algae levels down. Then in 1983 a pathogen moved in and decimated the urchin population, sending the reef into a state of algal dominance. Thus, the loss of diversity through overfishing eroded the resilience of the system, making it vulnerable to an attack it likely could have withstood in the past.

For Crawford “Buzz” Holling, widely acknowledged as the father of resilience theory and founding director of the Resilience Alliance, a small international network of academics who collaborate to explore the dynamics of social-ecological systems, this year marked a definite coming of age of an idea. At the first annual Resilience 2008 summit, held at the newly opened Resilience Center at the University of Stockholm, Holling delivered the keynote address to more than 600 scientists, policymakers, and artists, convened for a four-day brainstorm session. As was the case at the AMNH symposium just weeks earlier, the focus was on how to move from theory to practice. And once one starts thinking through the lens of resilience, the policy implications are indeed enormous. Economics necessarily morphs into its social-ecological analogue, “ecological economics” — so that a city seeking to expand its boundaries, for example, must consider not only costs and benefits in human terms, but also the same calculus as applied to the environment. Efficiency at the expense of diversity becomes anathema, so that a company struggling to stay afloat thinks twice before replacing five human workers with one seemingly smarter machine. Redundancy is encouraged, rather than quashed, on the grounds that more genes and more memes ultimately provide insurance against a time when changing conditions overwhelm the dominant paradigm of the day. There is no “sacred balance” in nature, says Holling. “That is a very dangerous idea.”

Resilience science can get bogged down in its own specific lexicon: a cloud of “adaptive capacities,” “functional groups,” and “self-organizing principles.” But pull back from the jargon and the essence is simple: Homogeneous landscapes — whether linguistic, cultural, biological, or genetic — are brittle and prone to failure. The evidence peppers human history, as Jared Diamond so meticulously catalogued in his aptly named book, Collapse. Whether it was due to a shifting climate that devastated a too-narrow agricultural base, a lack of cultural imagination in how to deal with the problem, or a devastating combination of the two, societies insufficiently resilient enough to cope with the demands of a changing environment invariably crumbled. The idea is perhaps best summed up in the pithy standard, “What doesn’t bend, breaks.”

Jeremy Grantham's 2Q Letter: Summer Essays

Jeremy Grantham's 2Q Letter is a collection of six essays on topics ranging from "Finance Goes Rogue (But Volcker Wins a Round," to "The Fearful Speculative Market," to "Everything You Need to Know About Global Warming in 5 Minutes."

The busy mind on meditation

Even brief sessions can help with multitasking, dealing with deadlines - and pain relief, too

Fadel Zeidan has proven that minimal training in meditation can lessen the perception of pain in research subjects.

He also has shown that similarly brief sessions of meditation can increase cognitive function - the ability to multitask, recall items in a series and complete tests on a deadline.

Now, he wants to find out why even short stints of meditation affect the brain that way.


Related article (thanks Peter!): Contemplating Oneness: The Neuroscience of Meditation

Related previous posts:

Matthieu Ricard: Change your Mind, Change your Brain

Matthieu Ricard - The Art of Meditation

John Mauldin: The Debt Supercycle

The Debt Supercycle

When I mention The End Game, you’ll immediately want to know what is ending. What I think is ending for a significant number of countries in the “developed” world is the Debt Supercycle. The concept of the Debt Supercycle was originally developed by the Bank Credit Analyst. It was Hamilton Bolton, the BCA founder, who used the word supercycle, and he was referring generally to a lot of things, including money velocity, bank liquidity, and interest rates. Tony Boeckh changed the concept to the more simple “Debt Supercycle” back in the early 1970s, as he believed the problem was spiraling private-sector debt. The current editor of the BCA (and Maine fishing buddy) Martin Barnes has greatly expanded on the concept.

Essentially, the Debt Supercycle is the decades-long growth of debt from small and easily-dealt-with levels, to a point where bond markets rebel and the debt has to be restructured or reduced or a program of austerity must be undertaken to bring the debt back to manageable proportions.

As Bank Credit Analyst wrote back in 2007:

“The history of the U.S. is characterized by a long-run increase in indebtedness, punctuated by occasional financial crises and subsequent policy reflation. The subprime blow-up is the latest installment in this ongoing Debt Supercycle story. During each crisis, there are always fears that conventional reflation will no longer work, implying the economy and markets face a catastrophic debt unwinding. Such fears have always proved unfounded, and the current episode is no exception.

“A combination of Fed rate cuts, fiscal easing (aimed at relieving subprime distress), and a lower dollar will eventually trigger another upleg in the Debt Supercycle, and a new round of leverage and financial excesses. The objects of speculation are likely to be global, particularly emerging markets and resource related assets. The Supercycle will end if foreign investors ever turn their back on U.S. assets, triggering capital flight out of the dollar and robbing U.S. authorities of any room for maneuver. This will not happen any time soon.”

I was talking with Martin a few months ago, and about the topic turned to the ending of the Debt Supercycle. Martin said we are nowhere near the end, as the government is stepping in where private debtors are cutting back. We have just shifted the focus of where the debt is coming from. And he is right, in that the Debt Supercycle in the US, Great Britain, Japan and other developed countries (yes, even Greece!) is still very much in play as governments explode their balance sheets. Total debt continues to grow.

Somewhere Over the Rainbow

And yet, and yet… While the Debt Supercycle may not yet have ended, I think we can begin to see a clear case that, like the sandwich-board-wearing cartoon prophet warning, “The End is Nigh!” Greece is the harbinger of fundamental change. Spain and Portugal are pointing to the same outcome, as their cost of debt keeps rising. And Ireland? The Baltics?

There is a limit to how much debt you can pile on. But as the work of Reinhart and Rogoff points out (This Time Is Different), there is not a fixed limit or some certain percentage of GNP. Rather, the limit is all about confidence, a theme I have written on many times. Everything goes along well, and then “Boom!” it doesn’t. That “Boom” has happened to Greece. Without massive assistance, Greek debt would be unmarketable. Default would be inevitable. (I still think it is!)

The limit is different for every nation. For Russia in the 1990s, it was a rather minor total debt-to-GDP ratio of around 12%. Japan will soon have a debt-to-GDP ratio of 230%! The difference? Local savers bought government debt in Japan and did not in Russia.

The end of the Debt Supercycle does not have to mean calamity for each country, depending on how far down the road they are. Yes, if you are Greece your choices are between very, very bad and disastrous. Japan is a bug in search of a windshield. Each country has its own dynamics.

Take the US. We are some ways off from the end. We have time to adjust. But let’s be under no illusions, we cannot run deficits of 10% of GDP forever. At some point the Fed will either have to monetize the debt or the bond market will simply demand an ever-higher interest rate. Why can’t we go the way of Japan? Because we do not have the level of savings they have traditionally had. But their savings levels are rapidly declining, which says that if they want to continue their deficit spending at 10% of GDP, they will have to go into the foreign markets to borrow money at a much higher cost, or their central bank will have to print money. Neither choice is good.


Related book: The Great Reflation

Related previous post: Reflections on the Sovereign Debt Crisis - By Edward Chancellor

Greenlight Capital Q2 2010 Letter

Found via My Investing Notebook.

Link to: Greenlight Capital Q2 2010 Letter

Hussman Weekly Market Comment: Don't Take the Bait

Investors who allow Wall Street to convince them that stocks are generationally cheap at current levels are like trout - biting down on the enticing but illusory bait of operating earnings, unaware of the hook buried inside.

I continue to urge investors to have wide skepticism for valuation metrics built on forward operating earnings and other measures that implicitly require U.S. profit margins to sustain levels about 50% above their historical norms indefinitely. Forward operating earnings are Wall Street's estimates of next year's earnings, omitting a whole range of actual charges such as loan losses, bad investments, restructuring charges, and the like. The ratio of forward operating earnings to S&P 500 revenues is now higher than it has ever been. Based on historical data (see August 20, 2007 Long Term Evidence on the Fed Model and Forward Operating P/E Ratios), the profit margin assumptions built into forward operating earnings are well beyond two standard deviations above the long-run norm. This is largely because, as Bill Hester noted in his research article last week, forward operating earnings are heavily determined by extrapolating the most recent year-over-year growth rate for earnings. In the current instance, this is likely to overshoot reality, and in any event, has little to do with the long-term cash flows that investors can actually expect to receive over time.

I can't emphasize enough that when you hear an analyst say "stocks are cheap based on forward operating earnings" it would be best to replace that phrase in your head with "stocks are cheap based on Wall Street's extrapolative estimates of a misleading number."

More sober and historically reliable measures of market valuation create a much more challenging picture. Apart from our own measures, which indicate continued overvaluation, there are several good indicators of market valuation that are not overly sensitive to year-to-year fluctuations in profit margins. One is based on the 10-year average of actual net (not operating) earnings, which is advocated by economist Robert Shiller, and another is Tobin's "q" ratio which is based on comparing market value to replacement cost, and is advocated by Andrew Smithers. Both of these measures largely agree with our own measures, both presently and on a historical basis. Based on last week's valuations, both suggest that the S&P 500 is substantially overvalued.

Friday, July 16, 2010

Warren Buffett Tells Obama Still 'Long Way to Go' After 'Wrenching Recession'

Link to CNBC article:

John Hussman on CNBC - 6/30/2010


And his interview on CNBC the last time he made a recession call, in November of 2007:

Morningstar interview with John Hussman

Thanks to Steve F. for passing this along.

Morningstar interview clips with John Hussman:

Hussman: The Market Is Significantly Overvalued

Hussman: Expect 7% Annual Total Returns in Stocks

Hussman: We Haven't Fixed the Mortgage Problem

Hussman on the Risk/Reward Trade-Off for 30-Year Treasuries

Michael Mauboussin: Untangling Skill and Luck

Found via Simoleon Sense.

For almost two centuries, Spain has hosted an enormously popular Christmas lottery. Based on payout, it is the biggest lottery in the world and nearly all Spaniards play. In the mid 1970s, a man sought a ticket with the last two digits ending in 48. He found a ticket, bought it, and then won the lottery. When asked why he was so intent on finding that number, he replied, “I dreamed of the number seven for seven straight nights. And 7 times 7 is 48.”

Outcomes from many activities—including sports, business, and investing—are the combination of skill and luck. Most people recognize that skill and luck play a role in results, yet they have a poor sense of the relative contribution of each. The ability to properly untangle skill and luck leads to much better thinking about most day-to-day outcomes, and allows for sharply improved decision making.

The process of asset allocation in the institutional investment industry is a practical example of the failure to conceptualize skill and luck. In the aggregate, institutional money tends to flow to assets that have done well and fails to consider sufficiently the role of luck. One recent study suggested that this misallocation of resources had cost these portfolios $170 billion from 1985 to 2006. The study’s authors conclude that those institutions “could have saved hundreds of billions of dollars in assets if they had simply stayed the course” instead of moving money based on a naive extrapolation of past results.

It’s important to define skill and luck before we get too far into the discussion. Skill is “the ability to use one’s knowledge effectively and readily in execution or performance.” You can think of skill as a process, or a series of actions to achieve a specific goal. Luck is “the events or circumstances that operate for or against an individual.” Luck, in this sense, is above and beyond skill. Consider luck as a distribution that has an average of zero. By this definition, luck tends to be transitory.

Thursday, July 15, 2010

Complex systems: Ecology for bankers

Article from February 2008.

There is common ground in analysing financial systems and ecosystems, especially in the need to identify conditions that dispose a system to be knocked from seeming stability into another, less happy state.

'Tipping points', 'thresholds and breakpoints', 'regime shifts' — all are terms that describe the flip of a complex dynamical system from one state to another. For banking and other financial institutions, the Wall Street Crash of 1929 and the Great Depression epitomize such an event. These days, the increasingly complicated and globally interlinked financial markets are no less immune to such system-wide (systemic) threats. Who knows, for instance, how the present concern over sub-prime loans will pan out?

Well before this recent crisis emerged, the US National Academies/National Research Council and the Federal Reserve Bank of New York collaborated1 on an initiative to "stimulate fresh thinking on systemic risk". The main event was a high-level conference held in May 2006, which brought together experts from various backgrounds to explore parallels between systemic risk in the financial sector and in selected domains in engineering, ecology and other fields of science. The resulting report was published late last year and makes stimulating reading.

Catastrophic changes in the overall state of a system can ultimately derive from how it is organized — from feedback mechanisms within it, and from linkages that are latent and often unrecognized. The change may be initiated by some obvious external event, such as a war, but is more usually triggered by a seemingly minor happenstance or even an unsubstantial rumour. Once set in motion, however, such changes can become explosive and afterwards will typically exhibit some form of hysteresis, such that recovery is much slower than the collapse. In extreme cases, the changes may be irreversible.

As the report emphasizes, the potential for such large-scale catastrophic failures is widely applicable: for global climate change, as the greenhouse blanket thickens; for 'ecosystem services', as species are removed; for fisheries, as stocks are overexploited; and for electrical grids or the Internet, as increasing demands are placed on both. With its eye ultimately on the banking system, the report concentrates on the possibility of finding common principles and lessons learned within this medley of interests. For instance, to what extent can mechanisms that enhance stability against inevitable minor fluctuations, in inflation, interest rates or share price for example, in other contexts perversely predispose towards full-scale collapse?


Related links:

New Directions for Understanding Systemic Risk

On Robustness & Fragility

Related books:

The Age of the Unthinkable

The Black Swan

Evolutionary Well-Being: the paleolithic model

An evolutionary philosophy has direct implications for a happy and healthy lifestyle. By understanding how we as humans have evolved, we will get a much better understanding of how we can optimally function.

Natural selection has shaped our body and mind for life as paleolithic hunter-gatherers (HGs). Hominids have been living in that way for millions of years after they diverged from the chimpansees. Agriculture only appeared about 10,000 years ago in the Middle East, and even later in most other parts of the world. Therefore, our genes have not really had the time to adapt to the lifestyle of farmers or industrial workers: they still prepare us for a life of hunting and gathering.

This means that there is a fundamental misadaptation between our present lifestyle and the one that our genes expect. This discord can explain a host of so-called "diseases of civilisation": coronary heart disease, obesity, cancer, diabetes, Alzheimer, depression, chronic stress, anxiety, ADHD, etc. These diseases needlessly degrade body and mind, while significantly reducing our life expectancy and sense of well-being.

On the positive side, this insight now allows us to improve our quality of life. We first need to better understand how our paleolithic ancestors lived. We can then choose the elements of that lifestyle that are most appropriate to adopt in our present circumstances. As summarized below, there exists an extensive and quickly growing literature on changes in diet, exercise, and contact with nature that are inspired by the paleolithic lifestyle. Many of those have already been proven to increase our well-being, although further empirical tests are or course welcome.


Related article: Evolutionary Fitness: the diet that really works

Related link: 2 Hour Weight Loss

Wednesday, July 14, 2010

The Boeckh Investment Letter - The Great Reflation: The Mother of all Financial Experiments

Chuck Prince, the former CEO of Citigroup, who presided over the bank’s collapse, famously remarked in July 2007 that "as long as the music is playing, you’ve got to get up and dance. We’re still dancing.” Shortly after, the music stopped, the financial system broke, and Citigroup and other financial behemoths went under.

To rescue the economy and financial system from near‐total meltdown, the government created an unprecedented package of bailouts, stimulus, free money and massive fiscal deficits. It succeeded, and a 1930s style debt deflation and depression were aborted. Liquidity, on a vast scale was unleashed into the financial system, demonstrating, once again, the power of such flows to drive up the prices of stocks, commodities and other risky assets.

In The Great Reflation we focus on how the authorities pumped air back into the balloon, and got the music playing again. Investors and banks, including Citigroup, are back out on the dance floor. However, just because the system was saved, doesn’t mean it has been fixed.

Why do we say that the system isn’t fixed? The major theme running through The Great Reflation is that we have been living through a multi‐decade period of money and credit inflation that started back in the 1960s when the post‐World War II global monetary system (Bretton Woods) began to break down. The Great Reflation is about this inflation and the consequences of the Act II, which is now unfolding.


The centerpiece of our own strategy, and outlined in the book, is understanding liquidity flows. They are the single most important force driving investment markets both up and down. Contracting liquidity caused the crash in 2008‐2009 and dramatically expanding liquidity since March 2009 has triggered one of the greatest bull markets in U.S. history. The next bear market will also be driven, at some point, by a contraction in liquidity flows. However, as long as the great reflation is doing its work, that day can be postponed. Chuck Prince, if he were to comment today, would probably point out that the music is playing again. People are back out on the dance floor. But, if the great reflation is as artificial as we believe, then this is still musical chairs. When the music stops, there won’t be a chair for everyone, just like the last time.


Book: The Great Reflation: How Investors Can Profit From the New World of Money

Real-world turbulence, market lull: Apollo Asia Fund - the manager's report for 2Q2010

During the quarter, activity in the whole portfolio was again very limited: we added one new name, increased two other positions, and trimmed one. Value is not particularly compelling by historical standards, and macro concerns make us significantly more cautious than consensus on the earnings outlook for many sectors. We are also very wary of current psychology, and see the potential for western markets to retest 2009 lows. We have not, however, moved significantly to cash. Firstly, we have demonstrably no ability to market-time. Secondly, many of our holdings are illiquid, and even if we were certain of an imminent 50% or 80% fall in value, it would not necessarily be possible to sell out entirely and get back in. Thirdly, a current-year earnings yield of 8% and a net dividend yield of 3.5% on our portfolio holdings seem respectable, especially compared to the few basis points now available on deposit. However, we have also felt no urgency to deploy the current cash balance, while awaiting either more conviction on relative merits, or more compelling entry points.

One headwind for Asian exporters is FX. Asian currencies have appreciated against the Euro by 22% since late October. Against the US$, the moves have been relatively muted, but Europe is as important an export market, and for some industries a key competitor. The closure of airspace by the unpronounceable Icelandic volcano, a disruption which featured in few contingency plans, and the fears of a larger eruption at the neighbouring Katla, will also have boosted the case for shorter supply chains.

The broader problem for most exporters is global demand. The easy year-on-year comparisons against 1H09 are now over, and the effects of government stimulus are wearing off (with more distortion than lasting benefit achieved). Military spending is one area of strength; the PC replacement cycle is another, relevant to a larger number of Asian companies - but the Asian export model may struggle over the next few years, and it seems unlikely that new markets will compensate for the lack of demand in North America and Europe.

Caution on the cyclical outlook has made us cautious on the medium-term growth expectations for a number of sectors; a sense of the resource/environmental limits to growth makes us wary of some long-term assumptions. The future may not look like the past, and heightened risk perceptions have reduced our stock universe by eliminating a number of sectors in which consensus growth assumptions seem too optimistic.

So far that has been the main practical effect of our concern about energy. (See 'Energy for Asia: an overview', March/April 2010). Risks to business-as-usual seem widespread; clear beneficiaries are likely to be fewer, and seem harder to value. (Profits from a perceived windfall may have to be shared, and may not accrue to current owners of a resource.)

Shifts in Asian energy usage are of global importance - and may be underestimated, despite newsflow on international oil and gas moves, because China and India have hitherto depended to a large extent on coal, and have been self-sufficient therein, so the magnitude of their domestic energy usage may not have been fully appreciated. In 2009, the energy consumed by China in the form of coal was 3.3 times the energy produced by Saudi Arabia from oil. So if China and India now need to import coal, this is important - not just for the listed coal producers, which have rocketed to significant market capitalisation (without our participation, to date), but for anyone pondering global supply and demand.

Few of our investors seem to share our concerns on this front, and relatively few company executives - but I commend the subject to your attention.

Jim Grant Discusses Potential New Federal Reserve Governors

Found via Zero Hedge.

Risky Business: James Bagian—NASA astronaut turned patient safety expert—on Being Wrong - By Kathryn Schulz

Thanks to Peter for passing this along.

In the weeks after I launched this series, several readers e-mailed me to suggest that I interview a man named James Bagian. When I began looking into his background, it became clear to me why: Name a high-stakes industry, and odds are Bagian has been involved in trying to make it safer. He is, among other things, an engineer, an anesthesiologist, a NASA astronaut (he was originally scheduled to be on the fatal Challenger mission), a private pilot, an Air Force-qualified freefall parachutist, and a mountain rescue instructor. And then there's his current job: director of the Veteran Administration's National Center for Patient Safety. In that capacity, Bagian is responsible for overseeing the reduction and prevention of harmful medical mistakes at the VA's 153 hospitals.

Given that most of us are far more likely to find ourselves in a health clinic than a space shuttle, it's sobering to hear Bagian compare the overall attitude toward error in his various fields. "If you look at the percent of budget we spend on safety activity in healthcare versus, say, nuclear power or aviation or the chemical industry, it's not even close," he told me. "Granted, that's just one metric, and I'm not saying money is the be-all end-all. But if people in industry look at what happens in healthcare, they say, ‘Man, this doesn't look like anything we recognize.'" In the below interview, Bagian and I talk about how to make medicine safer, why he doesn't like the word "error," and what it was like to dodge the Challenger bullet.

Tuesday, July 13, 2010

Obscure book by British adviser becomes cult hit after Warren Buffett tip

Update (7/15): Apparently the article below was way off base and Mr. Buffett never recommended the book or said what the article says he said, although I still think the 2 books (and the "When Money Dies" article) below could be interesting:


Thanks to Matt for first passing this along.

Mr Buffett, known as the Sage of Omaha because of his shrewd investments, apparently told friends that When Money Dies illustrated what could happen today if European governments attempt to spend their way out of the downturn.

Written in 1975 by Adam Fergusson, a one-time adviser to Tory minister Lord Howe, the book charts how the German economy was ruined by hyperinflation after the Weimar government allowed public spending to run out of control.

The collapse of the Weimar Republic cleared the way for Adolf Hitler’s Nazis to seize power in 1933.

After Mr Buffett tipped off a Dutch financier friend about the wisdom of Fergusson's analysis, his book became the talk of right-wing blogs and economics websites, with copies changing hands for up to £1,600.

Old Street Publishing, a small British publisher, has rushed out a new edition to meet demand.


Book: When Money Dies: The Nightmare of the Weimar Hyper-inflation

Related article (Feb. 2009): “When Money Dies

Related book: The Economics Of Inflation - A Study Of Currency Depreciation In Post War Germany