Rental economics in the American housing market are attractive, particularly relative to capital market returns available in general. Clearing the housing market would address the imbalance between rental and purchase values, but requires capital entry. Government policymakers’ attention may encourage capital movement, and the bottoming of house prices.
Tuesday, January 31, 2012
After all the back and forth, we still fall into the camp that believes there will eventually be inflation, largely because of the unprecedented liquidity creation noted in our arguments for inflation. However, that doesn’t mean that deflationary pressure won’t rule the roost for the foreseeable future.
We don’t proffer a better ability to divine the future, but we do suggest that you resist putting too much confidence in what you read about the economy (here or anywhere else). We think the market is unlikely to experience a decline similar to that of 2008-09, if for no other reason than that people now view the world more fearfully than they did during the more sanguine pre-2008 period. Once one climbs a wall of worry, there isn’t as far to fall—an oxymoron, but consistent with our view that there’s less to fear when there’s fear. After considering all of the above and more, we still let price be our guide. If an investment discounts the present, allowing for a host of negative outcomes, you will see more equity exposure as our expected risk-adjusted return should be good. If a prospective investment discounts the future and hereafter, you will see more cash.
We find investing especially challenging today—not that it’s ever been easy. We feel like we are forced to bet on policy, and how does one do that? Particularly when we believe we are betting that too many of the wrong people will make the right decisions. We feel a little like explorers, blazing new trails, learning about the new world we’ve come upon, charting a different path with new information, all while trying to avoid being scalped. We continue to seek the best path, even if it’s new, to both protect your capital (first) and to provide a return on it (second). It’s as the Scottish missionary and explorer David Livingstone once declared: “I am prepared to go anywhere, provided it be forward.” Along the way though, we sometimes feel a bit like Daniel Boone, who said, “I have never been lost, but I will admit to being confused for several weeks.” We’re left with the hope that selfish and uneducated views coalesce somehow to form appropriate policy. But we’re not seeing it, so we maintain our cautious positioning, with net exposure to risk assets at 70.5%, which includes 5.0% of corporate bonds that are largely lower risk. As a result, we are not positioned for the world being great, and our performance will lag should that prove the case. We continue prudently, however, aware that the metaphor of ‘kicking the can down the road’ is misleading because it implies a problem of a constant proportion instead of what we see as more of a snowball, rolling downhill and gathering momentum and size with each advancing yard. Volatility is our friend. We anticipate more of it, and will commit capital accordingly.
“Defensive investing, insistence on value, and shying away from leverage -they’re all important. And much of the reason they’re important stems from the fact that so little of short-term performance is under our control….We build portfolios based on the intrinsic values we see and the developments we think will unfold. But uncontrollable factors will have a profound impact on the results…. It’s essential to remember that the fact that something’s probable doesn’t mean it’ll happen, and the fact that something happened doesn’t mean it wasn’t improbable.”
BLODGET: A lot of people have just called the bottom in the housing market in the United States, and there's been some okay data recently. Is that your take? That finally housing prices are bottoming?
SHILLER: When people phrase is that way, they say 'we've reached the bottom.' That suggests that we have the expectation of a major turning point right now. But I don't see that. I don't see any reason to think that prices are going to start heading up dramatically now. We do have some good news. Permits are up. Notably, the National Association of Homebuilders Housing Market Index is up and that's a forward-looking index. But it's not up very much. If you look at the rate of change it looks dramatic but it's still at a low level.
Our foundation’s work around the world gives me opportunities to meet really smart, visionary people who are doing pioneering work in fields that I might not get a chance to learn much about otherwise. For example, in December Melinda and I went to Cairns, Australia, where James Dale and his team from Queensland University of Technology are doing advanced research on bananas. As odd as that might sound, this research could make a big contribution to public health in a lot of Africa and Asia.
Before our visit, I didn’t know much about bananas. Dale, an agricultural scientist, is one of the world’s leading experts. He has been profiled in The New Yorker, in a fascinating article about the history of bananas as an export crop. As the article explains, a blight has spread among plantations in Asia and Australia in recent years, badly damaging production of the one type of banana that is grown for export, the Cavendish. This disease, a fungus, hasn’t spread to Latin America yet, but if it does, bananas could get a lot scarcer and more expensive in North America and elsewhere. Dale is working to develop new versions of the Cavendish that resist the fungus. He does this by inserting genetic material from other organisms into banana plants.
This work is separate from the research that our foundation supports, although some of the same techniques and scientific principles are involved, including transgenic experiments. Making banana plants less susceptible to diseases is a secondary goal for us. Our primary goal is to help Dale develop new types of banana that are more nutritious – specifically, much richer in Vitamin A and Iron that the body can absorb.
Related article: “WE HAVE NO BANANAS”
Related book: Banana: The Fate of the Fruit That Changed the World
Monday, January 30, 2012
I haven’t read this yet, but it looks like an interesting compilation and analysis of Berkshire’s investments and subsidiaries. A link to an abridged version is below. The complete book is available HERE.
Link to: Abridged Version of Moats
Welcome to the first Wired Smart List. We set out to discover the people who are going to make an impact on our future --by asking today's top achievers who, emerging in their field, they'd most like to have a leisurely lunch or dinner with. So we approached some of the world's brightest minds -- from Melinda Gates to Ai Weiwei -- to nominate one fresh, exciting thinker who is influencing them, someone whose ideas or experience they feel are transformative.
Some suggested names you may be aware of, others might be new. Either way, they're all people you really need to know about. And wired will be inviting all nominators and nominees to a giant dinner party...
The ditties are too high-pitched for human hearing, but scientists at Vienna's University of Veterinary Medicine analyzed them and found they convey information about identity and kinship. The findings are published in the journal Physiology & Behavior and in the Journal of Ethology.
“It seems as though house mice might provide a new model organism for the study of song in animals,” said Dustin Penn of the university, one of the co-authors of the work. “Who would have thought that?”
Scientists knew house mice make sounds during courtship, but assumed they were just squeaks, according to the group. In reality, they said, they are complex and show characteristics of song: during slowed-down playbacks, a similarity to bird song becomes striking.
When stocks recently hit a six-month high, U.S. Trust's chief investment officer, Christopher Hyzy, expected to hear from investors eager to buy more shares. Instead, calls came in from clients who wanted to know if they should take profits, or how they could protect their winnings following the Standard & Poor's 500's quick 20% jump to break through 1300.
It's not just U.S. Trust investors who are cautious. Across the country, employers are gradually adding jobs, and fears of a double-dip U.S. recession have receded momentarily—enough to propel U.S. stocks up 4.7% in January, double their gain from a year ago. Yet financial advisors and money managers are listening to the same anxious refrain from their clients: Make sure you don't lose our money! Investors may be resigned to diminished returns, what with bond yields plumbing historic depths and banks paying almost no interest, but their biggest priority remains to avoid, at all cost, a repeat of the 2008's disastrous losses.
Nearly three months after MF Global Holdings collapsed, officials hunting for an estimated $1.2 billion in missing customer money increasingly believe that much of it might never be recovered, according to people familiar with the investigation.
As the sprawling probe that includes regulators, criminal and congressional investigators, and court-appointed trustees grinds on, the findings so far suggest that a "significant amount" of the money could have "vaporized" as a result of chaotic trading at MF Global during the week before the company's Oct. 31 bankruptcy filing, a person close to the investigation was cited as saying Monday.
Many officials now believe certain employees at MF Global dipped into the "customer segregated account" that the New York company was supposed to keep separate from its own assets -- and then used the money to meet demands for more collateral or to unfreeze assets at banks and other counterparties as they grew more concerned about their financial exposure to MF Global.
Investigators also are examining other scenarios that have gained traction in recent weeks, such as the possibility that MF Global suffered steep losses on investments made using customer money. Officials investigating the case have looked into whether such investments were appropriate under rules at the time.
As money poured out of MF Global, much of it likely passed through J.P. Morgan Chase and other banks where the securities firm had accounts, as well as trade-clearing partners such as Depository Trust & Clearing and LCH.Clearnet Group, people familiar with the matter said.
Over the years, of the most frequent phrases in these weekly comments has been "on average." Most of the investment conditions we observe are associated with a mix of positive and negative outcomes, so rather than making specific forecasts about future market direction, we generally align our investment position in proportion to the average return/risk outcome, recognizing that the actual outcome may be different than that average in any particular instance.
Increasingly however, we have observed sets of conditions that are so heavily skewed toward bad outcomes that they deserve the word "warning" (see Extreme Conditions and Typical Outcomes near the 2011 peak, Don't Mess with Aunt Minnie before the 2010 market break, Expecting a Recession in late 2007, A Who's Who of Awful Times to Invest at the 2007 market peak, and our shift from a modestly constructive investment position to a Crash Warning in October of 2000). While the downturns that followed have provoked increasingly large and desperate actions of central banks to kick the can down the road by preventing debt restructuring and financial deleveraging (in some cases by violating legal constraints - see The Case Against the Fed ), the fact is that the S&P 500 has achieved a total return of just 1.2% annually over the past 12 years, as a predictable outcome of rich valuations and still-unresolved economic imbalances.
I could admittedly do better, and would certainly have captured more upside from temporary speculation, had I committed myself to the principle that central banks will act strictly to defend the bondholders of the banks they represent, even if it means trespassing into fiscal policy, subordinating public interest, empowering the worst stewards of capital, violating legal restrictions, and inviting long-term instability. Still, none of those actions improve the long-term outcome for the markets, and more importantly, none have prevented repeated and serious downturns from occurring, despite all the can-kicking.
Once again, we now have a set of market conditions that is associated almost exclusively with steeply negative outcomes. In this case, we're observing an "exhaustion" syndrome that has typically been followed by market losses on the order of 25% over the following 6-7 month period (not a typo). Worse, this is coupled with evidence from leading economic measures that continue to be associated with a very high risk of oncoming recession in the U.S. - despite a modest firming in various lagging and coincident economic indicators, at still-tepid levels. Compound this with unresolved credit strains and an effectively insolvent banking system in Europe, and we face a likely outcome aptly described as a Goat Rodeo.
My concern is that an improbably large number of things will have to go right in order to avoid a major decline in stock market value in the months ahead. We presently estimate that the S&P 500 is likely to achieve a 10-year total return (nominal) of only about 4.7% annually, which reduces the likelihood that further gains will be durable even if they persist for a while longer. In the context of present valuations and a probable Goat Rodeo in the months ahead, my impression is that the recent market advance may be a transitory gift.
Sunday, January 29, 2012
Friday, January 27, 2012
Jan. 27 (Bloomberg) -- Billionaire investor George Soros talks about the European debt crisis. He speaks with Erik Schatzker on Bloomberg Television's "InsideTrack" from the World Economic Forum in Davos, Switzerland.
Found via ValueWalk.
Against the backdrop of fear over European debt and stagnant global growth, the hedge fund, led by one of Wall Street’s more enigmatic titans, Ray Dalio, sidestepped the mess. The fund did it with bets on United States Treasuries, German bonds and the Japanese yen, according to people familiar with the firm’s investment strategy, who spoke on condition of anonymity because the information is private.
Such performance adds up. Over the last 20 years, Bridgewater had annualized returns of 14.7 percent, amounting to $50 billion of gains for investors. Over the same period, the Standard & Poor’s index of 500 stocks returned about 8.7 percent a year.
Jan. 27 (Bloomberg) -- International Monetary Fund Managing Director Christine Lagarde discusses Greece's progress on structural overhauls and the role of the IMF in avoiding a default. She speaks with Maryam Nemazee and John Fraher on Bloomberg Television's "The Pulse" from the World Economic Forum's annual meeting in Davos, Switzerland.
“My financial success stands in stark contrast with my ability to forecast events. In this context, we must distinguish between events in financial markets and events in the real world. Events in financial markets determine financial success; events in the real world are relevant only in evaluating the scientific merit of my approach.
Even in predicting financial markets my record is less than impressive: the best that can be said for it is that my theoretical framework enables me to understand the significance of events as they unfold—although the record is less than spotless. One would expect a successful method to yield firm predictions; but all my forecasts are extremely tentative and subject to constant revision in the light of market developments. Occasionally I develop some conviction and, when I do, the payoff can be substantial; but even then, there is an ever-present danger that the course of events fails to correspond to my expectations. The concept of the “bull market of a lifetime” is a case in point: it was highly rewarding in Phase 1 but it became more of a hindrance than a help in Phase 2. My approach works not by making valid predictions but by allowing me to correct false ones.
With regards to events in the real world, my record is downright dismal. The outstanding feature of my predictions is that I keep on expecting developments that do not materialize. During the real-time experiment I often envisioned a recession that was just around the corner, but it never occurred….” –George Soros, The Alchemy of Finance
Related previous posts (see quotes from Hendry and Taleb in these posts relating to Soros and the quote above):
Thursday, January 26, 2012
Found via The Big Picture.
In November 1997, on a night of pounding rain in midtown Manhattan, Rupert Murdoch threw a party for Jane Friedman, the new chief executive officer of News Corp.’s (NWS) HarperCollins book division. The luminaries of the publishing business, such as Random House’s then-CEO Alberto Vitale and literary agent Lynn Nesbit, crowded into the Monkey Bar on 54th Street, with its red-leather booths and hand-painted murals of gamboling chimps. Trudging six blocks through the downpour from the Time & Life Building, Laurence J. Kirshbaum, then the powerful head of Time Warner Book Group, brought a guest: a young online bookseller named Jeffrey P. Bezos, whose ambitions would eventually end up affecting the lives of everybody at the party. “It was one of those moments in your life where you remember everything,” Kirshbaum says. “In fact, I think Bezos still owes me an umbrella.”
How times have changed. Physical book sales have been flat for a decade and are starting to get eclipsed by e-books. Friedman left News Corp. in 2008. And Jeff Bezos, who once courted the publishing aristocracy of New York, now competes against them. Last May, Amazon (AMZN) hired Kirshbaum, 67, to run Amazon Publishing, a fledgling New York-based imprint whose lofty goal is to publish bestselling books by big-name authors—the bread and butter of New York’s book industry. In the high-rise offices of the big publishers, with their crowded bookshelves and resplendent views, the reaction to Amazon’s move is analogous to the screech of a small woodland creature being pursued by a jungle predator.
Found via Market Folly.
On behalf of our entire team at East Coast, I want to extend to you and your family our sincere wishes for health and prosperity in the new year. Although we would love to start the year reporting that the equity market turbulence is behind us, we are expecting volatility to persist. Continued deleveraging of the global economic system coupled with heightened political inputs will fuel fear of the unknown. Our best absolute performance years have rarely been born out of a cheery consensus, thus this prognosis may not result in anemic returns. While an emotional “all clear” sign remains elusive for investors, we are finding the environment attractive for purchasing equity of competitively entrenched businesses.
We observe a general misclassification between uncertainty and risk. Looking forward, we also anticipate the general perception of “risk” versus” risk-free” assets will change. Central bank intervention to mitigate the effects of the inevitable deleveraging cycle will raise the cost of capital and compromise the value of paper currency. We expect this could be a disappointing realization for those seeking long-term shelter in cash and bonds. We will share some insight on these observations in this year-end letter.
Another story on my Alma Mater and its new football coach, a friend of Warren Buffett according to the article.
The new boss opens the door of his office, where the walls are still bare, and walks into the adjacent conference room. When he sits at the head of the table, his employees get quiet. Then Joe Moglia begins talking about how his new team will sell their new product.
This is a familiar scene for Moglia, the 61-year-old Fortune 500 CEO-turned-football coach: Uniting a team under a big-picture vision while obsessing over details. Details like getting Equal instead of Splenda for the coffee room. Or using a bigger font for the list of recruits. Or that it's of utmost importance to pronounce a recruit's name correctly -- to know Octavius goes by "Tae" -- because that makes a kid feel special.
But at this coaches' meeting just weeks before signing day, it's not Moglia's obsessing over small details that defines him. Instead, it's the inspirational qualities we all want in our football coaches that captures the room.
"'You think you may have an opportunity to play in the NFL?'" Moglia says. "'We very well could help you with that, but that's not what we're about. Because at some point in time, your career comes to an end … The decision you're really making at this point in your life is this: Where am I going to go that's going to give me the best chance to make it as a man, as a leader, as a father, as a husband?'"
The stuff of a head coach -- the delegating, the analyzing problems and making decisions on the fly, the projecting an aura of decisiveness from the head of the room: it's old hat to this man. He rose through Merrill Lynch until he was in charge of all investment products for private clients. He became CEO of Ameritrade Holding Corp., and he increased the company's market capitalization from $700 million to $12 billion.
But the most striking difference on this sunny morning near Myrtle Beach? The surroundings. Right now, outside Moglia's conference room window aren't the high-rises of Manhattan or the TD Ameritrade campus in Omaha but instead the quaint football stadium at Coastal Carolina University, a low-level Division 1 school where Moglia was hired last month.
Prominent hedge fund manager David Einhorn, who is known for seeing problems at Lehman Brothers and publicly shorting the stock prior to the bank's demise, was fined yesterday by the U.K. Financial Services Authority.
Einhorn and his fund Greenlight Capital, which has about $8 billion AUM, were slapped with a $11.2 million penalty by the FSA for trading stock in Punch Taverns PLC on inside information back in 2009.
"I agree this is a serious matter, but not for the same reasons as the FSA. The FSA says this was an act of 'insider dealing.' This resembles insider dealing as much as soccer resembles football," Einhorn said.
Wednesday, January 25, 2012
Jan. 25 (Bloomberg) -- Niall Ferguson, a history professor at Harvard University and a Bloomberg Television contributing editor, talks about Europe's challenges, China's growth and the global economy. He speaks with Tom Keene on Bloomberg Television's "Surveillance Midday."
“Popper introduced the mechanism of conjectures and refutations, which works as follows: you formulate a (bold) conjecture and you start looking for the observation that would prove you wrong. This is the alternative to our search for confirmatory instances. If you think the task is easy, you will be disappointed—few humans have a natural ability to do this. I confess that I am not one of them; it does not come naturally to me.” –Nassim Taleb, The Black Swan
Adam Smith understood the difference between policies that favoured free trade and policies that favoured established business. “The interest of the dealers in any particular branch of trade or manufacturers,” he wrote, “is always in some respects different from, and even opposite to, that of the public.” He went on to observe that any proposals coming from business “ought never to be adopted till after having been long and carefully examined, not only with the most scrupulous, but with the most suspicious attention”. Information and communications technology today is dominated by Microsoft and Intel, Apple, Amazon and Google. The oldest of these, Intel, was founded in 1968; at about that time the British government sponsored a merger of the computer divisions of electrical companies to create a national champion able to compete in world markets. Every big European country put an entrant into the same race. They all fell before the post – and so did IBM.
Content was king, they said: but digital publishing was to be dominated not by Time Warner, EMI or Columbia Pictures, but by Apple and Amazon. Rapid innovation is everywhere associated with market entry. Google occupies the position that only a decade ago people expected would be occupied by Yahoo and AOL, just as Facebook displaced MySpace. What became of Sirius (the Exxon subsidiary that made the first personal computer I ever used) or CompuServe (which provided its communications)?
Joseph Schumpeter applied the term “creative destruction” to the dynamic of the market economy. Not only does the new technology displace the old: the new company displaces the old. Innovation mostly comes from entrepreneurs outside established businesses, engaged in an endless succession of experiments. Most fail, but not all. Bill Gates, Andy Grove, Jeff Bezos and Steve Jobs were talented people, but most of all they were lucky people.
Related book: The Innovator's Dilemma
Related previous post: Clayton Christensen Presentation: Reinventing IT
Jan. 25 (Bloomberg) -- Kenneth Rogoff, an economist at Harvard University, talks about the European debt crisis and the impact of a Greek default on the region. Rogoff, speaking with Erik Schatzker on Bloomberg Television's "InsideTrack," also discusses the mood at the World Economic Forum annual meeting in Davos, Switzerland.
As most readers of this blog probably also follow my friend Miguel at Simoleon Sense, you’ve probably seen that he’s going to be starting a podcast. I can’t wait to be able to watch the quality content he produces. He’s almost halfway to his fundraising goal to be able to purchase the proper equipment to get started. If you have the means, please consider helping to get him all the way there by visiting the bottom of his post HERE.
Throughout my careers in software and philanthropy—and in each of my annual letters—a recurring theme has been that innovation is the key to improving the world. When innovators work on urgent problems and deliver solutions to people in need, the results can be magical.
Right now, just over 1 billion people—about 15 percent of the people in the world—live in extreme poverty. On most days, they worry about whether their family will have enough food to eat. There is irony in this, since most of them live and work on farms. The problem is that their farms, which tend to be just a couple acres in size, don’t produce enough food for a family to live on.
Fifteen percent of the world in extreme poverty actually represents a big improvement. Fifty years ago, about 40 percent of the global population was poor. Then, in the 1960s and 1970s, in what is called the “Green Revolution,” Norman Borlaug and other researchers created new seed varieties for rice, wheat, and maize (corn) that helped many farmers vastly improve their yields. In some places, like East Asia, food intake went up by as much as 50 percent. Globally, the price of wheat dropped by two-thirds. These changes saved countless lives and helped nations develop.
We have the ability to accelerate this historic progress. We can be more innovative about delivering solutions that already exist to the farmers who need them. Knowledge about managing soil and tools like drip irrigation can help poor farmers grow more food today. We can also discover new approaches and create new tools to fundamentally transform farmers’ lives. But we won’t advance if we don’t continue to fund agricultural innovation, and I am very worried about where those funds will come from in the current economic and political climate.
The world faces a clear choice. If we invest relatively modest amounts, many more poor farmers will be able to feed their families. If we don’t, one in seven people will continue living needlessly on the edge of starvation. My annual letter this year is an argument for making the choice to keep on helping extremely poor people build self-sufficiency.
My concern is not only about farming; it applies to all the areas of global development and global health in which we work. Using the latest tools—seeds, vaccines, AIDS drugs, and contraceptives, for example—we have made impressive progress. However, if we don’t make these success stories widely known, we won’t generate the funding commitments needed to maintain progress and save lives. At stake are the future prospects of one billion human beings.
Fight the Fed Model: The Relationship Between Stock Market Yields, Bond Market Yields, and Future Returns - By Cliff Asness (December 2002)
The "Fed Model" has become a very popular yardstick for judging whether the U.S. stock market is fairly valued. The Fed Model compares the stock market's earnings yield (E/P) to the yield on long-term government bonds. In contrast, traditional methods evaluate the stock market purely on its own without regard to the level of interest rates. My goal is to examine the theoretical soundness, and empirical power for forecasting stock returns, of both the "Fed Model" and the "Traditional Model". The logic most often cited in support of the Fed Model is that stocks should yield less and cost more when bond yields are low, as stocks and bonds are competing assets. Unfortunately, this reasoning compares a real number to a nominal number, ignoring the fact that over the long-term companies' nominal earnings should, and generally do, move in tandem with inflation. In other words, while it is a very popular metric, there are serious theoretical flaws in the Fed Model. Empirical results support this conclusion. The crucible for testing a valuation indicator is how well it forecasts long-term returns, and the Fed Model fails this test, while the Traditional Model has strong forecasting power. Long-term expected real stock returns are low when starting P/Es are high and vice versa, regardless of starting nominal interest rates. I also examine the usefulness of the Fed Model for explaining how investors set stock market P/Es. That is, does the market contemporaneously set P/Es higher when interest rates are lower? Note the difference between testing whether the Fed Model makes economic sense, and thus forecasts future long-term returns, versus testing whether it explains how investors set current P/Es. If investors consistently confuse the real and nominal, high P/Es will indeed be contemporaneously explained by low nominal interest rates, but these high P/Es lead to low future returns regardless. I confirm that investors have indeed historically required a higher stock market P/E when nominal interest rates have been lower and vice versa. In addition, I show that this relationship is somewhat more complicated than described by the simple Fed Model, varying systematically with perceptions of long-term stock and bond market risk. This addition of perceived risk to the Fed Model also fully explains the previously puzzling fact that stocks "out yielded" bonds for the first half of the 20th century, but have "under yielded" bonds for the last 40 years. Finally, I note that as of the writing of this paper, the stock market's P/E (based on trend earnings) is still very high versus history. A major underpinning of bullish pundits' defense of this high valuation is the Fed Model I discredit. Sadly, the Fed Model perhaps offers a contemporaneous explanation of why P/Es are high, but no true solace for long-term investors.
Tuesday, January 24, 2012
I was approached by Bloomberg to write an 800-word feature on “The Future of Economics” for the World Economic Forum, which starts today in Davos. I haven’t heard back as to whether they actually ran it in their newsletter, but hopefully the Davos participants had the following item in their breakfast reading this morning.
Related previous post: Steve Keen: Behavioral Finance Lectures
This week we look at a report called “Working Out of Debt,” about debt and deleveraging, from the McKinsey Global Institute. This is a well-done summary of their longer paper, which has been updated, called “Debt and deleveraging: Uneven progress on the path to growth.” I discussed the original paper both in my regular letter and in Endgame. It is one of the best, most definitive pieces on the topic I have read. For those trying to understand how the deleveraging process will affect their particular world, I think it is a must-read. I have been spending more and more time thinking about the whole process of deleveraging, and am coming to think deleveraging is the critical and fundamental factor shaping the economic environment and impacting every decision countries and businesses are faced with. This paper was done by Karen Croxson, Susan Lund, and Charles Roxburgh; and they are to be especially commended for their insight and work.
This summary and the full report look at the relevant lessons from history about how governments can support economic recovery amid deleveraging, and at the signposts business leaders can look for to see where economies are in that process.
Overall, they tell us, the deleveraging process has only just begun: “During the past two and a half years, the ratio of debt to GDP, driven by rising government debt, has actually grown in the aggregate in the world’s ten largest developed economies. Private-sector debt has fallen, however, which is in line with historical experience: overextended households and corporations typically lead the deleveraging process; governments begin to reduce their debts later, once they have supported the economy into recovery.”
Before starting on the subject of debt I wanted to make a quick reference to something sent to me by Charles Horner, a senior fellow at the Hudson Institute. I am glad to say that the overinvestment thesis is much more widely acknowledged today than it was even two or three years ago, but one myth, I think, is that most of the overinvestment excesses in China are concentrated in the real estate sector. I have always argued that it is infrastructure where the most amount of investment has been wasted.
Its impossible to prove one way or the other, but Horner sent me a paper in the Oxford Review of Economic Policy, by Oxford’s Bent Flyvbjerg, with the rather alarming title “Survival of the unfittest: why the worst infrastructure gets built—and what we can do about it”, which suggests why we need to be so worried about infrastructure spending in China – aide from the fact that the numbers are simply huge.
In the paper Flyvbjerg looks at infrastructure projects in a number of countries (not in China, though, because he needed decent data) and shows how the benefits of these projects are systematically overstated and the costs systematically understated. More important, he shows how these terrible results are simply the expected outcomes of the way infrastructure projects are typically designed and implemented.
It is not a very happy paper in general, but I am pretty sure that many people who read it probably had a thought similar to mine: if infrastructure spending can be so seriously mismanaged in relatively transparent systems with greater political accountability, what might happen in a country with a huge infrastructure boom stretching over decades, much less transparency, and very little political accountability? Isn’t the potential for waste vast?
Whenever reading Soros’ market thoughts, it’s good to keep in mind that he maintains the flexibility to change his mind on a dime. And to keep in mind what Hugh Hendry said about him in The Invisible Hands: “Take Soros and the insights he generously provides to the outside world in books such as The Alchemy of Finance, where he keeps a journal of his thoughts during the tumultuous period in the mid-1980s. With the benefit of hindsight, we know that he is often wrong and yet he always makes money. Having years with 100 percent returns while getting some trends wrong means there is an instinctive genius in his trading that I don’t fully comprehend.”
You know George Soros. He’s the investor’s investor—the man who still holds the record for making more money in a single day’s trading than anyone. He pocketed $1 billion betting against the British pound on “Black Wednesday” in 1992, when sterling lost 20 percent of its value in less than 24 hours and crashed out of the European exchange-rate mechanism. No wonder Brits call him, with a mix of awe and annoyance, “the man who broke the Bank of England.”
Soros doesn’t make small bets on anything. Beyond the markets, he has plowed billions of dollars of his own money into promoting political freedom in Eastern Europe and other causes. He bet against the Bush White House, becoming a hate magnet for the right that persists to this day. So, as Soros and the world’s movers once again converge on Davos, Switzerland, for the World Economic Forum this week, what is one of the world’s highest-stakes economic gamblers betting on now?
He’s not. For the first time in his 60-year career, Soros, now 81, admits he is not sure what to do. “It’s very hard to know how you can be right, given the damage that was done during the boom years,” Soros says. He won’t discuss his portfolio, lest anyone think he’s talking things down to make a buck. But people who know him well say he advocates making long-term stock picks with solid companies, avoiding gold—“the ultimate bubble”—and, mainly, holding cash.
Buffett has “either bought companies outright, which allows him to make the changes that he sees necessary, or he focuses on companies that are run really well and buys a large investment stake, and then doesn’t say a word,” says Chad Brand, founder and president of Peridot Capital Management and also a shareholder with Biglari Holdings.
“If Buffett had bought Steak ‘n Shake, you can bet he would have hired an operations guy to run Steak ‘n Shake, and Buffett would have stayed in his office and looked for ways to invest the profits from Steak ‘n Shake,” Brand says. “Biglari hasn’t done that.”
Biglari has instead jumped into the everyday operations of Steak ‘n Shake, a company that was founded in 1934 by Gus Belt as a place for customers to get a premium hamburger and hand-dipped milkshake.
First, there was the 20-for-1 reverse stock split in December 2009 that sent the price of shares from about $13 to about $260, and the attempted 15-for-1 split that could have shot the price to nearly $7,000 (shareholders vetoed the latter).
“We will continue to strive to avidly excite the attention of blue-chip shareholders who are unfazed by near-term fluctuations in our stock or by the vagaries of the stock market,” he said in his 2010 letter. “Rather, such investors are placing their confidence in us and, like us, judge performance on the basis of long-term value creation.”
Brand, who wrote a letter to Biglari crying foul over the second reverse stock split, says the first one was a sensible move for a company trying to establish long-term success. “He’s trying to build this company up for the next 30 years, not necessarily for the next 30 days,” Brand says.
The next move that baffled some investors was a name change; in April 2010, Biglari changed the name of Steak ‘n Shake corporate to Biglari Holdings and consolidated his other brands within the company.
The final move that was quite unlike Buffett was the compensation package he proposed for himself. Although his salary was already $900,000, he proposed a deal that would pay him 25 percent of the increase in Biglari Holdings’ adjusted book value, exceeding a 6 percent hurdle rate; in other words, potentially millions of dollars a year.
I think there's an investing checklist item to be developed from this article, specifically related to this: "So yes: taking a break is important. But make sure you do something that makes you happy, as positive moods make us even better at diagnosing the value of our creative work. After a few relaxing days of vacation, you’ll suddenly know which new ideas deserve more time and which need to be abandoned."
I’ve always been fascinated by the failures of genius. Consider Bob Dylan. How did the same songwriter who produced Blood on the Tracks and Blonde on Blonde also conclude that Down in the Groove was worthy of release? Or what about Steve Jobs: what did he possibly see in the hockey puck mouse? How could Bono not realize that Spiderman was a disaster? And why have so many of my favorite novelists produced so many middling works?
The inconsistency of genius is a consistent theme of creativity: Even those blessed with ridiculous talent still produce works of startling mediocrity. (The Beatles are the exception that proves the rule, although their subsequent solo careers prove that even Lennon and McCartney were fallible artists.) The larger point is that mere imagination is not enough, for even those with prodigious gifts must still be able to sort their best from their worst, sifting through the clutter to find what’s actually worthwhile.
“Artists have a vested interest in our believing in the flash of revelation, the so-called inspiration…shining down from heavens as a ray of grace. In reality, the imagination of the good artist or thinker produces continuously good, mediocre or bad things, but his judgment, trained and sharpened to a fine point, rejects, selects, connects…All great artists and thinkers are great workers, indefatigable not only in inventing, but also in rejecting, sifting, transforming, ordering.”
Did your interview in Boomerang of Kyle Bass, the founder of Hayman Capital Management in Dallas and one of the first investors to develop a bearish view on European sovereign debt, come from the cutting-room floor of your work on The Big Short?
Kind of. I went back to him. So a lot of the interview in Boomerang came after I finished The Big Short, but he was, in fact, on the cutting-room floor of The Big Short. I talked to him about the subprime trade mainly, not the European debt trade.
It's funny you ask that, because the world would benefit from Kyle Bass getting up on a podium and presenting the research that he did at his firm, showing the inevitability of sovereign default. They were trying to see if there was a quantitative tipping point with sovereigns. Bass looked at sovereign debt differently than the markets, because he was counting not just the sovereign debt itself, but also debt in the banking sector that he thought the government would be responsible for.
But when you look at, for example, France, you can't ignore the government assuming bank debts. If Credit Agricole or BNP goes down, the liabilities of those banks will become a French government liability.
What I didn't do in the introduction to Boomerang, because I didn't want to lose the general reader, is to report on a conversation with Bass in which he walked me through the numbers, and he explained the argument.
Bass’ firm, Hayman Capital – and there must be other firms with this position – is holding long-dated put options on this sovereign debt, so they can afford to wait, but they are still trying to figure out when default happens. Bass thought the endgame would be the end of last year or the beginning of this year, and he may be right; he was talking about Greece. But his argument applies to other countries, and I didn't have the time or energy to lay out his argument in great detail. I was interested in conveying his general argument to the reader, because it was so breathtaking.
Monday, January 23, 2012
Jan. 23 (Bloomberg) -- Billionaire Warren Buffett, chairman and chief executive officer of Berkshire Hathaway Inc., and U.S. Representative Scott Rigell, a Virginia Republican, talk about the U.S. budget deficit, tax policy and the Republican presidential race. They speak with Betty Liu on Bloomberg Television's "In Business With Margaret Brennan.
Not long ago, Apple boasted that its products were made in America. Today, few are. Almost all of the 70 million iPhones, 30 million iPads and 59 million other products Apple sold last year were manufactured overseas.
The president’s question touched upon a central conviction at Apple. It isn’t just that workers are cheaper abroad. Rather, Apple’s executives believe the vast scale of overseas factories as well as the flexibility, diligence and industrial skills of foreign workers have so outpaced their American counterparts that “Made in the U.S.A.” is no longer a viable option for most Apple products.
The paper is straightforward in its description of the hunting observations: They hunt slow lorises, the practice is rare, it occurs at times when their other preferred foods are scarce, some individuals hunt but most don't, and food sharing among individuals other than mother-infant pairs wasn't observed. This isn't the first time hunting has been reported by wild orangutans, what it does is report a longer-term observation of one hunting female, tying this case to earlier observations.
“I confess, I think about the future. So do my colleagues. If someone who’s spent decades investing doesn’t have an opinion about what lies ahead, there’s something wrong. I believe our clients want us to apply the benefit of our experience in gauging and reacting to the opportunities and risks that lie ahead.But I have a mantra on this subject, too: “It’s one thing to have an opinion; it’s something very different to assume it’s right and act on that assumption.” We have views on the future. And they can cause us to “lean” toward offense or defense. Just never so much that for the results to be good, our views have to be right.”
Leading economic evidence continues to teeter at levels that have always and only been breached in recessions, but the sharp deterioration we initially observed late last year has been followed by modest stabilization - though still near the area that has historically marked the entry to economic contraction. The uncertain outcome and the incomplete view evoke a line from Leon Russell - "I'm up on a tightwire, one side's ice and one is fire... but the top hat on my head is all you see."
We can respond to the easing of downward momentum in several ways. We could pound the table about recession risk, based on the fact that previous breakdowns of the same magnitude in leading indicators have always resulted in recessions. Alternatively, we could emphasize the more favorable recent data and abandon our concern about recession, particularly because of the significant decline in new unemployment claims (though there is a great deal of seasonal impact here, and new claims also tend to be lagging indicators by about 3-6 months - see Leading Indicators and the Risk of a Blindside Recession ). The problem with both of these responses is that, in our view, each would overstate the case, and grasp at interpretations that are not supported by the data.
The interpretation best supported by the data is that recession risk remains very high based on the leading evidence and the typical outcomes that have resulted, but that the rate of deterioration has eased significantly, and it is simply unclear whether this is a temporary pause or a reversal. Rather than overstating the case one way or another, we remain strongly concerned about recession risk, but recognize the recent stabilization and the potential for a low-level continuation of that. On the indicator front, the economic data over the coming week could be informative (especially the introduction of the Conference Board's revised LEI, the Chicago Fed National Activity Index, and unemployment claims), but if the new data also muddles around near the flat-line, it will essentially reinforce the overall view that the global economy is close to slipping into recession, but is at least temporarily stabilizing.
It is shortsighted to view the actions of the Fed and the ECB as costless, because the difficult question comes later - whether they will be able to reverse their actions and shrink their balance sheets without major economic disruption. This will require the financial assets they presently hold (sovereign debt and mortgage securities) to be willingly absorbed back by the private sector. From my perspective, central banks are playing a dangerous economic experiment, that has its main constituency - the banking sector - as the primary beneficiary. Of course, if the Fed and the ECB are unable to reverse these transactions, or if any of the assets they hold lose value for any reason (sovereign default, counterparty failure, etc.) they will ultimately have printed enormous volumes of currency, not for public benefit, but to reduce the losses experienced by the bondholders of financial institutions.
Europe's leaders are committed to keeping both the euro and the eurozone as it is. But for it to do so, everything must change, as the wonderful quote from the 1958 Italian novel suggests. This is no easy task, as no one wants a change that will impact them negatively; and there is no change that will allow things to stay the same that does not impact all severely, as we will see. In the third part of a continuing series, we look at the actual options that are available on the menu of choices, or as one group called it, the menu of pain. I offer some guideposts that we should watch for along the way, and end by offering a suggestion as to what Europe should do. As has been the case in this series, I do my best to offend everyone at some point. If by some small, unintended oversight I do not, then wait another week, I will get to you. What else are friends for?
Sunday, January 22, 2012
Friday, January 20, 2012
“For, after all, the foundation of our whole nature, and, therefore, of our happiness, is our physique, and the most essential factor in happiness is health, and, next in importance after health, the ability to maintain ourselves in independence and freedom from care.” -Arthur Schopenhauer
"Without health there is no happiness. An attention to health, then, should take the place of every other object." -Thomas Jefferson
My favorite health-related books:
Tesco shares declined 16 percent on Jan. 12, the most since at least 1988, after the company reported Christmas sales that missed estimates and reined back profit expectations. Buffett told CNBC in November he’d buy more shares if the price fell.
Thursday, January 19, 2012
Related previous posts:
Related book: Applied Value Investing