Monday, April 27, 2009

Hussman Weekly Market Comment

Now, assuming that the government is able to persist in misusing public funds and abusing public trust in order to protect the bondholders of these institutions from losses, it's reasonable to ask: Could the banks eventually “earn their way out” of their losses over the longer-term?

To answer that question, you have to think in terms of equilibrium. Even holding GDP constant, the earnings to recover the losses have to come from somewhere, which implies a redistribution away from where they were going before. Really, money doesn't grow on trees. We've got an economy running with outstanding debt of about 350% of GDP. Even a moderate percentage of that as loan losses will represent a significant share of GDP. To reallocate enough funds to fill that hole, we would have to keep deposit rates near zero, and corporate lending rates high, so that financial institutions would earn a persistently wide spread, or “net interest margin.” Over the short-term, that's what's been happening, so ironically, banks are more “profitable” today than they probably will ever be. Unfortunately, that “profitability” is an artifact of a) unsustainably wide net interest margins, and b) a failure to adequately book losses, at the encouragement of government bureaucrats.

Consider the economic landscape. The U.S. government is running huge deficits, selling debt to foreigners in order to make the bondholders of mismanaged financial institutions whole. This will put a claim on our future national output and allow foreign owners to scoop up U.S. businesses in the years ahead. We are also running a large current account deficit (though somewhat smaller than in recent years thanks to a collapse in U.S. gross domestic investment).

In order for U.S. financial institutions to earn their way out of the losses, they will have to accrue and retain an amount on the order of 25% to 35% of GDP. From where will they reallocate that amount? Well, prior to the recent earnings downturn, corporate profits were running at about 8% of GDP, a figure that was already based on unusually high profit margins (the sustainable norm is less than 6%). The personal savings rate was about zero, but has increased to about 4% as consumers have scaled back consumption. If banks were able to sustainably charge high interest rates on loans and pay low interest rates on deposits, the earnings of the banks would come at a cost to what would otherwise have been retained: corporate earnings and private savings. Essentially, savers will earn less, and corporate borrowers will pay more. To accrue 25-35% of GDP to cover the debt losses (which is a mainstream estimate, not a worst-case by any means), you would have to persistently depress non-financial corporate profits and personal savings by about 25% for well over a decade.

Friday, April 24, 2009

Fortune: How Bernie did it

There were other mysteries, as we shall see. But even after it detonated five months ago in a fireworks display of betrayal and recrimination, Madoff's scheme -- possibly the biggest investment fraud in the nation's history -- has remained among the hardest to penetrate. Most commonly, white-collar cases begin with a quiet, behind-the-scenes investigation, followed by a series of deals with junior employees, who are squeezed by prosecutors to cough up details about their superiors. Step by step, the prosecutors move up. Finally comes the denouement: the ringmaster hauled into court in handcuffs.

But with Madoff every aspect of that traditional narrative has been inverted. The case began with his flabbergasting confession, which set off the investigation. Madoff claimed he committed his crimes all by himself, but because they spanned decades and continents, a fog of suspicion immediately engulfed Madoff family members who worked at the firm, as well as employees and business associates.

Now that fog may be about to lift. Fortune has learned that Frank DiPascali is trying to negotiate a plea deal with federal prosecutors in which, in exchange for a reduced sentence, he would divulge his encyclopedic knowledge of Madoff's scheme. And unlike his boss, DiPascali is willing to name names.


Related previous post: Influence in the Madoff Case

Related link: Dan Ariely offers 3 irrational lessons from the Bernie Madoff scandal

Wednesday, April 22, 2009

The Marketing Alliance – A Micro Cap with a Network Effect Advantage

Below is an article written by my colleague, Matt Miller, and I about a small company that we think is a good business trading at a significant discount to its intrinsic value.

The Marketing Alliance – A Micro Cap with a Network Effect Advantage

By Joe Koster and Matt Miller

Companies that benefit from the network effect can be a powerful source of investment return when purchased at the right price, especially if one can discover them when they are still relatively small. Businesses like eBay, American Express and Microsoft have grown from something very small to something very large thanks to the compounding effects of their networks.

The basic premise behind a network effect is that the value of the network increases as more users are added. If you’re a seller on eBay, each new person added to the network is another potential buyer of your merchandise or a seller of other merchandise that could bring in other buyers to the network. So the network continues to grow and become more valuable with each and every person/user added to it.

The concept of network effects may sound pretty simple, but it can be very difficult to find companies that benefit from such an advantage and those that are well known (like those companies mentioned above) are often either too desired to buy at a good price or too big to get the full benefit as the network scales. However, there are some companies in the micro-cap world that, although they aren’t in an industry or network capable of getting anywhere near the size of the well known large cap names, benefit from the network effect and derive some level of competitive advantage from that effect. We believe The Marketing Alliance (Ticker:
MAAL.PK) is one of those companies.

The Marketing Alliance, Inc. (TMA), which is fully reporting and traded on the pink sheets, is an aggregator for a network of small, individually owned and operated insurance agents. The agents that the company serves typically offer a variety of products, but TMA specifically focuses on their life and long-term care insurance and annuity businesses. TMA provides marketing support and back-office support that is crucial to the underwriting process. The back-office support includes technology and application processing. TMA also works with and negotiates directly with insurance carriers on behalf of the agents it represents.

Below are the three key features that are attractive to us about the business model:

§ High returns on capital employed
§ Significant benefits from the effects of a network
§ Moderate competitive advantage

TMA manages a network of small agents. At its essence, that is the business—the network. Because there is a limited fixed investment to maintain the network, the company delivers high returns on capital. The bargaining power created by the pooled production of a large network enables TMA to negotiate directly with insurance carriers for better terms than any individual agent could achieve on its own. And, as each agent is added to the network and as each agent grows its business, TMA improves its bargaining position. Though some of the benefits of this increased leverage returns to the agent, TMA also benefits. The company’s advantage comes from this network of small agents. It has successfully built up a captive agency base, something that would take years to develop and scale to achieve. From an agent’s perspective, it is usually not attractive to leave one network for a smaller network. Additionally, because of the demands of automation pushed by the insurance carriers, TMA has integrated their technology, systems and processing with that of the insurance carriers and its agents. Agents prefer not to, and often cannot, make the investments necessary to accomplish this in a cost-effective manner. The scale of the network allows TMA to do it for them.

We believe the attractiveness of TMA’s business is matched by the attractiveness of the valuation at which we have acquired our shares and at which it is currently valued by the market. At $4.00 per share, where the current ask is, here are some statistics relating to the company’s valuation:

Price $4.00
Shares Outstanding 1,945,702
Market Cap $7,782,808
No Debt Outstanding
Excess Capital (estimated) $3,700,000
Net Capitalization $4,082,808
LTM Operating Earnings $2,178,151

Net Capitalization / Operating Earnings 1.87

We believe that the company is worth between $9.00 and $13.00 per share depending on assumptions for future growth. So with little growth the company is worth more than twice its current price.

An astute observer will notice that special attention is required regarding management’s stewardship of the excess cash that the company is generating. TMA is generating so much cash in excess of the company’s needs to grow the business that the problem becomes what to do with that cash. TMA does pay a significant dividend, resulting in a 5.75% yield on the quarter-end price. Unfortunately, the company entered mid-2007 with a substantial portion of its excess capital in the equity markets. As you might expect, the performance of that capital over the last 18 months has not been great. In fact, the company has shown large losses on its investment portfolio, including a loss of approximately $1.8 million on a marked-to-market basis since October 2007. Though the company continues to allocate some capital to equities, its exposure has now declined. We have encouraged the company to store excess capital in a more prudent manner or return more capital to shareholders via dividends and buybacks. Given how well the company’s management team, including CEO Tim Klusas, has positioned the company there is little need for such equity exposure on the company’s balance sheet.

As a note, the company’s stock is fairly illiquid, and so a word of caution is in order. Despite the illiquid nature of the stock, we believe an investor ought to be excited to own a good, small business with attractive prospects for growth at an attractive price. The company’s dividend yield and the fact that it benefits from a network add significantly to the thesis. We believe the recent poor performance of the company’s investments will abate and in time the market will recognize the true intrinsic value of the company.

*This is not a recommendation to buy or sell a security. Please do your own research before making an investment decision. The authors of this article both have an indirect interest in the stock of The Marketing Alliance (MAAL.PK).

Malcolm Gladwell at the 92nd Street Y

Book: Outliers: The Story of Success (also available in an Audio Book)

Related previous posts:

Tuesday, April 21, 2009

WSJ: How the E-Book Will Change the Way We Read and Write

Every genuinely revolutionary technology implants some kind of "aha" moment in your memory -- the moment where you flip a switch and something magical happens, something that tells you in an instant that the rules have changed forever.

I still have vivid memories of many such moments: clicking on my first Web hyperlink in 1994 and instantly transporting to a page hosted on a server in Australia; using Google Earth to zoom in from space directly to the satellite image of my house; watching my 14-month-old master the page-flipping gesture on the iPhone's touch interface.

The latest such moment came courtesy of the Kindle, Inc.'s e-book reader.


 Kindle 2

Hussman Weekly Market Comment

In short, we should be careful to make distinctions between what constitutes improvement, and what only constitutes a backing off from extreme risk aversion. Put bluntly, the economy is not improving, and it is not likely to improve within a few months, because we have far more defaults, foreclosures, and credit excesses to work through. It is simply not true that the stock market heads higher 6 months before the economy bottoms. That simplification was true of 1970 and 1975, but not much else. Rather, there is enormous variation, and about the only reliable tendency is that stocks are usually advancing strongly within about 3 months of a recession's end. That said, in the 2000-2002 plunge, the market didn't bottom until about a year after the recovery started.

It is wishful thinking to believe that the stock market is forecasting the economy here just because we've observed a sharp advance off of an oversold trough. Yes, the stock market will probably bottom before the economy does, but lacking any credible approach to foreclosure abatement, the economic pain could easily extend well into 2010. We are likely to see a very wide and extended trading range, more deep selloffs, more short squeezes, and eventually disillusionment and revulsion from investors.

Monday, April 20, 2009

Warren Buffett on Wells Fargo

Fortune: How is Wells Fargo unique?

Warren Buffett: It's sort of hard to imagine a business that large being unique. You'd think they'd need to be like any other bank by the time they got to that size. Those guys have gone their own way. That doesn't mean that everything they've done has been right. But they've never felt compelled to do anything because other banks were doing it, and that's how banks get in trouble, when they say, "Everybody else is doing it, why shouldn't I?"

What about all the smart analysts who think no big bank can survive in its present form, including Wells Fargo?

Almost 20 years ago they were saying the same thing. In the end banking is a very good business unless you do dumb things. You get your money extraordinarily cheap and you don't have to do dumb things. But periodically banks do it, and they do it as a flock, like international loans in the 80s. You don't have to be a rocket scientist when your raw material cost is less than 1-1/2%. So I know that you can have a model that works fine and Wells has come closer to doing that right than any other big bank by some margin. They get their money cheaper than anybody else. We're the low-cost producer at Geico in auto insurance among big companies. And when you're the low-cost producer - whether it's copper, or in banking - it's huge.

Then on top of that, they're smart on the asset size. They stayed out of most of the big trouble areas. Now, even if you're getting 20% down payments on houses, if the other guy did enough dumb things, the house prices can fall to where you get hurt some. But they were not out there doing option ARMs and all these crazy things. They're going to have plenty of credit losses. But they will have, after a couple of quarters of getting Wachovia the way want it, $40 billion of pre-provision income.

And they do not have all kinds of time bombs around. Wells will lose some money. There's no question about that. And they'll lose more than the normal amount of money. Now, if they were getting their money at a percentage point higher, that would be $10 billion of difference there. But they've got the secret to both growth, low-cost deposits and a lot of ancillary income coming in from their customer base.

Insurance revenues for example, which had double-digit revenue growth in 2008.

And I would say that most of the critics of Wells don't even know they've got that business. That business alone is worth many billions of dollars. And their mortgage business, as you can imagine in this period, I mean, the volume that is poring through there, is huge. The critics have been right on other big banks, so I think they're inclined to sweep Wells in as well to some extent. And if you've been right on Citi and you've been right on BofA, it gets easy to say, well, they're all going to go.

We own stock in four banks: USB, Wells, M&T, and SunTrust. SunTrust I don't know about because South Florida is going to be the last to come back, and they've got a concentration down there. The other three, they're going to have a lousy year, but they'll come out of it with far more earnings power. The deposits are flowing in. The spreads are wide. It's a helluva good business.

Dick Kovacevich specifically told me to ask you your views on tangible common equity.

What I pay attention to is earning power. Coca-Cola has no tangible common equity. But they've got huge earning power. And Wells ... you can't take away Wells' customer base. It grows quarter by quarter. And what you make money off of is customers. And you make money on customers by having a helluva spread on assets and not doing anything really dumb. And that's what they do.

Incidentally, they won't lend Berkshire money. They're not interested in national credits or any of that stuff where the spreads are narrow. We did a big deal about six or seven years ago on Finova, which we did jointly with Leucadia. And what was then the old First National of Boston sort of headed the deal up, and people would come in for $500 million or $200 million. Wells wasn't interested. There wasn't enough money in it, basically. I got a big kick out of that because that was exactly how they should think. Everybody else wanted to be in it, and they were doing it for 20 basis points or something of the sort. And they'd make commitments for all kinds of credit for 6 or 8 basis points, and the ones that were in the underwriting business, they would do it just get the underwriting.

But back to tangible common equity...

You don't make money on tangible common equity. You make money on the funds that people give you and the difference between the cost of those funds and what you lend them out on. And that's where people get all mixed up incidentally on things like the TARP. They say, 'Well, where'd the 5 billion go or where'd the 10 billion go that was put in?' That isn't what you make money on. You make money on that deposit base of $800 billion that they've got now. And that deposit base I guarantee you will cost Wells a lot less than it cost Wachovia. And they'll put out the money differently.

They'll have to work through a lot of this stuff that they inherited from Wachovia. Those option ARMs, they explained exactly how they break them down, and in the end they may lose 3 or 4 billion more. Nobody knows exactly. But I would say that California residential real estate is not deteriorating. It hasn't moved up. But it has flattened out with good volume recently. So my guess is that the option ARMs will work out about as they guessed.

What if the Treasury imposes new capital requirements? Will it hamper their earnings power?

I don't think it'll hamper their earnings. But if you make them sell a lot of common equity it would kill the common shareholder. It wouldn't increase the earning power in the future, and it would increase the shares outstanding. Wells, if they want another $10 billion in common equity or something like that in Wells, they'll have it in a very short period of time at this dividend rate. [In March, Wells cut its dividend by 85%.] Wells will be piling up the equity while they're paying nominal dividends. They could afford to pay the old dividend. But since they won't be paying the old dividend, that's $4 billion a year or something that they'll be adding to equity.

I would have been fine if they had just said, 'Look it, we'll quit paying any common dividend until our equity has gone up by whatever it might be, 10 or 15 billion.' And they'd get there in no time. Then they could pay the regular dividend. They elected to do it this other way because everybody seems to be kind of doing it. The idea of forgoing all or most of the dividend for a year to build the common equity ratio up, if that's what the government wants, that's fine. But that isn't really the key to the future of Wells, unless the regulators make it the key to the future of Wells. The key to the future of Wells is continuing to get the money in at very low costs, selling all kinds of services to their customer and having spreads like nobody else has.

How is Wells differentiated from the banks you own and the ones you don't?

Wells just has a whole different attitude. That's why Kovacevich calls them retail stores. He doesn't even like the word banking. I mean, he is looking to have a maximum enduring relationship with many, many millions of people. Tens of millions. And at the base of it involves getting money in very cheap. When you do that that's a helluva start in the business. The difference between getting your money at 1-1/2 % and 2-1/2% on a trillion-dollar asset base is $10 billion a year. It's hard to overemphasize that. He thinks more like Sam Walton than he thinks like J.P. Morgan. I'm talking about the individual there. He's a retailer. He's not trying to influence Washington or be the most important guy on the scene or anything like that. He's just trying to do business with millions of people every day and make a few bucks off of them.

Now that you mention it, Kovacevich has done a pretty good job of annoying Washington, wouldn't you say?

That's hard to tell. There's an advantage to being that way too. He's not going to cozy up or be sycophantic toward his regulator, and I would say most bankers probably are now. They need to be. But his strong point is retailing not diplomacy. I kind of like that. It's hard for a guy that knows his institution forward and backwards to have somebody come in that really may be working off a check list or something and is telling him what to do. And I'm sure that Dick gets antagonized by that sometimes. In the end, he's got the record. And he's got the business to back up what he's doing.

To the extent that his tangible common equity is low, a) nobody was even talking about that a year ago. And b) they should be talking about earning power. But it comes about in part because he saved the FDIC's bacon on Wachovia. I mean they had a deal on Citigroup (C, Fortune 500) that had big assistance involved in it, and the FDIC moved about what would have been about 5% of the deposits in the United States without a dime of expense to the taxpayer or the FDIC to Wells. And Wells took it over. And if they'd gone to Citigroup a) they would have looked like idiots, and within a very short period considering what happened to Citi. So to penalize them because they solved the FDIC's problem without cost to the FDIC would be a little crazy. And I imagine that's what gets Dick a little riled up.

So what is your metric for valuing a bank?

It's earnings on assets, as long as they're being achieved in a conservative way. But you can't say earnings on assets, because you'll get some guy who's taking all kinds of risks and will look terrific for a while. And you can have off-balance sheet stuff that contributes to earnings but doesn't show up in the assets denominator. So it has to be an intelligent view of the quality of the earnings on assets as well as the quantity of the earnings on assets. But if you're doing it in a sound way, that's what I look at.

How confident will you be in Wells when Kovacevich retires?

Well, John [Stumpf] is in charge. Dick is a terrific help to John. I play bridge with John on the Internet. He plays under the name of HTUR. His wife's name is Ruth. My bridge partner, who I probably play bridge with four times a week, developed online banking for Wells. A woman named Sharon Osberg. And she's worked with those people. And she told me about John Stumpf ten years ago. I've had some insight through her on these people. But the real insight you get about a banker is how they bank. You've got to see what they do and what they don't do. Their speeches don't make any difference. It's what they do and what they don't do. And what Wells didn't do is what defines their greatness.

Oak Value Fund: Investment Adviser’s Review – First Quarter 2009

Recent Purchases

Becton, Dickinson & Co. – Becton, Dickinson is a global medical technology company that is focused on improving drug delivery, enhancing the diagnosis of infectious diseases and cancers and advancing drug discovery. The company develops, manufactures and sells medical supplies, devices, laboratory instruments, antibodies, reagents and diagnostic products through its three operating segments: Medical, Diagnostics and Biosciences. In our view, Becton, Dickinson is a consumables business in the healthcare value chain. The predictability of the business is enhanced by the company’s market leading positions with a limited number of competitors in each of its three business units. Becton, Dickinson generated more than $7 billion in revenue in 2008 and has more than doubled its cash flow from operations over the last six years. In our view, Becton, Dickinson is conservatively positioned and well prepared to weather a global economic slowdown with its strong balance sheet, healthy cash flow and solid credit ratings. Company management has continued to reiterate its commitment to growing the business organically through its Diagnostics and Biosciences segments, while maintaining steady growth at the Medical segment.

Robert Shiller on WealthTrack

Robert Shiller was a guest on last week's Consuelo Mack WealthTrack: Video - 4/17/09


Related books:

Friday, April 17, 2009

Jeff Bezos' Letter to Shareholders

In this turbulent global economy, our fundamental approach remains the same. Stay heads down, focused on the long term and obsessed over customers. Long-term thinking levers our existing abilities and lets us do new things we couldn’t otherwise contemplate. It supports the failure and iteration required for invention, and it frees us to pioneer in unexplored spaces. Seek instant gratification – or the elusive promise of it – and chances are you’ll find a crowd there ahead of you. Long-term orientation interacts well with customer obsession. If we can identify a customer need and if we can further develop conviction that that need is meaningful and durable, our approach permits us to work patiently for multiple years to deliver a solution. “Working backwards” from customer needs can be contrasted with a “skills-forward” approach where existing skills and competencies are used to drive business opportunities. The skills-forward approach says, “We are really good at X. What else can we do with X?” That’s a useful and rewarding business approach. However, if used exclusively, the company employing it will never be driven to develop fresh skills. Eventually the existing skills will become outmoded. Working backwards from customer needs often demands that we acquire new competencies and exercise new muscles, never mind how uncomfortable and awkward feeling those first steps might be.

Kindle is a good example of our fundamental approach. More than four years ago, we began with a long-term vision: every book, ever printed, in any language, all available in less than 60 seconds. The customer experience we envisioned didn’t allow for any hard lines of demarcation between Kindle the device and Kindle the service – the two had to blend together seamlessly. Amazon had never designed or built a hardware device, but rather than change the vision to accommodate our then-existing skills, we hired a number of talented (and missionary!) hardware engineers and got started learning a new institutional skill, one that we needed to better serve readers in the future.


 Kindle 2

Jamie Dimon's Letter to Shareholders

After Lehman’s collapse, the global financial system went into cardiac arrest. There is much debate over whether Lehman’s crash caused it – but looking back, I believe the cumulative trauma of all the aforementioned events and some large flaws in the financial system are what caused the meltdown. If it hadn’t been Lehman, something else would have been the straw that broke the camel’s back.

The causes of the financial crisis will be written about, analyzed and subject to historical revisions for decades. Any view that I express at this moment will likely be proved incomplete or possibly incorrect over time. However, I still feel compelled to attempt to do so because regulation will be written soon, in the next year or so, that will have an enormous impact on our country and our company. If we are to deal properly with this crisis moving forward, we must be brutally honest and have a full understanding of what caused it in the first place. The strength of the United States lies not in its ability to avoid problems but in our ability to face problems, to reform and to change. So it is in that spirit that I share my views.

Jim Grant on CNBC

Wednesday, April 15, 2009

Warren Buffett takes charge

(Fortune Magazine) -- Warren Buffett is famous for his rules of investing: When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is usually the reputation of the business that remains intact. You should invest in a business that even a fool can run, because someday a fool will. And perhaps most famously, Never invest in a business you cannot understand.

So when Buffett's friend and longtime partner in Berkshire Hathaway (BRKB), Charlie Munger, suggested early last year that they invest in BYD, an obscure Chinese battery, mobile phone, and electric car company, one might have predicted Buffett would cite rule No. 3 above. He is, after all, a man who shunned the booming U.S. tech industry during the 1990s.

But Buffett, who is 78, was intrigued by Munger's description of the entrepreneur behind BYD, a man named Wang Chuan-Fu, whom he had met through a mutual friend. "This guy," Munger tells Fortune, "is a combination of Thomas Edison and Jack Welch - something like Edison in solving technical problems, and something like Welch in getting done what he needs to do. I have never seen anything like it."

Coming from Munger, that meant a lot. Munger, the 85-year-old vice chairman of Berkshire Hathaway, is a curmudgeon who frowns on most investment ideas. "When I call Charlie with an idea," Buffett tells me, "and he says, 'That is really a dumb idea,' that means we should put 100% of our net worth into it. If he says, 'That is the dumbest thing I've ever heard,' then you should put 50% of your net worth into it. Only if he says, 'I'm going to have you committed,' does it mean he really doesn't like the idea."

This time Buffett asked another trusted partner, David Sokol, chairman of a Berkshire-owned utility company called MidAmerican Energy, to travel to China and take a closer look at BYD.

Last fall Berkshire Hathaway bought 10% of BYD for $230 million. The deal, which is awaiting final approval from the Chinese government, didn't get much notice at the time. It was announced in late September, as the global financial markets teetered on the abyss. But Buffett and Munger and Sokol think it is a very big deal indeed. They think BYD has a shot at becoming the world's largest automaker, primarily by selling electric cars, as well as a leader in the fast-growing solar power industry.

Friday, April 10, 2009

How Obama Is Using the Science of Change

Great find from Simoleon Sense (where I find a lot of the things I post).

Two weeks before Election Day, Barack Obama's campaign was mobilizing millions of supporters; it was a bit late to start rewriting get-out-the-vote (GOTV) scripts. "BUT, BUT, BUT," deputy field director Mike Moffo wrote to Obama's GOTV operatives nationwide, "What if I told you a world-famous team of genius scientists, psychologists and economists wrote down the best techniques for GOTV scripting?!?! Would you be interested in at least taking a look? Of course you would!!"

Moffo then passed along guidelines and a sample script from the Consortium of Behavioral Scientists, a secret advisory group of 29 of the nation's leading behaviorists. The key guideline was a simple message: "A Record Turnout Is Expected." That's because studies by psychologist Robert Cialdini and other group members had found that the most powerful motivator for hotel guests to reuse towels, national-park visitors to stay on marked trails and citizens to vote is the suggestion that everyone is doing it. "People want to do what they think others will do," says Cialdini, author of the best seller Influence. "The Obama campaign really got that."

The existence of this behavioral dream team — which also included best-selling authors Dan Ariely of MIT (Predictably Irrational) and Richard Thaler and Cass Sunstein of the University of Chicago (Nudge) as well as Nobel laureate Daniel Kahneman of Princeton — has never been publicly disclosed, even though its members gave Obama white papers on messaging, fundraising and rumor control as well as voter mobilization. All their proposals — among them the famous online fundraising lotteries that gave small donors a chance to win face time with Obama — came with footnotes to peer-reviewed academic research. "It was amazing to have these bullet points telling us what to do and the science behind it," Moffo tells TIME. "These guys really know what makes people tick."

President Obama is still relying on behavioral science. But now his Administration is using it to try to transform the country. Because when you know what makes people tick, it's a lot easier to help them change.


Related books:



Predictably Irrational


Animal Spirits


The Wisdom of Crowds

The Crowd

How We Decide

The Logic of Life


Related previous posts:

TED Talk - Dan Ariely: Why we think it's OK to cheat and steal (sometimes)

The Behavioral Revolution - by David Brooks

Adam Smith, Behavioral Economist

Thursday, April 9, 2009

John Hussman's March 30, 2009 Weekly Market Comment

I'm a little late getting to this, but I think it is worth the read if you haven't gotten to it either:

Apollo Asia Fund: the manager's report for 1Q2009

March saw a fast and furious rally in Asian & global indices: the rise in our shares has been much more subdued. Globally, I see this as a rally in an ongoing bear market, with the economic crisis having many further stages to run. Asian equities seem attractive, for the long run. I would not be surprised to see the bear regain global dominance and take Asian shares with it, but have never claimed any ability in market timing, and am comfortable having the fund almost fully invested. The accompanying 2-year chart of the Asia-ex-Japan index puts the rally in context (calls of 'a new bull market' may be over-excited), and shows that the regional markets overall marked time during the four months of most appalling news flow, rather than hitting new lows like the US, UK, Europe and Japan. Although the region's export dependence has made it highly vulnerable in the short term, with double digit falls in GDP forecast for some countries and regions, its relative structural flexibility and fiscal / banking strength should make it a safer long-term haven.

Politics is the most obvious wildcard which could upset this prediction. Much of Asia currently looks politically complex, but we see no clear trends to cause a change to our asset allocation. The profligacy of western politicians seems to present more immediate dangers. From this distance, the tensions of monetary without political union in Europe look tricky.

We seek companies of Buffett-style quality with good growth prospects at a reasonable price: we now have an abundance of plausible candidates from which to choose, and ideas to pursue.

Wednesday, April 8, 2009

Ten principles for a Black Swan-proof world - By Nassim Nicholas Taleb

1. What is fragile should break early while it is still small. Nothing should ever become too big to fail. Evolution in economic life helps those with the maximum amount of hidden risks – and hence the most fragile – become the biggest.

2. No socialisation of losses and privatisation of gains. Whatever may need to be bailed out should be nationalised; whatever does not need a bail-out should be free, small and risk-bearing. We have managed to combine the worst of capitalism and socialism. In France in the 1980s, the socialists took over the banks. In the US in the 2000s, the banks took over the government. This is surreal.

3. People who were driving a school bus blindfolded (and crashed it) should never be given a new bus. The economics establishment (universities, regulators, central bankers, government officials, various organisations staffed with economists) lost its legitimacy with the failure of the system. It is irresponsible and foolish to put our trust in the ability of such experts to get us out of this mess. Instead, find the smart people whose hands are clean.

4. Do not let someone making an “incentive” bonus manage a nuclear plant – or your financial risks. Odds are he would cut every corner on safety to show “profits” while claiming to be “conservative”. Bonuses do not accommodate the hidden risks of blow-ups. It is the asymmetry of the bonus system that got us here. No incentives without disincentives: capitalism is about rewards and punishments, not just rewards.

5. Counter-balance complexity with simplicity. Complexity from globalisation and highly networked economic life needs to be countered by simplicity in financial products. The complex economy is already a form of leverage: the leverage of efficiency. Such systems survive thanks to slack and redundancy; adding debt produces wild and dangerous gyrations and leaves no room for error. Capitalism cannot avoid fads and bubbles: equity bubbles (as in 2000) have proved to be mild; debt bubbles are vicious.

6. Do not give children sticks of dynamite, even if they come with a warning . Complex derivatives need to be banned because nobody understands them and few are rational enough to know it. Citizens must be protected from themselves, from bankers selling them “hedging” products, and from gullible regulators who listen to economic theorists.

7. Only Ponzi schemes should depend on confidence. Governments should never need to “restore confidence”. Cascading rumours are a product of complex systems. Governments cannot stop the rumours. Simply, we need to be in a position to shrug off rumours, be robust in the face of them.

8. Do not give an addict more drugs if he has withdrawal pains. Using leverage to cure the problems of too much leverage is not homeopathy, it is denial. The debt crisis is not a temporary problem, it is a structural one. We need rehab.

9. Citizens should not depend on financial assets or fallible “expert” advice for their retirement. Economic life should be definancialised. We should learn not to use markets as storehouses of value: they do not harbour the certainties that normal citizens require. Citizens should experience anxiety about their own businesses (which they control), not their investments (which they do not control).

10. Make an omelette with the broken eggs. Finally, this crisis cannot be fixed with makeshift repairs, no more than a boat with a rotten hull can be fixed with ad-hoc patches. We need to rebuild the hull with new (stronger) materials; we will have to remake the system before it does so itself. Let us move voluntarily into Capitalism 2.0 by helping what needs to be broken break on its own, converting debt into equity, marginalising the economics and business school establishments, shutting down the “Nobel” in economics, banning leveraged buyouts, putting bankers where they belong, clawing back the bonuses of those who got us here, and teaching people to navigate a world with fewer certainties.

Then we will see an economic life closer to our biological environment: smaller companies, richer ecology, no leverage. A world in which entrepreneurs, not bankers, take the risks and companies are born and die every day without making the news.

In other words, a place more resistant to black swans.

Related books:
The Black Swan: The Impact of the Highly Improbable (also available in an Audio Book)
Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets (also available in an Audio Book)

Martin Capital Management - Fireside Chat No. 4

Related book: Speculative Contagion: An Antidote for Speculative Epidemics

Tuesday, April 7, 2009

Advisor Perspectives: Au revoir Jean-Marie Eveillard: A Final Interview

Which worries you more – a decline in the dollar, rapid inflation, or deflation? How are you positioning your portfolio to defend against these scenarios?

We have many worries, but we are not positioned against any particular outcome. Our top-down analysis is focused on those trends that will affect the intrinsic values of the companies we own. We believe the most effective defense against these scenarios is to spread risks through diversification.

You have called your billion-dollar purchase of gold “calamity insurance.” What potential events do you perceive possible that makes such a large position advisable? How do you go about determining your allocation to gold?

Our gold position is based on our belief that gold is a universal store of value. We believe a gold position of less than 5% of our assets is irrelevant and a position of more than 15% would be too painful if we are wrong. For most of 2008, our position was between 7-8%, but it eventually grew to almost 15%. This was not because we bought more gold, but because the value of gold rose relative to the value of the rest of our holdings.

After World War I, during the great inflation of the Weimar Republic, the German government acted very shrewdly. They forbade German citizens from buying gold and from holding foreign currencies, and they taxed real estate very heavily. As a result, some rich farmers bought grand pianos. They did not want the paper currency being issued, because they knew it would be worthless the next day. Instead, they chose pianos as a hard asset that would hold its value. Today, we see gold as having these same characteristics.

The current actions of the US and UK governments, through “quantitative easing” – which is really just a code word for printing more money – will be rather good for common stocks. Initially, at least, these actions will be bad for cash and Treasury bonds. At some point, they will be good for real estate and fine art. However, these actions are very good for gold.

The path of increased money supply leads to real assets, and gold is our asset of choice. Common stocks will also benefit, as they are representative of real assets.

Remember, the opportunity cost of holding gold is near zero, because interest rates are so low. Gold investors should keep in mind the two extremes. The government has a strong incentive to keep long-term Treasury rates low, because it allows them buy Treasury bonds to increase the money supply. At the other extreme, the government dislikes high gold prices, because it reflects poorly on their policies. This is partly why FDR, during the Great Depression, made it illegal to own gold. So, to some degree, gold investors are betting against the government.

Is the worst behind us? Will we continue to see more surprises on the downside, or will there be unexpectedly good news?

A bit of a reprieve may be in the making, thanks to the stimulus package. One year from now, however, a wave of option ARMs begins to reset. [Ed. Note: See our article on this topic.] These loans were made at the peak of the credit cycle and the magnitude of this problem will rival that of the sub-prime problem. The housing market will need to absorb another round of foreclosures.

We are one year into the recovery process, but a full recovery will likely take longer.

We worry about the actions of the authorities, who are attempting to subvert the laws of nature. By printing more money, they are doing a rain dance in Washington, but the result could be a hurricane of inflation.

What sources of information world-wide should people in the United States seek out to become more informed and better investors?

Read the Financial Times. It is more international and, overall, better than the Wall Street Journal. We also recommend Jim Grant’s Interest Rate Observer. Grant was one of the rare few people who correctly forecast the financial crisis. Nor is he a “perma-bear” – just recently he was bullish and correctly advised readers to buy long-dated call options on a basket of bank stocks.