Tuesday, August 31, 2010

Not All Are True to Schools

Thanks to Will for passing this link along.

It's a schoolyard brawl that's leaving some of Wall Street's titans bruised and others thumping their chests.

The bull-bear clash is over for-profit education stocks, or publicly traded companies offering secondary education to students, many of whom rely on government financial assistance. Betting for or against the companies has led to some of the year's biggest gains and most painful losses.

On the "bull" side are well-known hedge funds such as Tiger Global Management LLC, Maverick Capital Ltd. and Lone Pine Capital LLC. Some have praised the companies, citing rising revenues as new groups of people, often adults, seek to improve their chances of getting a job through education.

Lately, though, several for-profit college operators have come under fire from government bodies who say the schools are pushing prospective students to take on heavy debt while failing to prepare them for careers that allow the students to pay off the loans. Stocks like those of Corinthian Colleges Inc., Apollo Group Inc. and Strayer Education Inc. have tumbled in recent months.

Warren Buffett's Berkshire Hathaway Inc. owns nearly 22% of the Class B shares of Washington Post Co. The company has seen operating income from its Kaplan education unit, which includes colleges, offset weakness from its media businesses. Washington Post shares also have fallen lately.

On the "bear" side of the bet are Steve Eisman, Jim Chanos and other investors who spotted past stock blowups. They have seen wagers against these companies lead to millions of dollars in gains lately. These big-name skeptics maintain that the troubles of for-profit colleges have just begun.


Related previous post: Steve Eisman's Ira Sohn Conference Presentation and Speech

Beware those who think the worst is past - By Carmen Reinhart and Vincent Reinhart

The landscape of Jackson Hole, Wyoming, where central bankers gathered at their annual conference last week, is spectacular and forbidding. Jagged peaks and vast empty spaces stretch across the horizon. For the attendees, however, it was both a vista and a metaphor. Having lived through a precipitous global economic drop, they now must forecast how steep or flat will be the incline of recovery.

Ben Bernanke, chairman of the Federal Reserve, painted a sober but reassuring picture of US prospects. The basis for sustained recovery is in place, and canny Fed officials are now alive to the dangers of both deflation and inflation. Similarly Jean Claude Trichet, head of the European Central Bank, spoke about how the dust had begun to settle on the crisis. Policymakers and financial markets seem to be looking at what comes next.

Such optimism, however, may be premature. We have analysed data on numerous severe economic dislocations over the past three-quarters of a century; a record of misfortune including 15 severe post-second world war crises, the Great Depression and the 1973-74 oil shock. The result is a bracing warning that the future is likely to bring only hard choices.


A prudent post-crisis policy, therefore, must be alert to threats both to supply and demand, not demand alone. But the bigger worry remains the assumption that dust has begun to settle; that the shock from the crisis is temporary, when it is likely to be deep and persistent. Today, as in the past, over-optimistic fiscal authorities are over-estimating tax revenues. Financial supervisors want to believe that troubled banks are temporarily illiquid, not permanently insolvent. And central bankers like Mr Bernanke may soon attempt to restore employment to unattainably high levels. If they do so, the road to recovery will be long, and the lessons of history will have been ignored once more.

James Montier: Bond bubble - a sterile debate on semantics


Wilbur Ross on BNN

Thanks to Wally for passing these links along.

Wilbur Ross on BNN:

Part 1

Part 2

Part 3

Monday, August 30, 2010

First Eagle: Views on Developing Markets

At First Eagle we are often asked how we view the developing markets. Some prospective investors also wonder about our noticeable lack of exposure to the BRIC countries (Brazil, Russia, India and China). After all, the world’s wealth seems to be created in developing economies at an increasing rate, and many Asian nations in particular are growing at a pace that underscores the supposed resiliency of their economic models. As the developed world stumbles from crisis to crisis, many developing countries seem poised to continue taking a greater share of the world’s wealth.

While we do not dispute the notion that the developing markets are becoming the world’s growth engines, we are value-oriented, bottom up investors who do not automatically interpret this trend as a signal to invest. According to Matt McLennan, Portfolio Manager and Head of the Global Value Team, the top-line growth of an economy does not necessarily translate into strong returns from the ownership of equities. “The problem with buying the developing market-growth story is that a great many companies are trying to get into the market and participate. In economies with a lot of structural change, the companies that will generate earnings in five or ten years may not be the same companies that are thriving today. It’s very hard to know who the winners will be.”

The Boeckh Investment Letter: Increasing Risks

The artificial nature of the U.S. economic recovery from the recession lows has always been obvious. In recent months, judging from media coverage, it is now mainstream. While there are a few lingering signs that support some modest optimism, it is getting difficult to find much to cheer about. In our letter Vol. 2.10, The Artificial Economic Recovery, dated July 23, 2010 we pointed out that the U.S. growth trajectory was converging on 1% p.a. With revisions to second quarter GDP that seems to be fact now. A double-dip U.S. recession is still not a done deal but forces are all on the side of economic weakness and deflation, and a double-dip recession next year carries a significant possibility.

Academic Bankruptcy - By Mark C. Taylor

WITH the academic year about to begin, colleges and universities, as well as students and their parents, are facing an unprecedented financial crisis. What we’ve seen with California’s distinguished state university system — huge cutbacks in spending and a 32 percent rise in tuition — is likely to become the norm at public and private colleges. Government support is being slashed, endowments and charitable giving are down, debts are piling up, expenses are rising and some schools are selling their product for two-thirds of what it costs to produce it. You don’t need an M.B.A. to know this situation is unsustainable.

With unemployment soaring, higher education has never been more important to society or more widely desired. But the collapse of our public education system and the skyrocketing cost of private education threaten to make college unaffordable for millions of young people. If recent trends continue, four years at a top-tier school will cost $330,000 in 2020, $525,000 in 2028 and $785,000 in 2035.

Yet most faculty and administrators refuse to acknowledge this crisis.


Related book: Crisis on Campus

Related article: “End the University as We Know It

Related previous post: The American Spectator: What Would Sir John Say? – By Theodore Roosevelt Malloch

This is No Way to Run a Railroad - By Michael Lewitt

The misallocation of capital to speculative rather than productive uses is a great American tragedy. As described in detail in The Death of Capital, the manifestations of this misallocation include most private equity transactions and the lion’s share of the derivatives and computer-driven trades of stocks and other financial instruments on the world’s securities markets.

The markets are dominated by investment strategies that have as their common denominator a reliance on momentum. There are many flaws in these strategies, beginning with the fact that they typify the “Greater Fool” theory. Adding insult to injury, the economy currently underlying the market is evidencing little momentum one way or the other. As a result, most investors have spent 2010 chasing their tails. Unfortunately, one of the most plausible arguments for believing that financial markets will rally is to endorse the view that investors will be as cynical and short-sighted in their thinking as their political and business leaders. That’s a hell of way to run a railroad.

The railroad known as the United States economy is also chasing its own tail these days. Driven by misbegotten fiscal and monetary policies that ignore the lessons of history in favor of discredited financial and economic theories, the economy is trapped in a cycle of boom and bust. Every time the economy falters, our political leaders run to bail it out with politically-mandated Keynesian prescriptions that only exacerbate the underlying excesses and imbalances. Little or nothing is done to direct capital to productive uses and speculation is allowed to reign. As John Hussman recently wrote: “If our only response to excess consumption is to pull out all the stops trying to ‘stimulate’ consumption every time it falters; if our only response to reckless lending is to defend the bondholders every time their poor allocation of capital threatens to produce a loss for them, then quite simply, we will destroy our economy, our future, and our standard of living….[I]t’s difficult to envision a return to long-term saving, productive investment, and thoughtful allocation of capital until – as happens every two or three decades – the speculative elements of Wall Street are crushed to powder.”

We have self-appointed diminutive macho-men like Rahm Emanuel barking about how crises are terrible things to waste while proceeding to do precisely that – squandering the opportunity that crises offer to effect meaningful reform by surrendering to special interests and lacking the courage to engage in genuine systemic change. The result – an expensive and profoundly flawed healthcare bill, an absurdly complex and at its core neutered financial reform bill – is not that the status quo is left in place but that it is made even worse. For this reason, the debates about whether the U.S. economy is enjoying a self-sustaining economy (HCM believes the recovery has been primarily government funded and is already fading as stimulus recedes) is primarily of short-term interest. In the long term, absent dramatic entitlement and other reforms, the economic outlook is bleak. There is genuine doubt concerning the ability of the U.S. government, as currently operative under the Constitution and other laws of the land, to deal with the mess in which we find ourselves.


Related books:

The Death of Capital

Crisis on Campus

End Looms For Era of Cheap Chinese Labor

It feels like the end of an era. The spate of strikes and suicides that have rocked China’s southern manufacturing belt over the last fortnight could well go down as the moment that China stopped being a place of endless cheap labor. And for the economy, it could be a thoroughly good thing.

The manufacturing hub in Guangdong province has been buzzing with two different but related stories—the spate of suicides at Foxconn, the company that makes the iPad and other hi-tech gadgets, and a high-profile strike at a Honda components plant.

Both events have also resulted in eye-catching wage increases—30 percent in the case of the Foxconn workers and a 24 percent offer at the Honda factory (they want 50 percent).

They are part of a pattern of rising wages across the economy. Dai Qinlan, director of the Careers Information Center in Wenzhou, another export hub on the east coast, said that wages are up around 20 percent in most of the region’s factories this year.

“Companies in China can still get young workers for their factories, but they are going to have to pay significantly more for them,” says Arthur Kroeber, managing director of Dragonomics in Beijing.


Related paper: What Does the Lewis Turning Point Mean for China?

Hussman Funds 2010 Annual Report

Present Conditions

A year ago, I noted “investors have become hopeful about ‘green shoots’ of economic recovery. However, nearly all of the improvement has reflected enormous doses of debt-financed government spending, and it is questionable that any of this will translate into sustained private activity. From my perspective, much of the enthusiasm about these green shoots overlooks the extent to which economic recoveries have historically relied on the expansion of private lending and debt creation. Economic expansions are paced not by major growth in consumption (which tends to be fairly smooth even during economic downturns), but instead by gross investment in capital goods, technology and housing, as well as debt-financed durables such as autos. We are in the midst of – and will continue to require – perhaps the largest adjustment in U.S. personal, corporate and government balance sheets that we will see in our lifetimes. This will be a very long process. Most likely the economic outlook is not up, but very widely sideways.”

While debt-financed government spending helped the U.S. economy to achieve three quarters of moderate economic growth, it is notable that growth has been slightly negative when the impact of federal deficit spending is removed. This is the worst performance in the private economy in any of the 50 years preceding the recent crisis. Meanwhile, the volume of outstanding bank credit has continued to collapse. In recent months, a variety of leading indicators of economic activity, such as the ECRI leading index, have moved to negative readings, suggesting that economic growth may have already peaked. At the time of this report, a number of our own measures of recession risk have deteriorated to the point that very modest declines in stock prices and the ISM Purchasing Managers Index would be sufficient to complete a set of criteria that has always and only been present during or immediately prior to recessions.

A larger concern relates to valuation and long-term return prospects that are likely from current market levels. Measured from peak-to-peak across economic cycles, S&P 500 earnings have rarely exceeded a 6% annual growth rate. While earnings experience a great deal of “cyclical” fluctuation beneath that long-term trend, they can be normalized in a variety of ways to better reflect their long-term dynamics. A decade ago, the valuation of the S&P 500 was well over twice the historical norm, relative to normalized earnings. Despite experiencing a loss over the past decade, the valuation of the S&P 500 is still not at a point, relative to the now higher level of normalized earnings, that has historically resulted in average or above-average long-term returns.

Over more than a century, the pattern displayed by stock market valuations has been broadly characterized by “cyclical” fluctuations typically about 4-5 years in length, each comprising what investors commonly identify as bull and bear markets. However, the larger historical pattern is that the stock market has periodically achieved major extremes of overvaluation and major extremes of undervaluation spaced closer to 17-18 years apart. The deep undervaluation of 1982, and the striking overvaluation of 2000, are examples of these extremes. The long intervening periods between these “secular” extremes generally contain a number of shorter cyclical bull and bear market phases. During periods from a secular trough such as 1982 to a secular peak such as 2000, each successive bull market tends to peak at a higher level of valuation. In contrast, during periods from a secular peak such as the mid-late 1960’s to a secular trough such as 1982, each successive bear market tends to bottom at a lower level of valuation (though not necessarily a lower absolute price level, if earnings and other fundamentals have grown in the interim).

This context is important, because while the market lows we observed in early 2009 appeared extreme relative to the market highs of 2007, the trough was not particularly deep from a long-term valuation perspective. Moreover, the subsequent market advance quickly restored valuations that are, on the metrics we use, among the highest 25% of historical observations. With little basis to expect strong long-term returns from the standpoint of valuations at present, and little basis to expect robust economic growth from the standpoint of credit expansion, it is important to allow for the possibility that investors will require a substantial revision in market valuations in order to accept sustained long-term exposure to market risk.

Without question, there are many Wall Street analysts who presently argue that stocks are cheap. Almost without exception, these assertions are based on 1) using a single year of projected “forward operating earnings” to value the stock market; 2) applying an improperly high “norm” for the price-to-earnings ratio; and 3) ignoring the variation in long-term earnings growth induced by changes in profit margins. To the extent that the usefulness of a valuation model can be judged by its ability to explain subsequent market returns, this valuation debate can be resolved by an examination of historical evidence (see in particular “Valuing the S&P 500 Using Forward Operating Earnings” in the weekly market commentaries of the Hussman Funds website). While the simplistic use of forward operating earnings fails to adequately explain subsequent long-term market returns, it is possible to produce historically accurate 10-year total return projections for the S&P 500 by properly correcting for earnings growth, profit margins and historical valuation norms. Unfortunately, these projections concur with other historically reliable measures in suggesting that the U.S. stock market is substantially overvalued at present.

Still, while valuations and economic considerations may create sufficient headwind to require periodic hedging of market risks, I do expect that we will continue to see a great number of opportunities in individual securities and industries that will provide a basis for investment returns on the basis of security selection. The same difficulties that have prompted what we view as reckless fiscal and monetary policy in recent years is likely, in our view, to provoke inflationary pressures in the second half of this decade, suggesting that securities with returns tied to real assets and commodity exposure may represent opportunity. As credit strains often produce concerns about deflation rather than inflation, my impression is that the next few years will provide adequate opportunities to establish holdings in these areas during occasional periods of price weakness.

Moreover, despite economic challenges, there is every reason for optimism about innovation and discovery in a wide range of areas including wireless communications, medical devices, consumer electronics, genomic medicine, alternative energy, and even creative niche companies within established industries such as apparel and food services. When a company has well-received products that are not easily replicated, has significant opportunity to reinvest earnings into its growing business (rather than repurchasing shares to offset stock-based compensation to insiders), appears capable of delivering a long-term stream of cash flows to its investors over time, and has a stock price that appears reasonable in relation to the present value of those expected cash flows, that company may be a useful component to a well-diversified portfolio. Over the years, the emphasis of the Hussman Funds on careful security selection has been an important factor in our investment returns. I expect that, regardless of overall market prospects, we will observe numerous investment opportunities in securities characterized by favorable valuation and market action.

Why another fiscal stimulus won't do - By Mohamed A. El-Erian

Thanks to Will for passing this along.

In sum, the current policy approaches here and abroad are unlikely to deliver a durable and robust U.S. recovery and, critically, create sufficient growth in jobs. Yet the main debate in Washington is whether to do more of the same -- namely, another fiscal stimulus and another round of quantitative easing by the Federal Reserve. This clearly conflicts with evidence that a broader and more holistic response is needed.

These realities will fuel debate among economists, who already hold unusually divergent views, and reignite the discomforting notion that economic unthinkables and improbables -- such as a double-dip recession and a deflation trap -- are more of a possibility.

What is critical to keep in mind is that this situation is part of a broad, multiyear process driven by national and global realignments. It's a secular phenomenon that needs to be better understood and navigated -- by recognizing its structural dimensions and by urgently broadening the excessively cyclical policy mindsets that abound. Unfortunately, the approach in too many industrial countries has been to kick the can down the road, seemingly hoping for a series of immaculate economic recoveries.

Policymakers must break this active inertia by implementing a structural vision to accompany their current cyclical focus. Measures are needed to address key issues, which include the change in drivers of growth and employment creation; the high risk of skill erosion and lost labor productivity; financial deleveraging in the private sector; debt overhangs; the uncertain regulatory environment; and the unacceptably high risks facing the most vulnerable segments of society.

Specific measures would include pro-growth tax reform, housing finance reform, increased infrastructure investments, greater support for education and research, job retraining programs, removal of outdated interstate competition barriers and stronger social safety nets.

That, of course, is what is desirable; how about what is likely?

Sunday, August 29, 2010

John Mauldin: The Dark Side of Deficits

Secular Bull and Bear Markets

Market analysts (of which I am a minor variety) talk all the time about secular bull and bear cycles. I argued in this column in 2002 (and later in Bull's Eye Investing) that most market analysts use the wrong metric for analyzing bull and bear cycles.

(For the record, even though I am talking about the US stock market, the principles apply to most markets everywhere. We are all human.)

"Cycles" are defined as events that repeat in a sequence. For there to be a cycle, some condition or situation must recur over a period of time. We are able to observe a wide variety of cycles in our lives: patterns in the weather, the moon, radio waves, etc. Some of the patterns are the result of fundamental factors, while others are more likely coincidence. The phases of the moon occur due to cycles among the moon, the earth, and the sun. In other situations, though, apparent patterns are no more than the alignment of random events into an observable sequence.

All cycles have several components in common. Cycles have a start and an end, they have characteristics that repeat from cycle to cycle, and they often have an explainable cause.

Stock market observers have identified what they believe to be scores of cycles, patterns, correlations, and relationships that have spawned a seemingly endless inventory of predictions and trading schemes. Every trader has his favorite system, well-fortified with back-tested "research" and "facts." These systems all work fine until you begin to use them with real money.

The patterns are so numerous that some market experts discount all theories and acquiesce to a philosophy of randomness (that would be you, Burt!). However, just because we don't understand it, doesn't mean there's not useful information contained within a pattern.

I argue that we should use valuations and not prices as the criterion for determining secular bull and bear cycles. If you use valuations, the cycles jump off the page at you. Using prices, it is very difficult.

Secular bulls begin with low valuations and continue until valuations get "too high" in terms of P/E ratios. The opposite for secular bears. The average cycle over the last 110 years lasted about 13 years. These are not short-term phenomena.

Within those longer-term secular cycles you can have so-called cyclical swings based on price, and some of those counter-trend cycles can be quite large!


Related book: Unexpected Returns: Understanding Secular Stock Market Cycles

Saturday, August 28, 2010

Friday, August 27, 2010

WSJ: Economist Shiller Sees Potential for 'Double Dip' Recession

Chou Funds: 2010 Semi-Annual Report

NON-INVESTMENT GRADE AND INVESTMENT GRADE BONDS ARE NOW FULLY PRICED: Non-investment grade bonds have rallied tremendously from their lows in March 2009, and at current prices we believe they are close to fully priced. For example, three and a half years ago the spread between U.S. corporate high yield debt and U.S. treasuries was 311 basis points. Currently, it is about 696 basis points, down from its peak of over 1,900 basis points in December 2008. (Source: JP Morgan).

Similarly, we believe that investment grade bonds are now close to fully priced.

However, when compared to corporate bonds, U.S. treasuries are in bubble territory. In our opinion, this is the worst time to hold cash and short-term treasuries unless you believe we are headed into a 1930s style depression. And if you believe that you should redeem all your Fund units.

In equities, we believe the financial, retail and pharmaceutical sectors are undervalued.


An Interesting Way to Invest in Banks

Please note: the investment described below is the view of the writer and should not be seen as a recommendation.

One of the more interesting ways to invest in the better capitalized banks is through the stock warrants that were issued to the U.S. Treasury by the banks when they received funds under TARP. The stock warrants give the holder the right to buy the bank's stock at a specific price. When the banks repaid TARP funds to the U.S. Treasury, the U.S. Treasury either sold the stock warrants back to the banks or they auctioned them to the public.

So, what is so unique about these stock warrants?

Banks’ Self-Dealing Super-Charged Financial Crisis

Over the last two years of the housing bubble, Wall Street bankers perpetrated one of the greatest episodes of self-dealing in financial history.

Faced with increasing difficulty in selling the mortgage-backed securities that had been among their most lucrative products, the banks hit on a solution that preserved their quarterly earnings and huge bonuses:

They created fake demand.

A ProPublica analysis shows for the first time the extent to which banks -- primarily Merrill Lynch, but also Citigroup, UBS and others -- bought their own products and cranked up an assembly line that otherwise should have flagged.

The products they were buying and selling were at the heart of the 2008 meltdown -- collections of mortgage bonds known as collateralized debt obligations, or CDOs.

As the housing boom began to slow in mid-2006, investors became skittish about the riskier parts of those investments. So the banks created -- and ultimately provided most of the money for -- new CDOs. Those new CDOs bought the hard-to-sell pieces of the original CDOs. The result was a daisy chain that solved one problem but created another: Each new CDO had its own risky pieces. Banks created yet other CDOs to buy those.

Individual instances of these questionable trades have been reported before, but ProPublica's investigation, done in partnership with NPR's Planet Money, shows that by late 2006 they became a common industry practice.

Thursday, August 26, 2010

Ex-SEC Chief Levitt: Muni Market Massacre Is Coming

Found via My Investing Notebook. This is an area where Mr. Buffett has sent some warning signals as well.

Former Securities and Exchange Commission chairman Arthur Levitt says there's a massacre about to happen in the municipal bond market.

The muni market is “rife with the hallmarks of abuse: poor disclosure, little regulatory oversight, made-to-order accounting rules and insider deals driven by banker and consultant fees," Levitt writes at Bloomberg.

Moreover, Levitt says the culprit is not the SEC, but Congress, which should repeal the 1975 Tower Amendment that prevents such SEC oversight of the municipal bond market.

“There is no other law in the U.S. with the same capacity to harm investors — and despite repeated calls for its repeal, the new financial regulatory reform legislation did nothing significant on it,” Levitt observes.

20 Must-See Business TED Talks

Every year, today’s greatest thinkers gather at various TED (Technology Entertainment and Design) conferences around the world. Their talks, which you can find on TED’s website, are often insightful, educational, and fascinating.

As a TED junkie, I decided to compile 20 of the best business talks in the conference’s history. Each talk offers insights either into a business leader’s mind, or into concepts that will change the way you think about business and the economy. (If you have any favorites not included on this list, please mention them in the comments below.)

Albert Edwards: "We Are Returning To 450 On The S&P"

Via Zero Hedge.

So far the equity market has shrugged off much of the weaker data that abounds, and has not joined the bond market in a perceptive move. The equity market will though crumble like the house of cards it is, when the nationwide manufacturing ISM slides below 50 into recession territory in coming months. Indeed the new orders data for August, already reported in regional ISM’s suggests the equity market is going to get some sentiment crushing data in the very near term.

The structural bear market has not reached the end. We have long said that the de-bubbling process would end only when equities became very cheap and revulsion in equities as an asset class hangs in the air like a fog. The problem remains more of excess valuation within the US rather than Europe, but that will not prevent the bear market hurting other cheaper markets as much. We will return to the valuation nadir last seen in 1982 with the S&P bottoming around 450 (see chart below).


Related previous posts:

Recent SocGen Pieces

Albert Edwards: Europe Is On The Edge Of A Deflationary Precipice That Will, Paradoxically, Usher In 20-30% Inflation

Albert Edwards: Global Strategy Weekly - 16 March 2010

Why Did the Crisis of 2008 Happen? - By Nassim Nicholas Taleb

Found via Farnam Street.

Summary of Causes: The interplay of the following five forces, all linked to the misperception, misunderstanding, and hiding of the risks of consequential low probability events (Black Swans).


1) Increase in hidden risks of low probability events (tail risks) across all aspects of economic life, not just banking; while tail risks are not possible to price, neither mathematically nor empirically. The same nonlinearity came from the increase in debt, operational leverage, and the use of complex derivatives.

2) Asymmetric and flawed incentives that favor risk hiding in the tails, two flaws in the compensation methods, based on cosmetic earnings not truly risk-adjusted ones a) asymmetric payoff: upside, never downside (free option); b) flawed frequency: annual compensation for risks that blow-up every few years, with absence of claw-back provisions.

3) Increased promotion of methods helping to hide of tail risks VaR and similar methods promoted tail risks. See my argument that information has harmful side effects as it does increase overconfidence and risk taking.

4) Increased role of tail events in economic life thanks to "complexification" by the internet and globalization, in addition to optimization of the systems.

5) Growing misunderstanding of tail risks Ironically while tail risks have increased, financial and economic theories that discount tail risks have been more vigorously promoted (while operators understood risks heuristically in the past), particularly after the crash of 1987, after the "Nobel" for makers of "portfolio theory". Note the outrageous fact that the entire economics establishment missed the rise in these risks, without incurring subsequent problems in credibility.

Firm Makes Bold Bet on Falling Prices

Thanks to Will for passing this article along.

A Canadian insurer is turning to a seldom-used strategy to make a big wager on falling prices over the next decade.

As more investors worry about the possibility of deflation—or a sustained period of falling prices that could cripple stocks—Fairfax Financial Holdings Ltd. has spent nearly $200 million to buy derivative contracts wagering on a decline in the consumer-price index, an inflation indicator. The trade could lead to huge profits if deflation occurs.

Loews Chief Tisch Says Buy Exxon as Bond Yields Fall

Found via The Corner of Berkshire & Fairfax.

Jim Tisch, chief executive officer of Loews Corp., said investors should buy stocks like Exxon Mobil Corp. and Johnson & Johnson after the decline in Treasury and municipal-bond yields.

“There are equities that are rather intriguing, especially when compared to fixed income,” Tisch said today in an interview at Bloomberg headquarters in New York. “When I look at what we’re earning on T bills and round it to the closest whole number, it’s zero.”

Wednesday, August 25, 2010

Matt Miller Interview and Eastern Insurance Holdings, Inc.

My colleague, Matt Miller, did an interview in which he described his thesis for Eastern Insurance Holdings, Inc. (EIHI), which is one of the larger positions in the fund we co-manage.

Link to: Interview with Matt Miller

Bill Gates' favorite teacher

Sal Khan, you can count Bill Gates as your newest fan. Gates is a voracious consumer of online education. This past spring a colleague at his small think tank, bgC3, e-mailed him about the nonprofit khanacademy.org, a vast digital trove of free mini-lectures all narrated by Khan, an ebullient, articulate Harvard MBA and former hedge fund manager. Gates replied within minutes. "This guy is amazing," he wrote. "It is awesome how much he has done with very little in the way of resources." Gates and his 11-year-old son, Rory, began soaking up videos, from algebra to biology. Then, several weeks ago, at the Aspen Ideas Festival in front of 2,000 people, Gates gave the 33-year-old Khan a shout-out that any entrepreneur would kill for. Ruminating on what he called the "mind-blowing misallocation" of resources away from education, Gates touted the "unbelievable" 10- to 15-minute Khan Academy tutorials "I've been using with my kids." With admiration and surprise, the world's second-richest person noted that Khan "was a hedge fund guy making lots of money." Now, Gates said, "I'd say we've moved about 160 IQ points from the hedge fund category to the teaching-many-people-in-a-leveraged-way category. It was a good day his wife let him quit his job." Khan wasn't even there -- he learned of Gates' praise through a YouTube video. "It was really cool," Khan says.


Link: Khan Academy

Related previous post: The man who’s tutoring Bill Gates

Related link: The Gates Notes

James Montier: A Man from a Different Time


Monday, August 23, 2010

The Overconfidence Problem in Forecasting – By Richard Thaler

Found via Simoleon Sense.

BUSINESSES in nearly every industry were caught off guard by the Great Recession. Few leaders in business — or government, for that matter — seem to have even considered the possibility that an economic downturn of this magnitude could happen.

What was wrong with their thinking? These decision-makers may have been betrayed by a flaw that has been documented in hundreds of studies: overconfidence.

Most of us think that we are “better than average” in most things. We are also “miscalibrated,” meaning that our sense of the probability of events doesn’t line up with reality. When we say we are sure about a certain fact, for example, we may well be right only half the time.


Two lessons emerge from these papers. First, we shouldn’t expect that the competition to become a top manager will weed out overconfidence. In fact, the competition may tend to select overconfident people. One route to the corner office is to combine overconfidence with luck, which can be hard to distinguish from skill. C.E.O.’s who make it to the top this way will often stumble when their luck runs out.

The second lesson comes from Mark Twain: “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”

Planet Money Deep Read: Interview with Nassim Taleb

Found via Simoleon Sense.

Link to: Interview with Nassim Taleb


Related previous posts:

Nassim Nicholas Taleb talks with James Surowiecki

Nassim Taleb on EconTalk

Hussman Weekly Market Comment: Why Quantitative Easing is Likely to Trigger a Collapse of the U.S. Dollar

A week ago, the Federal Reserve initiated a new program of "quantitative easing" (QE), with the Fed purchasing U.S. Treasury securities and paying for those securities by creating billions of dollars in new monetary base. Treasury bond prices surged on the action. With the U.S. economy predictably weakening, this second round of quantitative easing appears likely to continue. Unfortunately, the unintended side effect of this policy shift is likely to be an abrupt collapse in the foreign exchange value of the U.S. dollar.


So it is important to avoid misinterpretation - the policy of quantitative easing is likely to force a large adjustment on the U.S. dollar because the Federal Reserve is choosing to lay a heavier hand on the Treasury bond market than would result from economic conditions alone. The resulting shift in interest rates and long-term inflation prospects combine to dramatically reduce the attractiveness of the U.S. dollar. A significant and relatively abrupt devaluation is then required, in an amount sufficient to set up expectations of a U.S. dollar appreciation over time.

One way to think about the price jump required by exchange rate overshooting is to think about a long-term bond. If a 10-year zero-coupon bond with a $100 face is priced to deliver 0% annually, it will have a price of $100. If investors suddenly demand the bond to be priced to deliver 2% annually, the bond must experience an immediate drop in price to $82. Once that price drop occurs, the selling pressure on the bond will abate, since it will now be expected to appreciate at a 2% annual rate.

My impression is that Ben Bernanke has little sense of the damage he is about to provoke. A central banker who talks about throwing money from helicopters is not only arrogant but foolish. Nearly a century ago, the great economist Ludwig von Mises observed that massive central bank easing is invariably a form of cowardice that attempts to avoid the need to restructure debt or correct fiscal deficits, avoiding wiser but more difficult choices by instead destroying the value of the currency.

Von Mises wrote, "A government always finds itself obliged to resort to inflationary measures when it cannot negotiate loans and dare not levy taxes, because it has reason to fear that it will forfeit approval of the policy it is following if it reveals too soon the financial and general economic consequences of that policy. Thus inflation becomes the most important psychological resource of any economic policy whose consequences have to be concealed; and so in this sense it can be called an instrument of unpopular, that is, of antidemocratic policy, since by misleading public opinion it makes possible the continued existence of a system of government that would have no hope of the consent of the people if the circumstances were clearly laid before them. That is the political function of inflation. When governments do not think it necessary to accommodate their expenditure and arrogate to themselves the right of making up the deficit by issuing notes, their ideology is merely a disguised absolutism."

As a side note, von Mises also cautioned against the misconception that destroying the value of a currency would have a sustainable benefit for the economy, writing "If the depreciation is desired in order to 'stimulate production' and to make exportation easier and importation more difficult in relation to other countries, then it must be borne in mind that the 'beneficial effects' on trade of the depreciation of money only last so long as the depreciation has not affected all commodities and services. Once the adjustment is completed, then these 'beneficial effects' disappear. If it is desired to retain them permanently, continual resort must be had to fresh diminutions of the purchasing power of money."

Friday, August 20, 2010

Brian Arthur – Reinventing the Economy: Combination, complexity and value


James Montier's Latest Blog Post: Reports of the death of mean reversion are premature


Letter from a Washington Conference Room – By Michael Farrell

On Tuesday, I attended the “Conference on the Future of Housing Finance” hosted by Treasury Secretary Tim Geithner and Housing and Urban Development Secretary Shaun Donovan in the Cash Room at Treasury. I believe Annaly was invited because we have been actively engaged in the process in Washington, including submitting a response to Treasury’s request for public input on housing finance reform, and because we are a sizeable representative of the constituency of mortgage investors. We’re glad to be a part of the discussion, as I feel it is incumbent on us to share our views with policymakers and legislators on this matter of great national importance. As a company we are active in the markets, and we believe that our experience and insight can help provide some context and sense of consequences for different policy options.

The purpose of this letter is not to provide a play-by-play summary of the conference, as these details have been well-described in other venues and media. Rather, with this letter I hope to provide a few of my main take-aways.