Links to videos:
60 Minutes Segment: Malcolm Gladwell: The Power of the Underdog
60 Minutes Overtime Segment: How Bill Gates inspired the book, "Outliers"
60 Minutes Overtime Segment: Life lessons from the best-selling book, "Blink"
Saturday, November 30, 2013
Friday, November 29, 2013
From Nassim Taleb, in Antifragile:
"The psychologist Gerd Gigerenzer has a simple heuristic. Never ask the doctor what you should do. Ask him what he would do if he were in your place. You would be surprised at the difference."
"The psychologist Gerd Gigerenzer has a simple heuristic. Never ask the doctor what you should do. Ask him what he would do if he were in your place. You would be surprised at the difference."
PARIS—After years of steady growth, Rémy Cointreau SA warned that China's crackdown on extravagant gifts is set to hit the company's profit sharply this year and dent sales for some time, the latest sign of how major liquor makers face broad fallout from the shift in policy.
The French company has suffered along with rivals in recent quarters as the Chinese government has scaled back on sponsored banquets and gift giving, which for years had propelled sales of high-end spirits and other luxury goods.
"The situation in China is clearly weighing on our outlook," Chief Executive Frederic Pflanz said Tuesday during a conference call with analysts. "We do not expect any improvement in the Chinese market in the coming months."
Rémy Cointreau said it expected that current operating profit would drop at least 20% for the year ending March 31. The warning battered its shares and those of rivals such as Pernod Ricard SA.
Thursday, November 28, 2013
I want to do something I haven’t done before. I feel obligated because so many of you came from such great distances, so I’ll talk about a question I’ve chosen, one that ought to interest you: Why were Warren Buffett and his creation, Berkshire Hathaway, so unusually successful? If that success in investment isn’t the best in the history of the investment world, it’s certainly in the top five. It’s a lollapalooza.
Why did one man, starting with nothing, no credit rating, end up with this ridiculous collection of assets: $120 billion of cash and marketable securities, all from $10 million when Warren took over, with about the same number of shares outstanding. It’s a very extreme result.
You’ll get some hints if you read Poor Charlie’s Almanack, which was created by my friend Peter Kaufman, almost against my will – I let him crawl around my office when I wasn’t there. He said it would make a lot of money, so he put up $750,000 and promised that all profits above this would go to the Huntington Library [one of Munger’s favorite charities]. Lo and behold, that’s happened. He got his money back, and the donee’s receiving a large profit. Some people are very peculiar, and we tend to collect them.
A confluence of factors in the same direction caused Warren’s success. It’s very unlikely that a lollapalooza effect can come from anything else. So let’s look at the factors that contributed to this result:
The first factor is the mental aptitude. Warren is seriously smart. On the other hand, he can’t beat all comers in chess blindfolded. He’s out-achieved his mental aptitude.
Then there’s the good effect caused by his doing this since he was 10 years old. It’s very hard to succeed until you take the first step in what you’re strongly interested in. There’s no substitute for strong interest and he got a very early start.
This is really crucial: Warren is one of the best learning machines on this earth. The turtles who outrun the hares are learning machines. If you stop learning in this world, the world rushes right by you. Warren was lucky that he could still learn effectively and build his skills, even after he reached retirement age. Warren’s investing skills have markedly increased since he turned 65. Having watched the whole process with Warren, I can report that if he had stopped with what he knew at earlier points, the record would be a pale shadow of what it is.
The work has been heavily concentrated in one mind. Sure, others have had input, but Berkshire enormously reflects the contributions of one great single mind. It’s hard to think of great success by committees in the investment world – or in physics. Many people miss this. Look at John Wooden, the greatest basketball coach ever: his record improved later in life when he got a great idea: be less egalitarian. Of 12 players on his team, the bottom five didn’t play – they were just sparring partners. Instead, he concentrated experience in his top players. That happened at Berkshire – there was concentrated experience and playing time.
This is not how we normally live: in a democracy, everyone takes turns. But if you really want a lot of wisdom, it’s better to concentrate decisions and process in one person.
It’s no accident that Singapore has a much better record, given where it started, than the United States. There, power was concentrated in one enormously talented person, Lee Kuan Yew, who was the Warren Buffett of Singapore.
Lots of people are very, very smart in terms of passing tests and making rapid calculations, but they just make one asinine decision after another because they have terrible streaks of nuttiness. Like Nietzsche once said: “The man had a lame leg and he’s proud of it.” If you have a defect you try to increase, you’re on your way to the shallows. Envy, huge self-pity, extreme ideology, intense loyalty to a particular identity – you’ve just taken your brain and started to pound on it with a hammer. You’ll find that Warren is very objective.
All human beings work better when they get what psychologists call reinforcement. If you get constant rewards, even if you’re Warren Buffett, you’ll respond – and few things give more rewards than being a great investor. The money comes in, people look up to you and maybe some even envy you. And if you buy a whole lot of operating businesses and they win a lot of admiration, there’s a lot of reinforcement. Learn from this and find out how to prosper by reinforcing the people who are close to you. If you want to be happy in marriage, try to improve yourself as a spouse, not change your spouse. Warren has known this from an early age and it’s helped him a lot.
Alfred North Whitehead pointed out that civilization itself progressed rapidly in terms of GDP per capita when mankind invented the method of invention. This is very insightful. When mankind got good at learning, it progressed in the same way individuals do. The main thing at institutions of learning is to teach students the method of learning, but they don’t do a good job. Instead, they spoon feed students and teach them to do well on tests.
In contrast, those who are genuine learners can go into a new field and outperform incumbents, at least on some occasions. I don’t recommend this, however. The ordinary result is failure. Yet, at least three times in my life, I’ve gone into some new field and succeeded.
Mozart is a good example of a life ruined by nuttiness. His achievement wasn’t diminished – he may well have had the best innate musical talent ever – but from that start, he was pretty miserable. He overspent his income his entire life – that will make you miserable. (This room is filled with the opposite [i.e., frugal people].) He was consumed with envy and jealousy of other people who were treated better than he felt they deserved, and he was filled with self-pity. Nothing could be stupider. Even if your child is dying of cancer, it’s not OK to feel self pity. In general, it’s totally nonproductive to get the idea that the world is unfair. [Roman emperor] Marcus Aurelius had the notion that every tough stretch was an opportunity – to learn, to display manhood, you name it. To him, it was as natural as breathing to have tough stretches. Warren doesn’t spend any time on self-pity, envy, etc.
As for revenge, it’s totally insane. It’s OK to clobber someone to prevent them from hurting you or to set an example, but otherwise – well, look at the Middle East. It reminds me of the joke about Irish Alzheimer’s: when you’ve forgotten everything but the grudges.
So this is a lesson for you to draw on – and I think almost anybody can draw those lessons from Warren’s achievement at Berkshire. The interesting thing is you could go to the top business schools and none are studying and teaching what Warren has done.
There’s nothing nutty in the hard sciences, but if you get into the soft sciences and the liberal arts, there’s a lot of nuttiness, even in things like economics. Nutty people pick people like themselves to be fellow professors. It gets back to what Alfred North Whitehead talked about: the fatal unconnectedness of academic disciplines. When people are trying to recruit people to be PhDs in their subjects – the results are often poor.
On the other hand, if you have enough sense to become a mental adult yourself, you can run rings around people smarter than you. Just pick up key ideas from all the disciplines, not just a few, and you’re immensely wiser than they are. This is not a great social advantage, however, as I can tell you from experience of the early Charlie Munger. To meet a great expert in a field and regard him as a malformed child is not a winning social grace. I got a lot of hard knocks when I was young. You could say I was forced into investing. The world will not ordinarily reward you for correcting other people in their area of expertise.
Wednesday, November 27, 2013
92nd Street Y Launches a New Online Archive with 1,000 Recordings of Literary Readings, Musical Performances & More
From the Open Culture description:
Kurt Vonnegut once commented, in an interview with Joseph Heller, that the best audience he had ever encountered was at the 92nd Street Y in New York. “Those people know everything. They are wide awake and responsive.”
Located at the corner of 92nd Street and Lexington Avenue, the 92Y has a venerable history of public performance, conversation, poetry and beyond.
Lucky for the rest of us, the 92Y recorded the vast majority of those performances. And now 1,000 recordings appear on a new site, 92Y On Demand. It’s a fantastic archive of audio and video files, searchable by topic, year or performer name.
Link to: 92Y On Demand
“There is no author whose books I look forward to more than Vaclav Smil,” Bill Gates wrote this summer. That’s quite an endorsement—and it gave a jolt of fame to Smil, a professor emeritus of environment and geography at the University of Manitoba. In a world of specialized intellectuals, Smil is an ambitious and astonishing polymath who swings for fences. His nearly three dozen books have analyzed the world’s biggest challenges—the future of energy, food production, and manufacturing—with nuance and detail. They’re among the most data-heavy books you’ll find, with a remarkable way of framing basic facts. (Sample nugget: Humans will consume 17 percent of what the biosphere produces this year.)
I’ve written a lot of memos to clients over the last 24 years – well over a hundred. One I’m particularly proud of is The Race to the Bottom from February 2007. I think it provided a timely warning about the capital market behavior that ultimately led to the mortgage meltdown of 2007 and the crisis of 2008. I wasn’t aware and didn’t explicitly predict (in that memo or elsewhere) that the unwise lending practices that were exemplified in sub-prime mortgages would lead to a global financial crisis of multi-generational proportions. However, I did detect carelessness-induced behavior, and I considered it worrisome.
The ability to destroy your ideas rapidly instead of slowly when the occasion is right is one of the most valuable things. You have to work hard on it. Ask yourself what are the arguments on the other side. It’s bad to have an opinion you’re proud of if you can’t state the arguments for the other side better than your opponents. This is a great mental discipline.
Tuesday, November 26, 2013
I’ve said that American society is near its apex. It could be just before or just ahead of that point. Other people are more optimistic; Warren is more optimistic than I am. We’ve had the most incredible generations. Do you think it can go from generation to generation, from apex to apex? The historical record would give you some caution.Whether the good behavior and values will outweigh the bad, I don’t know. On my way over here, I stopped to watch the concrete being poured for a new Wesco building. The design is sound. The system for putting it together is sound. The skill of the crews is sound. The inspection process is sound – every single pour of concrete is watched by an inspector paid by the city of Pasadena, and he’s a good, competent man. He watches to make sure every bar of rebar is correct. This building will outlast the pyramids. This system is a credit to our civilization. In contrast, look at the same process in Latin America or Japan, where guys take bribes.There is a lot that is right in our country. In a recent five-year period, not one passenger died on a major airline. Imagine if other engineering systems were as good. A lot of pilots are recovering alcoholics, yet the system is safe enough to get us around this.
I think people have a duty when they rise high in life to be exemplars. A guy who rises high in the Army or becomes a Supreme Court justice is expected to be an exemplar, so why shouldn’t a guy who rises high in a big corporation act as an exemplar and not take every last penny?It’s not a problem we’ve had at Berkshire, but look at how far it’s spread. We have about two imitators. [Laughter]
Monday, November 25, 2013
FORTUNE — Marc Andreessen is never short on opinions and never shy about sharing them either. The co-creator of Mosaic, the first commercially used web-browser that he helped evolve into Netscape, he now runs the upstart and uber venture capital firm Andreessen Horowitz (with partner Ben Horowitz.) Andreessen serves on the board of Facebook (FB) and HP (HPQ) and has invested in Twitter (TWTR) among myriad other advisory and investment relationships. Now an emblematic figure of Silicon Valley, Andreessen is actually a product of the Midwest, growing up in Cedar Falls, Iowa and New Lisbon, Wisconsin and attending the University of Illinois. He returned to that part of the world to speak at an investor meeting at BDT Capital Partners in Chicago, a merchant bank run by Byron Trott that invests in and advises large family-controlled and closely held companies. The inspiration for this conversation came from an interview of Andreessen I did there. What follows are the highlights.
An excerpt especially worth keeping in mind in regards to thinking about competition and investing:
Jeff Bezos has this line where he says there's really two kinds of businesses in the world: those that try to charge consumers more, and those that try to charge consumers less, or try to save consumers money. I think about that more broadly. I reframe it as: There are businesses that have the mentality of adding value, and businesses that have the mentality of extracting value. And the Internet, I think, is an enormous benefit to the model of adding value, and it's an enormous danger to the model of extracting value.
I think you see that across the economy today. The music industry is a classic case in point. The whole piracy boom of music on the Internet really arose when music buyers essentially rose up in protest and said, "I want one song. Why am I being forced to pay $16 for the entire CD when all I want is one song that I can listen to online." That's when you had an earthquake hit the music industry. It was when consumers viewed the pricing to be fundamentally unfair.
Car dealers are going through another version of this. Carbuyers have never liked the process. Maybe a few have, but most carbuyers have not liked the process of having to go in and really get raked over the coals by a car dealer who takes advantage of the fact that consumers have no idea what the wholesale price of the car is. Now, after a little research online, you can walk in armed with a car's complete wholesale information and get a much better deal.
In traditional business circles that kind of transparency gets viewed mostly as a threat. I think that's unwarranted. I think the opportunities are just as large and probably larger, especially for businesses that have this view that their role in the world is to add value, is to bring consumers benefits.
I have never believed that interest rates have a perfect correlation to inflation. I think there’s some relation, but it’s complex and not easily quantifiable.
Always beware of inflation and interest rate exposures
The comments the article linked to below bring back to mind:
John Templeton (June 2005): “Most of the methods of universities and other schools, which require residence, have become hopelessly obsolete. Probably, over half of the universities in the world will disappear as quickly in the next 30 years.” (LINK)
Clayton Christensen (June 2013): “Historically there has never been competition on the basis of price. Colleges would compete by adding professors, enhancing programmes or building nicer facilities. So they competed by making institutions better. This initiates retribution [from other colleges] which make things better and better. And every step adds cost. So the cost of higher education has increased faster than healthcare. And there just isn't any more space in the budget to do this. So this year you are seeing, in a fixed cost environment, that colleges need to fill all their spaces. And there are fewer people applying. So this year for the first time there is real competition on price. For online universities, like Liverpool and the University of Phoenix, if prices drop by 60% they still make money. But for the vast majority of traditional universities, if the prices fall by 10% they are bankrupt; they have no wriggle room. So I'd be very surprised if in ten years we don't see hundreds of universities in bankruptcy.” (LINK)
After years of leaning on tuition increases to make up for declining state support, about four in 10 public universities now report tuition revenue is not keeping pace with inflation, according to a new report by Moody’s Investors Service.
Hussman Weekly Market Comment: An Open Letter to the FOMC: Recognizing the Valuation Bubble In Equities
How does one establish the value of a long-lived asset? Hopefully, that question stirs the economist in all of you, and you immediately respond that every security is a claim on some long-term stream of cash payments (including any terminal value) that the holder can expect to receive over time. If price is known, the discount rate that equates price to the present value of expected future payments can be interpreted to be the expected long-term return of that security. This is how one calculates the yield-to-maturity on a long-term bond, for example. Conversely, we can make assumptions about the long-term return that investors will require over time and then calculate an implied price. Discounting the expected long-term stream of cash flows using some required long-term return results in a “fair value” that quietly incorporates those underlying assumptions.
Saturday, November 23, 2013
Friday, November 22, 2013
Related previous post: Oxford Distinguished Speaker Series: Bill Ackman
Related previous post: Max Levchin, co-founder of PayPal, on Charlie Rose
Excerpt from an article on Bloomberg about his comments:
Stan Druckenmiller, who boasts one of the hedge-fund industry’s best long-term track records of the past three decades, said he’s betting against the shares of International Business Machines Corp. (IBM) because the company’s business will be replaced by technology such as cloud computing.
“It’s one of the more higher-probability shorts I have seen in years,” Druckenmiller, 60, said in an interview with Bloomberg TV’s Stephanie Ruhle at the Robin Hood Investors Conference in New York today. “IBM is old technology being replaced by cloud technology.”
Related link: Warren Buffett IBM Case Study
Thursday, November 21, 2013
In case any readers are interested in a break from the investment reading and want to dive into a novel, a college mentor of mine recently published his first one, which I just ordered and am looking forward to making my first break from the non-fiction realm in a very long time.
Link to: Waccamaw Gold – by William Woodson
Wednesday, November 20, 2013
Thanks to Will for passing this along.
Lucky sevens? Not so fast. Asset manager GMO's seven-year forecast doesn't show investors having much luck over that span, much less big returns. The Boston-based value shop, which oversees about $112 billion, doesn't like the broad U.S. stock market, which it maintains is too reliant on expanding price-earnings ratios, and it doesn't see great things ahead for bonds, either, given how low interest rates are. Two of the brighter spots, in its view, are high-quality stocks in the U.S. and emerging-market equities. For insight into the firm's views, Barron's spoke recently with Ben Inker, co-head of asset allocation at GMO, where he's worked for 21 years. The 43-year-old investment pro and his colleagues believe that assets' returns eventually revert to their mean, and they insist that will be the case for U.S. stocks, which have enjoyed big gains in recent years. The GMO Benchmark-Free Allocation Fund III (ticker: GBMFX), whose minimum investment is $10 million, has a 10-year annual return of 9.88%, besting 84% of its Morningstar peers. A much newer fund with an identical strategy—but just a $1,000 minimum—is Wells Fargo Absolute Return fund (WARAX).
Related previous post: GMO's 3Q 2013 Letter
Yesterday, I had the pleasure of speaking with the Bowden Group at ASU and meeting with this year’s CFA Research Challenge Team. It’s still early, and we have a lot of work (and glazed doughnuts) ahead of us, but I’d say our chances of a three-peat are strong . . . to quite strong.
Tuesday, November 19, 2013
Monday, November 18, 2013
Link to: GMO's 3Q 2013 Letter
But enough about the details. The basic point for us remains the same – the U.S. stock market is trading at levels that do not seem capable of supporting the type of returns that investors have gotten used to receiving from equities. Our additional work does nothing but confirm our prior beliefs about the current attractiveness – or rather lack of attractiveness – of the U.S. stock market. To answer the question we get most often about our forecast – “How could you be wrong?” – there are a couple of ways we could be wrong. One of them is pleasant and implausible, the other is more plausible, but far less pleasant.
The pleasant way we could be wrong is if the U.S. is about to embark on a golden age of corporate investment and economic growth that will gradually compete down the current return on capital such that overall profits manage to grow decently as the P/E of the stock market wafts slowly down. This would solve lots of problems, including the federal deficit and unemployment and, quite possibly, health care costs as well, but there is sadly no evidence whatsoever that it is occurring, as can be seen in Exhibit 4.
In equities there are few signs yet of a traditional bubble. In the U.S. individuals are not yet consistent buyers of mutual funds. Over lunch I am still looking at Patriots’ highlights and not the CNBC talking heads recommending Pumatech or whatever they were in 1999. There are no wonderful and influential theories as to why the P/E structure should be much higher today as there were in Japan in 1989 or in the U.S. in 2000, with Greenspan’s theory of the internet driving away the dark clouds of ignorance and ushering in an era of permanently higher P/Es. (There is only Jeremy Siegel doing his usual, apparently inexhaustible thing of explaining why the market is actually cheap: in 2000 we tangled over the market’s P/E of 30 to 35, which, with arcane and ingenious adjustments, for him did not portend disaster. This time it is unprecedented margins, usually the most dependably mean reverting of all financial series, which are apparently now normal.) By June this year, markets felt relatively quiet and under the surface there was still a considerable undertow of risk aversion in the institutions. The Russell 2000 and the GMO High Quality universe were both just level with the S&P, all up 16%. Normally we would have expected the Russell to outperform handsomely. However, since then speculation has perked up so that today, the broad U.S. market is up 20% and the Russell 2000 is a more typical six points ahead while stocks in the GMO High Quality universe are several points behind. We have also had a sharp and unexpected uptick in parts of the IPO market in the U.S., so I would think that we are probably in the slow build-up to something interesting – a badly overpriced market and bubble conditions. My personal guess is that the U.S. market, especially the non-blue chips, will work its way higher, perhaps by 20% to 30% in the next year or, more likely, two years, with the rest of the world including emerging market equities covering even more ground in at least a partial catch-up. And then we will have the third in the series of serious market busts since 1999 and presumably Greenspan, Bernanke, Yellen, et al. will rest happy, for surely they must expect something like this outcome given their experience. And we the people, of course, will get what we deserve. We acclaimed the original perpetrator of this ill-fated plan – Greenspan – to be the great Maestro, in a general orgy of boot licking. His faithful acolyte, Bernanke, was reappointed by a democratic president and generally lauded for doing (I admit) a perfectly serviceable job of rallying the troops in a crash that absolutely would not have occurred without the dangerous experiments in deregulation and no regulation (of the subprime instruments, for example) of his and his predecessor’s policy. At this rate, one day we will praise Yellen (or a similar successor) for helping out adequately in the wreckage of the next utterly unnecessary financial and asset class failure. Deregulation was eventually a disappointment even to Greenspan, shocked at the bad behavior of financial leaders who, incomprehensibly to him, were not even attempting to maximize long-term risk-adjusted profits. Indeed, instead of the “price discovery” so central to modern economic theory we had “greed discovery.”
In the meantime investors should be aware that the U.S. market is already badly overpriced – indeed, we believe it is priced to deliver negative real returns over seven years – and that most foreign markets having moved up rapidly this summer are also overpriced but less so. In our view, prudent investors should already be reducing their equity bets and their risk level in general. One of the more painful lessons in investing is that the prudent investor (or “value investor” if you prefer) almost invariably must forego plenty of fun at the top end of markets. This market is already no exception, but speculation can hurt prudence much more and probably will. Ah, that’s life. And with a Fed like ours it’s probably what we deserve.
That is a very good question. When I operated a partnership, I got hit in 1973 and 1974, which was the worst collapse since the 1930s. So I got hit with a once-in-50-years-type event. It didn’t bother me with my own money, but it made me suffer the tortures of hell as I thought through the loss of morale of the limited partners who had trusted me. And the agony was compounded because I knew that these assets were sure to rise because they could be liquidated for more than I’d bought them for in due course. But the individual securities were traded in liquid markets so I couldn’t mark them up from the trading price because the opportunity cost for my partners was set by the trading price. I would say that was pure agony. The lesson from that for all of you is that you can have your period of pure agony and live through is for many decades. It’s a test of character an endurance.
I don’t think any fully engaged young man wouldn’t have gotten into the pain that I did in 73-74. If you weren’t aggressive enough and buying on the way down and having some agony at the bottom, then you weren’t living a proper investment life. I wouldn’t quarrel with anyone who was more cautious and less aggressive than I was. But what got me into the agony was buying things for far less than what I was sure I could liquidate them for in due course. I don’t think it was wrong, but it was agony.
We don’t do a lot of involved math with schedules of investments. Certainly we expect a decent return or we don’t do it. We use a lot of experience and do it in our heads. We distrust others’ systems [and complex models] and think it leads to false confidence. The harder you work, the more confidence you get. But you may be working hard on something you’re no good at. We’re so afraid of that process that we don’t do it.
Sunday, November 17, 2013
“The seed of a bamboo tree is planted, fertilized and watered. Nothing happens for the first year. There´s no sign of growth. Not even a hint. The same thing happens – or doesn´t happen – the second year. And then the third year. The tree is carefully watered and fertilized each year, but nothing shows. No growth. No anything. Then the bamboo tree suddenly sprouts and grows thirty feet in three months.”
This story is more than a quote about persistence – it’s actually a reasonable description of risk-managed investing. Over the years, I’ve observed that numerous simple risk-managed investment strategies have substantially outperformed the market over the complete market cycle – particularly those that accept market risk in proportion to the estimated return/risk profile associated with prevailing conditions at each point in time. What I may not have done sufficiently is to describe the profile of how that outperformance is typically achieved over the market cycle.
Now you have the problems of the macro scene. Let’s take credit expansion. Consumer credit has expanded to levels that nobody’s ever seen before. All of these credit cards and all of these algorithms… people [meaning lenders] really want that particular customer that’s just crazy enough to overspend but not so crazy that he goes bankrupt. [Laughter] They have computer algorithms to identify these people – they seek them out with clever marketing techniques. I always say it’s like having serfs when you finally get them. They while away at their job and you’re the lord of the manor and at the end of the month they send you [the money they make]. They’ve gotten so rich that [the lenders] keep surfing for more serfs with ever more liberal credit, and so forth. That is the world of consumer credit.
Now you get into mortgage credit. Again, to the people in this room, this is a new world. Warren sold that house in Laguna that he’d owned for many years. He asked the buyer how much he’d borrowed for the $3.5 million or whatever the house cost, and he said 100%. He got an 80% loan and then got an equity line and with a little manipulation, he could borrow 100%. Now you have all these mortgages that say that if it’s inconvenient to pay the interest, it’s no big deal, just add it to the principal and you can get to it later. [Laughter] You not only don’t have to pay the principal, you don’t have to pay the interest! Of course, with this arrangement, you can buy a lovely spread.
And the accountants let people write mortgages like that and let you accrue substantially all of the income even though the credit risk has obviously gone up. And they do that because they can’t see any difference in the credit losses yet. That is not the way I would do accounting – but a lot that I see is not the way I would do accounting.
It was quite logical for people to gamble that with interest rates going down, housing prices would go up. And if you really took advantage of the low interest rates and really laid it on and took on a lot of leverage, I think that was very clever and you could even argue it was totally sound. People did it big time and made enormous amounts of money – unbelievable amounts of money. The rest of us were really dumb. It was a very logical thing to do if you stop to think about it: as interest rates were sure to go down, the value of property was sure to go up. The rest of us were stupid. It looked risky, but really wasn’t. It was a pretty smart thing for these people to do.
Whether it’s smart to continue it now from our present level is a very interesting question. I would think no. There are many instances of collapse after liberal mortgage lending. England had a tremendous collapse maybe 10 or 15 years ago.
Let’s talk about commercial lending to real estate developers. A good friend of mine just invested in a very intelligent real estate development project, with a good developer. The total development is going to cost $140 million. And guess how much non-recourse equity the developer put up? $8 million! I don’t care how promising the real estate market is – if you leverage something that much, there could be a lot of pain for the real estate lenders.
We are in a weird period. I think it’s extra dangerous because it’s worked so marvelously well for everybody who did these loony things in the past.
Saturday, November 16, 2013
It doesn’t matter to Warren where the opportunity is. He has no preconceived ideas about whether Berkshire’s money ought to be in this or that. He’s scanning the world trying to get his opportunity cost as high as he can so his individual decisions would be better.
Friday, November 15, 2013
Found via GuruFocus.
Nov. 14 (Bloomberg) -- Nassim Nicholas Taleb, a professor at New York University and author of "The Black Swan" and "Antifragile: Things That Gain From Disorder," talks about risks created by government debt and Federal Reserve monetary policy. He speaks with John Dawson on Bloomberg Television's "First Up" on the sidelines of Barclays Asia Forum in Hong Kong.
What is the central theme that the people in this room represent? I’d argue that it’s rationality rather than to make more money than other people. I’d argue that rationality is a high moral duty. It’s the idea the binds us all together. I think that is a really good idea. It requires that you avoid taking in a lot of the nonsense that’s conventional in your time. There’s always a lot of nonsense in anyone’s time. It requires gradually developing systems of thought that improve your batting average and thinking correctly.
Thursday, November 14, 2013
Warren Buffett's conglomerate Berkshire Hathaway owned a stake of about 40 million shares in oil major Exxon Mobil as of the end of September, according to an SEC filing on Thursday.
Based on the most recently available holdings data, that would be enough to make Berkshire the 6th-biggest holder of Exxon shares, with about one percent of the shares outstanding.
Found via Jon Shayne's Blog.
The pending appointment of Janet Yellen as chair of the Federal Reserve Board of Governors gives me great cause for concern. By all reports, she is highly intelligent and, in the opinion of her peers, highly qualified for her new role.
However, we've seen errors in monetary easing set off a bubble in asset prices and the worst recession since the 1930s, proving that at least one other quality is essential for the job she is about to undertake: the intellectual integrity essential for sound judgement.
Yellen could legitimately defend quantitative easing in a number of ways. She could, for example, argue that the risks of high asset prices are counterweighed by QE's intended benefits, including the prevention of deflation. But, instead, she's defended the program with meritless arguments to claim that equity prices are not at dangerous levels.
The problem is the metric she uses to value equity prices. The metric she uses is a common one: the ratio of stock prices of companies overall to their overall earnings -- the traditional price/earnings (PE) ratio. The PE ratio is based, reasonably, on the premise that when you buy a share of any firm, you're essentially buying a stake in its profits, which will either be given to you directly in the form of dividends or invested on your behalf by the company.
A question, though: what measure of profits to use? Yellen is on record claiming that the PE multiple based on assumptions about next year's earnings can be used to show that the market is not overpriced. Here's what she said in 2011:
"Overall ... indicators do not obviously point to significant excesses or imbalances in the United States. ... forward price-to-earnings ratios in the stock market fall within the ranges prevailing in recent decades, and are well below the early-2000 peak."
This is nonsense. On several occasions in the past, the market, based either on the past 12 months' or the next 12 months' earnings, has appeared to be reasonably priced, despite being demonstrably and dangerously expensive based on more reliable measures.
Those more reliable measures include q, which is the ratio of stock market value to real-world replacement value. (It is similar, but not identical, to James Tobin's q, as I explain here.) Another more reliable measure is the Cyclically-Adjusted Price-Earnings ratio or "CAPE," which compares the value of the stock market not to just one year's worth of earnings, but rather to the inflation-adjusted average of earnings for the past 10 years.
And on the flip side, there have also been times when the market looked expensive based on the 12-month PE, but was demonstrably cheap using the much more reliable q or CAPE.
The point is that in order to know whether a market is expensive or cheap, we need many years of data. Cheap markets often fall in the short-term and expensive markets often rise. We cannot therefore judge whether a stock market was cheap or expensive simply by looking back at the following year's change in the share price. Similarly, we cannot even judge from looking at the return over the subsequent decade, say, because the market 10 years from the starting date may have been heavily depressed (as during the Great Depression) or massively over-priced (as in the Roarin' '20s or the dot.com '90s).
Using prospective earnings today is particularly suspect because no one knows what they will be; such forecasts are habitually overstated and they can be wildly wrong. Why were they used? Even the least cynical must suspect that they were used not because of their virtues but because of their defects.
Had the emphasis been placed on q, Yellen should have been worrying that the market on Wednesday, Nov. 13, (S&P 500 at 1782 ) was 68 percent overpriced according to q and over 80 percent according to CAPE. (It was also over 100 percent overpriced according to the dividend yield and while, admittedly, we know the dividend yield is a poor guide to value, it has at least better claims than the PE based on next year's assumed earnings per share.)
I hope, but do not expect, that Yellen apologizes for the error that she has committed. If she does this, my accusation of a lack of intellectual integrity will be promptly and happily withdrawn. It would provide a welcome change to other comments from central bankers who seem to think they can atone for their past mistakes by obstinately adhering to them.
It is weird the way that capital occurs. We have monetized houses in this country in a way that’s never occurred before. Ask Joe how he bought a new Cadillac [and he’ll say] from borrowing on his house. We are awash in capital.
[Being] awash is leading to very terrible behavior by credit cards and subprime lenders -- a very dirty business, luring people into a disadvantageous position. It’s a new way of getting serfs, and it’s a dirty business. We have financial institutions, including those with big names, extending high-cost credit to the least able people. I find a lot of it revolting. Just because it’s a free market doesn’t mean it’s honorable.
UPDATE: Bruce Berkowitz was on CNBC discussing this HERE.
Thanks to Will for passing this along.
Thanks to Will for passing this along.
(Reuters) - Fairholme Capital Management has proposed to buy the insurance businesses of Fannie Mae (FNMA.OB) and Freddie Mac (FMCC.OB), a move that seeks to resolve the uncertain future of the mortgage financiers by freeing them from U.S. government control.
Bruce Berkowitz's Fairholme said it wants to buy the mortgage-backed securities insurance businesses of Fannie and Freddie by bringing in $52 billion in new capital.
The recapitalization plan seeks to raise about $34.6 billion in exchange for preferred stock, and at least $17.3 billion from preferred stockholders in a rights offering.
Wednesday, November 13, 2013
We regard the Leucadia people as very smart. Is it conceivable that the Leucadia people could have one outcome that didn’t work very well? Sure, it’s possible.
I look at telecom and all the change and my reaction is that of Samuel Goldman: “Include me out.” I’m just not suited for this; I don’t know how to predict those outcomes, so I leave it to other people.
This interview took place on September 23 at the annual Clinton Global Initiative meeting, a kind of wonk Woodstock occurring in conjunction with the opening of the 67th session of the UN General Assembly in New York. The 42nd president was ubiquitous at his event, moderating a panel that included Bono, Sheryl Sandberg, and Christine Lagarde. Gates himself bounced between the conference and the UN, appearing on a CGI panel (“‘Big Bets’ Philanthropy”) and meeting with the leaders of Chad, Ethiopia, Pakistan, Japan, and Canada. After warmly greeting each other, the two Bills jumped into conversation, edited here for space and clarity.
Tuesday, November 12, 2013
That said, it’s [AIG] a lot like GE. It is a fabulously successful insurance operator, and with success it morphed into a massive carry business: borrowing a lot of money at one price and investing it at another price. AIG was a big operator that was a lot like GE Credit. We never owned either because even the best and wisest people make us nervous in great big credit operations with swollen balance sheets. It just makes me nervous, that many people borrowing so many billions.
As you can tell in our operations, we are much more conservative. We borrow less, on more favorable terms. We’re happier with less leverage. They’ve been successful, but we’re too chicken to join them. You could argue that we’ve been wrong, and that it’s cost us a fortune, but that doesn’t bother us. Missing out on some opportunity never bothers us. What’s wrong with someone getting a little richer than you? It’s crazy to worry about this.
There’s a lot of leverage in those carry-trade games. Other people are more certain than I am that aircraft can always be leased.
Cort benefited from the venture-capital-financed, new-company boom. You could argue that we made a macro mistake. These companies went away for a while and Cort was affected.
Monday, November 11, 2013
Via Zero Hedge:
In the old days central banks moved interest rates to run monetary policy. By watching the flows, we could see how lowering interest rates stimulated the economy by 1) reducing debt service burdens which improved cash flows and spending, 2) making it easier to buy items marked on credit because the monthly payments declined, which raised demand (initially for interest rate sensitive items like durable goods and housing) and 3) producing a positive wealth effect because the lower interest rate would raise the present value of most investment assets (and we saw how raising interest rates has had the opposite effect).
All that changed when interest rates hit 0%; "printing money" (QE) replaced interest-rate changes. Because central banks can only buy financial assets, quantitative easing drove up the prices of financial assets and did not have as broad of an effect on the economy. The Fed's ability to stimulate the economy became increasingly reliant on those who experience the increased wealth trickling it down to spending and incomes, which happened in decreasing degrees (for logical reasons, given who owned the assets and their decreasing marginal propensities to consume).
As shown in the charts below, the marginal effects of wealth increases on economic activity have been declining significantly. The Fed's dilemma is that its policy is creating a financial market bubble that is large relative to the pickup in the economy that it is producing. If it were targeting asset prices, it would tighten monetary policy to curtail the emerging bubble, whereas if it were targeting economic conditions, it would have a slight easing bias. In other words, 1) the Fed is faced with a difficult choice, and 2) it is losing its effectiveness.
We expect this limit to worsen. As the Fed pushes asset prices higher and prospective asset returns lower, and cash yields can't decline, the spread between the prospective returns of risky assets and those of safe assets (i.e. risk premia) will shrink at the same time as the riskiness of risky assets will not decline, changing the reward-to-risk ratio in a way that will make it more difficult to push asset prices higher and create a wealth effect.
Said differently, at higher prices and lower expected returns the compensation for taking risk will be too small to get investors to bid prices up and drive prospective returns down further. If that were to happen, it would become difficult for the Fed to produce much more of a wealth effect. If that were the case at the same time as the trickling down of the wealth effect to spending continues to diminish, which seems likely, the Fed's power to affect the economy would be greatly reduced.
It isn’t enough to buy the right business. You’ve also have to have a compensation system that’s satisfactory to the people running them. At Berkshire Hathaway, we have no [single] system; we have different systems. They’re very simple and we don’t tend to revisit them very often. It’s amazing how well it’s worked. We wrote a one-page deal with Chuck Huggins when we bought See’s and it’s never been touched. We have never hired a compensation consultant.
And an example of it gone wrong:
The recent historical experience of mobile homes – actually, it’s “manufactured”; they’re not manufactured to move – is that you had a bunch of no-good nut cases and a balloon of unfortunate, commission-sales-driven activity. Any time you let people on sales commission set the credit standards for people using margin [e.g., debt to buy the home], you create a disaster. It’s like mixing oxygen and hydrogen and lighting a match.
Investors who believe that history has lessons to teach should take our present concerns with significant weight, but should also recognize that tendencies that repeatedly prove reliable over complete market cycles are sometimes defied over portions of those cycles. Meanwhile, investors who are convinced that this time is different can ignore what follows. The primary reason not to listen to a word of it is that similar concerns, particularly since late-2011, have been followed by yet further market gains. If one places full weight on this recent period, and no weight on history, it follows that stocks can only advance forever.
What seems different this time, enough to revive the conclusion that “this time is different,” is faith in the Federal Reserve’s policy of quantitative easing. Though quantitative easing has no mechanistic relationship to stock prices except to make low-risk assets psychologically uncomfortable to hold, investors place far more certainty in the effectiveness of QE than can be demonstrated by either theory or evidence. The argument essentially reduces to a claim that QE makes stocks go up because “it just does.” We doubt that the perception that an easy Fed can hold stock prices up will be any more durable in the next couple of years than it was in the 2000-2002 decline or the 2007-2009 decline – both periods of persistent and aggressive Fed easing. But QE is novel, and like the internet bubble, novelty feeds imagination. Most of what investors believe about QE is imaginative.
As Ray Dalio of Bridgwater recently observed, “The dilemma the Fed faces now is that the tools currently at its disposal are pretty much used up. We think the question around the effectiveness of QE (and not the tapering, which gets all the headlines) is the big deal. In other words, we’re not worried about whether the Fed is going to hit or release the gas pedal, we’re worried about whether there’s much gas left in the tank and what will happen if there isn’t.”
Sunday, November 10, 2013
Thanks to Kjetil for passing this along. I hope there's a full class video that comes out of Columbia one day of Mohnish's presentation.
The stock market is near record highs. More money came into U.S. stock mutual funds the week of Oct. 23 than during any other week since 2007. Initial public offerings like Twitter are booming.
At first, the question sounds crazy. With interest rates and inflation at current levels, holding cash virtually guarantees you will suffer losses after accounting for the erosion of your purchasing power. Major money-market funds yield an average of 0.02%, according to Crane Data. As a result, you will need a year to wring $2 in interest out of a $10,000 account. And by then, inflation will have taken $120 of your money at the 1.2% annual rate reported by the Department of Labor for September.
But cash doesn’t earn its keep on yield alone. All investors should realize that cash can be priceless, even when its yield after inflation is negative. Cash “is an option on the future,” says Abhay Deshpande, a portfolio manager at the New York-based First Eagle Global and First Eagle Overseas mutual funds, which have $58.4 billion in combined assets.
Having a cushion of cash can help you stay invested when stocks tumble — as they surely will sooner or later. And a cushion can enable you to do what cash-poor investors find almost impossible: Buy stocks and other assets as bear markets turn them into bargains.
There are worse fates than posting losses on cash after inflation, says Dowe Bynum, a portfolio manager at the Cook & Bynum Fund in Birmingham, Ala. “Putting a lot of money to work in overpriced, inferior businesses — that’s going to end up way more destructive to your capital than sitting in cash for a while with a negative return,” he says.
Mr. Bynum and co-manager Richard Cook haven’t been able to find a significant new stock position to add to their fund in more than a year. So cash has climbed to roughly 43% of the fund’s $135 million in assets, up from 26% in 2011.