Tuesday, August 23, 2016

Biased Geeks ?

Republicans like to believe that journalists are closet-liberals, and I suspect there is some truth to that.  They also like to believe that professors are closet-liberals, and, with notable exceptions, there may be some truth to that as well.  But, I'm not aware of any similar sweeping generalizations about economists.

There are two main trade groups for economists, i.e., the American Economic Association and the National Association of Business Economics.  While there is considerable overlap in membership, AEA tends to have more academic and government economists, while NABE has more economists from the private sector.  (I have been a NABE member for many years.)

The latest survey from NABE found that 55% of the members think Hillary Clinton would do a better job than Donald Trump in managing the economy.   Only 14% thought Trump could do a better job.  Surprising, 15% thought Libertarian Gary Johnson could do a better job, slightly more than Trump.

One possible conclusion is that business economists are overwhelmingly in favor of Clinton.  Another conclusion is that they understand the economic plans of Clinton and Johnson, who have presented more detailed economic plans than Trump.  That tired bromide of "reducing taxes on job-creators" resonates with economists less and less.

One impossible conclusion is that business economists are also closet liberals.

Sunday, August 21, 2016

A Real Local Legend

Luckily, I grew up on the beaches of Virginia Beach.  My perception of reality was an endless loop of Beach Blanket Bingo movies with Annette Funicello.  It was a pleasant perception of reality, indeed!

A generation before me, Ed Shames was born in 1922 in Virginia Beach and also enjoyed being outdoors as he grew up there.  His father died at age 42 from pneumonia in 1927.  The family owned a country store on Virginia Beach Boulevard, and Ed lived with them above the store, until Ed volunteered to become a paratrooper in World War II, where he became a legend.

A new book by Ian Gardner entitled Airborne:  The Combat Story of Ed Shames of Easy Company brings his heroic story back to life vividly.  Ed became one of the famous "Band of Brothers" who parachuted into Normandy on D-Day, landing behind enemy lines on a milk factory, and fought in some of the best known campaigns, including Bastogne at the Battle of the Bulge.  He was involved in the liberation of the horrible extermination camp of Dachau and the technically difficult capture of Hitler's Eagle's Nest, at the end of the war.  His bravery and heroism is beyond question.

I speculate that his perception of reality was very different from mine.  Reading his autobiography was like describing a pinball machine - a steel ball bouncing unpredictably across geography and between people.  Fortunately, Ed somehow survived to return to Virginia Beach, where he still lives.  While I have never met him, it would be my honor to salute him!

To better understand the horror of war, you should read this book.

To better understand how heroes think and process emotion, you should read this book.

Saturday, August 20, 2016

Insuring A 77% Loss

Some people think of their financial advisors as just that -- someone to discuss and "brainstorm" financial matters.  Some people think of us as someone to delegate and perform financial duties.  Some people think of us as economic or financial wizards to manage their investments.  I think we are paid to worry.  (Years ago, a dear client visited Greece and brought back a fancy set of "worry-beads" for me, because I was his "designated worrier."  He has now passed, but those worry-beads still hang beside my monitor, and I look at them every day.)

Good financial investors do worry, especially about risk -- all types of risk.  Investors want to see investment returns but rarely ask about risk-adjusted returns, which are much more important.  But, does a good financial advisor need to worry about a client who has a high probability of suffering a life-altering event over the next 25 years with an average decrease of 77% in their net worth?  Yes, of course!

According to AAA, there is a 33% probability you will get divorced, compared to a mere 25% probability you will have a serious car accident in the next decade.  (67% of second marriages fail, proving people don't learn from their mistakes.)  We would always advise clients to have car insurance, but should we advise them to also buy marriage insurance?

One insurance company is preparing to launch such a product.  Obviously, we could never recommend it until the details are published, but do we have an obligation to protect our clients from divorce?  We are designated worriers, not designated busy-bodies!  We already do estate planning for the possibility of divorce, including pre-marital and post-marital financial counselling, and are very careful with account titles, but do we have the responsibility to recommend insurance for that type of risk, as we do for life insurance, auto insurance, and property insurance, etc.

I think we do, especially for younger female clients, but watch this space . . .

Friday, August 19, 2016


Bullying is getting the condemnation that it deserves.  Saying hurtful things to some poor kid is simply wrong.  Yet, saying hurtful things about some government official is somehow viewed as patriotic.

Hurtful and ignorant things are said about the Fed every day.  The stock market obsesses over every word and comma in Fed minutes.  Now, put yourself in one of the vacant seats on the Fed's Board.  You know you need to raise interest rates, because low interest rates hurt savers, mostly old people.  You also know that rising rates typically cause the economy to slow somewhat, which hurts the unemployed.  You know that deflation is a much worse problem than inflation and that raising rates pushes us closer toward deflation.  Importantly, you know that raising interest rates makes the dollar stronger.

Many people view a strong dollar as a patriotic objective, but those people are not exporters (down 4% for the first half of this year).  This makes our balance of payments more negative, which actually subtracts from GDP.  A stronger dollar is bad for employees in export-related industries.  If the Fed raises interest rates, savers will be happy, but export workers will be unhappy.  The Fed must pick which people are winners and which are losers.  Theoretically, the Fed is insulated from political considerations and can pick winners and losers on the basis of the greater good, and I believe they are.

But, there is no shortage of Fed-bullies!  Libertarians hate the Fed precisely because the Fed can pick winners and losers.  Tea-partiers hate the Fed because they hate everything about the government, any government.  Establishment Republicans privately support the Fed but are too cowed to defend it.  And, Democrats are too fixated on employing every last American to even discuss an interest rate increase, much less actually raise rates.

Now, how would you like Janet Yellen's job?  Did you enjoy being bullied as a kid?

Wednesday, August 17, 2016

Wise Advice From The Left

Arianna Huffington is a highly successful businesswoman and founder of The Huffington Post.  Therefore, I assumed she was just another political hack and not worth reading.  Then, I read a review of her new book entitled The Sleep Revolution and decided to buy it.  I recommend you do the same.

Everybody knows sleep is important, but she writes about numerous scientific studies and anecdotal evidence that strongly suggest it is not just more important than you think -- but is far more important than you ever suspected.  The most important thing you can do each morning is to plan for and protect your sleep for that night.

Everybody knows the basics of sleeping better, i.e., don't eat a heavy meal, go to bed earlier, cut off the TV and other electronic devices, etc.  Now, do you follow those rules faithfully and religiously . . . or only when convenient?

Everybody knows alcohol is bad for you. but did you know that, while it can increase the quantity of your sleep, it reduces the quality of your sleep?  Higher quality is more important than higher quantity.

She does pose an interesting question:  when there must be trade-offs between eating, exercising, and sleeping, why is it that sleep is the first to be short-changed?  In our competitive society, why do we brag about how little we sleep, instead of being ashamed?  What is the value of eating and exercising intelligently, if you sleep stupidly?

How can you manage your health if you have a flippant attitude toward sleep?

Tuesday, August 16, 2016

We Deserve Better

Our government can shape our economy with both monetary policy and fiscal policy.  Monetary policy is controlled by the Fed and is concerned with interest rates, changes in the money supply, management of its huge portfolio of Treasury debt, and so forth.  Fiscal policy is controlled by Congress primarily and the President secondarily.  It includes budget policy, debt policy, trade policy, and tax policy.

While the world is transfixed by our clownish presidential election, Congress has gone home, and there is no budget for the new fiscal year beginning in six weeks.  When they return, they will only have seventeen working days to agree on the budget.  That means we will have yet another government shutdown October 1st, or Congress will string together enough "continuing resolutions" (CR) to keep the doors open and to minimize our national embarrassment.

Budget policy is important, because it allocates funds across sectors of the economy.  For example, infrastructure-related companies will be hurt if infrastructure funds are instead allocated to Medicare spending.  How do you allocate funds across the economy determines whether you eat your seed corn in the short-term or plant it for the long-term.  Budget policy is very important, and Congress only has seventeen days to develop a thoughtful budget . . . fat chance!

Debt policy has become important since the U.S. decided to become the only nation with an arbitrary ceiling on the amount of debt issued by the central government.  Since it has become a pointless exercise in partisan brinkmanship, the debt ceiling has been temporarily suspended, but it returns next March.  Unless either party wins the presidency and both legislative houses, it is unlikely this ridiculous relic can be eliminated.  Another bitter, nonproductive partisan battle can be expected.

So, if you are hoping for less partisan bickering when you get out of bed on Wednesday, November 9th . . . just go back to bed!

What a way to run the greatest country in the world!

Thursday, August 11, 2016

The TINA Effect

Probably, before the first investment strategist was ever born, investors were asking if the stock market was over-priced and headed for a collapse.  Today, the most common response is in terms of the price-earnings (PE) ratio.  It is the same as the PE ratio for individual stocks.  You take the market price of the stock and divide it by the earnings-per-share (EPS) for that stock.  Tallying up all the stock PE ratios, you find the overall market's PE ratio.

Looking at this chart, you can see the market's PE ratio has broken above an important resistance line, which is 22 times or 22X.  This suggests the stock market is indeed over-priced and headed for a fall.

Chart of the Day

Of course, nothing is ever as simple as it first appears.  This chart looks at earnings in the rear-view mirror.  As EPS have dropped slowly for the last five quarters, the simple arithmetic  has driven up the PE ratio.  Now, most strategists expect EPS to start rising this quarter, which will decrease the market's PE ratio, hopefully back below 20X.

Another argument is that PE ratios were a useful benchmark when we had a "free market economy" instead of a "monetary policy economy." which is driven by the Fed.  Frankly, I think that lends too much significance to the Fed's actions, but it is clear that abnormally low interest rates do boost EPS and increase demand for those stocks paying dividends.

This is called the "TINA" stock market, meaning There-Is-No-Alternative to stocks.  If investors want income, they have to buy stocks, since bonds pay less than stocks.  This alone will push the PE ratio above the resistance line.

So, is the stock market over-priced?  Yes, based on current earnings, but not by much.  No, based on projected earnings.  Is the sky falling?  No, not today . . . but tomorrow is always another day!

Wednesday, August 10, 2016

August All Twelve Months

The August projections from the august and imperial Goldman Sachs (GS) are as follows:

1.  GDP growth remains stable in the U.S., rising from 1.9% this year to only 2.0% by 2018.  (I'm guessing they expect a Clinton victory and a continuation of current economic policies.)

2.  In Japan, it rises from 0.4% this year to 1.1% in two years.  (This nice increase is driven by debt.)

3.  European GDP growth will bump along from 1.3% this year, 1.2% next year, and 1.6% in 2018.

4.  Post-Brexit Britain will drop from 2.3% last year to only 0.2% next year but up to 1.3% in 2018.  (This is what happens when you shoot yourself in the foot.)

5.  China's growth continues to drop from 6.9% last year, 6.4% next year and 6.1% in 2018.  (This reflects the Law of Large Numbers.)

6.  Significantly, advanced economies will grow at a 1.7% level, while the world will grow 3.1% this year and 3.8% in 2018.  (This is an important shift!)

7.  The S&P 500 will decrease a minor 1.2% over the next twelve months, while European stocks will drop 1.6% and Japan's will drop 2.1%.  (A nice improvement in Japan's GDP growth rate, but their stock market will have a slight decline.)

8.  Interest rates will increase 0.73% in the U.S., 0.53% in Europe, and 0.35% in Japan over the next twelve months.  (I don't believe this, especially for the U.S.)

9.  The euro will drop 8.9% against the dollar over the next twelve months, compared to the pound dropping another 4.5% but the Yen appreciating a 17.6%.  (Start planning your next European vacation.)

10.  Oil will increase 24.8% to $57/bbl over the next twelve months, while gold will lose 5.4% and copper will lose 19.3%  (The increase in the oil price makes sense, but I don't understand how copper could drop so much unless there is a recession, which they are not predicting.)

Tuesday, August 9, 2016

Good Things Are Not Always Good

When President Kennedy cut taxes, the economy boomed and the GDP grew nicely.  When President Reagan cut taxes, the economy boomed and the GDP grew nicely.  Since two dots make a line, does that mean that all tax cuts make the economy boom and GDP grow nicely?  If so, why didn't the two Bush II tax cuts do the same?

Below is the Laffer Curve by Arthur Laffer, the father of Supply-side economics.  Now study it!  If the economy is left of the vertical red line, you can increase taxes and government revenue will also increase.  If the economy is right of the vertical red line, any further movement to the right or any increase in tax rate will actually lower revenues to the government, because taxes will begin strangling the economy.

Laffer argues the economy is somewhere far to the right of the vertical red line already, and any tax cut will actually increase revenue to the government.  That's what happened when Kennedy and Reagan decreased tax rates.

The difference between Republicans and Democrats is that Republicans think the economy is on the RIGHT side of the vertical red line, while Democrats think the economy is on the LEFT side of that line.

But, what explains the success of Kennedy and Reagan, along with the failure of Bush II?

Taxes never exist in a vacuum.  There are always other factors.  Kennedy and Reagan were lucky enough to have a weak labor market and a low national debt-to-GDP level, which meant increases in the national debt were bearable.  Bush II was not that lucky, and our national debt spiraled from his tax cuts.  Another tax cut now would have the same effect - another explosive increase in our national debt without improving an already strong labor market.

Go to www.usdebtclock.org 

No, stop what you are doing and go there . . . NOW!

Monday, August 8, 2016

Great Advice!

One of the smartest things my father ever taught me was the importance of being informed, especially about international affairs.  Of course, he had no way of knowing the burden of being over-informed would ever become so great, especially about politics.

The smartest thing I've done this year is to put myself on a news-diet by declaring Saturdays a news-free zone.  That means no network news, plus no Fox News, no CNN, and no MSNBC.  (Is there really anything more you need to know about the "truthiness" of either Clinton or Trump?)  The initial withdrawal pangs of being news-free will be quickly replaced by an improved ability to both breath and think.

I must confess to making an exception for local news, primarily for weather and sports.  Another murder down the street is no more depressing than another joke about the size of Trump's hands.

Banal, repetitive news is only going to get worse over the next three months, between now and election.  Do yourself a favor -- find a news-free zone!  Do your spouse a favor -- create a news-free time to be together!  Do the world a favor -- cut off the television!

Besides, a tormented mind is not a useful tool for decision-making, especially about your portfolio!

Saturday, August 6, 2016

Just Another Great "Jobs Report"

Economists have been hard-pressed to find something they don't like about yesterday's "jobs report."  I found two.

Expecting 180 thousand jobs, America produced 255 thousand jobs in July.  This repeated the same happy surprise in the June jobs report.  Where is the recession?  Is the economy really as slow as indicated by the GDP reports over the first two quarters?  No!

So, what is not to like in yesterday's report?

Primarily, the U-6 level of unemployment actually increased slightly to 9.7%.  This is that heartbreaking level of unemployment of those people who are unemployed, plus those people who are under-employed, plus those people who want full-time work but can only find part-time work, plus those people who have just given up.  It has been falling faster, thankfully, than the more widely-discussed U-3 level of 4.9%.  Why did the unemployment rate for the most desperate workers stop decreasing and actually tick up?

Secondarily, the Labor Force Participation Rate (LFPR) is barely moving.  Only 62.8% of working-age Americans are contributing to the GDP.  Over a third of working-age Americans are not working.  Republicans argue people have been made lazy by welfare payments.  Democrats argue that huge numbers of baby-boomers are retiring and no longer contributing.  Austrian economists argue that anything that encourages people NOT to work is un-American.  We call it Social Security.

Thursday, August 4, 2016

The View From The Bottom

Mega-bank Wells Fargo does an excellent Small Business Survey each quarter, and I look forward to it.  The latest is interesting on two points.

First, business confidence is now the highest since the Global Financial Crisis of 2008/9.  While they are accepting limited upside in revenue, they are keeping a tight rein on expenses.  (This is the main reason that business investment and hiring have been so slow to improve.)  They don't foresee any recession in the near term.

This economic data point is often used as a guidepost for the health of small cap stocks.  Right now, this latest survey reinforces the traditional notion that small cap stocks are more profitable in the long run, even if more volatile in the short run.  Given the slowing economies of Europe and Asia, we can expect weaker performance from large cap stocks, relative to small cap stocks.

Second, 87% of small business owners are paying close attention to the presidential election, with 54% saying they understand the positions of the candidates "very well or extremely well."  72% expect their businesses to be impacted by the election.

This is interesting when compared to the latest University of Michigan survey of consumers, instead of businesses.  36% of consumers think the election makes no difference at all,  Maybe, this difference between consumers and business can be explained by businessmen being more educated voters.  Maybe, it is the paranoia of businessmen.  Or, maybe not . . .

Things are not so bad . . . regardless of what the media says . . .

Wednesday, August 3, 2016

Following The Nose

Long ago, farmers and ranchers learned that the easiest way to control cattle and other large livestock was to put a ring in their nose.  They could then tether the cattle to a particular location or lead them around by simply controlling the ring.

The stock market has always had a ring in its nose.  Since the Global Financial Crisis of 2008/9, the Fed has controlled the ring and the market has faithfully followed the Fed upward.  However, since mid-2015, the oil sector has controlled the ring.  Taking a look at this graph, it appears that oil may be leading the market in the wrong direction again.

Chart of the Day

But  notice the long-term trend-line for oil prices -- that area between the red and green lines.  History suggests that oil prices will revert to the mean -- that it will come back within the trend-lines, at least above the green lower boundary.  If so, oil will release the nose-ring, and the market will wander aimlessly . . . until something else seizes the ring, like some geopolitical event or some technological breakthrough or some change in corporate tax rates or ... ?

More important than who is controlling the ring -- is whether the animal is still getting bigger and stronger in the meantime?

Yes, it will !!

Tuesday, August 2, 2016

On The Other Hand ...

Bob Doll is the highly-respected chief equity strategist at Nuveen Asset Managment.  In his commentary yesterday, he stated "a slowly growing economy, improving earnings, and low bond yields should provide a tailwind for U.S. equities."  Despite the unexpectedly low 1.2% GDP growth in the second quarter, I agree with him.

Yesterday, the equally-respected Jeff Gundlach of DoubleLine said "investors seem to have been hypnotized that nothing can go wrong."  He advocates selling everything and buying gold.  Despite the certainty of a recession somewhere in our future, I disagree with him.

One of the best practices in portfolio management is avoid making 100% bets, and selling everything is a 100% bet.  If you are that concerned, just increase your cash position to, say, 25% and allocate your remaining stocks into consumer staples, which normally weather recessions fairly well.

Another thought is "that's what makes a market!"  Every time you buy a stock, there is a seller who doesn't want it.  Every time you sell a stock, there is a buyer who thinks that stock is a good deal.  Investment strategists are the same way.  Some are bullish, and some think the sky is falling.  That's what makes a market for ideas!

There has never been a day in American history when somebody was not standing on a street corner, wearing a sign that says "the end is near."  Listen respectfully, and then . . . be brave!

Monday, August 1, 2016

Timing Is Everything

Last week, I wrote that the stock market would continue dancing as long as the band keeps playing the music -- meaning there are few worrisome near-term danger signals to the stock market from either the economic or valuation standpoint, as long as the Fed remains "accommodative."

A friend and faithful reader told me that was inconsistent with my oft-stated concerns about the debt level causing a "black swan event."  By definition, timing such an event is unknowable.  I still expect a "black swan event" or a "Minsky Moment" when there will be a sudden financial collapse . . . but not in the foreseeable future.  The only defense against the unknowable is acting fast when it starts.  And, how do you know when it starts?  When derivatives start defaulting . . .

There has never been a day in American history when there was not an upcoming recession.  There is always a recession out there somewhere . . . but not today.

In the meantime, may I have this dance?

Saturday, July 30, 2016

What, Me Worry?

As 2016 began, worldwide stock markets were suffering with the collapse in the energy sector, as well as a slowing China.  (I was especially concerned about a derivatives default by Glencore.)  Yet, the markets recovered.

In June, the surprise Brexit vote stunned worldwide stock markets, who were terrified of the possible collapse of the European Union.  Yet, the markets recovered.  Indeed, European stock markets gained 4.81% in July!

July was good to all worldwide stock markets.  Developed markets outside the U.S. gained 5.11%.  Emerging markets gained 4.84%  Japan was up 5.73%, Latin America up 5.52%, and Australia up a whopping 6.95%.  The Dow was up a relatively modest 2.94%.

It would be pleasant to believe these improving worldwide stock markets reflect improving worldwide economies.  Oh, how naive!  Part of this good stock performance is undoubtedly due to some stabilization in China's economy and the energy sector, but most is due to increasing confidence in central banks to keep increasing the supply of money.  As long as they keep playing the music, stock markets will continue dancing.  Darn it!

Friday, July 29, 2016

Real Men Don't Cry

Real men don't cry!  Yet, tears rolled down my cheeks last night.  Nothing - absolutely nothing - brings me to tears quicker than our American soldiers.  I am sorry for the loss of every person, every adult, every child and even animals.  But, I don't cry . . . except for our soldiers.

Last night, the quiet dignity, grace and barely-contained-rage of Khizr Kahn from Charlottesville brought me to tears, as he remembered the brave death of his 27-year-old son in Iraq, a Muslim Army Captain who laid down his life for his Christian troops.  I felt his pain, I felt his rage . . . and I cried.

The powerful emotional tug was not surprising.  That it occurred during a partisan attack was both surprising and disturbing to me.  My unrelenting cynicism of partisan blathering just melted away.  With sunrise, my brain has now silenced my heart, and I can feel the cynicism returning . . . thankfully.

Thank you, Mr. Khan!  Thank you for sacrificing your son for us!  Thank you for your powerful speech last night.  But, I never want to hear it again!

Thursday, July 28, 2016

The Most Common Question

Everybody lives in fear . . . of something!  Investors live in fear of sudden market crashes (even though each has been followed a recovery).  They have vivid memories of the Crash of 1929, the Crash of 1987, and the Global Financial Crisis of 2008/9.  As long as the bulls run, there will be an increasing fear that "the end is near."  It is the most common question I receive.

The shorthand method of explaining whether the market is over-priced is by examining PE ratios.  A Price-Earning ratio is the market price of a stock divided by the earnings-per-share of that stock.  For example, if a stock is earning $10 per share, while the value of that stock is $100, then the PE ratio is ten.  Aggregating all those individual stocks into one number is a reasonable indication of whether the stock market is over-priced and likely to soften.  (While analysts have devised variations of a PE ratio, this is still the most common shorthand method.)

Historically, we've said the market is overpriced when the PE ratio rises above the 16 - 18 range.  Today, it stands at 20, making it overpriced.  However, the PE ratio for the energy stocks is a whopping 53.  That means the fall in stock prices of oil companies has not kept up with the fall in oil prices.  There is no equilibrium in the energy sector, causing an abnormally high PE.  This skews the average PE higher for the whole stock market.  If you factor out the energy sector PE, the overall PE ratio is only 16.

So, the market is not overpriced.

That does not mean the stock market will not soften, because IT WILL . . .  at some point.  It will strengthen and soften mildly with the normal ebb-and-flow of investment dollars sloshing around, but I don't believe the stock market will soften because it is overpriced . . . today!

Tuesday, July 26, 2016

Live Luggage

As anybody who has boarded an airplane recently knows, passengers have almost as many rights as their suitcases in the hold.  There is a website that follows this issue, i.e.,www.flyersrights.org

Here is a copy/paste from today's email from them:

Dysfunctional Relationship
The Reason for Congressional dysfunction
July 26, 2016

To put it briefly, it's minority rule. In the House, under the Hastert Rule -named for a disgraced  former Speaker - legislation cannot be voted on unless a majority of the majority approve.
So, as little as 26% can block votes. In the Senate, as explained to me by former Senate Republican Leader Bob Dole, unanimous consent is required for most votes. Any one senator can place an indefinite and anonymous hold on legislation and the mere threat of a filibuster normally stops the Senate cold.

These congressional rules used by both parties thwart majority rule and popular will in a way never imagined by the Founding Fathers and not supported by anything in the Constitution.

They enable partisan factions, or even a single member of Congress, to block legislation and even shut down the government. When approval of a governing legislature sinks to single digits in other countries it often leads to revolution or a coup.

Short of that, or a state-called constitutional convention, both parties and both presidential candidates should make restoration of majority rule in Congress a cornerstone of reform for 2017.  

Otherwise it will be SOS going forward, as practical, popular and needed legislation is continually smashed, needed compromises cannot happen and American government will continue as by and for entrenched special interests. 

Paul Hudson
President, FlyersRights.org
Sarasota, Florida

Aging Investment Clubs

Years ago, I had lunch in the historic Old Ebbet Grill across 15th Street from the White House and next to my office at the corner of New York Avenue in Washington, D.C.  I was with two security analysts - genuine nerds - who got into a rather heated argument as to whether Merck (MRK) or Pfizer (PFE) was a better stock to own.  From memory, they were actually quoting footnotes from the financial statements of the two companies.  I was amazed.

To me, it was the perfect example of classic security analysis, originated by legendary Benjamin Graham in his aptly-named Security Analysis back in 1934, who was incidentally the mentor to Warren Buffett.  He advocated extensive, never-ending analysis of all financial statements.  There is still general agreement among investment analysts that this is very important - important as the basic foundation of general security analysis.

Investment clubs sprouted all over the country, composed of individuals willing to share the work of studying so many different financial statements.  Over time, they earned a good reputation for investment performance, often beating the professionals.  Club members were justifiably proud of their portfolios.  But, their performance has started to falter.  Unfairly, some has suggested the problem is the advanced average age of the investment clubs, but that is incorrect.

The real problem is that basic security analysis started developing after the year 1934, during the industrial age and long before the information age.  (Read Alvin Toffler's The Third Wave.)  It was during this period that generally accepted accounting standards (GAAP) were also developed.  Despite honest efforts of the accounting standards board to evolve, GAAP just doesn't help very much in the evaluation of non-industrial companies.

When the company name is so ubiquitous it becomes a verb, like Google (now Alphabet), what is the value of that asset?  When the company name becomes dominant in an industry, like Facebook dominating social media, what is that worth?  How do you amortize the front-end costs of getting new subscribers, like Netflix?  Industrial age accounting is actually an obstacle to evaluating information age stock.

My advice to all investment clubs is to put down the financial statements, take off your bifocals, recruit more teenagers, and actually listen to them.  (I know, I know . . . I don't like doing that either.)

Wednesday, July 20, 2016

R.I.P. (Run-In-Peace)

Thirty-two years ago - today - one of my personal heroes died, at the tender age of 52.  Like many veterans, my physical conditioning slowly faded away after leaving the military.  Then, in 1977, Jim Fixx wrote The Complete Book of Running, helping me lose 20 pounds and regain some of that lost-fitness.  Ironically, when he died, the lean, muscular runner . . . was running.  One day, everything was fine, and the next day, it wasn't.

In 1996, Hyman Minsky died.  He was an American economist, arguably a Keynesian economist, even though he often sounded like an Austrian economist.  He developed the notion that borrowers would keep borrowing money until they couldn't.  In other words, the balloon will keep expanding until it finally bursts.  That moment of bursting is now called "'the Minsky moment."  We saw such a moment in 2008, following the subprime crisis.  One day, everything was fine, and the next day, it wasn't.

In 2007, Nassim Nicholas Taleb wrote the instant classic Black Swan:  The Impact of the Highly Improbable.  He explained the advent of bad things as (1) surprising, (2) sudden and (3) obvious only in hindsight.  The global financial crisis of 2008/9 illustrated his theory perfectly.  One day, everything is fine, and the next day, it isn't.

The philosophical point might be to enjoy every minute of every day, as everything could change in a heart beat.  The investing point is that the "buy-and-hold" strategy -- holding investments throughout all bear markets because the stock market always comes back -- applies only during normal garden-variety recessions, not during Black Swan events.

Now, get out there and enjoy THIS day!  Do it for Jim . . .

Tuesday, July 19, 2016

A Stumbling Giant ?

Italy is one of the ten largest economies in the world, and it is the weakest.  Real GDP is the same now as it was fifteen years ago.  The heart of any economy is the banking system, and Italy may have the weakest.  Remember how low stock prices were in January of 2009?  The share prices of Italian banks are already 60 percent lower than that!  Bad loans (which become direct charges against the capital account when written-off) stand at 8 percent and could rise to a staggering 15 percent this year.  If so, watch out!

Early this year, I was worried about Glencore, the U.K.-based commodities giant, posing a global financial threat.  Fortunately, they sold enough assets quickly to avoid that fate.  Now, I'm worried about the Italian banks.  The combination of under-capitalized banks with as much as 15 percent non-performing loans in a nation with no productivity growth, an aging population, and lavish entitlements . . . . . what could go wrong?

What could go wrong are the credit default swaps, sold to protect bondholders against losses in bonds issued by the Italian banks.  Nobody knows who is "holding the bag" and must absorb those losses.  Therefore, nobody knows which of these derivatives may "blow-up."

Analysts point out that direct U.S. exposure to Italian banks is only 0.4 percent of bank assets, but that reminds me of Ben Bernanke saying subprime mortgages only represented 1 percent of all mortgages in this country and look what happened.

The next pivotal date is July 29th, when European authorities will release results from a stress test of their banks.  If it calls for a major re-capitalization, the stock market will over-react.  If it does not, I will be even more worried.

Monday, July 18, 2016

Pet Peeve #139

Are engineers the only travelers permitted to take showers?  When I grew up, it was easy to turn the shower on and set just the right temperature.  Today, in an effort to be "new and trendy," hotels compete on having exotic hardware in the bathrooms.  I'm sure that costs the hotel a little extra, which is embedded my bill somewhere, which means I'm paying more to rent a shower I cannot figure out.  After all, I only have three college degrees and two certifications . . . but I have no degree
in engineering.

Remember:  Don't just innovate - design something totally unnecessary!

Pet Peeve #207

Is there no place to hide from pollution?  I'm talking about political pollution!  Are we so polarized that we must carry our political leanings onto the beach with us?  Does beautiful weather on a July Sunday afternoon compel true-believers to strut their opinions?  What is the point anyway?  Do they think they will change somebody's opinion?  Do they think this is just another silly game?

Of course, in a state where you can carry a gun into church, why wouldn't you demonstrate your politics on a beach?

Merely being legal . . . does not mean it is in good taste!

Sunday, July 17, 2016


Warren Buffett has said you should buy the stock of a company when you like it and sell it when you don't like it.  His point was to ignore the stock market as a whole.

Some investment managers like to invest on the basis of "drivers" or things that will drive the value of a stock upwards.  Examples are stock buybacks, takeover rumors, or activist interference.  (This is sometimes called "factor-based" investing.)   Guess what -- so far this year, 82 percent of those investment managers have under-performed the Russell 1000 index, which is huge!

It appears there are too many investment managers chasing the few companies that have one of these characteristics or "factors."  These causes stocks with those characteristics to become "crowded."  The ten most crowded stocks under-performed the ten least crowded stocks by a whopping eighteen points so far this year, which is also huge.

This re-ignites the long-running debate as to whether professional investment management is worth the cost or whether the investor should simply buy the index.  The research on this is voluminous, and it is easy to argue both sides.  My observation is that simply buying the index is fine in a bull market but not in a bear market.  Of course, it is always convenient to have a professional manager when making that decision.

Besides, if 82 percent of managers did not beat the index this year, that means 18 percent -- or one out of five managers -- did beat it.