The Great Unwind

A few thoughts on tapering by your faithful-if-irregular correspondent and country singer. This went up at the PBS NewsHour's site today.

Quote of the Day

"Some people who seem crazy turn out to be smart after all. Apparently that is what Fama thinks. I think they are just crazy," Shiller said, conceding his remarks "may be insulting" to his fellow laureate.

More here. I'm with Shiller, of course.

Running with the Bulls

Hard not to think of Pamplona, in the stock market we have now.

Quotes of the Day

"One of my few economic heroes, Kenneth Boulding, said that while mathematics had indeed introduced rigor into economics, it unfortunately also brought mortis."

"Being wrong on your own, as Keynes describes so eloquently in Chapter 12 of The General Theory, is the cardinal crime for an investment manager. To avoid this, the professionals try very hard to ensure that if they are going to run off any cliff they will: a) have a lot of company; and b) that most of the company will be one step ahead."

Both of these are from Jeremy Grantham's November letter to clients, available here as a PDF. An excellent letter from Ben Inker, a younger colleague of Grantham, is part of the same document. Both are well worth reading, as usual.

How Janet Yellen Misvalues the Stock Market

A careful argument by Andrew Smithers, at the PBS NewsHour's Making Sen$e page.

One hopes that central bankers will be better at spotting market excesses in the future than they have been in the past. I applaud Andrew for trying to keep them more focused on this important topic than they tend to be, and for backing his argument so thoroughly with data.

How Econometrics Got Used as a Weapon in WWII

Sounds surprising, but a set of econometric equations was essential to the wartime development of the gunsight of the B-29 bomber.

I recorded an interview a few months ago with Charlie Roos on this topic.

Charlie is an emeritus professor of physics at Vanderbilt University. His father, Charles F. Roos, was the chief economist of the National Recovery Administration under FDR, and one of the founders of econometrics (along with Irving Fisher and Ragnar Frisch).

The video I have linked goes for three minutes. There is a much longer interview with Charlie about his father's work and more, which you can get to via the pop-up at the end.

"Cash for Clunkers" was Clunky

As discussed here by Luke Froeb.

Matt Brice's Blog, and More

I am really enjoying Matt Brice's blog. He is the principal at The Sova Group, a new money management firm.

Very smart guy.

Here is a typically nice post of his. In it, he contrasts two economists who won Nobel prizes earlier this month, Eugene Fama and Robert Shiller. Like Matt, I am a Shiller fan. (If you have been reading this blog, that's not news.)

At the link, you'll see a description of one finance course offered by Fama, and another offered by Shiller. Fama's course is, in esssence, really about math; his models capture somewhat less of the world than Fama believes. Shiller, on the other hand, is actually trying to study reality directly, in all its messiness.

The world is big enough to house both modes of thought, but I agree with Matt that studying with Shiller's approach is going to be a much better use of time.

Matt and I think in similar ways about investments. Coincidentally (?), we each are non-practicing lawyers; and we each worked, prior to becoming investment managers, in mergers and acquisitions. Observing the workings of financial markets up close will cure almost anyone of the tendency to be overly impressed with pure math as a way of describing them.

Speaking of which, there is a wonderful new interview in the Finanical Times of Alan Greenspan, by Gillian Tett. Of interest: Greenspan's own belated, post-crisis realization of the limited ability we have to model financial markets mathematically. Link is here (registration may be required). What took him so long?

Don't get me wrong; I believe in valuing companies largely based on numbers. But that's very different from predicting where securities will trade in the market in the short and medium term. As Ben Graham put it, the market is a voting machine in the short run, and a weighing machine in the long run.

De gustibus non est disputandum -- and non est computandum, too.

Make Mine a Lite, Please

Cov-lite lending is back, and setting records, according to Reuters:

Huge demand for leveraged loans from billions of dollars flowing into U.S. loan funds pushed covenant-lite loan volume to a record $188.7 billion, far surpassing the record of 2007, and still going strong.

Demand for yield by investors is so high now that cov-lite loans are close to becoming the standard, according to the report; covenants in a debt deal are now viewed as a sign that the borrower is risky. Also, credit quality is going down:

As lending to lower-rated companies has increased generally, more of them are also opting for covenant-lite financings.That trend is evident particularly in the B3 ratings category. Around 18 percent of covenant-lite loans are for B3 rated companies so far this year, versus 8 percent in 2012 and 3.7 percent in 2011.

Amazing.

Quote of the Day

As one analyst observed, it is curious when investors are forced to purchase shares for yield and bonds for capital gains.

This gem of a quote is courtesy of the brilliant Satyajit Das, in the FT (registration required). I still think sometimes of an interview he gave in September, 2007, the first four paragraphs of which are about as prescient as a pre-Lehman, pre-Bear-Stearns interview could have been.

More Wisdom from Tett

Gillian Tett has written yet another great column for the Financial Times, summarizing what should have changed, but has not, since the darkest days of the 2008 crisis. Her main points are:

1. The big banks got bigger
2. Shadow banking grew
3. Investors believe in central banks more, not less
4. The rich got richer
5. There have been few relevant criminal convictions
6. Fannie and Freddie Mac are still in business

I recommend the whole thing (registration may be required).

Tett's depth and prescience are a marvel. In January of 2007, too, she wrote a great piece (registration, again). She compared the financial system at that time to "candy floss":

...what worries some policy-makers is that structured finance is often so opaque that dangerous concentrations of credit risk could develop in the system - unseen until a shock. Banks, for example, now seem to be buying each others' securitised bonds through their investment arms, which could mean they are acquiring risk through the back door even as they appear to be shedding it in their published accounts. 

That makes it harder to assess overall leverage in the economy. But it could also make it difficult for central banks to control credit conditions with old-fashioned monetary tools.

 I am a huge fan of hers.

News Flash: Bubbles Exist

It is news when a central banker admits that bubbles exist.

But it happened earlier this week, when John Williams, who heads the the San Francisco branch of the Federal Reserve System, gave a very good speech. An excerpt:

The lesson from history is clear: asset price bubbles and crashes are here to stay. They appear to be a consequence of human nature. And the events of the past decade demonstrate the enormous human costs of asset price bubbles and crashes. 

To understand the past and avoid a recurrence of the devastating events we lived through so recently, we need to acknowledge that investors and financial markets do not behave the way rational asset price theory implies. We need to incorporate these channels into the models we use for forecasting, risk analysis, and policy evaluation. This opens up a world where actions, including regulatory and monetary policy measures, may have unintended consequences—such as excessive optimism, risk taking, and the formation of bubbles—that are assumed away in standard rational models.

If everyone acted rationally, independently, and with perfect information, then, yes, bubbles would be impossible. But guess what? They don't.

Cautionary Words from Leon Black

Leon Black, of Apollo Asset Management, quoted in Barron's last month (registration or subscription may be required):

"It's almost biblical. There is a time to reap and there's a time to sow," Leon Black, chairman and chief executive of Apollo Global Management declared to the Milken Institute's global conference in Los Angeles, alluding to that same Scriptural passage. "We are harvesting," he added pointedly.

That is, the private-equity giant is a net seller because things simply can't get much better. "We think it's a fabulous environment to be selling," he says, noting Apollo has sold about $13 billion in assets in the past 15 months. "We're selling everything that's not nailed down. And if we're not selling, we're refinancing."

That's because there has never been such a good time to borrow -- which is raising warning flags for Black. "The financing market is as good as we have ever seen it. It's back to 2007 levels. There is no institutional memory," he observed, referring to the peak of the last credit bubble.

Black worked for Drexel Burnham Lambert, back in the bad ol' days. Black is bright and has a privileged view of the market for bank loans, especially for buyouts.

I don't think that everything literally should be sold, and he doesn't seem to be saying exactly that, but it's more of a seller's market than a buyer's market, and that it is a good time to tidy up a portfolio. Of course, for as long as the Fed chooses, cash will not be keeping up with inflation.

Nice to be Getting Back to Normal (Not)

From the WSJ today:

Investors are once again clamoring for a risky investment blamed for helping unleash the financial crisis: the synthetic CDO.

In a sign of how hard Wall Street is trying to satisfy voracious demand for higher returns amid rock-bottom interest rates, J.P. Morgan Chase & Co. and Morgan Stanley bankers in London are moving to assemble so-called synthetic collateralized debt obligations.

Again! Full story here (registration required). Article is titled "One of Wall Street's Riskiest Bets Returns."

This reminds me of a passage in Charles Kindleberger's excellent book, Manias, Panics, and Crashes: A History of Financial Crises, which first came out in 1978. (Just another light summer read.) He writes,

The paradox is equivalent to the prisoner's dilemma. Central banks should act one way (lending freely) to halt the panic, but another (leaving the market to its own devices) to improve the chances of preventing future panics. Actuality inevitably dominates contingency. Today wins over tomorrow. (Fourth edition, p. 164)

Unfortunately, all medicine, even necessary medicine, has side effects. I do not envy the decisions that the Federal Reserve is faced with making, but with junk bond yields near record lows and CDOs returning, the sooner we can end q.e. and ultra-low interest rates, the better.

Worth Reading

Both of these are good:

1. William Dudley, CEO of the New York branch of the Fed, reflecting on what the Fed got right, and wrong, since the crisis of 2008. Calculated Risk did a good job highlighting key passages here. Dudley is thoughtful, and the whole thing is worthwhile. Dudley delivered this talk at the Japan Society (appropriately enough) yesterday.

2. Speaking of bubbles and their consequences, Washington Irving wrote an amazingly accurate description of bubbles almost two centuries ago, in 1820. Forget the Financial Times; this passage from Irving's The Crayon Papers may be the timeliest thing I have read this year. Just read pages 41-43. A friend just sent it. New to me, but I see that it gets quoted on the web from time to time.

Cautionary Words from Paul Volcker

This new piece in Forbes quotes former Federal Reserve Board Chairman Paul Volcker saying that the U.S. mortgage markets are now a subsidiary of the state.

Some see Volcker's views as simplistic. I think he favors being clear, but that is not the same thing as being simplistic.

Quantification of Love

Can love be reduced to a number? Some songs have tried, at least, to quantify it:

Can't Get Enough of Your Love, Babe (Barry White, soul)
Heartaches by the Number (Ray Price; country)

How Deep is Your Love? (Bee Gees; disco)

Three Times a Lady (Lionel Richie and the Commodores; pop)
You're the First, the Last, My Everything (Barry White; soul)

A poem by Browning begins, "How do I love thee? Let me count the ways."

When we try to count something that goes beyond reason, we are going to have some trouble. Maybe that is why this conceit appeals: built-in tragedy.

Granted, measuring the ways in which I love you is not the same, exactly, as quantifying love itself. I don't want to be too literal here.

My wife, Ann, noticed this theme in Barry White's music. Landy Pupo-Thompson and Matt Thompson came up with the pop and disco examples.

Can you think of any more quantifying-the-unquantifiable songs? If so, please tell me.

Berkshire Hathaway Meeting Notes

So far, the best set of notes from Saturday's annual meeting, in Omaha, of Berkshire Hathway shareholders I have seen is this one from Motley Fool.

[UPDATE 5/7/13: This set, by Peter Boodell, is even better. It is nearly a transcript.]

I also found the NYT's set, here, helpful.

There is a good set from Morningstar, too. I don't think a subscription is required (but if so, it is a good excuse to sign up for Morningstar, which is useful).

That's probably enough, but for those wanting every tidbit, this set from the FT is worthy, and Charlie Munger did a long CNBC interview with Becky Quick.

I often go to the meeting, but skipped it this year.

El-Erian Interview

Nice video interview of Mohammed El-Erian, posted earlier this month at the WSJ. El-Arian emphasizes how artificial asset prices are these days. The main reason is aggressive experimentation by central bankers who, of course, are in a very tight spot. Nine minutes.

The interview is by Francesco Guerrera, who is smart, independent of mind, and one of the few financial journalists worth reading.

The Business of Investing, and Actual Investing

The business of investing requires, or, at least, seems to require:
- a steady stream of ideas
- attention to appearances
- light knowledge of many things.

Actual investing requires:
- patience and a very few good ideas
- contempt for appearances
- deep knowledge of a few things.

Yep

"The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version."  John Kenneth Galbraith, A Short History of Financial Euphoria, 1994.

Seth Klarman

Ever eager to pass along fast-breaking, up-to-the-minute news about the investment world to the readers of this blog, I recommend this profile, from 2010, of Seth Klarman. Klarman is a very disciplined and successful value investor in Boston.

Klarman wrote a book, Margin of Safety, that came out in 1991. It now sells for, literally, $1,000 per copy, used, on Amazon. (I can't help but notice that this violates the Graham-and-Dodd style of valuation that Klarman favors.)

I am glad I got my copy for the regular retail price of $20 or so, back when.

Postscript:  I.M. Young, a reader, mentioned that you can find PDF copies for free online. I found one by Googling "Margin of Safety PDF." (I feel a little guilty passing this along.)

Sex Advice from Warren Buffett

"It's very important to live your life by an internal yardstick.... Would you rather be considered the best lover in the world and know privately that you're the worst -- or would you prefer to know privately that you're the best lover in the world but be considered the worst?"

Worth pondering.

This is from a write-up by Guy Spier of a lunch he had with Buffett in 2008.

Warren Buffett on CNBC

Buffett is just about always worth watching. There are clips embedded in this CNBC story, from his interview with them this morning.

Perhaps most interesting are his comments on the challenges the Federal Reserve will face in unwinding its balance sheet, which has more than tripled in size since 2008. These are in the video so labeled at the top of page two.

Dilbert on Greatness

Perhaps my favorite Dilbert yet. The link is here. (Sent to me by Brad Reed, Nashville's answer to Charlie Munger.)

Ben Inker on the Non-Death of Equities

Ben Inker, of GMO, put out a piece last year that is one of the best things on equity investing I have read in a long time. Here is "Reports of the Death of Equities Have Been Greatly Exaggerated: Explaining Equity Returns."

I am sure there is a bit of GMO party line in it. However, the piece is so good that it does not really matter. Inker discusses the non-correlation (negative correlation, actually) of GDP growth and returns to equity holders; the nature of the equity risk premium (why it exists, and why it must continue to exist, long-run); how to infer the degree to which GAAP accounting overstates economic profit; and the width of profit margins.

Truly insightful and interesting.

[I updated this post on 2/14/14 with a live link to the Inker article; the link I used before had stopped working.]

Stealth Jubilee

Central banks have been blowing a lot of air – should I say life? – into western economies. The U.S. and European central banks have used their fiat power to print trillions of dollars and euros, bailing out the banks here, and both banks and sovereigns there.

We can call this period a jubilee. Not a party for the Queen, but rather, I mean, the Biblical, once-in-fifty-year release of debtors from their obligations. With a modern twist: this is a stealth jubilee, low-grade and gradual. Short-term interest rates are being kept at the lower bound of zero, while inflation is around 2% per year. So the real rate of return to savers, at least savers with money in the bank or Treasury Bills, is negative. They earn about zero in nominal terms, and about negative 2% after taking account of inflation. Normally, T-bills would beat inflation.

This is a slow transfer of wealth from creditors to debtors, taking place through monetary policy rather than a rewriting of contracts. In theory, the same result could be achieved legislatively or judicially. We could just keep interest rates at natural (i.e. higher) levels, and then have all creditors pay 2% of the face value of the notes and bank deposits they hold into a pool, to be distributed pro-rata to debtors.

But we are doing it by Federal Reserve policy, instead. A jubilee via committee -- the Federal Open Market Committee, to be precise.

Is our stealthy, slow-mo jubilee a good thing, or a bad thing? The degree of jubilation this policy induces for you will likely depend on your politics, and what you think the world would look like if we did not do it.

At the risk of sounding too calculating: when I am thinking as an investor, rather than as a citizen, I just take a cue from Nietzsche and regard it as beyond good and evil. Either way, it is useful to see that it is happening.

Orlando, the Stock-Picking Cat, meets Nate Silver

A piece I wrote for Paul Solman's Making Sen$e page, at the PBS NewsHour site, is up today.

Against Writing

An excellent post from the blog Farnam Street, which I like, on the arguments against writing.

The basic idea is that writing and reading are not a good substitute for dialogue, and that is hard to disagree with. (Though even a monologue is better than nothing.)

The classic example of the literate non-writer is Socrates, whom we know through Plato rather than from his own writings.

The 20th Century philosopher Sidney Morgenbesser is a modern example, and his recorded quotations here are wonderful. One of my favorites of his, spoken on his death bed: "Why is God making me suffer so much? Just because I don't believe in him?"

Outsourcing Your Own Job

This is an amusing story, making the rounds today, about a software engineer who outsourced his own job without telling his bosses. He pocketed the cost difference and it worked, for a while.

Second Smithers Interview

My follow-up interview with British economist Andrew Smithers is up at Paul Solman's "Making Sen$e" (PBS NewsHour) page.

Our discussion is about the decades-long decline in labor's share of output. Andrew sees bonus-oriented management compensation as the main cause, and, at the link, gives more of his reasoning. He sees some merit in the idea that a weaker environment for antitrust regulation may also be part of it, and he considers the bottom-line effect on the earnings of the S&P 500.

Pam, the Flood, and Erosion

My clients uniformly tell me how much they like talking to Pam Wilmoth, who runs the office here at Shayne & Co. Me too!

She is the president of the the homeowners' association in her neighborhood, where she and her neighbors are still dealing with the some of the aftermath of the 2010 Nashville flood. Her neighborhood could use help from local students of engineering or architecture, or firms in those fields, to help them deal with erosion. WSMV-TV interviewed her, here, about this. The link currently has only the text from the interview, not the video.

(The reporter calls her Pam Miller; her full name is Pam Wilmoth-Miller.)

Good Chart on Profit Margin Reversion

U.S. corporate profit margins are, in aggregate, wide now, and at risk of reverting to the mean.

The second chart in this piece by John Hussman, who is a money manager and a former professor of economics at Michigan, is interesting as evidence of this.

(I have blogged about this topic before, here.)

Whether the problem is pervasive across the economy, or isolated within particular industries, is hard to know. If the cause is a weak bargaining position for employees because unionization has declined, or because foreign competition has increased, then the widening of profit margins is probably fairly pervasive across income statements in nearly all industries. If, however, the cause is weaker antitrust enforcement, then the wider margins may be limited to industries in which concentration has increased over the past two or three decades. And a third possibility is that if Andrew Smithers is correct in his argument (discussed at second link above) that the widening is caused by the bonus culture run amok, then the effect may be mostly in companies that have incentive-heavy management compensation cultures.

It may be a mix of these. Anyway, the fact that capital is getting a bigger piece of the pie than it used to is much clearer than the "why."