Does John Bogle Like Anything?

John Bogle is the originator of index investing.  Scanning recent headlines leaves the casual reader with the impression that he's a crusty old dude who can't stand modern life.  He dislikes the current federal tax scheme that gives big breaks to private equity firms.  I totally agree with him on that one.  He doesn't like ETFs because they tempt investors to actively trade something that should be a passive allocation to an asset class.  I see his point but I disagree; ETFs are useful for an index-based strategy that seeks to enhance yield over the short term using options.  He doesn't even like the financial system as a whole for its weak governance.  I do agree and I would come down even harder on proprietary trading than the Volcker Rule.

I've read enough of Mr. Bogle's writing to figure out what he really does like.  He's fond of low-cost, passive indexed, long-term approaches to investing.  Nothing else matters much for the average investor.  The unique thing about him is that he recognizes the existence of outliers like Warren Buffett who somehow outperform average investors and market indexes.  I believe Mr. Buffett's success comes from taking passive investing to an extreme, with a disciplined focus on minimizing risk and cost.  That is deep value investing in a nutshell, and when combined with some simple insights into market anomalies (like merger arbitrage, monopolistic pricing power, and very limited use of options) it makes for an awesome approach to building wealth.

Long live John Bogle, Paul Volcker, and Warren Buffett.  They are in the twilight of life and there are very few investment professionals who can step up to replace them.  Except me, of course.  I've been ready for a while.  

The Haiku of Finance for 02/28/12

Auctioning spectrum
Asset sale for stimulus
Going, going, gone

Money Market Fund "New Rules"

Comedian Bill Maher popularized the catch phrase "new rule" to describe some cultural truism that cries out for instant change.  Maybe financial regulators are trying out some material from his script.  The SEC is thinking out loud about some new rules for money market funds.  You may remember those funds from 2008 when the inability of the Primary Reserve Fund to maintain its NAV north of one dollar almost brought commercial activity in North America to a halt.

The only proposed rule that makes sense to me is to make the share price a floating value.  Such a fund isn't cash if it's invested in securities that have some kind of maturity, even an overnight maturity.  Money market funds belong in the general category of actively managed fixed income funds but brokerages are reluctant to break this bad news to clients.  It will mean one less cash management tool in a toolbox already bereft of yield thanks to the Fed's zero interest rate policy.  Wealth management firms had better quickly find some other place to sweep overnight balances if they want to avoid an MF Global kind of collapse in the next surprise credit crunch.

I'm more than willing to use Bill Mahr's method here.  "New rule: A money market fund is no such thing if it doesn't hold money (as cash) and can't be exchanged on a market (due to illiquidity)."  That wording should be easy enough for the SEC to implement.

Full disclosure:  No position in any money market funds at this time.

The Limerick of Finance for 02/26/12

G20 tells Europe to do more
Or mass defaults will be in store
Germany holding out
Leaves a backstop in doubt
And a bond market crash through the floor

The Haiku of Finance for 02/25/12

Buffett's successor
Inherits record profits
So who is The One?

There Are Bigger Numbers Than Dow 13,000

The DJIA is flirting with 13,000 after a few years of resetting closer to what I believe should be its fair market value (hint: a lot lower!).  There are plenty of numbers far larger than that one.  Our planet is about 4.5 billion years old, with 7 billion people living on it, and it's approximately 93 million miles from the Sun.  Okay, I'm goofing off here.

The big numbers we should really concern ourselves with as investors are the federal government's unfunded liabilities, which totaled over $61 trillion in 2011.  That's the figure that will ultimately drive the global bond market away from Treasuries and any other dollar-denominated fixed income investment.  I don't listen to market commentators who urge the investing public not to miss the next bull market into Dow 13,000.

Full disclosure:  No position in Treasuries at this time.

The Haiku of Finance for 02/23/12

AIG tax games
Fool some investors some time
Real profit still small

Greece Is Going to Rumble

Here's a quick note on how the European rescue of Greece is probably going to unravel.  Credit rating agencies continue to cut Greece's debt rating because the bailout deals requirement for bondholders to write off debt is for all intents and purposes a default.  It just can't be called a default because the ISDA, owned by its member banks and hedge funds, isn't going to call it that.  Doing so would trigger CDS payouts that would render multiple counterparties insolvent and instantly freeze the European and American financial systems.  Doing it the new European way means selective destruction of some creditor banks and hedge funds, country by country, in a way that allows the rest of the system to function.  Trans-Atlantic financial elites remember AIG from 2008.  They don't want a repeat.

The problem with this method is that it requires PIIGS to implement austerity programs their populations won't swallow.  Greece will continue experiencing severe civil unrest as long as austerity policies sacrifice popular programs to preserve debt repayment.  The alternative, of course, is to rip the bandage off quickly in the manner of Iceland.  Greek citizens may accept that path, or they may just blindly follow radical parties promising an end to austerity and continuation of the unsustainable status quo.

I maintain that the most likely outcome for Greece is continued unrest, contraction of GDP induced by austerity that keeps debt-to-GDP unsustainably high, and an eventual inability to fund new debt in March.  That will likely result in Greece being the first PIIGS nation to leave the euro.  Some European and American banks will fail even if CDS limits are blithely ignored.  The European and American policy classes will work overtime to triage failed banks and preserve select banks.

Full disclosure:  No equity positions in European or American financial institutions at this time.  No positions in European sovereign debt, ever.  

Alpha-D Updates for Feb. 2012

I made no real changes to my Alpha-D Strategy this month.  My covered calls on FXI and GDX expired unexercised so I renewed them for another month.  I made no changes to the small amount of California state municipal bonds I hold and I am waiting for them to mature in a few months.  For the record, I'm still thinking about buying some TIPS but only if I can conclude that a TIPS ETF will reprice quickly enough to hold its NAV near fair value regardless of the face values of its constituent bonds.  This is a theory worthy of a severe real-world test.

I'm sitting on cash, just waiting for this Greek default action to really get going.  Nothing has been resolved by this week's deal in Brussels.  Too many Greeks on the street will refuse to accept austerity measures.  Pressure from below will probably obliterate the deal and remove Greece from the euro.  I expect other bankrupt nations in the PIIGS to line up for bailouts that will prove just as impossible to execute, and then their exits will follow.

Any future eurozone bank destruction will be felt on American shores.  It is a matter of time but the timing is unknowable. That is why the personal capital I've committed to equities is at the lowest percentage of my net worth since August 2007.  That was the last time the markets had some kind of high point, and they are reaching similar highs now.  I'd rather wait for new lows.  

The Haiku of Finance for 02/21/12

Goldman sukuk bonds
Saudi investors seek them
Islamic finance

The Haiku of Finance for 02/20/12

Boomers have to work
They didn't save for old age
Golden years are gone

The Limerick of Finance for 02/19/12

Some Greek bailout game is in play
Brussels wants to have the final say
Austerity's tough
Many Greeks have it rough
Spain is next to learn this the hard way

Entrepreneurship Creates Hyperinflation-Resistant Cash Flow

The mess in Europe will eventually come to an inflection point.  Maybe late March 2012, when Greek bond auctions and EU/IMF bailout payments coincide, will determine whether a sovereign nation in a currency union can execute a controlled crash.  Global policymakers should concern themselves with the most likely policy responses, namely a repeat of the Fed's ginormous dollar swap lines and uncontrolled quantitative easing.  Investors should concern themselves with the most likely economic consequences, namely a hyperinflationary depression.

Owning a fully-paid business can be a boon during inflation because the proprietor can raise prices to keep up with the devaluation of a domestic currency.  Some business types may prove more useful to own than others.

So what are some of the most useful types, IMHO?  I'll suggest a sample list for starters.

Hard asset producers.  Owning a gold mine could literally be . . . well, a gold mine.  So could oil and gas wells, wind turbines (the large rural kind, not the useless "small urban" kind), solar arrays, potash deposits, and other stuff that produces a "flow" from some physical source.  The flow of hard assets will always have some value regardless of its currency of denomination.

Urban necessities.  I seriously think an urban laundromat would be a decent inflation-resistant thing for me personally to own.  This is anecdotal, but a Bay Area businessperson I've known for years has grown rich partly from the cash flow of laundromats he's owned for years.  The big risk here is the method of payment.  Coin-operated machines would quickly become useless if physical currency loses value by the day.  There is no point in pumping quarters into a washing machine if one cycle costs a million inflated dollars.  Hyperinflation demands machines whose prices can be updated daily.  I have yet to find washing machines and dryers configured to take credit cards with LED displays that carry seven-digit price readouts.  It would be a hoot to watch the price change during the spin cycle.

What would be the least useful types of businesses to own during hyperinflation?  I for one would not want to own these in hyperinflation.

Residential real estate.  Rent control laws become very popular with politicians when renters start seeing their disposable income seriously pinched by inflation.  Commercial real estate would not be subject to this problem.

Import/export businesses.  Hyperinflation invites capital controls that restrict the ability to move currency out of the country or exchange it at a rate other than one set by the government.  The government-controlled rate will probably not be a market rate, so anyone in the import/export sector will have problems.  Importers will find it difficult to buy goods from non-U.S. customers if those customers are reluctant to be paid in rapidly depreciating U.S. dollars. Exporters may find it easier to make a sale to a strong-currency customer, but they will lose money on many transactions if they have to convert foreign currency to dollars at an artificially unattractive rate.  Terms of trade financing and payment will make all the difference.

I should caveat this post's title in a couple of ways.  I think a wholly-owned business is inflation-resistant rather than inflation-proof.  No business will be completely unaffected by hyperinflation.  Even enterprises that produce and distribute hard assets - mining, pipelines, railroads, etc. - incur energy and transaction costs that can be unpredictable during hyperinflation.  I also think earnings are more vulnerable to inflation than cash flow.  This subtle difference is key.  Collecting cash payments from customers immediately is imperative to keeping a business afloat during hyperinflation, as is delaying cash payments to vendors for as long as sales terms will allow.  Booked earnings that look attractive at the time of sale look less desirable a month later when the cash flow is collected in a devalued currency.  The delay between recorded accounting earnings and collected cash can wreck a balance sheet for a business subject to covenants from lenders.  Then again, recording a liability and then paying it a month later with devalued cash may offset this effect.

I periodically check listings of businesses for sale (using resources like BizBuySell) for examples of potential winners.  I am reluctant to take on debt but the effects hyperinflation can have on reducing a debt load are tempting.  Going into debt to buy a business in this type of environment is a high-risk, high-reward strategy where timing is everything.  Taking on debt to soon before the onset of hyperinflation risks an indefinite wait before the devaluing power of inflation reduces a mountain of debt to a molehill.  Waiting too long risks seeing credit providers close off loans to anyone unwilling to pay usurious rates.

Do not take any of this discussion as some kind of recommendation to rush out and buy a business.  I have no idea whether anyone who reads my blog is capable of handling the risks of running a business.  That is why I don't tell people what to do with their money.  None of the speculation I have discussed above constitutes advice of any kind.  It merely outlines possibilities I am considering for my own personal portfolio.  The months ahead will test entrepreneurs' mettle.  Thinking out loud is how I prepare for trying times.  

Rant About SFMOMA's Worthless Mark Bradford And Rineke Dijkstra Exhibits

I support the arts.  Let's be sure we're all clear about that.  I especially like the arts in San Francisco.  I like the arts in this town so much that I want them to be as high in quality as they can be.  That's why I'm calling out SFMOMA's new exhibit of works from Mark Bradford and Rineke Dijkstra as being unworthy of serious consideration as art. I got a chance to preview these exhibits because I bequeathed a legacy gift to SFMOMA in my will.  I don't regret my gift, but I hope the museum spends its portion of my estate wisely after I've departed.  Stuff like this is not an encouraging sign.

I saw the Bradford exhibit first.  The guy taped over a basketball and called it art, some kind of tribute to an NBA player.  How juvenile.  He also papered over a room with black paper and masking tape.  That is something anyone can do with zero artistic training.  His most complicated works were collages of found paper printouts from advertisements that he mixed with tape, tinfoil, and other street junk before scrawling and scratching on them in various ways.  The whole thing was embarrassing to see.  It was even more embarrassing to see so many urbane sophisticates standing around admiring this garbage.

I sauntered over to the Dijkstra side of the fourth floor after becoming thoroughly bored with the Bradford exhibit.  I didn't get any more excited.  Her photographs had zero emotion, personality, or action.  I'm guessing that she directed each of her portrait subjects to look as bored and uninspired as possible.  The only photo full of life was from her bullfighter series, with one guy smirking at the camera after a successful fight.  He was the only subject I connected with, because I actually wondered why he was so full of life among all of the Dijkstra photographs.  The curators praised Ms. Dijkstra's video works as some kind of inspiration.  I just think they were pedestrian.  The teenage video subjects could have shot the videos themselves and no one would have known the difference.

I haven't been this turned off by an SFMOMA exhibit since I saw a Richard Tuttle exhibit in 2005.  That was the dumbest display of non-art I've ever had the misfortune to witness.  I didn't think SFMOMA could ever top that but these current exhibits come pretty close.  It's depressing to see an entire industry of art critics, curators, and buyers degenerate into praising nonsense for the sake of exploration.  Conceptual art has its place but seeing the same concept repeated in a single exhibition - bored photo subjects, junk wallpaper - demands some minimal effort at differentiation.  I'm all about innovation, but when experiments fail then the gatekeepers of our most prominent art institutions should discriminate in favor of quality.  Someone has to say the emperor has no clothes.

The Haiku of Finance for 02/16/12

China gold market
Soon to outgrow India
Sign of a bubble