Wednesday, February 29, 2012

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.  

Monday, February 27, 2012

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.

Sunday, February 26, 2012

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

Friday, February 24, 2012

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.

Thursday, February 23, 2012

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.  

Wednesday, February 22, 2012

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.  

Saturday, February 18, 2012

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.  

Friday, February 17, 2012

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.

Wednesday, February 15, 2012

European Weakness Is Extremely Obvious

Today's market decline got a few headlines as "worst of 2012 so far" and other appropriate names.  I wonder when we'll see more severe declines.  Consider Moody's downgrade review for a large number of European financial institutions.  Greece's private sector creditors really do exist, they really do have balance sheets subject to the Basel regime, and they really will be impaired when Greece executes a debt write-off.  Eurocrats know this and are floating policy reform trial balloons as a stalking horse for kicking insolvent countries out of the eurozone.  

China seems to prefer keeping the large European common market together for a while longer to avoid the headache of having to reprice its exports in multiple currencies.  That may be why China is offering some vendor finance to the European Union's bailout project.  Note the careful diplomatic wording of China's communique.  They support the "principle of holding assets of EU sovereign debt," which avoids a pledge to buy more immediately and leaves them wiggle room to sell some of their current holdings so long as they maintain some minimal level.  I think China's rationale has less to do with managing foreign exchange risk and more to do with securing more favorable trade terms that will keep its export engines humming.  

Those investors who can't see the clear and present danger to their portfolios posed by this state of affairs can't be helped.  I've been sounding the alarm about overvaluation in equities for a long time now.  I may not have to sound it much longer if the alarm becomes a real conflagration.  

Monday, February 13, 2012

Greece Deal Not Done Until Europe Sends Money

Television and Wall Street both give us reruns.  The happy news at every twist in the Greek insolvency drama sparks a U.S. equity market bump, just as repeated reports of the housing collapse's containment pushed sucker rallies in 2007 and 2008.  Saying that Greece faces further obstacles to receiving its bailout is the notable understatement of the day.  The main obstacles to the deal's completion aren't in the parliamentary offices of Athens or Brussels; they're in the streets of Greece where indolent youth are torching neighborhood businesses.  It's ironic that these aspirants to membership in the "black bloc" have set fire to productive businesses and banks that will be needed for a Greek recovery.  Trashing government offices would have been less harmful to the country's future, as many of those offices will soon be empty of redundant public sector employees.  Greek parliamentarians voting for austerity ignore news reports showing the Communist Party polling at a 40% approval rating.  Hey, I heard that on NPR while driving around town, so it's probably true.

U.S. equity markets are pricing in headlines and ignoring reality.  The stock market rally continues despite real unemployment still north of 20%, debt-to-GDP over 100%, and a European financial system on a hair trigger.  Wondering whether capital markets traders can see the forest for the trees is an exercise in futility.  I learned from personal experience years ago that financial markets professionals rarely see the forest, the trees, the underbrush, or the wildlife simultaneously thanks to the bonuses that drop out of the blue sky.  All of that money is just too darn pretty.

What lies ahead will not be pretty for most people on Wall Street.  The C-suite execs are pumping their media contacts with Facebook IPO chatter.  The deals in the 2012 pipeline will float the last possible chances for financial insiders' sudden wealth in this generation.  The next round of wealth creation comes after the eurozone breakup and the daisy chain ripple across the Atlantic, whenever that comes and however bad that will be.  Liquidity events after the deluge may look more unconventional than what we have traditionally seen in this country.  The spectrum will run from desktop manufacturing at the community level to financial repression at the national level.  Creating wealth after 2012, at least for this observer, will have little to do with anticipating the stock market's reaction to headline news out of insolvent countries.  

Sunday, February 12, 2012

Friday, February 10, 2012

US Persists With Big Twin Deficits Into 2012

Those of us who grew up in the America of the 1980s remember persistent political handwringing over America's big twin deficits in foreign trade and the federal budget.  Well, a few of us remember, while many others in Generation X were doing something else.  My admiration for public television came partly from informative reports on the MacNeil/Lehrer NewsHour (now the PBS NewsHour), Nightly Business Report, and Wall $treet Week. The alarmist tone of these reports throughout the Reagan Administration all mentioned how the nation's competitiveness and national wealth would suffer if America could not curb its appetite for deficits.  I remember it like it was yesterday.

That was yesterday.  Tomorrow is here.  The twin deficits are worse than ever today.  The trade deficit in December 2011 widened despite the current Administration's stated goal of doubling exports by 2015 or whenever.  Maybe they also meant that imports should quadruple in the same time period so our trade deficit can continue unabated.  The federal budget deficit is also persistently large despite the political theater of Super Committees and debt ceiling fights.  The warnings about the harm these deficits would do to our economy went unheeded.  Now America suffers from wide-scale structural unemployment partly hidden by statistical tricks; the transfer of value-added manufacturing capability to strategic competitors; and a growing willingness among our largest trading partners to use anything but the U.S. dollar as a means of exchange.

America is about as serious as Greece when it comes to impulse control.  No ambitious country ever overspent its way to dominance but every former empire overspent itself into decline.  Partisans can nitpick over whether the absolute deficit numbers recorded by the current Administration are comparable to the percentages of national debt added by previous administrations.  Such a debate is akin to arguing over whether more lifeboats should have been installed while the Titanic is sinking.  A good debate could start by examining countries with healthy economies to see if low debt-to-GDP ratios are a factor in their success.  I am a patriotic American.  I care enough to keep sounding the alarm.  

Tuesday, February 07, 2012

Free Trade For Cuba

The US economic embargo against Cuba is half a century old.  It has utterly failed to accomplish its stated purpose of regime change in Cuba.  It is prone to leakage because the US does not enforce it with a naval task force that can interdict seaborne commerce.  The pain it inflicts on ordinary Cubans has spurred some to seek refuge in the United States, adding to our country's immigration burden.  This embargo is even outside the norms of the trade relations the US had with other Communist bloc countries during the Cold War.  The US allowed American companies to buy Soviet oil and sell the Russkies some Midwestern wheat.  Trade relations gave the US an additional lever it could pull to influence the Soviet Union's internal human rights policies.

Let's try a radical, outside-the-box solution to our Cuba problem.  The US should lift the embargo and negotiate a free trade agreement with Cuba.  The immediate effect of such a deal would be a rush of American companies looking to offshore low-wage production to Cuba.  The follow-on effect would be newly prosperous Cuban workers looking to spend money on material goodies.  Access to modern goods helped ordinary Soviet citizens see what they were missing in a system of central planning.  A little middle class spending in Cuba would go a long way toward breaking Communism's psychological grip on the island.

The US can declare victory in the last Cold War front in the Western Hemisphere.  The Castro boys have one foot in the grave anyway.  Opening up trade relations now would undermine any plans they may have for a familial transfer of power in the style of North Korea's Kim dynasty.  The Cuban-American lobby may not like this approach but they are much less influential now than in the 1960s.  If Richard Nixon could go to China, then modern American leaders can go to Cuba.  Economic influence is an element of national power.  We should use it to invite Cuba into the capitalist world.

Nota bene:  I have never smoked a Havana cigar.

Monday, February 06, 2012

Europe Divests Hedgies While England Doubles Down

Some European pension plans are finally wising up to the statistical reality that hedge funds are an expensive way to add no value.  These plans are reducing their stakes in hedge funds or divesting altogether.  Good for them.  It's too bad that the Church of England has yet to figure that out.  It has increased its commitment to hedge funds.  The Church's commitment makes no sense in light of its governing body's commitment to better corporate governance.

Hedge funds are among the most opaque, poorly managed investment vehicles available.  So-called evidence that these things proved their worth in the 2008 financial crisis ignores what would have happened if a few more prime brokers had gone under.  Prime brokerages provide credit to hedge funds.  Those funds' leveraged bets on obscure, illiquid instruments would have collapsed without the bailouts that backstopped the largest investment banks.

England is further from insolvency than than the Continent.  Its troubles are no more than a year or two behind Europe's so there is still a small window during which British institutions can be foolish with money.

Nota bene:  Alfidi Capital is not a hedge fund.  I have never invested in hedge funds and never will.  

Sunday, February 05, 2012

The Limerick of Finance for 02/05/12

A south-of-the-border joint bank
Fuels Chavez's image as crank
With a nebulous goal
Funds are hard to control
Its credit won't have a high rank

Friday, February 03, 2012

Frivolous Lawsuit Bothers Hecla Mining (HL)

Some people just can't take life's setbacks in stride.  Drops in a company's share price are normal and can happen for any reason or no reason at all.  Some shareholders are suing Hecla Mining just because the share price dipped.  They allege the company made statements that overestimated its value.  Numbers from operational results don't support such an allegation.  Hecla is generating decent ROE (about 12%) and margins are extremely healthy.  It helps that the price of silver is at record highs but Hecla has been around for over a century, so somebody there must know what they're doing.  

Accidents happen in mining.  It figures that a union would bring this suit.  Unions just don't get the free market.  It also figures that the source of this irritation is a bricklayers' union.  These particular opportunists must be as dumb as bricks, reflecting unfairly on the vast majority of bricklayers.  The case should be thrown out forthwith for lack of merit.  

Full disclosure:  No position in HL at this time.

Wednesday, February 01, 2012

Facebook IPO Looking Smaller Already

Greedy financial advisors love to gouge their clients by pushing some hot new thing.  The hot new thing in the 1990s was an Internet company going IPO.  Everything old is new again.  Facebook's long-awaited IPO is almost ready.  The company is making plenty of money but there are still plenty of reasons why I'm not buying any FB shares.  These are the same reasons I didn't buy shares in any tech companies fifteen years ago.

Facebook's sector has no barriers to entry.  The basic principles of good social media design are now universally accepted: a central scrolling timeline with constant minor tweaks to add data embeds; a front page with sidebars to commonly used items like an accepted appointment reminder; a simple messaging tool; and a couple of other gizmos.  All of the attendees at social media conferences pick up on these key items.  Any of them could rapidly create and deploy a competitor to FB at little or no cost.  Someone in China has probably already started.

Facebook's business model expects unlimited compound growth.  The user base is already so large that FB has probably saturated the market for all literate computer users and as many of the semi-literate ones who can be reached.  Growing market share into "under-computed" parts of the globe is probably a waste of effort. Maybe semi-intelligent metering devices linked to energy "smart grids" could be some blue-sky source for exponential growth, especially if they are enabled with their own avatars that can push updates to their owners. On second thought, forget I said that.  Semi-intelligent bots crawling around Facebook 2.0 sounds like a scenario for a globally self-aware AI.

Facebook offers little customer service.  I use this platform daily and I still cannot figure out how to turn off certain applications.  Facebook claims to change its design to enhance the user experience but hasn't yet mastered the arts of testing changes with trial runs.  They should take a hint from how Microsoft and Apple manage their developers' conferences.  App designers already congregate to display their monetized wares, but it is not clear how well Facebook cultivates their contributions.  Maybe I should attend the next Facebook developers conference so I can ask them what changes would make the platform more valuable.

Facebook's CEO is still running a big company like a small one.  Mark Zuckerberg is undoubtedly a sharp guy.  The problem founding CEOs often have is their inability to run a large, mature company the same way they ran the startup version when it was still in their garage.  Steve Jobs at Apple was the rare founding CEO who could make the psychological transition.  Bill Gates at Microsoft did it too, growing into larger strategic roles later in life and eventually stepping away completely.  Jerry Yang at Yahoo could not pull this off and that is why Yahoo has been so troubled for so long.  I have not seen any evidence yet that Mr. Zuckerberg is capable of making the kind of transition that will cement his legend as a transformational entrepreneur.  Anecdotal stories of temper tantrums and spiteful terminations are not encouraging signs.

Count me out of the FB IPO.  The smartest money on the planet usually likes to liquidate big private stakes when they smell troubled times ahead.  Note that Blackstone Group went IPO in the summer of 2007, just before the market's all-time high.  Major smart money is pushing this IPO both as a liquidity event for their own stakes and as a positive news event that will push more IPOs through the deal pipeline.  The underwriters are already spinning the $5B debut as a deliberate step down from the planned $10B deal for the sake of conservatism and follow-on interest.  That's a nice story.  Maybe they're lowering expectations just in case it doesn't do so well.

Nota bene:  I am a heavy user of Facebook but I have no investment in FB at this time.