Saturday, August 30, 2014

Alfidi Capital at The MoneyShow San Francisco 2014

I attended the annual MoneyShow San Francisco last week, as has been my preference most years since 2001.  I wasn't on the speaking calendar this year but there were plenty of other experts to keep me occupied in 2014.  My original thoughts in bold text are the most important things to read in this article.

Kim Githler welcomed us to note that the show's younger demographic was now mostly online.  The ease of participating in online conferences and webinars points the way for a trade show industry in the midst of transformation.  Virtual shows are the future.  She reminded us of her favorite themes in globalization and diversification, but noted the use of hard assets as inflation protection.

Jim Jubak gave the first keynote on the questionable quality of government economic data series.  The four major data sets driving daily market action are US GDP, US unemployment, US inflation, and China's GDP.  Jim noted that China's GDP is definitely skewed because the sum of its provincial GDP data is greater than the national figure.  The farther down the reporting chain one goes in China, the more pressure local officials feel to report positive numbers.  I have followed ShadowStats for years and Jim thinks that site raises real concerns dating to the Boskin Commission's 1996 report.  The MIT Billion Prices Project once again receives praises for its accuracy.  I used to hear it praised at fringe meetings but now mainstream commentators like Jim see its value.  Jim also prefers the U-6 rate as an unemployment measure.  He specifically used the word "baloney" to describe US quarterly GDP numbers due to swing inventories.  That's one of my favorite words!  He prefers to use the real final sales numbers that take out swing inventories.  China's GDP mismatch with its export and energy numbers should IMHO drive analysts to use the Keqiang Index instead.  Jim's bottom line is that a bunch of completely unreliable data is driving market moves.  Amen, brother.

George Gilder spent his keynote endorsing Bitcoin and gold for their supposed time-based value.  George is a really smart guy with a long career of delivering bold insights, but I just wasn't buying his line this time.  I agree with him that financial markets are dysfunctional and that something's wrong when currency market trading is larger than financial markets and physical goods markets.  His insights into knowledge driving wealth and resource abundance are still valid, but I don't agree that Bitcoin and gold somehow build from the one diminishing resource - time - that we all face.  He would have made more sense if he had said gold's scarcity was a function of its extraction cost, but that does not support his time-based thesis.  He made little sense in describing Bitcoin; I don't think he understands that its self-limiting algorithm makes it scarce in the short run, but its ability to "fork" into new currencies obliterates that scarcity.  He totally lost me when he claimed Bitcoin drives an advance in information theory by creating a surprise entropy of "unexpected bits."  That sounds more like a theological argument for angels dancing on pin heads than something empirical.  He wandered off into an analogy that interest rates are the expected returns of an economy and profits are unexpected returns that correspond to Bitcoin's unexpected bits.  Oookaaay, George, but where are the corresponding expected bits that are inputs driving Bitcoin?  Sorry, dude, but the arguments for time-limiting currency bases make less sense the further you take them.  If Bitcoin is such a challenge to monetarism and central banking, then it should solve the periodically high velocity of money that limits monetarism's power.  Bitcoin is too volatile itself to damp down velocity, and too illiquid to use as a monetary base precisely because it is scarce.  Come on, George.  Fractional reserve banking allows economic growth when otherwise scarce hard assets (namely gold) would limit growth if they were currency bases.  Gold and Bitcoin, or other assets with George Gilder's self-limiting time-based supply, do not allow for credit-based growth.  I respect our society's distinguished thinkers for their lifetime of contributions, but even super-smart people can slow down in their old age.  I've watched people go senile and it isn't pretty.

David Blitzer from the Standard and Poor's Dow Jones Indexes spoke on how the DJIA is calculated.  Highly priced stocks skew its value, so the index designers consider range-bound stocks.  Index changes immediately drive turnover in that portion of an index owned by index funds and ETFs.  I have long known about arbitrage strategies for index changes but I've never tried to execute one.  Analysts who want to study such an opportunity should review the index inclusion guidelines and SPIVA studies on benchmark performance.  I have long been familiar with those sources, and once this insanely overvalued market drops to normalcy I'll be ready to pursue some index arbitrage.  I will be curious to see if TD Ameritrade's InvestorMovement Index keeps up a strong correlation with broader indexes on the way down.

I did not find the panel of "top financial advisors" to be particularly impressive.  Financial advisers succeed at relationship management, not analytical accuracy or market outperformance.  In other words, they succeed on personality and not technical competence.  They would be more appropriate in forums requiring emotional intelligence and it sometimes showed.  They all sounded fairly optimistic about the stock market, and IMHO fairly ignorant.  One lady thought Tesla Motors was profitable because of robots.  Wrong!  It's trying to be profitable because of tax credits and green energy rebates.  LOL.  These people sounded very conventional and pedestrian.  My jaw dropped when they said they still like certain types of bonds even after acknowledging the risk in this very old bond market bull run.  They really like emerging markets but IMHO they ignore weaknesses in the rule of law and transparency in those countries.  Hey folks, geopolitical risk is a fact of life in emerging markets.  It's stupid to paint with a broad brush saying some emerging markets can grow if you don't know how to hedge exposures to each country.  Sheesh.

Steve Forbes was a classic but he wasn't as funny as in years past.  I agree with him that today's political authorities know far less bout money than their predecessor.  His best zinger was about monetary policy:  "Government monetary stimulus is a form of counterfeiting."  LOL, that's awesome.  I believe he is correct that Russia is about to relearn a lesson the Soviets learned in the 1980s when oil prices declined and energy exporting countries suffered.  I still don't agree with his argument for a return to the gold standard.  He compares apples to oranges by claiming the historically average GDP growth rate under the gold standard would continue today.  Dude, I'd like to see data showing how all of the gold mined in the US since the end of the gold standard in 1933 would be a viable basis for our growth since then.  I would also argue that the US has had some form of central bank for much of its history, including those years when we held to the gold standard.  Central banking probably has a stronger relationship with growth than gold does with growth.  I do like what Steve said about weak currencies correlating with high crime societies as trust erodes, but correlation is not causation.  His strong point about the harm done by central banks is hard to refute without challenging his central argument that economic growth was higher during the US's gold standard era.  History does show that inflationary periods occurred after the Revolutionary War and during the Civil War; a gold standard did nothing to stop it.  Gold bugs need to compare inflationary periods to the US history of central banking and gold standards, or they can ride their gold hobby horse off into the sunset.

Rich Karlgaard drew from his book The Soft Edge to argue that corporate cultures matter in investing.  His argument for a "triangle of health" referenced other sources that have little to do with corporate functions.  Warren Buffett's thinking on durable cash flows, for example, has a lot to do with market position and switching costs.  He has had very little to say about corporate culture.  I have no objection to claims that fact-based disciplined thinking forms a strategic base, or that supply chain leadership and capital efficiency form a hard edge.  I am not convinced that internal culture delivers some long-term competitive advantage, because any change in C-level leadership will eventually change that soft edge.  It all makes for great reading and new management theories allow consultants to sell new feel-good concepts to executives who know little about their own professions.  I prefer to rely on fundamental analysis in judging an investment, because then I don't need to know whether an internal culture makes a company a nice place to work.

The tech trends panel looked for paths to big IPO events.  Bill Harris of Personal Capital, Jim Hurd of Green Science Exchange. and Cody Willard of Scutify all tried to figure out where we're going.  Disruption from drones, robots, wearables, nanotech, and cleantech is coming our way but it won't be readily apparent in equities.  Professional investors buying post-IPO on dips will probably do better than retail investors eager to jump on an IPO's first day.  Fallen angel companies in tech have a hard time recovering if their corporate life cycle is really a reflection of a dominant product life cycle.  All low-priced stocks have risk, and many nanotech plays are microcaps that may be worth something as merger plays.  This panel was lively and funny, with many nano-puns.  I would look at nanopriced nanostocks but I'd rather have mega profits than nanoprofits.

I got my picture taken after the keynote with Kim Githler, the founder and owner of the MoneyShow.  I thanked her for the speaking slot I had last year.  The rest of you who were too busy to attend will have to catch me at a future event.  Kim is an awesome businessperson and she can sense that times are changing for the trade show sector.  She sure looks happy to hang out with me, and I can't blame her.  Attractive women find me irresistable.

Steve Forbes signed copies of his latest book Money for fans on the expo floor.  I didn't buy a book and an earlier photo I took with him did not turn out well, so this is the only record I have that Steve was in the proximity of yours truly, Greatest Man Who Ever Lived, Anthony J. Alfidi.

TD Ameritrade's options seminar was based on lessons developed for their Think or Swim platform.  Once investors understand that volatility is a standard deviation of movement, they can understand its use in analysis.  The CBOE's VIX implied volatility measure intentionally omits short-term volatility, thus ignoring its imminent risk in favor of looking 30 days forward.  I suspect that any preference traders display for short-maturity options may have an explanation in behavioral finance; search for academic papers on "jump memory" to see for yourself.  I took away two good lessons from TD Ameritrade's presentation.  First, weekly options help price risk.  Those options' implied volatility has no directional bias but does indicate the probability of a move.  In other words, one standard deviation represents a 68% probability that a share price's move will stay within that measured range until the option's expiration.  Second, option markets are forward-looking by definition because they have expiration dates.  That's better than using technical analysis, which is only historical.  The implied volatility thus helps investors gauge the risk of an increased allocation to that security.  My only additional caveat is that the known effect of option order flow on security prices brings an additional risk factor, because large option orders just prior to expiration may move a share price in a manner that implied volatility does not anticipate.

Todd Petersen of PetersenLowe and the Diamond Market had a very informative presentation on colored diamonds.  Good for him.  I had a run-in with another colored diamond purveyor in 2013 who tried to rip me off, and I ended up backing down from a lawsuit because I didn't have enough information to prove they were up to no good.  Fortunately, I now have enough knowledge to avoid such traps in the future thanks to Todd's presentation.  He noted that high net worth investors (HNWIs) like the rarity of treasure assets such as collectibles, fine wine, and gemstones.  He made my day when he said that diamond sellers who aggregate the stones' returns are disreputable because each stone is unique.  Well, that's exactly what my erstwhile legal opponent tried to claim last year!  It's good to hear some sanity from the fancy colored diamond (FCD) sector.  I was intrigued to learn that the wealthy instill so much emotional meaning in their illiquid treasures that they consider their auction proceeds a valid philanthropic avenue.  There's a lot to know about conflict-free certifications, appraisals, and other factors for anyone who wants to invest knowledgeably in FCDs.  I wonder why diamonds capture so much of the HNWI imagination and whether lesser gemstones (rubies, emeralds, etc.) deserve similar consideration.  I'm sure I'll figure it out.  Todd had tons of expertise, and he even gave me some wisdom I can apply to Alfidi Capital.  Thanks, Todd.

I found one presentation to be totally useless in formulating a forward-looking economic outlook.  Some guy tried to fit investor psychology into secular bear markets but it looked like he had a hard time drawing conclusions that fit the data.  He referred to the Reinhart-Rogoff inflection point for sovereign debt overhangs without mentioning the controversy around their data errors.  The ratio of full-time workers to part-time workers is not as great of an indicator as he thinks.  Lots of other things determine the economy's inflection points, like credit availability, inventory swings, supply shocks, and margin debt.  Come on, dude.  Spend more time studying endogenous shocks than on adjusting bear market asset prices for inflation and you might have some workable theories.

I was one of a select few MoneyShow alumni who was invited to attend morning tea on the second day with longtime speaker Mark Skousen.  That's the kind of exclusive offer I get all the time.  I'm so darn special.  I ate way more free croissants with butter than anybody else, so I have that additional claim to fame.  Anyway, Mark spent a lot of time reminiscing for those of us who've been attending the MoneyShow for many years.  He pitched his latest book The Maxims of Wall Street by quoting many of Wall Street's mystery men.  He didn't quote me so I guess I'm not ranked up there with Warren Buffett just yet.  His best line was about his time in the CIA in the 1970s and how they fail at predicting crises.

The serious action on the second day kicked off with Barron's keynote on the economy and markets.  I have no idea which equity analysts he claimed see a record high wall or worry, or which fixed income pros seek safety.  I keep hearing the same bullish nonsense from both camps.  Barron's notes that money managers can't escape macro data and don't want to go against trends when everyone else is winning.  Anchoring bias for the pain of 2008 explains why some portfolio managers sit on the sidelines.  Well, I'm sitting there with a very small crowd, and I'm got getting up until these other bulls fall down.  Barron's struck the right note.

Piper Jaffray's keynote threw a bunch of technical chartist eyewash at the audience.  I ignored it.  I also ignored the claim that US treasury yields are higher than the G7 average because such a claim ignores the structural problems in all G7 countries.  I don't break down portfolio choices as "offensive" or "defensive" sectors but those simplistic and faddish ideas give money managers some cute talking points.  Portfolio managers who review sector relative strength charts are idiots.  I did at least get a free technical analysis periodical out of this session and it confirms how money pros take the wrong ideas so seriously.  Otherwise, this session was a look into how many dumb portfolio managers blindly follow trends.  Sheesh.

Roger Conrad from Capitalist Times presented some unconventional income investing ideas.  It's good to be reminded that interest rates have less effect on returns in dividend stocks and REITs than they do on fixed income investments.  Some alternatives are not as useful as they appear.  The CBOE's tradable TNX 10-year Treasury index is really another leveraged product and I'm not sure how to estimate its fair value.  Plenty of ideas litter the landscape:  yield cos, gen cos, utility stocks (aka "utes"), MLPs, REITs, and natural resource royalty trusts.  This was the first MoneyShow where I heard someone describe telecom stocks as income plays, particularly when they spin off REITs.  Oookaaay, but some investors lost big when MCI WorldCom went bankrupt last decade.  Memories are short on Wall Street.  The big Kinder buyout of its MLPs is recent news on many people's minds, and it may set a precedent for further consolidation as operating companies watch MLP tax advantages erode.  Investors who hold Canadian-domiciled income investments were curious about whether IRS Form 1116 allows the recovery of foreign withholding taxes on qualified dividends.  They were also concerned about UBTI liability for MLPs held in IRAs.  That's beyond the scope of this blog because I'm not a tax adviser; I keep my own affairs simple by not owning such Canadian instruments.  I have long sought to find firm criteria for determining a dividend's sustainability, so that may be a subject for a future blog article.

Zions Direct shared some specialized fixed income knowledge.  Bond liquidity matters for investors who don't hold bonds to maturity, which IMHO is pretty stupid but some investors don't take portfolio volatility seriously.  Bonds below investment grade are less liquid and have higher bid-ask spreads.  Smaller size issues are less liquid because not every institutional bond investor will be able to fit them into their profiles at a moment's notice.  FINRA has a very robust Bond Market Data search capability.  Bond investors who are really into such searches should watch out for canary calls, Bermuda calls, and other things that can involuntarily remove a bond from a fixed income ladder.  The MSRB EMMA search tool is a cool way to find munis and read their official statements.  Those statements reveal which munis are subject to extraordinary redemption clauses that can make them riskier than general obligation bonds.  Zions also shared some insights into sinking fund mechanics.  Sinking funds allow muni bond issuers to retire bonds by lottery, and their clearing firm runs a second lottery to decide which bonds get called.  Hey folks, that's two layers of probability a bond call has to work through to remove it from a portfolio, and according to the laws of probability a large institutional investor holding many bonds of a given issue is more likely to get that call than any individual investor.  This is more evidence that individual investors need to quit worrying about the exotic exigencies of a single muni bond issue.  Bond investors who need to know more than what their brokerage tells them can check out SIFMA's Investing in Bonds tutorials.

Grom Social demonstrated their social network for kids.  Their extensive live monitoring must be costly, so IMHO they'll need dirt-cheap moderators.  I can see how their colorful avatars appeal to kids.  I can also see a problem with high turnover, because kids will leave the network as they mature.  Turnover means growth from new users will have to be about twice as big as their natural attrition rate.  The media buzz around their story reminds me of the Duck Dynasty franchise.  I think the biggest winners from this are the founding family monetizing their own unique story.

Mark Skousen appeared on my radar because I was interested in hearing about how politicians invest.  The US Senate Financial Disclosure site is searchable but that does not necessarily mean investors can get actionable investing insights.  OpenSecrets tracks political finance but that does not mean politicians' financial decisions are well-informed.  Washington, DC and Wall Street insiders do share semi-permeable membranes but that does not ensure something useful will pass through in either direction.  The Federal Reserve's market instructions pass through the FRBNY but their firewalls between traders and board members minimize the chances for unfair insider advantages.  "Insiders" in sectors that make heavy campaign contributions can demand regulatory advantages up to a point, like with the Affordable Care Act's protections for health care oligopolies.  That point ends when the insiders' parasitical rent extractions kill the host of the broader economy, and their regulatory capture then becomes untenable.  Much of the stuff I heard in this session was irrelevant to me.  Some themes like BDCs ignore the vulnerability of senior secured loan portfolios to high inflation, but the story sounds cute to people who think they're sticking it to insiders.  Banks' high net investment income from the Fed's yield subsidy has similar appeal, but the Fed can't keep those plates spinning forever.  Arguing that precious metals prices reflect inflation sentiment ignores the broad supply and demand fundamentals that really drive prices.

Mark Skousen went through a lot of what must be his typical script and topped it off by tearing up a one dollar bill, showing his disdain for fiat currency.  I picked up the shards after his lecture and he said I could have them.  There's the picture above, showing that a couple of the shards were unrecoverable from the floor.  I took them to my local bank branch this week and exchanged them for an undamaged one dollar bill, as the Federal Reserve allows.  I consider this dollar to be found income for tax purposes, just like picking up spare change off the ground.  I know the value of a dollar.

Here's a brief note on fracking.  Insider interest in its expansion is driven by market demand, not powerful people playing games.  Anyone interested in watching the fracking boom unfold can check out the North Dakota Industrial Commission's website for oil and gas data.  The retro '90s look of that site brings back memories of my old GeoCities site on Yahoo.  Ah, those were the days, when we could all get rich by doing nothing.  It happens again every so often.

The equity crowdfunding forum was brand new at this MoneyShow.  TheCrowdCafe tracks data for the sector.  JOBS Act Title III still hasn't passed, so the non-accredited investor community still has to wait for its shot at true crowdfunding.  The cumbersome, expensive legacy of Reg A state registered securities is still with us.  The panelists believe the next step in crowdfunding is Big Data predictive analytics revealing investor preferences, time between raises, and successful raise amounts.  I asked the panel whether they thought leading portals will become acquisition targets for big banks.  That is absolutely my favorite thing to ask anyone in crowdfunding.  They answered that acquisitions will happen because good crowdfunding portals are more capital efficient than big firms with legacy costs.

I attended Mark Skousen's evening talk on private equity.  That made for three Skousen events in one day.  It turned out to be three more than I needed.  I expected a talk on how private equity works and how investors of any qualification can participate.  The coverage of a few years' worth of returns from the traded stocks of leading private equity firms made me think ahead to the next available hospitality suite.  Folks, I've seen this stuff before, and a single price movement chart isn't going to tell me whether a stock belongs in my portfolio.  Mitt Romney worked in private equity but he had nothing to do with the publicly traded stocks of private equity firms, and Bain Capital is still privately held.  Most Americans didn't want to hear Mitt Romney's campaign pitch for private enterprise in 2012 because they're all dependent on some form of welfare now.  A nation of entitlement brats doesn't want successful people lecturing them on productivity.

George Gilder dropped in toward the end of Mark Skousen's evening talk.  There they are above, out in the hallway.  George is gesturing his approval of something Mark said and Mark is enjoying the attention.  I did not stick around for autographs because I had to go find some free food from a hospitality suite.  Fortunately one of the exhibitors promoting investment in Myanmar had some excellent free food and booze in their suite.  Mission accomplished.

I started my third and final day at the MoneyShow with Marilyn Cohen's bond expertise.  She noted how 10-year yields have defied most analysts' predictions.  US rates must look better than rates in the rest of the world.  Her key insight is that bond investors can use bonds with "moving parts" (floating Libor, coupon resets, etc.) to mitigate the risks of inflation and rising interest rates.  Bonds with coupon resets often come with call features.  She liked the bonds of one REIT but also thought the REIT itself was a good deal, a rare non-bond pick for her.  If you want to know more about her specific picks, you'll have to ask her yourself.  She was one of the rare contrarians at this MoneyShow who thought the stock market was at a peak valuation!  Woo hoo!  She's always been a genius in my book, and not just because she agrees with me.  Marilyn likes bonds with state intercept enhancements.  She also likes water and sewer bonds in good areas, defined as a prosperous region with stable incomes, no urban blight, and no municipal bankruptcies.  I'm pretty sure that Detroit and Stockton would not meet that definition of a good area for infrastructure bonds.

One other speaker offering some insight did not generate insights I would find useful.  I won't name this person because I don't want to drive Web traffic to sources that I think offer little value.  Folks, I don't need to walk through a fictional character's literary history to conclude that confirmation bias is bad.  I also won't throw out CAPEs as a buy signal just because it doesn't time a sector rotation strategy very well.  I like watching the P/E ratio for individual stocks and the whole market, and CAPE Ratio Calculator is free to use.  Sector rotation is smack in the middle of the spectrum that puts stock picking on one end and broad market analysis on the other, and I'm no fan of splitting the difference that way in portfolio management.  I would like to see data supporting the claim that stocks with high institutional ownership are more sensitive to bullish analyst sentiment.  It may indeed open contrarian opportunities for investors tracking stocks with low institutional ownership, but those same stocks will also be less liquid.

Marilyn Cohen was up for a second time with some overlooked bond ideas.  I learned from her that muni yield changes usually trail broader bond market yield changes.  That makes sense if muni issuers' underwriters reset the offering prices of new issues when the 10-year Treasury yield moves.  She revisited her earlier mention of bond intercept programs, which are mainly for school districts.  States can divert school appropriations to pay school bondholders under such programs.  That's a good enhancement to munis.  She also likes port and harbor bonds, along with senior lien airport revenue bonds.  She definitely does not like pension liability bonds or health care obligation bonds.  She expects some hospitals to go bankrupt under ACA, destroying their bond holders.  She likes watching bonds that are connected to merger plays because their change of control provisions will activate.  I hope bond fund managers have fun watching the bonds of hard asset companies as the US enters hyperinflation.  Marilyn notes that bond market crises often cause stock market crises.  I agree with Marilyn that we can expect a very serious crash.  I can hardly wait.  She thinks bond ETFs may face serious problems in such a crash if investors sell in a panic.  I asked her about the possibility of bond exit fees, and she agreed it's likely.  Marilyn is totally awesome.

Morgan Housel of the Motley Fool told us why we can't have nice things in his afternoon keynote.  Bad investor behavior means many stock market investors underperform the indexes.  People buy high when they're greedy and sell low when they're fearful; Warren Buffett does the opposite.  Volatility is common, the world is complex, and compounding takes time.  Most investors lack the patience to see through that noise.  The P/E ratio isn't perfect but it is the single best statistical explanation of equity market returns.  That's good enough for me.  Read Morgan's site for the rest of his wisdom.

Wayne Allyn Root delivered the final keynote.  This was my first exposure to his bombastic personality.  I consider his performance to be entertainment and it's fitting that he aspires to a political career.  He threw lots of red meat at the audience and I got the impression he was test marketing some themes he can hit on the campaign trail.  Lots of his points got applause and some people objected vocally, so it made for a good stump speech.  If he runs as a Republican, he'll have to address some emerging research that shows economic performance to be superior under Democratic administrations in Washington.  I think his assumption that Americans' offshore wealth will return to the US with a tax holiday is unrealistic.  It may be there to facilitate trade or FDI, and no tax holiday will repatriate capital that is already productively deployed.  His stuff was great for the Tea Party, libertarian, gold and silver crowd.  He's definitely after the Ron Paul demographic because there's money to be made off those people now that their longtime patron saint is retired.  I'm surprised he didn't mention Bitcoin.  I'm sure he'll figure it out once his pollsters test it in Silicon Valley.  George Gilder even hung around until the very end.  That guy was everywhere.

The MoneyShow San Francisco 2014 was a winner for me.  I came out with more building materials for my own portfolio's architecture.  I'm amazed that the official program still mentioned Alfidi Capital as a participant even though I had no booth or speaking engagement.  I sometimes wonder whether my career would have taken a different turn if I had paid for a booth here in 2005 and 2006 when I was a financial adviser.  I can't turn back the clock to those days when I tried to find clients.  I can only look forward to a future where I never need to deal with humans.  The MoneyShow's wisdom will always be relevant to me.

Full disclosure:  I edited a brief mention of Tesla Motors in the "top financial advisors" above to clarify its attempt at profitability.  The company was not earning a net profit at the time of the MoneyShow San Francisco 2014.