Warren Buffett's rules for investing
Warren Buffett has amusingly spelled out his two rules for investing many times in the past:
Rule #1: Don't lose money
Rule #2: Don't forget Rule #1
This may seem like a gross oversimplification, but it holds a kernel of truth I believe few grasp.
Those who've made a lot of money investing--whether in real estate, equities, bonds, commodities, whatever--have almost always done so because they didn't lose very often, and when they did it was with small bets.
In my opinion, this stands in stark contrast with the belief that most people hold: that people who make a lot of money investing do it by gambling big and hitting the jackpot. They tend to think that great investors bet the farm on a wild toss of the coin and make out like bandits.
I'm certain some people have gotten rich that way, but they are a very small minority. The vast majority have done it by not losing their shirts on bad gambles.
Not losing money isn't very sexy. It's not like buying Cisco and watching it go up by 10 times. It's the hard work of picking things you're pretty certain will go up and almost 100% certain will not go down.
Instead of trying to catch shooting stars, not losing means finding a few things that, after a whole lot of research and study, look like they will provide good upside and have an extremely low likelihood of going down much, if at all over the long run.
Why is it that trying to catch shooting stars doesn't work and not losing does? Because most attempts to catch a shooting star ends with a large if not total loss. Even if you manage to catch a shooting star once, the next time you play you are more likely to lose than win. Over time, this just doesn't work.
Not losing slowly builds over time into a growing some of money. It doesn't happen fast. It doesn't look very sexy. But it works. If you aren't losing, you just keep building up and up.
That's what Mr. Buffett is trying to tell you.
Don't swing from your heels at a wild pitch and hope you connect and knock it out of the park. Instead, wait for a pitch you are almost positive you can hit, and then get a base hit that allows you to move forward in the game. Over time, this will build into a win.
Swinging for the fences will provide a couple of exciting moments, but will lead to loss after loss over time. And, that's not how to successfully invest.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, August 17, 2007
Wednesday, August 15, 2007
What will happen if the credit market's other shoe drops?
Recent bond and stock market turmoil has turned full attention to credit markets. What has surprised me is that conditions for credit markets aren't that bad. Am I mad, you may be thinking?
Here's my line of reasoning. There are three things that can really beat up the consumer credit market: availability of credit, interest rates and employment.
The fireworks seen so far are almost purely due to the availability of credit. Market participants have been scared by recent credit defaults and delinquencies, and so they are refusing to grant such markets more credit.
But, interest rates and employment are just as important, and they are doing great right now. Both look as good as they have since the 1950's and 1960's, with long term interest rates at 4-5% and unemployment down around 4-5%.
What would happen if this were to change, and why doesn't anybody seem to be discussing this?
I guaranty that if interest rates increase and employment starts to fall, you will see many more defaults and delinquencies. In other words, what we are witnessing in credit markets could just be the tip of the iceberg.
With Congress threatening 27.5% tariffs on Chinese goods and China threatening to sell the huge amount of US Government Treasury bonds they hold in response, the threat of higher interest rates is real. With credit market troubles in the US forcing the Fed to intervene and the dollar falling, higher interest rates are even more of a threat.
With the housing market supplying so many jobs since the 2001 recession and the housing market crashing, employment problems could just be surfacing. With recent retail sales so poor, additional employment problems could be rearing their ugly head, too.
I don't know how this will play out, but I'm watching it carefully. If the economy continues to be strong, then interest rates and employment will not be big concerns.
But, if the economy continues to slow, the dollar continues to fall, retails sales continue to look punk, the housing market continues to decline, or protectionist sentiment in Congress gains momentum, look out below!
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Recent bond and stock market turmoil has turned full attention to credit markets. What has surprised me is that conditions for credit markets aren't that bad. Am I mad, you may be thinking?
Here's my line of reasoning. There are three things that can really beat up the consumer credit market: availability of credit, interest rates and employment.
The fireworks seen so far are almost purely due to the availability of credit. Market participants have been scared by recent credit defaults and delinquencies, and so they are refusing to grant such markets more credit.
But, interest rates and employment are just as important, and they are doing great right now. Both look as good as they have since the 1950's and 1960's, with long term interest rates at 4-5% and unemployment down around 4-5%.
What would happen if this were to change, and why doesn't anybody seem to be discussing this?
I guaranty that if interest rates increase and employment starts to fall, you will see many more defaults and delinquencies. In other words, what we are witnessing in credit markets could just be the tip of the iceberg.
With Congress threatening 27.5% tariffs on Chinese goods and China threatening to sell the huge amount of US Government Treasury bonds they hold in response, the threat of higher interest rates is real. With credit market troubles in the US forcing the Fed to intervene and the dollar falling, higher interest rates are even more of a threat.
With the housing market supplying so many jobs since the 2001 recession and the housing market crashing, employment problems could just be surfacing. With recent retail sales so poor, additional employment problems could be rearing their ugly head, too.
I don't know how this will play out, but I'm watching it carefully. If the economy continues to be strong, then interest rates and employment will not be big concerns.
But, if the economy continues to slow, the dollar continues to fall, retails sales continue to look punk, the housing market continues to decline, or protectionist sentiment in Congress gains momentum, look out below!
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Monday, August 13, 2007
Graham and Dodd on guaranteed real-estate mortgages and mortgage bonds
I recently re-read--with pleasure--chapter XVII of the 1934 Edition of Security Analysis by Benjamin Graham and David Dodd. The chapter addresses guaranteed real-estate mortgages and mortgage bonds.
I re-read the section because I think it highlights the problems of mortgage insurance companies and other insurance companies that enter the business of guaranteeing the payment of mortgages and mortgage securities (such as surety businesses like bond insurers).
You see, the real estate boom of the 1920's led to a terrible real estate crash in the 1930's. It basically wiped out the mortgage insurance industry and many of the surety companies that ended up guaranteeing mortgage bonds. The history is illustrative for what can happen and what may be happening today.
I quote liberally from the text below (starting on page 184).
"The idea of underlying real-estate mortgage guarantees is evidently that of insurance."
"It is within the province of sound insurance practice to afford this protection in return for an adequate premium, provided of course, that all phases of the business are prudently handled. Such an arrangement will have the best chance of success if:
1. The mortgage loans are conservatively made in the first instance.
2. The guaranty or surety company is large, well managed, independent of the agency selling the mortgages, and has a diversification of business in fields other than real estate.
3. Economic conditions are not undergoing fluctuations of abnormal intensity.
The collapse in real-estate values after 1929 was so extreme as to contravene the third of these conditions."
"In the first place a striking contrast may be drawn between the way in which the business of guaranteeing mortgages had been conducted prior to about 1924 and the lax methods which developed there-after, during the very time that this part of the financial field was attaining its greatest importance."
"The amount of each mortgage was limited to not more than 60% of the value, carefully determined; large mortgages were avoided; and a fair diversification of risk...was attained." [loan to value ratios run very high today: 80%, 90% and even 95%]
"It is true also that the general practice of guaranteeing mortgages due only three to five years after their issuance contained the possibility, later realized, of a flood of maturing obligations at a most inconvenient time."
"The building boom which developed during the new era was marked by an enormous growth of the real-estate-mortgage business and of the practice of guaranteeing obligations of this kind."
"Great emphasis was laid upon the long record of success in the past, and the public was duly impressed...."
"The weakness of the mortgages themselves applied equally to the guarantees which were frequently attached thereto for an extra consideration."
"The rise of the newer and more aggressive real-estate-bond organizations had a most unfortunate effect upon the policies of the older concerns. By force of competition they were led to relax their standards of making loans."
"...the face amount of the mortgages guaranteed rose to so high a multiple of the capital of the guarantor companies that it should have been obvious that the guaranty would afford only the flimsiest of protection in the event of a general decline in values."
"When the real-estate market broke in 1931, the first consequence was the utter collapse of virtually every one of the newer real-estate-bond companies and their subsidiary guarantor concerns. As the depression continued, the older institutions gave way also."
"During the 1924-1930 period several of the independent surety and fidelity companies extended their operations to include the guaranteeing of real-estate mortgages for a fee or premium."
"...surety companies began the practice of guaranteeing real-estate-mortgage bonds only a short time prior to their debacle...."
"In most cases the resultant losses to the suretor were greater than it could stand; several companies were forced into receivership, and holders of bonds with such guarantees failed to obtain full protection."
Perhaps the real estate boom of the early 2000's was similar to that of the 1920's. If that is the case, and I believe it is to some degree, then Graham and Dodd's historical lesson served as a potent warning for investors in mortgage and bond insurance companies. Maybe that is why they have sold at such seemingly cheap prices over the years....
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
I recently re-read--with pleasure--chapter XVII of the 1934 Edition of Security Analysis by Benjamin Graham and David Dodd. The chapter addresses guaranteed real-estate mortgages and mortgage bonds.
I re-read the section because I think it highlights the problems of mortgage insurance companies and other insurance companies that enter the business of guaranteeing the payment of mortgages and mortgage securities (such as surety businesses like bond insurers).
You see, the real estate boom of the 1920's led to a terrible real estate crash in the 1930's. It basically wiped out the mortgage insurance industry and many of the surety companies that ended up guaranteeing mortgage bonds. The history is illustrative for what can happen and what may be happening today.
I quote liberally from the text below (starting on page 184).
"The idea of underlying real-estate mortgage guarantees is evidently that of insurance."
"It is within the province of sound insurance practice to afford this protection in return for an adequate premium, provided of course, that all phases of the business are prudently handled. Such an arrangement will have the best chance of success if:
1. The mortgage loans are conservatively made in the first instance.
2. The guaranty or surety company is large, well managed, independent of the agency selling the mortgages, and has a diversification of business in fields other than real estate.
3. Economic conditions are not undergoing fluctuations of abnormal intensity.
The collapse in real-estate values after 1929 was so extreme as to contravene the third of these conditions."
"In the first place a striking contrast may be drawn between the way in which the business of guaranteeing mortgages had been conducted prior to about 1924 and the lax methods which developed there-after, during the very time that this part of the financial field was attaining its greatest importance."
"The amount of each mortgage was limited to not more than 60% of the value, carefully determined; large mortgages were avoided; and a fair diversification of risk...was attained." [loan to value ratios run very high today: 80%, 90% and even 95%]
"It is true also that the general practice of guaranteeing mortgages due only three to five years after their issuance contained the possibility, later realized, of a flood of maturing obligations at a most inconvenient time."
"The building boom which developed during the new era was marked by an enormous growth of the real-estate-mortgage business and of the practice of guaranteeing obligations of this kind."
"Great emphasis was laid upon the long record of success in the past, and the public was duly impressed...."
"The weakness of the mortgages themselves applied equally to the guarantees which were frequently attached thereto for an extra consideration."
"The rise of the newer and more aggressive real-estate-bond organizations had a most unfortunate effect upon the policies of the older concerns. By force of competition they were led to relax their standards of making loans."
"...the face amount of the mortgages guaranteed rose to so high a multiple of the capital of the guarantor companies that it should have been obvious that the guaranty would afford only the flimsiest of protection in the event of a general decline in values."
"When the real-estate market broke in 1931, the first consequence was the utter collapse of virtually every one of the newer real-estate-bond companies and their subsidiary guarantor concerns. As the depression continued, the older institutions gave way also."
"During the 1924-1930 period several of the independent surety and fidelity companies extended their operations to include the guaranteeing of real-estate mortgages for a fee or premium."
"...surety companies began the practice of guaranteeing real-estate-mortgage bonds only a short time prior to their debacle...."
"In most cases the resultant losses to the suretor were greater than it could stand; several companies were forced into receivership, and holders of bonds with such guarantees failed to obtain full protection."
Perhaps the real estate boom of the early 2000's was similar to that of the 1920's. If that is the case, and I believe it is to some degree, then Graham and Dodd's historical lesson served as a potent warning for investors in mortgage and bond insurance companies. Maybe that is why they have sold at such seemingly cheap prices over the years....
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, August 10, 2007
The Fed to the rescue?
The Fed, also known as the Federal Reserve, had to ride to the rescue of financial markets today and yesterday.
The market suffered from a liquidity crunch this week, which means that many investors were unwilling to put their money into markets. This causes a dry up of so-called liquidity, or ready money.
You see, most financial institutions operate on a lot of borrowed money. When they can't borrow money, their operations seize up for a lack of a better term.
The Fed came to the rescue by pumping $24 billion into the market in two transactions yesterday and $38 billion into the market in three transactions today, more than the $50 billion pumped into markets after 9/11. (As an aside, the European Central Bank pumped almost $200 billion into their markets to keep things going)
How does the Fed do this? They lend money to banks at low rates. Not surprisingly, the Fed does not create value from thin air, they must do something for this so-called liquidity to appear.
The long and short is that they "printed" money out of thin air for the banks to borrow. I put printed in quotes because it's almost all done electronically now, so the printing is purely in computer bits.
Does such market aid come at a cost? You betcha! Printing money faster than economic growth causes inflation. As Milton Friedman said, inflation is everywhere and always a monetary phenomenon.
Perhaps that is why the price of gold decoupled from the stock market today. You see, the gold market has been moving in conjunction with the stock market lately, which is very unusual. Today it stopped moving in conjunction with the stock market, though, perhaps indicating that buyers and sellers of gold recognized that the Fed printing money to rescue the financial system is just another way of saying, "Here comes some inflation for ya!"
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
The Fed, also known as the Federal Reserve, had to ride to the rescue of financial markets today and yesterday.
The market suffered from a liquidity crunch this week, which means that many investors were unwilling to put their money into markets. This causes a dry up of so-called liquidity, or ready money.
You see, most financial institutions operate on a lot of borrowed money. When they can't borrow money, their operations seize up for a lack of a better term.
The Fed came to the rescue by pumping $24 billion into the market in two transactions yesterday and $38 billion into the market in three transactions today, more than the $50 billion pumped into markets after 9/11. (As an aside, the European Central Bank pumped almost $200 billion into their markets to keep things going)
How does the Fed do this? They lend money to banks at low rates. Not surprisingly, the Fed does not create value from thin air, they must do something for this so-called liquidity to appear.
The long and short is that they "printed" money out of thin air for the banks to borrow. I put printed in quotes because it's almost all done electronically now, so the printing is purely in computer bits.
Does such market aid come at a cost? You betcha! Printing money faster than economic growth causes inflation. As Milton Friedman said, inflation is everywhere and always a monetary phenomenon.
Perhaps that is why the price of gold decoupled from the stock market today. You see, the gold market has been moving in conjunction with the stock market lately, which is very unusual. Today it stopped moving in conjunction with the stock market, though, perhaps indicating that buyers and sellers of gold recognized that the Fed printing money to rescue the financial system is just another way of saying, "Here comes some inflation for ya!"
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Wednesday, August 08, 2007
What a roller coaster ride!
Boy have the markets been exciting lately!
After reaching a new intraday high of 14,121.04 on July 19th, the Dow Jones Industrial Average has plunged to an intraday low of 13,041.77 (a negative 7.6% return) on August 1st, and then hit an intraday high of 13,769.63 today (up 5.6%). That's quite a round trip in 20 days!
In the same time, bond yields, too, have plunged and then recovered to some degree. All this volume and price movement must be making some traders and brokers happy...
What does it all mean? I'm not going to act like I know, but I do know that market moves like this represent opportunity.
Sure enough, I took the opportunity to purchase a Real Estate Investment Trust for my income clients on August 1st. It was yielding almost 10% at that point and its price has already recovered 9.6% since I bought.
I don't see this as a chance to brag, because I know very well its price could plunge before I have a chance to publish this post. What I do want to highlight is the golden opportunity found in market volatility.
While some people panic, cooler heads find opportunities. It's not my area of specialty, but I guarantee you that some distressed debt gurus are out there picking up securities on the cheap that will pay them handsomely over time.
Market volatility equals market opportunity. Instead of panicking, go shopping instead.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Boy have the markets been exciting lately!
After reaching a new intraday high of 14,121.04 on July 19th, the Dow Jones Industrial Average has plunged to an intraday low of 13,041.77 (a negative 7.6% return) on August 1st, and then hit an intraday high of 13,769.63 today (up 5.6%). That's quite a round trip in 20 days!
In the same time, bond yields, too, have plunged and then recovered to some degree. All this volume and price movement must be making some traders and brokers happy...
What does it all mean? I'm not going to act like I know, but I do know that market moves like this represent opportunity.
Sure enough, I took the opportunity to purchase a Real Estate Investment Trust for my income clients on August 1st. It was yielding almost 10% at that point and its price has already recovered 9.6% since I bought.
I don't see this as a chance to brag, because I know very well its price could plunge before I have a chance to publish this post. What I do want to highlight is the golden opportunity found in market volatility.
While some people panic, cooler heads find opportunities. It's not my area of specialty, but I guarantee you that some distressed debt gurus are out there picking up securities on the cheap that will pay them handsomely over time.
Market volatility equals market opportunity. Instead of panicking, go shopping instead.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Monday, August 06, 2007
Buying great businesses
When the market is volatile, like it has been lately, I like to look hard at the underlying businesses I own.
Specifically, I like to focus on the economics of each business (competitive advantages, industry dynamics, industry growth, etc.), each business's management (their long term track record, their business ownership, their pay structure, their focus on shareholder value, etc.) and each business's valuation (some measure each business's long term value relative to current price).
Every time I do this, especially when the market is volatile, I'm most happy with the great businesses I own. Why? Because looking at their fundamentals, I feel comfortable they will do well regardless of how much stock market prices fluctuate.
In fact, the best businesses seem to benefit disproportionately when the market seems most shaky. This is when great businesses buy things on the cheap, take advantage of weaker competitors, plan for the next upswing, etc.
And, looking at such great businesses makes me feel very comfortable with how my clients' and my own money are invested, because I know that when the market eventually recovers, we'll almost always recognize disproportionate benefits. That's a nice feeling to have.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
When the market is volatile, like it has been lately, I like to look hard at the underlying businesses I own.
Specifically, I like to focus on the economics of each business (competitive advantages, industry dynamics, industry growth, etc.), each business's management (their long term track record, their business ownership, their pay structure, their focus on shareholder value, etc.) and each business's valuation (some measure each business's long term value relative to current price).
Every time I do this, especially when the market is volatile, I'm most happy with the great businesses I own. Why? Because looking at their fundamentals, I feel comfortable they will do well regardless of how much stock market prices fluctuate.
In fact, the best businesses seem to benefit disproportionately when the market seems most shaky. This is when great businesses buy things on the cheap, take advantage of weaker competitors, plan for the next upswing, etc.
And, looking at such great businesses makes me feel very comfortable with how my clients' and my own money are invested, because I know that when the market eventually recovers, we'll almost always recognize disproportionate benefits. That's a nice feeling to have.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, August 03, 2007
Clampdown on risky mortgages
The Wall Street Journal had an interesting article today by James Hagerty and Ruth Simon titled "Lenders Broaden Clampdown on Risky Mortgages."
In it, they highlighted that "Jittery home-mortgage lenders are cutting off credit or raising interest rates for a growing portion of Americans."
As they say, "This worsening credit crunch threatens to put further pressure on the housing market."
The mortgages being effected aren't just subprime, but also included so-called Alt-A loans, a category in between prime and subprime. This illustrates how the credit crunch impacting the subprime market is spreading to other markets.
The articles quotes Thomas Lawler, a housing economist in Vienna, Va, who said the credit squeeze "will further crimp the effective demand for housing, and will make the late summer home-sales season even worse than the dismal spring season."
Also, American Home Mortgage Investment stopped making loans earlier this week and said late yesterday it would cease most operations and lay off over 6,000 employees. Accredited Home Lenders Holding is almost in as much trouble after auditors said its "financial and operational viability" is uncertain.
In other words, the so-called "contained" credit market squeeze continues to impact more and more markets and businesses. It's my guess that it will take years for this situation to fully work out and that players in the credit markets will see record stress before it's all over.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
The Wall Street Journal had an interesting article today by James Hagerty and Ruth Simon titled "Lenders Broaden Clampdown on Risky Mortgages."
In it, they highlighted that "Jittery home-mortgage lenders are cutting off credit or raising interest rates for a growing portion of Americans."
As they say, "This worsening credit crunch threatens to put further pressure on the housing market."
The mortgages being effected aren't just subprime, but also included so-called Alt-A loans, a category in between prime and subprime. This illustrates how the credit crunch impacting the subprime market is spreading to other markets.
The articles quotes Thomas Lawler, a housing economist in Vienna, Va, who said the credit squeeze "will further crimp the effective demand for housing, and will make the late summer home-sales season even worse than the dismal spring season."
Also, American Home Mortgage Investment stopped making loans earlier this week and said late yesterday it would cease most operations and lay off over 6,000 employees. Accredited Home Lenders Holding is almost in as much trouble after auditors said its "financial and operational viability" is uncertain.
In other words, the so-called "contained" credit market squeeze continues to impact more and more markets and businesses. It's my guess that it will take years for this situation to fully work out and that players in the credit markets will see record stress before it's all over.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Wednesday, August 01, 2007
Beware the Black Swan
I've been babbling for several months now on this blog (and, as my wife can attest, for several years before that) about the risk of low probability, high impact events--what Nassim Taleb refers to as Black Swans--particularly related to the housing market.
It seems that chicken may finally be coming home to roost in the housing market and the markets that rely strongly on the housing industry.
Before I crow too loud about the malaise that is occurring, I must freely admit that I did not place any money-making bets on this decline. Quite the contrary, all I did was try to stay away from such a risk.
In staying away, I missed out on the huge run-up that has occurred in mortgage lenders, mortgage insurers, bond insurers, home builders, etc. This made me look pretty stupid in the short run, but right now I'm quite happy I don't own any companies in these industries.
Will these industries face a total collapse or a financial crisis? I have no idea. The odds are against it. But, like all Black Swans, I want to avoid such negative, low likelihood, high impact events.
I don't have to be able to predict when they will happen or how bad it will get, I simply have to stay away from risks I cannot accurately assess or that do not provide sufficient compensation for their risk.
I will be very interested to see how bad such housing related markets get, but I still don't think I'll be participating there for quite some time. After all, because it seems to be a Black Swan, I don't know how bad it will get, and so I'm staying away until I understand what's going on.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
I've been babbling for several months now on this blog (and, as my wife can attest, for several years before that) about the risk of low probability, high impact events--what Nassim Taleb refers to as Black Swans--particularly related to the housing market.
It seems that chicken may finally be coming home to roost in the housing market and the markets that rely strongly on the housing industry.
Before I crow too loud about the malaise that is occurring, I must freely admit that I did not place any money-making bets on this decline. Quite the contrary, all I did was try to stay away from such a risk.
In staying away, I missed out on the huge run-up that has occurred in mortgage lenders, mortgage insurers, bond insurers, home builders, etc. This made me look pretty stupid in the short run, but right now I'm quite happy I don't own any companies in these industries.
Will these industries face a total collapse or a financial crisis? I have no idea. The odds are against it. But, like all Black Swans, I want to avoid such negative, low likelihood, high impact events.
I don't have to be able to predict when they will happen or how bad it will get, I simply have to stay away from risks I cannot accurately assess or that do not provide sufficient compensation for their risk.
I will be very interested to see how bad such housing related markets get, but I still don't think I'll be participating there for quite some time. After all, because it seems to be a Black Swan, I don't know how bad it will get, and so I'm staying away until I understand what's going on.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Monday, July 30, 2007
Have corporate profit margins reached a permanently high plateau...doubtful
James Montier of Dresdner Kleinwort has another great article out.
In it, he takes Jeremy Siegel to task for his recent assertion that profit margins will not revert to the mean (go back to their average level of the past or below) and will stay at their current, record highs.
Jeremy Siegel is famous for being a professor at the esteemed University of Pennsylvania Wharton School of Business as well as being the well known author of Stocks for the Long Run.
Siegel's argument is that U.S. based firms are deriving much more of their profits from fast-growing, overseas economies and that including private firms' profits with public firms' profits reduces the profit margins close to average.
Both of these arguments are suspect in Montier (and my) opinion.
As Jeremy Grantham puts it, if profit margins don't mean revert (go back to average), then capitalism is broken. Competition will always drive aggregate profit margins down over time. This is an iron law of free market economics.
As for private plus public firms' profit margins, the current margin of profits to Gross Domestic Product are at a 45 year high of 20%, far above the 16% average. Perhaps Siegel is looking at different numbers than Montier is.
Added to this, market history is littered with brilliant people who believe "it's different this time." As John Templeton put it, those are the four most dangerous words in investing.
A brilliant economist named Irving Fisher is famous for having said that stocks had hit a permanently high plateau in 1929. Unfortunately for Fisher's reputation, the stock market proceeded to crash by over 90% over the following 3 years. Perhaps Siegel is hoping to supplant Fisher...
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
James Montier of Dresdner Kleinwort has another great article out.
In it, he takes Jeremy Siegel to task for his recent assertion that profit margins will not revert to the mean (go back to their average level of the past or below) and will stay at their current, record highs.
Jeremy Siegel is famous for being a professor at the esteemed University of Pennsylvania Wharton School of Business as well as being the well known author of Stocks for the Long Run.
Siegel's argument is that U.S. based firms are deriving much more of their profits from fast-growing, overseas economies and that including private firms' profits with public firms' profits reduces the profit margins close to average.
Both of these arguments are suspect in Montier (and my) opinion.
As Jeremy Grantham puts it, if profit margins don't mean revert (go back to average), then capitalism is broken. Competition will always drive aggregate profit margins down over time. This is an iron law of free market economics.
As for private plus public firms' profit margins, the current margin of profits to Gross Domestic Product are at a 45 year high of 20%, far above the 16% average. Perhaps Siegel is looking at different numbers than Montier is.
Added to this, market history is littered with brilliant people who believe "it's different this time." As John Templeton put it, those are the four most dangerous words in investing.
A brilliant economist named Irving Fisher is famous for having said that stocks had hit a permanently high plateau in 1929. Unfortunately for Fisher's reputation, the stock market proceeded to crash by over 90% over the following 3 years. Perhaps Siegel is hoping to supplant Fisher...
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, July 27, 2007
Jeremy Grantham "has almost never been this dire"
Jeremy Grantham heads one of the best quantitative, value-oriented firms out there, Grantham Mayo and Van Otterloo (referred to as GMO for short). In his quarterly letter (www.gmo.com, you have to register to read their letters, but it's worth it and I've never received a bit of unsolicited email from them), Grantham puts forward the same message he's been delivering for some time: the market is grossly over-valued.
Grantham has been preaching this for some time, but his record in being right, though almost always early, is excellent. Heeding his words back in the late 1990's would have saved you a lot of heart-ache if you were invested in the tech and telecom bubble.
Grantham's theme in the past focused on a reversion to the mean of corporate profit margins. In this letter, he doesn't spend much time on that subject, but he does take private equity, corporate tax rates, global financial markets, subprime mortgages, etc. to task. He simply sees too much risk taking out there and predicts it will end poorly.
I'll just quote Grantham here because he says it best, "To conclude, I have been trying to come up with a simple statement that would capture how serious the situation is for the overstretched, overleveraged financial system, and this is it: In 5 years I expect that at least one major "bank" (broadly defined) will have failed and that up to half the hedge funds and a substantial percentage of the private equity firms in existence today will have simply ceased to exist."
Wow, that's quite a prediction!
He goes on to say, "I have often been too bearish about the U.S. equity markets in the last 12 years (although bullish on emerging equity markets), but I think it is fair to say that my language has almost never been this dire. The feeling I have today is that of watching a very slow motion train wreck."
He's not mincing words there, either.
What's his suggested solution? In a word, "anti-risk." He doesn't take much time explaining what that means, but I think I can guess. Some investements will do a lot better than others if or when risk becomes a four-letter-word again. That may include shorting the market, buying commodities or gold, buying Treasury securities, or finding business managers who can benefit greatly in a market situation characterized by a lot of risk aversion.
In this last category, I'd put companies like Berkshire Hathaway, Leucadia and Fairfax Financial, companies that have a lot of cash on hand or are short the market and are waiting for a risk averse market to put their money to work. In the interest of full disclosure, I own positions in all three of these companies both personally and for clients.
A more risk averse market like we are facing usually scares people to death. In contrast, I see such situations as golden opportunities to buy when blood is running in the streets. In addition, I've purchased securities that I believe will do well even if the market does fair poorly.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Jeremy Grantham heads one of the best quantitative, value-oriented firms out there, Grantham Mayo and Van Otterloo (referred to as GMO for short). In his quarterly letter (www.gmo.com, you have to register to read their letters, but it's worth it and I've never received a bit of unsolicited email from them), Grantham puts forward the same message he's been delivering for some time: the market is grossly over-valued.
Grantham has been preaching this for some time, but his record in being right, though almost always early, is excellent. Heeding his words back in the late 1990's would have saved you a lot of heart-ache if you were invested in the tech and telecom bubble.
Grantham's theme in the past focused on a reversion to the mean of corporate profit margins. In this letter, he doesn't spend much time on that subject, but he does take private equity, corporate tax rates, global financial markets, subprime mortgages, etc. to task. He simply sees too much risk taking out there and predicts it will end poorly.
I'll just quote Grantham here because he says it best, "To conclude, I have been trying to come up with a simple statement that would capture how serious the situation is for the overstretched, overleveraged financial system, and this is it: In 5 years I expect that at least one major "bank" (broadly defined) will have failed and that up to half the hedge funds and a substantial percentage of the private equity firms in existence today will have simply ceased to exist."
Wow, that's quite a prediction!
He goes on to say, "I have often been too bearish about the U.S. equity markets in the last 12 years (although bullish on emerging equity markets), but I think it is fair to say that my language has almost never been this dire. The feeling I have today is that of watching a very slow motion train wreck."
He's not mincing words there, either.
What's his suggested solution? In a word, "anti-risk." He doesn't take much time explaining what that means, but I think I can guess. Some investements will do a lot better than others if or when risk becomes a four-letter-word again. That may include shorting the market, buying commodities or gold, buying Treasury securities, or finding business managers who can benefit greatly in a market situation characterized by a lot of risk aversion.
In this last category, I'd put companies like Berkshire Hathaway, Leucadia and Fairfax Financial, companies that have a lot of cash on hand or are short the market and are waiting for a risk averse market to put their money to work. In the interest of full disclosure, I own positions in all three of these companies both personally and for clients.
A more risk averse market like we are facing usually scares people to death. In contrast, I see such situations as golden opportunities to buy when blood is running in the streets. In addition, I've purchased securities that I believe will do well even if the market does fair poorly.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Wednesday, July 25, 2007
Continued ripple effects
It's been interesting to watch how the fallout in credit markets has rippled across other markets.
The initial indication of credit market stress showed up as subprime problems during late winter and early spring of this year. At the time, many market commentators were saying it was isolated and contained.
Then, as expected, credit tightening continued to ripple across other markets as it became more difficult to raise high yield debt. This, too, was described as a short term and isolated situation.
Now, it sounds like prime home equity loans are having trouble as are auto loans. The ripples keep showing up in more and more places. And, the market commentators continue to declare that it's contained and short term.
Is this unusual? Not at all. This is exactly the type of thing that happens every time credit markets get too loose. As the credit market gets further and further away from its most recent problems, lower quality borrowers are loaned more and more money, or money is lent to borrowers at a rates not high enough to compensate for the risk involved.
At some point in time (forecasting if it will happen is easy, forecasting when is extraordinarily difficult), credit markets tighten again as lenders realize they have made bad loans.
This usually takes several years to unfold and almost always includes a large and "unexpected" crisis such as Long Term Capital Management in 1998, the Saving and Loan Crisis in the late 80's and early 90's, or the corporate credit squeeze in 2002.
I expect greater difficulties for banks (especially mortgage banks) that made bad loans, bond insurers that insured AAA tranches that were much more risky than they assumed, and mortgage insurers who looked only at recent data when pricing their insurance premiums.
At a later point in time, the market will become so disgusted that great buying opportunities will occur. I don't think that time is here, yet, but I also assume that smart investors will start buying long before the bottom is reached. I just may be in that group, too.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
It's been interesting to watch how the fallout in credit markets has rippled across other markets.
The initial indication of credit market stress showed up as subprime problems during late winter and early spring of this year. At the time, many market commentators were saying it was isolated and contained.
Then, as expected, credit tightening continued to ripple across other markets as it became more difficult to raise high yield debt. This, too, was described as a short term and isolated situation.
Now, it sounds like prime home equity loans are having trouble as are auto loans. The ripples keep showing up in more and more places. And, the market commentators continue to declare that it's contained and short term.
Is this unusual? Not at all. This is exactly the type of thing that happens every time credit markets get too loose. As the credit market gets further and further away from its most recent problems, lower quality borrowers are loaned more and more money, or money is lent to borrowers at a rates not high enough to compensate for the risk involved.
At some point in time (forecasting if it will happen is easy, forecasting when is extraordinarily difficult), credit markets tighten again as lenders realize they have made bad loans.
This usually takes several years to unfold and almost always includes a large and "unexpected" crisis such as Long Term Capital Management in 1998, the Saving and Loan Crisis in the late 80's and early 90's, or the corporate credit squeeze in 2002.
I expect greater difficulties for banks (especially mortgage banks) that made bad loans, bond insurers that insured AAA tranches that were much more risky than they assumed, and mortgage insurers who looked only at recent data when pricing their insurance premiums.
At a later point in time, the market will become so disgusted that great buying opportunities will occur. I don't think that time is here, yet, but I also assume that smart investors will start buying long before the bottom is reached. I just may be in that group, too.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Monday, July 23, 2007
Just for fun
If you've ever wondered if you can pick stocks successfully, I've got a website I'd like to recommend to you: www.marketocracy.com
The concept of the site is that there may be many people out there that are good at managing money, but have never had the chance or are simply in a different career field.
Marketocracy allows you to start out with a theoretical portfolio of $1 million. You pick the stocks you think will beat the market, make theoretical buys and sell orders, and then can track your performance over time. The site allows yo to compare your performance to the Dow Jones Industrial Average, the S&P 500, the Nasdaq and the top 100 players on Marketocracy.
It's actually a lot of fun, too. I started a couple of fantasy portfolios there in the fall of 2001, and my picks have done pretty well. See here for yourself: Mike Rivers Mutual Fund and Rivers Capital. They've also let me experiment with some specific methods of applying the value investing philosophy before doing it in my own or my clients' accounts.
If you've ever wondered whether you're good at picking stocks, you may want to give Marketocracy a try. If you're good, you may want to start managing your own money, and if you're really good, perhaps you can become a professional money manager yourself!
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
If you've ever wondered if you can pick stocks successfully, I've got a website I'd like to recommend to you: www.marketocracy.com
The concept of the site is that there may be many people out there that are good at managing money, but have never had the chance or are simply in a different career field.
Marketocracy allows you to start out with a theoretical portfolio of $1 million. You pick the stocks you think will beat the market, make theoretical buys and sell orders, and then can track your performance over time. The site allows yo to compare your performance to the Dow Jones Industrial Average, the S&P 500, the Nasdaq and the top 100 players on Marketocracy.
It's actually a lot of fun, too. I started a couple of fantasy portfolios there in the fall of 2001, and my picks have done pretty well. See here for yourself: Mike Rivers Mutual Fund and Rivers Capital. They've also let me experiment with some specific methods of applying the value investing philosophy before doing it in my own or my clients' accounts.
If you've ever wondered whether you're good at picking stocks, you may want to give Marketocracy a try. If you're good, you may want to start managing your own money, and if you're really good, perhaps you can become a professional money manager yourself!
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Friday, July 20, 2007
Credit spreads too thin?
John Mauldin's latest Thoughts from the Frontline Weekly Newsletter featured an excellent article by Michael Lewitt of Harch Capital Management.
The subject was the state of credit markets. This may seem like an unimportant subject to many observers, but it impacts the financial markets and global economy in ways most don't grasp.
Specifically, the article talked about how credit spread are still very thin compared to historical average. What are credit spreads? Generally, they are the difference between the yield on a risky credit (corporate debt, mortgage backed securities) compared to a non-risky credit, which is considered to be a government bill, note or bond depending on the maturity of the bond.
When the credit spread is wide, market participants are worried about credit risk and are demanding a large spread over risk-free securities. When the spread is thin, the market is unworried about credit risk and is demanding very little compensation over risk-free securities.
Historically, credit markets go through swings of greater and lesser toleration for credit risk. Typically, the market gets complacent after a long period of low defaults and then gets over-concerned after a short period of high defaults.
Right now, we have just recently come off some of the lowest credit spreads in history. The normal result is a market shake-up that returns low credit spreads to high credit spreads. These can be very disturbing events, as it was in 1998 when Long Term Capital Management collapsed.
Credit markets tend to reflect the market's toleration for bearing risk. When the market is complacent, it signals trouble may be ahead. When the market is worried, it frequently signals a great time to invest. In my opinion, we are on our way from complacent to worried, and that means opportunity lies ahead.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
John Mauldin's latest Thoughts from the Frontline Weekly Newsletter featured an excellent article by Michael Lewitt of Harch Capital Management.
The subject was the state of credit markets. This may seem like an unimportant subject to many observers, but it impacts the financial markets and global economy in ways most don't grasp.
Specifically, the article talked about how credit spread are still very thin compared to historical average. What are credit spreads? Generally, they are the difference between the yield on a risky credit (corporate debt, mortgage backed securities) compared to a non-risky credit, which is considered to be a government bill, note or bond depending on the maturity of the bond.
When the credit spread is wide, market participants are worried about credit risk and are demanding a large spread over risk-free securities. When the spread is thin, the market is unworried about credit risk and is demanding very little compensation over risk-free securities.
Historically, credit markets go through swings of greater and lesser toleration for credit risk. Typically, the market gets complacent after a long period of low defaults and then gets over-concerned after a short period of high defaults.
Right now, we have just recently come off some of the lowest credit spreads in history. The normal result is a market shake-up that returns low credit spreads to high credit spreads. These can be very disturbing events, as it was in 1998 when Long Term Capital Management collapsed.
Credit markets tend to reflect the market's toleration for bearing risk. When the market is complacent, it signals trouble may be ahead. When the market is worried, it frequently signals a great time to invest. In my opinion, we are on our way from complacent to worried, and that means opportunity lies ahead.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Wednesday, July 18, 2007
Reading list for investors
James Montier of Dresdner Kleinwort came out with a great letter recently. In it, he provides his recommended reading list as Investing 101.
The list includes classics like Graham and Dodd's 1934 edition of Security Analysis, Chapter 12 of Keynes's General Theory, Kindelberger's Manias, Panics and Crashes, and John Burr William's Theory of investment value. I've read all of these and found them very illuminating.
In the modern category, he includes Greenblatt's Little Book That Beats The Market, Taleb's Fooled by Randomness, and Dreman's Contrarian Investment strategies. Once again, I've read each and really benefited.
In his psychological section, he suggests a bunch of books I haven't read, but am very interested in such as Keith Stanovich's Robot's Rebellion, Tim Wilson's Stranger to Ourselves, and Thomas Gilovich's How we know what isn't so. Gilovich's title is enough to get my brain going.
His final category is hidden gems and also includes several books I haven't read, yet. This includes Phil Rosenzweig's Halo Effect, Robert Haugen's The Inefficient Stock Market, and Jason Zweig's Your Money and Your Brain. Halo Effect is particularly interesting because it covers how people characterize things as good based on a general impression and then mistakenly attribute favorable details based on their general impression. Before reading the book, I already know this is a great description of what goes on in financial markets every day.
His letter goes into much more detail about the books and why Montier recommends them.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
James Montier of Dresdner Kleinwort came out with a great letter recently. In it, he provides his recommended reading list as Investing 101.
The list includes classics like Graham and Dodd's 1934 edition of Security Analysis, Chapter 12 of Keynes's General Theory, Kindelberger's Manias, Panics and Crashes, and John Burr William's Theory of investment value. I've read all of these and found them very illuminating.
In the modern category, he includes Greenblatt's Little Book That Beats The Market, Taleb's Fooled by Randomness, and Dreman's Contrarian Investment strategies. Once again, I've read each and really benefited.
In his psychological section, he suggests a bunch of books I haven't read, but am very interested in such as Keith Stanovich's Robot's Rebellion, Tim Wilson's Stranger to Ourselves, and Thomas Gilovich's How we know what isn't so. Gilovich's title is enough to get my brain going.
His final category is hidden gems and also includes several books I haven't read, yet. This includes Phil Rosenzweig's Halo Effect, Robert Haugen's The Inefficient Stock Market, and Jason Zweig's Your Money and Your Brain. Halo Effect is particularly interesting because it covers how people characterize things as good based on a general impression and then mistakenly attribute favorable details based on their general impression. Before reading the book, I already know this is a great description of what goes on in financial markets every day.
His letter goes into much more detail about the books and why Montier recommends them.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Monday, July 16, 2007
Is now a good time to invest in the stock market?
To see a historical take on where we are now, read John Hussman's latest.
Using historical analysis, he shows that today's valuations do not bode well for long term returns on the overall stock market.
Enjoy!
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
To see a historical take on where we are now, read John Hussman's latest.
Using historical analysis, he shows that today's valuations do not bode well for long term returns on the overall stock market.
Enjoy!
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Wednesday, July 04, 2007
Why I love the 4th of July
I believe the 4th of July is the most meaningful holiday we have in the United States.
It celebrates not when we defeated the British. It celebrates not when we signed our Articles of Confederation nor our great Constitution. It celebrates not the Boston Tea Party nor the Battle of Lexington.
In other words, the 4th of July does not celebrate the means by which we became independent nor the specific manner by which we decided to govern ourselves, but the principle behind our new government.
You see, the principles are much more important than the means or the manner. Principles are a necessary precursor.
And, that is what we celebrate each July 4th. We celebrate our separation from a tyrannical government through our declaration that a proper government is not tyrannical. The founding fathers, Thomas Jefferson in particular, put into words the proper form of government and our justified reasons for desiring separation.
There may be fireworks, hot dogs, burgers and beer at most people's celebration, but the real reason for this holiday is the principle that we have the right to form our own government, and that our government exists solely to allow individuals to pursue their life, liberty and happiness.
And I think the celebration of profoundly important principles makes the 4th of July a truly unique and wonderful holiday.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
I believe the 4th of July is the most meaningful holiday we have in the United States.
It celebrates not when we defeated the British. It celebrates not when we signed our Articles of Confederation nor our great Constitution. It celebrates not the Boston Tea Party nor the Battle of Lexington.
In other words, the 4th of July does not celebrate the means by which we became independent nor the specific manner by which we decided to govern ourselves, but the principle behind our new government.
You see, the principles are much more important than the means or the manner. Principles are a necessary precursor.
And, that is what we celebrate each July 4th. We celebrate our separation from a tyrannical government through our declaration that a proper government is not tyrannical. The founding fathers, Thomas Jefferson in particular, put into words the proper form of government and our justified reasons for desiring separation.
There may be fireworks, hot dogs, burgers and beer at most people's celebration, but the real reason for this holiday is the principle that we have the right to form our own government, and that our government exists solely to allow individuals to pursue their life, liberty and happiness.
And I think the celebration of profoundly important principles makes the 4th of July a truly unique and wonderful holiday.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Tuesday, July 03, 2007
The problem with tax deferred investments
If you've read much about investing or financial planning, you've heard the mantra about investing in tax deferred plans.
These plans come in many different forms (traditional IRAs (Individual Retirement Accounts), Roth IRAs, Simple IRAs, SEP IRAs, 401(k)s, Roth 401(k)s, Thrift Savings Plans, etc.), but they all provide the benefit of tax deferred savings.
For most investors, the problem isn't understanding why tax deferred plans are a good idea, but in selecting what to do with the money they've put into these plans.
Most investors don't even invest in these plans, frequently because they are overwhelmed by the options.
Many leave it in low returning money market accounts or chase the performance of the most recent "winners," both ending up with poor returns, but for different reasons.
When my clients come to me with lists varying from 25 to 900 options, their question is always the same, "where should I put my money?"
I'll admit right off, the answer isn't easy. Because I make my living focusing on investments, I know how to pick good money managers. But there's no reason to expect everyone to know how to do this.
When a plumbing leak occurs in my house, I call a plumber. When my car needs its timing belt changed, I take it to a maintenance professional. But, most people try to make the choice of where to invest their money on their own.
They usually ask a friend or relative, because they can trust such people. The problem is that they may end up with the blind leading the blind. A person can be trustworthy and still not know what they're talking about. I wouldn't ask my dad to change my timing belt unless I thought he knew what the heck he was doing.
The problem is that picking a money manager is notoriously difficult. A whole profession of consultants has sprung up to help people make this choice. Most of them, unfortunately, are paid commissions to sell certain funds. Others are entranced by the mathematical analysis of short term performance, which has the same utility as examining goat entrails.
No, the best way to find a good money manager is to ask a good money manager. Good investment managers tend to watch what other money managers do, and they have to spend a lot of time figuring out who is really good and who is just lucky. Because I'm in the field and follow the best managers closely, I know who's good and who isn't.
The secret is to watch their process. If you just look at their results, you may just be seeing luck. Even 20 year records can be built on sand if their process is flawed. If you had asked the folks in New Orleans about the levy before and then after Katrina, you would have heard two very different opinions. Past performance is no guarantee of future results.
If their process is sound, the results will take care of itself, even if their record doesn't look great in the short term. In the late 1990s, a lot of money managers were dumped because "they didn't get the 'net." Look at their records now and you'll see that process is much more important than a 1, 3 or 5 year records, especially if you're investing for the long run.
To solve the problem with tax deferred investments, people will have to spend more time either learning how to pick managers, or in finding people who can pick managers. I think the best approach is to ask investment managers who are good investors themselves, and to focus on process over results.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
If you've read much about investing or financial planning, you've heard the mantra about investing in tax deferred plans.
These plans come in many different forms (traditional IRAs (Individual Retirement Accounts), Roth IRAs, Simple IRAs, SEP IRAs, 401(k)s, Roth 401(k)s, Thrift Savings Plans, etc.), but they all provide the benefit of tax deferred savings.
For most investors, the problem isn't understanding why tax deferred plans are a good idea, but in selecting what to do with the money they've put into these plans.
Most investors don't even invest in these plans, frequently because they are overwhelmed by the options.
Many leave it in low returning money market accounts or chase the performance of the most recent "winners," both ending up with poor returns, but for different reasons.
When my clients come to me with lists varying from 25 to 900 options, their question is always the same, "where should I put my money?"
I'll admit right off, the answer isn't easy. Because I make my living focusing on investments, I know how to pick good money managers. But there's no reason to expect everyone to know how to do this.
When a plumbing leak occurs in my house, I call a plumber. When my car needs its timing belt changed, I take it to a maintenance professional. But, most people try to make the choice of where to invest their money on their own.
They usually ask a friend or relative, because they can trust such people. The problem is that they may end up with the blind leading the blind. A person can be trustworthy and still not know what they're talking about. I wouldn't ask my dad to change my timing belt unless I thought he knew what the heck he was doing.
The problem is that picking a money manager is notoriously difficult. A whole profession of consultants has sprung up to help people make this choice. Most of them, unfortunately, are paid commissions to sell certain funds. Others are entranced by the mathematical analysis of short term performance, which has the same utility as examining goat entrails.
No, the best way to find a good money manager is to ask a good money manager. Good investment managers tend to watch what other money managers do, and they have to spend a lot of time figuring out who is really good and who is just lucky. Because I'm in the field and follow the best managers closely, I know who's good and who isn't.
The secret is to watch their process. If you just look at their results, you may just be seeing luck. Even 20 year records can be built on sand if their process is flawed. If you had asked the folks in New Orleans about the levy before and then after Katrina, you would have heard two very different opinions. Past performance is no guarantee of future results.
If their process is sound, the results will take care of itself, even if their record doesn't look great in the short term. In the late 1990s, a lot of money managers were dumped because "they didn't get the 'net." Look at their records now and you'll see that process is much more important than a 1, 3 or 5 year records, especially if you're investing for the long run.
To solve the problem with tax deferred investments, people will have to spend more time either learning how to pick managers, or in finding people who can pick managers. I think the best approach is to ask investment managers who are good investors themselves, and to focus on process over results.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Monday, July 02, 2007
"Reasoning correctly from erroneous premises"
The quote above is from John Locke, but I found it second hand from Nassim Taleb's The Black Swan. Supposedly, it's Locke's definition of a madman.
In my opinion, this quote accurately describes the state of the art in academic finance and economics.
Although it may be hard to believe, the Nobel prize has been given out repeatedly to very smart people who are exemplars of the above quote.
As a result, the field of finance, economics and investing is populated with folks who seem to unquestioningly follow such teachings.
That's why most people are over-diversified and think risk equals volatility. The result is that most investors are under-protected from low probability, high impact, negative events and over-protected from low probability, high impact, positive events.
When a couple of Nobel laureates who exemplify the quote above followed their own advice, they lost almost all of their investors' money and nearly caused a temporary collapse in the world's financial system (if you think I'm exaggerating, read When Genius Failed by Roger Lowenstein).
Despite this paradigm shifting result, most market participants go right on assuming that erroneous premises can be followed with rigorously correct reasoning (and lots of higher math and Greek symbols).
Which reminds me of an apt definition of insanity: "doing the same thing over and over again and expecting different results" (Albert Einstein).
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
The quote above is from John Locke, but I found it second hand from Nassim Taleb's The Black Swan. Supposedly, it's Locke's definition of a madman.
In my opinion, this quote accurately describes the state of the art in academic finance and economics.
Although it may be hard to believe, the Nobel prize has been given out repeatedly to very smart people who are exemplars of the above quote.
As a result, the field of finance, economics and investing is populated with folks who seem to unquestioningly follow such teachings.
That's why most people are over-diversified and think risk equals volatility. The result is that most investors are under-protected from low probability, high impact, negative events and over-protected from low probability, high impact, positive events.
When a couple of Nobel laureates who exemplify the quote above followed their own advice, they lost almost all of their investors' money and nearly caused a temporary collapse in the world's financial system (if you think I'm exaggerating, read When Genius Failed by Roger Lowenstein).
Despite this paradigm shifting result, most market participants go right on assuming that erroneous premises can be followed with rigorously correct reasoning (and lots of higher math and Greek symbols).
Which reminds me of an apt definition of insanity: "doing the same thing over and over again and expecting different results" (Albert Einstein).
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Sunday, July 01, 2007
Bill Gross's Investment Outlook
Bill Gross is a legend in the investing industry. He doesn't work, though, in the more glamorous equity side of investing. Instead, he is a bond market investor, and has one of the best long term records in the business.
Gross also happens to be an outstanding writer. I envy his ability to say a lot with few words, and to explain complex financial concepts with amusing analogies.
For these reasons, his monthly Investment Outlook is a must read for me. As usual, his Investment Outlook for this month didn't disappoint.
Gross takes to task the mortgage market, how it has performed and will perform in the future. His conclusion is that the fallout is not over, and that we're just looking at the tip of the mortgage iceberg.
He believes this is the case because many adjustable rate loans made over the last several years have yet to reset, and when they do, many more homeowners will punt their houses back to the market.
He also indicates that these problems will be felt in the Mortgage Backed Security (MBS) and Collaterlized Debt Obligation (CDO) markets. This, along with legislative action, will tighten credit and limit the number of people who can get new loans.
His conclusion is that the housing market will takes years to work through it's problems (tougher credit, high inventories of homes for sale, anchoring by home sellers), and that the Federal Reserve may soon cut rates in an attempt to limit such problems now that inflation is looking less threatening (according to their narrow metrics).
Am I planning on acting on this advice? I can't say I am. Unlike a bond market guru with institutional clients who demand short term performance, I don't need to forecast interest rates or try to guess what the housing market will do. But, I find his thinking very provocative, and it reinforces my desire to stay far away from companies that deal intimately with the housing or mortgage market.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Bill Gross is a legend in the investing industry. He doesn't work, though, in the more glamorous equity side of investing. Instead, he is a bond market investor, and has one of the best long term records in the business.
Gross also happens to be an outstanding writer. I envy his ability to say a lot with few words, and to explain complex financial concepts with amusing analogies.
For these reasons, his monthly Investment Outlook is a must read for me. As usual, his Investment Outlook for this month didn't disappoint.
Gross takes to task the mortgage market, how it has performed and will perform in the future. His conclusion is that the fallout is not over, and that we're just looking at the tip of the mortgage iceberg.
He believes this is the case because many adjustable rate loans made over the last several years have yet to reset, and when they do, many more homeowners will punt their houses back to the market.
He also indicates that these problems will be felt in the Mortgage Backed Security (MBS) and Collaterlized Debt Obligation (CDO) markets. This, along with legislative action, will tighten credit and limit the number of people who can get new loans.
His conclusion is that the housing market will takes years to work through it's problems (tougher credit, high inventories of homes for sale, anchoring by home sellers), and that the Federal Reserve may soon cut rates in an attempt to limit such problems now that inflation is looking less threatening (according to their narrow metrics).
Am I planning on acting on this advice? I can't say I am. Unlike a bond market guru with institutional clients who demand short term performance, I don't need to forecast interest rates or try to guess what the housing market will do. But, I find his thinking very provocative, and it reinforces my desire to stay far away from companies that deal intimately with the housing or mortgage market.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
Tuesday, June 26, 2007
Mutual fund over-diversification (the artist formerly known as di-worse-ification)
One of John Mauldin's recent Outside the Box articles by James Montier (of Dresdner Kleinwort) highlights the fact that the average mutual fund holds around 160 stocks.
Now, this may not sound ludicrous to you, but let me walk you through why I think this is nuts.
First off, 160 is average. That means that some managers hold many more and some hold many less than 160, but let's just work with 160 to illustrate my point.
There are around 250 workdays in a year (52 weeks minus 2 weeks for vacation gives 50 weeks, multiply that times 5 workdays per week).
Most companies report their earnings once a quarter and provide a conference call with that.
That means a mutual fund manager must monitor around 5 companies every 2 workdays (160/(250/4)x2).
Given an 12 hour work day and a 5 day workweek, that means each mutual fund manager can devote 4.8 hours per company each quarter.
Most conference calls last 1.5 hours, so that leaves only 3.3 hours to understand, model, value and evaluate each company.
Let me add that this doesn't include time to visit companies, watch additional presentations that almost every company gives, look for new investment ideas, interact with clients, vote proxies, do administrative tasks, talk around the water cooler, etc. You get the idea.
Granted, such managers may have a herd of analysts chasing down details. But, the mutual fund manager is the one who has to make decisions, and how well can he understand a company and make decisions if he has so little time to follow and evaluate each company?
I know that when I look at a new investment, it usually takes me 3 hours just to read one 10k (annual report filed with the SEC). But then, I still need to read old 10k's (at 3 hours a pop), plus 10q's (quarterly reports filed with the SEC, 0.5 hour each), listen to conference calls and presentations (1.5 hours each), read current and old reports to shareholders (1.5 hours total), look up articles about the company (2 to 4 hours), read competitor's reports (another 10 hours), etc.
In other words, just to look at a new investment idea, I have to spend around 20 to 30 hours just getting to understand the business. And then, I need to think about the business analytically, evaluate management, analyze competitive advantage, drill down into the business's economics and business model, model the business into the future, analyze financial statements over time, etc. It takes a lot of time to thoroughly research a new investment idea.
To keep up with current investments, it usually takes about an hour to read the press release and think about and analyze the financial statements, 1.5 hours to listen to the conference call, 1.5 hours to update my model of the company, 1.5 hours to analyze the latest 10q or 10k, etc. It takes me about 6 hours per company just to stay up.
And then I still need to vote proxies and listen to annual meetings and analyst presentations!
It takes all my research time to keep up with 40 companies, have time to screen through a bunch of new ideas, and thoroughly research 10 to 20 new ideas a year.
So how can a mutual fund manager hold 160 stocks? By not doing a very thorough job of understanding the companies he owns. I think that's an irresponsible way to invest. Perhaps that's why 80% to 90% of mutual funds under-perform the market over the long run.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
One of John Mauldin's recent Outside the Box articles by James Montier (of Dresdner Kleinwort) highlights the fact that the average mutual fund holds around 160 stocks.
Now, this may not sound ludicrous to you, but let me walk you through why I think this is nuts.
First off, 160 is average. That means that some managers hold many more and some hold many less than 160, but let's just work with 160 to illustrate my point.
There are around 250 workdays in a year (52 weeks minus 2 weeks for vacation gives 50 weeks, multiply that times 5 workdays per week).
Most companies report their earnings once a quarter and provide a conference call with that.
That means a mutual fund manager must monitor around 5 companies every 2 workdays (160/(250/4)x2).
Given an 12 hour work day and a 5 day workweek, that means each mutual fund manager can devote 4.8 hours per company each quarter.
Most conference calls last 1.5 hours, so that leaves only 3.3 hours to understand, model, value and evaluate each company.
Let me add that this doesn't include time to visit companies, watch additional presentations that almost every company gives, look for new investment ideas, interact with clients, vote proxies, do administrative tasks, talk around the water cooler, etc. You get the idea.
Granted, such managers may have a herd of analysts chasing down details. But, the mutual fund manager is the one who has to make decisions, and how well can he understand a company and make decisions if he has so little time to follow and evaluate each company?
I know that when I look at a new investment, it usually takes me 3 hours just to read one 10k (annual report filed with the SEC). But then, I still need to read old 10k's (at 3 hours a pop), plus 10q's (quarterly reports filed with the SEC, 0.5 hour each), listen to conference calls and presentations (1.5 hours each), read current and old reports to shareholders (1.5 hours total), look up articles about the company (2 to 4 hours), read competitor's reports (another 10 hours), etc.
In other words, just to look at a new investment idea, I have to spend around 20 to 30 hours just getting to understand the business. And then, I need to think about the business analytically, evaluate management, analyze competitive advantage, drill down into the business's economics and business model, model the business into the future, analyze financial statements over time, etc. It takes a lot of time to thoroughly research a new investment idea.
To keep up with current investments, it usually takes about an hour to read the press release and think about and analyze the financial statements, 1.5 hours to listen to the conference call, 1.5 hours to update my model of the company, 1.5 hours to analyze the latest 10q or 10k, etc. It takes me about 6 hours per company just to stay up.
And then I still need to vote proxies and listen to annual meetings and analyst presentations!
It takes all my research time to keep up with 40 companies, have time to screen through a bunch of new ideas, and thoroughly research 10 to 20 new ideas a year.
So how can a mutual fund manager hold 160 stocks? By not doing a very thorough job of understanding the companies he owns. I think that's an irresponsible way to invest. Perhaps that's why 80% to 90% of mutual funds under-perform the market over the long run.
Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.
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