Chinese Car Trolls

In case anyone was still worried about Chinese world domination ... this is the kind of innovation the country is betting their future on:


http://www.bbc.com/autos/story/20150818-youxia-ranger-x-is-totally-not-a-tesla

"We are no longer surprise by Cinese carmakers paying legally questionable homage to successful Western models"

"The driver interacts with that system through a vertically oriented 17in touchscreen display, much like the driver of a Model S would interact with that car’s vertically oriented 17in display. Small world. "

The idiots who sent this bunch of posers their investment dollars got exactly what they deserved. You are what you invest in.

What Will Tomorrow Bring: Is it a Bubble?

Stock market indexes have broken records multiple times in past weeks. Yes, this is a stock bubble.

It will likely turn into a more general bubble on the price of everything  ... which is another way of describing .... inflation. This is just the mathematical result of the very-very-very low interest rates. 

On the other hand, the Fed (or Congress) can reverse the inflation in a couple of ways, all of which are like hitting the brakes on the Titanic ... the effect takes a long time to be felt, by which time the facts on the ground have largely changed. They can:

• Threaten to change interest rate policy and people would  immediately change their behavior. People would borrow a lot and buy a few big items in the short term, but would reduce spending in the longer term
• Increase interest rates or bank reserve requirements. Both would have the effect of reducing new borrowing, which would in turn reduce industrial production as well as family consumption. People don't buy cars as often when car payment interest rates are high.
• Increase tax rates without increasing spending ... or reduce spending without changing tax rates
• Toy with the exchange rate of the dollar (for example, through tariffs or WTO complaints)
• Continue to be unclear about future US taxation and regulation policy. People are more conservative when they don't know what the future holds
• Impose uncomfortable (or unknown) rules on future taxation and/or regulation of borrowing, buying, selling, and/or profits. 
• "Prick" the stock market bubble either through taxes/rules or by convincing big investors that the world is scarier than they thought it was

However, all of the above will also reduce GDP and growth, which will increase unemployment.

The tougher question is how can we avoid getting drowned by the inflation if it happens. Options would include:

• Horde stuff now which will rise in value faster than the coming inflation ... tough to know what this would be. You have to look at supply and demand (SnD) forecasts
• Gold is one option, but as recent history shows, the SnD situation is sketchy. The majority of the supply is held by basically a cartel of central banks (US, Germany, Italy, France, China, Switzerland, Russia, Japan in descending order ... google "world gold holdings" for details) who keep threatening to dump it. If this happens, then individuals who own gold would get screwed. Recently, the ECB has tried to make countries sell their gold prior to getting a bailout. If Italy or Japan decided to do this, gold value would fall steeply. I prefer to protect my money from politics as much as possible.
• Other commodities are another option (metals, minerals)
• Oil is another option, but the recently-found supplies and the alternative energy investments may mess up supply as well as demand, and the mideast can always be annoying. Politics and money again.
• Real estate is another one. The US SnD situation is pretty predictable, but the possibility of a change to the mortgage-interest-tax-deductibility rules might screw things up. Real estate abroad is often subject to politics.
• Other limited-supply and high-demand valuables. Fancy cars. Wines. Jewelry. Industrial metals. Bubaru. Whatever.
• Move money into assets in a foreign currency which is not going to have as much inflation. For example, if it's $1 per 1 EUR today ... and you think that USD will inflate faster than EUR for the next 10 years ... then you might want to convert your money to EUR today. Then, in 10 years, when it's $2 per 1 EUR, you could convert it back to dollars and buy stuff here. The key to this is finding assets in that foreign currency which will appreciate at an acceptable rate vs. what you could get in $.
  For example, assume you have $1000. You can:
• keep it in dollars and buy something like IBM stock which will increase in value. Assume USD inflation is 10% and IBM stock increases at 15% per year. This would mean that over time you would neutralize inflation PLUS gain an extra +5% of appreciation each year. The net impact on your purchasing power (=what you can buy with your money) would be an increase of+5% per year. At the end of the first year you'd have $1050
• OR you could convert it to EUR1000 and buy something like BNPP stock.  Assume that the USD/EUR exchange rate depreciates by 5% per year due to the US inflation situation. Also assume BNPP stock increases  7% per year. This would mean that over time your total appreciation in USD terms would be 5%+7% = 12%. This would neutralize USD inflation plus an extra +2% per year. At the end of the first year, you'd have $1020 if you converted back to USD, so it wouldn't be worth all the trouble. There's also the possibility of paying double-taxes on foreign income once you bring it back to the US.
• Which brings us to inflation-proof profit-generating assets. Owning companies (or investment properties) creates a cash flow. Some companies/properties will "float" like a boat meaning that they can increase their prices at the same rate their costs increase (at least). These "inflation proof" companies would be good investments assuming they:
• Have an innovation/growth/improvement/efficiency plan which will allow them to expand their market share and/or charge higher prices than competitors, 
• Are in good financial health
• Are not vulnerable to other inflation-related issues like floating interest rates on loans (or short-term loans that they have to frequently roll over)
• Or you can just ignore it and hope that Social Security increases with inflation ... which it historically hasn't

As always, a "portfolio" approach is probably best, rather than putting all your eggs in one basket. 

An alternative is to outsource the decision to somebody you think is super smart. Obviously, an investment advisor is one way to do this, but another way is to invest in a company that you think will be smart about maximizing value in the face of inflation. For example, Warren Buffett has survived several periods of inflation and is very watchful of inflation. His Berkshire Hathaway would ... probably ... maybe ... figure out the smartest  way to preserve value. Buying shares in that company lets you ride his coattails.

Goldman needs Privacy

At one point this week, the headline was:

Roiled by op-ed, Goldman loses $2.15 bn m-cap

Goldman didn't get where it was by being a public company. It was a partnership for the first 130 years before going public only 13 years ago. Those have been a pretty awful 13 years for the firm.

The latest round of headline-generators and talking head fodder would have never happened if Goldman were still private. The dude wouldn't have even had the motivation to publish the op-ed. The Times wouldn't have cared to print it. Nobody outside the firm would care to read it.

Instead, over the course of a few hours of stock trading, value was "destroyed" to the tune of ... well, more money than 99.999% of the world's population will see in their lifetimes. Actually, add a few more 9's after the decimal. Billions. With a "B." As in Buffett-sized.

Or was it? If a whiny Dear John to a former employer full of news (which, as Forbes pointed out, everybody already knew) can destroy billions of bucks, then maybe that value didn't really exist to begin with. Stepping back from the greater fool theory, perhaps GS should be valued based on the discounted cash flows it can generate. Novel concept, eh? Maybe I should write a book and teach at Wharton.

Then again, maybe my book should take a different approach. Perhaps Goldman should never have become GS in the first place. Perhaps a financial firm with ridiculous leverage ratios, a wacky capital structure, a penchant for mercenary dealings (AIG collateral call ring a bell?)  needs a small, concentrated, captive based of owners rather than a whole "street" of busybodies to answer to.

The only way Goldman's stock has impressed is in its volatility. It hasn't even doubled over the past 10 years. Hardly a good investment. The management has never been able to find an acceptable balance between staff incentives and shareholder value. Perhaps no such balance can exist for more than a few microseconds. Perhaps GS is an unstable element with a short halflife. Maybe they're in a constant state of containing the meltdown, hoping it wont Fukushima on them tomorrow ... or the next day. Perhaps this is distracting them from their "day jobs" of making deals with and on behalf of clients.

Nice adventure, guys, but it's time to take your marbles and go home. Cash in the chips and go private.

Buy!/Sell!: Uninformed Stock Picks

Long:

+ Um... Well... There's... No, wait. I know this one ... 

Short:

- Research In Motion. How's this for a losing strategy: Happen onto a temporary natural monopoly. Underinvest for a decade. Let Apple and Google (et al) blow you away in the market. Ignoring your lack of expertise or differentiating value, throw millions at trying to flank these titans. Discover you've created a product nobody wants and sell it at cost (less marketing). Justify this by saying you are going to sell your old products in emerging markets at a high margin. Discover emerging markets are even more sophisticated than mature markets in this industry, with Apple and Google (et al) already dominating.

They will get bought by Google or one of its suppliers for pennies. RIM's customers will be ported over to the buyer's platform and products. The end.

(note: this is not investment advice!)

Follow Up 2: Less is More

The lead story in the August 6, 2011 Economist minces no words in their opinion of US politicians' "current uselessness" which the paper fears will be responsible for a double-dip recession. They specifically highlight the negative impact of the growing US governmental unpredictability:

Any hard decisionshave been given to a commission--a cop-out that condemns workers and firms to more crippling uncertainty about how the country's fiscal mess will be tackled. Would you build a factory today if you knew that taxes had to rise eventually, but had no idea which ones?

Worse, the poisonous politics of the past few weeks have created new sorts of uncertainty.

This was precisely my message in a January 2010, blog post:

Risk is equivalent to unpredictability. The more able one is to predict the future, the lower the risk and the more confidently one can make moves today which create a nice return tomorrow. Conversely, when the rules of the game may significantly change tomorrow or next year, risk is dramatically increased. This raises the risk-vs-reward bar such that fewer investment options are viable.

Its no wonder that corporations and banks are choosing to sit on "piles of cash" instead of launching big, strategic, long-term investments which would support long-term and largely high-skilled job creation ... and hopefully long-term profitability for the investors.

No, US federal policy currently discourages that type of thing. More precisely, it forces such investment offshore. When US businesses choose to NOT use their cash for investment in their own commercial projects, they must find something else to do with the cash. People say that Apple has umpteen-hundred-billion dollars "in the bank" but more accurately, Apple has this cash invested in non-apple projects in that Apple owns shares, CDs, bonds, and IOUs from other banks and companies who are not subject to the unpredictability and caprice of the US government.

As my blog post continued:

Governments can increase or decrease this risk. Those with the discipline to stick to a stable, sensible, transparent industrial policy over a long period build tremendous "trust equity" with investors ... Ideas become businesses become economic value ...Unfortunately, being based entirely on intangibles (consensus expectations), this trust equity is a very fragile thing. Governments can quickly sabotage themselves, their economies, and thus their citizens by giving off even the whiff of erratic or ill-advised behavior.

 The current lot in Washington reek of it. Like Renaissance French nobility, they slather themselves in ever-increasing amounts of perfume to cover it up, but the flies still swarm. Here's David Brooks:

"If you ask people, 'why aren't you investing? Why aren't you lending?' it all comes down to uncertainty ... If bankers and entrepreneurs don't have any sense of certainty, they're just not going to invest ... We've not only got this economic problem, but its compounded by a psychological problem, magnified by the fact that distrust of institutions is at its highest level in history." - David Brooks, Meet the Press 1/31/2010

The answer? Of course, it's complicated but a good start is in the title of this blog. The Economist is concerned that immediate fiscal austerity would thrust the economy deeper into trouble. They suggest that we wait a bit. They're half right. I'd listen to Greenspan, who has been a long proponent of using the economic power of "signalling." Without changing a single regulation or appropriation today, the government can clearly communicate what changes are coming when. If the message is credible, people will respond as though the change had happened today. Markets will rapidly price in the new information, and the trajectory of the whole economy will shift.

IF the government's message is credible. This is the rub, given the extent to which Washington has squandered that intangible "trust equity." Given this situation, I'd suggest Obama and Congress see a psychologist ... to better understand how to psychologically build trust in a population.

I'd suggest follow-though is key.

What Will Tomorrow Bring: Financial Utilities

The story of the financial industry is a breathless one. With all that money sloshing around, smart people know that there is profit to be made. Unfortunately, due to that same money (=liquidity) and profit potential, financial products and services get commoditized very quickly. Competitive advantage is fleeting. It's textbook hyper-competition. Constant, hostile, explosive innovation is necessary to survive.

Unfortunately, that also leads smart, sensible people to do horrifically stupid, risky, nonsensical things which relieve immediate (financial or political) pressures but which have been entirely "un-thunk" in terms of their end-state consequences.

Hyper-competition also intrinsically conflicts with hyper-regulation.

Last year I predicted that the weight of new regulations (written and unwritten), political instability, and economic realities would force financial institutions to give up their for-profit status to become utilities:

Financial Institutions will once again be lobotomized. Divided into two classes:
- Utilities (aka retail banking)
- Casinos (aka everything else)

"Utilities" are done for as a for-profit enterprise. Just like Amtrack and Con Ed, they will require permanent and heavy subsidy verging on nationalization to survive the tonnage of regulations which will be piled on.

Evidence continues to pour in to support this including:

• More than 8,000 entries in the OCC's list of sanctions here. They are just one of a half-dozen governmental agencies which take enforcement actions against banks
• 111 bank collapses in the past 12 months per the FDIC's Bank Failure website. Twenty-six banks collapsed between 2000 and the end of 2007
  
• Voluntary closure of a regional bank this week "in an extreme example of the frustration felt by many bankers as regulators toughen their oversight of the nation's financial institutions"
• According to a Marakon report (source of the chart above), "only four US banks, or 10% of banking equity capital, are expected to generate returns above the cost of equity; a staggering 90% of banking capital is not performing"

But you ain't seen nothing yet. The above are mostly smaller institutions. The financial titans (Titanics?) are better at fighting and delaying, but trust me they are also bending under the weight. Their stock prices are beginning to reflect it.

UCSD professor Frank Partnoy yesterday published his opinion in the Financial Times with a piece titled "The coming world of smaller banks." He highlights not only the unavoidable reductions in share prices and headcounts, but more damningly, the unavoidable extinction (or drastic evolution) of the standard banking business model:

If all of the world’s major banks had failed during 2007-08, and regulators had permitted Apple, Facebook, Google and Microsoft to take over the economy’s capital allocation function, how would employment numbers have changed? Surely any neo-bank would hire smart lenders, traders, analysts and advisers, the people who have the strongest relationships with, and knowledge of, the institutions that demand or supply capital. But would they have hired all of them? Half? How many people would a new bank really need? Hedge funds take on traditional bank functions with a fraction of the employees.

He concludes:

[Banks] will occupy a smaller place in the economy and they will be less profitable. In a decade, there will be fewer professionals working on Wall Street than there are today.

If I map his comments onto my own, it becomes clear where the job losses will be. The "Financial Utilities" will be characterized by a low-skill, low-innovation, low-margin, high-volume business model. Since capital and information are almost entirely digital these days, there is nary a barrier to massive automation. The remaining jobs will be the folks keeping the computers humming and the 'relationship' people in high-touch areas like customer complaints and regulatory relations.

Time for Timmy to Take a Page from the Dick Nixon Book

Three months ago, on April 19, Timmy G flashed that charming nose-flair and scowl as he proclaimed "no risk" of credit rating downgrade. With a Treasury Secretary like that, who needs enemies?




That incredible foresight has created quite a bank of political capital and immense credibility for Timmy. Knowing that his fatherly tone alone can instill confidence in the most dubious heart, he decided today to leverage a bit of his capital, saying, in effect, 'trust me - China will continue to support borrowing habit.' No need to get our fiscal houses in order. That's just too hard. Too confusing. Too complicated for the average dumb voter. Better to just distract everyone by attacking the ratings agencies ... for ... um ... our fiscal mess?


Also based on his incredible Volcker-like, Lula-like track record of securing our country's fiscal future, he shared some friendly advice with his colleagues in Europe, admonishing those pre-pubescent countries to make sure they don't spend more than they make. If only they were as fiscally responsible as we are. If only they were lead by such world-class minds as we.


Investors are expressing their immense appreciation for Timmy's FDR fireside chat moment by voting with their feet ... from equities, debt, swaps, and even energy straight into gold.

The Zeitgeist of the BearDogs

Sometimes Simple IS the best way to communicate. Here's to the simpletons.

The Word about The Fed and The Plan for the Change

The Fed is powerful. I'm a fan of a good Fed. We currently do not have a good Fed. I'm horrified.

Be horrified.

Follow Up: Talk Amongst Yourselves: Governmental .... Effectiveness??

(specifically ... the part about the likely impact of financial industry regulatory reform)

In a recent blog post, I said:

Financial Institutions will once again be lobotomized. Divided into two classes:
- Utilities (aka retail banking)
- Casinos (aka everything else)

Utilities" are done for as a for-profit enterprise. Just like Amtrak and Con Ed, they will require permanent and heavy subsidy verging on nationalization to survive the tonnage of regulations which will be piled on.

"Casinos" will have to escape to the Bahamas, Monaco, or Indian reservations. I would not be surprised to see these firms further subdivided into firms that are allowed to play with other peoples' money ("brokerages") and those playing with their own money ("proprietary dealers").

Well ... the pudding of proof is starting to pour in ... even without the fancy new regulations:

1. Anglo Irish Bank will be split into a "good bank"which will retain only deposits, and an "asset recovery bank" which will run down its loans over time. Leave it to the Irish to invent a casino that always loses. BTW - Seeking Alpha (blog) doesn't think this is the end of the story.
   
2. Everyone's favorite financial institution, Goldman, has now announced that they're following my advice (at least in the US) by voluntarily winding down slash selling their proprietary equity trading operation called the "principle strategies group." No casinos here, Mr. Regulator, we're just a buncha blue-collar broker-types ... keep mooooving.

Follow Up: Less is More

As if responding to the Kramer and Greenspan quotes I blogged about here in December, folks on today's Talk-Shops had the following to say:

"That's what I think people beyond the beltway find so hard to believe. Why can't you find things that they agree on and pass that into legislation? But somehow that never seems to happen." - Bob Schieffer, Face the Nation 1/31/2010

Okay, Bob, but now we have Hope and Change, right?

David Brooks tackled the same core issue from a very different angle:

"If you ask people, 'why aren't you investing? Why aren't you lending?' it all comes down to uncertainty ... If bankers and entrepreneurs don't have any sense of certainty, they're just not going to invest ... We've not only got this economic problem, but its compounded by a psychological problem, magnified by the fact that distrust of institutions is at its highest level in history." - David Brooks, Meet the Press 1/31/2010

Exactly.

I'm frequently asked, "As someone in finance, what do YOU think of the government's proposal on ... "

• New bank taxes
• New windfall taxes
• Bailouts
• Evil banker hunts
• Prop trading bans
• Goldman Sachs
• Too big to fail
• The National Debt

My uniform answer, no matter what topic they bring up: "I'm against it. Whatever 'it' is." Does that make me the exemplar member of the Party of No?

Nope. I'm against that too. And I'm in good company.

"Experience hath shewn, that even under the best forms of government those entrusted with power have, in time, and by slow operations, perverted it into tyranny." - Thomas Jefferson

"And to preserve their independence, we must not let our rulers load us with perpetual debt. We must make our election between economy and liberty, or profusion and servitude." - Thomas Jefferson

"That government is best which governs least." - Thomas Jefferson

"Government is not a solution to our problem. Government IS the problem." - Ronald Reagan

Bloated bureaucrazies, by definition, separate pieces of the incentive mechanism. He who makes the decisions is never he who must implement them, nor he who pays for them, nor he who is impacted most greatly by them. This problem is no less present in large corporations than it is in governments the world over. To me, the only cure for bureaucratic inefficiencies and mistakes ... is LESS bureaucracy. Second best is a paralyzed bureaucracy. That, at least, leaves individuals and businesses the liberty they crucially need to maximize their own happiness/wealth/utility/economic value. Least best is an erratically spasming bureaucracy.

As we all know, investors and entrepreneurs make a risk-vs-reward decision every time they choose what to do with their capital (money, ideas, and energy). As I've explained in past blogs, risk is equivalent to unpredictability. The more able one is to predict the future, the lower the risk and the more confidently one can make moves today which create a nice return tomorrow. Conversely, when the rules of the game may significantly change tomorrow or next year, risk is dramatically increased. This raises the risk-vs-reward bar such that fewer investment options are viable.

Governments can increase or decrease this risk. Those with the discipline to stick to a stable, sensible, transparent industrial policy over a long period build tremendous "trust equity" with investors. The benefit should be self-evident to the most causual observer: stability reduces perceived risk, which encourages investment, the fuel of economic activity. Ideas become businesses become economic value. Govermnents, too, reap the benefit by being able to borrow cheaply.

Unfortunately, being based entirely on intangibles (consensus expectations), this trust equity is a very fragile thing. Governments can quickly sabotage themselves, their economies, and thus their citizens by giving off even the whiff of erratic or ill-advised behavior.

Don't take my word for it. Look at successful economies the world over. There is ample empirical evidence that, while stability is not the only factor of economic success, its absence is certainly a factor of economic failure. Contrast North and South Korea. Contrast Argentina and Costa Rica. Contrast Greece and Germany. The success stories plodded quietly for decades, one reassuring yet boring step at a time, to amass their trust equity.

Let's be clear: governments do not create economic value. Governments limit (regulate) its creation in order to make sure one person or business doesn't take advantage of another. We grant them permission to exert this control based on some stew of goals which we've set for them.

Here's another one. Goverments don't own any economic value. Governments are simply temporary stewards of value which they've taken (taxed) from individuals and businesses. By definition, this regime of regulation and taxation reduces economic activity to the extent it limits and dis-incentivizes investors and entrepreneurs. Sometimes we accept this reduction because we understand that we're trading it for our social goals, such as stability, security, equality, or fairness.

But let's combine this with my earlier point. The dis-incentive of regulation and taxation is multiplied by a risk factor which captures its future volatility (=unpredictability). When the future amount of this dis-incentive cannot be confidently predicted, risk is higher and thus fewer opportunities are worth the risk-vs-reward dice roll. Money drifts to the sidelines and the whole economy slows down.

Sound familiar?

So, here's something I'm FOR: minimizing the risk multiplier while maximizing the return ... financially, socially, environmentally, and any other -ly.

Less is More

From today's Meet the Press:

Kramer: The CEOs I talk to - they're hiring ... in Russia, they're hiring in Brazil, China ... its rather quizzical that we know what the Communists will give us, but we don't know what the capitalists will give us.

Greenspan: Investment occurs when you have a stable economy and when you can foresee what's going on in the future ... it's very critical that we get the uncertainties out of the system.

It's simple math, included in pretty much every good risk model - volatility is a multiplier on risk. Higher risk leads to lower willingness to invest at a given return. (Smart) investment is a multiplier on growth. Growth is a multiplier on income. Sustained income (without excessive debt) creates wealth.

Washington ... don'tcha want wealth? Think of all the new taxes you could levy.

And I Suppose People Were Not Expecting This ...

From the FT today:

Dubai shockwave hits global markets

Tremors from the shock request by Dubai’s flagship government-owned holding company for a debt standstill spread through global equity markets on Friday, triggering a sell-off in Asia and heavy losses on Wall Street.

While European markets staged a modest but nervous
rally after heavy sell-offs this week, investor sentiment remained jittery amid
a scramble to assess the broader fallout of the problems of Dubai World.
In depth: Dubai in turmoil - Jul-06
Editorial Comment: Dubai reveals the fragility of finance - Nov-27
Lex: Banks’ Dubai exposures - Nov-27
Opinion: Reality catches up with the Gulf’s model global city - Nov-27
Nakheel’s creditors dash to minimise damage - Nov-27
Abu Dhabi expected to prop up smaller brother - Nov-27

Hmm ... a scrap of the most inhospitable, useless land on the planet somehow convinces the world that it's rich simply by fiat. It goes on a spending spree to prove it. It falls flat on its face. I suppose that won't stop people from being shocked and awed.

Merriam-Webster defines a Mirage as:

... 2 : something illusory and unattainable like a mirage
synonyms: see delusion

Get it? A mirage? In the desert?

How's this for a rule, space cadets: nothing times any amount of leverage is still nothing. Remember that next time you are considering what to do with your kids' inheritance.

What Will Tomorrow Bring: Program Trading for Everyone!

When the stock market (and every other market) is on a one-way trip to the clouds, brokers convince their prey (err, I mean customers) to "buy and hold" via "dollar-cost-averaging" with some nice "rebalancing" from time to time. As the great investor Issac Newton explained: What goes up must continue up. It's simple physics. It's the laws of Mother Nature. Don't you like nature? Of course. In that case, they might have a hot tip on a cool green stock you should sink your children's inheritance into.

Or you could just discipline yourself to sock away 10% of your monthly income in Spiders and forget about it.

Or you could get all control-freak and OCD and get all into options and day trading and lose your shirt.
These days, the markets follow a different law of physics called the Super Rubber Bouncy Ball law. What goes up hits the ceiling, accelerates, shoots downward, hits the bottom, accelerates further, shoots upward, bounces off the furniture and pings sideways into Mom's expensive vase. The vase shatters on the floor and scares the cat, which shreds the nearest curtain and then pisses on the carpet.

In such a world, the only way to grow your kids' inheritance is to be able to make money no matter what direction the market is moving. The only way to do that is to buy and cover low, sell and short high ... and play volatility in between ... all the while hedging against soaring interest rates and inflation.

In short - do what hedge funds and Wall Street have done for years ... Hopefully, with a little more prudence since it's your own dinero ... and maybe within the law.

I suspect you won't have armies of traders and analysts to do this for you like Wall Street does. Fear not. Hedge funds don't have armies either. You just have to learn to invest like they do: with computahs. Over 70% of all US stock trades are executed by computers following rules with no human intervention. Welcome to Program aka Algorithmic Trading. In short: rather than picking specific investments or trades, you define rules for investing and trading. Then the computers do the grunt work of hunting for opportunities that fit your rules and they execute the trades for you.

Yesterday: Have lunch with your broker. Listen and nod for an hour as he ruminates, boasts, rattles off arcane irrelevancies, pretends to see the future, and slips in stock pick recommendations. Then blindly agree, give him a check for another ten grand, and let him pay the lunch tab.
Tomorrow: Have a pre-defined amount of money automatically sent from each paycheck to your brokerage account. Have lunch with your broker. Listen and nod for an hour as he ruminates ... well, you know, they're creatures of habit ... but the difference is that his suggestions should be strategies (aka packages of rules that make sense together) as opposed to prognostication and specific picks.

Yesterday: Pore over stock info online. Read the WSJ. Check Morningstar and Jaywalk. Watch CNBC and Kramer (yuck!). Every day or two, jot down a stock symbol that someone seems to think are going to "pop." Then, log into eTrade or Merrill Online and key in your stock symbol, amount, and price. Then, sit back and watch as that stock inevitably does the unexpected. Finally, freak out and sell the stock. Take the money that's left and repeat.
Tomorrow: Pore, read, check and watch, but much less frequently. Every month or two, jot down a strategy that fits the new market and economic realities. Log on and key in the rules comprising the strategy. Have a pre-defined amount of money automatically sent from each paycheck to your brokerage account. Then, sit back and watch (or not) as the computer buys and sells things you didn't even know existed at prices you don't care about. Some trades go the right way and the computer exits with a nice profit for you. Other trades go the wrong way and the computer applies your stop-loss rules to ensure you don't end up living in a cardboard box. The computer repeats tens, hundreds of times a week without your input. Hopefully, profits pile up. If not ... well, bad strategy. Just like LTCM.

Don't look now, but the future is already here. Folks have been developing trading rules for decades. A growing number of folks are using a growing number of online brokerage sites which offer rule-based trading. It's a bit amateurish still, but getting better ... fast. This time last year, it was a treat to enter a rule requiring more than a stock symbol and a price. Now, the likes of TD-Strategy Desk and Credit Suisse-AES have rolled out platforms allowing folks to effectively build entire entry and exit strategies, taking into consideration multiple asset classes, company fundamentals, and market conditions.

Vague and arcane, right? Here's a simple concrete example:

Assumptions: Short-term, the dollar will continue to slide against Chinese and Emerging Market currencies. The US will buy less from abroad. Emerging market stocks will do better than domestic ones. The US stock markets will be volatile around earnings seasons. Medium-term, drug companies will be pressured by Obama to cut costs, and profits will shrink accordingly. Long-term, house prices will go back up while commercial real estate prices will go down.

A strategy might include a set of rules like:

• Constantly assess cash available and asset allocation
• Constantly assess current interest rates, dollar prices, relative yuan prices, etc
• Constantly assess prices of bazillions of assets and fundamentals of bazillions of companies around the globe
• Always maintain a certain cash balance, subject to a hard minimum plus some extra when market volatility increases ... and at Christmas times
• Slowly build up interest bearing assets which mature in about June 2012, because that's when you'll be ready to buy your next fancy new car
• Always maintain asset allocations within a few percentage points of the target pie-chart you've defined. If this appears to be limiting your profits because of missed opportunities (meaning another rule would have fired in the past and would have made you money, but it was prevented from doing so because of the allocation limits), alert you to reassess the allocation strategy
• Auto-buy into dips in the market, especially around earnings seasons
• Auto-sell when the asset reaches a relative target, either a % gain or crossing a certain statistical threshold like a moving average
• Auto-exit if any trade goes south by more than a few percentage points
• Auto-exit if a better opportunity presents itself
• Keep an eye out for opportunities to buy residential real estate and related assets (like homebuilders, landlords, and residential REITs) when the asset's fundamentals look better than the average for the market and its price is below its 3-month moving average. Exit these positions once the price has jumped more than 10% in a day, risen by at least 20% overall, dips more than 3% below acquisition price, or 6 months have passed, whichever comes first.
• Keep an eye out for opportunities to sell commercial real estate and related assets whose debt levels look particularly ugly and prices are above their 3-month moving averages. Exit these positions once the price has fallen more than 10% in a day, fallen by at least 20% overall, drifted up by 5% above acquisition price, or 3 months have passed, whichever comes first.
• Ceterus paribus, slowly transition from US, dollar-denominated assets to those from China and other emerging markets. When the dollar temporarily spikes against these currencies, exit some laggard dollar-denominated assets and move the money into attractive Chinese and other emerging market assets. Avoid companies that export a lot to the US
• Ceterus paribus, watch for opportunities to slowly move from investments in companies with non-dollar-denominated debt into those of similar companies with more dollar debt
• If a headline turns up for one of the assets in your current portfolio, analyze the price vector (direction of change) after the headline and buy more or close out in order to beat everyone else to the punch.
• Always maintain an appropriate level of rate hedge (for example, shorting treasuries, selling dollar futures/options, etc) in proportion to overall exposure, especially around significant announcements about the economy or the FOMC. If rates surge over a decent period of time, alert you to re-assess the strategy
• And, of course, the security blankey: tell you if the model seems wrong compared with other peoples' behavior. Before accepting new rules from you, back-test them over some previous, similar time period to tell you you're being dumb. Oh, and slam on the brakes if the portfolio starts hemorrhaging money because of a flawed rule.

And Bob's your uncle! Ten years forward, investing like this will be commonplace. Believe me: I can see the future!

Illustrations Copyright http://www.niquette.com

The Skyrocketing Cost of Education!

To all ye out-of-work destitute Wall Street bankers: Fear not. Minimal vocational re-education is required for you to join the next big industry .... Education.

Yes, a standard Harvard MBA only costs $175,000, leaving little room for nine-figure professorial salaries. Yes, for some people, a copy of Atlas Shrugged ($8.95) is enough of an eye opener. But the new trend in education caters to those "feeling" style learners who must experience it to learn it ... of course, with copious amounts of hand holding. For them, a few current offerings:

• Hands-on independent studies on pitfalls of Leveraged Buy Outs of failed businesses:

Course.......Price
GM...........$50 billion ($19 billion deposit required)
Chrysler.....$12 billion and 100,000 jobs (best value!)
AIG..........$170 billion plus 10% of the value of shares on NYSE
Act now! Inflation pricing starts soon!

• Popular! New! "Trial-by-fire" Style Finance 101 .... Price: $700 billion
  
• Private! Experiential MBA: .... Price: $1.9 Trillion (and counting)
  
• Investment Basics: .... Price: $ ("socially priced" at 35% of your net worth)
  
• Keynes vs. Friedman vs. Hayek: Fiscal and Monetary Policy: .... Price: $ (1 percent of GDP)
  
• Pass-or-Fail Monetary Policy 301: .... Price: $(price determined one generation after you take the class)


• And the ultimate: On-the-job-training in the White House: .... Price: $ Priceless

Like Spending a Dollar to Get a Dime

That's how Louisiana Govenor Piyush "Bobby" Jindal described the Stimulus payments on unemployment on Meet the Press 2/22/09.

Leave it to a first-generation American to cast an objective eye on US politics. His parents, as most immigrant families, struggled to make a better life for their kids. They fended for themselves. They took responsibility for improving their own lives. They sacrificed. Bobby was undeniably acculturated from the outset, preferring the Brady Bunch to Bollywood, but his parents' lessons were clearly not lost.

He's not the only one, of course, but he's a nice contrast to the likes of Puerto Rico, which sees no problem asking for nearly 5% of the total stimulus, though their population is under 4 million and their economy contributes nearly nothing to GDP. Boy, it must be expensive to build down there. "100 acres of new energy efficiency industrial zones" is gonna cost us $17 billion. That would be $4,000 a square foot ... or $11 million per job created. Why don't they just hand out shovelfuls of cash to these Caribbean shits? That would probably be cheaper than one of their other requests: $500 million to give solar water heater tanks to rural families. 14 very short-term jobs there (by their own count), so $35 million per job. Apparently the current $2,000 tax credit just isn't enough for these people, even though that's precisely the price of a one-family sized tank.

Not that they're the only ones. Miami (city and county) have put in for nearly the same amount, mostly for transportation projects like the "Two hundred million dollar mile" project ($2.4 billion to extend the "Orange Line" east-west transit by 10 miles). By comparison, their pitch for $1.4 billion to expand the same "Orange Line" north-south is a bargain.

And there's:

• The "Billion Dollar Bridge" in Moline Illinois
• The $600 million 100MW solar plant in Alabama using outdated technology. Strangely, other states can use newer technology to generate the same 100MW for hundreds of millions less.
• The new digs for the chief of Oakland police, $450 million
• And a parking garage for the Oakland Airport $300 million. Who can blame them? Its just SO TIRING to walk through their current lot.
• The events center and hotel in Albuquerque, $418 million
• Not to be outdone, a similar pitch in Irving, TX (and here and here), including residential, commercial, and every other kind of -ial $1.4 billion. Where the hell is Irving anyway?
• Or a Performing Arts Center in Vegas. $375 million. Apparently they don't have enough stages in that town.
• Or $2 billion to put (outmoded) solar panels on every roof in LA

Below the $300 million mark (aka chump change), there are literally thousands of projects to replace things that aren't broken (over 1,000 fire/police station renovations) and install things that range from unnecessary (over 100 police or fire "training centers" for every village and hamlet from here to Timbuktu) to downright infuriating (dog parks; river walks; a $20 million "downtown quiet zone" for raucous San Diego; several multi-million dollar golf courses in Texas ... including a 36 hole Disc Golf course for the dusty hipsters in Austin).

I make no mystery of my opposition to each and every one of these government bailouts. Everyone has their reasons for advocating or opposing it. Here are one or two of mine:

• Today, 12% of GDP is spent servicing the national debt With our new expenditures, this will likely increase to 20%. This is an untenable level for any economy. There is no way to prevent it from reducing GDP growth (and thus standard of living) other than to bring it back down to single digits where it should be.


• The above is just to "service" (maintain) the debt. Fees and interest. To actually reduce debt means increasing taxes and reducing government spending over the 5-to-25 year horizon. Mathematically, when people and businesses have an increase in taxes without a commensurate increase in earnings, investment, savings, and/or consumption must fall. In other words, the major "drivers" of our economy must be throttled back in favor of the non-productive, non-job-creating, non-profit-generating activity of paying down government debt. GDP will necessarily fall.


• There is a strong inverse relationship between the amount of debt a country has and the long-term value of the currency. Currency values are determined by supply and demand, just like everything else (pay attention, Tim and Barry). Any schmuck who didn't sleep through Econ 101 knows that supply and demand meet at a price which "clears the market." For currencies, that "price" is the NPV of all future interest payments one can get by owning the currency minus inflation. In other words, the interest rate now, plus the PV of expected interest rates into the future, adjusted for inflation, determine the current exchange rate. All of this is a round-about way of explaining what most people just accept: the interest rate drives the exchange rate. So what drives the interest rate? It is a consensus opinion about the credit-worthiness of the country. Just like a corporation's bond issue, the US government has to offer an interest rate which compensates investors (=holders of dollar assets) for expected inflation plus the risk that the US economy goes tits-up. Inflation expectations and default risk have been low, so interest rates have been low. This thanks to Paul Volcker and the Reagan economic team (including Greenspan) who realized that a high interest rate stifles investment and savings. It thus stifles financial stability and economic growth. The inflation component drives people to put their money in other currencies and thus other economies instead of ours. With the current gratuitous increase in debt, coupled with the decrease in long-term growth due to inflation and taxation, this risk is increasing significantly. Interest rates will necessarily increase.

Call me crazy, but personally I'm a fan of financial stability and economic growth.

PS: I'm amazed by the notoriety Rick Santelli of CNBC has garnered by refusing to accept the Washington line. The snarky childish response from the White House, referring to him by name, is a little Putin-esque. Last I checked, we still had freedom of speech around here.

Buy!/Sell! #5: 2008 Annual Report

Happy 2009! This January will bring you a number of really ugly annual reports. I suggest that you don't read them.

However, here's a fun one: the annual report on my Buy!/Sell! model portfolios to date.
The idea is to see which of my prediction-market bets were right, or at least more likely to be right now than when I made them (=in the money in derivatives-speak) or not (=underwater).

As I mentioned at the outset of this project, prediction markets are thin (=not many transactions) yet, so most of my bets couldn't be made or priced on an actual prediction market. The only thing they were focused on this year was the Presidential election. Thus, my bets were "model" bets, the same riskless cheat used by hedge funds, economists, investment advisors and analysts to show how smart they are without actually putting their money where their mouths are. So, I'll also steal another cheat from the financial industry. I'll plead helplessness on marking these bets to market. No market means no market price, means no marking-to-market to quantify the Dollar gains/losses.

All the same, I can at least compare the predictions I made to the events which actually transpired to see if someone woulda made or lost money on my model portfolios.

So here goes:

Blog Shout Out: Separation of Owners and Executives

Phil Goldstein guest-blogged on The Icahn Report recently advocating more inclusivity in proxy vote ballots. While I agree with him, I'm not sure I see it as the end-all be-all that he does. That's not why I'm giving him a shout out. It's his priceless intro. He had me at "nutshell" but went on to offer some awesome and appropos quotes:

What is fundamentally wrong with corporate governance in America? In a nutshell, it is difficult for stockholders to hold management accountable for its misdeeds.

This is not a new insight. In 1776, Adam Smith wrote in The Wealth of Nations: "The directors of such companies, being the managers rather of other people’s money than of their own, will not watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. Negligence and profusion therefore must always prevail in such a company."

Let's fast forward to 1934. Here is what Congressman Lea of California said in the Congressional record of May 1, 1934: "In the main, the men controlling these great corporations are not large owners of the stocks of the corporations they control. Too often they have yielded to the temptation to control these great business institutions to their own interests, and with a zeal out of proportion to the loyalty they have shown their stockholders. Thus in recent years we have seen the directors of corporations, without the knowledge of their shareholders, voting themselves vast bonuses out of all proportion to what legitimate management would justify. We have had revelations of salaries paid to directors and officers of great corporations which showed shameful mismanagement; which showed that the men in charge of some of these corporations were more concerned in managing its affairs for their own benefit than for the benefit of the stockholders."

It is now 2008 and it is fair to say that the lot of shareholders has hardly improved, considering the trillions of dollars in lost shareholder value over the last year, along with the egregious bonuses and salaries paid for this dismal performance.

Yes, yes, yes. Intermediation between owners and managers clearly creates perverse incentive structures and thus, as you may have noticed, opens up a gaping chasm of opportunity for disaster.

Once again it's back to basics: incentives must be aligned. Any crack of variance between the interests of management and that of the owners will be found and exploited if not monitored like a hawk. My prior post on the ills of modern boards of directors tried to highlight this. I was so bold as to suggest a few incentive-alignment mechanisms for directors.

At root, corporations are organizational structures to facilitate the most effective decision making across a bazillion tiny capital allocation choices. Layers of management are supposed to enhance that "effective" part by setting strategy, establishing standards, reviewing decisions, training staff, monitoring success metrics, and so on.

For the most part, corps do the above successfully. The trick lies in how you define "effective."

For long-term shareholders, effective probably means profit-maximizing whilst risk-minimizing in order to maximize the company's valuation (NPV of future cash flows). For day traders, it probably means share price volatility, for a shareholder-CEO, it might mean meeting revenue or share price targets on certain dates in order to release his performance bonus ... You can already see that even a perfect board would have to arbitrate among conflicting goals of various owners.

For managers, it means getting a good perfomance review and keeping their boss happy so they get a nice promo or bonus. For a middle-aged staffer, it might be stability and healthcare. A Gen-Y up-n-comer's interest might be in flexibility, excitement, and recognition.

Each of this plethora of interests creates an incentive mechanism which guides the person's every action. There are a lot of smarties lately making a sport of disparaging the idea that humans make rational decisions. While I recognize we're not robots and thus mess up, I think that the vast majority of apparently "strange" or "bad" decisions would appear sensical if you could fully map the "context."

I use "context" as a shorthand term for the three factors I feel are at the heart of decision-making:

• the complete incentive mechanism environment faced by the maker
• all the information available at the point of the decision
• and the (current) "horsepower" of the maker's brain process this information. Some humans are better than others at processing information and making decisions, but there are biological limits. Then environmental factors determine whether or not one's brain is working at full capacity like a well oiled machine.

And that's why I don't believe the board (or it's members) are always the cause and solution to every business problem. You can clean up a totally absentee board and improve the company's governance, but they're just a small group of humans. Not even Rain Man could process enough info to make enough decisions per hour to singlehandedly run GE, GM, or Microsoft.

For better and for worse, a board is just a bottleneck of power within an organization. Convenient in some cases, but inhibitory and ineffective if you try to cram too much through it. The daily scandals we see are the direct consequence of an absenteeism which arises less from lazy boards than from the skewed incentive structure under which each employee (especially management) operates.

So while I very much enjoy an agree with most of the gems that appear on Icahn's blog, I would argue that they need to spend a little less time inventing ways to gerrymander and a little more time getting the "context" right. This might require:

• Mapping, measuring, assessing, and alining the incentive mechanisms. Here's a hint for all those newly out-of-work brains in finance and consulting: invent a demonstrably effective framework for rooting out perverse incentives and you'll have companies lining up at your doorstep like Macy's on the 26th of December.
• Ensuring board members have enough information. Accurate information. This implys the need for a staff, as well as inciteful 3rd party analytics (are you listening entrepreneurs?)
• Maximizing each member's computing capacity (for example, by limiting other demands on their attention as I suggested in my earlier blog), and then being realistic about how much you can expect the board to effectively handle. In a sense, this is just another incentive mechanism to be aligned. They're often incentivized to get through their agenda in set number of minutes, and will compromise on the other incentives to achieve that. Bad bad bad. Add board members, add time, and/or delegate power.

Just a start. Now You.

Follow Up 2: Idle Shareholders

Jinx!

Apparently, at the exact same time I was blogging about irresponsible boards, Carl Icahn was on Fast Money echoing my comments, right down to my "fox in the henhouse" allusion. The video is here. For the record, I first said this about corporate execs back in July. Also for the record, I'm sure he's been saying it since before I was born. It's just nice to be in good company!

In a nutshell, Icahn doesn’t feel corporate management is properly held accountable for their actions. And going forward, he’s determined to see that they are. "It's like asking the proverbial fox to guard the henhouse," he said. Ichan said he is starting a cause called the United Shareholders of America to fight in Washington to change the rules on how corporate management in America operates.
- Unintended Consequences, Recap of CNBC's Fast Money, Seeking Alpha Blog 10/6/08

Follow Up: Idle Shareholders

Way back in July when the financial crisis was just a dull, irritating hum, I wrote a blog to explain the biggest reason why big corporations go afoul. In short, I argued that CEO foxes are left to guard the corporate hen house by absentee owners (shareholders) and their surrogates (fund managers).

I promised to be back with some suggested cures for this corporate cancer. So here I am ... with a new buddy.

Governance Guru Nell Minow talked to Congress about Lehman today. After watching the proceedings, I'm certain they brought her in to lend a sliver of credibility to their populist attack on executive compensation, but she slyly took the opportunity to point the finger a different direction:

the board was too old, had served too long, was too out of touch with massive changes in the industry, had too little of their own net worth at risk, and was too compromised for rigorous independent oversight

I couldn't have told the story better myself. Therein lies the problem and the cure for the cancer. The Board are the ultimate representatives of shareholders, and they are just as guilty of negligence as absentee shareholders. If leverage over CEOs can be had, the Board is the vehicle. The trick is to fix their incentives in order to align with shareholders at large.

A Board seat is a position of honor and prestige. Unfortunately, some members are after these alone, and only grudgingly accept the duties of representing shareholders. Some don't even bother to pretend they care. They usually get nominated because they are famous or connected, not because they are qualified. To align the Board's interests with the interests of us shareholders, we must flex our public opinion muscle by pressuring ALL corporations to implement some game rules.

• Corporations must finally figure out what Governance really means. I'll devote an upcoming blog to this one soon. As an amuse-bouche, I offer the Washington Post's 2006 corporate governance primer.
  
• Boards must meet monthly. Each committee must meet twice monthly or more. Repeated truancy must be rewarded with expulsion. If this is too burdensome to fit into one's social calendar ... well, board seats are not for everyone.
  
• Executives must not sit on their own boards. Period. They can submit proposals. They can submit reports. They can visit when invited.
  
• In the interest of combatting boardroom ADHD, board members should focus on one organization in most cases.
  
• Board members must "buy in" just like a poker table. And the stakes must be enough to make it interesting to them. Explicitly, shareholders must invest a significant share (25% might be a good guideline) of their net worth in the company's common stock or unsecured debt. Furthermore, they must agree to sell deeply underwater puts with expiry at least 5 years out. These must be rolled each year they are on the board, such that they continue to be in force for 5 years after departure from the board. Again, if this sounds too harsh ... NEXT. I can already hear people calling me elitist, "if seats are bought, only the rich will have them." To that I counter that anyone should be able to get on the board if enough shareholders are willing to "sponsor" them. But then it's up to those shareholders to actively police their representative.
  
• Board members must be able to demonstrate a germane area of expertise. For some it might be accounting, for others economics, for others management, for others past experience in the industry. If their only claims to fame are money and ... well ... fame ... NEXT. This should be policed by the owners. Here's a million dollar idea for someone: set up a board member rating agency. Nell's group The Company Library is a good start, but focuses on the enterprise as a whole, not specific board members. Additionally, their soup-to-nuts prosaic appoach is a bit much. My advice (to them or their start-up challengers): keep it simple: A through F based on pre-determined and public criteria.

This is just a starter kit. I'm sure Nell and the other Governance-ators have their own hats to throw in the ring. Go ahead, new buddies-o-mine!