Saturday, June 24, 2006

Strike Two on the SEC

Several years ago, when I was serving on the U.S. Advocacy committee of the CFA Institute (formerly called the Association for Investment Management and Research), we were invited to meet with staff members of the Securities and Exchange Commission to discuss some proposed regulations. At the time, the SEC staff had just finished an extensive paper on hedge funds. Largely because of the Long Term Capital Management blowup, there was pressure on the Commission to regulate these funds. Interestingly, the Commission's concern was not that these funds took too many risks, but that it was too easy for unaccredited investors to get into them.

An accredited investor is defined as one who has at least $200,000 in annual income ($300,000 if married) or $1 million in net assets. The SEC was concerned that some investors who didn't meet these thresholds were able to invest in hedge funds. There was also concern that perhaps the thresholds were too low.

It seemed to me that the solution was obvious. Instead of regulating hedge funds, the SEC could simply raise the thresholds that define an accredited investor. It could even peg the thresholds to inflation.

However, the SEC called for regulation. The commissioners voted along party lines. The two Democrats voted in favor of regulation; two Republicans voted against. Chairman William Donaldson, a Republican appointee, sided with the Democrats and hedge funds were required to register with the SEC and provide a minimal amount of information.

Well on Friday, an appeals court threw out the rule. While the court's reasoning may be complicated and hinge on legal nuances, it represents the second time that regulation introduced during Chairman Donaldson's tenure was set aside. The first had to do with the mutual fund independence rule that required that at least 75% of a fund's board, including the chair, be independent of the management of the fund. Mr. Donaldson sided with the Democrats on this issue as well.

At the time, I wrote in the Forbes Growth Investor that as an investor, I'd feel more comfortable knowing there was a critical mass on the board who was familiar with the management of the fund. While having some independent board members may be a good idea, 75% seemed ridiculously high.

I discussed both hedge fund regulation and the mutual fund independence rule just last week with former SEC Chairman Harvey Pitt. Interestingly, he said he didn't think we need more regulation of hedge funds. He felt we just need better regulation of the relationship between hedge funds and their investors. He also had some interesting things to say about mutual fund independence. This discussion took place on my MoneyMasters video program. I wish we could make it available to you sooner. Unfortunately, it won't be posted for viewing until Thursday, June 29. Please take a look at that time.

Wednesday, June 21, 2006

Technicals Look Good. Fundamentals Do Not

Given the market's recent weakness, it's good to see today's strong rally. The bull market that began in March 2003 is still intact as the S&P 500 continues to set higher highs and higher lows. Although the index is below its 200-day moving average, it has broken below this level and rebounded back several times during this bull phase. So on a technical basis, the market still looks good. In fact, the S&P 500 will have to close below its October 2005 low of 1176 to break this trend.

Today's rally is being credited to the positive earnings reports issued by Morgan Stanley and Federal Express. Of course, all rallies and sell-offs must be credited to or blamed on something. However, we really won't get a firm handle on what corporate earnings look like until the third week of July when second quarter results start pouring in.

On a fundamental basis, I'm still concerned about the market's overall health. I continue to focus on the Big 3: interest rates, energy prices, and housing. The Fed is still pushing through rate increases, energy prices remain stubbornly high, and the housing boom continues to fizzle. The combination of these three factors is what really worries me. Yes, stocks are way up today, but so is oil. Right now, it's up about 90 cents per barrel. Gold is up, too--about $10 an ounce. The yield curve is inverted between two and 10 years, and the 30-year bond is yielding exactly the same as the two-year note. These are not encouraging signs. Neither is it encouraging to see that the best performing stock year-to-date in the Dow Jones Industrial Average is General Motors, a company that lost more than $11 billion over the past 12 months.

The Fed makes its next announcement regarding interest rates on June 29. Almost everyone expects another quarter point hike. As usual, however, what the Fed says in the statement is what will really move the markets. Any indication that further rate hikes will be needed to fight inflation could result in a sell-off.

Friday, June 16, 2006

Eating Salad at Delmonico's

I'm wrapping up a fun but exhausting week. It began with lunch at Delmonico's, which is one of the oldest restaurants in the U.S. It is located within a short walk of the New York Stock Exchange. I was meeting with two real estate investors. One immigrated to this country not too long ago, but has already made a respectable fortune through sale and leaseback transactions. These guys are somewhat bearish on residential real estate, but still bullish on commercial real estate. Interestingly, they are also interested in opportunities abroad. I'm a little embarrassed to say that I ate nothing but a salad at one of America's most famous steak houses.

Then I was off to Wayland, MA to play golf with a venture capitalist, a private banker for U.S. Trust, and an attorney who specializes in estate plans. I also met Luis Tiant, the former great Red Sox pitcher famous for contorting his body into knots before releasing the ball.

Toward the end of the week I interviewed Harvey Pitt for my MoneyMasters video program. This will go live on July 29. Chairman Pitt was very forthcoming on a number of key issues currently occupying the SEC. He expressed opinions on backdating options, expensing options, hedge funds, mutual funds, etc. He pointed out that even though a number of corporate executives have gone to jail, no one has been convicted for violating any of the Sarbanes-Oxley provisions. He also spoke none too kindly about the Financial Accounting Standards Board (FASB). It's a fascinating interview and I strongly encourage you to watch it on the 29th.

I was also interviewed myself for the The Leon Charney Report, which airs in the New York City area. We talked at length about the economy and markets. My interview airs this Sunday, but you can also watch it soon after on Leon's website.

Finally, my MoneyMasters interview with hedge fund manager Renee Haugerud is currently available for viewing. Renee manages about $675 million in a commodities-based global macro fund. She said she thinks we're in for a period of inverse stagflation, a new theory she explains at length in the video.

Monday, June 12, 2006

Buybacks Don't Fool Investors

Today's Wall Street Journal has a front page article about the record amounts of share repurchases and how they are upwardly biasing reported earnings per share. By reducing the share count some companies are making the growth in earnings per share look real good despite much more meager growth in absolute earnings. The WSJ references a study by Standard & Poor's Howard Silverblatt. Of course, Howard already discussed all this two weeks ago on MoneyMasters. I suggest taking a look if you haven't yet seen the video.

Furthermore, Howard and I also pointed out that an increasing proportion of net income is being generated from interest rather than operations. While it's nice to get a boost from interest income, investors should worry when industrial companies aren't producing more from operations. After all, these are not investment companies. If you like interest income, it's much cheaper and more efficient for you to generate it yourself by purchasing CDs and the like than to have a corporation do it for you.

The WSJ also pointed out that despite all these buybacks, some companies aren't even reducing their share count. This is because their executives are exercising stock options, which results in more shares outstanding.

This may be yet another factor contributing to recent market weakness. After all, it's not just the quantity of earnings that count. Quality matters, too.

By the way, I mentioned in the last issue of the Forbes Growth Investor that I expected to post a MoneyMasters interview with Harvey Pitt on June 15. This has been postponed to June 29. Mr. Pitt traveled all the way to New York from Washington last week to film our segment. Unfortunately, his plane was extremely delayed due to bad weather. He has graciously agreed to make another trip. Let's hope we get better weather this time.

Tuesday, June 06, 2006

Forbes Roundtable Discussion

As mentioned in yesterday's posting, we held a Roundtable discussion last night here at Forbes Inc. Headquarters. The timing couldn't have been better. We began our discussion just half an hour after the markets closed. The Dow sold off 200 points at least in part due to Ben Bernanke's comments about inflation and a slowing economy.

Barbara Marcin wasn't too concerned about an economic slowdown. However, she favors large-cap dividend payers, which are typically the kinds of stocks that hold up best in a bear market. Chuck Brunie was very concerned about central bankers around the world mopping up liquidity, which could be bad news for investors. Liz Ann Sonders turned bearish a couple of months ago. She believes there is a good chance we could see a fairly strong market sell-off. Mike Holland said a sell-off wouldn't surprise him. However, he was more sanguine about the economy. While he believes economic growth will slow, he doesn't foresee a recession. Although some participants were short-term bearish on stocks, all were long-term bullish. They believe a strong market sell-off will be a good buying opportunity. Despite yesterday's 200-point drop in the Dow, everyone agreed the sell-off hasn't yet occurred.

We will transcribe and edit the comments for clarity. Then we will make them available to all subscribers to the Forbes Growth Investor and Special Situation Survey investment newsletters. This process will take a few weeks, so please bear with us.

Monday, June 05, 2006

Bernanke Talks, Markets Listen

Fed Chairman Ben Bernanke expressed genuine concern about inflationary pressures today. Stocks, which were already weak, fell further on his words. Mr. Bernanke said the economy is entering "a period of transition." That was a nice way of saying growth will slow. This combination of slowing growth and rising inflation is certainly not good news.

Last Friday I was a guest on Kudlow & Co. on CNBC. I advised decreasing equity allocations. Furthermore, I said what you invest in stocks should be tilted toward those issues that hold up best in down markets. These would be non-cyclical stocks and stocks that pay dividends.

Tonight, we will be hosting a Roundtable discussion here at Forbes. Participants will include Liz Ann Sonders of Charles Schwab, Barbara Marcin of the Gabelli Blue Chip Value Fund, Mike Holland of Holland & Co., and Charles Brunie of Brunie Associates. It will be interesting to see if these experienced investors are becoming more cautious. More on that later.