A dozen years ago, when I was on the faculty at Boston College, I was teaching in the Master of Science in Finance program. One of my students was a quantitative analyst at a hedge fund. This guy was an excellent student who instinctively understood derivatives and their pricing models. He was an active member of the Boston Security Analysts Society and provided great encouragement as I toiled with the CFA exams.
I joined Forbes in 1997. Every now and then I spoke with this former student of mine. Eventually, he quit his job. He told me he had become disillusioned with the whole Wall Street game and was convinced there was a lot of fraud going on in the industry. He said he was going into business for himself investigating fraud in the securities industry. Without being specific, he said he was on to one of the biggest Ponzi schemes ever. He also told me about his frustrations dealing with the SEC.
Sounds kind of paranoid, doesn't it? I knew this guy wasn't crazy, but I had to wonder if he wasn't exaggerating a bit. Well, imagine my surprise when I read about him on the front page of the Wall Street Journal on Thursday morning. His name is Harry Markopolos and he has been mentioned on my blog before. It turns out the Ponzi scheme Harry was looking into was the one run by Bernie Madoff.
Thanks Harry for doing such a great service to your country. I wish the powers that be had paid more attention to what you had to say long ago.
Friday, December 19, 2008
Wednesday, December 17, 2008
Facebook Friend
One of the best things about Facebook is that it allows you to track down long lost friends. That's how I found Mark Stivers, the kid who lived three houses down from me when we were growing up. Mark is a multi-talented individual. It turns out he is also an excellent cartoonist. I suggested he draw this cartoon of Ron Gettelfinger, which fits in nicely with my Dec. 12 post. I hope to feature Mark's work from time to time in the Forbes Growth Investor.
Friday, December 12, 2008
The UAW has Priced Itself Out of the Auto Market
When the $14 billion bailout for the auto industry fell through last night, Senate Majority leader Harry Reid said, "I dread looking at Wall Street tomorrow. It's not going to be a pleasant sight."
Stocks opened lower as Reid predicted, but not nearly as much as his words suggested. And soon after the open, stocks began to rally. Some will say investors grew hopeful that the White House and Treasury Secretary Henry Paulson would step in and use TARP money to save the auto industry. However, I believe investors are simply pleased that Congress is taking a hard stand against bailout seekers. Bad companies should be allowed to fail. At least some of our politicians have finally gotten that message.
Ron Gettelfinger, president of the United Automobile Workers, gave a press conference this morning blaming Republicans for the failure of the bailout, but the conference only proved how defensive Gettelfinger has become. The U.S. auto industry is dying, yet the UAW refused to allow any wage concessions in 2009. The UAW doesn't seem to understand that it has priced its membership out of the market. While this union tries to "protect" its members, foreign manufacturers are grabbing market share and putting Americans to work throughout the South. It won't be long before out-of-work union members begin migrating south seeking employment at these non-union shops.
Stocks opened lower as Reid predicted, but not nearly as much as his words suggested. And soon after the open, stocks began to rally. Some will say investors grew hopeful that the White House and Treasury Secretary Henry Paulson would step in and use TARP money to save the auto industry. However, I believe investors are simply pleased that Congress is taking a hard stand against bailout seekers. Bad companies should be allowed to fail. At least some of our politicians have finally gotten that message.
Ron Gettelfinger, president of the United Automobile Workers, gave a press conference this morning blaming Republicans for the failure of the bailout, but the conference only proved how defensive Gettelfinger has become. The U.S. auto industry is dying, yet the UAW refused to allow any wage concessions in 2009. The UAW doesn't seem to understand that it has priced its membership out of the market. While this union tries to "protect" its members, foreign manufacturers are grabbing market share and putting Americans to work throughout the South. It won't be long before out-of-work union members begin migrating south seeking employment at these non-union shops.
Thursday, December 11, 2008
Initial Jobless Claims Get Worse
The Department of Labor reported today that initial jobless claims for the week ending December 6 hit 573,000 on a seasonally-adjusted basis. The news is certainly unsettling. Nonetheless, even though the number exceeded the consensus estimate by almost 50,000, the stock market gave the report a rather ho-hum reception.Because the week-to-week initial claims figures can be volatile, economists prefer to focus on the four-week moving average. This average climbed to 540,500. It has risen six weeks in a row. During the previous recession (March to November 2001), the 4-week average climbed five weeks in a row before peaking at 489,250. I suspect, however, that this time we haven't yet hit the peak. The graph above plots the 4-week moving average ever since the 2001 recession began. As you can see, it has been rising sharply since late 2007, and so far shows no sign of leveling off. I really don't think it is alarmist to suggest that the unemployment rate could hit 8-9% by mid-2009.
Friday, December 05, 2008
Dismal Employment Numbers May Mark Bottom in Stocks
Today the Bureau of Labor Statistics released the employment figures for November. They weren't pretty. Nonfarm payrolls fell by a much bigger-than-expected 533,000. Even worse, the September and October figures were revised. October's job losses went from 240,000 to 320,000. September's went from 284,000 to 403,000.
The service sector alone lost 370,000 jobs in November. Losses were widespread from retail to automobile dealerships to leisure and hospitality. Health care was the only bright spot, gaining 34,000 jobs.
Surprisingly, the unemployment rate ticked up to just 6.7%. No doubt, this measure will rise considerably in coming months. I was criticized for suggesting it could surpass 8% by mid 2009. I sincerely hope I am wrong about that.
So far in 2008, the economy has lost an astounding 1.9 million jobs. It won't be easy to put all these people back to work on short notice. But that is exactly what President-elect Barack Obama hopes to do. Part of his economic stimulus plan is to increase infrastructure spending by $60 billion over 10 years. He estimates this will create about two million jobs--about the same number of jobs lost so far this year.
The American Society of Civil Engineers estimates that $1.6 trillion is needed just to bring all U.S. public works to good condition, so increasing spending on infrastructure is certainly a good idea. It is also inevitable. But $60 billion over 10 years is just a drop in the bucket. Despite so many other priorities right now, such as bailing out the the finance and auto industries, this figure is likely to rise.
The market initially responded to the employment figures just as one might expect. It sold off. Yet by the end of the day, stocks were up. The Dow finished higher by 259 points. I don't think investors are wrong to bid up stocks right now. The recession, which started a year ago, is already growing long in the tooth; and when employment numbers get this bad, it often marks a bottom in stocks. I continue to expect a strong rally in 2009.
The service sector alone lost 370,000 jobs in November. Losses were widespread from retail to automobile dealerships to leisure and hospitality. Health care was the only bright spot, gaining 34,000 jobs.
Surprisingly, the unemployment rate ticked up to just 6.7%. No doubt, this measure will rise considerably in coming months. I was criticized for suggesting it could surpass 8% by mid 2009. I sincerely hope I am wrong about that.
So far in 2008, the economy has lost an astounding 1.9 million jobs. It won't be easy to put all these people back to work on short notice. But that is exactly what President-elect Barack Obama hopes to do. Part of his economic stimulus plan is to increase infrastructure spending by $60 billion over 10 years. He estimates this will create about two million jobs--about the same number of jobs lost so far this year.
The American Society of Civil Engineers estimates that $1.6 trillion is needed just to bring all U.S. public works to good condition, so increasing spending on infrastructure is certainly a good idea. It is also inevitable. But $60 billion over 10 years is just a drop in the bucket. Despite so many other priorities right now, such as bailing out the the finance and auto industries, this figure is likely to rise.
The market initially responded to the employment figures just as one might expect. It sold off. Yet by the end of the day, stocks were up. The Dow finished higher by 259 points. I don't think investors are wrong to bid up stocks right now. The recession, which started a year ago, is already growing long in the tooth; and when employment numbers get this bad, it often marks a bottom in stocks. I continue to expect a strong rally in 2009.
Sunday, November 23, 2008
How Low Can It Go?
No, I'm not talking about the stock market. I'm talking about crude oil and gasoline.
Back when oil prices were still well over $100 per barrel, I wrote in Forbes magazine that they were likely to fall. I thought the global slowdown and the rapid change in driving habits would bring oil down to about $70. Of course, we've already fallen well below that mark. Crude is now selling for less than $50. Gasoline prices have also plunged. According to the AAA Fuel Gauge Report, the national average retail price for regular unleaded gasoline is currently $1.93 per gallon.
It would be nice if prices were falling because the world had discovered a lot more oil. Unfortunately, prices are falling because demand is being destroyed. Much of the demand destruction is due to the global economic slowdown. In particular, people are driving less in the U.S. They are also driving more efficient cars. U.S. auto manufacturers are struggling in part because no one wants to buy a gas guzzler anymore. The Honda Civic is suddenly chic.
Other countries are being impacted as well. Europe and much of Asia are in recession. Although demand is still growing in China, it is growing at lower-than-expected rates.
So how low can oil go? It all depends on the severity of the global recession. It also depends on how serious we remain about alternative energy. Plug-in hybrids and all-electric vehicles seemed to make economic sense when oil was at $140 per barrel and $5 gasoline was within sight. But how many drivers would be willing to give up their internal combustion engines if gasoline is expected to remain below $2 per gallon?
Not long ago, no one seriously thought we'd see $40 crude oil again. However, now it appears that we'll see $30 very soon.
Back when oil prices were still well over $100 per barrel, I wrote in Forbes magazine that they were likely to fall. I thought the global slowdown and the rapid change in driving habits would bring oil down to about $70. Of course, we've already fallen well below that mark. Crude is now selling for less than $50. Gasoline prices have also plunged. According to the AAA Fuel Gauge Report, the national average retail price for regular unleaded gasoline is currently $1.93 per gallon.
It would be nice if prices were falling because the world had discovered a lot more oil. Unfortunately, prices are falling because demand is being destroyed. Much of the demand destruction is due to the global economic slowdown. In particular, people are driving less in the U.S. They are also driving more efficient cars. U.S. auto manufacturers are struggling in part because no one wants to buy a gas guzzler anymore. The Honda Civic is suddenly chic.
Other countries are being impacted as well. Europe and much of Asia are in recession. Although demand is still growing in China, it is growing at lower-than-expected rates.
So how low can oil go? It all depends on the severity of the global recession. It also depends on how serious we remain about alternative energy. Plug-in hybrids and all-electric vehicles seemed to make economic sense when oil was at $140 per barrel and $5 gasoline was within sight. But how many drivers would be willing to give up their internal combustion engines if gasoline is expected to remain below $2 per gallon?
Not long ago, no one seriously thought we'd see $40 crude oil again. However, now it appears that we'll see $30 very soon.
Tuesday, November 18, 2008
This Recession Will Last Longer Than Average
Most sensible economists agree the U.S. economy is in recession. Yet the fact remains that no recession has been officially declared.
The textbook definition of recession is two successive quarters of contraction. After posting very strong growth during the second and third quarters of 2007, GDP fell 0.2% during the fourth quarter of that year. However, it rebounded to 0.9% growth in the first quarter of 2008. The tax rebate checks, billed as an economic stimulus plan, boosted second quarter 2008 GDP to 2.8%. GDP fell 0.3% in the third quarter. So if the economy contracts during the fourth quarter, which it certainly will, we will have satisfied the textbook definition of recession.
The more relevant definition, however, is the one stated by the National Bureau of Economic Research. This is the entity that has the authority to declare official recessions in the U.S. According to the NBER, "a recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales." By this definition, it appears that a case could be made that we have been in recession for almost a year.
The NBER takes its time in declaring recessions. According to the NBER, the last recession began in March 2001 and ended in November of that year. But the NBER did not declare the start of the recession until November, when the recession was already over. Furthermore, it did not declare the end of the recession until July 2003. That's almost two years after the recession had already ended.
Employment is one of the many factors the NBER studies when trying to determine if the economy is in recession. In December 2006, the unemployment rate stood at 4.6%. One year later, it had climbed to 5.0%. After dipping a bit in January and February of 2008, it resumed its upward drift. The unemployment rate for October hit 6.5%, 150 basis points higher than it was just 10 months earlier. The last time the unemployment rate visited this level was in April 1994.
Given layoffs like the one announced yesterday by Citigroup, there is no doubt unemployment will jump to much higher levels. Some economists hope the unemployment rate will peak around 7%. I think this forecast is much too optimistic. In June 1992, the unemployment rate hit 7.8%. In November and December of 1982 it peaked at 10.8%. Furthermore, it is not unusual for the unemployment rate to continue rising for some time even after a recession has ended. This is because employers are wary about hiring until they are convinced that better times lie ahead. At this time, I am expecting the unemployment rate to rise to somewhere between 8-9% by June 2009.
I believe the current (undeclared) recession began in January 2008. I am optimistic that it will end around June 2009. If I have the starting and ending points right, this recession will have lasted 18 months in duration. That is about the average length of all recessions recorded in the U.S. since 1854, but it is 10 months longer than the average since 1945. In fact, 18 months would set a post-WWII recession record.
Of course, if businesses become more aggressive with layoffs, retail sales continue to fall, and housing prices fail to stabilize by next spring, this recession could last considerably longer than 18 months. That would be a dire outcome indeed.
The textbook definition of recession is two successive quarters of contraction. After posting very strong growth during the second and third quarters of 2007, GDP fell 0.2% during the fourth quarter of that year. However, it rebounded to 0.9% growth in the first quarter of 2008. The tax rebate checks, billed as an economic stimulus plan, boosted second quarter 2008 GDP to 2.8%. GDP fell 0.3% in the third quarter. So if the economy contracts during the fourth quarter, which it certainly will, we will have satisfied the textbook definition of recession.
The more relevant definition, however, is the one stated by the National Bureau of Economic Research. This is the entity that has the authority to declare official recessions in the U.S. According to the NBER, "a recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales." By this definition, it appears that a case could be made that we have been in recession for almost a year.
The NBER takes its time in declaring recessions. According to the NBER, the last recession began in March 2001 and ended in November of that year. But the NBER did not declare the start of the recession until November, when the recession was already over. Furthermore, it did not declare the end of the recession until July 2003. That's almost two years after the recession had already ended.
Employment is one of the many factors the NBER studies when trying to determine if the economy is in recession. In December 2006, the unemployment rate stood at 4.6%. One year later, it had climbed to 5.0%. After dipping a bit in January and February of 2008, it resumed its upward drift. The unemployment rate for October hit 6.5%, 150 basis points higher than it was just 10 months earlier. The last time the unemployment rate visited this level was in April 1994.
Given layoffs like the one announced yesterday by Citigroup, there is no doubt unemployment will jump to much higher levels. Some economists hope the unemployment rate will peak around 7%. I think this forecast is much too optimistic. In June 1992, the unemployment rate hit 7.8%. In November and December of 1982 it peaked at 10.8%. Furthermore, it is not unusual for the unemployment rate to continue rising for some time even after a recession has ended. This is because employers are wary about hiring until they are convinced that better times lie ahead. At this time, I am expecting the unemployment rate to rise to somewhere between 8-9% by June 2009.
I believe the current (undeclared) recession began in January 2008. I am optimistic that it will end around June 2009. If I have the starting and ending points right, this recession will have lasted 18 months in duration. That is about the average length of all recessions recorded in the U.S. since 1854, but it is 10 months longer than the average since 1945. In fact, 18 months would set a post-WWII recession record.
Of course, if businesses become more aggressive with layoffs, retail sales continue to fall, and housing prices fail to stabilize by next spring, this recession could last considerably longer than 18 months. That would be a dire outcome indeed.
Sunday, November 16, 2008
Tax-Related Selling Will Keep Market Volatile Until 2009
The following is from a Special Report sent to subscribers of the Forbes Special Situation Survey.
In our Oct. 7 Special Report we discussed the unprecedented level of volatility plaguing the markets. Things have gotten much worse since. Both the intra-day and inter-day swings on the Dow and other major indexes are simply mind boggling. There have been a number of days when the Dow opened up or down several hundred points only to finish in the opposite direction.
We believe this volatility will continue through the end of the year. We believe much of it is due to tax-related trading. Earlier this year, many investors sold stocks for hefty capital gains. They then invested that money back into the market. Now they are sitting on large capital losses. These investors will sell shares in order to realize those losses to offset their earlier gains in order to minimize their tax bill. This activity puts downward pressure on stocks.
Other investors have already realized large capital losses. Because the IRS limits investors to only $3,000 per year in net capital losses, these investors have an incentive to sell into rallies in order to realize whatever gains they can to offset their large losses. This activity keeps the market from going higher than it otherwise would.
Of course, on top of all this, hedge funds and mutual funds are selling in order to meet redemptions. Investors who want their money back from hedge funds by yearend must notify them by Nov. 15. If large numbers of investors do so, selling pressure could increase between now and the end of the year. Mutual funds are also selling heavily. Many investors who have seen the value of their mutual fund holdings collapse will be doubly shocked when they realize they will owe capital gains taxes on shares the mutual fund managers sold at a profit.
Given the extreme sell-off in stocks this year, subscribers should keep a watchful eye on their tax situation. Make sure you realize net losses of $3,000 ($1,500 if married and filing separately). If you realize more than that, you will have to carry forward the losses into the next tax year. That’s not a bad thing, but it is not as valuable as taking them now.
Once all this tax-loss selling is completed, the market will stabilize. We expect volatility to subside once January rolls around. Furthermore, even though the economy will exhibit tremendous weakness for at least another six months or so, the stock market is likely to rally long before the economy improves. A strong rally after a bad year is not unusual. A 50% rally in the Dow from current levels would bring us back to only about 12,750. A 25% rally translates into a 10,625 Dow. This is a level that looks quite achievable by the end of 2009.
In our Oct. 7 Special Report we discussed the unprecedented level of volatility plaguing the markets. Things have gotten much worse since. Both the intra-day and inter-day swings on the Dow and other major indexes are simply mind boggling. There have been a number of days when the Dow opened up or down several hundred points only to finish in the opposite direction.
We believe this volatility will continue through the end of the year. We believe much of it is due to tax-related trading. Earlier this year, many investors sold stocks for hefty capital gains. They then invested that money back into the market. Now they are sitting on large capital losses. These investors will sell shares in order to realize those losses to offset their earlier gains in order to minimize their tax bill. This activity puts downward pressure on stocks.
Other investors have already realized large capital losses. Because the IRS limits investors to only $3,000 per year in net capital losses, these investors have an incentive to sell into rallies in order to realize whatever gains they can to offset their large losses. This activity keeps the market from going higher than it otherwise would.
Of course, on top of all this, hedge funds and mutual funds are selling in order to meet redemptions. Investors who want their money back from hedge funds by yearend must notify them by Nov. 15. If large numbers of investors do so, selling pressure could increase between now and the end of the year. Mutual funds are also selling heavily. Many investors who have seen the value of their mutual fund holdings collapse will be doubly shocked when they realize they will owe capital gains taxes on shares the mutual fund managers sold at a profit.
Given the extreme sell-off in stocks this year, subscribers should keep a watchful eye on their tax situation. Make sure you realize net losses of $3,000 ($1,500 if married and filing separately). If you realize more than that, you will have to carry forward the losses into the next tax year. That’s not a bad thing, but it is not as valuable as taking them now.
Once all this tax-loss selling is completed, the market will stabilize. We expect volatility to subside once January rolls around. Furthermore, even though the economy will exhibit tremendous weakness for at least another six months or so, the stock market is likely to rally long before the economy improves. A strong rally after a bad year is not unusual. A 50% rally in the Dow from current levels would bring us back to only about 12,750. A 25% rally translates into a 10,625 Dow. This is a level that looks quite achievable by the end of 2009.
Tuesday, November 11, 2008
Give (Small) Businesses a Chance to Flourish
I gave a talk yesterday at William Paterson University in Wayne, NJ about the economy and stock markets. Many of the participants were small business owners and were very concerned about how the dismal economic climate will affect small businesses in particular.
Small business is the backbone of the U.S. economy. It accounts for about half of all private sector employment, but it also accounts for most of the job growth. At least it did during the last decade. These days, of course, there is no job growth. The economy has shed almost 1.2 million jobs over the past 10 months--more than half a million in the last two months alone.
While the failure rate for new businesses is high, the fact is that owning your own business is one of the best ways to achieve economic prosperity. The new Obama administration should consider ways to make it easier for individuals to start and run businesses. One good idea is to exempt all new businesses from taxes for the first five years. Let them build up some steam before you slow them down. Besides, they will employ more people as they grow and the government will get its due from payroll taxes.
Small business is the backbone of the U.S. economy. It accounts for about half of all private sector employment, but it also accounts for most of the job growth. At least it did during the last decade. These days, of course, there is no job growth. The economy has shed almost 1.2 million jobs over the past 10 months--more than half a million in the last two months alone.
While the failure rate for new businesses is high, the fact is that owning your own business is one of the best ways to achieve economic prosperity. The new Obama administration should consider ways to make it easier for individuals to start and run businesses. One good idea is to exempt all new businesses from taxes for the first five years. Let them build up some steam before you slow them down. Besides, they will employ more people as they grow and the government will get its due from payroll taxes.
Thursday, November 06, 2008
Everyone Should Pay Their Fair Share of Taxes, But Not a Penny More
I just returned from the Fourteenth Forbes Cruise for Investors. We left New York City on Oct. 29 and toured the Caribbean. I got off in Angtigua on Nov. 4, but the cruise is still in progress. I arrived at JFK airport around 11 p.m. on the 4th and entered the baggage claim area just as CNN declared Barack Obama the winner of our presidential election. The place erupted in cheers.
Most participants on the investment cruise were resigned to an Obama victory, but they worried about what this would mean for the economy. Of course, Obama has threatened to raise taxes on the so-called rich. Depending on the day, his definition of rich seems to include anyone who makes $200,000 per year or so. I know in some parts of this country this sounds like a good sum of money, but I do not know anyone in the New York City area who makes this amount of money who considers himself rich--especially if he is supporting a family. With the top 1% of income earners already paying 40% of all the federal income taxes, it seems the "rich" already pay way too much tax.
More than one-third of Americans pay no federal income tax at all. Some are honest hard-working people who simply do not make enough money to pay taxes. But others either refuse to work or work in the underground economy. Many grocers, landscapers, painters, waiters, musicians, etc. deal only in cash. Are all these cash-based businesses declaring their income and paying their fair share of taxes? Some experts estimate that the illegal drug trade alone has a global value of $400 billion--all of it tax free. Instead of trying to squeeze more money out of the rich, Obama should first make sure that everyone pays his fair share.
Most participants on the investment cruise were resigned to an Obama victory, but they worried about what this would mean for the economy. Of course, Obama has threatened to raise taxes on the so-called rich. Depending on the day, his definition of rich seems to include anyone who makes $200,000 per year or so. I know in some parts of this country this sounds like a good sum of money, but I do not know anyone in the New York City area who makes this amount of money who considers himself rich--especially if he is supporting a family. With the top 1% of income earners already paying 40% of all the federal income taxes, it seems the "rich" already pay way too much tax.
More than one-third of Americans pay no federal income tax at all. Some are honest hard-working people who simply do not make enough money to pay taxes. But others either refuse to work or work in the underground economy. Many grocers, landscapers, painters, waiters, musicians, etc. deal only in cash. Are all these cash-based businesses declaring their income and paying their fair share of taxes? Some experts estimate that the illegal drug trade alone has a global value of $400 billion--all of it tax free. Instead of trying to squeeze more money out of the rich, Obama should first make sure that everyone pays his fair share.
Monday, October 27, 2008
Lower Gasoline Prices Won't Pay the Mortgage
In my previous post I said, "Lower oil prices and more efficient cars will leave consumers with more cash to spend on other things." While this is certainly a move in the right direction, I don't want to leave the impression that we're talking about a lot of money here.
Assuming the average driver rolled up about 12,000 miles per year and got 20 miles per gallon, he would need to purchase 600 gallons of gasoline per year. At $3.50 per gallon, he would spend $2,100 per year for gasoline.
But now gasoline costs about $1 per gallon less than it did a month ago. Furthermore, drivers are also driving less and more of them are shifting to fuel efficient cars. So let's assume our average driver now drives only 10,800 per year and gets 28 miles per gallon. At $2.50 per gallon, he spends $964 per year for gasoline.
While that might look like a big saving, it comes out to less than $100 per month. Yes, it does leave consumers with more cash, but not enough to make a mortgage payment.
Assuming the average driver rolled up about 12,000 miles per year and got 20 miles per gallon, he would need to purchase 600 gallons of gasoline per year. At $3.50 per gallon, he would spend $2,100 per year for gasoline.
But now gasoline costs about $1 per gallon less than it did a month ago. Furthermore, drivers are also driving less and more of them are shifting to fuel efficient cars. So let's assume our average driver now drives only 10,800 per year and gets 28 miles per gallon. At $2.50 per gallon, he spends $964 per year for gasoline.
While that might look like a big saving, it comes out to less than $100 per month. Yes, it does leave consumers with more cash, but not enough to make a mortgage payment.
Saturday, October 25, 2008
Lower Oil Prices and Tax Cuts Will Boost the Economy
The financial crisis, economic turmoil, and the stock market sell-off have investors in the doldrums. One bright spot, however, is the recent plunge in oil prices. While this is a welcome development, it is not entirely unexpected. In recent years, easy monetary policy brought us the tech stock bubble, the housing bubble, and the commodities bubble.
High oil prices were largely the result of a weak dollar. They had less to do with strong demand or too little supply. Perhaps it took longer than it should have, but high oil prices finally caused the demand destruction we have been expecting. In reality, this destruction has been going on for months, but it become noticeable only recently. For example, the Department of Transportation just documented a decline of 15 billion fewer miles driven in August 2008 than in August 2007. But it's already late October. No doubt, demand has continued to fall during the last two months as well. Furthermore, as I explained more than a month ago in Forbes magazine, "with global economies slowing, the dollar strengthening and U.S. demand declining, even the threat of hurricanes can't keep oil's price up."
OPEC has long been saying there is plenty of supply. Now it is worried there is too much. Cooler heads at OPEC never wanted to see prices go as high as they did because they feared high prices would cause a global recession—something that is clearly bad for their business. Now they are just as worried that prices will plunge to levels not seen in years. This is why OPEC just announced a 1.5 million barrel per day production cut.
But just as OPEC was unable to keep prices from spiking, it is likely to find that it can't prevent prices from falling. Some OPEC nations with weak economies were already exceeding their quotas, trying to sell as much oil as they could at ridiculously high prices. On paper, these nations are entirely in favor of a production cut. However, in practice, they will find it much harder to stick to their promises.
Some economists fear that lower oil prices will cause Americans to return to their profligate ways—putting conservation aside and buying up SUVs and pick-up trucks once again. This won't happen. Every automobile company has invested millions—if not billions—retooling their factories to produce more fuel-efficient vehicles. No one is in favor of going back to old ways.
Lower oil prices and more efficient cars will leave consumers with more cash to spend on other things. This could do as much good as a meaningful tax cut, helping to revive the economy. Combine lower oil prices with a real tax cut and the economy is likely to boom. But if OPEC manages to push oil prices back up to recent highs, the U.S. and the entire world will have an extremely difficult time shaking off this recession.
High oil prices were largely the result of a weak dollar. They had less to do with strong demand or too little supply. Perhaps it took longer than it should have, but high oil prices finally caused the demand destruction we have been expecting. In reality, this destruction has been going on for months, but it become noticeable only recently. For example, the Department of Transportation just documented a decline of 15 billion fewer miles driven in August 2008 than in August 2007. But it's already late October. No doubt, demand has continued to fall during the last two months as well. Furthermore, as I explained more than a month ago in Forbes magazine, "with global economies slowing, the dollar strengthening and U.S. demand declining, even the threat of hurricanes can't keep oil's price up."
OPEC has long been saying there is plenty of supply. Now it is worried there is too much. Cooler heads at OPEC never wanted to see prices go as high as they did because they feared high prices would cause a global recession—something that is clearly bad for their business. Now they are just as worried that prices will plunge to levels not seen in years. This is why OPEC just announced a 1.5 million barrel per day production cut.
But just as OPEC was unable to keep prices from spiking, it is likely to find that it can't prevent prices from falling. Some OPEC nations with weak economies were already exceeding their quotas, trying to sell as much oil as they could at ridiculously high prices. On paper, these nations are entirely in favor of a production cut. However, in practice, they will find it much harder to stick to their promises.
Some economists fear that lower oil prices will cause Americans to return to their profligate ways—putting conservation aside and buying up SUVs and pick-up trucks once again. This won't happen. Every automobile company has invested millions—if not billions—retooling their factories to produce more fuel-efficient vehicles. No one is in favor of going back to old ways.
Lower oil prices and more efficient cars will leave consumers with more cash to spend on other things. This could do as much good as a meaningful tax cut, helping to revive the economy. Combine lower oil prices with a real tax cut and the economy is likely to boom. But if OPEC manages to push oil prices back up to recent highs, the U.S. and the entire world will have an extremely difficult time shaking off this recession.
Friday, October 24, 2008
Nouriel Roubini is a Star
I've been out of the office for several days. I spent a couple of enjoyable days in Blacksburg, VA, home of VA Tech University and one of my all-time favorite places. The view of the mountains as I flew into Roanoke airport was phenomenal. I went to Blackburg to give a talk about my book, Even Buffett Isn't Perfect. I was hoping to attract 100 people. About 300 showed up. In times like these, everyone is seeking Buffett's wisdom.
The Blue Ridge mountains provided much needed relief from these troubled markets. Readers of my blog know I had been bearish for quite some time. In fact, in June 2007, I even wrote a piece in Forbes magazine called Here Comes the Bear arguing that stocks were likely to sell off. Yet in all honesty, what we've seen has far exceeded my expectations. I never thought we would have this kind of selling.
One man who did is Nouriel Roubini. More than a year ago, when most economists were still very bullish on the economy, Roubini was calmly and clearly explaining why we were about to have a serious recession. When he warned about subprime mortgages and collapsing home prices and how this would cause systemic problems, he was often ridiculed. I'm sure his critics wish they could take back their words.
Roubini remains very bearish. In fact, he has been warning about widespread financial panic, arguing that fundamentals don't matter because everyone is selling. Take a look at his blog RGE Monitor. It is definitely worth a close read.
On Wednesday, Oct. 29, we are hosting the Forbes Family Business Forum. We were hoping to sign up Roubini as a speaker. Unfortunately, he wasn't available saying he had to teach class. No doubt his students at New York University appreciate his dedication.
Roubini may be right about his views. It is extremely difficult to predict when the economy, let alone the markets, will turn. I have long believed this mess would end when housing prices stabilized, which I still expect to happen by spring 2009. However, I'm now beginning to wonder if stable housing prices are enough. Despite my concerns, I have been buying stocks anyway. I know stock prices could go much lower in the short term, yet I am comfortable buying at these levels. I feel confident that the world will avoid a great depression and that the investments I make today will appreciate over time.
The Blue Ridge mountains provided much needed relief from these troubled markets. Readers of my blog know I had been bearish for quite some time. In fact, in June 2007, I even wrote a piece in Forbes magazine called Here Comes the Bear arguing that stocks were likely to sell off. Yet in all honesty, what we've seen has far exceeded my expectations. I never thought we would have this kind of selling.
One man who did is Nouriel Roubini. More than a year ago, when most economists were still very bullish on the economy, Roubini was calmly and clearly explaining why we were about to have a serious recession. When he warned about subprime mortgages and collapsing home prices and how this would cause systemic problems, he was often ridiculed. I'm sure his critics wish they could take back their words.
Roubini remains very bearish. In fact, he has been warning about widespread financial panic, arguing that fundamentals don't matter because everyone is selling. Take a look at his blog RGE Monitor. It is definitely worth a close read.
On Wednesday, Oct. 29, we are hosting the Forbes Family Business Forum. We were hoping to sign up Roubini as a speaker. Unfortunately, he wasn't available saying he had to teach class. No doubt his students at New York University appreciate his dedication.
Roubini may be right about his views. It is extremely difficult to predict when the economy, let alone the markets, will turn. I have long believed this mess would end when housing prices stabilized, which I still expect to happen by spring 2009. However, I'm now beginning to wonder if stable housing prices are enough. Despite my concerns, I have been buying stocks anyway. I know stock prices could go much lower in the short term, yet I am comfortable buying at these levels. I feel confident that the world will avoid a great depression and that the investments I make today will appreciate over time.
Wednesday, October 15, 2008
One Step Forward, Two Steps Back
Today's market action was extremely disappointing. On Monday, Oct. 13, the S&P 500 rallied 11.6%. That had many investors hoping the sell-off was finally over. Unfortunately, the market wasn't able to sustain Monday's gains. It gave up 0.5% yesterday. Today it plunged 9%.
Monday's rally and today's sell-off are indicative of the kind of volatility we've been experiencing lately. To measure volatility, market traders often focus on the VIX, which is hovering near all-time highs. A simpler way to measure volatility is to look at the daily percentage changes in a major index like the S&P 500. For example, during the first six months of 2008, there were 17 days on which the S&P 500 Index changed in value by more than 2%. The biggest change during that period occurred on March 18 when the S&P 500 rallied 4.24%.
Since then, however, volatility has skyrocketed. From July 1 to Oct. 15, there were 22 days when the change in the S&P 500 exceeded 2%. In the last month alone, the change in the Index exceeded 4% on 11 days.
Monday's almost 1,000 point rally in the Dow was nice, but it would have been better to see the Dow rally 100 points a day for 10 days. Investors have no confidence in stocks right now. They need to be convinced that rallies can be sustained.
While it is true that Even Buffett Isn't Perfect, he is clearly one of the greatest, and it is encouraging to see him putting money to work at this time. Buffett has complained for several years that he couldn't find anything worth buying. By pouring $8 billion into Goldman Sachs and General Electric, and making a couple of other key investments, he has obviously changed his tune.
Monday's rally and today's sell-off are indicative of the kind of volatility we've been experiencing lately. To measure volatility, market traders often focus on the VIX, which is hovering near all-time highs. A simpler way to measure volatility is to look at the daily percentage changes in a major index like the S&P 500. For example, during the first six months of 2008, there were 17 days on which the S&P 500 Index changed in value by more than 2%. The biggest change during that period occurred on March 18 when the S&P 500 rallied 4.24%.
Since then, however, volatility has skyrocketed. From July 1 to Oct. 15, there were 22 days when the change in the S&P 500 exceeded 2%. In the last month alone, the change in the Index exceeded 4% on 11 days.
Monday's almost 1,000 point rally in the Dow was nice, but it would have been better to see the Dow rally 100 points a day for 10 days. Investors have no confidence in stocks right now. They need to be convinced that rallies can be sustained.
While it is true that Even Buffett Isn't Perfect, he is clearly one of the greatest, and it is encouraging to see him putting money to work at this time. Buffett has complained for several years that he couldn't find anything worth buying. By pouring $8 billion into Goldman Sachs and General Electric, and making a couple of other key investments, he has obviously changed his tune.
Friday, October 10, 2008
The Smartest CEO
It is said that the stock market is a forecasting mechanism. Let's pray it is a bad one. Otherwise, we may be in for a deep depression. The sell-off we have been witnessing is simply unbelievable. Investors, especially institutional investors, are selling everything—the good, the bad, and they ugly.
In December 2007, when I still held a bearish view of the economy and stock market, a colleague and I met with the CEO of a small biotechnology company. The purpose of the meeting was to discuss his finances and a proper asset allocation. Because of my bearish outlook, I made what I thought was an extremely conservative recommendation, suggesting he keep much of his money in cash (i.e., short-term Treasuries, CDs, and municipals) for the time being and put only about 50% in stocks.
He thanked me for my advice, but said he had an even more bearish view. He said he was convinced that leverage was going to come back to haunt us. He said he was worried about counter-party risk and did not trust the investment banks. He said he was using some cash to buy gold coins and he was shorting as many financial stocks as he could-the investment banks in particular.
When we left his office, I was in shock. I was bearish myself and had spoken with a number of bearish investors, but I had never met anyone who was so full of doom and gloom. I knew this CEO was a smart man, but I hoped he was wrong. Unfortunately, he wasn't.
If he maintained his short positions, he is no doubt a very wealthy man today. For the sake of the economy and all long-term investors, let's hope the selling is finally done. At this point, it's hard to imagine stocks going any lower.
In December 2007, when I still held a bearish view of the economy and stock market, a colleague and I met with the CEO of a small biotechnology company. The purpose of the meeting was to discuss his finances and a proper asset allocation. Because of my bearish outlook, I made what I thought was an extremely conservative recommendation, suggesting he keep much of his money in cash (i.e., short-term Treasuries, CDs, and municipals) for the time being and put only about 50% in stocks.
He thanked me for my advice, but said he had an even more bearish view. He said he was convinced that leverage was going to come back to haunt us. He said he was worried about counter-party risk and did not trust the investment banks. He said he was using some cash to buy gold coins and he was shorting as many financial stocks as he could-the investment banks in particular.
When we left his office, I was in shock. I was bearish myself and had spoken with a number of bearish investors, but I had never met anyone who was so full of doom and gloom. I knew this CEO was a smart man, but I hoped he was wrong. Unfortunately, he wasn't.
If he maintained his short positions, he is no doubt a very wealthy man today. For the sake of the economy and all long-term investors, let's hope the selling is finally done. At this point, it's hard to imagine stocks going any lower.
Thursday, October 02, 2008
A $700 Billion Investment, Not Bailout
The following commentary is from the October issue of the Forbes Growth Investor.
The biggest stock market sell-off occurred on October 17, 1987. The Dow Jones Industrial Average plunged 508 points or 22.6% on what has come to be known as Black Monday. Yet, on average, stocks have shown a tendency to do worse in September than in any other month and what happened this past September was nothing less than ugly. Despite a strong rally on the last day, all major market indexes took a nosedive.
September’s sell-off came in reaction to the expanding economic crisis, which has seen one major financial institution after another either go out of business or get gobbled up at fire-sale prices. Lehman Brothers, for example, filed for bankruptcy protection. One of the oldest investment banks on Wall Street was selling for $85 per share less than two years ago, but could find no buyers in its time of need. The remaining investment banks on Wall Street, Goldman Sachs and Morgan Stanley, have since decided to move to Bank Street.
While investment and commercial banks went under, our elected officials twiddled their thumbs. Eventually, they raised investors’ hopes by finally agreeing to vote on Secretary Hank Paulson’s unpopular $700 billion rescue package. Then they quickly dashed those hopes by voting it down. Ironically, more Democrats than Republicans voted in favor of the bill, which was being pushed by the Bush administration. It remains to be seen if Republicans will pay a political price for refusing to go along. No doubt their constituents are extremely angry about the so-called bailout, yet they will be even angrier when they lose their jobs and watch their retirement savings shrink.
Those who voted against the bill say they are protecting taxpayers. How much truth is there to this statement? After all, one-third of Americans do not pay any federal income tax at all. The bulk of the taxes are actually paid by a rather small portion of the population. Most of the ones I know are in favor of the bill. Are the politicians listening to what real taxpayers have to say?
Furthermore, it is completely wrong to assume that the rescue plan will cost the quoted $700 billion. In fact, the government stands to make money on the deal. Because of mark-to-market accounting rules, financial institutions must pretend there is little if any value to these “toxic” securities. Yet once housing prices stabilize, a market for these securities will reemerge. The government is in an enviable position. It can borrow money at low Treasury rates and use that cheap money to purchase securities it will later sell—perhaps at higher prices. Even if it ends up losing money on the deal, those losses will be nowhere near $700 billion.
Warren Buffett, widely acknowledged as the world’s greatest investor, thinks Mr. Paulson’s rescue plan is a good idea. Buffett decided to take advantage of the current financial turmoil by purchasing $5 billion worth of Goldman Sachs preferred stock. He also got warrants to buy $5 billion of common stock at $115 per share. He cut a similar deal with General Electric. This kind of private investment in public equity (PIPE) is Buffett’s modus operandi. He said his decisions to invest in Goldman and GE were predicated on the assumption that the government would approve the rescue package.
There is still hope that government officials will overcome political gridlock and get their act together by week’s end. Expect a big rally once they do—or at least a smaller sell-off than we would otherwise see.
The biggest stock market sell-off occurred on October 17, 1987. The Dow Jones Industrial Average plunged 508 points or 22.6% on what has come to be known as Black Monday. Yet, on average, stocks have shown a tendency to do worse in September than in any other month and what happened this past September was nothing less than ugly. Despite a strong rally on the last day, all major market indexes took a nosedive.
September’s sell-off came in reaction to the expanding economic crisis, which has seen one major financial institution after another either go out of business or get gobbled up at fire-sale prices. Lehman Brothers, for example, filed for bankruptcy protection. One of the oldest investment banks on Wall Street was selling for $85 per share less than two years ago, but could find no buyers in its time of need. The remaining investment banks on Wall Street, Goldman Sachs and Morgan Stanley, have since decided to move to Bank Street.
While investment and commercial banks went under, our elected officials twiddled their thumbs. Eventually, they raised investors’ hopes by finally agreeing to vote on Secretary Hank Paulson’s unpopular $700 billion rescue package. Then they quickly dashed those hopes by voting it down. Ironically, more Democrats than Republicans voted in favor of the bill, which was being pushed by the Bush administration. It remains to be seen if Republicans will pay a political price for refusing to go along. No doubt their constituents are extremely angry about the so-called bailout, yet they will be even angrier when they lose their jobs and watch their retirement savings shrink.
Those who voted against the bill say they are protecting taxpayers. How much truth is there to this statement? After all, one-third of Americans do not pay any federal income tax at all. The bulk of the taxes are actually paid by a rather small portion of the population. Most of the ones I know are in favor of the bill. Are the politicians listening to what real taxpayers have to say?
Furthermore, it is completely wrong to assume that the rescue plan will cost the quoted $700 billion. In fact, the government stands to make money on the deal. Because of mark-to-market accounting rules, financial institutions must pretend there is little if any value to these “toxic” securities. Yet once housing prices stabilize, a market for these securities will reemerge. The government is in an enviable position. It can borrow money at low Treasury rates and use that cheap money to purchase securities it will later sell—perhaps at higher prices. Even if it ends up losing money on the deal, those losses will be nowhere near $700 billion.
Warren Buffett, widely acknowledged as the world’s greatest investor, thinks Mr. Paulson’s rescue plan is a good idea. Buffett decided to take advantage of the current financial turmoil by purchasing $5 billion worth of Goldman Sachs preferred stock. He also got warrants to buy $5 billion of common stock at $115 per share. He cut a similar deal with General Electric. This kind of private investment in public equity (PIPE) is Buffett’s modus operandi. He said his decisions to invest in Goldman and GE were predicated on the assumption that the government would approve the rescue package.
There is still hope that government officials will overcome political gridlock and get their act together by week’s end. Expect a big rally once they do—or at least a smaller sell-off than we would otherwise see.
Monday, September 29, 2008
Blame the Feds, Not Wall Street
Given the unprecedented financial crisis and the government's proposed $700 billion so-called bailout, I have to say I am a little sick of hearing how greedy Wall Street bankers are to blame for getting us into this mess. I agree some of them do bear some responsibility. I also agree that many CEOs are grossly overpaid. (So are many professional athletes for that matter.) Yet the fact is that the government bears at least some of the blame for the current crisis.
Many years ago (circa 1993), I listened to a lecture delivered by a then prominent Federal Reserve governor. He argued that banks had to be pressured to lend money to those who were otherwise not creditworthy. The government in its wisdom had decided that home ownership was a good thing and wanted to see more of it. It is often argued that neighborhoods are safer, cleaner, and better kept when a large number of people own (rather than rent) the homes in which they live. The government wanted to promote home ownership so it pressured lenders to make mortgages available to those who did not qualify under traditional standards.
The New York Times (not known for espousing a conservative point of view) published a prescient article in 1999 (that's before George W. took office) exposing all this. Steven Holmes wrote, "Fannie Mae...has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people..." The article then went on to predict the current crisis. It warned, "In moving, even tentatively, into this new area of lending, Fannie Mas is taking on significantly more risk, wihch may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980s."
I thank Cesar Chekijian for bringing this article to my attention. Click below to read the article's full content.
Fannie Mae Eases Credit To Aid Mortgage Lending
Many years ago (circa 1993), I listened to a lecture delivered by a then prominent Federal Reserve governor. He argued that banks had to be pressured to lend money to those who were otherwise not creditworthy. The government in its wisdom had decided that home ownership was a good thing and wanted to see more of it. It is often argued that neighborhoods are safer, cleaner, and better kept when a large number of people own (rather than rent) the homes in which they live. The government wanted to promote home ownership so it pressured lenders to make mortgages available to those who did not qualify under traditional standards.
The New York Times (not known for espousing a conservative point of view) published a prescient article in 1999 (that's before George W. took office) exposing all this. Steven Holmes wrote, "Fannie Mae...has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people..." The article then went on to predict the current crisis. It warned, "In moving, even tentatively, into this new area of lending, Fannie Mas is taking on significantly more risk, wihch may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980s."
I thank Cesar Chekijian for bringing this article to my attention. Click below to read the article's full content.
Fannie Mae Eases Credit To Aid Mortgage Lending
Monday, September 15, 2008
The Perils of Long-Term Investing
The following commentary is extracted from a special report sent to subscribers of the Forbes Special Situation Survey.
Lehman Brothers was selling for more than $85 per share in early 2007. American International Group (AIG) was around $70. Both companies were thought to be among the bluest of the blue chips. So much so, that Dow Jones even added AIG to its prestigious Industrial Average in April 2004. Yet over the course of just a few short months, both Lehman and AIG have been decimated. Lehman is now a penny stock seeking bankruptcy protection. AIG is scrambling to stay alive.
Yet Lehman and AIG are not the only “great” long-term investments that have since collapsed. For years, General Motors, Ford, Fannie Mae, and Freddie Mac were included in almost all long-term oriented portfolios. Fannie Mae, for example, generated a 25% annualized return for the 20 years ending in 2000—and that does not include dividends. Unfortunately, those who bought the stock back then and are still holding it, are now sitting on a loss. As impossible as it is to believe, Fannie Mae is worth less today than it was even 30 years ago!
Warren Buffett is clearly one of the greatest investors of all time. He is famous for avoiding risk and for having a long-term buy-and-hold orientation. Like Buffett, many investment professionals are also convinced that buy-and-hold is the best way to go. Yet recent events should make all investors question this advice. Buying, after all, is just half the story. Successful investing also requires selling. And despite his reputation, even Buffett engages in short-term trades from time to time. PetroChina and Pier 1 Imports provide just two recent examples.
There is no doubt that a buy-and-hold approach can be profitable. After all, those who buy and rarely sell minimize trading costs. They also minimize taxes because, if they do not sell, they do not realize their gains. However, I have seen too many investors get burned by holding onto a stock too long simply because they wanted to avoid paying taxes. Recent events should convince even the most diehard buy-and-holders that sometimes there is fate worse than taxes. (But, of course, not worse than death.)
It is extremely important to keep an eye on intrinsic value. If a stock is no longer undervalued, it makes little sense to keep holding it. In hindsight, I have gotten out of many positions much too soon. However, I would rather move on to a stock I believe is undervalued than take the risk of holding on to one that is becoming overvalued.
Lehman Brothers was selling for more than $85 per share in early 2007. American International Group (AIG) was around $70. Both companies were thought to be among the bluest of the blue chips. So much so, that Dow Jones even added AIG to its prestigious Industrial Average in April 2004. Yet over the course of just a few short months, both Lehman and AIG have been decimated. Lehman is now a penny stock seeking bankruptcy protection. AIG is scrambling to stay alive.
Yet Lehman and AIG are not the only “great” long-term investments that have since collapsed. For years, General Motors, Ford, Fannie Mae, and Freddie Mac were included in almost all long-term oriented portfolios. Fannie Mae, for example, generated a 25% annualized return for the 20 years ending in 2000—and that does not include dividends. Unfortunately, those who bought the stock back then and are still holding it, are now sitting on a loss. As impossible as it is to believe, Fannie Mae is worth less today than it was even 30 years ago!
Warren Buffett is clearly one of the greatest investors of all time. He is famous for avoiding risk and for having a long-term buy-and-hold orientation. Like Buffett, many investment professionals are also convinced that buy-and-hold is the best way to go. Yet recent events should make all investors question this advice. Buying, after all, is just half the story. Successful investing also requires selling. And despite his reputation, even Buffett engages in short-term trades from time to time. PetroChina and Pier 1 Imports provide just two recent examples.
There is no doubt that a buy-and-hold approach can be profitable. After all, those who buy and rarely sell minimize trading costs. They also minimize taxes because, if they do not sell, they do not realize their gains. However, I have seen too many investors get burned by holding onto a stock too long simply because they wanted to avoid paying taxes. Recent events should convince even the most diehard buy-and-holders that sometimes there is fate worse than taxes. (But, of course, not worse than death.)
It is extremely important to keep an eye on intrinsic value. If a stock is no longer undervalued, it makes little sense to keep holding it. In hindsight, I have gotten out of many positions much too soon. However, I would rather move on to a stock I believe is undervalued than take the risk of holding on to one that is becoming overvalued.
Tuesday, September 09, 2008
Whether Or Not the Facts Change
While preparing for an MSNBC interview recently about the presidential candidates' energy plans, I was struck by how similar they are. They are both in favor of reducing carbon emissions, they both want more wind and solar power, they both favor clean coal technologies, they both like cap-and-trade systems to reduce greenhouse gases, and they both want to see more nuclear power. Of course, they differ on degree and implementation on some of these issues. John McCain would rely on market forces and incentives. Barack Obama prefers more government mandates.
Until very recently, one critical difference was where they stood on offshore drilling. Obama was opposed to it. McCain is in favor. Obama stressed that oil companies already hold leases to 68 million acres of land and 40 million acres offshore. He said he would force them to drill in these areas or lose their rights to do so. However, McCain thinks it is better to let oil companies drill where the oil actually is. He has called for lifting federal restrictions on drilling in the Outer Continental Shelf.
But now Obama has changed his tune. Last weekend, he indicated a willingness to compromise on offshore drilling. Some have criticized him for changing his mind. I applaud him. Obama is moving from idealism to reality on this and other key issues. Even the Wall Street Journal applauded Obama this morning for backpedaling on his threatened tax increases. Apparently his advisors have told him that tax increases (even if they are intended to hit only the rich) can indeed slow the economy. That's not a particularly good idea when unemployment is rising and recession is a real possibility.
John Maynard Keynes once said, "When the facts change, I change my mind." Facts haven't changed, but it is encouraging to see that Senator Obama shows a willingness to change his mind as he becomes more familiar with the facts.
Until very recently, one critical difference was where they stood on offshore drilling. Obama was opposed to it. McCain is in favor. Obama stressed that oil companies already hold leases to 68 million acres of land and 40 million acres offshore. He said he would force them to drill in these areas or lose their rights to do so. However, McCain thinks it is better to let oil companies drill where the oil actually is. He has called for lifting federal restrictions on drilling in the Outer Continental Shelf.
But now Obama has changed his tune. Last weekend, he indicated a willingness to compromise on offshore drilling. Some have criticized him for changing his mind. I applaud him. Obama is moving from idealism to reality on this and other key issues. Even the Wall Street Journal applauded Obama this morning for backpedaling on his threatened tax increases. Apparently his advisors have told him that tax increases (even if they are intended to hit only the rich) can indeed slow the economy. That's not a particularly good idea when unemployment is rising and recession is a real possibility.
John Maynard Keynes once said, "When the facts change, I change my mind." Facts haven't changed, but it is encouraging to see that Senator Obama shows a willingness to change his mind as he becomes more familiar with the facts.
Wednesday, September 03, 2008
McCain or Obama: Who is Better for Taxes?
The following commentary is from the Sept. issue of the Forbes Growth Investor:
The stock market was open for trading last month, but as a former track & field athlete, I have to admit that the Olympics monopolized my attention. Usain Bolt was magnificent, as was the entire contingent of Jamaican sprinters. With a population of just 2.8 million, this small island country managed to win 11 medals on the track—six of them gold.
During the commercials, however, I did notice that stocks were rallying. In fact, the S&P 500 gained 1.22% in August. This is better than it did every month so far this year except for April. At least some of August’s rally was due to the 3.3% preliminary GDP figure for the second quarter, which was announced on August 28. This number was much better than expected and significantly better than the 1.9% advance figure reported a month earlier. Because the preliminary figure is based on more complete data, investors can have more confidence in it. Although overall growth was certainly robust, it came primarily from importing fewer goods and services and exporting more. It turns out the weak dollar is having a much bigger impact on international trade than almost anyone expected. I hope Barack Obama is listening.
Personal consumption expenditures were also very strong in the second quarter. Unfortunately, this is not likely to be repeated during the third quarter because the tax rebate checks have been fully disbursed. Some economists are already calling for another stimulus package. You can put me in that camp. However, tax rebates won’t do the trick. Their impact is just temporary. Tax cuts are the way to go if you really want to boost the economy in a long-lasting manner.
Speaking of taxes, here is something to ponder. Is it possible that taxes could actually go higher in a McCain administration than in an Obama one? That certainly does not sound logical. After all, Obama has been threatening to raise taxes while McCain has been calling for tax cuts. Yet a Congress controlled by Democrats is not likely to help a president McCain reduce taxes. Instead, under McCain, Congress could very well let the Bush tax cuts expire, in effect, giving us a significant tax increase. However, with Obama in the White House, Congress will almost certainly deliver a package of tax hikes. Yet this option could be less onerous than an outright expiration of the Bush tax cuts. “You’re next stop: The Twilight Zone!”
Stocks also may have responded to the latest S&P/Case-Shiller figures on housing prices. As I discussed in last month’s issue, a bottoming out process is underway. Housing prices are still falling at an accelerating rate, but the rate of acceleration is beginning to stabilize. Because the Case-Shiller figures are delayed by almost two months, we could actually learn in October that August was not so bad. Furthermore, we have already seen an uptick in mortgage applications. Yet despite marginally better news in the housing market, Fannie Mae and Freddie Mac continue to get crushed. There is even talk that these mortgage giants will be restructured and equity investors will be wiped out completely. However, if these government sponsored entities survive, those who have the guts to buy now could eventually find themselves sitting on huge gains. While this is a distinct possibility, it is a much better bet that an American relay team will drop the baton in the next major track meet.
The stock market was open for trading last month, but as a former track & field athlete, I have to admit that the Olympics monopolized my attention. Usain Bolt was magnificent, as was the entire contingent of Jamaican sprinters. With a population of just 2.8 million, this small island country managed to win 11 medals on the track—six of them gold.
During the commercials, however, I did notice that stocks were rallying. In fact, the S&P 500 gained 1.22% in August. This is better than it did every month so far this year except for April. At least some of August’s rally was due to the 3.3% preliminary GDP figure for the second quarter, which was announced on August 28. This number was much better than expected and significantly better than the 1.9% advance figure reported a month earlier. Because the preliminary figure is based on more complete data, investors can have more confidence in it. Although overall growth was certainly robust, it came primarily from importing fewer goods and services and exporting more. It turns out the weak dollar is having a much bigger impact on international trade than almost anyone expected. I hope Barack Obama is listening.
Personal consumption expenditures were also very strong in the second quarter. Unfortunately, this is not likely to be repeated during the third quarter because the tax rebate checks have been fully disbursed. Some economists are already calling for another stimulus package. You can put me in that camp. However, tax rebates won’t do the trick. Their impact is just temporary. Tax cuts are the way to go if you really want to boost the economy in a long-lasting manner.
Speaking of taxes, here is something to ponder. Is it possible that taxes could actually go higher in a McCain administration than in an Obama one? That certainly does not sound logical. After all, Obama has been threatening to raise taxes while McCain has been calling for tax cuts. Yet a Congress controlled by Democrats is not likely to help a president McCain reduce taxes. Instead, under McCain, Congress could very well let the Bush tax cuts expire, in effect, giving us a significant tax increase. However, with Obama in the White House, Congress will almost certainly deliver a package of tax hikes. Yet this option could be less onerous than an outright expiration of the Bush tax cuts. “You’re next stop: The Twilight Zone!”
Stocks also may have responded to the latest S&P/Case-Shiller figures on housing prices. As I discussed in last month’s issue, a bottoming out process is underway. Housing prices are still falling at an accelerating rate, but the rate of acceleration is beginning to stabilize. Because the Case-Shiller figures are delayed by almost two months, we could actually learn in October that August was not so bad. Furthermore, we have already seen an uptick in mortgage applications. Yet despite marginally better news in the housing market, Fannie Mae and Freddie Mac continue to get crushed. There is even talk that these mortgage giants will be restructured and equity investors will be wiped out completely. However, if these government sponsored entities survive, those who have the guts to buy now could eventually find themselves sitting on huge gains. While this is a distinct possibility, it is a much better bet that an American relay team will drop the baton in the next major track meet.
Wednesday, August 27, 2008
The Worst May Soon Be Over
The latest (June) S&P/Case-Shiller figures provide a little (and I emphasize little) comfort that housing prices are bottoming out. With year-over-year prices down a record 15.92% on average in 20 major markets, that may sound like an odd thing to say. But that decline is only a little worse than the previous month's figure. In fact, if you look at the rate of change of the rate of change of the rate of change (what a mathematician would call the third derivative), things have been improving since February.
By no means does this imply that price drops are a thing of the past. On the contrary, housing prices will likely keep falling for another 12-18 months. However, the evidence suggests that the rate of decrease is about to slow. In fact, there is a good chance that the year-over-year decline in prices for July (to be reported at the end of September) will be less than it was for June.
Because almost all of the problems in the financial sector have been related to falling real estate prices, a stabilization of prices is critical for the health of our financial institutions. And because real estate prices will keep falling on an absolute basis for many more months, banks will continue writing down assets. Yet it is encouraging to see that the worst may soon be over for both the housing and finance industries.
By no means does this imply that price drops are a thing of the past. On the contrary, housing prices will likely keep falling for another 12-18 months. However, the evidence suggests that the rate of decrease is about to slow. In fact, there is a good chance that the year-over-year decline in prices for July (to be reported at the end of September) will be less than it was for June.
Because almost all of the problems in the financial sector have been related to falling real estate prices, a stabilization of prices is critical for the health of our financial institutions. And because real estate prices will keep falling on an absolute basis for many more months, banks will continue writing down assets. Yet it is encouraging to see that the worst may soon be over for both the housing and finance industries.
Tuesday, July 29, 2008
Added VLO to FGI and SSS
In my June 2 posting, "Avoiding Oil Related Stocks", I said I was in the bubble camp when it came to oil prices. This is why we had no energy stocks in the Forbes Growth Investor and only one in the Special Situation Survey.
Now that oil prices are starting to ease, we decided it was a good time to add an energy stock to both newsletters. That may seem a bit nonsensical, but the stock we added is a refiner. High oil prices have squeezed margins at refiners. With oil prices falling, margins should expand once again. As a result, we decided to add Valero Energy (VLO) to both newsletters. In fact, in today's earnings release, Valero said gasoline margins (aka the crack spread) fell to $6.60 per barrel in the second quarter of 2008. They were at $28.95 per barrel a year ago. This explains why the stock price has been cut by more than half during the same time.
Of course, the crack spread won't expand if gasoline prices fall as rapidly as oil prices. While we certainly expect gasoline prices to ease, we think they will hold up better than oil because they didn't climb as much as oil to begin with.
While we expect VLO's profit margins to improve, we think the bigger risk over the near term has to do with volumes. Gasoline demand is falling sharply as drivers respond to high prices by cutting back, car pooling, and switching to more efficient vehicles. That's a risk we are willing to take. Low price multiples and a recent dividend increase make this stock extremely attractive.
Now that oil prices are starting to ease, we decided it was a good time to add an energy stock to both newsletters. That may seem a bit nonsensical, but the stock we added is a refiner. High oil prices have squeezed margins at refiners. With oil prices falling, margins should expand once again. As a result, we decided to add Valero Energy (VLO) to both newsletters. In fact, in today's earnings release, Valero said gasoline margins (aka the crack spread) fell to $6.60 per barrel in the second quarter of 2008. They were at $28.95 per barrel a year ago. This explains why the stock price has been cut by more than half during the same time.
Of course, the crack spread won't expand if gasoline prices fall as rapidly as oil prices. While we certainly expect gasoline prices to ease, we think they will hold up better than oil because they didn't climb as much as oil to begin with.
While we expect VLO's profit margins to improve, we think the bigger risk over the near term has to do with volumes. Gasoline demand is falling sharply as drivers respond to high prices by cutting back, car pooling, and switching to more efficient vehicles. That's a risk we are willing to take. Low price multiples and a recent dividend increase make this stock extremely attractive.
Saturday, July 19, 2008
Supervalu Gets Clobbered
Shares of Supervalu (SVU) took a big hit last week. This is a stock on our recommended list in the Forbes Special Situation Survey. It is also a stock I own personally. The sell-off had nothing to do with any specific news related to the company. Instead, investors sold the stock in reaction to disappointing results from Safeway (SWY) and the Great Atlantic & Pacific Tea Co. (GAP). Safeway beat earnings by a penny, but missed its revenue target. A&P missed earnings by seven cents per share. On the other hand, Kroger (KR) reported strong results a month ago and the stock rallied in response.
Tight economic times are taking a toll on supermarkets. Food price inflation is prompting shoppers to seek out bargains. They are trading down from name brands to store brands. This may depress revenues, but it should also boost earnings since store brands are more profitable. However, revenues are getting a bit of a boost from consumers who are trying to save money by preparing meals at home instead of eating out in restaurants as often.
Our view is that Supervalu has been unfairly punished for Safeway's and A&P's shortfalls. The stock was already undervalued even before the sell-off. Supervalu will announce fiscal first quarter results on Tuesday, July 22. Those who want to play it safe should wait until then. Those who prefer to take some risk, should buy on Monday.
Tight economic times are taking a toll on supermarkets. Food price inflation is prompting shoppers to seek out bargains. They are trading down from name brands to store brands. This may depress revenues, but it should also boost earnings since store brands are more profitable. However, revenues are getting a bit of a boost from consumers who are trying to save money by preparing meals at home instead of eating out in restaurants as often.
Our view is that Supervalu has been unfairly punished for Safeway's and A&P's shortfalls. The stock was already undervalued even before the sell-off. Supervalu will announce fiscal first quarter results on Tuesday, July 22. Those who want to play it safe should wait until then. Those who prefer to take some risk, should buy on Monday.
Sunday, July 06, 2008
Housing Market is Still Struggling, But Positive Signs Are Beginning to Emerge
With rising energy prices, falling nonfarm payrolls, a plunge in consumer confidence, and a host of other negative indicators, economists have plenty to worry about. Their biggest concern, however, continues to be the housing market. Yet there is finally a little hope that the worst may be over.
According to the S&P/Case-Shiller indices, housing prices are still falling. Furthermore, they are still falling at an accelerating rate. This is the bad news. However, for the second month in a row, the rate of acceleration has declined. While this is not a reason to start celebrating yet, it is a necessary sign before the crisis finally ends. And because there is a two-month delay in the numbers, things may actually be a little better than the available data suggest. Right now, economists are studying April's numbers. The figures for May won't come out until the end of July.
Another encouraging sign is the recent week-over-week increase in mortgage applications for both refinancings and home purchases. While total applications were down almost 23% from a year ago, applications for home purchases were up 2.8% from the prior week.
Some parts of the country are also seeing interest from foreign investors who are backed with stronger currencies; and vulture investors are getting interested in purchasing condos in bulk in places like Miami. The Fed is hoping for more such signs that the worst for housing is over. Because inflation is becoming a concern, the Fed is itching to start raising interest rates. It will not do so, however, until it is believes the housing debacle is nearing an end.
According to the S&P/Case-Shiller indices, housing prices are still falling. Furthermore, they are still falling at an accelerating rate. This is the bad news. However, for the second month in a row, the rate of acceleration has declined. While this is not a reason to start celebrating yet, it is a necessary sign before the crisis finally ends. And because there is a two-month delay in the numbers, things may actually be a little better than the available data suggest. Right now, economists are studying April's numbers. The figures for May won't come out until the end of July.
Another encouraging sign is the recent week-over-week increase in mortgage applications for both refinancings and home purchases. While total applications were down almost 23% from a year ago, applications for home purchases were up 2.8% from the prior week.
Some parts of the country are also seeing interest from foreign investors who are backed with stronger currencies; and vulture investors are getting interested in purchasing condos in bulk in places like Miami. The Fed is hoping for more such signs that the worst for housing is over. Because inflation is becoming a concern, the Fed is itching to start raising interest rates. It will not do so, however, until it is believes the housing debacle is nearing an end.
Saturday, July 05, 2008
Discussion of Economy on CNBC
There is tremendous debate these days about oil prices. Some say given tight supplies and strong demand, $140 per barrel is fully justified. Others say there is a bubble in the oil markets. I am in the bubble camp.
I don't question that supply is tight and demand is strong. I also agree that there is much less slack than there used to be. Nonetheless, the intraday volatility tells me there is much more going on than simple supply and demand considerations. Federal Reserve policy must take some of the blame for rocketing oil prices. The Fed's policies have significantly weakened the dollar, causing investors to seek ways to hedge the Fed's actions. Oil is suddenly viewed as an investable asset. This is true for a number of other commodities as well. I recently argued in the Forbes Growth Investor that the stock market will not rally until the Fed and Treasury Department get serious about defending the dollar. I discussed this and other matters in a July 3 interview on CNBC with Peter Klein of Fifth Third Asset Management and John Ryding of RDQ Ecnomics (formerly of Bear Stearns). The segment was hosted by Michelle Caruso-Cabrera of CNBC. Steve Liesman of CNBC also took part.
I don't question that supply is tight and demand is strong. I also agree that there is much less slack than there used to be. Nonetheless, the intraday volatility tells me there is much more going on than simple supply and demand considerations. Federal Reserve policy must take some of the blame for rocketing oil prices. The Fed's policies have significantly weakened the dollar, causing investors to seek ways to hedge the Fed's actions. Oil is suddenly viewed as an investable asset. This is true for a number of other commodities as well. I recently argued in the Forbes Growth Investor that the stock market will not rally until the Fed and Treasury Department get serious about defending the dollar. I discussed this and other matters in a July 3 interview on CNBC with Peter Klein of Fifth Third Asset Management and John Ryding of RDQ Ecnomics (formerly of Bear Stearns). The segment was hosted by Michelle Caruso-Cabrera of CNBC. Steve Liesman of CNBC also took part.
Wednesday, July 02, 2008
Tempting Warren Buffett
I did an interview this afternoon with WBBM News Radio 780 in Chicago. The hosts, Kris Kridel and Sherman Kaplan, wanted to discuss Berkshire Hathaway. The stock is down about 15% year to date—not the kind of performance one would ordinarily expect from a company run by Warren Buffett.
Berkshire, of course, if heavily invested in the insurance business. Although it owns more than 70 subsidiary companies, many of the non-insurance companies, such as Fruit of the Loom and Jordan’s Furniture, are rather small. Most are dwarfed by the likes of GEICO and General Re.
Buffett warned at this year’s shareholders’ meeting that the insurance business would be quite difficult this year. Berkshire just can’t command the kinds of premiums it did in the recent past. Buffett also warned that Berkshire stock will not generate the kinds of returns it did in the past.
Berkshire also owns more than 40 publicly-traded stocks, but just four stocks account for more than half the value of this portfolio. This group, referred to as the Big Four, consists of Coca-Cola, American Express, Wells Fargo, and Procter & Gamble. Each of these stocks is down more than 15% year to date.
Given Berkshire’s heavy exposure to the finance industry, it is rather impressive that the stock is down only 15%. Compared to the likes of AIG, Citigroup, and the investment banks, Berkshire is doing quite well.
Buffett is sitting on a boatload of cash. Many observers have been wondering when he will put some of that money to work. We know he likes to buy when others are selling. Given, the extent of the sell-offs witnessed lately, perhaps Buffett is getting at least a little tempted. But is he willing to invest in the financial stocks that have gotten killed? With Citigroup, Fannie Mae, Freddie Mac, AIG, Lehman Brothers, Merrill Lynch, and a host of others, there is a lot to choose from. Unless Buffett is completely bearish on the future of America, chances are he is thinking hard about buying one of these companies.
Berkshire, of course, if heavily invested in the insurance business. Although it owns more than 70 subsidiary companies, many of the non-insurance companies, such as Fruit of the Loom and Jordan’s Furniture, are rather small. Most are dwarfed by the likes of GEICO and General Re.
Buffett warned at this year’s shareholders’ meeting that the insurance business would be quite difficult this year. Berkshire just can’t command the kinds of premiums it did in the recent past. Buffett also warned that Berkshire stock will not generate the kinds of returns it did in the past.
Berkshire also owns more than 40 publicly-traded stocks, but just four stocks account for more than half the value of this portfolio. This group, referred to as the Big Four, consists of Coca-Cola, American Express, Wells Fargo, and Procter & Gamble. Each of these stocks is down more than 15% year to date.
Given Berkshire’s heavy exposure to the finance industry, it is rather impressive that the stock is down only 15%. Compared to the likes of AIG, Citigroup, and the investment banks, Berkshire is doing quite well.
Buffett is sitting on a boatload of cash. Many observers have been wondering when he will put some of that money to work. We know he likes to buy when others are selling. Given, the extent of the sell-offs witnessed lately, perhaps Buffett is getting at least a little tempted. But is he willing to invest in the financial stocks that have gotten killed? With Citigroup, Fannie Mae, Freddie Mac, AIG, Lehman Brothers, Merrill Lynch, and a host of others, there is a lot to choose from. Unless Buffett is completely bearish on the future of America, chances are he is thinking hard about buying one of these companies.
Wednesday, June 25, 2008
Inflation Ahead
According to the Hulbert Financial Digest, which tracks the performance of almost 200 investment newsletters, the Forbes Special Situation Survey is the best-performing letter year to date. Hulbert has us up 28.1% through the end of May.
Obviously, we are extremely pleased with this result. However, stocks have weakened considerably in June. Indeed, one of our holdings, Coventry Health Care (CVH), took a big hit last week when management warned that earnings would fall well short of expectations. Yet CVH will report strong revenue growth for the year, and 2008 earnings will likely exceed $3.50 per share. With a forward multiple of just nine times earnings, the stock is extremely attractive. Assuming management does not unload any more surprises, CVH should stage a bit of a rebound in the near term
Of course, macroeconomic factors continue to cast a pall over the entire market. Consumer confidence fell to a 16-year low and housing prices are still falling at an accelerating rate. It is at least a little encouraging, however, to see that the rate of change of the rate of change in housing prices is finally slowing down. Nonetheless, housing prices will probably keep falling on an absolute basis throughout 2008 and possibly into 2009.
Energy prices are another major concern. The extremely high price of gasoline is one major reason why shares of General Motors have plummeted to levels not seen in three decades. But crude oil prices are not just high; they are also remarkably volatile. Intra-day swings of 2% or more now occur on a regular basis.
As for the Fed, its most recent statement mentioned rising inflationary expectations and an uncertain outlook. The FOMC chose to hold interest rates steady at 2%, but it now has a clear upward bias. One member, Richard Fisher, voted against the decision to keep rates steady. He believes the time has come to start increasing interest rates. This comes as no surprise to Fed watchers since Mr. Fisher has dissented on every decision since being appointed to the FOMC in January. He may be a party pooper, but it looks as if he is also the only FOMC member who is ahead of the curve.
Obviously, we are extremely pleased with this result. However, stocks have weakened considerably in June. Indeed, one of our holdings, Coventry Health Care (CVH), took a big hit last week when management warned that earnings would fall well short of expectations. Yet CVH will report strong revenue growth for the year, and 2008 earnings will likely exceed $3.50 per share. With a forward multiple of just nine times earnings, the stock is extremely attractive. Assuming management does not unload any more surprises, CVH should stage a bit of a rebound in the near term
Of course, macroeconomic factors continue to cast a pall over the entire market. Consumer confidence fell to a 16-year low and housing prices are still falling at an accelerating rate. It is at least a little encouraging, however, to see that the rate of change of the rate of change in housing prices is finally slowing down. Nonetheless, housing prices will probably keep falling on an absolute basis throughout 2008 and possibly into 2009.
Energy prices are another major concern. The extremely high price of gasoline is one major reason why shares of General Motors have plummeted to levels not seen in three decades. But crude oil prices are not just high; they are also remarkably volatile. Intra-day swings of 2% or more now occur on a regular basis.
As for the Fed, its most recent statement mentioned rising inflationary expectations and an uncertain outlook. The FOMC chose to hold interest rates steady at 2%, but it now has a clear upward bias. One member, Richard Fisher, voted against the decision to keep rates steady. He believes the time has come to start increasing interest rates. This comes as no surprise to Fed watchers since Mr. Fisher has dissented on every decision since being appointed to the FOMC in January. He may be a party pooper, but it looks as if he is also the only FOMC member who is ahead of the curve.
Thursday, June 19, 2008
Making the Rounds in Boston
I have been in Boston the past few days. No, I did not come here to root for the Celtics. I came to give a couple of talks about my book and to attend a Forbes conference.
On Wednesday morning I spoke at the UMass Club in downtown Boston, which boasts a wonderful view. On Wednesday evening, I spoke at the Armenian Library and Museum of America in Watertown. I ran into several old friends at both venues.
On Thursday afternoon I tried to drive into the City to attend the Forbes Leadership Networks Forum. Unfortunately, I got caught up in the Celtics parade. Although the parade was officially over, the police still had not opened several key streets and I could not get to the Four Seasons Hotel where the event was taking place. I had to give up and try again a few hours later. I finally made it to the Four Seasons toward the end of the program.
When I finally got settled, I noticed that oil prices had fallen more than $4 per barrel because the Chinese said they were going to ease gasoline subsidies. It's about time they did this. By keeping gasoline artificially cheap, they have been encouraging consumption. Higher fuel prices in China should take the heat off of demand. Now if we can get the dollar to strengthen a bit, oil prices should fall back down to a level that is more in line with supply and demand considerations. I expect that level is about $80 per barrel.
On Wednesday morning I spoke at the UMass Club in downtown Boston, which boasts a wonderful view. On Wednesday evening, I spoke at the Armenian Library and Museum of America in Watertown. I ran into several old friends at both venues.
On Thursday afternoon I tried to drive into the City to attend the Forbes Leadership Networks Forum. Unfortunately, I got caught up in the Celtics parade. Although the parade was officially over, the police still had not opened several key streets and I could not get to the Four Seasons Hotel where the event was taking place. I had to give up and try again a few hours later. I finally made it to the Four Seasons toward the end of the program.
When I finally got settled, I noticed that oil prices had fallen more than $4 per barrel because the Chinese said they were going to ease gasoline subsidies. It's about time they did this. By keeping gasoline artificially cheap, they have been encouraging consumption. Higher fuel prices in China should take the heat off of demand. Now if we can get the dollar to strengthen a bit, oil prices should fall back down to a level that is more in line with supply and demand considerations. I expect that level is about $80 per barrel.
Tuesday, June 03, 2008
The Pro-American Ahmadinejad?
There has been much debate lately about high oil prices. Some say they are fully justified simply because of the forces of supply and demand. Others say they are in a bubble. Well, I came across a rather bizarre story on Bloomberg.com. It appears that President Mahmoud Ahmadinejad of Iran believes in the bubble theory. He says there is plenty of oil available and the price rise is unjustified. He blames it on efforts by some to weaken the U.S. dollar. He also called for greater use of nuclear energy, which he called "clean and cheap."
Ahmadinejad suddenly sounds like an American. In defending the U.S. dollar, he is doing a better job than our own Treasury Secretary. And by urging greater use of nuclear energy, he is encouraging us to stop relying on OPEC. Ahmadinejad is not particularly popular in Iran. Perhaps he has aspirations for a political career in America? You can read the Bloomberg story by clicking here.
Ahmadinejad suddenly sounds like an American. In defending the U.S. dollar, he is doing a better job than our own Treasury Secretary. And by urging greater use of nuclear energy, he is encouraging us to stop relying on OPEC. Ahmadinejad is not particularly popular in Iran. Perhaps he has aspirations for a political career in America? You can read the Bloomberg story by clicking here.
Monday, June 02, 2008
The Leon Charney Report
Although I have been interviewed dozens of times on television and radio, I always enjoy appearing on the Leon Charney Report. Charney is an extremely successful investor. He also served as an advisor to Jimmy Carter during the Camp David Accords. He hosts one of the most intelligent talk shows on television. There are no sound bites on this program. No screaming, no yelling, no cutting people off. Instead, Charney takes the time to conduct interesting conversations with interesting people. I have had the honor to appear on his show four or five times. In my most recent appearance on May 18, Charney interviewed me about my new book, Even Buffett Isn't Perfect. I thank him for the plug. You can watch this May 18 interview at the Leon Charney Report website.
Avoiding Oil-Related Stocks
Today, we released the June issue of the Forbes Growth Investor. The 50 stocks on our recommended list are up 2.11% year-to-date. In comparison, all the major indexes are down more than 4% during the same period. We have been seeing quite a bit of strength in the technology sector. For example, Sohu.com (SOHU) surged 83% during the three months it spent on our recommended list.
Our Special Situation Survey investment newsletter takes a more concentrated approach. We typically have only about 15 stocks on the recommended list in this newsletter. One of our best picks this year was Trinity Industries. The stocks in this newsletter are up 26% year-to-date, making it one of the best-performing investment newsletters so far this year as well as over the past five years.
Interestingly, neither newsletter has benefited from the surge in oil prices. There are no oil-related stocks on the recommended list of the Forbes Growth Investor. Currently, there is only one in the Special Situation Survey, but it hasn’t done particularly well. In general, energy is an area I have been avoiding. In fact, as far as oil goes, I am in the bubble camp. Supply and demand factors certainly explain a good part of the rise in crude oil prices, but I believe Federal Reserve policies that have weakened the dollar also carry some blame. U.S. demand for gasoline is actually falling. Gasoline is subsidized in many other countries, but their governments are finding it increasingly difficult to continue this practice. Oil prices could plunge as subsidies are lifted and as the dollar strengthens.
Our Special Situation Survey investment newsletter takes a more concentrated approach. We typically have only about 15 stocks on the recommended list in this newsletter. One of our best picks this year was Trinity Industries. The stocks in this newsletter are up 26% year-to-date, making it one of the best-performing investment newsletters so far this year as well as over the past five years.
Interestingly, neither newsletter has benefited from the surge in oil prices. There are no oil-related stocks on the recommended list of the Forbes Growth Investor. Currently, there is only one in the Special Situation Survey, but it hasn’t done particularly well. In general, energy is an area I have been avoiding. In fact, as far as oil goes, I am in the bubble camp. Supply and demand factors certainly explain a good part of the rise in crude oil prices, but I believe Federal Reserve policies that have weakened the dollar also carry some blame. U.S. demand for gasoline is actually falling. Gasoline is subsidized in many other countries, but their governments are finding it increasingly difficult to continue this practice. Oil prices could plunge as subsidies are lifted and as the dollar strengthens.
Thursday, May 22, 2008
Fed Minutes Forecast Recession
Yesterday's release of the minutes from the Federal Open Market Committee's April 29-30 meeting shook the markets. In particular, investors were put off by forecasts for slower economic growth and indications that no more rate cuts are in store. Just about the only good news that could be found in the minutes were references to stronger exports and slowing core inflation. At the same time, however, the Fed raised concerns about elevated overall inflation and rising expectations for future inflation. Committee members also expressed concern about slowing economies abroad, especially in Japan, the U.K., the euro zone, Canada, and Mexico.
The Fed actually expects U.S. GDP to contract during the first half of 2008, which of course is almost over. This is one way to say recession. The Fed remains hopeful, however, that the American economy will strengthen during the second half due to "accommodative monetary policy and fiscal stimulus." The former refers to the significant interest rate cuts that the Fed has already delivered. The latter refers to the tax rebate checks. Despite this expectation for a stronger second half, Fed economists reduced their projections for GDP growth for the full year. Their projections now range from just 0% to 1.5%, down significantly from the 1.0% to 2.2% range delivered just three months earlier.
Rebate checks are not likely to provide much stimulus. This money will probably be used to pay down debt or fill the family car's gas tank a few times. Real fiscal stimulus requires tax cuts. Unfortunately, there is no hope of that happening in the current political climate.
The minutes also said that "most members viewed the decision to reduce interest rates at this meeting as a close call." They don't want to cut rates again unless things really go to hell in a handbasket. The Fed said, it is "unlikely to be appropriate to ease policy in response to information suggesting that the economy was slowing further or even contracting slightly in the near term."
Two FOMC members actually voted against the latest cut. Richard Fisher warned that rate cuts were hampering economic activity by reducing the value of the dollar and contributing to the rise in import and commodity prices.
So there we have it. According to the Fed, although we can expect much slower economic growth than we previously anticipated, we can no longer count on further interest rate reductions. There certainly wasn't much in the report to be optimistic about. Of course, that explains the big sell-off in stocks that took place soon after the minutes were released.
The Fed actually expects U.S. GDP to contract during the first half of 2008, which of course is almost over. This is one way to say recession. The Fed remains hopeful, however, that the American economy will strengthen during the second half due to "accommodative monetary policy and fiscal stimulus." The former refers to the significant interest rate cuts that the Fed has already delivered. The latter refers to the tax rebate checks. Despite this expectation for a stronger second half, Fed economists reduced their projections for GDP growth for the full year. Their projections now range from just 0% to 1.5%, down significantly from the 1.0% to 2.2% range delivered just three months earlier.
Rebate checks are not likely to provide much stimulus. This money will probably be used to pay down debt or fill the family car's gas tank a few times. Real fiscal stimulus requires tax cuts. Unfortunately, there is no hope of that happening in the current political climate.
The minutes also said that "most members viewed the decision to reduce interest rates at this meeting as a close call." They don't want to cut rates again unless things really go to hell in a handbasket. The Fed said, it is "unlikely to be appropriate to ease policy in response to information suggesting that the economy was slowing further or even contracting slightly in the near term."
Two FOMC members actually voted against the latest cut. Richard Fisher warned that rate cuts were hampering economic activity by reducing the value of the dollar and contributing to the rise in import and commodity prices.
So there we have it. According to the Fed, although we can expect much slower economic growth than we previously anticipated, we can no longer count on further interest rate reductions. There certainly wasn't much in the report to be optimistic about. Of course, that explains the big sell-off in stocks that took place soon after the minutes were released.
Monday, May 19, 2008
Because I recently completed a book on Warren Buffett, and because Buffett is touring Europe right now, I've been asked a number of times why he is there. In particular, Fox Business asked me today if it made sense for Buffett to be trying to purchase European companies at a time when the dollar is so weak relative to the euro.
The first thing to keep in mind about Warren Buffett is that he does not actively seek companies to buy. Instead, he waits for good companies to contact him. He is in Europe just to make it clear that he is available and ready to buy if they are ready to sell.
Second, Buffett's European tour is not a bet on the dollar. He is still bearish on the dollar for the long term because he believes U.S. economic policy is geared to make the dollar weaker, but he also says he has absolutely no idea what the dollar will do in the short term. Just two weeks ago, he told shareholders he would like to diversify Berkshire's revenue stream. He wants more revenues from foreign economies. And because he has so much money to invest, he is focusing on Europe. He prefers to buy very large established family businesses.
Stuart Varney had a difficult time with my name, but he managed to pull it off at the end. Click here to view.
The first thing to keep in mind about Warren Buffett is that he does not actively seek companies to buy. Instead, he waits for good companies to contact him. He is in Europe just to make it clear that he is available and ready to buy if they are ready to sell.
Second, Buffett's European tour is not a bet on the dollar. He is still bearish on the dollar for the long term because he believes U.S. economic policy is geared to make the dollar weaker, but he also says he has absolutely no idea what the dollar will do in the short term. Just two weeks ago, he told shareholders he would like to diversify Berkshire's revenue stream. He wants more revenues from foreign economies. And because he has so much money to invest, he is focusing on Europe. He prefers to buy very large established family businesses.
Stuart Varney had a difficult time with my name, but he managed to pull it off at the end. Click here to view.
Thursday, May 15, 2008
Broadcom Co-Founders Snagged for Backdating Options
According to the SEC, Broadcom founders Henry Nicholas III and Henry Samueli and two other executives were involved in a scheme to backdate employee stock options. Backdating, which may have been more widespread than we know, didn't come to light until just a few years ago.
When a corporation grants stock options to an employee, it is supposed to be honest about the grant date. Backdating refers to the practice of selecting a date from the past when the stock price was at a lower and more favorable level for the employee. This is one way to recruit or retain valued employees. If the options are already in the money, the employee is less likely to leave.
About two years ago I had a conversation with former SEC chairman Harvey Pitt about this issue. Interestingly, he said the practice itself may not necessarily be illegal as long as it is fully disclosed. Microsoft, for example, routinely backdated options, but it also disclosed doing so in its SEC filings. Pitt, however, said that failing to disclose is outright fraud.
Apparently a number of other high profile companies, most notably Apple, have also engaged backdating options. However, some commentators have said the SEC is reluctant to go after Steve Jobs, Apple's founder, savior, and CEO. But these latest charges against the Broadcom executives indicate that the SEC considers backdating a serious offense. We may hear about more such cases in the future.
When a corporation grants stock options to an employee, it is supposed to be honest about the grant date. Backdating refers to the practice of selecting a date from the past when the stock price was at a lower and more favorable level for the employee. This is one way to recruit or retain valued employees. If the options are already in the money, the employee is less likely to leave.
About two years ago I had a conversation with former SEC chairman Harvey Pitt about this issue. Interestingly, he said the practice itself may not necessarily be illegal as long as it is fully disclosed. Microsoft, for example, routinely backdated options, but it also disclosed doing so in its SEC filings. Pitt, however, said that failing to disclose is outright fraud.
Apparently a number of other high profile companies, most notably Apple, have also engaged backdating options. However, some commentators have said the SEC is reluctant to go after Steve Jobs, Apple's founder, savior, and CEO. But these latest charges against the Broadcom executives indicate that the SEC considers backdating a serious offense. We may hear about more such cases in the future.
Monday, May 12, 2008
A Stronger Dollar and Falling Demand Should Cause Gas Prices to Retreat
According to the AAA's Daily Fuel Gauge Report, the national average price of gasoline just hit a record $3.72 per gallon, up 35 cents per gallon in just one month. Many consumers now believe the $4.00 mark will be broken very soon.
I am absolutely convinced that the run-up in oil and gasoline prices has more to do with the weak U.S. dollar than it does with supply and demand considerations. To a large extent, Federal Reserve policy decimated the dollar and caused inflation in dollar-denominated commodities. The Fed felt a need to aggressively loosen monetary policy because of the U.S. financial crisis and the slowing economy. However, it went way overboard by slashing the target fed funds rate from 5.25% in September all down to 2% where it stands today. Although the dollar had been weakening against the euro since 2002, the Fed's recent actions contributed to the dollar sell-off and the rush toward oil and other commodities.
This is not to say, however, that supply and demand played no part. Most oil producers are running close to full output and there isn't as much slack in the system as there was in the past. Furthermore, several oil-producing nations have serious problems. In Nigeria, it seems there is a new attack on production facilities almost everyday. Iraq, which has among the largest proven reserves in the world, is still mired in conflict and isn't producing anywhere near its full capability. And Venezuela has hampered its production by nationalizing assets and driving out foreign companies.
As for demand, it continues to climb in China and India. However, demand is actually falling in the U.S. We are currently consuming close to a million barrels of gasoline a day less than we were during last summer's peak. While demand is likely to climb as a new summer season dawns, it is unlikely to rise as much as it usually does if prices remain at elevated levels.
Now that it appears the Fed is through (or almost through) cutting interest rates, there is hope that the dollar will soon start to strengthen. With a stronger dollar and waning U.S. demand for gasoline, it is hard to believe that prices won't ease off a bit from current levels.
I am absolutely convinced that the run-up in oil and gasoline prices has more to do with the weak U.S. dollar than it does with supply and demand considerations. To a large extent, Federal Reserve policy decimated the dollar and caused inflation in dollar-denominated commodities. The Fed felt a need to aggressively loosen monetary policy because of the U.S. financial crisis and the slowing economy. However, it went way overboard by slashing the target fed funds rate from 5.25% in September all down to 2% where it stands today. Although the dollar had been weakening against the euro since 2002, the Fed's recent actions contributed to the dollar sell-off and the rush toward oil and other commodities.
This is not to say, however, that supply and demand played no part. Most oil producers are running close to full output and there isn't as much slack in the system as there was in the past. Furthermore, several oil-producing nations have serious problems. In Nigeria, it seems there is a new attack on production facilities almost everyday. Iraq, which has among the largest proven reserves in the world, is still mired in conflict and isn't producing anywhere near its full capability. And Venezuela has hampered its production by nationalizing assets and driving out foreign companies.
As for demand, it continues to climb in China and India. However, demand is actually falling in the U.S. We are currently consuming close to a million barrels of gasoline a day less than we were during last summer's peak. While demand is likely to climb as a new summer season dawns, it is unlikely to rise as much as it usually does if prices remain at elevated levels.
Now that it appears the Fed is through (or almost through) cutting interest rates, there is hope that the dollar will soon start to strengthen. With a stronger dollar and waning U.S. demand for gasoline, it is hard to believe that prices won't ease off a bit from current levels.
Saturday, May 03, 2008
In Omaha at the Warren and Charlie Show
I’m posting this from Omaha. I arrived here yesterday for the Berkshire Hathaway shareholders’ meeting. My trip was exhausting. I got up and 3 a.m. and headed for LaGuardia Airport. I made a connection in Chicago, but due to bad weather sat on the runway for almost three hours. I finally arrived in Omaha, rented a car, and raced to Borsheim’s Fine Jewelry, a Berkshire subsidiary. I went there to do an interview about my new book, Even Buffett Isn't Perfect, with Liz Claman of the Fox Business Network. I was starving and had a splitting headache. Except for some water, I had not eaten anything all day. Fortunately, the interview went very well.
After the interview, I headed off to my hotel in Bellevue, which is about 15 miles south of Omaha. Because 30,000 Berkshire shareholders came to Omaha for the meeting, there were no more rooms available in the city. I checked into my hotel and immediately fell asleep for several hours. As soon as I awoke, I headed back to Borsheim’s for a reception. The place was packed. As I walked past displays of $20,000 watches and other kinds of expensive trinkets, I could not help but notice the diversity of people, all of whom were Berkshire shareholders. They were young, they were old, and they were from all over the world.
The actual meeting began this morning at the Qwest Center. There was a large exhibit hall with many of Berkshire’s subsidiary companies showing off their wares. Shareholders could buy everything from See’s Candies to Fruit of the Loom underwear at discounted prices. Soon, the real show began. Susan Lucci, star of the soap opera “All My Children,” took the stage and announced that Warren Buffett decided to leave the company. She said she had just been appointed the new CEO of Berkshire Hathaway and that her first decision would be to initiate a dividend payment. Suddenly, Buffett came on stage and put a stop to that. This was all in keeping with his great sense of humor.
For several hours, shareholders bombarded Buffett and Munger with questions. Many of the questions had little to do with Berkshire’s business operations. Young people asked what they should do with their lives, a teacher asked what she should teach her students, and one man wanted to know if Buffett had accepted Jesus Christ as his Lord and Savior. Others asked about nuclear proliferation and mass transit policies. One man made a plea that Buffett read the U.S. Constitution and then call Roger Pilon of the Cato Institute. It quickly became evident that for many people in the audience, Buffett and Munger were more like cult figures than great businessmen. All of these people were clearly smart to invest in Berkshire stock. Nonetheless, some were quite wacky.
Although most people in the audience revere Buffett and Munger, not everyone was enamored with the dynamic duo. Several indigenous Americans complained that PacificCorp, which is owned by MidAmerican Energy Holdings, another Berkshire subsidiary, was damaging waterways with its damns. They wanted to know what Buffett intended to do about it. They also complained that they weren’t treated very nicely at last year’s meeting. Buffett was polite, but tossed these questions to David Sokol, chairman of MidAmerican, who gave some very diplomatic answers that did not quite seem to satisfy the questioners.
I was surprised that no one asked about Joe Brandon, General Re’s former CEO who suddenly resigned just a couple of weeks ago. Buffett has frequently praised Brandon in his annual letters to shareholders. The rumor is that Brandon resigned because federal prosecutors pressured Buffett to let him go. These authorities seem to believe Brandon was closely associated with some of the fraudulent schemes involving General Re and American International Group. Four people, included General Re’s former CEO, Ron Ferguson, were recently convicted for these schemes. Brandon, however, has not even been charged with any wrongdoing. Yet his reputation has been tarnished. It would have been nice if Buffett had shed some light on Brandon’s departure.
All in all, while I am glad I attended the event, I can’t say it was particularly instructive. It certainly was fun to meet and mingle with many of Buffett’s fans and to see all of Berkshire’s products on display in one place. However, I am convinced that one can learn a whole lot more by studying Berkshire’s annual reports than by attending its shareholders’ meetings.
After the interview, I headed off to my hotel in Bellevue, which is about 15 miles south of Omaha. Because 30,000 Berkshire shareholders came to Omaha for the meeting, there were no more rooms available in the city. I checked into my hotel and immediately fell asleep for several hours. As soon as I awoke, I headed back to Borsheim’s for a reception. The place was packed. As I walked past displays of $20,000 watches and other kinds of expensive trinkets, I could not help but notice the diversity of people, all of whom were Berkshire shareholders. They were young, they were old, and they were from all over the world.
The actual meeting began this morning at the Qwest Center. There was a large exhibit hall with many of Berkshire’s subsidiary companies showing off their wares. Shareholders could buy everything from See’s Candies to Fruit of the Loom underwear at discounted prices. Soon, the real show began. Susan Lucci, star of the soap opera “All My Children,” took the stage and announced that Warren Buffett decided to leave the company. She said she had just been appointed the new CEO of Berkshire Hathaway and that her first decision would be to initiate a dividend payment. Suddenly, Buffett came on stage and put a stop to that. This was all in keeping with his great sense of humor.
For several hours, shareholders bombarded Buffett and Munger with questions. Many of the questions had little to do with Berkshire’s business operations. Young people asked what they should do with their lives, a teacher asked what she should teach her students, and one man wanted to know if Buffett had accepted Jesus Christ as his Lord and Savior. Others asked about nuclear proliferation and mass transit policies. One man made a plea that Buffett read the U.S. Constitution and then call Roger Pilon of the Cato Institute. It quickly became evident that for many people in the audience, Buffett and Munger were more like cult figures than great businessmen. All of these people were clearly smart to invest in Berkshire stock. Nonetheless, some were quite wacky.
Although most people in the audience revere Buffett and Munger, not everyone was enamored with the dynamic duo. Several indigenous Americans complained that PacificCorp, which is owned by MidAmerican Energy Holdings, another Berkshire subsidiary, was damaging waterways with its damns. They wanted to know what Buffett intended to do about it. They also complained that they weren’t treated very nicely at last year’s meeting. Buffett was polite, but tossed these questions to David Sokol, chairman of MidAmerican, who gave some very diplomatic answers that did not quite seem to satisfy the questioners.
I was surprised that no one asked about Joe Brandon, General Re’s former CEO who suddenly resigned just a couple of weeks ago. Buffett has frequently praised Brandon in his annual letters to shareholders. The rumor is that Brandon resigned because federal prosecutors pressured Buffett to let him go. These authorities seem to believe Brandon was closely associated with some of the fraudulent schemes involving General Re and American International Group. Four people, included General Re’s former CEO, Ron Ferguson, were recently convicted for these schemes. Brandon, however, has not even been charged with any wrongdoing. Yet his reputation has been tarnished. It would have been nice if Buffett had shed some light on Brandon’s departure.
All in all, while I am glad I attended the event, I can’t say it was particularly instructive. It certainly was fun to meet and mingle with many of Buffett’s fans and to see all of Berkshire’s products on display in one place. However, I am convinced that one can learn a whole lot more by studying Berkshire’s annual reports than by attending its shareholders’ meetings.
Tuesday, April 29, 2008
Still no Light at End of Housing Tunnel
This morning's release of the Standard & Poor's Case/Shiller Indices proves extremely disappointing for those who are looking for evidence that home prices are nearing a bottom. Unfortunately, prices are still falling at an accelerating rate.
S&P tracks 20 major markets. The most recent data, which are for February, show that nineteen of those markets experienced year-over-year declines that were bigger than the declines seen in January. Prices fell more than 20% in Las Vegas, Phoenix, and Miami. In Las Vegas, prices are down 25% from their all-time high set in August 2006, yet because they remain 77% higher than they were in January 2000, they could go quite a ways lower. Charlotte was the only market to see a year-over-year gain in February. Prices in Charlotte inched up 1.48%, but even this was smaller than the increases in previous months.
Home prices will likely fall throughout 2008. Before they can stop falling entirely, their declines have to slow down. Because the S&P data are almost two months old, there is hope this may already be happening. Evidence of a slowdown in price decreases is the light at the end of the tunnel that will ultimately bring confidence back into the housing market.
S&P tracks 20 major markets. The most recent data, which are for February, show that nineteen of those markets experienced year-over-year declines that were bigger than the declines seen in January. Prices fell more than 20% in Las Vegas, Phoenix, and Miami. In Las Vegas, prices are down 25% from their all-time high set in August 2006, yet because they remain 77% higher than they were in January 2000, they could go quite a ways lower. Charlotte was the only market to see a year-over-year gain in February. Prices in Charlotte inched up 1.48%, but even this was smaller than the increases in previous months.
Home prices will likely fall throughout 2008. Before they can stop falling entirely, their declines have to slow down. Because the S&P data are almost two months old, there is hope this may already be happening. Evidence of a slowdown in price decreases is the light at the end of the tunnel that will ultimately bring confidence back into the housing market.
Thursday, April 24, 2008
Housing Stocks Surge Despite Plunging Sales
New home sales continue to plummet. According to the joint release issued this morning from the Census Bureau and the Dept. of Housing and Urban Development, only 51,000 new single-family homes were sold in March in the entire country. Seasonally-adjusted and annualized, that comes out to about 526,000 new home sales, down 8.5% from February and down 36.6% from March 2007. Because the 90% confidence level is ±11.1%, it is possible that the decline was much worse. We'll find out for sure over the next two months as this figure is revised.
If that's not bad enough, it turns out that inventory is still growing. If sales stopped falling and homebuilders stopped working, there would still be enough new homes available for sale to satisfy demand for 11 months. Furthermore, the median price of a new home is down 6.8% over the past month and down 13.3% over the past year.
Despite this seemingly dismal news, almost all homebuilding stocks are up today. Although most homebuilding stocks are down by huge amounts over the past year, they are also some of the best-performing stocks year to date. At least three of them, Hovnanian Enterprises, Standard Pacific, and M/I Homes, are up more than 50% so far this year.
Many investors are obviously betting that the worst is over for the homebuilders. I doubt this is the case. Most of these companies will report huge operating losses this year. Indeed, they may report losses next year as well, assuming they survive that long. While some may consolidate, others will go out of business. At current prices, it's still too early to buy the homebuilders.
If that's not bad enough, it turns out that inventory is still growing. If sales stopped falling and homebuilders stopped working, there would still be enough new homes available for sale to satisfy demand for 11 months. Furthermore, the median price of a new home is down 6.8% over the past month and down 13.3% over the past year.
Despite this seemingly dismal news, almost all homebuilding stocks are up today. Although most homebuilding stocks are down by huge amounts over the past year, they are also some of the best-performing stocks year to date. At least three of them, Hovnanian Enterprises, Standard Pacific, and M/I Homes, are up more than 50% so far this year.
Many investors are obviously betting that the worst is over for the homebuilders. I doubt this is the case. Most of these companies will report huge operating losses this year. Indeed, they may report losses next year as well, assuming they survive that long. While some may consolidate, others will go out of business. At current prices, it's still too early to buy the homebuilders.
Wednesday, April 16, 2008
More Questions About JPMorgan/Bear Stearns Deal
A recent SEC filing from JPMorgan Chase raises more questions about the government's role in JPMorgan's pending acquisition of Bear Stearns. Steven Davidoff does an excellent job of pointing all this out in a New York Times DealBook piece. For example, he asks why the New York Fed agreed to give Bear Stearns a secured lending facility on Friday, March 14, then suddenly changed it's mind and backed out of the agreement by the end of the day. The SEC filing also notes that JPMorgan indicated a willingness to pay $8-$12 per share for Bear Stearns, but eventually offered only $2 per share following discussions with government officials. Take a look at Anatomy of a Merger for more questions prompted by the SEC filing. I thank Gary Lutin for bringing Davidoff's piece to my attention.
Monday, April 14, 2008
Buffett Loses Another General Re CEO
After a week of rumors, Joseph Brandon finally stepped down as CEO of General Re, a Berkshire Hathaway subsidiary and one of the country's largest reinsurance companies.
Brandon's resignation is big news because he was frequently praised in Buffett's annual letters to shareholders. Berkshire followers considered Brandon a leading candidate to replace the great man when he eventually retires. But Brandon is now the second General Re CEO to step down under a cloud. Ron Ferguson was the first.
Warren Buffett does not like to use stock to consummate acquisitions. He made an exception, however, when he bought General Re on Berkshire's behalf in 1998 for $22 billion using a combination of cash and stock. Things soured almost from the start.
When writing about General Re in his 1999 letter to shareholders, Buffett said, "we had a huge--and, I believe aberrational--underwriting loss." He said General Re was underpricing policies, yet he also praised CEO Ferguson. However, just a couple of years later, Ferguson was out and Brandon was in.
It turns out General Re was also plagued with other problems. It had accounting irregularities that resulted in $800 million of costs being charged against 2001 earnings. It had derivatives-related losses that amounted to about $400 million. In fact, these losses prompted Buffett to make his now famous statement calling derivatives "financial weapons of mass destruction."
Just two months ago, Ferguson and three other General Re executives were convicted of helping American International Group, formerly run by Maurice Greenberg, deceive investors by manipulating earnings with fraudulent reinsurance contracts. Although Brandon was not convicted of any crime, prosecutors considered him a co-conspirator and Buffett came under intense pressure to let him go. Today, he relented to that pressure.
Losing Brandon can not be easy for Buffett. Each year, Buffett heaps praise on several of his managers in his annual letter to shareholders. Brandon's name frequently showed up in these letters. Now that Brandon is gone, Ajit Jain is the leading candidate to become Berkshire's next CEO. If interested, you can read more about Berkshire's investment in General Re in my forthcoming book, Even Buffett Isn't Perfect.
Brandon's resignation is big news because he was frequently praised in Buffett's annual letters to shareholders. Berkshire followers considered Brandon a leading candidate to replace the great man when he eventually retires. But Brandon is now the second General Re CEO to step down under a cloud. Ron Ferguson was the first.
Warren Buffett does not like to use stock to consummate acquisitions. He made an exception, however, when he bought General Re on Berkshire's behalf in 1998 for $22 billion using a combination of cash and stock. Things soured almost from the start.
When writing about General Re in his 1999 letter to shareholders, Buffett said, "we had a huge--and, I believe aberrational--underwriting loss." He said General Re was underpricing policies, yet he also praised CEO Ferguson. However, just a couple of years later, Ferguson was out and Brandon was in.
It turns out General Re was also plagued with other problems. It had accounting irregularities that resulted in $800 million of costs being charged against 2001 earnings. It had derivatives-related losses that amounted to about $400 million. In fact, these losses prompted Buffett to make his now famous statement calling derivatives "financial weapons of mass destruction."
Just two months ago, Ferguson and three other General Re executives were convicted of helping American International Group, formerly run by Maurice Greenberg, deceive investors by manipulating earnings with fraudulent reinsurance contracts. Although Brandon was not convicted of any crime, prosecutors considered him a co-conspirator and Buffett came under intense pressure to let him go. Today, he relented to that pressure.
Losing Brandon can not be easy for Buffett. Each year, Buffett heaps praise on several of his managers in his annual letter to shareholders. Brandon's name frequently showed up in these letters. Now that Brandon is gone, Ajit Jain is the leading candidate to become Berkshire's next CEO. If interested, you can read more about Berkshire's investment in General Re in my forthcoming book, Even Buffett Isn't Perfect.
Friday, April 11, 2008
Shiller at the BSAS
I want to thank one of my former students from Boston College, Harry Markopolos, for sending me his notes from a talk delivered last month by Robert Shiller to members of the Boston Security Analyts Society. Shiller, who is a member of the faculty at Yale University, is also the man who closely tracks housing prices. He was instrumental in developing the now famous S&P/Case-Shiller Home Price Index. I had the pleasure of interviewing him a couple of years ago shortly after he released the second edition of his prescient book, "Irrational Exuberance." I call the book prescient because the first edition correctly called the top of the stock market in 2000; and the second edition correctly called the top in housing.
As everyone knows, housing prices are still falling. Shiller expects them to keep falling for quite some time since the monthly year-over-year declines are still accelerating. Actions taken by government officials may slow these price declines, but eventually the market will have to find its equilibrium. In fact, it would probably be better for our economy if the government did not intervene and allowed this process to proceed as quickly as possible.
Shiller pointed out that the price gains seen in recent years were historically unusual. From 1890 to 1990, housing prices appreciated at about the same rate as inflation. Starting in 1990, however, prices took off as home buyers began to view a house more as an investment rather than just a place to live.
Shiller pointed out that for many home owners, their house is their most valuable asset. Unlike other assets, however, it was nearly impossible to hedge against a drop in value. But he has helped develop financial derivatives linked to the Case-Shiller indexes that allow home owners to do just that. Shiller believes the existence of such instruments make it much less likely that a housing bubble will develop again in the future.
Interestingly, Shiller said that in every market he examined, lower-priced homes exhibited the greatest price increases during the recent housing bubble. He attributes this to the widespread availability of sub-prime mortgages, which sometimes did not even require a down payment or the verification of income. This made it possible for individuals, who would not have otherwise qualified for mortgages, to buy homes. As a result, lower-priced homes saw the biggest increase in demand, and therefore, the biggest percentage increase in price. But now, this is also where most of the pain is being felt. Unfortunately, other segments of the housing market and the wider economy are not entirely immune. They, too, are feeling some pain.
As everyone knows, housing prices are still falling. Shiller expects them to keep falling for quite some time since the monthly year-over-year declines are still accelerating. Actions taken by government officials may slow these price declines, but eventually the market will have to find its equilibrium. In fact, it would probably be better for our economy if the government did not intervene and allowed this process to proceed as quickly as possible.
Shiller pointed out that the price gains seen in recent years were historically unusual. From 1890 to 1990, housing prices appreciated at about the same rate as inflation. Starting in 1990, however, prices took off as home buyers began to view a house more as an investment rather than just a place to live.
Shiller pointed out that for many home owners, their house is their most valuable asset. Unlike other assets, however, it was nearly impossible to hedge against a drop in value. But he has helped develop financial derivatives linked to the Case-Shiller indexes that allow home owners to do just that. Shiller believes the existence of such instruments make it much less likely that a housing bubble will develop again in the future.
Interestingly, Shiller said that in every market he examined, lower-priced homes exhibited the greatest price increases during the recent housing bubble. He attributes this to the widespread availability of sub-prime mortgages, which sometimes did not even require a down payment or the verification of income. This made it possible for individuals, who would not have otherwise qualified for mortgages, to buy homes. As a result, lower-priced homes saw the biggest increase in demand, and therefore, the biggest percentage increase in price. But now, this is also where most of the pain is being felt. Unfortunately, other segments of the housing market and the wider economy are not entirely immune. They, too, are feeling some pain.
Wednesday, April 09, 2008
Forbes Roundtable Discussion
About once every quarter, the Forbes Investors Advisory Institute hosts a roundtable discussion with some leading investment strategists and portfolio managers. Wally Forbes moderated one such discussion last night at Forbes headquarters. Panelists included Barbara Marcin of GAMCO, Mike Holland of Holland & Company, Joe Battipaglia of Stifel Nicolaus, Rich Peterson of Thomson Financial, and me. Most participants were bearish about the economy. Views on the stock market, however, were more varied with some being bullish and others expecting only mediocre returns at best for quite some time. The Forbes video department filmed the discussion and expects to post highlights on Forbes.com within a few days. We also expect to prepare a transcript for subscribers to the Forbes Growth Investor and Special Situation Survey investment newsletters. They will be notified when it is ready.
Monday, April 07, 2008
Olympic Boycotts
As a former track and field athlete, I can't help but comment on the commotion surrounding the upcoming Olympic Games in Beijing. China is coming under severe criticism for its crackdown in Tibet, as well as its cooperation with the government of Sudan, which is accused of perpetrating genocide in Darfur. The most recent developments involve protesters in France accosting a wheelchair bound athlete who was carrying the torch.
Like it or not, the Olympic Games have long been politicized. President Jimmy Carter made the Olympics a political issue for Americans when he kept our team out of the Moscow Olympics in 1980. Carter's boycott was meant to protest the Soviet Union's invasion of Afghanistan. The Russians eventually vacated Afghanistan, but not because of the boycott. Ironically, the U.S. military now finds itself mired in that very country.
As you might imagine, the Russians were not pleased with the U.S. led boycott. They felt America was trying to embarrass them. Therefore, it came as no surprise when they retaliated by boycotting the very next Olympic games, which conveniently were held in Los Angeles.
I was never an Olympic caliber runner, yet I had the opportunity to train with runners who were. In fact, one of my former track coaches was a member of the 1980 team. As you can imagine, he was not happy to see all his training go for naught. After making the Olympic team, all he got was a trip to the White House and a handshake from the man who kept him from competing in Moscow.
I am not saying that China's policies should not be protested. Indeed, they should be vigorously protested. However, an Olympic boycott is not going to do much good. It certainly is not going to convince China's leaders to change their ways. On the contrary, a boycott will probably make them close ranks and become even more belligerent than they already are. Those who are really serious about delivering a strong message to China should seek other ways. Boycotting Chinese made goods, for example, would be more effective than boycotting the Olympics. But are consumers willing to pay higher prices for goods manufactured elsewhere?
Like it or not, the Olympic Games have long been politicized. President Jimmy Carter made the Olympics a political issue for Americans when he kept our team out of the Moscow Olympics in 1980. Carter's boycott was meant to protest the Soviet Union's invasion of Afghanistan. The Russians eventually vacated Afghanistan, but not because of the boycott. Ironically, the U.S. military now finds itself mired in that very country.
As you might imagine, the Russians were not pleased with the U.S. led boycott. They felt America was trying to embarrass them. Therefore, it came as no surprise when they retaliated by boycotting the very next Olympic games, which conveniently were held in Los Angeles.
I was never an Olympic caliber runner, yet I had the opportunity to train with runners who were. In fact, one of my former track coaches was a member of the 1980 team. As you can imagine, he was not happy to see all his training go for naught. After making the Olympic team, all he got was a trip to the White House and a handshake from the man who kept him from competing in Moscow.
I am not saying that China's policies should not be protested. Indeed, they should be vigorously protested. However, an Olympic boycott is not going to do much good. It certainly is not going to convince China's leaders to change their ways. On the contrary, a boycott will probably make them close ranks and become even more belligerent than they already are. Those who are really serious about delivering a strong message to China should seek other ways. Boycotting Chinese made goods, for example, would be more effective than boycotting the Olympics. But are consumers willing to pay higher prices for goods manufactured elsewhere?
Friday, March 28, 2008
Even Buffett Isn't Perfect
I gave a talk Wednesday night in White Plains, NY about my forthcoming book, Even Buffett Isn't Perfect. I was quite pleased with the response, so I am posting a short excerpt here. The book is available for pre-order at a significant discount at Amazon.com and Barnesandnoble.com, as well as a number of other book sellers.
Buffett firmly believes the rich should pay more tax. So why would he choose to give so much of his money to these various foundations rather than allow the government to take a huge chunk from his estate after his death? The only reasonable explanation is that Buffett is convinced that these foundations will spend his money much more wisely than the government would.
Many of the megarich, including Buffett, favor the estate tax. Yet they continue to take advantage of the loophole in the law that allows them to avoid the tax by giving their money away before they die. What explains this paradox? Perhaps the answer lies somewhere between guilt and altruism. They may feel guilty about having so much money, yet they don't trust the government to spend it wisely. But as conservatives point out, we don't need the estate tax to get the same result. Those who feel guilty are free to give their money to whomever they want--even the government. But they should not force the same on others.
Buffett firmly believes the rich should pay more tax. So why would he choose to give so much of his money to these various foundations rather than allow the government to take a huge chunk from his estate after his death? The only reasonable explanation is that Buffett is convinced that these foundations will spend his money much more wisely than the government would.
Many of the megarich, including Buffett, favor the estate tax. Yet they continue to take advantage of the loophole in the law that allows them to avoid the tax by giving their money away before they die. What explains this paradox? Perhaps the answer lies somewhere between guilt and altruism. They may feel guilty about having so much money, yet they don't trust the government to spend it wisely. But as conservatives point out, we don't need the estate tax to get the same result. Those who feel guilty are free to give their money to whomever they want--even the government. But they should not force the same on others.
Monday, March 24, 2008
Grand Theft Investment Bank
J.P. Morgan's acquisition of Bear Stearns is starting to look more and more like a crime with the Federal Reserve and Treasury Department guilty of aiding and abetting. Government officials orchestrated grand theft investment bank.
As of yet, of course, there is no definitive deal. Yet Morgan almost got away with "buying" Bear for just $2 per share. The government, it seems, was desperate to close a deal and just as desperate to punish Bear's shareholders. Morgan was smart enough to realize they were the only bidder in the game. They could name any price they liked and that's exactly what they did.
But shares of Bear immediately started trading well above the offer price. And now, after only one week, Morgan decided it needed to allay some of the ill will it's initial offer created. So it decided to increase its offer--by five times! If this does not confirm that Morgan's initial offer amounted to highway robbery, I don't know what does.
With Morgan's new offer the government is still assuming most of the risk by guaranteeing Bear's toxic mortgages. But instead of doing this through Morgan, it could have done the same thing directly through Bear. Either way, the burden to taxpayers is the same. By working through Morgan, however, the government can be sure that Bear's employees and shareholders get absolutely pummeled.
One day a lot of hard questions will be asked about exactly what went on. Harvard professors are probably already working on a case study. Dozens of books will eventually be written on the subject. In the final analysis, it will become evident that, with the government's help, J.P. Morgan almost stole Bear Stearns.
As of yet, of course, there is no definitive deal. Yet Morgan almost got away with "buying" Bear for just $2 per share. The government, it seems, was desperate to close a deal and just as desperate to punish Bear's shareholders. Morgan was smart enough to realize they were the only bidder in the game. They could name any price they liked and that's exactly what they did.
But shares of Bear immediately started trading well above the offer price. And now, after only one week, Morgan decided it needed to allay some of the ill will it's initial offer created. So it decided to increase its offer--by five times! If this does not confirm that Morgan's initial offer amounted to highway robbery, I don't know what does.
With Morgan's new offer the government is still assuming most of the risk by guaranteeing Bear's toxic mortgages. But instead of doing this through Morgan, it could have done the same thing directly through Bear. Either way, the burden to taxpayers is the same. By working through Morgan, however, the government can be sure that Bear's employees and shareholders get absolutely pummeled.
One day a lot of hard questions will be asked about exactly what went on. Harvard professors are probably already working on a case study. Dozens of books will eventually be written on the subject. In the final analysis, it will become evident that, with the government's help, J.P. Morgan almost stole Bear Stearns.
Thursday, March 20, 2008
On the Road in New Orleans and Austin
I was in New Orleans yesterday taking part in a market forecast panel discussion sponsored by the CFA Society of New Orleans. The event was held at the Bourbon House. Vinny Catalano, president and global investment strategist of Blue Marble Research, moderated the discussion. The audience included Don Chance, my financial derivatives professor at Virginia Tech, and Pat Mooney, a former student of mine from a CFA review course I used to teach in Boston. Both are now working in Louisiana.
The other panelists included Mark Freeman, an investment advisor, and Dek Terrell, an economist from Louisiana State University. Interestingly, Dek talked about Louisiana's strong economy. Louisiana, which is heavily dependent on the oil industry, is actually benefiting from the high oil prices that are haunting the rest of the nation. He pointed out that there are pockets of desperation in Louisiana, but for the most part, the state is doing well.
Mark warned the attendees that volatility in the stock market is likely to continue, but he had a favorable view overall.
I focused my discussion on the continuing acceleration in the drop in housing prices. Almost all of the problems we are seeing in the financial sector are related to housing. Until housing prices start falling at a decelerating rate, we will not be approaching bottom. I also warned that high energy prices are taking a big toll on consumers. We are already seeing a decline in gasoline demand due to these prices. However, I said oil prices are more likely to fall than rise. Current prices are more the result of the weak U.S. dollar and less a result of strong demand or limited supply. For more than a week I have been trying to short the USO, an oil ETF, to take advantage of the expected decline. But my brokerage firm claims they have no shares in inventory available to short.
Today I am in Austin and will take part in a similar discussion sponsored by the CFA Society of Austin. This event will take place at the Austin Club. I'm also hoping to visit Roux, a trendy restaurant owned by my cousin Dan Janjigian.
The other panelists included Mark Freeman, an investment advisor, and Dek Terrell, an economist from Louisiana State University. Interestingly, Dek talked about Louisiana's strong economy. Louisiana, which is heavily dependent on the oil industry, is actually benefiting from the high oil prices that are haunting the rest of the nation. He pointed out that there are pockets of desperation in Louisiana, but for the most part, the state is doing well.
Mark warned the attendees that volatility in the stock market is likely to continue, but he had a favorable view overall.
I focused my discussion on the continuing acceleration in the drop in housing prices. Almost all of the problems we are seeing in the financial sector are related to housing. Until housing prices start falling at a decelerating rate, we will not be approaching bottom. I also warned that high energy prices are taking a big toll on consumers. We are already seeing a decline in gasoline demand due to these prices. However, I said oil prices are more likely to fall than rise. Current prices are more the result of the weak U.S. dollar and less a result of strong demand or limited supply. For more than a week I have been trying to short the USO, an oil ETF, to take advantage of the expected decline. But my brokerage firm claims they have no shares in inventory available to short.
Today I am in Austin and will take part in a similar discussion sponsored by the CFA Society of Austin. This event will take place at the Austin Club. I'm also hoping to visit Roux, a trendy restaurant owned by my cousin Dan Janjigian.
Monday, March 17, 2008
Is Bernanke's Job on the Line?
Over the weekend, the Federal Reserve orchestrated the takeover of Bear Stearns by J.P. Morgan for $2 per share. This is an almost unbelievable development. Bear Stearns, which started 2007 with a $22 billion market capitalization, is now valued at only $250 million! Some observers argue that this is better than the alternative--bankruptcy; but some Bear Stearns shareholders are wondering if that is really true.
There are two big problems leading to this latest crisis in financial markets. The first is falling housing prices. This is something that was easily foreseen. Many well known and respected economists, including Robert Shiller, Gary Shilling, and Nouriel Rubin, have been warning for years that housing prices could not possibly keep appreciating. Simple reversion to the mean dictated that prices had to fall considerably just to get back to long-term trends. Excessively easy access to mortgages created the housing bubble. Now that banks are tightening their lending standards, the air is coming out of the balloon.
The second problem is the Fed. It no longer has the confidence of investors. Instead of providing targeted liquidity to frozen credit markets, the Fed has destroyed the value of the dollar and created a tremendous amount of inflation in dollar-denominated commodities by aggressively cutting interest rates. Foreign tourists are having a ball vacationing and shopping in the U.S., and foreign investors are gobbling up our decimated assets, which are even cheaper than they appear when priced in euros and yens. Americans, however, are paying a steep price.
Treasury Secretary Henry Paulson (jokingly known as Mr. Strong Dollar) is trying to assure investors that we're just going through a blip. He wants us to believe that there is light at the end of the tunnel. Mr. Paulson, along with President Bush, will be out of work in 10 months. How much longer will Ben Bernanke have his job? To be fair, he can't be fully blamed for all of the ills in the economy. Some of the seeds of the current crisis were sown before he took office. Nonetheless, it is starting to look as if Mr. Bernanke's tenure at the Fed will not be setting any records.
There are two big problems leading to this latest crisis in financial markets. The first is falling housing prices. This is something that was easily foreseen. Many well known and respected economists, including Robert Shiller, Gary Shilling, and Nouriel Rubin, have been warning for years that housing prices could not possibly keep appreciating. Simple reversion to the mean dictated that prices had to fall considerably just to get back to long-term trends. Excessively easy access to mortgages created the housing bubble. Now that banks are tightening their lending standards, the air is coming out of the balloon.
The second problem is the Fed. It no longer has the confidence of investors. Instead of providing targeted liquidity to frozen credit markets, the Fed has destroyed the value of the dollar and created a tremendous amount of inflation in dollar-denominated commodities by aggressively cutting interest rates. Foreign tourists are having a ball vacationing and shopping in the U.S., and foreign investors are gobbling up our decimated assets, which are even cheaper than they appear when priced in euros and yens. Americans, however, are paying a steep price.
Treasury Secretary Henry Paulson (jokingly known as Mr. Strong Dollar) is trying to assure investors that we're just going through a blip. He wants us to believe that there is light at the end of the tunnel. Mr. Paulson, along with President Bush, will be out of work in 10 months. How much longer will Ben Bernanke have his job? To be fair, he can't be fully blamed for all of the ills in the economy. Some of the seeds of the current crisis were sown before he took office. Nonetheless, it is starting to look as if Mr. Bernanke's tenure at the Fed will not be setting any records.
Tuesday, March 11, 2008
Physician, Heal Thyself
Saying that Eliot Spitzer is a hypocrite is stating the obvious. Yet it is a little gratifying to see this "holier than thou" crusader get caught in his own ethical lapse. Spitzer made a career of ruining the reputations of numerous businessmen; not by convicting any of them of doing anything criminal, but by threatening to indict their companies if they didn't resign.
Richard Grasso, Ken Langone, and Hank Greenberg are still trying to get their reputations back. Take Grasso for instance. What was his big crime according to Spitzer? He was paid too much. That's undoubtedly true. Personally, I think anyone who gets paid more than me is paid too much, but that doesn't constitute a crime. Spitzer also went after a number of directors at the NYSE, but he decided to give former New York State comptroller H. Carl McCall a pass. Perhaps he felt he needed McCall's support in his ambitious quest to become governor.
Today's Wall Street Journal mentioned a speech Spitzer gave to the New York Society of Security Analysts in 2003. I was there. I remember being disappointed that the NYSSA chose to invite Spitzer to address our membership. I watched as investment professionals fell all over themselves to shake Spitzer's hand, as if doing so somehow certified their high ethical standards. When Spitzer delivered his speech, he joked about indicting people in our profession. It became very evident to me that this man was focused more on promoting his career than he was in protecting investors from criminals. What goes around, comes around.
Richard Grasso, Ken Langone, and Hank Greenberg are still trying to get their reputations back. Take Grasso for instance. What was his big crime according to Spitzer? He was paid too much. That's undoubtedly true. Personally, I think anyone who gets paid more than me is paid too much, but that doesn't constitute a crime. Spitzer also went after a number of directors at the NYSE, but he decided to give former New York State comptroller H. Carl McCall a pass. Perhaps he felt he needed McCall's support in his ambitious quest to become governor.
Today's Wall Street Journal mentioned a speech Spitzer gave to the New York Society of Security Analysts in 2003. I was there. I remember being disappointed that the NYSSA chose to invite Spitzer to address our membership. I watched as investment professionals fell all over themselves to shake Spitzer's hand, as if doing so somehow certified their high ethical standards. When Spitzer delivered his speech, he joked about indicting people in our profession. It became very evident to me that this man was focused more on promoting his career than he was in protecting investors from criminals. What goes around, comes around.
Monday, March 10, 2008
SIFMA at Wharton
I just returned from the Wharton School at the University of Pennsylvania. The Securities Industry and Financial Markets Association (SIFMA) is holding a one-week conference for its membership. They kicked off the event this morning with a panel discussion entitled "Wall Street Comes to Wharton." I was honored to take part in the discussion, which focused on the economy and the markets. Bob Stovall, Managing Director and Global Strategist at Wood Asset Management, hosted the panel. Other panelists included Sam Stovall, Chief Investment Strategist at Standard & Poor's; Randall Eley, President of the Edgar Lomax Company; and Michelle Girard, Managing Director and Senior Economist at RBS Greenwich Capital.
Housing prices got a lot of attention. All panelists agreed that prices will continue to fall for some time. However, Michelle pointed out that realtors are reporting a pick up in interest from buyers looking for bargains. Nonetheless, I said I was more concerned about the fact that the drop in prices is still accelerating. Although I am hopeful that prices will start falling at slower rates in the very near future, I expect overall housing prices to keep falling throughout 2008 and perhaps into 2009. I also warned that problems could spread in the commercial sector and banks could soon start announcing writeoffs of commercial mortgages.
Sam Stovall talked about historical trends and pointed out that it is rare for stocks to fall as much as they have without a meaningful recovery within a year while the Fed is aggressively cutting interest rates. Sam's point was that it is more risky to be out of the market right now than it is to be in it because stocks could rally strongly and unexpectedly. While I certainly believe stock prices could go lower in the short term, I am more confident that they will be at higher levels 3-5 years out. As a result, I would agree with Sam. Take advantage of strong sell-offs by doing some bargain hunting.
Randall Eley is a value manager who favors large-cap blue chip companies. He, too, has a bullish long-term outlook. Stocks he likes right now include Chevron (CVX), Bank of America (BCA) and Home Depot (HD).
Housing prices got a lot of attention. All panelists agreed that prices will continue to fall for some time. However, Michelle pointed out that realtors are reporting a pick up in interest from buyers looking for bargains. Nonetheless, I said I was more concerned about the fact that the drop in prices is still accelerating. Although I am hopeful that prices will start falling at slower rates in the very near future, I expect overall housing prices to keep falling throughout 2008 and perhaps into 2009. I also warned that problems could spread in the commercial sector and banks could soon start announcing writeoffs of commercial mortgages.
Sam Stovall talked about historical trends and pointed out that it is rare for stocks to fall as much as they have without a meaningful recovery within a year while the Fed is aggressively cutting interest rates. Sam's point was that it is more risky to be out of the market right now than it is to be in it because stocks could rally strongly and unexpectedly. While I certainly believe stock prices could go lower in the short term, I am more confident that they will be at higher levels 3-5 years out. As a result, I would agree with Sam. Take advantage of strong sell-offs by doing some bargain hunting.
Randall Eley is a value manager who favors large-cap blue chip companies. He, too, has a bullish long-term outlook. Stocks he likes right now include Chevron (CVX), Bank of America (BCA) and Home Depot (HD).
Thursday, March 06, 2008
In Defense of Peter Lynch
Peter Lynch is a legend in the investment world. If you ask investors to name America's all-time best money managers, Warren Buffett would no doubt come out on top. But chances are Peter Lynch would be close behind.
Lynch managed Fidelity's Magellan fund for 13 years. Under his watch, assets under management ballooned to $14 billion. He authored several books on investing and coined the term "ten-bagger," which describes a stock that goes up 10 times in value. He was famous for walking around shopping malls and paying attention to what people were buying. Today, he spends a great deal of time on philanthropy.
Yet the man who is so revered by investors, stands a little tarnished. You see, Lynch accepted gifts from brokerage firms that were seeking Fidelity's business. This is considered a big no-no in the mutual fund industry because gifts from brokers might be construed as bribes. A manager who accepts a gift might feel pressured to channel business in that broker's direction.
Because Lynch managed so much money, you might expect to find that it took hundreds of thousands of dollars in bribes to buy his business. You would be wrong. What is the value of all the gifts Lynch received? A grand total of $15,948! The man who managed billions of dollars on behalf of investors all over the world got into trouble for accepting $15,948 worth of tickets to sporting events and a rock concert. He didn't even use many of the tickets he received.
I have no doubt that Peter Lynch is a man of integrity--an honest man of high ethical standards. Obviously, he would have been smarter not accepting any gifts whatsoever. But there is absolutely no evidence that Magellan shareholders were harmed in any way. On the contrary, Mr. Lynch delivered outstanding market-beating returns to his investors. In my view, if a man like Lynch can get into trouble for something like this, there is something wrong with the system. The government barked up the wrong tree in this case. My respect for Mr. Lynch has not been diminished in the least.
Lynch managed Fidelity's Magellan fund for 13 years. Under his watch, assets under management ballooned to $14 billion. He authored several books on investing and coined the term "ten-bagger," which describes a stock that goes up 10 times in value. He was famous for walking around shopping malls and paying attention to what people were buying. Today, he spends a great deal of time on philanthropy.
Yet the man who is so revered by investors, stands a little tarnished. You see, Lynch accepted gifts from brokerage firms that were seeking Fidelity's business. This is considered a big no-no in the mutual fund industry because gifts from brokers might be construed as bribes. A manager who accepts a gift might feel pressured to channel business in that broker's direction.
Because Lynch managed so much money, you might expect to find that it took hundreds of thousands of dollars in bribes to buy his business. You would be wrong. What is the value of all the gifts Lynch received? A grand total of $15,948! The man who managed billions of dollars on behalf of investors all over the world got into trouble for accepting $15,948 worth of tickets to sporting events and a rock concert. He didn't even use many of the tickets he received.
I have no doubt that Peter Lynch is a man of integrity--an honest man of high ethical standards. Obviously, he would have been smarter not accepting any gifts whatsoever. But there is absolutely no evidence that Magellan shareholders were harmed in any way. On the contrary, Mr. Lynch delivered outstanding market-beating returns to his investors. In my view, if a man like Lynch can get into trouble for something like this, there is something wrong with the system. The government barked up the wrong tree in this case. My respect for Mr. Lynch has not been diminished in the least.
Monday, March 03, 2008
Oil Sets All-Time High
Oil prices set an all-time high today on both a nominal and inflation-adjusted basis. Yet gasoline prices are still below their May 2007 highs. Interestingly, oil prices were much lower last May. But gasoline prices surged anyway due to problems at refineries. Today, however, it is oil, the raw material for making gasoline, that is just starting to push gasoline prices higher.
But oil prices are not climbing because of a lack of supply. Instead, they are rising due to demand for oil futures contracts. Investors are pouring money into the commodity because the Fed is trashing the dollar. Because oil is a dollar denominated commodity, it provides a hedge for investors worried about a falling dollar. They are looking for ways to preserve the value of their dollar denominated assets. Eventually, these higher oil prices will drive up the price of gasoline, too.
In the past, higher gasoline prices had little effect on consumption. This is because it takes time for consumers to adjust their behavior. You don't immediately dump your SUV and buy a Civic just because gasoline prices spike. But if you are convinced that higher gasoline prices are here to stay, the next time you are in the market for a new vehicle, you will consider something more efficient. After several years of watching gasoline prices climb higher and higher, consumers are making the switch.
These days automobile manufacturers can't sell SUVs and pick-up trucks without making large concessions. In fact, GM just reported a 19% drop in light truck sales. Consumers are doing the math and they now want more efficient vehicles. At $3 per gallon, if you drive 12,000 miles per year and get 20 mpg, a 50% improvement in mileage saves you $600 per year. At $4 per gallon, you will save $800 per year. If there are three cars in your family and they rack up a total of 36,000 miles per year, at $4 per gallon, the total savings adds up to $2,400 per year.
The government can take steps to encourage conservation. CAFE standards, however, are not the way to go. A better approach is to put a floor on gasoline prices. While I'm no fan of higher taxes, it cannot be denied that taxes are a great way to affect behavior. If we want to reduce our dependence on foreign oil, we should encourage people to consume less gasoline. The best way to do that is to make driving more expensive. However, any incremental revenue the government generates from a floor on gasoline prices should be used to offset other taxes or to fund research into alternative technologies. Using it for general funding purposes would be nothing but a big waste.
But oil prices are not climbing because of a lack of supply. Instead, they are rising due to demand for oil futures contracts. Investors are pouring money into the commodity because the Fed is trashing the dollar. Because oil is a dollar denominated commodity, it provides a hedge for investors worried about a falling dollar. They are looking for ways to preserve the value of their dollar denominated assets. Eventually, these higher oil prices will drive up the price of gasoline, too.
In the past, higher gasoline prices had little effect on consumption. This is because it takes time for consumers to adjust their behavior. You don't immediately dump your SUV and buy a Civic just because gasoline prices spike. But if you are convinced that higher gasoline prices are here to stay, the next time you are in the market for a new vehicle, you will consider something more efficient. After several years of watching gasoline prices climb higher and higher, consumers are making the switch.
These days automobile manufacturers can't sell SUVs and pick-up trucks without making large concessions. In fact, GM just reported a 19% drop in light truck sales. Consumers are doing the math and they now want more efficient vehicles. At $3 per gallon, if you drive 12,000 miles per year and get 20 mpg, a 50% improvement in mileage saves you $600 per year. At $4 per gallon, you will save $800 per year. If there are three cars in your family and they rack up a total of 36,000 miles per year, at $4 per gallon, the total savings adds up to $2,400 per year.
The government can take steps to encourage conservation. CAFE standards, however, are not the way to go. A better approach is to put a floor on gasoline prices. While I'm no fan of higher taxes, it cannot be denied that taxes are a great way to affect behavior. If we want to reduce our dependence on foreign oil, we should encourage people to consume less gasoline. The best way to do that is to make driving more expensive. However, any incremental revenue the government generates from a floor on gasoline prices should be used to offset other taxes or to fund research into alternative technologies. Using it for general funding purposes would be nothing but a big waste.
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