Thursday, November 11, 2010

The Glitter of Gold Hangs Over Seoul

The G-20 summit is underway in Korea and Robert Zoellick's comments about using a gold standard for currencies has shaken things up a bit. Here is view of the summit at The Fiscal Times.

Monday, November 08, 2010

Let Businesses Get Down to Business

Friday's jobs report was better than expected. Non-farm payrolls increased by 151,000 in October and all of the gains came in the private sector. Unfortunately, there isn't much in what I would call the productive industries. The job gains came in areas like health care and eating and drinking establishments. Mining saw some gains, but most of it was in support services. Things like construction and manufacturing are still doing badly. Here is my interview on MSNBC about the jobs report.

Thursday, November 04, 2010

Kill This Subsidy

I have never understood why mortgage interest is tax deductible. This subsidy simply bloats the value of homes, favors the home building and real estate industries over other industries, and encourages people to take on more debt than they otherwise would. Read more at Let's Kill This Housing Subsidy.

Friday, October 22, 2010

U.S. Should Follow U.K.'s Lead

The United Kingdom is getting serious about reducing spending and shrinking its deficit. The United States wants to spend even more money that it does not have. Read more at U.S. Should Follow U.K.'s Lead.

Saturday, October 16, 2010

A Weak Dollar is Bad Policy

A weaker dollar should reduce the trade deficit and create jobs in the U.S. However, the most recent trade data from the Commerce Department suggest the strategy is not working. Read more at A Weak Dollar is Bad Policy.

Thursday, October 14, 2010

The Fed is Out to Destroy Your Money

The Fiscal Times is a relatively new online publication focused on economic issues. I recently agreed to start providing content. Here's my first piece: The Fed is Out to Destroy Your Money.

Thursday, September 30, 2010

Stocks Buck the September Curse

Ken Fisher once told me to always expect the unexpected. He was talking about stocks. What he meant was that stocks rarely do what everyone expects them to do. For example, on average, stocks have done worse in September than in any other month. Many investors were betting the same would be true this year.

It wasn't to be. The S&P 500 surged 8.76% this September, which was more than enough to push the index into positive territory for the year. In fact, during the past 20 years (i.e. 240 months), the S&P 500 has done better than that on only three occasions. It gained 11.16% in December 1991, 9.67% in March 2000, and 9.39% in April 2009.

Our Forbes Special Situation Survey portfolio went along for the ride and then some. It gained 10.88%. Terex Corp. (TEX) did the best, surging 22.31%.

I continue to hold a bearish view on the economy. Housing and employment are what I worry about the most. Nonetheless, I am still avoiding bonds. Because interest rates are so low, bonds are too risky for my taste. I would rather hold a mix of cash and selective stocks.

Friday, September 24, 2010

The Gold Bubble

Vahan Janjigian issued the following commentary on Sept. 24 in a Special Report to subscribers of the Forbes Special Situation Survey.

Although our focus at the Forbes Special Situation Survey is equities, we can’t help but notice the extremely strong bull market in gold. In our opinion, however, gold prices have gone up much too high. Like equities in 2000 and housing in 2006, we are concerned that gold will be the next bubble to burst.

Historically, gold has been considered a safe haven. Investors often hoard gold and other precious metals when they are concerned about the economy or the value of paper currencies. Since global economies have been shaken to the core and are still teetering, a run up in the price of gold makes perfect sense. However, it is the extent of the run up that concerns us. In early 2007, before the financial crisis hit, gold was selling for less than $700 per ounce. Today, it broke above $1,300 per ounce for the first time.

Although gold does have some industrial applications, the strength in its price has nothing to do with increased demand. Furthermore, gold’s primary use is in jewelry and demand there is actually down. So investors are clearly buying this precious metal out of fear. They are afraid that the Fed and the Treasury are not on the right path to restoring the health of the economy. They are also afraid that the U.S. dollar will lose even more of its value if the Fed actually embarks on another round of quantitative easing (i.e., the so-called QE II).

We agree that the government has made considerable mistakes in trying to stimulate the economy. Nonetheless, we believe that gold prices have surged too high. The stock market is up almost 70% from its March 2009 low, yet gold has rallied about 40% during the same period. This positive correlation is historically unusual. Furthermore, the Fed will eventually have to ease up on its efforts to stimulate the economy. When the Fed begins to reverse course, gold prices could tumble dramatically.

One thing we have learned over the years is that a bubble can get much bigger before it pops. Therefore, it is entirely possible that gold prices could go much higher. Momentum investors might want to go along for the ride. However, while we agree that gold should be a core holding in most portfolios, we suggest that at this time it makes more sense to pare back on your exposure to gold. Those who have more guts might even want to take a short position against the metal. The proliferation of exchange-traded funds (ETFs) on the market makes shorting gold relatively easy. Some ETFs that short gold include GLL, DZZ, and DGZ. However, we strongly urge you to carefully research these and any other financial instruments before you execute a trade. ETFs sometimes use a significant amount of leverage. This could cause you to lose much more money than you might have anticipated if gold prices continue to rise.

Friday, September 17, 2010

CNBC Worldwide Exchange


I got up at 4:30 this morning to do my first interview on CNBC's Worldwide Exchange. I had a little trouble hearing the first question, but things went well after that. I expressed my continuing concerns about the economy--in particular the jobs market and housing. I was also asked about gold. I have to admit up front, I've been wrong there. I really see no justification for the tremendous rally in gold and I certainly wouldn't get in now. But then again, like I said, I've been wrong about gold for quite some time!

Tuesday, September 14, 2010

To Dip or Double-Dip?

There has been a lot of talk lately about whether or not we will have a double-dip recession. I have long been in the camp that says a double-dip is a real possibility. I believe the probability for a second recession is higher now than it was last March. But how does one actually assign a number to this probability?

The economists Nouriel Roubini and Martin Feldstein are perhaps the most bearish on the economy. They say the chances of a second recession are about one in three. This means they believe that if the economy were to experience the same exact conditions it is experiencing now hundreds of times, one-third of those times would result in a recession. Another way to look at is that the probability that we will not have a second recession is about 67%. In other words, even the most bearish economists believe there is a much better chance that we will avoid a second recession than there is that we will actually have one.

That doesn't mean we should not take seriously the probability of a second recession. Yesterday, Warren Buffett expressed his confidence that a second recession would not occur. But I don't think that Buffett would entirely rule out the possibility. It is encouraging to hear him say that Berkshire Hathaway's businesses are "coming back almost across the board." He also claims that headcount at his companies has risen.

Some experts have complained that the real problem is that the banks are refusing to lend money to businesses--particularly small businesses. Instead, they are being cautious and keeping lots of capital on their balance sheets. Of course, to some extent, they are being forced to hold onto their capital due to regulatory requirements. So it was interesting to hear Buffett say, "I know Wells Fargo, they would love to have $50 billion more of loans now. Go in and talk to the banker."

This sounds like an invitation to me. I would encourage small businesses to do exactly what Buffett suggests. Let's put Wells Fargo to the test and see if they are really willing to make those loans.

Friday, August 27, 2010

Give Me Cash and Stocks, No Bonds.

"How do you invest in a slow-growth environment?" That's what Michelle Caruso-Cabrera of CNBC asked me on Power Lunch yesterday. I recommended a barbell approach focused on cash and equities.

I told her I would avoid bonds because the yields are much too low. I know that cash pays nothing, but why would I settle for almost nothing from bonds, tie my money up for several years, and take the risk that interest rates suddenly rise? Instead, I'd rather keep cash on hand to take advantage of any major sell-offs in equities when they occur.

As for the other end of the barbell, I would focus on non-cyclical companies that pay dividends and show some evidence of dividend growth. That way, I can earn a yield equivalent to bonds and be able to participate in capital appreciation. As I explain in my most recent Forbes column, dividend paying stocks outperform non-dividend paying stocks over the long term. A new study shows that the difference in performance is even greater during economic recessions and down markets.

One company that fits this mold is Hormel Foods (HRL), the maker of SPAM. It's a stock I recommended in my newsletter, Forbes Special Situation Survey last October. The stock currently yields 2% and has a long history of dividend increases. I'd rather hold a stock like HRL than the 10-year Treasury note.

Tuesday, August 24, 2010

The Plunge in Housing Must Continue

Last spring, we saw some strength in the housing market. I warned at the time that the strength may not last once the tax credits expire. That turned out to be quite an understatement.

If you recall, in order to help prop up the sick housing market, the government began offering tax credits to first time homeowners. It soon decided that wasn't enough. So it extended the tax credits to all home buyers. Basically, the government did everything it could to boost demand for houses.

What government officials did not realize is that they could not prevent the housing market from reaching equilibrium. They could delay the process, but could not prevent it.

The housing market is sick for a good reason. There are simply too many homes in America and not enough demand. Home builders went absolutely nuts during the turn of the century. They were building houses like crazy. Back in 2004, I took part in a panel discussion about housing. Much to the chagrin of the other panelists, I questioned the wisdom of buying stocks of home building companies. Home ownership rates were at all time highs and home prices were reaching levels I believed were unaffordable for most Americans. I asked, "Where is all the demand going to come from for new homes? Will everybody in America own a second or third home? How can people afford to buy these homes?" Demand, I was told, would come from immigration. As for financing, I was told that new kinds of mortgages would make money available for just about anybody who wanted to buy a house.

Well, we know where that kind of thinking got us. Today, we found out that the housing market's long delayed march toward equilibrium is back on path. Existing home sales in July plunged 27.2% from June and 25.5% year-over-year to a seasonally adjusted annual rate of 3.83 million. Single family home sales plunged to their lowest level since 1995. Inventory surged to a twelve-and-a-half month supply. Of course, the inventory figures do not account for the so-called shadow inventory. Think of all those people who would like to sell their houses, but haven't listed them because they don't think they could get a good price right now.

It's truly amazing to think that the housing market could be so troubled at a time when mortgage rates are at all-time lows. Here's a news flash for policymakers: People cannot afford to buy houses when they don't have jobs. Even if mortgage rates turn negative, many people would not be able to make the monthly payments necessary to service the mortgage.

There are only two possible solutions to this problem: Either the employment market must start improving tremendously, or housing prices must go lower than they already have. Given the misguided government policies already implemented to try and address the economic recession, I suspect the latter is the most likely outcome.

Sunday, August 15, 2010

For-Profit Education on the Skids

In my column in the August 9 issue of Forbes magazine, I warned of a double-dip recession and talked about the importance of investing in stocks with growing dividends in a down market. I gave Washington Post (WPO) as an example of such a stock. The stock, however, has gone lower ever since.

In fact, all for-profit education stocks have been hit. Other examples include Corinthian Colleges (COCO), Apollo Group (APOL), American Public Education (APEI), Strayer Education (STRA), DeVry (DV), Career Education (CECO), Grand Canyon Education (LOPE), Bridgepoint Education (BPI), Education Management Corp. (EDMC), and Lincoln Education (LINC). Not surprisingly, the catalyst for the sell-off is proposed government regulation.

The for-profit education industry has grown in leaps in bounds. An estimated two million students are currently enrolled in such programs. That's about 10% of all students eligible to receive federal financial aid, and that's where the problem lies.

The Department of Education is concerned that at least some for-profit educational institutions are not on the up-and-up. They may be aggressively encouraging students to enroll and borrow money to pay for tuition without offering them any real prospect of finding jobs and paying back their loans. Not unreasonably, the government wants to see evidence that former students are able to pay back their loans and are actually doing so. To be specific, to meet the new guidelines, at least 45% of former students must be paying back principal on their loans, or the average debt burden of former students must be less than 8% of total income or 20% of discretionary income.

Having spent 12 years as a professor at traditional (i.e., not-for-profit) educational institutions, I am in favor of introducing market discipline to higher education. For-profit educational institutions have grown in popularity because they have proven their ability to deliver quality education at a fraction of the price that traditional colleges charge. Too many traditional universities are bloated with highly paid administrators and tenured faculty members who spend little time in the classroom and produce research of only marginal value.

While the profit motive can introduce efficiency and discipline, it can also result in corruption. Yet there is plenty of corruption at not-for-profit institutions as well. The Department of Education should monitor both groups closely. It is perfectly reasonable to ask all for-profit and not-for-profit educational institutions to provide evidence that they are admitting students on a selective basis and teaching them skills that result in gainful employment. Otherwise, we will end up with yet another tax-payer funded bailout.

Disclosure: Vahan Janjigian currently has a long position in Washington Post (WPO).

Tuesday, August 03, 2010

Don't Fall for the Rally. Economy is Still Sick

The following is Vahan Janjigian's commentary from the August issue of the Forbes Growth Investor:

On the last trading day of July, the Bureau of Economic Analysis (BEA) announced that GDP growth for the second quarter of the year was 2.4%. While this was less than the consensus estimate, I thought it was surprisingly strong. I was expecting a figure somewhat less than 2.0%. Keep in mind that this is just the BEA’s first estimate, the so-called advance estimate. A month from now it will publish a more accurate estimate. That second figure could be higher or lower than 2.4%. In any case, it is encouraging to see any amount of real economic growth taking place.

The biggest contributor to growth last quarter was private domestic investment, especially investment in equipment and software. Personal consumption expenditures were also a major contributor to GDP growth last quarter, but to a lesser extent than they were in the first quarter. However, net exports subtracted almost 2.8 points from GDP growth as the increase in imports far exceeded the increase in exports.

Government stimuli, both direct and indirect, were largely responsible for much of the growth in the second quarter. Without all those incentives, the economy would have likely dipped into a second recession. Of course, without those incentives, the budget deficit and the federal debt would not be nearly as large as they are now.

For the most part, corporate earnings reports have been strong. Unfortunately, revenues are still anemic. Companies are doing an excellent job of cutting costs, but headcount is one of those costs. Until they are absolutely convinced that sales will grow steadily, corporate managers are not going to resume hiring. In the meantime, corporations are piling up large amounts of cash. This bodes
well for those hoping for dividend increases. Many companies are also taking advantage of almost unbelievably low interest rates by refinancing higher rate obligations. They view this interest rate environment as a once-in-a-lifetime opportunity.

The same holds true for mortgages. With sales and prices down, this is a great time to finance the purchase of a house with a long-term mortgage—at least for those who can get approved. The national average for a 30-year fixed-rate mortgage is about 4.5%. Five years ago home prices and interest rates were much higher, but back then, just about anybody could get approved for a mortgage. Today, prices and rates are way down, yet lending standards have been tightened. If lenders had been this diligent in the years leading up to the housing bubble, we would not be in this mess to begin with.

In the meantime, the S&P 500 keeps gyrating between 1,025 and 1,125, rallying whenever there is a hint of economic recovery and selling off on any prospect of another recession. It seems that on some days, investors can’t even decide if a particular bit of news is good or bad. Traders are making good money on the big swings. Investors, however, are getting nowhere.

I continue to believe the economy is still sick. GDP growth is being artificially generated by a large government deficit and corporations are creating profits by squeezing costs. In the meantime, home foreclosures keep rising and jobs remain scarce. While stocks could rally strongly on any given day, I see nothing yet that makes me more bullish for the long term.

Monday, July 26, 2010

Beating the Estimate Isn't Saying Much

Investors are reacting positively to today's report that new home sales in June were better than expected. However, better than expected isn't necessarily good. On a seasonally adjusted and annualized basis, June sales were 330,000 units. That's 20,000 better than the consensus estimate and 63,000 more than were sold in May. Yet it is 66,000 fewer units than a year ago. There is currently a 7.6 months supply of new homes on the market.

The tax credits, which expired in April, caused April sales to surge to 422,000 and May sales to plunge to 267,000. That's no surprise. The June figure is merely the market's attempt to get back to equilibrium. Unfortunately, the long-term trend is still down for both sales and prices. The median price for a new home fell to $213,400 in June from $216,400 in May. It was $214,700 a year ago. The large number of foreclosures on existing homes won't help support prices for new homes.

The housing market is still in a process of finding a bottom. It may be close to getting there. If you are in the market for a new house, it's probably not a bad time to buy--depending on where it is located and how long you are planning to live in it. However, the longer-term health of the housing market depends on the health of the employment market. As long as large numbers of people who want jobs can't find jobs, housing prices and sales were remain depressed.

Tuesday, July 20, 2010

Housing Starts Fall

As I explain in a forthcoming column in Forbes magazine, the poor housing market is a major reason why I have remained skeptical about an economic recovery. Today's report on housing starts reinforces my view.

Housing starts in June fell to a seasonally adjusted annual rate of 549,000, 5% less than a month ago and almost 6% less than a year ago. The number was also significantly below the consensus estimate. Of course, much of the blame for the shortfall goes to the expiration of government tax credits. That should not surprise anyone.

Housing foreclosures and inventories are also on the rise. Foreclosures are closely related to the employment market. Despite the recent decline in the unemployment rate to 9.5%, there is little evidence of private sector job gains. Most of the employment growth is in the public sector. Although state and local governments have reduced payrolls, the federal government has more than made up for those job losses.

One bright sign is the financial services sector in New York City. Some firms, including Goldman Sachs, are finally hiring again. While this could be a turning point, it is still too early to be certain.

Thursday, July 08, 2010

Let's Listen to Arthur Laffer

Arthur Laffer is a conservative economist who is frequently pilloried by the left. He is best-known for popularizing the "Laffer Curve," a graphical depiction of the relationship between tax revenues and tax rates. The curve shows how tax revenues rise as tax rates rise, but only up to a certain point. Once tax rates surpass a critical level, tax revenues actually fall. In other words, when tax rates are already high (as they are now), the government can generate more tax revenues only by reducing tax rates. Many people find this obviously logical conclusion extremely counterintuitive.

In today's Wall Street Journal, Laffer takes on employment and makes a cogent argument as to why more generous unemployment benefits simply result in more unemployment. The facts clearly support his conclusion, yet those who point out facts are often accused of being cold hearted. There are 26 million Americans who are "officially" unemployed, marginally attached to the labor force, or working part-time for economic reasons. Many more are still working, but are extremely nervous about losing their jobs. One of my best friends just joined the ranks of the unemployed. He lost a job he held for 18 years. This guy is very smart and hard working. He would never consider milking the system to collect benefits while he sits at home. Yet the evidence is clear. The more generous unemployment benefits are, the longer people take to find jobs. It may appear to be cold hearted to limit benefits, but it is even more cold hearted to initiate policies that keep people out of work for longer periods of time.

Today, the Department of Labor announced that there were 454,000 initial jobless claims for the week ending July 3. Amazingly, this is considered good news because it is 21,000 fewer than the week before and 6,000 less than what economists expected. The private sector is still paring jobs. So are state and local governments. Yet the federal government keeps employing more and more Americans. These days, a job with the federal government is the only job that offers some security. However, as the government's role in the economy increases, so does the national debt.

Laffer's remedy is radical, but it would have no doubt worked. He says that instead of wasting all that money trying to stimulate the economy, we should have eliminated all taxes for 18 months. Imagine how many jobs would have been created if workers and employers didn't have to pay any taxes. Is it too late to implement this solution now? I say better late than never.

Thursday, July 01, 2010

Is a Double Dip Recession in the Cards?

The following is an edited version of Vahan Janjigian's commentary from the July issue of the Forbes Growth Investor:

When I was a kid, a double dip was a special treat. It meant you got two scoops of ice cream instead of one. When it comes to the economy, however, a double dip is no treat at all. It means you recover from a recession only to go into another one.

Readers of this page know I have been bearish on the economy for some time. In my view, things had gotten so bad there was no way they could quickly rebound. While I felt a rally off the March 2009 lows was justified, I also believed the market got way ahead of economic realities. After all, I saw no evidence of real demand for goods and services. Whatever demand I did see was artificially induced by increased amounts of government spending. However, with the national debt at 90% of GDP and a budget deficit of $1.4 trillion, the government cannot keep spending for long.

A few months ago, it was a faux pas to talk of a double dip recession. Today, it is de rigueur. A double dip is by no means a certainty, yet the odds are certainly growing in its favor. All that government spending was not particularly effective.

Look at housing. The latest figures on new home sales were abysmal. Why that would surprise any economist is beyond my comprehension. What happens when the government offers generous tax breaks to anyone who signs a contract to buy a house? We get plenty of signed contracts. And what happens when the tax breaks expire? Sales fall off a cliff. This is why April’s new home sales were strong and why May’s new home sales plunged. It also explains why pending sales of existing homes plunged in May. Furthermore, a signed contract does not guarantee a closing. Thanks to the mortgage-related financial crisis we are still struggling through, lenders have significantly tightened credit standards. Mortgage rates are at historic lows, yet many would be homebuyers cannot get approved to close the deal.

Housing is not the only market in distress. The latest ADP Employment Report showed a gain of only 13,000 nonfarm private jobs. That was 50,000 less than expected. Prepare yourselves for Friday when the Department of Labor releases its nonfarm payroll figures. The market is expecting a loss of 100,000 jobs. A number significantly worse than that will cause tremendous volatility in stock prices.

With the housing and employment markets so weak, how confident could consumers be? Not confident at all. After rising three months in a row, the Conference Board’s Consumer Confidence Index plunged in June. Only 8% of consumers surveyed think business conditions are good and only 4% believe jobs are plentiful. Consumers who lack confidence do not usually behave in a manner that spurs economic growth.

Finally, while I focus almost solely on stocks, I cannot help but notice the behavior of two non-equity assets. The yield on the 10-year Treasury note dipped well below 3%, yet gold prices are near $1,200 per ounce. Investors who believe these assets are reliable gauges of inflationary expectations are confused. The low bond yield signals no fear of inflation, but the high gold price signals the opposite. However, things really are different this time. Inflation has nothing to do with the prices of these assets. Increasingly risk averse investors now view Treasury bonds and gold as safe havens. They are selling risky assets such as stocks and bidding up the prices of safe assets. Stocks are getting cheaper, but I believe it is still too early to jump in with both feet.

Tuesday, June 15, 2010

Manufacturing Survey is Lame Excuse for Rally

Today's strong rally in stocks is being credited to a favorable Empire State Manufacturing Survey. This survey is administered by the Federal Reserve Bank of New York. Not surprisingly, investors reacted primarily to the headline, which does indeed suggest that things are getting better. Keep in mind, however, that the survey covers business conditions in just one state. Furthermore, the results are derived by surveying only 200 top executives at New York manufacturing companies; of which only about 100 actually responded.

That so many investors would pay this much attention to a rather esoteric report seems a bit odd. At least for today anyway, investors chose to buy stocks due to how 100 executives responded to this one question: "What is your evaluation of the level of general business activity?" The New York Fed was not looking for a well thought out essay. Instead, it was a multiple choice question with only three possible answers: Decrease, No Change, and Increase. The Fed then creates an index from the answers. Investors apparently got excited because the index was somewhat higher than it was a month ago, which suggests a positive trend.

The survey does contain other questions as well, but stocks surged primarily because of how 100 executives answered that lead question. Of course, the value of the index could have been quite different if just one or two executives responded in a different manner, or if some of the 100 who skipped the survey had actually responded. Which brings up another question, why didn't those executives respond? Was it because business conditions were so good that they were simply too busy? Or was it because business conditions were so bad that they were too disillusioned?

The survey also asked about the number of employees and about the average employee workweek. The results from the 100 executives who responded suggest that manufacturing companies added employees, but at a slower pace than they did a month ago, and that employees are working longer hours. The survey results also indicate that the executives are optimistic about future business conditions (i.e., six months from now), but not as optimistic as they were a month ago.

Overall, the survey does not really tell us much that we did not already know. Results are better than they were a year ago, but not that different than they were a month ago. Nonetheless, investors seized on the report as an excuse to buy stocks. However, the real reason they started buying was because they were convinced stocks were oversold. As I've argued before, there will be many days on which stocks rally strongly, yet the overall trend is still unfavorable. A somewhat upbeat manufacturing report is certainly nice to see, but we still have to deal with much larger problems in the economy, including huge amounts of sovereign debt, stubbornly high unemployment, a still sick housing market, and a general lack of demand for goods and services. (Except, of course, when demand is being fueled by generous government subsidies!)

Tuesday, June 01, 2010

Greece and the Gulf Oil Spill Scare Investors in May

April 20 marks the start of the biggest environmental disaster in U.S. history. It was on this date that an oil rig operated by British Petroleum in the Gulf of Mexico exploded. Initial reports said oil was leaking into the Gulf at a rate of 1,000 barrels per day. That sounds like a lot, but most of us probably figured BP would stop the leak quickly. Days later,we learned that not only was oil still leaking, but that the rate of flow was more like 5,000 barrels per day. Forty-two days later, oil is still leaking, but now they say the flow could be as high as 19,000 barrels per day. The level of incompetence seems to prove Murphy’s Law. The scale of the catastrophe is so extensive and unimaginable that we have all but forgotten the 11 people who died on the rig on the day of the explosion.

On May 6,we had a bit of an explosion in the financial markets, which distracted us from the oil spill—at least for a while. That was the day the Dow Jones Industrial Average suffered its largest intra-day point drop ever. Almost suddenly, the Dow fell 998.5 points before bouncing back and closing down 347.8 points for the day. The blame for the “flash crash” was initially placed on everything from computers that automatically executed programmed trades to a trader with “fat fingers” who hit the wrong letter on his keyboard. The SEC is still investigating the events of the day and has yet to determine what the actual cause was.

There can be no doubt, however, that part of the blame goes to the rioting in Greece. Gil Scott Heron, a 1970s poet and musician once said, “The Revolution Will Not be Televised.” He was wrong—at least in this case. The selling of stocks took off in earnest at the same moment that Greek police and demonstrators clashed, an event widely televised on the trading floor of the NYSE. Investors were already nervous about Greece. Not only was there doubt about Germany’s commitment to saving Greece and the euro, but there was also a real Greek tragedy that took place the day before when three employees, one of them pregnant, were killed by a demonstrator who decided to firebomb their bank.

The events in Greece have brought the risks of sovereign debt to the forefront. At the CFA Institute’s annual conference in mid-May, several speakers focused on the dire consequences of too much sovereign debt. Niall Ferguson’s remarks were the most sobering. He suggested that the situation in Greece pales in comparison to what could happen in many larger economies—including the U.S. He said that focusing on debt as a percentage of GDP can be misleading. A more relevant metric is the percentage of tax revenues that must service the debt. In the U.S., interest on the federal debt already eats up more than 9% of our revenues. Yet at a time when rates are at historic lows, the government continues to rely on short-term financing, taking on tremendous rollover risk. Ferguson says that if rates were to rise just slightly,we could soon be spending 20% of our tax revenues on interest payments, a situation that would be untenable.

Unfortunately, stocks suffered one of their biggest monthly declines just as many reluctant retail investors decided to go back into the market. I expect more selling ahead.

Tuesday, May 18, 2010

Schapiro Virtually Addresses CFA Institute

The CFA Institute is currently holding its annual conference in Boston. There are about 1,600 investment professionals in attendance from all over the world. Not surprisingly, there is much discussion about regulatory failures. Therefore, it was appropriate that SEC chairman Mary Schapiro kicked off the morning session on Tuesday. Unfortunately, she did not appear in person. She addressed the crowd remotely from her office.

Schapiro talked about a number of issues, but one she stressed strongly was the need for high quality international accounting standards. She called for a convergence of U.S. and international accounting standards.

The audience, however, was more interested in hearing about reforms at the SEC that might prevent the kinds of failures seen in recent years. Harry Markopolos, who was sitting in the audience, is particularly interested in this. Markopolos is a former student of mine from Boston College's M.S. program in finance. He is best known as the man who tried to stop Bernie Madoff. Markopolos complained to the SEC for years about Madoff, but was ignored. He recently published a book titled "No One Would Listen," which details all of this.

Its failure to stop Madoff before things got worse is one of the SEC's most embarrassing moments--even more embarrassing than the recent revelation that some employees had spent a considerable amount of time surfing pornographic websites during working hours. Without directly mentioning its Madoff failure, Schapiro said the SEC receives thousands of tips and leads every month. She is trying to get the agency to do a better job of processing all of these.

Some observers have complained that the SEC has too many lawyers and not enough financial experts. Schapiro admitted the agency is heavily lawyered, but said that is necessary since it is a law enforcement agency. However, she also said the SEC has been hiring individuals with broader talents and experiences. For example, many recent hires have worked at hedge funds and rating agencies. Schapiro mentioned that a lack of proper funding has long been a problem, but said funding was recently restored to 2005 levels. Nonetheless, she argued that the SEC should have independent sources of funding.

Schapiro explained that the reason she could not appear in person was because the SEC was going to release a statement later in the day about the May 6 meltdown. That was the day when the Dow suddenly lost 1,000 points on an intraday basis. Sure enough, the SEC announced a proposal to pause trading for five minutes on any stock that moves by 10% or more in a five minute period. It is hoped that such a pause would prevent high frequency, algorithmic, computer-driven trades from moving stock prices in a disorderly fashion. Click here to read the SEC press release regarding this proposal.

Friday, May 07, 2010

MoneyShow Las Vegas Webcast

If you can’t make it to the MoneyShow Las Vegas, May 10-13, 2010 at Caesars Palace, you can still see my presentation, "Quantitative Stock Picking for the Forbes Growth Investor," by webcast LIVE on Tuesday, May 11, from 7:45am – 8:30am PDT. Click here to register then return on Monday to view the event.

Thursday, May 06, 2010

Fat Fingers Cause Panics

Trading couldn't get more exciting than it was today. At one point this afternoon, the Dow Jones Industrial Average was down almost a thousand points. It staged a huge rally, but still closed down 348 points. At one point, Apple (AAPL) dipped below $200 before jumping back to $246. All this happened very quickly. This is the kind of volatility traders live for.

I have been expecting a pullback in stock prices for some time. I have argued that a strong rally off the March 2009 lows was fully justified, but not to the extent we have seen. Yet, I did not expect a selloff to happen in a matter of minutes. Why the market plunged so much and so fast in the middle of the afternoon isn't entirely clear. Some blame an erroneous quote on Procter & Gamble (PG), saying it caused panic selling across the board. Others say the selloff was caused by a trading error on the Nasdaq. This so-called fat-finger error occurred when a trader accidentally entered an order to sell a billion shares rather than a million shares. Still others blame the rioting in Greece for the selloff. That rioting was widely broadcast on trading floors.

These reasons might explain the extent of today's selloff only if investors were already extremely nervous to begin with, which I believe they were. Like myself, many investors have been skeptical of the rally. They were happy to see their stocks go up, but they were also prepared to sell at the first hint of trouble. That trouble came this afternoon, so they sold with a vengeance.

Those who were paying close attention to the markets today had an opportunity to make a fast buck. However, everyone else needs to focus on the longer term. While there are many stocks selling at attractive prices (especially after today's action), I continue to expect further weakness. After all, the recent growth we have seen in the U.S. economy is largely the result of government programs. The jobs market will probably start improving soon, but not enough to significantly reduce the unemployment rate. The recent strength in the housing market may not last now that those tax credits have expired. Finally, troubles in Greece could spread to other European nations.

I prefer to hold onto much of my cash for the time being. I suspect there will be better buying opportunities in the weeks ahead.

Sunday, May 02, 2010

Goldman Sachs, Washington, and the Theater of the Absurd

The following commentary is from the May issue of the Forbes Growth Investor.

Albert Camus was an Algerian French writer linked with a philosophy known as absurdism. His spirit must have been in Washington last week where Congress and Goldman Sachs performed in the Theater of the Absurd.

I have no particular desire to defend Goldman Sachs, a firm full of arrogant, overpaid bankers. In fact, about 15 years ago, Goldman turned down a friend of mine for a job. She was told, "You are very smart, but you are not a guru. We only hire gurus." We got a great laugh out of that comment. Today, I have to wonder, "Where have all the gurus gone?"

The SEC is suing Goldman Sachs for fraud, so you would think Goldman’s attorneys would have advised those called to testify in Congress to keep mum. There can be no doubt that the SEC will use their words against them. Instead, current and former Goldman executives answered questions politicians posed. I use the word "answered" loosely. More often than not, these executives came across as being obviously evasive. Now the Justice Department has jumped into the fray by filing criminal charges against Goldman.

The case against Goldman boils down to three issues: 1) Did the firm have an obligation to disclose who the parties were on both sides of a trade, 2) did it have an obligation to advise one of those parties not to make what appears to be a stupid trade, and 3) did it represent to one of the parties that the securities in question were something other than what they really were? In my opinion, the answer to the first two questions is no. As for the third, we will have to wait and see what the evidence shows.

Whether we are talking stocks, bonds, or houses, by definition, the buyer has a more bullish outlook than the seller does. Only time will tell who guessed right. If you go back to when these infamous trades were made, you will see that it was not obvious to everyone that housing prices were going to collapse. Back in 2004, I was not yet convinced we had a housing bubble. Still, I wrote an article called, Why I Hate Homebuilders arguing that housing prices could fall. A year later, I told NBC Nightly News that homeowners with interest-only subprime mortgages will be shocked by how much their monthly payments will increase. This was a full year before housing prices peaked. At the time, most housing experts still thought prices would never fall.

John Paulson figured out a way to bet against subprime mortgages. I wish I had been smart enough to do that. Goldman Sachs helped Paulson put the instrument together. Those on the other side of the trade were simply wrong.

Furthermore, Goldman’s actions did not cause the housing market to collapse. Housing prices fell simply because irresponsible lenders gave mortgages to unqualified borrowers. Both the lenders and the borrowers knew (or should have known) that these mortgages were designed to blow up if housing prices simply stopped rising. The government bears more responsibility for the mortgage mess than Goldman does. The government thought it was good public policy to encourage home ownership. For years, it urged lenders to make money available to unqualified borrowers. The government used Fannie Mae and Freddie Mac to prop up the mortgage market. Will the government take its share of the blame? Of course not. Instead, it will go after Goldman Sachs (and probably several other banks). After all, that is where the money is.

Tuesday, April 27, 2010

Shorts vs. Net Shorts

I don't want to put myself in the awkward position of defending a bunch of overpaid bankers from Goldman Sachs, but today's Congressional questioning was a bit ridiculous. The first thing that struck me was how evasive many of the current and former executives of Goldman Sachs were. However, this was no surprise. After all, these guys are being sued by the SEC. They must be very careful about what they say.

The second thing that struck me was Senator Carl Levin's apparent misunderstanding of short positions and net short positions. Goldman CFO David Viniar kept trying to explain to Senator Levin that Goldman's net short position wasn't material. Yet Levin did not want to hear it. Instead, he kept trying to get Viniar to admit that Goldman had a large short position.

Viniar is right. In order to understand Goldman's exposure, you must compare the size of its short position to the size of its long position. It is meaningless to say that the company made a lot of money on its shorts unless you also consider how much money it lost on its longs. Senator Levin did not seem to understand this point.

By way of comparison, suppose an individual with $1,000 to his name borrows $100,000 and puts the full amount into his savings account. Senator Levin would argue that the value of his assets went up materially. That's true, but it's meaningless because the value of his liabilities also went up by the same amount. In fact, this individual's net worth hasn't changed at all. You can't look at just one side of the balance sheet.

If you make a lot of money on a trade, the IRS does not tax you on that trade alone. Instead, it allows you to net your gains against your losses and taxes you only on your net gains. Why can't Senator Levin understand a concept as simple as this?

Goldman may have done a lot of things wrong, but David Viniar is absolutely right to insist that examining the company's short position in isolation is completely misleading.

Tuesday, April 20, 2010

The Future of Entrepreneurship Looks Bright

Just a couple of months ago, I had never heard of The Kairos Society. However, I received an invitation from Kristen Santerian, president of the University of Pennsylvania chapter, to attend their annual summit and make some remarks about opportunities in emerging markets. So I did a little research. What I learned was amazing.

The Kairos Society is an entirely student-run organization whose aim is to promote entrepreneurship. It was started three years ago by Ankur Jain, another undergraduate student at the University of Pennsylvania.

Imagine the effort that goes into pulling off a multi-day conference in New York City. You have to find a venue, you have to make hotel arrangements, and you have to provide meals and transportation. There are professionals who make a living putting together conferences like this, yet all of it was done through the efforts of Ankur and a whole cadre of student volunteers. They even managed to arrange a dinner cruise around lower Manhattan for all the attendees, which I would estimate numbered about 500. All of America's top universities were represented. There were also delegations from all over the world including China, India, Hungary, Spain, and the U.K.

These students managed to pull in some of the most impressive speakers I have heard. The list included Carl Schramm, who heads the Kauffman Foundation, Peter Diamandis, founder of the X-Prize Foundation, Bruce Mosler of Cushman & Wakefield, and Admiral William Owens, former Vice-Chairman of the Joint Chiefs of Staff. Even the ever-popular Maria Bartiromo of CNBC was on hand.

Without doubt, however, the most impressive portion of the conference was learning about the student's business ideas. And where do you think they demonstrated their ideas? On the floor of the New York Stock Exchange, of course.

A true entrepreneur sees a problem that needs to be addressed and tries to solve it. Or, he/she thinks of a product or service that people don't even realize they want, and develops it. Ideas are great, but they are not enough. As the old saying goes, ideas are a dime a dozen. Execution is the most critical step. People come up with great ideas all the time, but it takes a special talent to do something about it. An idea is useless unless it is put into action. The amazing part of the conference was that many of the ideas these students had come up with were actually being implemented.

Here are a few examples:

*Installing moisture sensors in farms that control irrigation systems. The students who came up with this plan estimate it will cut water usage by 10%.

*Streamlining the on-line college application process through a website that consolidates applications to all universities.

*Providing an on-line campus service network that allows students to advertise their services and find the services they need from other students. Want someone to do your laundry? Find them on-line. Students use credits purchased from PayPal to pay for services.

*Selling custom-made fixed-gear bicycles, a hot urban craze, at a substantial discount by directly connecting the buyer and manufacturer.

*Fish farms that go way beyond salmon.

Many nations, including the U.S., are currently dealing with difficult economic times. We may continue to struggle a while longer. However, hanging around these incredibly bright young students for a couple of days raised my level of confidence about the future. I suspect I just met some of the people who will be changing our lives for the better in the very near future.

Friday, April 16, 2010

Goldman Tarnishes Buffett's Image

Each year about this time, the media gears up for a major event: Berkshire Hathaway's annual shareholders' meeting. This year's meeting will be held on Saturday, May 1. As usual, everyone's interest turns to Berkshire CEO Warren Buffett, who is perhaps America's most-loved business executive. Not only is Buffett considered one of the world's greatest businessman, he is also thought to be one of the most ethical.

Because I wrote a book about Buffett, I am often asked about him. Usually, people want to know how he became so rich, what stock or company he might buy next, or what they should do to be like him.

About a week ago, Betty Liu of Bloomberg television interviewed me about Buffett. Her questions were a bit more sophisticated. She seemed particularly interested in his investment in Goldman Sachs. Given today's announcement that the SEC is suing Goldman Sachs for subprime mortgage fraud, her timing couldn't have been better.

Liu wanted to know if Buffett had tarnished his image by getting involved with an investment bank that is not exactly loved on Main Street. After all, Goldman's executives seem to exist in a world of their own. They have little in common with the ordinary "man on the street." These are people who think nothing of getting paid several million dollars each year. No doubt, some of them think they are entitled to more. In comparison, Buffett is one of the most underpaid executives. He gets just $100,000 per year to run Berkshire Hathaway. Despite Goldman's excesses, I defended Buffett's investment in the bank. Buffett felt he was getting a great deal, so he took it.

Over the years, Buffett has strongly criticized the investment banking industry. However, he has also made it clear that Goldman Sachs was the best of the lot. He often praised former Goldman executive Byron Trott. And during the recent financial crisis, Buffett invested $5 billion of Berkshire's money in Goldman Sachs preferred stock. Berkshire also received warrants to buy Goldman's common stock at $115 per share.

Today, after the SEC made its announcement, shares of Goldman plunged 13% to close at just under $161 per share. Berkshire lost a ton of money on paper. Although its warrants are still well in the money, Buffett's armor looks at least a little bit less shiny.

Tuesday, April 13, 2010

Special Situation Survey Ranked As One of the Best.

I'm happy to say that our stock picks in the Forbes Special Situation Survey have done extraordinarily well over both the short and long term. In fact, according to the Hulbert Financial Digest, we have generated a 17.8% annualized return (excluding dividends) over the past five years. In no small part, this is due to my crack staff of equity analysts including Taesik Yoon and Sam Ro. Mark Hulbert recently singled us out as a top-performing investment newsletter in an article he wrote for MarketWatch. This follows an article written by Peter Brimelow for MarketWatch about a year-and-a-half ago. WBBM radio in Chicago noticed our performance record and interviewed me about our stock picking strategy.

Based on our record, we have received a number of requests to manage money. That is not a service we offer at the present time, but it is something we may do in the future. I'll certainly keep you all posted if anything develops on that front.

Monday, April 12, 2010

When Better-Than-Expected Isn't Good Enough

Earnings season is upon us again and, for the most part, analysts' forecasts are rather rosy. After all, corporations have slashed costs over the past two years. With some companies now seeing a pick up in sales, their bottom lines could see a nice jump.

Furthermore, as optimistic as the analysts are, their history in recent periods suggests caution. In other words, they have underestimated earnings more often than they have overestimated them. To some extent, they do this on purpose. After all, unless they are short, investors are more likely to get upset if a company falls short of the earnings estimate than if it beats it.

So we shouldn't be surprised if the majority of earnings reports for the first quarter come in ahead of the forecasts. The bigger question is how will the stocks react? Will beating the "number" by a penny or two be good enough?

The S&P 500 is up 7.5% year-to-date suggesting that investors are expecting stellar results for Q1. Given the strength of the rally, there is a good chance that stocks could sell off even if earnings beat the forecasts. I suspect this earnings season, "better-than-expected" will not be good enough.

Tuesday, April 06, 2010

A Review of "Investing Without Borders"

I've been reading a new book by Daniel Frishberg called Investing Without Borders: How 6 Billion Investors Can Find Profits in the Global Economy. Frishberg, a former Marine, is the founder of BizRadio Network and the host of the MoneyMan Report, a radio program I have been a guest on many times.

The foreword to the book is written by Arthur Laffer, the father of the so-called Laffer Curve, which is a graphical depiction of the relationship between tax revenues and tax rates. In fact, Frishberg credits Laffer in his opening chapter for his unique take on the classic tale of Robin Hood. As Laffer points out, if Robin Hood keeps stealing from the rich, the rich will simply avoid traveling through Sherwood Forest.

In general, Frisherg's book provides a refreshing take on investing and challenges much of financial theory. Frishberg is a man with a tremendous amount of common sense, a trait that has served him well over the years. For example, as Frishberg points out, financial experts would tell you not to try to time the market. In fact, they say no one can do this successfully over the long run. Frishberg, however, argues that you can and should time the market. The recent financial crisis showed us all how a buy-and-hold strategy will decimate your wealth. Furthermore, the experts say you should always hold an extremely well-diversified portfolio. Frishberg argues that you should not diversify too much. Instead, you should do your research, avoid the bad stocks, and buy only the good ones.

Frishberg is also a big fan of greater foreign exposure. He believes most American investors have too little exposure to foreign markets--especially the markets that will drive much of the global growth in future periods. This is not to say he is bearish on America. He isn't. In fact, Frishberg says, "The real long-term success of the United States is still ahead of us." However, he thinks it would be foolish to ignore the fact that the rest of world wants to be like us. They are catching up and there is a lot of money to be made by investing in those markets.

As the title of the book suggests, Frishberg wants you to think about investing in global terms. Traditional borders are becoming less of an obstacle than they once were. Entrepreneurs can set up shop almost anywhere. They will go where conditions are most friendly. Governments will have less ability to force consumers to buy overpriced products simply because they are manufactured at home. These are the trends that Frishberg thinks will dominate the future. They are also trends Frishberg says will make investors rich if they are smart enough to exploit them.

Sunday, April 04, 2010

FGI Commentary

The following commentary appeared in the April issue of the Forbes Growth Investor.

It seems that no amount of bad news will keep this market down. Stocks soared in March, a month that saw a horrific terrorist attack in Moscow, rising trade tensions with China, and the passage of a major government healthcare bill that will no doubt add to the national debt and deficit no matter how loudly Democrats insist that it won’t.

That’s not to say there was nothing to cheer. Housing prices appear to be firming and even rising in some parts of the country, state governments are projecting better-than expected tax revenues, consumer sentiment and confidence numbers appear to be trending higher, the IPO market is coming alive, M&A activity is picking up, economists are forecasting real GDP growth, and some corporations are finally seeing a pickup in demand and sales.

Yet there is still plenty to worry about. Most notably, employment is still a concern. Initial jobless claims are still too high even though the latest nonfarm payroll figures were encouraging. However, even if the economy creates 100,000 net new jobs per month, it would take seven years just to get back all the jobs we’ve lost since the recession began in Dec. 2007. And that doesn’t take population growth into account. As a result, the unemployment rate could remain elevated even as job creation strengthens.

In addition, the government is playing too large a role in the economy. The recent announcement that it plans to reduce its stake in Citigroup is welcome news, but what government gives with one hand, it usually takes away with the other. For example, chances are investors are underestimating the true cost of healthcare reform. Already, several major corporations have announced plans to take huge writeoffs as a direct consequence of the new healthcare law. Instead of applauding their executives for honest accounting, Democrats are accusing them of playing politics.

Investors are also underestimating the real possibility of a trade war with China. Last month, China tried and convicted an Australian national employed by Rio Tinto for accepting bribes. Because the trial was held behind closed doors, there is no way to know the extent of the evidence. The accused man may indeed be guilty, yet the lack of transparency during the trial makes global businesses wary.

Rio Tinto was not the only company to raise China’s ire. Google, one of the world’s largest companies, decided to pull out of China. Now it is trying to serve Chinese users from Hong Kong. Google was particularly upset about censorship issues and hacker attacks that appear to be government orchestrated. Google clearly decided that the possible rewards of doing business in China are no longer worth the risks. It remains to be seen how many other companies, if any, follow Google’s lead.

Another worry is the rising level of interest rates. The Fed insists that it won’t be raising the fed funds rate any time soon. However, it is planning an "exit strategy" that involves selling assets. Higher interest rates may be needed to entice investors to purchase those assets. Furthermore, recent government bond auctions raised worries as the yield on the 10-year note moved closer to 4%. China, a big buyer of U.S. debt, has reduced purchases in recent months. There is speculation it may cut back further; and not just to send the U.S. a message. As hard as it may be to believe, China is expected to report a trade deficit for March—its first monthly deficit in six years.

Monday, March 22, 2010

Communism is Dead, but State Capitalism Thrives

Ian Bremmer, founder of the Eurasia Group, is a political risk expert. Investors all over the world pay big bucks to hear his views on what various governments might or might not do. At the moment, he is in Japan--just one stop on a tour visiting clients. Bremmer says "Everywhere I turn on this Asia trip, folks have been pressing me with their concerns about the deterioration of the U.S.-China relationship...and what it means for them."

Indeed, the relationship between these two key countries appears to be deteriorating rapidly. I've written before about the looming trade war brewing between the U.S. and China. America is pressing China to revalue its currency and Google is threatening to leave China entirely. But the Chinese are also flexing their muscles against other nations. They have detained an Australian businessman who works for Rio Tinto, accusing him of taking bribes.

Bremmer is the author of several books. Three years ago, he wrote the "The J Curve: A New Way to Understand How Nations Rise and Fall." A year ago, he wrote "The Fat Tail: The Power of Political Knowledge for Strategic Investing." His newest book, which comes out in May, sports a title that is anything but subtle. It's called "The End of the Free Market: Who Wins the War Between States and Corporations?" No doubt, you can make a good guess at the answer to that question.

In the Introduction to his newest book, Bremmer begins with another question--one posed by a Chinese diplomat during a meeting that took place in the midst of the global financial crisis. The diplomat asked Bremmer, "Now that the free market has failed, what do you think is the proper role for the state in the economy?"

There is no denying that in almost every country, government is exploiting the recent crisis by assuming a bigger role in the economy. This is true even in the U.S.--once considered a bastion of free market capitalism. The U.S. government now owns substantial equity stakes in formerly blue chip companies, and it is getting involved in everything from strategic managerial decision making to executive compensation.

However, as Bremmer explains, the free market has not failed and we are not witnessing a resurgence of communism. Instead, what we are seeing is a new system called state capitalism. It is a system in which governments use capitalism and free markets to advance their own power and interests.

Bremmer's book does not focus on China or the U.S. alone. In fact, it provides an excellent around-the-world tour of almost every country that has an economy of any meaningful size. All investors, professional or novice, who are looking for global diversification, will benefit from a careful read of the insights provided in this book. Nonetheless, the most interesting and fascinating portions of the book focus on the world's largest and fastest growing economies.

That includes China. The book does an excellent job of explaining how the Chinese government uses state-controlled companies to advance its policies. It uses its power to make sure these companies have every possible advantage. In this way, the government is literally engineering China's development.

As communist governments collapsed all over the world, communists in China maintained power through brute force, best exemplified by the quashing of the Tiananmen Square protests. Yet China's communists also understood that command economies could not effectively compete against free markets. The trick, as far as they were concerned, was to grow the economy while maintaining political control. Their solution was state capitalism, an ideal that has spread around the globe--even to the U.S.

Friday, March 19, 2010

More Info Needed on Pay for Performance

James Reda, founder of James F. Reda & Associates, is a leading executive compensation expert. His firm just released a study of pay and performance metrics for senior executives at the 200 largest companies in the S&P 500 Index. The study is based on information submitted by corporations during the 2009 proxy season.

Of course, executive compensation has long been a hot button issue for corporate watchdogs. Investors often complain about compensation that appears excessive, especially compensation at the CEO level. This is a particularly serious problem when performance results are poor.

In addition to paying a salary, most large companies reward their top executives through short term and long term incentive plans. Short term plans are usually based on pre-determined fixed targets such as EPS or net income. Long term plans rely on relative performance measures such as total shareholder return relative to the average return for other companies in the same industry. The SEC requires corporations to disclose their compensation policies and performance targets for both short term and long term incentive performance measures.

Unfortunately, Reda concludes, "Reporting of performance metrics and related payouts has not improved at the largest companies in the U.S. In fact, the numbers have deteriorated over the last year." To a large extent, investors are not getting the information the SEC says corporations must give them. Reda says this is because companies believe that disclosing specific targets could result in competitive harm. They also do not want to be held to specific published targets. They would rather keep their performance goals flexible, adjusting them as they see fit.

When share prices are going up, stockholders do not get worked up about compensation issues. After all, they usually do not have a problem with the CEO and other executives making lots of money if they, too, are making good money. However, shareholders get very upset when the CEO rakes in millions of dollars of compensation when the company is reporting net losses and the share price is sinking. Pay for performance makes a lot of sense. However, as Reda's study shows, existing plans and practices leave a lot to be desired.

Wednesday, March 17, 2010

The Looming Trade War With China

In recent weeks, Chinese leaders have stepped up the verbal assault on the West by attacking U.S. policy as well as U.S. and European corporations.

Due to the global recession and falling demand, some Chinese factories had to lay off workers and close their doors. While there has been some talk of finding ways to boost domestic consumption, that's a tough sell with China's leaders. After all, consumption still has a bitter taste on a communist tongue. Chinese leaders would prefer instead to see the export ball rolling once again. Furthermore, they blame free market capitalism for the worldwide financial crisis and recession. They don't take kindly to U.S. politicians lecturing them about a weak currency. On the contrary, they say America is the one that is purposely debasing the value of its currency in order to boost its exports and raise the cost of China's goods for American consumers. For good measure, they have even complained about U.S. arms sales to Taiwan and President Obama's temerity for meeting with the Dalai Lama.

The Chinese have also gone on the offensive against Google, putting the company in a rather awkward position. Google executives are asking themselves if they should compromise their values and censor searches (especially searches on political speech) in order to maximize shareholder wealth, or if instead they should live up to the company's code of conduct, 'don't be evil,' even if doing so results in the loss of an estimated $600 million (according to JP Morgan) in revenue this year alone.

It seems that values are winning this debate. Now that Google appears set to pull out of China, its advertising partners are up in arms. They say Google's decision will put them out of business. They want compensation for their losses. Are lawsuits far behind?

Not long ago, Google and a number of other American companies were targeted by computer hackers who were operating from within China. Some experts suspect the Chinese government was actually behind those attacks.

On top of all this, Chinese officials are suddenly claiming that Western luxury goods makers are selling shoddy products in China. This seems like a thinly veiled attempt to urge Chinese consumers to buy only Chinese made goods.

The bottom line is that corporations are finding it much more difficult and costly to make a buck in China. Others may follow Google's lead and leave the country entirely. Or, they may complain to their governments to apply diplomatic pressure. The end result could be an ugly trade war, which would hurt all parties involved. That's an outcome that will make the Great Recession even greater.

Tuesday, March 16, 2010

Financial Engines is a Sharpe IPO

As an academic, William Sharpe was one of the most brilliant and prolific financial researchers. MBA students are familiar with his work on portfolio analysis and the capital asset pricing model. Portfolio managers often use the eponymous Sharpe ratio to determine how much excess return they are producing per unit of risk. Dr. Sharpe has received innumerable honors. In 1990 he was even named a co-recipient of the Nobel Prize in Economics.

This man, however, is no ivory-tower academic. His theories are used every day in the world of finance. Dr. Sharpe is also an entrepreneur. In 1998, he founded what is now Financial Engines (FNGN). The idea was to use the power of the Internet to deliver independent financial advice to investors.

Well, Financial Engines just went public. The company issued 10.6 million shares at $12 per share. That was above the indicated offering range of $9-11 per share. Since the underwriters, Goldman Sachs and UBS, have a 15% over-allotment option, the offering will raise about $146 million before fees. A little less than half the net proceeds is going to selling shareholders.

The stock immediately rallied higher as soon as it became available on the secondary market. At last look, it was trading around $17 per share. That's 42% above the offering price. That gives the company a $675 million market capitalization. FNGN is now selling for 7.9 times sales and more than 100 times trailing earnings. The stock ain't cheap.

Jay Ritter, another respected academician, is best known for his work on IPOs. According to Professor Ritter's work, IPOs tend to underperform the market over a rather long period of time. His research suggests that it would make little sense to buy into an IPO unless you can get it at the offering price and sell it soon after it runs up on the secondary market.

I gave Professor Ritter a call to ask what he thought about the Financial Engines IPO. He said he isn't too concerned about long-run underperformance in this case. He said, "Long-run underperformance is concentrated among companies with less than $50 million in sales in the year before going public." Because Financial Engines generated $85 million in revenues in 2009, it does not fall into that category. As a result, Professor Ritter isn't worried about Financial Engines being a long-run underperformer.

As a former academic myself, I am tempted to buy a few shares just to keep a close eye on the stock. However, I will probably wait until the stock falls back a bit before I get in. Of course, that was my plan with Google when it went public at $85 per share in 2004. I'm still waiting for my buy order to execute on that one.

Thursday, March 11, 2010

Get Rich by Investing Like The Rich

Every year at this time, we at Forbes magazine publish a list of the world's billionaires. This year, Carlos Slim of Mexico took the top honors, marking the first time in 16 years that the richest person in the world is not an American. In fact, there are only three Americans in the top 10 this year. The top 10 also include two Indians, a Brazilian, and three Europeans.

Those who made the list have demonstrated an uncanny ability to invest well, which brings up an interesting question. Can you, too, get rich by investing like the rich? The results of a research study out of Babson College suggest you can.

In a yet unpublished paper, Professor Joel Shulman examines the holdings of 1,125 entrepreneurs who made the Forbes billionaires list during the period April 1996 to March 2009. He identifies 495 publicly traded companies that represent major investments for these ultra-rich individuals. He was able to secure reliable data on 200 companies that trade on 41 different exchanges across 22 countries. His conclusion? Investing in these 200 companies during the period studied would have generated an annualized return of just over 20%. That compares to only a 1-2% annual return for relevant benchmarks.

Of course, what worked in the past may not work in the future. Yet entire hedge funds have been created to implement strategies based on much flimsier evidence. This one certainly seems worth a try.

Tuesday, March 09, 2010

Who Has the Greatest Propensity to Spend Tax Rebates?

Economists sometimes argue that tax rebates can spur economic growth. Furthermore, they say that in order to get the biggest bang for the buck, the money should go to those most likely to spend it. According to conventional wisdom, that would be the poor.

Some argue that giving tax dollars to people who haven't actually paid taxes should not be called a tax rebate. Yet even they would agree that lower wealth, lower income individuals are more likely to put this money back into the economy by spending it. Richer people who don't really need the money would probably just end up saving it. That wouldn't do the economy much good in the short term.

Well, now there is a study that turns this conventional wisdom on its head. In "Household Spending Response to the 2008 Tax Rebate," authors Claudia R. Sahm, Matthew D. Shapiro, and Joel B. Slemrod argue that the $96 billion tax rebate resulted in only $32 billion of extra consumer spending. The majority of recipients either saved the extra money or used it to pay down debt.

What is even more startling is that the propensity to spend the money increased as one's age, wealth, and income increased. In other words, of those who were eligible to receive the payments, the ones who were older, wealthier, and had more income were the most likely to put the money back into the economy in the form of consumer spending. This result is completely contrary to the accepted wisdom.

If you are interested, you can get a copy of the paper from the National Bureau of Economic Research.

Friday, February 26, 2010

Bernanke's Next Trick

Ben Bernanke says the Fed has an exit strategy, but it doesn't involve raising interest rates. Sounds like magic to me. One thing is for sure, the fed funds rate will not stay at zero forever.

Thursday, February 25, 2010

No Slave to Fashion

I tend to be a skeptic by nature. So at a time when the economy is weak, employment numbers are terrible, consumer credit is contracting, and foreclosures are rising, I am particularly skeptical of high flying stocks whose fortunes depend on spendthrift consumers.

True Religion Apparel (TRLG) comes to mind. This is a company that sells incredibly pricey jeans to both men and women. Because I can't bring myself to pay more than $25 or $30 for a pair of Levi's, I am particularly perplexed as to why anyone in their right mind would pay $250 for one pair of jeans. My daughters say this proves I am out of touch. I prefer to think instead that it proves there are a lot of consumers out there who are not in their right minds.

It's true that I am not a slave to fashion, but I do have some appreciation for the stuff. After all, my wife subscribes to Vogue, and her brother Serge Gandzumian is a professional designer who has achieved some success and fame with his Lithuanian company SwanPh. Thanks to capitalism, those who really care about fashion have lots of choices; unlike in this parody of Soviet fashion made famous by an old Wendy's television commercial.

Don't get me wrong. I actually liked TRLG back when it was selling for $11 per share. I even recommended the stock in March 2009 to subscribers of my newsletter, the Forbes Growth Investor. However, now I have to wonder if it still makes sense to own the stock.

My concern has nothing to do with fundamentals. TRLG is selling for about two times sales and 12 times the low end of expected 2010 earnings. Furthermore, the company has lots of cash on hand and no long-term debt. Its latest financial release was actually quite good. Revenues and profits are still growing nicely. Although sales are falling in the company's U.S. Wholesale segment, they are surging in the more profitable Consumer Direct segment. This segment includes the growing number of company-owned stores where TRLG commands the highest prices for its products. Yet at the same time, the overall operating profit margin is slowly declining. It will probably go lower in the near term as the company ramps up advertising expense.

The stock jumped higher immediately after the earnings announcement. Although I remain bewildered, I have to ask. Does anyone know where I can buy some True Religion jeans for my daughters at a big discount?

Wednesday, February 24, 2010

Market Skeptic Needs Convincing

About three weeks ago, while many experts were growing more optimistic about economic growth and the stock market's prospects, Karen Gibbs asked why I was so skeptical. Click here to watch the interview.

Monday, February 22, 2010

Trying Too Hard to Assuage Investors

After last week's hike in the discount rate, a number of Fed officials have said that the fed funds rate will not be increased for a long time. It seems they are trying a bit too hard to convince skeptical investors.

The latest salvo came from Janet Yellen, San Francisco Federal Reserve President. Yellen said interest rates must be kept "extraordinarily low" because economic growth will fall short of its potential through 2011. Yellen and others believe interest rate hikes are not yet necessary, especially since the Fed is planning to take other measures to reduce liquidity. For example, it will stop buying mortgage-backed securities (which could result in another round of declines in housing sales and prices), and it may start reducing the size of its balance sheet by selling some of its assets, thus draining money from the economy.

While such tightening measures can be effective, an increase in the fed funds rate sends a much stronger signal. In my previous post, I argued that a modest increase in the fed funds rate should be welcome news. I continue to believe the Fed will raise the fed funds rate sooner than it is currently telegraphing. If it fails to do so, investors should worry that the economy is sicker than the Fed would like us to believe.

Friday, February 19, 2010

Discount Rate Hike is no Surprise

The announcement late yesterday that the Federal Reserve was raising the discount rate by 25 basis points to 0.75% came as a surprise to many investors. It shouldn't have. The Fed has been broadcasting its intentions for several weeks. For example, in its Jan. 27 press release, the Fed said, "economic activity has continued to strengthen." This was the strongest statement yet from the Fed that the crisis is over. And just a week ago, Chairman Ben Bernanke actually said in a speech that the Fed might raise the discount rate. So yesterday's action should have been fully anticipated. It should also be seen as good news. Extremely low interest rates are not good for the economy. They signal a continuing crisis. Yet the Fed has been trying to convince investors for quite some time that the worse is over. It finally figured out that actions speak louder than words. By raising the discount rate, the Fed is signaling that it actually believes what it is saying. The Fed may deny it, but it will probably start raising the more important fed funds rate before long. Contrary to popular opinion, stocks will probably hold up well on the news. A modest increase in the fed funds rate should give investors confidence that the economy really is getting stronger.

Monday, February 08, 2010

Orlando MoneyShow

I gave a couple of talks last week at the World MoneyShow in Orlando. I have spoken at this event numerous times in the past. My impression is that attendance at the MoneyShow provides a good, albeit imperfect, indicator of investors' interest in the markets. To my untrained eye, attendance looked strong. In fact, I heard registrations were up about 12% from last year's event. There were also plenty of sponsors and exhibitors around. Of course, strong interest isn't too surprising given the double-digit gains in all stock market indexes last year.

Saturday, January 30, 2010

The Elephant in the Room

I'm working on putting together the next issue of the Forbes Growth Investor. I still have President Obama's State of the Union speech on my mind, so I asked Mark Stivers to draw this cartoon.

Wednesday, January 27, 2010

Hank Greenberg's Take

While Timothy Geithner was being grilled on Capital Hill today, former AIG CEO Maurice "Hank" Greenberg was delivering a talk at the Union League Club. He made several important points.

He said the legal system needs to be fixed. A politically ambitious attorney general (i.e., Eliot Spitzer) should not be allowed to destroy companies and reputations in order to reach higher office. Greenberg said AIG has already spent approximately $700-800 million in legal fees. Greenberg has spent almost as much himself. He asked, "For what?"

He pointed out that government officials played favorites by forcing AIG to pay Goldman Sachs 100 cents on the dollar. He said it didn't pass the smell test when former Treasury Secretary Henry Paulson fired AIG's then CEO Robert Willumstad and replaced him with Edward Liddy, who was on the board of directors at Goldman Sachs.

He said that when the government took an 80% stake in AIG, it should have immediately stated that the government's AAA credit rating also applied to AIG. However, government officials claimed they didn't have the authority to do such a thing. Greenberg found this explanation odd since the government did many things it did not previously have the authority to do. Yet it always managed to get the authority quickly whenever it wanted.

It turns out that Hank Greenberg is writing a book about all this. I can't wait to read it.

Friday, January 22, 2010

An Oldie, But a Goodie

Scott Brown's U.S. Senate victory in Massachusetts on Tuesday has certainly gotten the attention of all Democrats. Barney Frank, long-time protector of Fannie Mae and Freddie Mac, suddenly said today that these entities should be abolished in their current form. More importantly, a growing number of Senate Democrats now oppose the renomination of Ben Bernanke as Fed Chairman. I thought this would be a good time to revisit a cartoon we published in the July 2009 issue of the Forbes Growth Investor. It was in response to what seemed to me as a very lukewarm endorsement at the time by President Obama.

Thursday, January 21, 2010

Pickens and Fracturing

When T. Boone Pickens tried to take over Phillips Petroleum in 1984, he was accused of not willing to make any concessions. He responded by saying he would move to Bartlesville, Oklahoma. Yesterday, I attended a luncheon at the Union League Club of New York City. Pickens was the guest speaker. Although he made his name as an oil man, more recently he has been trying to promote the use of natural gas in this country. During his talk, he was very critical of the failure of all presidential administrations to articulate a coherent energy plan.

Pickens says the United States is much too dependent on foreign oil--especially on oil imported from countries that are not particularly friendly to us. He pointed out that the U.S. has the world's largest natural gas reserves, and that we can easily decrease our reliance on imported oil by switching to natural gas for transportation purposes. He proposed mandating that all 18-wheelers (i.e., tractor-trailers) be forced to switch to natural gas over some period of time. His idea is to provide a $65,000 tax credit for the purchase of each of these vehicles. However, he did not address the safety concerns, how the trucks would be refueled, or if natural gas could even provide sufficient power to push a fully loaded semi up a mountain.

He also failed to make a strong case that drilling for natural gas would be environmentally friendly. While the available technology may be good enough to drill safely, the natural gas industry must do a better job of conveying this message. In fact, today's Wall Street Journal featured a front-page article about hydraulic fracturing, a process of using pressurized water mixed with certain chemicals to break rock formations in order to get at the gas. Opponents claim fracturing will pollute ground water. As the article pointed out, Exxon Mobil insisted on a clause that would allow it to back out of its proposed acquisition of XTO Energy if the government decides to outlaw fracturing.

How big a role natural gas plays in the future is uncertain, but one thing is becoming clear. Oil prices are too high. There is a big push to promote the use of alternative fuels. Society will remain dependent on oil for a long time, but natural gas, nuclear, wind, battery, and solar will all play bigger roles in the future. Unless global growth suddenly surges, demand for oil, which is already down, will continue to decline.

Wednesday, January 20, 2010

Stocks Sell Off on Good News

For the most part, there was good news in the markets today, so the strength of the sell-off caught many investors by surprise.

Today's housing numbers from the Commerce Department bode well for the home building industry. Even though housing starts in December fell 4% from November on a seasonally adjusted and annualized basis, they were flat compared to a year ago. Furthermore, building permits, an indicator of future activity, jumped 10.9% from November to December. They were up 15.8% from a year ago. However, don't get too excited about housing. It is still a very sick industry. Almost one in four homeowners with a mortgage are believed to be underwater, and foreclosure rates are still sky high. This will keep housing prices from heating up any time soon.

Wholesale purchasing prices were up just 0.2%, and there was no change in core figure. Although I have argued that the Fed needs to begin its exit strategy, today's PPI data means it is more likely to stick to its policy of keeping rates low.

Finally, Scott Brown's victory in Massachusetts means Congress will have to take a more moderate approach to health care reform. In fact, Amedisys (AMED), a home health care stock we recommended back in September in the Forbes Special Situation Survey added to its gains today.

The sell-off in the overall market is being blamed on China's decision to reduce lending. This stoked fears that global growth might fall short of prior expectations. This kind of thinking could drive stock prices even lower.

Friday, January 08, 2010

Jobs Report Dampens Workers' Hopes

By Vahan Janjigian - Today's announcement by the Bureau of Labor Statistics that nonfarm payrolls dropped by 85,000 in December is a big disappointment, especially to the many investors who were betting that the economy was on the mend. While the headline number is bad enough, the figures down below are worse. For example, although the number of officially unemployed people fell slightly to 15.267 million, the number of employed people dropped by 589,000 because the labor force shrank. In fact, 2.5 million people are no longer considered a part of the labor force even though they want to work and they sought work during the past 12 months. They are excluded because they did not look for work during the past four weeks. In addition, 9.2 million people are working part time, not by choice, but because they can't find full time employment.

One bright spot of the labor report is that temporary jobs increased by 47,000. This is considered good news because corporations often hire temporary workers as business conditions improve before making a commitment to take on permanent employees. In fact, in recent months, at least a couple of equity analysts raised their outlook on Manpower (MAN), a leading temporary employment agency. The stock is up about 30% since November and has more than doubled since the March 9, 2009 low.

Disclosure: The author has an ownership interest in Manpower (MAN) shares.

Thursday, January 07, 2010

FGI Gains 35% in 2009

The following commentary appeared in the January issue of the Forbes Growth Investor.

By Vahan Janjigian - When I was in graduate school, a marketing professor told me that investing was easy. He said,“All you need to do is buy low and sell high.” However, many investors did exactly the opposite last year. They threw in the towel at precisely the wrong time. As stocks sold off in March and the Dow dipped below 6,600, they decided stocks were too risky, so they got out of the market. They did not understand that stocks are actually less risky after that kind of selloff. Instead of selling in March, they should have been buying. Even if they had to wait a few years, chances are the returns they would have realized from stocks would have exceeded the returns generated from safer assets such as cash.

As it turns out, however, those who did buy in March did not have to wait long at all. Stocks went straight up after the selloff in the beginning of the year. The Dow finished 2009 with a 19% gain, the S&P 500 rallied 23%, and the Nasdaq Composite surged 44%. Our Forbes Growth Investor Top 40 climbed 35%. While it did not outpace the tech-laden Nasdaq, it did exhibit less volatility. Since inception (Oct. 6, 2000), our stock picks have gained 75%. The three major indexes lost ground during the same period. The Dow fell 2%, the S&P plunged 21%, and the Nasdaq plummeted 32%.

However, the higher stock prices go, the more cautious I become. Investor sentiment may drive stocks higher in the short term, but fundamentals are more important over the long term. As I see it, the fundamentals are not particularly good.

While the worst of the financial crisis is probably over, the economy is still troubled. The unemployment rate may have peaked, but it will probably remain elevated for years. Housing prices may have bottomed, but they will likely remain depressed for quite some time. Retail sales during the holiday season were better than expected, but that trend will probably fade in 2010. Corporations are producing profits not by selling more goods, but by cutting expenses. In addition to all this, capacity utilization is near all-time lows, new home sales are at a standstill, government debt has surged to almost unfathomable levels, consumer credit is falling, and savings rates are rising at precisely the wrong time. A particularly worrisome trend is the growing role government is playing in the economy. It is the nation’s largest employer, it has become the largest shareholder in a number of previously blue-chip companies, and it is about to take over the healthcare system.

Given this backdrop, there are a number of things to watch for in 2010. We may have emerged from the recession, but a double dip is possible. However, a second recession, if it does indeed occur, should be less severe than the first. Gold prices could fall significantly. They have not risen to current levels because of strong demand or a lack of supply. Gold prices have climbed because of the Fed’s easy monetary policy and the resulting weak dollar. Similarly, oil prices should go lower. The recession has reduced demand for gasoline and other refined products. The big push toward alternative energy is also having an impact on the demand for fossil fuels. As for stocks, they could sell off again. A retest of the March 2009 lows is unlikely, but the Dow could easily shed a thousand points or so. If that happens, it will be time to start thinking about buying once again.