MoneyMasters With Vahan Janjigian

Review of The Vig

2012-01-29T14:49:00.003-05:00

The internet is changing all kinds of businesses. It seems that no industry can escape its disruptive force. Publishing is perhaps one of the hardest hit industries. The internet's transformation of publishing started with how books were sold. It then transformed how newspapers and magazines are published and read. Now it is affecting the actual publication of books.

Not long ago, a would-be author would submit a manuscript to a publishing company. If he wanted to increase his chances of being taken seriously, he would hire an agent to try to sell the book on his behalf. However, traditional publishers don't want to take chances on unknown authors unless they feel fairly sure that a minimum number of books can be sold. If the author is a motivational speaker with a strong following or a celebrity with many fans, publishers know the book has a ready audience. A book by these kinds of authors will sell whether it is good or bad. For anyone else, however, it is almost impossible to get published by the traditional route.

However, today's promising authors are no longer at the mercy of the traditional publishing houses. Instead, they can self publish their works and put them up for sale through online retailers such as Amazon.com. Of course, many self-published books are of poor quality. Yet every once in a while, you come across a gem. That's how I would describe John Nuckel's new book, The Vig. In full disclosure, I probably would never have read this book if I did not know the author personally. While this makes me less than perfectly objective, I have to say that despite some minor flaws, I really did enjoy reading The Vig.

For those not in the know, "vig" is short for "vigorish," a term traditionally used to describe a bookie's commission. Nuckel, a former options trader at the American Stock Exchange, uses the term to describe an illegal scheme designed by the characters in his book to skim a little out of the accounts of the traders every day.

The book begins on September 11, 2001. Nuckel, who was present when the World Trade Center towers came crashing down, actually witnessed the horrific scenes of death and destruction that he describes through the eyes of the book's protagonist, a floor trader whose mind is as sharp as a calculator. When the trader is able to return to work, he realizes that something is not quite right with his accounts. They seem to be just a little off. He starts asking questions, which result in a whirlwind of murder, mystery, and intrigue. The author is especially deft at character development. One unsavory criminal doesn't hesitate to murder his own brother. A sexy female assassin is as cold blooded as any assassin literature has produced.

The book's flaws mainly involve minor copy editing issues that do not prevent the reader from enjoying the read. In fact, the book really is hard to put down. It grabs your attention immediately and it doesn't let go. At 194 pages, The Vig is a relatively quick read. While some readers may find the details of floor trading and arbitrage a little hard to follow, anyone interested in investing will enjoy those sections as much as the others. I liked this book very much and I recommend it strongly.

Mitt Romney and Taxes

2012-01-24T10:05:00.003-05:00

I have a tendency to avoid watching presidential debates, primarily because I'm convinced that the best debater does not necessarily make the best president. Of course, debates can be quite entertaining; however, they tell us more about how well a candidate can think on his feet than they do about what he really stands for. In addition, one mistake in a debate could kill an entire campaign. Witness Rick Perry's inability to recall one of three departments he would shut down if elected president.

Nonetheless, the topic du jour is Mitt and Ann Romney's taxes. It has become a big issue, largely due to Mitt Romney's unwillingness to release information about his tax returns earlier in the campaign, as well as his inability to properly defend what he actually pays in taxes.

So instead of relying on what is being reported in the media, I decided to take a look at the Romney's just-released tax returns. In 2010, Mitt and Ann Romney reported interest income of $3,295,727. Interestingly, only $557 of that amount was non-taxable. Obviously, they are not big buyers of municipal bonds. The Romneys also reported $4,923,348 in dividend income. Of this amount, $3,327,678 were considered qualified dividends, meaning they were taxed at the lowest rate of 15%.

The Romneys also had quite a lot of capital gains, in fact $12,573,249 worth. Most of the capital gains were of the long-term variety, which means they, too, were taxed at the lowest rate of 15%. Making some relatively minor adjustments, the Romney's total adjusted gross income for 2010 was $21,646,507. That's certainly a lot of dough by almost anyone's standards.

It turns out the Romneys are also very charitable people. In fact, they donated $2,983,974 to charity in 2010. Their total allowable itemized deductions came out to $4,519,140. Including their exemptions, their taxable income was $17,120,067. Their total tax bill (which includes the alternative minimum tax, self-employment tax, tax on IRA or 401(k) income, and a credit for foreign taxes paid) came out to $3,009,766. In other words, their tax rate was 17.6% of their taxable income. This is higher than the 14% tax rate widely reported in the media. The difference is explained by the fact that the media is calculating the tax rate on adjusted gross income rather than the tax rate on taxable income. But the media's calculation is misleading because it ignores things such as charitable contributions.

The Romneys also released projections of their tax return for 2011. Even though they increased their charitable contributions, their tax rate on taxable income is actually expected to rise to 21.2% for 2011, quite a bit higher than it was in 2010.

Here are two points that Mitt Romney needs to articulate better: 1) One reason the Romneys' tax rate appears low (as a percentage of adjusted gross income) is because they have been extremely charitable. If the Romneys had not donated so much money to charity, their tax rate would be substantially higher. 2) A second reason their tax rate appears low is because the vast majority of their income is in the form of qualified dividends and capital gains.

Some will argue that it isn't fair to tax capital gains and qualified dividends at a lower rate than ordinary income. I would argue that it isn't fair to tax this kind of income at all. Why? Because it has already been taxed at the corporate level. Taxing corporations is exactly the same thing as taxing shareholders directly. When corporations pay taxes, there is less money left over for the shareholders.

When a corporation hires an employee, that employee's salary is a tax-deductible expense for the corporation. As a result, it is perfectly fair to tax that employee's wages at the ordinary rate. However, when a corporation pays dividends, that money comes from after-tax earnings. When the stock price rises creating capital gains, those gains represent the after-tax performance of the corporation. If corporations were not taxed at all, the sum of the dividends and capital gains would be much larger than they are now. In that case, it would be perfectly fair to tax dividends and capital gains at the ordinary rate.

As things currently stand, the effective tax rate on dividends and capital gains is actually much higher than the effective tax rate on ordinary income. This is because the effective tax rate is actually equal to the tax rate that corporations pay plus the tax rate that individuals pay on dividends and capital gains, a figure that is closer to 50%, and much higher when state taxes are taken into account.

I have long been an advocate for a simplified tax code. Our current tax code has become so convoluted and confusing that only expert accountants can make heads or tails out of it. Furthermore, our current code fools large numbers of people into believing that the rich pay less taxes than the poor. In my perfect world, I would eliminate the tax on corporations (which would also eliminate the incentive that corporations currently have to finance themselves with tax-deductible debt). I would also eliminate ALL tax deductions (including those for mortgage interest and charitable contributions). Finally, I would introduce one low flat tax rate on all income. Although I would hate to do it, I would even be willing to go along with mildly progressive tax rates. All of this could be done in a revenue neutral manner. Yet I wouldn't hold my breath. With so many groups lobbying Congress for one exception or another, I don't really expect any of this to become reality. On the contrary, if I had to bet money, I would bet that the tax code will only get more and more convoluted as time goes on.

Discounting the Trade Deficit

2012-01-13T14:31:00.004-05:00

Today, the Census Bureau released trade figures for the month of November. The deficit grew to $47.752 billion in November, up from $43.271 billion in October and much larger than the consensus expectation of $44.0 billion. A larger deficit is a subtraction from GDP, but a larger deficit does not necessarily mean the economy is in trouble. For example, the deficit would increase if the increase in imports is greater than the increase in exports. Yet if both are increasing, the economy could be doing fine. Unfortunately, that wasn't the case in this report. The report showed that imports increased by $2.947 billion in November while exports decreased by $1.535 billion.

The good news is that the report tells us what happened two months ago. As a result, it may not be giving us a good indication of what is happening now. Other economic figures indicate that the economy is improving. Nonfarm payrolls, housing starts, and consumer sentiment are moving in the right direction. While today's trade report is not consistent with an improving economy, we shouldn't put too much weight on it.

2012 Should Be Better Than 2011

2012-01-04T22:44:00.003-05:00

I spoke with Tracy Byrnes at Fox News about a couple of issues including the tendency for stocks to rally in January and why I think 2012 could be a better year than 2011 was for U.S. stocks. You can see the discussion here.

RIMM Hangs Up on Amazon, Microsoft, and Nokia

2011-12-21T11:20:00.012-05:00

It is difficult to find a stock that is more out of favor than Research in Motion (RIMM), the company best known for the BlackBerry smartphone. RIMM is led by a pair of co-CEOs, a highly unusual arrangement for any publicly-traded company and one that has proven extremely ineffective in recent periods. This dysfunctional structure has resulted in one misstep after another. In particular, the company has delayed the launch of key new models and new software a number of times. RIMM also had a disastrous launch of its tablet computer dubbed the PlayBook. Although some experts claim the PlayBook is technologically superior to other tablets, consumers complain that there are too few apps.

It turns out that at least a few companies thought RIMM was worth buying. While it isn't clear if any formal offers were made, Amazon.com, Microsoft, and Nokia were all recently mentioned in press reports as possible suitors. In any case, it seems that RIMM's co-CEOs weren't keen to be bought out. They apparently refused to entertain any offers. Instead, they continue to believe that they can orchestrate a turnaround by themselves.

Whether they will succeed or not remains to be seen. What is clear, however, is that RIMM is no Lehman Brothers. Although the company is losing market share in the U.S., it is still a leader in several key international markets. In fact, the company's subscriber base actually surged 35% year-over-year during the most recently completed quarter. The board of directors will release a report in January that is widely expected to recommend some drastic changes.

Management has been begging investors to exercise a little more patience. Instead, investors have been selling the stock. Today's news caused the stock to rally. The fact that any company sees value in RIMM is giving investors some assurance--at least for now. In any case, it is much too early to write RIMM's obituary. Despite reduced earnings expectations ($4.10 per share for fiscal 2012), with absolutely no debt on the books, well over a $1 billion in cash, and the real possibility of a management shake up, RIMM is worth a second look.

Disclosure - Vahan Janjigian holds RIMM in portfolios he manages.

Unemployment vs. Participation: Which Shows a Truer Picture?

2011-12-02T12:09:00.010-05:00

Equity futures were up strongly this morning thanks to reports that the International Monetary Fund would get involved to help resolve the European debt crisis. Futures remained strong when the U.S. employment report came out showing a big drop in the unemployment rate. The unemployment rate, however, is misleading and by early afternoon, stocks gave up much of their gains as investors looked deeper into the numbers.

According to the Bureau of Labor Statistics, nonfarm payrolls rose by 120,000 in November. Nonfarm private payrolls rose by 140,000. Both figures were close to the consensus estimates and they show that the economy is creating jobs, albeit at an anemic pace. The big surprise, however, was the dramatic decline in the unemployment rate. It fell to 8.6%, much better than the consensus estimate of 9.0%. While this grabbed the headlines, things beneath the surface don't look as rosy.

The unemployment rate is defined as the number of unemployed (but looking for work) divided by the civilian labor force. As a result, the unemployment rate can improve simply because fewer people are looking for jobs. This can happen when they get discouraged and drop out of the labor force.

A better measure of the state of employment is the participation rate. This rate divides the civilian labor force by the civilian noninstitutional population. The denominator includes everyone aged 16 and over who is not institutionalized, meaning that they are not in the military, jail, mental institution, or home for the aged. Everyone else is considered capable of working. Of course, some people have legitimate reasons not to work. Perhaps they are still in school, or they prefer to stay at home with the kids, or they have retired. As a result, the participation rate will always be below 100%; however, in a healthy economy, it should be somewhere near 70%.

The bad news is that the participation rate fell from 64.2% in October to 64.0% in November. In fact, as shown in the figure below, this rate has been declining steadily for quite some time.

I don't want to throw cold water on today's jobs report. The nonfarm payroll figures are somewhat encouraging and at least they show that the economy is moving in the right direction. However, don't get fooled by the lower unemployment rate. It may make some people in the White House feel a little better, but the economy won't be out of the woods until the participation rate improves significantly.

I had a discussion in late October about this with Karen Gibbs in Chicago. Interestingly, MoneyShow decided to release the video today in conjunction with the employment report. As you'll see in the video, I stress the importance of focusing on the the participation rate.

Retail Investors Staying Away From Stocks

2011-12-01T18:58:00.006-05:00

Bank of America recently conducted a survey of about 1,000 "mass affluent" investors. The results are found in its Merrill Edge Report: November 2011.

The mass affluent are defined as people who have $50,000 to $250,000 in investable assets. These people are not rich. In fact, they are solidly in the middle class. They are extremely important because there are so many of them and they form the backbone of the investing public. An estimated 28 million households fall into this category. That's about a quarter of total U.S. households.

Some of the findings are encouraging. For example, about a quarter of those surveyed said their financial situation is better than it was a year ago because they are spending less, paying bills on time, and sticking with a budget. Other results, however, are worrisome. More than a quarter of the respondents said they are dipping into savings to meet short-term needs and they are neglecting their long-term goals. Almost half think they will retire later than they had hoped just a year ago, and more than 40% have become more conservative with their investments.

Interestingly, these people are taking less risk with their investments at a time when the Federal Reserve is trying to encourage risk taking. These people would rather hold cash, which pays little or no interest, than take the risk of losing money in the stock market. I discussed some of this with Tracy Byrnes today on Fox Business.

How Much Cash Does Apple Have?

2011-11-18T12:31:00.004-05:00

Commentators sometimes make exaggerated remarks about the amount of cash Apple Inc. holds. The figure often cited is that Apple has about $80 billion in cash. That's not quite right, but this is how they arrive at that number.

According to the company's recently filed 10-K, Apple actually has $9.8 billion in cash and cash equivalents. It also holds another $16.1 billion in short-term marketable securities. Although these securities are not exactly cash, they can be converted into cash rather quickly if needed. Including short-term marketable securities in the mix is not unusual. So that brings us to about $26 billion. In addition to this, Apple also has $55.6 billion invested in long-term marketable securities. These securities are less cash-like than short-term marketable securities. It is true that they could be sold and converted into cash, but so could any long-term asset. It isn't quite right to classify long-term assets, even the ones that are marketable, as cash. Nonetheless, the total of cash, cash equivalents, and marketable securities (both short and long term) does come out $81.6 billion, or approximately $87.70 per share of outstanding common stock. Any way you look at it, that's a lot of dough.

Where is all this money invested? Apple holds U.S. Treasury and agency securities, foreign government securities, certificates of deposit, commercial paper, corporate securities, and municipal securities. The company's 10-K states that in fiscal 2011, the entire amount earned a weighted average interest rate of 0.77%! Can Apple find no better use for this money? Perhaps a dividend is in order.

By the way, Apple says $54.3 billion of the total is held by foreign subsidiaries. This money would be subject to U.S. taxes of as much as 35% if Apple ever tried to repatriate it. But the tax would not end there. If Apple repatriated the money and then paid a dividend, shareholders would have to pay an additional tax. Is it any wonder that the company is sitting on so much money earning next to nothing? It is high time for Congress to revisit this inane tax policy.

Defense Stocks Could Rally on Supercommittee Compromise

2011-11-17T20:07:00.005-05:00

The so-called supecommittee, tasked with finding a way to reduce the national debt by at least $1.2 trillion over 10 years, is facing a looming deadline. It it fails to agree on a proposal by November 23, there will be automatic spending cuts. There are those who would welcome such a dire outcome. The problem is that some of those automatic cuts would put our national security at risk. Defense Secretary Leon Panetta warned that such cuts would be devastating.

For this reason, I am still hopeful that the committee will find some resolution. It is difficult to believe that even the most partisan politician would be willing to put our nation at risk. If a compromise is reached, defense stocks could rally. Some of my favorites include Raytheon (RTN), ManTech International (MANT), and ITT Exelis (XLS). All three also pay generous dividends.

Should You Mimic Buffett?

2011-11-14T15:33:00.003-05:00

A few years ago, a couple of academic scholars did some research on Warren Buffett's trades. Their paper, entitled Imitation is the Sincerest Form of Flattery, concluded that investors could indeed have earned excess returns simply by buying the same stocks Warren Buffett bought for Berkshire Hathaway. This is true even if they bought the stocks after the information became public.

In today's interview with CNBC I discuss some of Buffett's recent investments, including IBM, and explain why it matters if Buffett is actually buying the common stock or if he is making a private investment in public equity (PIPE).

Supercommittee Rally?

2011-11-09T20:34:00.005-05:00

The conventional wisdom says the Supercommittee, charged with finding a way to reduce the deficit by $1.2 trillion over 10 years, will not be able to reach a compromise. If they don't, automatic spending cuts will go into effect. Cuts to defense spending would put this nation's security at risk. That's why I believe (at least hope) that the committee will put forth a reasonable proposal. The result would be a surprise rally in defense stocks. Read more at MarketWatch.

Market Continues to React to Europe

2011-11-08T15:12:00.003-05:00

The stock market has been paying more attention recently to events in Europe than to economic numbers in the U.S. This may continue for some time. Click here to watch and listen to a recent discussion I had about this with Tracy Byrnes of FoxBusiness.

Berkshire Buffeted by Financial Weapons of Mass Destruction

2011-11-05T14:18:00.005-04:00

Warren Buffett is a critic of derivative securities. Soon after his company, Berkshire Hathaway, acquired General Reinsurance, he discovered a boatload of derivatives that took years to unwind and resulted in massive losses. That's what prompted him to label derivatives, "financial weapons of mass destruction."

So it's a bit of a surprise to see Berkshire report $2.44 billion worth of derivative-related losses (on a before-tax basis) for the third quarter. These derivatives are European style equity index put options. A European option is one that can be exercised only at maturity, but never before.

Berkshire received a premium for selling these options to investors. Buffett is making a bet that stock markets will rise over time. If he is right, Berkshire keeps the premiums. But if he is wrong and stock markets fall, the investors can force Berkshire to buy the indexes from them at higher prices.

The outcome will not be known until the actual expiration dates; however, Berkshire must mark the derivatives to market every quarter. This can introduce a tremendous amount of volatility to the company's earnings. The large derivatives-related losses in the third quarter were a direct result of falling stock prices.

The good news is that Berkshire's operating businesses are doing fine. If not for the derivatives, the company would have earned close to $4 billion last quarter. Instead, it earned just $2.3 billion or $1,380 per share. Still not too shabby.

Poverty in U.S. Lower Than Reported

2011-11-04T08:34:00.003-04:00

We are frequently bombarded by reports about how bad things are in America for the poor. Nations not friendly to the U.S. often use our own statistics to convince their populations that life in America is intolerable. Well, it turns out the statistics are flawed.

As reported in the The New York Times, those compiling the numbers for the government have ignored all the benefits, such as food stamps, that the poor receive. It turns out that when the calculations are done correctly, the rise in poverty since 2006 is less than half of what was previously reported.

This is not to say that poverty is not a problem. It is. We should continue to make serious efforts to address the needs of the truly needy. Yet poverty in the United States is not the same thing as poverty in most parts of the world. The average American who officially lives in poverty eats regular meals, has a place to live with heat in the winter time, and owns both a car and a color television set. In many places of the world, this person would be considered very well off.

The Power of Competition

2011-11-01T13:20:00.004-04:00

On October 6, I wrote about President Obama's ridiculous attack on Bank of America for its plans to impose a $5.00 monthly debit-card fee, and I explained how competition is the best way to limit profits. Specifically, I said, "Bank of America may have made a mistake by introducing this fee. If so, its competitors will pounce. They will begin advertising debit card services with lower fees or no fees at all. Bank of America will notice that it is losing customers."

This is exactly what happened. Several competitors said they would not impose debit-card fees and some customers started switching banks. Here's the latest from Bloomberg: Bank of America Eliminates Plan for $5 Debit-Card Fee. It wasn't government regulation that convinced Bank of America to scrap the fee. It was competition.

Greece Continues to Rock the Markets

2011-11-01T09:49:00.004-04:00

In my September 1 post, I wrote about the increasing level of volatility in the markets, which continues to be one of my major concerns. The S&P 500 plunged 7.2% in September then surged 10.8% in October. Although few investors complain about upside volatility, I see it almost as problematic as downside volatility. Upside volatility provides further evidence of the high level of uncertainty currently plaguing the markets, and it does not provide comfort to the average retail investor who is sick and tired of seeing his/her portfolio balance jumping around like the electrocardiogram of a heart attack victim. And without a critical mass of retail investors, who are more likely than institutions to invest for the long term, the market is not likely to calm down.

Clearly, there were some good economic reasons for October's gains. Most importantly, the advance GDP estimate for the third quarter was better than expected. Although the 2.5% growth figure might eventually be reduced when more data becomes available, it was a pleasant surprise to many economists and investors. However, most of October's gains can be credited to growing optimism that Europe would actually be able to appropriately address its debt problems. I continue to believe this optimism is premature.

Europe's problems are serious and they are beginning to have a negative impact on U.S. companies in unexpected ways. C.R. Bard (ticker "BCR"), for example, a $7 billion (by market cap) medical device maker, took a $7 million write down in the third quarter for the impairment of Greek bonds. I have no doubt that there will be more companies taking similar write downs in coming quarters.

Despite the recent jubilation about Europe, we are already seeing trouble ahead. The latest news that the Greek government wants to hold a referendum on the bailout package it has already agreed to, has really shaken the markets. Greek politicians hope the referendum will pass and put an end to street demonstrations and riots. However, austerity measures are extremely unpopular and not likely to be approved by popular vote. This all but assures that the markets will remain incredibly volatile.

Volatility may be a trader's best friend. Those nimble enough to jump in and out of the markets can make a quick buck. (Quick bucks, by the way, are good for the government because they are taxed at higher rates.) However, volatility does not mean that long-term buy-and-hold investing is dead. But it does make entry points more important than ever. If you are a long-term investor, I suggest taking the big selloffs as good opportunities to add to positions in high-quality, profitable, dividend-paying stocks.

Pay to Go Away (Kind of)

2011-10-31T12:10:00.004-04:00

As most of my readers know, I am not a fan of the "Occupy Wall Street" movement. In fact, I've been quite critical of these people. But I do have to agree with OWS on one thing: Executive compensation has gotten out of hand. The latest evidence comes from Nabors Industries, which has just named a new CEO. What happens to 81-year old Eugene Isenberg, the former CEO and Chairman? Well, he's not exactly going away. He will remain Chairman. But since one of his titles is being taken away, he will get $100 million to help soothe his sorrows. Nice gig if you can get it. OWS would be right to be irate about this. I just wish those protestors felt the same way about overpaid athletes and entertainers, too.

Obama Goes After Starbucks

2011-10-07T14:07:00.005-04:00

Rising commodity prices are taking their toll on all kinds of manufacturers, but the latest news that Starbucks will be raising prices anywhere from five cents to a quarter per cup of "joe" has customers really worked up.

Some coffee lovers are even asking for a consumer coffee protection agency to prevent this kind of predatory pricing. They want the government to act right now. One latte lover who asked not be identified said, "I can't live without my coffee. It is completely unfair for Starbucks or any other coffee shop to just raise prices whenever they want to."

President Obama even got into the fray. While clutching a caramel macchiato with both hands, he said, "Starbucks doesn't have some inherent right just to get a certain amount of profit." He urged Congress to immediately pass legislation that would require fully transparent coffee pricing and limit by how much any coffee brewer could increase prices. He said consumers need to know exactly how much money they are paying for their coffee.

Starbucks CEO Howard Schultz defended his company. He insisted that Starbucks is already very transparent in its pricing. He said, "Every purchase is rung up on a state-of-the-art cash register. Each customer is told exactly how much he or she must fork over for our coffee. If they don't like it, they can drink that stuff from the diner down the street." Furthermore, in a complete rebuff to the President, Schultz insisted, "We at Starbucks believe we do have a right to make a profit!"

When informed of Schultz's remarks, President Obama admitted that he doesn't actually buy his own coffee anyway. "Joe Biden usually picks it up for me on the way to the office every morning."

Note to readers: In case you lack a sense of humor, this blog post was completely fabricated from my own imagination.

Competition is the Best Way to Limit Profits

2011-10-06T11:56:00.003-04:00

A few observations:

1. Steve Jobs, who passed away yesterday, was one of the greatest innovators in the technology sector. He was also one of the world's greatest business executives. He became a very rich man because his company, Apple Inc. made tremendous profits. He was admired by those on the political left.

2. Warren Buffett is one of the greatest investors of all time. He became a very rich man because his company, Berkshire Hathaway, made tremendous profits. He is admired by those on the political left.

3. When asked about Bank of America's plan to charge its customers a fee for using their debit cards, President Obama said his administration could stop this service charge "If you say to the banks you don't have some inherent right just to get a certain amount of profit." President Obama is admired by those on the political left.

It is true that no company has a right to make a certain amount of profit, but it is also true that in the United States we don't limit how much profit a company can make. A competitive free market capitalistic system does that for us automatically. High profits invite competition. Competition drives profits down.

Bank of America may have made a mistake by introducing this fee. If so, its competitors will pounce. They will begin advertising debit card services with lower fees or no fees at all. Bank of America will notice that it is losing customers.

That doesn't mean government has no role. We need regulations to make sure the banks don't take excessive risks that leave taxpayers on the hook for their mistakes. But we don't need the government telling banks what fees they can or can't charge. As long as those fees are transparent and as long as the market is competitive, consumers can decide for themselves which services they value and where they want to maintain their accounts.

Investors Ignore Buffett's Obama Endorsement

2011-10-03T13:02:00.007-04:00

Warren Buffett is admired for his investment prowess. Unfortunately for Democrats, that admiration is not translating into influence in the political sphere. The White House is counting on Buffett to help raise lots of money for President Obama's campaign, and for the Democratic party in general. The president even dubbed his initiative of making "millionaires and billionaires" pay at least the same tax rate as those in the middle class the "Buffett Rule." He should have called it the "Buffett Tax."

The name results from Buffett's claim that his tax rate is well below that of his secretary's even though he makes much more money than she does. Although Buffett has not released his tax returns, we can assume his favorable tax rate occurs because his income is primarily in the form of dividends and long-term capital gains, which are taxed at just 15%, and because of the large deductions he probably takes for his charitable contributions. His secretary's income, on the other hand, consists primarily of her salary, which is considered ordinary income and taxed at a higher rate.

Before trying to occupy Wall Street, consider the following: First, it is not true that most millionaires and billionaires pay taxes at a lower rate than the middle class. In fact, figures from the IRS prove they pay taxes at much higher rates. Even if they have a lot of deductions, they get snared by the alternative minimum tax. If Buffett's tax rate is indeed as low as he claims, that's highly unusual. Rather than raising rates on everybody, let's first scrutinize Buffett's tax return.

Second, there is a valid reason why dividends and long-term capital gains are taxed at only 15%. It is because that money has already been taxed at the corporate level. It would make perfect sense to tax dividends and capital gains at the same rate as any other income, but only if we eliminate the tax on corporations first.

Getting back to Warren Buffett's rather insubstantial political influence, The New York Times recently reported that the turnout was disappointing at a recent fundraiser for President Obama hosted by Buffett. While investors no doubt still prize Buffett's keen sense for detecting undervalued assets, they apparently have much less admiration for his political views.

Volatility Likely to Subside

2011-09-01T09:36:00.005-04:00

The following commentary was released earlier to subscribers of the Forbes Special Situation Survey investment newsletter.

August was a particularly trying month for equity investors. During the first six trading days alone the S&P 500 Index lost a whopping 13.4%. Even though stocks rallied nicely over the last seven trading days, the Index still lost 5.6% for the full month. That’s the kind of return one might expect for a full year. For a single month, it is extremely unusual.

Perhaps more surprising was the extremely high level of volatility. While investors know that buying stocks is risky, few investors, if any, expected to see the kind of explosive volatility that has plagued the markets in recent periods. It wasn’t this way when 2011 began. At the start of the year, the markets were quite calm, but the incidence of large price swings began to rise as the year progressed. This surge in volatility is seen quite clearly in the table below. The table notes the number of trading days for each month on which the S&P 500 moved up or down by at least 1%. For example, there were only three trading days in January on which the Index moved between 1% and 2% and there was none on which it move by more than 2%. Now take a look at August. The difference is stark. In August the Index moved by more than 1% on 14 trading days. On six of those days it moved by at least 4% and on one remarkable day it moved by more than 6%; unfortunately, that was a down day. Since there were only 23 trading days in the entire month, these are rather remarkable statistics.

Stocks recommended by the Forbes Special Situation Survey were also hit by this staggering level of volatility and most closed lower. One stock, however, bucked the trend. Remarkably, Research in Motion (RIMM) surged 30% in August. Of course, that does not negate the fact that RIMM is still down by half since we recommended it in January. It does demonstrate, however, how sudden changes in investor sentiment can cause violent movements in stock prices, both up and down.

Given the economic uncertainties in the U.S. and abroad, volatility will likely remain high, yet it should subside well below the levels seen in August. A calmer market alone could give individual investors the confidence they require to start buying stocks again.

Vahan Janjigian and his clients at Greenwich Wealth Management have positions in the stocks mentioned in this column.

Stop Taxing Corporations on Foreign Earnings

2011-08-30T13:37:00.008-04:00

As many investors know, U.S. corporations are holding large amounts of cash on their balance sheets. Some commentators argue they are doing so because they believe investing is too risky right now. Furthermore, they ask, if these corporations, which are run by very sophisticated managers, are unwilling to put their money to work, does it make sense for ordinary investors to risk their own money in the stock market at this time?

I took a look at some of the largest corporations in the S&P 500. I examined their most recent SEC filings. As shown in the table below, they are indeed holding lots of cash and short-term marketable securities that could be quickly converted into cash.

Perhaps we can conclude from these large cash balances that these companies are reluctant to invest because of economic uncertainties and other risks, including political risks. Yet, at least to some extent, we can also conclude that the decision to pile up cash is motivated by taxes. After all, many of these companies have significant operations abroad. To a large extent, their cash balances reflect profits earned overseas. Repatriating those profits would result in significant U.S. tax liabilities.

Consider this statement from Google's most recent 10-Q filing with the SEC, "As of June 30, 2011, $18.8 billion of the $39.1 billion of cash, cash equivalents, and marketable securities was held by our foreign subsidiaries. If these funds are needed for our operations in the U.S., we would be required to accrue and pay U.S. taxes to repatriate these funds."

Perhaps Google does not need to invest the money in the U.S. right now, but it is clearly objecting to the tax consequences it would face if it did try to bring the money home. It's pretty clear that Google would probably repatriate at least some of this $18.8 billion if it did not have to pay an onerous tax.

Google is not the only company on the list to mention repatriation and taxes. Several companies commented on this. Here's what Microsoft had to say in its most recent 10-K: "We earn a significant amount of our operating income from outside the U.S., and any repatriation of funds currently held in foreign jurisdictions may result in higher effective tax rates for the company."

By forcing companies to pay a tax that runs as high as 35% on repatriated profits, our government is all but ensuring that the money stays overseas. It seems like common sense to reduce this tax rate dramatically. Better yet, why not eliminate it entirely? Doing so could be one of the most effective job creation initiatives the government could take.

Warrants Warrant Warren's Investment

2011-08-25T11:16:00.003-04:00

The big news for a while this morning was Steve Jobs' resignation as CEO of Apple. But it wasn't long before Warren Buffett stole the headlines. On Berkshire Hathaway's behalf, Buffett decided to invest $5 billion in Bank of America. Berkshire is buying cumulative preferred stock that pays 6% dividends. But that's not all. The preferred stock also comes with warrants that give Berkshire the right to buy 700 million shares of common stock at $7.14 per share.

Yesterday, before the deal was announced, shares of Bank of America rallied 11% to close at $6.99. Today, after the deal was announced, the stock opened at $8.29. That means the warrants immediately went into the money.

I discuss this kind of deal, known as a PIPE (private investment in public equity), in my book Even Buffett Isn't Perfect. PIPEs are not available to ordinary investors. Buffett used this structure not too long ago to invest in Goldman Sachs and General Electric. So far, at least, those stocks haven't done very well.

It remains to be seen if Bank of America pays off for Berkshire in the long run. But given the exercise price on the warrants, the odds are certainly in Berkshire's favor.

Is France Next?

2011-08-08T12:16:00.004-04:00

Last Friday, in a widely telegraphed move, Standard & Poor's downgraded America's credit rating one notch from AAA to AA+. The real surprise was the timing, not the downgrade. Nonetheless, officials at the Treasury Department went ballistic, in part due to an error in the calculation of projected debt. Yet after acknowledging the error, S&P stood by its downgrade.

Whether the downgrade was deserved or not, it has clearly shaken up financial markets around the world. Stocks, in particular, sold off everywhere. Yet U.S. bonds rallied. This seemingly nonsensical reaction in the bond market is due to investors trying to reduce risk. They are selling "risky" stocks and buying "safe" bonds. In other words, they believe the S&P downgrade is more a comment about dysfunction in the U.S. government than it is a concern about the government's inability to pay back its debts. As for stocks, the lower they go, the safer they get.

What comes next? No doubt the other rating agencies, Moody's and Fitch, are doing their homework and might issue downgrades of their own. I don't expect that to happen in the very near future. More likely, Moody's and Fitch will wait until they see how Washington reacts. The recent agreement to raise the debt ceiling and reduce spending requires the formation of a commission to come up with the cuts. Members of this commission have yet to be named. If the commission looks credible and if it makes serious recommendations in a timely fashion, Moody's and Fitch will likely maintain their prime ratings on U.S. credit. But if the commission turns out to be another dysfunctional political group that cannot agree on serious spending cuts, more ratings cuts are likely.

Now that S&P has downgraded America, you have to wonder about the remaining countries that still enjoy AAA ratings. France, in particular, looks vulnerable. Ten-year notes in France are yielding significantly more than 10-year notes in America--even after America's downgrade. In other words, investors are telling S&P it is wrong. They perceive French bonds to be riskier. Remember, the U.S. can always print more money. France no longer has its own currency. After downgrading the U.S., it would be entirely inconsistent for S&P to maintain its prime rating on France. I expect a downgrade of France will be the next shoe to drop.

Market Snubs Congress

2011-08-02T17:26:00.003-04:00

Conventional wisdom said stocks would rally once Congress settled on an agreement to raise the debt ceiling and cut spending. Yet on the same day that President Obama signed the Budget Control Act of 2011 into law, the S&P 500 sold off more than 2.5%. The S&P is down almost 7% in the last seven trading days.

Of course, the selloff can't be blamed entirely on the events in Washington. Economic factors deserve some of the blame. For example, yesterday's ISM manufacturing index came in at just 50.9 for July, well below expectations and well below the 55.3 reading for June. Because the figure was greater than 50, it indicates expansion, yet the pace of growth in the manufacturing sector has markedly slowed. Tomorrow, ISM will release its services index, which has been weaker than the manufacturing index in recent months. Economists expect a reading of 53.7, but there is a good chance the index will fall below the critical 50 level.

Yet the bulk of the blame for the selloff must go to Congress and the president. Even those politicians who voted for the bill were anything but happy. There was no backslapping and President Obama chose not to host a signing ceremony. And as soon as he signed the bill in the privacy of his office, he talked about the need to increase taxes on the so-called rich. In his book that means people making as little as $200,000 per year. How they can be called millionaires and billionaires, I don't know. In any case, investors understood that today's bill was nothing but a temporary fix. They see nothing but more political dysfunction ahead. Investors came to one conclusion: Risk Off!

The Dysfunctional U.S. Government

2011-07-29T15:14:00.004-04:00

It's Friday afternoon and amazingly the U.S. Congress has yet to agree on a bill that raises the debt ceiling and reduces spending. This is forcing investors to deal with an unprecedented level of uncertainty. Stocks have been selling off despite recent financial reports that largely show strong revenue and earnings growth. Despite strong earnings, a number of CEOs have commented that increased macroeconomic uncertainty and political risk make it extremely difficult to plan for the future.

On top of all this, the latest GDP report was extremely disappointing. All of the increased spending by the government to try to save the economy appears to have been for naught. The Advance Estimate for Q1 showed extremely meager growth of just 1.3%. As disappointing as that figure is, the downward revisions for prior quarters were even worse. In fact, for the entire 2007-2010 period, the Commerce Department had previously estimated that the economy grew at an average annual rate of 0.1%. In other words, it hardly grew at all. Yet now the Commerce Department says the economy actually shrank at an average annual rate of 0.3%. Furthermore, the average annual rate of growth of real disposable income during the period was halved from 1.2% to 0.6%.

These revisions make it clear that the U.S. economy was doing much worse than the government’s already dismal statistics suggested. Of course, all those unemployed people who are still having trouble finding jobs already knew that. However, during the same period, most corporations have done an excellent job of getting their own houses in order. Although the Commerce Department revised corporate profits down by 1.1% for 2008, it revised profits up 8.3% in 2009 and 10.8% in 2010. Unlike the government, corporations don’t have the luxury of financing losses ad infinitum with indefinite amounts of borrowing. Corporations that can’t generate profits do not stay in business for very long. If there was any doubt, recent events in Washington confirm that the average corporation is much better run than the government is.

A last minute compromise between Republicans and Democrats is still possible. However, the dysfunctional manner in which an agreement is being hashed out makes it almost a certainty that America’s credit rating will eventually be lowered. While a downgrade would be unfortunate indeed, it does not necessarily mean that interest rates will skyrocket. While events in Washington make it clear that U.S. government securities are more risky than investors previously believed, there is little doubt that most investors would still prefer to own U.S. bonds than the bonds issued by almost any other nation. Even so, shares of well run companies would probably provide a safer haven.

Interest Rates May Not Surge After Ratings Downgrade

2011-07-18T12:44:00.007-04:00

Contrary to popular belief, Standard & Poor's has not reduced its rating on U.S. government debt--at least not yet. Last April, S&P did reduce its outlook on U.S. government debt. That was its way of warning that a downgrade was possible. In particular, at that time, S&P assigned a one-in-three chance of reducing the rating within two years. Last week, S&P made things more formal. It placed U.S. government debt on CreditWatch negative. This time S&P said there is a one-in-two chance it will reduce the rating within 90 days.

This is serious stuff. Investors have long considered U.S. government debt to be risk free. Business schools have long encouraged this line of thinking. Finance professors all across the country have long taught their students about the Capital Asset Pricing Model. One of the variables in the CAPM is the risk-free rate of interest, which is merely a theoretical concept. But professors have told their students that it is probably safe to assume that the rate on U.S. Treasury securities is a good proxy for the theoretical risk-free rate. Not anymore. S&P's threat to downgrade U.S. debt means Treasury securities should not be considered risk free.

All things equal, a reduction in the credit rating should result in higher interest rates because higher perceived risk means investors will demand greater expected return. Higher rates for government debt will likely mean higher rates for all kinds of loans, including home mortgages. Clearly, that's not a good thing when the housing market is in such bad shape.

If there is any glimmer of hope, it is that a downgrade in America's credit rating may not cause interest rates to rise as much as many investors currently fear. This is because relative to other countries, U.S. government debt will still look good. I am not saying that rates won't rise. I'm only saying that any increase may not be as great as some people expect. That's assuming, of course, that inflation remains tame.

I discussed some of these issues, as well as the still surprising strength in retail sales, with Tracy Byrnes. You can watch the interview here.

Buffett Won't Pay More Taxes Until He Must

2011-07-07T14:18:00.003-04:00

Warren Buffett appears on CNBC so often, you would be forgiven for thinking he was part of the staff. He was on the tube again this morning defending his view that the rich should pay more taxes. The media has always handled Buffett with kid gloves, rarely putting him on the spot or pushing a point. Therefore, I give kudos to Joe Kernen who this morning tried hard to question Buffett about taxes.

Kernen asked Buffett why he gives so much money to charity instead of voluntarily paying more taxes. Kernen asked if it was because he thought charities would spend the money more wisely than the government would. This is no doubt true. Buffett acknowledged that charities do some things better than the government does, but for the most part he dodged the question. Instead of addressing the issue, he opined that a voluntary tax would not be effective and cited statistics showing that very little money is voluntarily donated to the government by individuals willing to pay more taxes. He argued that, as a result, we have to tax the rich more in order to force them to pay more.

As they said when I was a kid, "What does this have to do with the price of tea in China?" There are really only two reasons why the rich don't voluntarily pay more taxes: 1) They believe they are already taxed too much, and 2) they believe the government does not do a good job of handling their money. In any case, no one is suggesting that taxes be voluntary. We're only wondering why Buffett dodges taxes (albeit legally) if he really believes the rich should pay more.

Perhaps Kernen could have phrased the question differently, or maybe he should have followed up. Buffett's argument that voluntary taxes won't work is entirely irrelevant. Besides, it overlooks the fact that charitable contributions are also voluntary. Yet Americans keep on giving generously to charity. In fact, Americans donate about $300 billion annually to charity--all of it voluntarily.

Some people argue that the rich donate to charity only to take advantage of a tax deduction. In fact, Bill Gates' dad once made this argument in Congress. He argued that lower tax rates would reduce the value of the tax deduction and, as a result, would reduce the amount of money contributed to charity. This is bunk. As I explain in Chapter 9 of Even Buffett Isn't Perfect charitable contributions actually increased during periods when tax rates were reduced. Why? Because lower tax rates leave people with more money to donate to charity.

Buffett is in an untenable position. He says the rich should be taxed more, yet he keeps his own money out of the hands of government. Not only does he take full advantage of the tax breaks he is entitled to, but he will also avoid much of the estate tax by giving away the bulk of his fortune before he passes on.

In short, Buffett's argument can be paraphrased as follows. "The rich should pay more taxes. Because I'm rich, I also should pay more taxes. However, I refuse to lead by example. I won't pay more taxes until the government forces all rich folks to pay more taxes."

The Coming Housing Boom

2011-06-29T18:48:00.006-04:00

The following commentary is also available at The Fiscal Times.

Yes, you read that right. Get ready for the next housing boom. You're probably thinking, "How can that be?" With all the mortgage delinquencies and foreclosures going on, and the record levels of housing inventory, how could we possibly have another housing boom?

It's not going to happen soon. In fact, it may not happen for several more years. Yet despite all the problems we are seeing today, pent up demand will create the next housing boom. This is because demand for housing is closely tied to the rate of household formation. As society creates more households, society needs more houses. Right now, due to the poor economy and the dismal jobs market, household formation is on hold. This is one reason why the housing market continues to remain depressed.

A household is simply a residential unit. It refers to a person or persons living under one roof. Traditionally, a household has been thought of as a nuclear family. Boy meets girl, boy marries girls, boy and girl buy a house or rent an apartment. In this way, marriage creates more households and demand for more places to live. Divorce, too, creates more households and demand for more housing. People who get divorced do not want to continue living together under the same roof. Households are also formed when children grow up and move out. Most kids can’t wait to get their own place.

However, much of this activity is currently on hold. In a recent interview on National Public Radio, Karl Case (one half of the famous S&P/Case-Shiller duo) recently said, “The process of generating new households seems to have stopped.” Due to the poor economy, some people are postponing marriage. Others are postponing divorce. And as much as they would like to be independent, many grown children are staying put. Some can't find jobs even after graduating from college, so they are choosing to live with mom and dad just a little longer. Even those lucky enough to be employed are moving in with their parents in order to cut expenses.

Believe it or not, this lack of household formation could be good news for housing in the long run. It means there is a lot of pent up demand for housing, and chances are it is growing. Current household formation may be depressed, yet potential household demand is strong. Once the economy begins to pick up steam and more people start to find jobs, household formation will surge. Once that happens, demand for houses and apartments will also surge.

This is not to say that any of this is imminent. More likely than not, the process could take a few more years. Yet unless you believe the United States is on a permanent trajectory toward economic decline, you have to believe that the housing market will eventually turn around. All that pent up demand for household formation should create a strong rebound in the demand for housing. Maybe this time if we are smart enough to keep our wits about us, we will avoid another housing bubble.

FoxBusiness

2011-06-28T12:03:00.002-04:00

Here's a link to a recent hit I did on FoxBusiness by Skype. We discussed the economy and housing markets.

Interpreting the Fed

2011-06-23T08:30:00.005-04:00

The Federal Reserve released the following statement after its meeting on Wednesday. Because people sometimes complain that the Fed's language isn't entirely clear, I have taken the liberty of interpreting the statement for you in what I hope is a more comprehensible form. Below is the full text of the Fed's statement. Following each paragraph, I have written my interpretation in italics of what the Fed really meant to say:

Information received since the Federal Open Market Committee met in April indicates that the economic recovery is continuing at a moderate pace, though somewhat more slowly than the Committee had expected. Also, recent labor market indicators have been weaker than anticipated. The slower pace of the recovery reflects in part factors that are likely to be temporary, including the damping effect of higher food and energy prices on consumer purchasing power and spending as well as supply chain disruptions associated with the tragic events in Japan. Household spending and business investment in equipment and software continue to expand. However, investment in nonresidential structures is still weak, and the housing sector continues to be depressed. Inflation has picked up in recent months, mainly reflecting higher prices for some commodities and imported goods, as well as the recent supply chain disruptions. However, longer-term inflation expectations have remained stable.

The economy is still stuck in a rut and things are not getting better. Ain't nobody getting jobs. We are hoping and praying that the bad state of the economy improves and that higher food and gasoline prices go back down. We also hope the earthquake/tsunami/nuclear catastrophe in Japan does not prevent that country from making things again. On a positive note, people keep spending more money and companies are buying more things. But don't get your hopes up because nobody is investing and nobody wants to buy a house. Like we said before, food and gasoline prices have gone up. Despite those rising prices, we are still pretending that nobody expects prices to keep going up.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The unemployment rate remains elevated; however, the Committee expects the pace of recovery to pick up over coming quarters and the unemployment rate to resume its gradual decline toward levels that the Committee judges to be consistent with its dual mandate. Inflation has moved up recently, but the Committee anticipates that inflation will subside to levels at or below those consistent with the Committee's dual mandate as the effects of past energy and other commodity price increases dissipate. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.

Congress wants us to create more jobs and keep a lid on inflation at the same time. We know this is impossible, but we're trying anyway. People still can't find jobs, but we're hoping they will find them soon so that the unemployment rate will continue going lower. Oh wait, the unemployment rate has been going higher. Never mind. Anyway, just in case you didn't understand us the first two times, we want to tell you again that prices are going up. Despite that, we are hoping nobody really notices. But the next time we go shopping, we'll be sure to check if prices are still going up.

To promote the ongoing economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent. The Committee continues to anticipate that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate for an extended period. The Committee will complete its purchases of $600 billion of longer-term Treasury securities by the end of this month and will maintain its existing policy of reinvesting principal payments from its securities holdings. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.

All you old folks out there who were hoping to earn more interest on your savings account, well you can forget about that. We're not kidding. You really can forget about earning more interest in your bank account because we're going to make sure interest rates stay low. We told you we would complete QE2 and we meant it. And just in case you don't like it, tough. Get used to it because we might even do QE3.

The Committee will monitor the economic outlook and financial developments and will act as needed to best foster maximum employment and price stability.

We'll be watching CNBC just like the rest of you so don't be surprised if we do something stupid just to spite Rick Santelli.

Oil Prices Should Ease on OPEC's Failure to Reach Agreement

2011-06-09T12:56:00.004-04:00

A cartel is a formal agreement among competing firms to control the price and supply of a particular good or service. In order to promote competition, U.S. companies are prohibited from forming cartels. In theory, cartels should not last anyway because there is too much incentive to cheat.

That hasn’t prevented OPEC, the world’s best known cartel, from defying theory. The Organization of Petroleum Exporting Countries, currently consisting of a dozen nations, has been thriving since it was first formed in 1960. OPEC operates under a system of production quotas agreed to by its members. Saudi Arabia, the largest producer by far, is also the most influential.

That didn’t stop Ali Naimi, Saudi Arabia’s Minister of Petroleum and Resources, from calling Wednesday’s OPEC meeting in Vienna one of the worst ever saying, “In my 16 years as a minister, I have not seen as obstinate a position without move like this meeting.” He was referring to the hard line taken by Iran and OPEC’s subsequent failure to reach agreement to increase supply. Oil prices immediately surged on the news.

They shouldn’t have. Naimi went on to explain that Saudi Arabia, Kuwait, Qatar, and the United Arab Emirates “are able and willing to supply whatever the market needs,” which he currently estimates as an additional 1.5 million barrels per day. He made it clear that there would be no shortage of supply.

Does this portend the end of OPEC? Probably not. Yet cheating on production quotas has been going on for a long time. Most oil producing nations would love to sell as much as possible at the current $100 per barrel. Now that OPEC has failed to reach an agreement, the spigots should open wider. It shouldn’t take long before oil falls to $90 per barrel.

Stocks Suddenly Losing Favor

2011-06-08T12:59:00.002-04:00

The following commentary was released today to subscribers of the Forbes Special Situation Survey.

Stocks have suddenly exhibited weakness with the S&P 500 down about 6% since its April 29 high. Housing, employment, and energy continue to present the greatest headwinds. The latest S&P/Case-Shiller figures indicate that existing housing prices have double-dipped, setting new lows since their 2006 highs; nonfarm payroll figures have weakened once again with the unemployment rate jumping to 9.1%; and although energy prices have backed off their recent highs, the high cost of gasoline continues to present a significant challenge to most consumers.

Furthermore, high levels of debt remain a serious concern. Some economists argue that government debt as a proportion of GDP is not out of line, at least when compared to WWII era levels. However, if we include unfunded liabilities (i.e., social security, Medicare and Medicaid), state and local government debt, corporate debt, and consumer debt, total debt as a percent of GDP is at record levels. Government’s inability to properly address the debt and deficit is becoming an increasingly worrisome issue for the economy and investors.

One concern not often discussed is the increasing amount of programmed trading taking place in the markets. Programmed trading was behind the “flash crash” of May 6, 2010 when the Dow plunged 600 points in a matter of minutes. As institutional investors increase their reliance on computerized algorithms to execute orders, fewer human beings are involved in the actual decision-making process of buying and selling stocks. This is exaggerating the movements in stock prices. Investing, as opposed to trading, becomes more challenging in this kind of market. While it is still safe to assume that relying on fundamentals makes sense over the long term, irrational behavior can dominate the markets over the short term. Just as bubbles often get larger before they burst, undervalued stocks can get cheaper before investors come to their senses. Research in Motion (RIMM), one of the stocks on our buy list, is getting hammered by this kind of activity. A combination of irrational behavior and programmed trading appears to have contributed to the stock’s decline.

Given the serious problems in the economy, there really was no justification for the market’s strong rally from last September through April. Although some stocks appear to be extremely cheap, investors should remain extremely cautious about the overall market’s prospects. I recently had the opportunity to meet with several experienced investors including Forbes columnists Gary Shilling and Ken Fisher. Shilling continues to be bearish on stocks. That’s no surprise. Fisher, who is usually bullish, says he now expects stocks to finish relatively flat for the year. Given the serious challenges that must be overcome, it’s starting to look as if even a flat year might be too optimistic of a forecast.

A Chink in His Armor

2011-05-17T11:18:00.006-04:00

A couple of weeks ago, Berkshire Hathaway's audit committee issued an 18-page report about David Sokol's stock trades in Lubrizol Corporation. What stood out was how vigorously the report defended Warren Buffett, how strongly it blamed David Sokol, and how much it differed from Warren Buffett's own news release dated just one month earlier.

The audit committee concluded that Sokol had violated company policies and that he made misleading and incomplete disclosures about his stock trades. All that might be true, yet Buffett's earlier release defended Sokol and his stock trades. Buffett wrote, "Neither Dave nor I feel his Lubrizol trades were in any way unlawful." That statement might also be true. So far, at least, Sokol has not been charged with a crime. However, since the SEC is still investigating, the matter isn't closed. In any case, it certainly does appear that Sokol violated his fiduciary responsibility to Berkshire Hathaway. It seems that Lubrizol's CEO and the Citigroup bankers who brought Lubrizol to Sokol's attention were under the impression that Sokol was representing Berkshire Hathaway. Sokol should not have been using that information to execute trades in his own account.

The mere fact that Sokol resigned suggests there is probably more to this story. Most likely, Sokol would not have resigned unless he was asked to resign or unless he thought he had done something wrong. Buffett wrote that Sokol's resignation "came as a surprise to me." That's a bit hard to believe, especially since Buffett also says that Sokol tried to resign twice before. Furthermore, the report issued by the audit committee states that Buffett asked Berkshire's CFO Marc Hamburg to look into Sokol's trades as early as March 15, two weeks before Sokol resigned.

Furthermore, if the company's board of directors is genuinely convinced that Sokol violated company policy by trading in Lubrizol stock, it seems they would have an obligation to all their shareholders to try and recoup Sokol's profits from those trades. Initiating legal action, however, could require that both Sokol and Buffett testify under oath; something the board might prefer to avoid.

Unfortunately, the entire matter has given Buffett's stellar reputation a bit of a blow. At worst, it appears that Buffett tacitly approved Sokol's inappropriate trades, or at least chose to ignore the matter. At best, it appears that Buffett was completely duped by one of his most trusted lieutenants. Either way, this incident has put a chink in Buffett's shining armor.

$3,000 Per Night

2011-05-16T15:15:00.003-04:00

No doubt everyone has heard by now of the arrest of Dominique Strauss-Kahn, Managing Director of the International Monetary Fund. Mr. Strauss-Kahn, whose past exploits have earned him the nickname "The Great Seducer," is accused of sexually assaulting a chambermaid in his suite in the Sofitel hotel in New York City. If true, this is a horrendous crime. A court of law is certainly the appropriate place to decide his guilt or innocence, but things don't look good for him. At least one other woman is now claiming that he sexually assaulted her almost 10 years ago.

In any case, another question needs to be asked as well. The IMF is an international organization tasked with helping countries that have run out of money. It gets its funding from member nations, each of which pays a quota. Not surprisingly, the United States has the largest quota by far. As Managing Director, Mr. Strauss-Kahn reportedly earns well over $400,000 per year tax free. Mr. Strauss-Kahn was staying in a room that costs $3,000 per night. So here's the question: Who paid for the hotel room? Did the money come from Mr. Strauss-Kahn's own pocket (not likely), or was the U.S. taxpayer on the hook for the bulk of the bill?

Don't Blame Gouging for High Gasoline Prices

2011-04-27T12:24:00.003-04:00

The price of gasoline is perhaps the one price consumers notice more than any other. They see it prominently displayed every time they drive by a gas station and they feel it right in their wallet every time they fill up their tank. So when gasoline prices are on the rise, it isn’t surprising to hear consumers complain. In recent weeks, they have been doing a lot of complaining.

According to the AAA’s Daily Fuel Gauge Report, the national average price of regular gasoline is currently $3.87 per gallon. That’s up from $2.85 a year ago and $3.58 just one month ago. Never mind that gasoline prices are still much cheaper in the U.S. than in most other countries, or that gasoline prices are not out of line when adjusted for inflation during the past several decades. The recent rapid rise has consumers crying foul and state attorneys general warning gas stations not to price gouge. Attorney General Martha Coakley of Massachusetts has been at the forefront of these efforts to scare gas station operators. She recently cited a provision in the law that prohibits the selling of petroleum based products at “an unconscionably high price,” whatever that means.

While some price gouging might be occurring in certain markets, in general, gouging is not nearly the universal problem some politicians would like us to believe it is. The fact of the matter is that gasoline prices are up for a number of valid economic reasons.

First, supply has been disrupted. Gasoline is made from crude oil and unrest in the Middle East, particularly Libya, has disrupted supply causing crude oil prices to rise. The Obama administration’s reluctance to allow more drilling in the U.S., especially after the BP oil spill in the Gulf of Mexico, is also having a negative impact on supply.

Second, in an attempt to stimulate the economy, the U.S. government has debased the value of the dollar. A cheaper dollar increases the price of imports. Not coincidentally, oil is our biggest import. In addition, when investors fear a falling dollar, they pile into commodity-based futures contracts, contributing to rise in prices.

Third, demand for gasoline is on the rise. Recessions soften demand for all kinds of goods and services, including gasoline. But when economies recover, demand strengthens. While the U.S. recovery has been lackluster, the fact is that jobs numbers are improving. Gasoline demand has strengthened as more people have begun commuting again to work.

Price gouging is an unlikely explanation in highly populated markets where there are several gas stations within a three or four mile radius. If you think the price is too high at one station, it is easy to go to another. For gouging to take place in such areas, gas station owners would have to be colluding with one another. Unless someone conducts a thorough forensic audit of their books, it would be impossible to prove they are gouging. On the contrary, most gasoline retailers typically make only about a nickel per gallon. While it’s true that some stations charge more than others, the difference is usually explained by higher costs. For example, a station located in a prime spot such as a busy intersection is probably paying more for its lease than one located in a more remote part of town.

If politicians really want to reduce the price of gasoline, they should get off the backs of gas station owners and focus instead on taxes. State and federal taxes add about 43 cents per gallon on average to the price of gasoline. Yet this doesn’t take into account the additional revenues they generate by taxing the profits of all the entities involved in the petroleum business. The truth is that the government makes more money when gasoline prices go up. Politicians will lend a sympathetic ear to complaining consumers, but the last thing they want is lower tax revenues.

Click on WBUR in Boston to listen to my interview on this topic.

Poor Governance at Berkshire Hathaway is Not a New Problem

2011-04-24T15:14:00.003-04:00

Corporate governance has long been a topic of interest to financial researchers in academia. Law schools, too, have spent a lot of time on the issue. The issue of corporate governance arises from the separation of ownership and control at large publicly traded companies. After all, governance is largely irrelevant at closely held companies that are managed by the owners. If the CEO owns all the stock and shirks his responsibilities, he hurts only himself. But when there are many shareholders with only a few actually working at the company, governance becomes a big deal.

With Berkshire Hathaway's shareholders' meeting coming up next weekend, there has been much talk about governance. Warren Buffett is famous for having a hands-off approach to management. He says he buys good companies with good managers and then stays out of the way. He does not want to get involved in the operations.

However, David Sokol's recent resignation from Berkshire Hathaway has a lot of observers wondering if Buffett should not be more hands on. They are also wondering if Berkshire's board of directors is paying sufficient attention to governance.

I find this sudden attention to corporate governance at Berkshire long overdue. In fact, I devoted an entire chapter to the topic in my 2008 book, Even Buffett Isn't Perfect. Yet when the book came out, some critics wondered why anyone would worry about governance at Berkshire. With Sokol's sudden resignation and with the SEC investigating his stock trades, I suspect the critics have finally figured out the answer to that question.

Sokol Tarnishes Buffett's Reputation

2011-04-01T10:45:00.006-04:00

Until just a few days ago, David Sokol was a star manager at Berkshire Hathaway. He was CEO of NetJets and Chairman of MidAmerican Energy Holdings. Now he's caught up in a stock trading scandal involving Lubrizol, a company Berkshire Hathaway is in the process of acquiring. I did a two-part interview on CNBC yesterday about this issue. Here is Part I, and here is Part II. In addition, here is an article I wrote about the situation for The Fiscal Times.

Housing Heads for a Double Dip

2011-03-30T18:00:00.002-04:00

The latest S&P/Case-Shiller figures are disconcerting. There is no evidence that the housing market is improving. On the contrary, it appears to be headed for a double dip. Read my latest commentary at The Fiscal Times.

Book Review

2011-03-17T21:54:00.002-04:00

Just want to thank Brenda Jubin who runs the blog, Reading the Markets,for the favorable review of my latest book, The Forbes/CFA Institute Investment Course co-authored with Steve Horan of the CFA Institute and Chuck Trzcinka of Indiana University.

We Could See More Selling Ahead

2011-03-11T14:35:00.003-05:00

I'm growing increasing concerned about the behavior of the stock market. Stocks have been strong despite serious concerns about the economy, but yesterday's almost two percent selloff could be a harbinger of things to come. While I continue to find compelling buys in individual stocks (which I highlight in the Forbes Special Situation Survey, my outlook for the market as a whole is growing more bearish. I explain why in a recent posting at The Fiscal Times.

Buffett's Letter Does Not Disappoint

2011-03-02T15:33:00.003-05:00

Buffett's annual letters to shareholders always make for interesting reading. They are full of pithy comments and there is usually a surprise or two. This year's letter was no exception. Read more at The Fiscal Times.

What's in a Name?

2011-02-17T14:37:00.002-05:00

Have you heard about the controversy surrounding Deutsche Borse's merger with NYSE Euronext? It seems people are more concerned about what the name of the combined entity might be than they are about a German company acquiring one of America's most venerated institutions. Read more at The Fiscal Times.

Correction Ahead

2011-02-15T11:02:00.003-05:00

I'm getting increasingly concerned that investors are being too complacent about some serious issues that will plague the economy for years to come. While investor sentiment could drive the stock market higher in the near term, unless we get our economic house in order, the long term does not look very rosy. You can read my views on these matters at The Fiscal Times and at Forbes.com.

Don't Blame Egypt

2011-01-30T16:49:00.002-05:00

You can try blaming the rioting in Egypt, lower-than-expected GDP growth, and disappointing guidance from bellwether Amazon for Friday’s sell-off in stocks. Most likely, however, the real culprit was simply jittery investors trying to lock in profits from an extremely strong rally, which they suspect cannot last much longer.

In fact, as of Thursday’s close, the S&P 500 had surged 27% from its July 2, 2010 low. That is a great return for a full year let alone for just six months. The average annualized gain from equities is closer to 10% (including dividends). Rational investors know this pace is not sustainable. Given the severe sell-off in 2008 and into 2009 that followed the financial crisis, and the sell-off from 2000 to 2002 that followed the dot com bubble, many investors are exercising much more caution than they did in the 1990s. They want to make sure they don’t get caught in the next round of heavy selling. Of course, this does not mean that stocks will plunge. However, it could mean that prices remain flat for the remainder of the year.

Stocks have done great since hitting bottom on March 9, 2009. The strong gains in recent months were probably justified. After all, pundits like to say that the bottom line is the bottom line. In other words, in the final analysis, profits are the only thing that matters. And there is no question that corporate profit growth has been impressive. In recent quarters, we have been treated to better-than-expected earnings reports and decent year-over-year earnings gains. With earnings results like these, there is no reason why stocks should not have rallied.

Yet many problems remain. The federal budget deficit is too large and the government is carrying too much debt. States and municipalities are drowning in public pension obligations. The unemployment rate is improving, but much too slowly. Mortgage delinquencies and foreclosures remain too high, there are too many homes available for sale, and housing prices remain depressed. Worldwide inflation is on the rise. There are even problems at the corporate level. Yes, corporate profits are strong, but the same cannot be said for sales. Many companies are reporting anemic growth on the top line at best. Others continue to see revenues decline. Corporations are squeezing more profits from fewer sales only by aggressively cutting costs. This kind of cost cutting cannot go on forever. All businesses eventually reach a point where more profits can be produced only from more sales. Most are probably at that point already.

Academics like to say that markets are efficient, meaning that, on average, stocks sell for what they are worth. Yet even the academics recognize that markets are not perfect. Stock prices often go to extremes. When sentiment turns negative, prices fall well below what the fundamentals would dictate. When investors turn too bullish, prices overshoot on the upside. A 10 percent correction should not surprise anyone. In fact, a healthy sell-off should be welcomed by all long term investors who are holding cash that needs to be put to work.

The Forbes/CFA Institute Investment Course

2011-01-24T16:30:00.002-05:00

Many years ago, Forbes began producing a product called The Forbes Stock Market Course. When I joined Forbes in 1997, it was time to revise it. So with the help of Steve Horan and Chuck Trzcinka, two finance professors, we rewrote and updated the draft. Recently, we did it again. I'm pleased to announce that this time it is published by Wiley and we have renamed it The Forbes/CFA Institute Investment Course. You can take a look at the Table of Contents at Amazon.com.

Forbes Special Situation Survey Investment Newsletter

2011-01-11T14:58:00.007-05:00

Investment newsletter editors constantly compete against one another, trying to pick the best stocks and turn in the best returns. Sometimes the performance claims sound too good to be believed. This is why Mark Hulbert created the Hulbert Financial Digest, a publication that does nothing but track the performance of investment newsletters. Hulbert tries to provide an independent and objective look at how newsletters really are performing.

I am pleased to report that Hulbert continues to rank the Forbes Special Situation Survey as one of the best. According to Hulbert, out of about 180 investment newsletters on the market, ours is ranked #2 over the past three and five years. The table below displays our annual returns as determined by Hulbert and compares them to the S&P 500. These results were achieved without the use of shorts, derivatives, or margin. The newsletter follows a long-only strategy that is always fully invested in stocks. The figures speak for themselves.

Don't Bet on Lower Housing Prices in 2011

2011-01-03T14:37:00.003-05:00

A month ago I was enjoying warm weather on the Crystal Symphony off the Pacific coast of Mexico. I was there for the 18th Forbes Cruise for Investors. We discussed many things including the housing and employment markets. Today, at The Fiscal Times I explain why housing prices won't go lower in 2011.

The Glitter of Gold Hangs Over Seoul

2010-11-11T09:15:00.002-05:00

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.

Let Businesses Get Down to Business

2010-11-08T21:17:00.002-05:00

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.

Kill This Subsidy

2010-11-04T15:23:00.004-04:00

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.

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

2010-10-22T12:00:00.003-04:00

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.

A Weak Dollar is Bad Policy

2010-10-16T11:30:00.004-04:00

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.

The Fed is Out to Destroy Your Money

2010-10-14T13:47:00.003-04:00

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.

Stocks Buck the September Curse

2010-09-30T16:29:00.003-04:00

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.

The Gold Bubble

2010-09-24T19:13:00.004-04:00

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.

CNBC Worldwide Exchange

2010-09-17T09:41:00.003-04:00

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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!

To Dip or Double-Dip?

2010-09-14T10:11:00.003-04:00

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.

Give Me Cash and Stocks, No Bonds.

2010-08-27T13:55:00.005-04:00

"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.

The Plunge in Housing Must Continue

2010-08-24T12:27:00.003-04:00

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.

For-Profit Education on the Skids

2010-08-15T08:29:00.003-04:00

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).

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

2010-08-03T12:18:00.002-04:00

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.

Beating the Estimate Isn't Saying Much

2010-07-26T14:27:00.003-04:00

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.

Housing Starts Fall

2010-07-20T15:03:00.003-04:00

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.

Let's Listen to Arthur Laffer

2010-07-08T11:31:00.003-04:00

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.

Is a Double Dip Recession in the Cards?

2010-07-01T16:03:00.004-04:00

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.

Manufacturing Survey is Lame Excuse for Rally

2010-06-15T13:59:00.003-04:00

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!)

Greece and the Gulf Oil Spill Scare Investors in May

2010-06-01T14:00:00.003-04:00

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.

Schapiro Virtually Addresses CFA Institute

2010-05-18T17:32:00.005-04:00

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.

MoneyShow Las Vegas Webcast

2010-05-07T14:34:00.002-04:00

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.

Fat Fingers Cause Panics

2010-05-06T15:39:00.004-04:00

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.

Goldman Sachs, Washington, and the Theater of the Absurd

2010-05-02T14:45:00.007-04:00

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.

Shorts vs. Net Shorts

2010-04-27T16:01:00.003-04:00

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.

The Future of Entrepreneurship Looks Bright

2010-04-20T11:11:00.004-04:00

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.

Goldman Tarnishes Buffett's Image

2010-04-16T15:31:00.004-04:00

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.

Special Situation Survey Ranked As One of the Best.

2010-04-13T16:38:00.004-04:00

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.

When Better-Than-Expected Isn't Good Enough

2010-04-12T13:25:00.003-04:00

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.

A Review of "Investing Without Borders"

2010-04-06T11:30:00.003-04:00

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.

FGI Commentary

2010-04-04T11:23:00.004-04:00

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.

Communism is Dead, but State Capitalism Thrives

2010-03-22T10:29:00.009-04:00

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.

More Info Needed on Pay for Performance

2010-03-19T10:53:00.004-04:00

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.

The Looming Trade War With China

2010-03-17T12:13:00.002-04:00

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.

Financial Engines is a Sharpe IPO

2010-03-16T12:34:00.005-04:00

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.

Get Rich by Investing Like The Rich

2010-03-11T10:03:00.006-05:00

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.

Who Has the Greatest Propensity to Spend Tax Rebates?

2010-03-09T12:56:00.003-05:00

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.

Bernanke's Next Trick

2010-02-26T18:02:00.004-05:00

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.

No Slave to Fashion

2010-02-25T10:43:00.007-05:00

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?

Market Skeptic Needs Convincing

2010-02-24T15:40:00.006-05:00

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.

Trying Too Hard to Assuage Investors

2010-02-22T12:32:00.003-05:00

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.

Discount Rate Hike is no Surprise

2010-02-19T14:00:00.003-05:00

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.

Orlando MoneyShow

2010-02-08T13:06:00.002-05:00

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.

The Elephant in the Room

2010-01-30T18:00:00.004-05:00

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.

Hank Greenberg's Take

2010-01-27T15:10:00.004-05:00

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.

An Oldie, But a Goodie

2010-01-22T12:10:00.005-05:00

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.

Pickens and Fracturing

2010-01-21T15:24:00.003-05:00

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.

Stocks Sell Off on Good News

2010-01-20T17:12:00.003-05:00

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.

Jobs Report Dampens Workers' Hopes

2010-01-08T09:00:00.003-05:00

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.

FGI Gains 35% in 2009

2010-01-07T12:05:00.002-05:00

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.

Home At Last

2009-12-08T12:50:00.004-05:00

By Vahan Janjigian - I'm finally back from the 16th Forbes Cruise for Investors. I got off the ship in Aruba on Sunday and took a long flight home. The Internet connection on the ship was not always reliable, so I did not get a chance until now to post my comments about Jack Ablin's presentation.

Jack is the Chief Investment Officer at Harris Private Bank. We first met in 1996 when I was on the faculty at Northeastern University. I signed up for a course to prepare for the Level II Chartered Financial Analyst exam and Jack was one of my instructors. He was an excellent lecturer.

It was nice to see that he hasn't lost his presentation skills. Jack is a quantitative analyst. One of his comments should give college students majoring in business something to think about. He said he only hires people with strong quantitative skills. He especially likes engineering majors. This is because he finds it easier to teach an engineer how to do finance than to teach a business major how to do quantitative analysis.

Jack is fond of using a momentum approach to investing. There are plenty of investors who are skeptical of this approach, but it really does work. Sheridan Titman, now a professor at the University of Texas, was one of the first to document that stocks exhibit momentum. One approach Jack relies on is to compare an index or sector to its moving average. In general, he avoids buying stocks until they start moving up. He is happy to miss the opportunity to buy at the bottom until he is confident that an upward trend has begun.

Jack believes the market is currently at a fair to full valuation. He thinks inflation will eventually become a problem, but says we will have about two to three years to prepare for it. He expects the Fed to sit tight through much of 2010. He mentioned two ETFs he currently likes: The S&P International Small Cap (GWX) and the WisdomTree International Small Cap Dividend (DLS).

Jack recently authored a book: Reading Minds and Markets: Minimizing Risk and Maximizing Returns in a Volatile Global Marketplace. He gave a copy to all attendees. I am putting it on my reading list.

Visiting St. Bart's

2009-12-03T20:26:00.003-05:00

By Vahan Janjigian - We took two days day off from our seminars to enjoy the cruise. We also got off the ship at a couple of ports. I went on a five-mile hike today in St. Bart’s. Nonetheless, I also managed to hold a number of impromptu discussions with several attendees about the economy and markets. Most of these people are retired and have a high net worth. Many are sophisticated investors. Yet I have not spoken with anyone who I would call bullish. They are all cautious about the economy and extremely skeptical about the strength of the recent rally in stocks. They are also worried that the government’s efforts to revive the economy will ultimately fail, especially since there is so much talk about increasing both taxes and spending.

I was thrilled to meet Ed Breen, CEO of Tyco International (pictured above left). Ed and I had an interesting discussion about the interaction between equity research analysts and corporate managements. We agreed that since the SEC promulgated Reg FD, there is little value to one-on-one meetings between these two parties. Corporations are disclosing a lot more information these days in their SEC filings. I personally find that my research is much more objective if I do not meet the management team. Unlike Warren Buffett, I am not trying to marry good companies. I am just trying to buy good stocks. Nonetheless, I am glad I had the opportunity to meet Ed personally. He is doing an excellent job of bringing Tyco back from the disgrace it suffered several years ago.

Also pictured above (right) is Barry Ritholtz. He always manages to provide an original point of view on the markets. One of my friends went to law school with Barry some years ago. She claims he was one of the smartest students in the class. I can believe it.