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.
Tuesday, August 24, 2010
Sunday, August 15, 2010
For-Profit Education on the Skids
In my column in the August 9 issue of Forbes magazine, I warned of a double-dip recession and talked about the importance of investing in stocks with growing dividends in a down market. I gave Washington Post (WPO) as an example of such a stock. The stock, however, has gone lower ever since.
In fact, all for-profit education stocks have been hit. Other examples include Corinthian Colleges (COCO), Apollo Group (APOL), American Public Education (APEI), Strayer Education (STRA), DeVry (DV), Career Education (CECO), Grand Canyon Education (LOPE), Bridgepoint Education (BPI), Education Management Corp. (EDMC), and Lincoln Education (LINC). Not surprisingly, the catalyst for the sell-off is proposed government regulation.
The for-profit education industry has grown in leaps in bounds. An estimated two million students are currently enrolled in such programs. That's about 10% of all students eligible to receive federal financial aid, and that's where the problem lies.
The Department of Education is concerned that at least some for-profit educational institutions are not on the up-and-up. They may be aggressively encouraging students to enroll and borrow money to pay for tuition without offering them any real prospect of finding jobs and paying back their loans. Not unreasonably, the government wants to see evidence that former students are able to pay back their loans and are actually doing so. To be specific, to meet the new guidelines, at least 45% of former students must be paying back principal on their loans, or the average debt burden of former students must be less than 8% of total income or 20% of discretionary income.
Having spent 12 years as a professor at traditional (i.e., not-for-profit) educational institutions, I am in favor of introducing market discipline to higher education. For-profit educational institutions have grown in popularity because they have proven their ability to deliver quality education at a fraction of the price that traditional colleges charge. Too many traditional universities are bloated with highly paid administrators and tenured faculty members who spend little time in the classroom and produce research of only marginal value.
While the profit motive can introduce efficiency and discipline, it can also result in corruption. Yet there is plenty of corruption at not-for-profit institutions as well. The Department of Education should monitor both groups closely. It is perfectly reasonable to ask all for-profit and not-for-profit educational institutions to provide evidence that they are admitting students on a selective basis and teaching them skills that result in gainful employment. Otherwise, we will end up with yet another tax-payer funded bailout.
Disclosure: Vahan Janjigian currently has a long position in Washington Post (WPO).
In fact, all for-profit education stocks have been hit. Other examples include Corinthian Colleges (COCO), Apollo Group (APOL), American Public Education (APEI), Strayer Education (STRA), DeVry (DV), Career Education (CECO), Grand Canyon Education (LOPE), Bridgepoint Education (BPI), Education Management Corp. (EDMC), and Lincoln Education (LINC). Not surprisingly, the catalyst for the sell-off is proposed government regulation.
The for-profit education industry has grown in leaps in bounds. An estimated two million students are currently enrolled in such programs. That's about 10% of all students eligible to receive federal financial aid, and that's where the problem lies.
The Department of Education is concerned that at least some for-profit educational institutions are not on the up-and-up. They may be aggressively encouraging students to enroll and borrow money to pay for tuition without offering them any real prospect of finding jobs and paying back their loans. Not unreasonably, the government wants to see evidence that former students are able to pay back their loans and are actually doing so. To be specific, to meet the new guidelines, at least 45% of former students must be paying back principal on their loans, or the average debt burden of former students must be less than 8% of total income or 20% of discretionary income.
Having spent 12 years as a professor at traditional (i.e., not-for-profit) educational institutions, I am in favor of introducing market discipline to higher education. For-profit educational institutions have grown in popularity because they have proven their ability to deliver quality education at a fraction of the price that traditional colleges charge. Too many traditional universities are bloated with highly paid administrators and tenured faculty members who spend little time in the classroom and produce research of only marginal value.
While the profit motive can introduce efficiency and discipline, it can also result in corruption. Yet there is plenty of corruption at not-for-profit institutions as well. The Department of Education should monitor both groups closely. It is perfectly reasonable to ask all for-profit and not-for-profit educational institutions to provide evidence that they are admitting students on a selective basis and teaching them skills that result in gainful employment. Otherwise, we will end up with yet another tax-payer funded bailout.
Disclosure: Vahan Janjigian currently has a long position in Washington Post (WPO).
Tuesday, August 03, 2010
Don't Fall for the Rally. Economy is Still Sick
The following is Vahan Janjigian's commentary from the August issue of the Forbes Growth Investor:
On the last trading day of July, the Bureau of Economic Analysis (BEA) announced that GDP growth for the second quarter of the year was 2.4%. While this was less than the consensus estimate, I thought it was surprisingly strong. I was expecting a figure somewhat less than 2.0%. Keep in mind that this is just the BEA’s first estimate, the so-called advance estimate. A month from now it will publish a more accurate estimate. That second figure could be higher or lower than 2.4%. In any case, it is encouraging to see any amount of real economic growth taking place.
The biggest contributor to growth last quarter was private domestic investment, especially investment in equipment and software. Personal consumption expenditures were also a major contributor to GDP growth last quarter, but to a lesser extent than they were in the first quarter. However, net exports subtracted almost 2.8 points from GDP growth as the increase in imports far exceeded the increase in exports.
Government stimuli, both direct and indirect, were largely responsible for much of the growth in the second quarter. Without all those incentives, the economy would have likely dipped into a second recession. Of course, without those incentives, the budget deficit and the federal debt would not be nearly as large as they are now.
For the most part, corporate earnings reports have been strong. Unfortunately, revenues are still anemic. Companies are doing an excellent job of cutting costs, but headcount is one of those costs. Until they are absolutely convinced that sales will grow steadily, corporate managers are not going to resume hiring. In the meantime, corporations are piling up large amounts of cash. This bodes
well for those hoping for dividend increases. Many companies are also taking advantage of almost unbelievably low interest rates by refinancing higher rate obligations. They view this interest rate environment as a once-in-a-lifetime opportunity.
The same holds true for mortgages. With sales and prices down, this is a great time to finance the purchase of a house with a long-term mortgage—at least for those who can get approved. The national average for a 30-year fixed-rate mortgage is about 4.5%. Five years ago home prices and interest rates were much higher, but back then, just about anybody could get approved for a mortgage. Today, prices and rates are way down, yet lending standards have been tightened. If lenders had been this diligent in the years leading up to the housing bubble, we would not be in this mess to begin with.
In the meantime, the S&P 500 keeps gyrating between 1,025 and 1,125, rallying whenever there is a hint of economic recovery and selling off on any prospect of another recession. It seems that on some days, investors can’t even decide if a particular bit of news is good or bad. Traders are making good money on the big swings. Investors, however, are getting nowhere.
I continue to believe the economy is still sick. GDP growth is being artificially generated by a large government deficit and corporations are creating profits by squeezing costs. In the meantime, home foreclosures keep rising and jobs remain scarce. While stocks could rally strongly on any given day, I see nothing yet that makes me more bullish for the long term.
On the last trading day of July, the Bureau of Economic Analysis (BEA) announced that GDP growth for the second quarter of the year was 2.4%. While this was less than the consensus estimate, I thought it was surprisingly strong. I was expecting a figure somewhat less than 2.0%. Keep in mind that this is just the BEA’s first estimate, the so-called advance estimate. A month from now it will publish a more accurate estimate. That second figure could be higher or lower than 2.4%. In any case, it is encouraging to see any amount of real economic growth taking place.
The biggest contributor to growth last quarter was private domestic investment, especially investment in equipment and software. Personal consumption expenditures were also a major contributor to GDP growth last quarter, but to a lesser extent than they were in the first quarter. However, net exports subtracted almost 2.8 points from GDP growth as the increase in imports far exceeded the increase in exports.
Government stimuli, both direct and indirect, were largely responsible for much of the growth in the second quarter. Without all those incentives, the economy would have likely dipped into a second recession. Of course, without those incentives, the budget deficit and the federal debt would not be nearly as large as they are now.
For the most part, corporate earnings reports have been strong. Unfortunately, revenues are still anemic. Companies are doing an excellent job of cutting costs, but headcount is one of those costs. Until they are absolutely convinced that sales will grow steadily, corporate managers are not going to resume hiring. In the meantime, corporations are piling up large amounts of cash. This bodes
well for those hoping for dividend increases. Many companies are also taking advantage of almost unbelievably low interest rates by refinancing higher rate obligations. They view this interest rate environment as a once-in-a-lifetime opportunity.
The same holds true for mortgages. With sales and prices down, this is a great time to finance the purchase of a house with a long-term mortgage—at least for those who can get approved. The national average for a 30-year fixed-rate mortgage is about 4.5%. Five years ago home prices and interest rates were much higher, but back then, just about anybody could get approved for a mortgage. Today, prices and rates are way down, yet lending standards have been tightened. If lenders had been this diligent in the years leading up to the housing bubble, we would not be in this mess to begin with.
In the meantime, the S&P 500 keeps gyrating between 1,025 and 1,125, rallying whenever there is a hint of economic recovery and selling off on any prospect of another recession. It seems that on some days, investors can’t even decide if a particular bit of news is good or bad. Traders are making good money on the big swings. Investors, however, are getting nowhere.
I continue to believe the economy is still sick. GDP growth is being artificially generated by a large government deficit and corporations are creating profits by squeezing costs. In the meantime, home foreclosures keep rising and jobs remain scarce. While stocks could rally strongly on any given day, I see nothing yet that makes me more bullish for the long term.
Monday, July 26, 2010
Beating the Estimate Isn't Saying Much
Investors are reacting positively to today's report that new home sales in June were better than expected. However, better than expected isn't necessarily good. On a seasonally adjusted and annualized basis, June sales were 330,000 units. That's 20,000 better than the consensus estimate and 63,000 more than were sold in May. Yet it is 66,000 fewer units than a year ago. There is currently a 7.6 months supply of new homes on the market.
The tax credits, which expired in April, caused April sales to surge to 422,000 and May sales to plunge to 267,000. That's no surprise. The June figure is merely the market's attempt to get back to equilibrium. Unfortunately, the long-term trend is still down for both sales and prices. The median price for a new home fell to $213,400 in June from $216,400 in May. It was $214,700 a year ago. The large number of foreclosures on existing homes won't help support prices for new homes.
The housing market is still in a process of finding a bottom. It may be close to getting there. If you are in the market for a new house, it's probably not a bad time to buy--depending on where it is located and how long you are planning to live in it. However, the longer-term health of the housing market depends on the health of the employment market. As long as large numbers of people who want jobs can't find jobs, housing prices and sales were remain depressed.
The tax credits, which expired in April, caused April sales to surge to 422,000 and May sales to plunge to 267,000. That's no surprise. The June figure is merely the market's attempt to get back to equilibrium. Unfortunately, the long-term trend is still down for both sales and prices. The median price for a new home fell to $213,400 in June from $216,400 in May. It was $214,700 a year ago. The large number of foreclosures on existing homes won't help support prices for new homes.
The housing market is still in a process of finding a bottom. It may be close to getting there. If you are in the market for a new house, it's probably not a bad time to buy--depending on where it is located and how long you are planning to live in it. However, the longer-term health of the housing market depends on the health of the employment market. As long as large numbers of people who want jobs can't find jobs, housing prices and sales were remain depressed.
Tuesday, July 20, 2010
Housing Starts Fall
As I explain in a forthcoming column in Forbes magazine, the poor housing market is a major reason why I have remained skeptical about an economic recovery. Today's report on housing starts reinforces my view.
Housing starts in June fell to a seasonally adjusted annual rate of 549,000, 5% less than a month ago and almost 6% less than a year ago. The number was also significantly below the consensus estimate. Of course, much of the blame for the shortfall goes to the expiration of government tax credits. That should not surprise anyone.
Housing foreclosures and inventories are also on the rise. Foreclosures are closely related to the employment market. Despite the recent decline in the unemployment rate to 9.5%, there is little evidence of private sector job gains. Most of the employment growth is in the public sector. Although state and local governments have reduced payrolls, the federal government has more than made up for those job losses.
One bright sign is the financial services sector in New York City. Some firms, including Goldman Sachs, are finally hiring again. While this could be a turning point, it is still too early to be certain.
Housing starts in June fell to a seasonally adjusted annual rate of 549,000, 5% less than a month ago and almost 6% less than a year ago. The number was also significantly below the consensus estimate. Of course, much of the blame for the shortfall goes to the expiration of government tax credits. That should not surprise anyone.
Housing foreclosures and inventories are also on the rise. Foreclosures are closely related to the employment market. Despite the recent decline in the unemployment rate to 9.5%, there is little evidence of private sector job gains. Most of the employment growth is in the public sector. Although state and local governments have reduced payrolls, the federal government has more than made up for those job losses.
One bright sign is the financial services sector in New York City. Some firms, including Goldman Sachs, are finally hiring again. While this could be a turning point, it is still too early to be certain.
Thursday, July 08, 2010
Let's Listen to Arthur Laffer
Arthur Laffer is a conservative economist who is frequently pilloried by the left. He is best-known for popularizing the "Laffer Curve," a graphical depiction of the relationship between tax revenues and tax rates. The curve shows how tax revenues rise as tax rates rise, but only up to a certain point. Once tax rates surpass a critical level, tax revenues actually fall. In other words, when tax rates are already high (as they are now), the government can generate more tax revenues only by reducing tax rates. Many people find this obviously logical conclusion extremely counterintuitive.
In today's Wall Street Journal, Laffer takes on employment and makes a cogent argument as to why more generous unemployment benefits simply result in more unemployment. The facts clearly support his conclusion, yet those who point out facts are often accused of being cold hearted. There are 26 million Americans who are "officially" unemployed, marginally attached to the labor force, or working part-time for economic reasons. Many more are still working, but are extremely nervous about losing their jobs. One of my best friends just joined the ranks of the unemployed. He lost a job he held for 18 years. This guy is very smart and hard working. He would never consider milking the system to collect benefits while he sits at home. Yet the evidence is clear. The more generous unemployment benefits are, the longer people take to find jobs. It may appear to be cold hearted to limit benefits, but it is even more cold hearted to initiate policies that keep people out of work for longer periods of time.
Today, the Department of Labor announced that there were 454,000 initial jobless claims for the week ending July 3. Amazingly, this is considered good news because it is 21,000 fewer than the week before and 6,000 less than what economists expected. The private sector is still paring jobs. So are state and local governments. Yet the federal government keeps employing more and more Americans. These days, a job with the federal government is the only job that offers some security. However, as the government's role in the economy increases, so does the national debt.
Laffer's remedy is radical, but it would have no doubt worked. He says that instead of wasting all that money trying to stimulate the economy, we should have eliminated all taxes for 18 months. Imagine how many jobs would have been created if workers and employers didn't have to pay any taxes. Is it too late to implement this solution now? I say better late than never.
In today's Wall Street Journal, Laffer takes on employment and makes a cogent argument as to why more generous unemployment benefits simply result in more unemployment. The facts clearly support his conclusion, yet those who point out facts are often accused of being cold hearted. There are 26 million Americans who are "officially" unemployed, marginally attached to the labor force, or working part-time for economic reasons. Many more are still working, but are extremely nervous about losing their jobs. One of my best friends just joined the ranks of the unemployed. He lost a job he held for 18 years. This guy is very smart and hard working. He would never consider milking the system to collect benefits while he sits at home. Yet the evidence is clear. The more generous unemployment benefits are, the longer people take to find jobs. It may appear to be cold hearted to limit benefits, but it is even more cold hearted to initiate policies that keep people out of work for longer periods of time.
Today, the Department of Labor announced that there were 454,000 initial jobless claims for the week ending July 3. Amazingly, this is considered good news because it is 21,000 fewer than the week before and 6,000 less than what economists expected. The private sector is still paring jobs. So are state and local governments. Yet the federal government keeps employing more and more Americans. These days, a job with the federal government is the only job that offers some security. However, as the government's role in the economy increases, so does the national debt.
Laffer's remedy is radical, but it would have no doubt worked. He says that instead of wasting all that money trying to stimulate the economy, we should have eliminated all taxes for 18 months. Imagine how many jobs would have been created if workers and employers didn't have to pay any taxes. Is it too late to implement this solution now? I say better late than never.
Thursday, July 01, 2010
Is a Double Dip Recession in the Cards?
The following is an edited version of Vahan Janjigian's commentary from the July issue of the Forbes Growth Investor:
When I was a kid, a double dip was a special treat. It meant you got two scoops of ice cream instead of one. When it comes to the economy, however, a double dip is no treat at all. It means you recover from a recession only to go into another one.
Readers of this page know I have been bearish on the economy for some time. In my view, things had gotten so bad there was no way they could quickly rebound. While I felt a rally off the March 2009 lows was justified, I also believed the market got way ahead of economic realities. After all, I saw no evidence of real demand for goods and services. Whatever demand I did see was artificially induced by increased amounts of government spending. However, with the national debt at 90% of GDP and a budget deficit of $1.4 trillion, the government cannot keep spending for long.
A few months ago, it was a faux pas to talk of a double dip recession. Today, it is de rigueur. A double dip is by no means a certainty, yet the odds are certainly growing in its favor. All that government spending was not particularly effective.
Look at housing. The latest figures on new home sales were abysmal. Why that would surprise any economist is beyond my comprehension. What happens when the government offers generous tax breaks to anyone who signs a contract to buy a house? We get plenty of signed contracts. And what happens when the tax breaks expire? Sales fall off a cliff. This is why April’s new home sales were strong and why May’s new home sales plunged. It also explains why pending sales of existing homes plunged in May. Furthermore, a signed contract does not guarantee a closing. Thanks to the mortgage-related financial crisis we are still struggling through, lenders have significantly tightened credit standards. Mortgage rates are at historic lows, yet many would be homebuyers cannot get approved to close the deal.
Housing is not the only market in distress. The latest ADP Employment Report showed a gain of only 13,000 nonfarm private jobs. That was 50,000 less than expected. Prepare yourselves for Friday when the Department of Labor releases its nonfarm payroll figures. The market is expecting a loss of 100,000 jobs. A number significantly worse than that will cause tremendous volatility in stock prices.
With the housing and employment markets so weak, how confident could consumers be? Not confident at all. After rising three months in a row, the Conference Board’s Consumer Confidence Index plunged in June. Only 8% of consumers surveyed think business conditions are good and only 4% believe jobs are plentiful. Consumers who lack confidence do not usually behave in a manner that spurs economic growth.
Finally, while I focus almost solely on stocks, I cannot help but notice the behavior of two non-equity assets. The yield on the 10-year Treasury note dipped well below 3%, yet gold prices are near $1,200 per ounce. Investors who believe these assets are reliable gauges of inflationary expectations are confused. The low bond yield signals no fear of inflation, but the high gold price signals the opposite. However, things really are different this time. Inflation has nothing to do with the prices of these assets. Increasingly risk averse investors now view Treasury bonds and gold as safe havens. They are selling risky assets such as stocks and bidding up the prices of safe assets. Stocks are getting cheaper, but I believe it is still too early to jump in with both feet.
When I was a kid, a double dip was a special treat. It meant you got two scoops of ice cream instead of one. When it comes to the economy, however, a double dip is no treat at all. It means you recover from a recession only to go into another one.
Readers of this page know I have been bearish on the economy for some time. In my view, things had gotten so bad there was no way they could quickly rebound. While I felt a rally off the March 2009 lows was justified, I also believed the market got way ahead of economic realities. After all, I saw no evidence of real demand for goods and services. Whatever demand I did see was artificially induced by increased amounts of government spending. However, with the national debt at 90% of GDP and a budget deficit of $1.4 trillion, the government cannot keep spending for long.
A few months ago, it was a faux pas to talk of a double dip recession. Today, it is de rigueur. A double dip is by no means a certainty, yet the odds are certainly growing in its favor. All that government spending was not particularly effective.
Look at housing. The latest figures on new home sales were abysmal. Why that would surprise any economist is beyond my comprehension. What happens when the government offers generous tax breaks to anyone who signs a contract to buy a house? We get plenty of signed contracts. And what happens when the tax breaks expire? Sales fall off a cliff. This is why April’s new home sales were strong and why May’s new home sales plunged. It also explains why pending sales of existing homes plunged in May. Furthermore, a signed contract does not guarantee a closing. Thanks to the mortgage-related financial crisis we are still struggling through, lenders have significantly tightened credit standards. Mortgage rates are at historic lows, yet many would be homebuyers cannot get approved to close the deal.
Housing is not the only market in distress. The latest ADP Employment Report showed a gain of only 13,000 nonfarm private jobs. That was 50,000 less than expected. Prepare yourselves for Friday when the Department of Labor releases its nonfarm payroll figures. The market is expecting a loss of 100,000 jobs. A number significantly worse than that will cause tremendous volatility in stock prices.
With the housing and employment markets so weak, how confident could consumers be? Not confident at all. After rising three months in a row, the Conference Board’s Consumer Confidence Index plunged in June. Only 8% of consumers surveyed think business conditions are good and only 4% believe jobs are plentiful. Consumers who lack confidence do not usually behave in a manner that spurs economic growth.
Finally, while I focus almost solely on stocks, I cannot help but notice the behavior of two non-equity assets. The yield on the 10-year Treasury note dipped well below 3%, yet gold prices are near $1,200 per ounce. Investors who believe these assets are reliable gauges of inflationary expectations are confused. The low bond yield signals no fear of inflation, but the high gold price signals the opposite. However, things really are different this time. Inflation has nothing to do with the prices of these assets. Increasingly risk averse investors now view Treasury bonds and gold as safe havens. They are selling risky assets such as stocks and bidding up the prices of safe assets. Stocks are getting cheaper, but I believe it is still too early to jump in with both feet.
Tuesday, June 15, 2010
Manufacturing Survey is Lame Excuse for Rally
Today's strong rally in stocks is being credited to a favorable Empire State Manufacturing Survey. This survey is administered by the Federal Reserve Bank of New York. Not surprisingly, investors reacted primarily to the headline, which does indeed suggest that things are getting better. Keep in mind, however, that the survey covers business conditions in just one state. Furthermore, the results are derived by surveying only 200 top executives at New York manufacturing companies; of which only about 100 actually responded.
That so many investors would pay this much attention to a rather esoteric report seems a bit odd. At least for today anyway, investors chose to buy stocks due to how 100 executives responded to this one question: "What is your evaluation of the level of general business activity?" The New York Fed was not looking for a well thought out essay. Instead, it was a multiple choice question with only three possible answers: Decrease, No Change, and Increase. The Fed then creates an index from the answers. Investors apparently got excited because the index was somewhat higher than it was a month ago, which suggests a positive trend.
The survey does contain other questions as well, but stocks surged primarily because of how 100 executives answered that lead question. Of course, the value of the index could have been quite different if just one or two executives responded in a different manner, or if some of the 100 who skipped the survey had actually responded. Which brings up another question, why didn't those executives respond? Was it because business conditions were so good that they were simply too busy? Or was it because business conditions were so bad that they were too disillusioned?
The survey also asked about the number of employees and about the average employee workweek. The results from the 100 executives who responded suggest that manufacturing companies added employees, but at a slower pace than they did a month ago, and that employees are working longer hours. The survey results also indicate that the executives are optimistic about future business conditions (i.e., six months from now), but not as optimistic as they were a month ago.
Overall, the survey does not really tell us much that we did not already know. Results are better than they were a year ago, but not that different than they were a month ago. Nonetheless, investors seized on the report as an excuse to buy stocks. However, the real reason they started buying was because they were convinced stocks were oversold. As I've argued before, there will be many days on which stocks rally strongly, yet the overall trend is still unfavorable. A somewhat upbeat manufacturing report is certainly nice to see, but we still have to deal with much larger problems in the economy, including huge amounts of sovereign debt, stubbornly high unemployment, a still sick housing market, and a general lack of demand for goods and services. (Except, of course, when demand is being fueled by generous government subsidies!)
That so many investors would pay this much attention to a rather esoteric report seems a bit odd. At least for today anyway, investors chose to buy stocks due to how 100 executives responded to this one question: "What is your evaluation of the level of general business activity?" The New York Fed was not looking for a well thought out essay. Instead, it was a multiple choice question with only three possible answers: Decrease, No Change, and Increase. The Fed then creates an index from the answers. Investors apparently got excited because the index was somewhat higher than it was a month ago, which suggests a positive trend.
The survey does contain other questions as well, but stocks surged primarily because of how 100 executives answered that lead question. Of course, the value of the index could have been quite different if just one or two executives responded in a different manner, or if some of the 100 who skipped the survey had actually responded. Which brings up another question, why didn't those executives respond? Was it because business conditions were so good that they were simply too busy? Or was it because business conditions were so bad that they were too disillusioned?
The survey also asked about the number of employees and about the average employee workweek. The results from the 100 executives who responded suggest that manufacturing companies added employees, but at a slower pace than they did a month ago, and that employees are working longer hours. The survey results also indicate that the executives are optimistic about future business conditions (i.e., six months from now), but not as optimistic as they were a month ago.
Overall, the survey does not really tell us much that we did not already know. Results are better than they were a year ago, but not that different than they were a month ago. Nonetheless, investors seized on the report as an excuse to buy stocks. However, the real reason they started buying was because they were convinced stocks were oversold. As I've argued before, there will be many days on which stocks rally strongly, yet the overall trend is still unfavorable. A somewhat upbeat manufacturing report is certainly nice to see, but we still have to deal with much larger problems in the economy, including huge amounts of sovereign debt, stubbornly high unemployment, a still sick housing market, and a general lack of demand for goods and services. (Except, of course, when demand is being fueled by generous government subsidies!)
Tuesday, June 01, 2010
Greece and the Gulf Oil Spill Scare Investors in May
April 20 marks the start of the biggest environmental disaster in U.S. history. It was on this date that an oil rig operated by British Petroleum in the Gulf of Mexico exploded. Initial reports said oil was leaking into the Gulf at a rate of 1,000 barrels per day. That sounds like a lot, but most of us probably figured BP would stop the leak quickly. Days later,we learned that not only was oil still leaking, but that the rate of flow was more like 5,000 barrels per day. Forty-two days later, oil is still leaking, but now they say the flow could be as high as 19,000 barrels per day. The level of incompetence seems to prove Murphy’s Law. The scale of the catastrophe is so extensive and unimaginable that we have all but forgotten the 11 people who died on the rig on the day of the explosion.
On May 6,we had a bit of an explosion in the financial markets, which distracted us from the oil spill—at least for a while. That was the day the Dow Jones Industrial Average suffered its largest intra-day point drop ever. Almost suddenly, the Dow fell 998.5 points before bouncing back and closing down 347.8 points for the day. The blame for the “flash crash” was initially placed on everything from computers that automatically executed programmed trades to a trader with “fat fingers” who hit the wrong letter on his keyboard. The SEC is still investigating the events of the day and has yet to determine what the actual cause was.
There can be no doubt, however, that part of the blame goes to the rioting in Greece. Gil Scott Heron, a 1970s poet and musician once said, “The Revolution Will Not be Televised.” He was wrong—at least in this case. The selling of stocks took off in earnest at the same moment that Greek police and demonstrators clashed, an event widely televised on the trading floor of the NYSE. Investors were already nervous about Greece. Not only was there doubt about Germany’s commitment to saving Greece and the euro, but there was also a real Greek tragedy that took place the day before when three employees, one of them pregnant, were killed by a demonstrator who decided to firebomb their bank.
The events in Greece have brought the risks of sovereign debt to the forefront. At the CFA Institute’s annual conference in mid-May, several speakers focused on the dire consequences of too much sovereign debt. Niall Ferguson’s remarks were the most sobering. He suggested that the situation in Greece pales in comparison to what could happen in many larger economies—including the U.S. He said that focusing on debt as a percentage of GDP can be misleading. A more relevant metric is the percentage of tax revenues that must service the debt. In the U.S., interest on the federal debt already eats up more than 9% of our revenues. Yet at a time when rates are at historic lows, the government continues to rely on short-term financing, taking on tremendous rollover risk. Ferguson says that if rates were to rise just slightly,we could soon be spending 20% of our tax revenues on interest payments, a situation that would be untenable.
Unfortunately, stocks suffered one of their biggest monthly declines just as many reluctant retail investors decided to go back into the market. I expect more selling ahead.
Tuesday, May 18, 2010
Schapiro Virtually Addresses CFA Institute
The CFA Institute is currently holding its annual conference in Boston. There are about 1,600 investment professionals in attendance from all over the world. Not surprisingly, there is much discussion about regulatory failures. Therefore, it was appropriate that SEC chairman Mary Schapiro kicked off the morning session on Tuesday. Unfortunately, she did not appear in person. She addressed the crowd remotely from her office.
Schapiro talked about a number of issues, but one she stressed strongly was the need for high quality international accounting standards. She called for a convergence of U.S. and international accounting standards.
The audience, however, was more interested in hearing about reforms at the SEC that might prevent the kinds of failures seen in recent years. Harry Markopolos, who was sitting in the audience, is particularly interested in this. Markopolos is a former student of mine from Boston College's M.S. program in finance. He is best known as the man who tried to stop Bernie Madoff. Markopolos complained to the SEC for years about Madoff, but was ignored. He recently published a book titled "No One Would Listen," which details all of this.
Its failure to stop Madoff before things got worse is one of the SEC's most embarrassing moments--even more embarrassing than the recent revelation that some employees had spent a considerable amount of time surfing pornographic websites during working hours. Without directly mentioning its Madoff failure, Schapiro said the SEC receives thousands of tips and leads every month. She is trying to get the agency to do a better job of processing all of these.
Some observers have complained that the SEC has too many lawyers and not enough financial experts. Schapiro admitted the agency is heavily lawyered, but said that is necessary since it is a law enforcement agency. However, she also said the SEC has been hiring individuals with broader talents and experiences. For example, many recent hires have worked at hedge funds and rating agencies. Schapiro mentioned that a lack of proper funding has long been a problem, but said funding was recently restored to 2005 levels. Nonetheless, she argued that the SEC should have independent sources of funding.
Schapiro explained that the reason she could not appear in person was because the SEC was going to release a statement later in the day about the May 6 meltdown. That was the day when the Dow suddenly lost 1,000 points on an intraday basis. Sure enough, the SEC announced a proposal to pause trading for five minutes on any stock that moves by 10% or more in a five minute period. It is hoped that such a pause would prevent high frequency, algorithmic, computer-driven trades from moving stock prices in a disorderly fashion. Click here to read the SEC press release regarding this proposal.
Schapiro talked about a number of issues, but one she stressed strongly was the need for high quality international accounting standards. She called for a convergence of U.S. and international accounting standards.
The audience, however, was more interested in hearing about reforms at the SEC that might prevent the kinds of failures seen in recent years. Harry Markopolos, who was sitting in the audience, is particularly interested in this. Markopolos is a former student of mine from Boston College's M.S. program in finance. He is best known as the man who tried to stop Bernie Madoff. Markopolos complained to the SEC for years about Madoff, but was ignored. He recently published a book titled "No One Would Listen," which details all of this.
Its failure to stop Madoff before things got worse is one of the SEC's most embarrassing moments--even more embarrassing than the recent revelation that some employees had spent a considerable amount of time surfing pornographic websites during working hours. Without directly mentioning its Madoff failure, Schapiro said the SEC receives thousands of tips and leads every month. She is trying to get the agency to do a better job of processing all of these.
Some observers have complained that the SEC has too many lawyers and not enough financial experts. Schapiro admitted the agency is heavily lawyered, but said that is necessary since it is a law enforcement agency. However, she also said the SEC has been hiring individuals with broader talents and experiences. For example, many recent hires have worked at hedge funds and rating agencies. Schapiro mentioned that a lack of proper funding has long been a problem, but said funding was recently restored to 2005 levels. Nonetheless, she argued that the SEC should have independent sources of funding.
Schapiro explained that the reason she could not appear in person was because the SEC was going to release a statement later in the day about the May 6 meltdown. That was the day when the Dow suddenly lost 1,000 points on an intraday basis. Sure enough, the SEC announced a proposal to pause trading for five minutes on any stock that moves by 10% or more in a five minute period. It is hoped that such a pause would prevent high frequency, algorithmic, computer-driven trades from moving stock prices in a disorderly fashion. Click here to read the SEC press release regarding this proposal.
Friday, May 07, 2010
MoneyShow Las Vegas Webcast
If you can’t make it to the MoneyShow Las Vegas, May 10-13, 2010 at Caesars Palace, you can still see my presentation, "Quantitative Stock Picking for the Forbes Growth Investor," by webcast LIVE on Tuesday, May 11, from 7:45am – 8:30am PDT. Click here to register then return on Monday to view the event.
Thursday, May 06, 2010
Fat Fingers Cause Panics
Trading couldn't get more exciting than it was today. At one point this afternoon, the Dow Jones Industrial Average was down almost a thousand points. It staged a huge rally, but still closed down 348 points. At one point, Apple (AAPL) dipped below $200 before jumping back to $246. All this happened very quickly. This is the kind of volatility traders live for.
I have been expecting a pullback in stock prices for some time. I have argued that a strong rally off the March 2009 lows was fully justified, but not to the extent we have seen. Yet, I did not expect a selloff to happen in a matter of minutes. Why the market plunged so much and so fast in the middle of the afternoon isn't entirely clear. Some blame an erroneous quote on Procter & Gamble (PG), saying it caused panic selling across the board. Others say the selloff was caused by a trading error on the Nasdaq. This so-called fat-finger error occurred when a trader accidentally entered an order to sell a billion shares rather than a million shares. Still others blame the rioting in Greece for the selloff. That rioting was widely broadcast on trading floors.
These reasons might explain the extent of today's selloff only if investors were already extremely nervous to begin with, which I believe they were. Like myself, many investors have been skeptical of the rally. They were happy to see their stocks go up, but they were also prepared to sell at the first hint of trouble. That trouble came this afternoon, so they sold with a vengeance.
Those who were paying close attention to the markets today had an opportunity to make a fast buck. However, everyone else needs to focus on the longer term. While there are many stocks selling at attractive prices (especially after today's action), I continue to expect further weakness. After all, the recent growth we have seen in the U.S. economy is largely the result of government programs. The jobs market will probably start improving soon, but not enough to significantly reduce the unemployment rate. The recent strength in the housing market may not last now that those tax credits have expired. Finally, troubles in Greece could spread to other European nations.
I prefer to hold onto much of my cash for the time being. I suspect there will be better buying opportunities in the weeks ahead.
I have been expecting a pullback in stock prices for some time. I have argued that a strong rally off the March 2009 lows was fully justified, but not to the extent we have seen. Yet, I did not expect a selloff to happen in a matter of minutes. Why the market plunged so much and so fast in the middle of the afternoon isn't entirely clear. Some blame an erroneous quote on Procter & Gamble (PG), saying it caused panic selling across the board. Others say the selloff was caused by a trading error on the Nasdaq. This so-called fat-finger error occurred when a trader accidentally entered an order to sell a billion shares rather than a million shares. Still others blame the rioting in Greece for the selloff. That rioting was widely broadcast on trading floors.
These reasons might explain the extent of today's selloff only if investors were already extremely nervous to begin with, which I believe they were. Like myself, many investors have been skeptical of the rally. They were happy to see their stocks go up, but they were also prepared to sell at the first hint of trouble. That trouble came this afternoon, so they sold with a vengeance.
Those who were paying close attention to the markets today had an opportunity to make a fast buck. However, everyone else needs to focus on the longer term. While there are many stocks selling at attractive prices (especially after today's action), I continue to expect further weakness. After all, the recent growth we have seen in the U.S. economy is largely the result of government programs. The jobs market will probably start improving soon, but not enough to significantly reduce the unemployment rate. The recent strength in the housing market may not last now that those tax credits have expired. Finally, troubles in Greece could spread to other European nations.
I prefer to hold onto much of my cash for the time being. I suspect there will be better buying opportunities in the weeks ahead.
Sunday, May 02, 2010
Goldman Sachs, Washington, and the Theater of the Absurd
The following commentary is from the May issue of the Forbes Growth Investor.
Albert Camus was an Algerian French writer linked with a philosophy known as absurdism. His spirit must have been in Washington last week where Congress and Goldman Sachs performed in the Theater of the Absurd.
I have no particular desire to defend Goldman Sachs, a firm full of arrogant, overpaid bankers. In fact, about 15 years ago, Goldman turned down a friend of mine for a job. She was told, "You are very smart, but you are not a guru. We only hire gurus." We got a great laugh out of that comment. Today, I have to wonder, "Where have all the gurus gone?"
The SEC is suing Goldman Sachs for fraud, so you would think Goldman’s attorneys would have advised those called to testify in Congress to keep mum. There can be no doubt that the SEC will use their words against them. Instead, current and former Goldman executives answered questions politicians posed. I use the word "answered" loosely. More often than not, these executives came across as being obviously evasive. Now the Justice Department has jumped into the fray by filing criminal charges against Goldman.
The case against Goldman boils down to three issues: 1) Did the firm have an obligation to disclose who the parties were on both sides of a trade, 2) did it have an obligation to advise one of those parties not to make what appears to be a stupid trade, and 3) did it represent to one of the parties that the securities in question were something other than what they really were? In my opinion, the answer to the first two questions is no. As for the third, we will have to wait and see what the evidence shows.
Whether we are talking stocks, bonds, or houses, by definition, the buyer has a more bullish outlook than the seller does. Only time will tell who guessed right. If you go back to when these infamous trades were made, you will see that it was not obvious to everyone that housing prices were going to collapse. Back in 2004, I was not yet convinced we had a housing bubble. Still, I wrote an article called, Why I Hate Homebuilders arguing that housing prices could fall. A year later, I told NBC Nightly News that homeowners with interest-only subprime mortgages will be shocked by how much their monthly payments will increase. This was a full year before housing prices peaked. At the time, most housing experts still thought prices would never fall.
John Paulson figured out a way to bet against subprime mortgages. I wish I had been smart enough to do that. Goldman Sachs helped Paulson put the instrument together. Those on the other side of the trade were simply wrong.
Furthermore, Goldman’s actions did not cause the housing market to collapse. Housing prices fell simply because irresponsible lenders gave mortgages to unqualified borrowers. Both the lenders and the borrowers knew (or should have known) that these mortgages were designed to blow up if housing prices simply stopped rising. The government bears more responsibility for the mortgage mess than Goldman does. The government thought it was good public policy to encourage home ownership. For years, it urged lenders to make money available to unqualified borrowers. The government used Fannie Mae and Freddie Mac to prop up the mortgage market. Will the government take its share of the blame? Of course not. Instead, it will go after Goldman Sachs (and probably several other banks). After all, that is where the money is.
Albert Camus was an Algerian French writer linked with a philosophy known as absurdism. His spirit must have been in Washington last week where Congress and Goldman Sachs performed in the Theater of the Absurd.
I have no particular desire to defend Goldman Sachs, a firm full of arrogant, overpaid bankers. In fact, about 15 years ago, Goldman turned down a friend of mine for a job. She was told, "You are very smart, but you are not a guru. We only hire gurus." We got a great laugh out of that comment. Today, I have to wonder, "Where have all the gurus gone?"
The SEC is suing Goldman Sachs for fraud, so you would think Goldman’s attorneys would have advised those called to testify in Congress to keep mum. There can be no doubt that the SEC will use their words against them. Instead, current and former Goldman executives answered questions politicians posed. I use the word "answered" loosely. More often than not, these executives came across as being obviously evasive. Now the Justice Department has jumped into the fray by filing criminal charges against Goldman.
The case against Goldman boils down to three issues: 1) Did the firm have an obligation to disclose who the parties were on both sides of a trade, 2) did it have an obligation to advise one of those parties not to make what appears to be a stupid trade, and 3) did it represent to one of the parties that the securities in question were something other than what they really were? In my opinion, the answer to the first two questions is no. As for the third, we will have to wait and see what the evidence shows.
Whether we are talking stocks, bonds, or houses, by definition, the buyer has a more bullish outlook than the seller does. Only time will tell who guessed right. If you go back to when these infamous trades were made, you will see that it was not obvious to everyone that housing prices were going to collapse. Back in 2004, I was not yet convinced we had a housing bubble. Still, I wrote an article called, Why I Hate Homebuilders arguing that housing prices could fall. A year later, I told NBC Nightly News that homeowners with interest-only subprime mortgages will be shocked by how much their monthly payments will increase. This was a full year before housing prices peaked. At the time, most housing experts still thought prices would never fall.
John Paulson figured out a way to bet against subprime mortgages. I wish I had been smart enough to do that. Goldman Sachs helped Paulson put the instrument together. Those on the other side of the trade were simply wrong.
Furthermore, Goldman’s actions did not cause the housing market to collapse. Housing prices fell simply because irresponsible lenders gave mortgages to unqualified borrowers. Both the lenders and the borrowers knew (or should have known) that these mortgages were designed to blow up if housing prices simply stopped rising. The government bears more responsibility for the mortgage mess than Goldman does. The government thought it was good public policy to encourage home ownership. For years, it urged lenders to make money available to unqualified borrowers. The government used Fannie Mae and Freddie Mac to prop up the mortgage market. Will the government take its share of the blame? Of course not. Instead, it will go after Goldman Sachs (and probably several other banks). After all, that is where the money is.
Tuesday, April 27, 2010
Shorts vs. Net Shorts
I don't want to put myself in the awkward position of defending a bunch of overpaid bankers from Goldman Sachs, but today's Congressional questioning was a bit ridiculous. The first thing that struck me was how evasive many of the current and former executives of Goldman Sachs were. However, this was no surprise. After all, these guys are being sued by the SEC. They must be very careful about what they say.
The second thing that struck me was Senator Carl Levin's apparent misunderstanding of short positions and net short positions. Goldman CFO David Viniar kept trying to explain to Senator Levin that Goldman's net short position wasn't material. Yet Levin did not want to hear it. Instead, he kept trying to get Viniar to admit that Goldman had a large short position.
Viniar is right. In order to understand Goldman's exposure, you must compare the size of its short position to the size of its long position. It is meaningless to say that the company made a lot of money on its shorts unless you also consider how much money it lost on its longs. Senator Levin did not seem to understand this point.
By way of comparison, suppose an individual with $1,000 to his name borrows $100,000 and puts the full amount into his savings account. Senator Levin would argue that the value of his assets went up materially. That's true, but it's meaningless because the value of his liabilities also went up by the same amount. In fact, this individual's net worth hasn't changed at all. You can't look at just one side of the balance sheet.
If you make a lot of money on a trade, the IRS does not tax you on that trade alone. Instead, it allows you to net your gains against your losses and taxes you only on your net gains. Why can't Senator Levin understand a concept as simple as this?
Goldman may have done a lot of things wrong, but David Viniar is absolutely right to insist that examining the company's short position in isolation is completely misleading.
The second thing that struck me was Senator Carl Levin's apparent misunderstanding of short positions and net short positions. Goldman CFO David Viniar kept trying to explain to Senator Levin that Goldman's net short position wasn't material. Yet Levin did not want to hear it. Instead, he kept trying to get Viniar to admit that Goldman had a large short position.
Viniar is right. In order to understand Goldman's exposure, you must compare the size of its short position to the size of its long position. It is meaningless to say that the company made a lot of money on its shorts unless you also consider how much money it lost on its longs. Senator Levin did not seem to understand this point.
By way of comparison, suppose an individual with $1,000 to his name borrows $100,000 and puts the full amount into his savings account. Senator Levin would argue that the value of his assets went up materially. That's true, but it's meaningless because the value of his liabilities also went up by the same amount. In fact, this individual's net worth hasn't changed at all. You can't look at just one side of the balance sheet.
If you make a lot of money on a trade, the IRS does not tax you on that trade alone. Instead, it allows you to net your gains against your losses and taxes you only on your net gains. Why can't Senator Levin understand a concept as simple as this?
Goldman may have done a lot of things wrong, but David Viniar is absolutely right to insist that examining the company's short position in isolation is completely misleading.
Tuesday, April 20, 2010
The Future of Entrepreneurship Looks Bright
Just a couple of months ago, I had never heard of The Kairos Society. However, I received an invitation from Kristen Santerian, president of the University of Pennsylvania chapter, to attend their annual summit and make some remarks about opportunities in emerging markets. So I did a little research. What I learned was amazing.
The Kairos Society is an entirely student-run organization whose aim is to promote entrepreneurship. It was started three years ago by Ankur Jain, another undergraduate student at the University of Pennsylvania.
Imagine the effort that goes into pulling off a multi-day conference in New York City. You have to find a venue, you have to make hotel arrangements, and you have to provide meals and transportation. There are professionals who make a living putting together conferences like this, yet all of it was done through the efforts of Ankur and a whole cadre of student volunteers. They even managed to arrange a dinner cruise around lower Manhattan for all the attendees, which I would estimate numbered about 500. All of America's top universities were represented. There were also delegations from all over the world including China, India, Hungary, Spain, and the U.K.
These students managed to pull in some of the most impressive speakers I have heard. The list included Carl Schramm, who heads the Kauffman Foundation, Peter Diamandis, founder of the X-Prize Foundation, Bruce Mosler of Cushman & Wakefield, and Admiral William Owens, former Vice-Chairman of the Joint Chiefs of Staff. Even the ever-popular Maria Bartiromo of CNBC was on hand.
Without doubt, however, the most impressive portion of the conference was learning about the student's business ideas. And where do you think they demonstrated their ideas? On the floor of the New York Stock Exchange, of course.
A true entrepreneur sees a problem that needs to be addressed and tries to solve it. Or, he/she thinks of a product or service that people don't even realize they want, and develops it. Ideas are great, but they are not enough. As the old saying goes, ideas are a dime a dozen. Execution is the most critical step. People come up with great ideas all the time, but it takes a special talent to do something about it. An idea is useless unless it is put into action. The amazing part of the conference was that many of the ideas these students had come up with were actually being implemented.
Here are a few examples:
*Installing moisture sensors in farms that control irrigation systems. The students who came up with this plan estimate it will cut water usage by 10%.
*Streamlining the on-line college application process through a website that consolidates applications to all universities.
*Providing an on-line campus service network that allows students to advertise their services and find the services they need from other students. Want someone to do your laundry? Find them on-line. Students use credits purchased from PayPal to pay for services.
*Selling custom-made fixed-gear bicycles, a hot urban craze, at a substantial discount by directly connecting the buyer and manufacturer.
*Fish farms that go way beyond salmon.
Many nations, including the U.S., are currently dealing with difficult economic times. We may continue to struggle a while longer. However, hanging around these incredibly bright young students for a couple of days raised my level of confidence about the future. I suspect I just met some of the people who will be changing our lives for the better in the very near future.
The Kairos Society is an entirely student-run organization whose aim is to promote entrepreneurship. It was started three years ago by Ankur Jain, another undergraduate student at the University of Pennsylvania.
Imagine the effort that goes into pulling off a multi-day conference in New York City. You have to find a venue, you have to make hotel arrangements, and you have to provide meals and transportation. There are professionals who make a living putting together conferences like this, yet all of it was done through the efforts of Ankur and a whole cadre of student volunteers. They even managed to arrange a dinner cruise around lower Manhattan for all the attendees, which I would estimate numbered about 500. All of America's top universities were represented. There were also delegations from all over the world including China, India, Hungary, Spain, and the U.K.
These students managed to pull in some of the most impressive speakers I have heard. The list included Carl Schramm, who heads the Kauffman Foundation, Peter Diamandis, founder of the X-Prize Foundation, Bruce Mosler of Cushman & Wakefield, and Admiral William Owens, former Vice-Chairman of the Joint Chiefs of Staff. Even the ever-popular Maria Bartiromo of CNBC was on hand.
Without doubt, however, the most impressive portion of the conference was learning about the student's business ideas. And where do you think they demonstrated their ideas? On the floor of the New York Stock Exchange, of course.
A true entrepreneur sees a problem that needs to be addressed and tries to solve it. Or, he/she thinks of a product or service that people don't even realize they want, and develops it. Ideas are great, but they are not enough. As the old saying goes, ideas are a dime a dozen. Execution is the most critical step. People come up with great ideas all the time, but it takes a special talent to do something about it. An idea is useless unless it is put into action. The amazing part of the conference was that many of the ideas these students had come up with were actually being implemented.
Here are a few examples:
*Installing moisture sensors in farms that control irrigation systems. The students who came up with this plan estimate it will cut water usage by 10%.
*Streamlining the on-line college application process through a website that consolidates applications to all universities.
*Providing an on-line campus service network that allows students to advertise their services and find the services they need from other students. Want someone to do your laundry? Find them on-line. Students use credits purchased from PayPal to pay for services.
*Selling custom-made fixed-gear bicycles, a hot urban craze, at a substantial discount by directly connecting the buyer and manufacturer.
*Fish farms that go way beyond salmon.
Many nations, including the U.S., are currently dealing with difficult economic times. We may continue to struggle a while longer. However, hanging around these incredibly bright young students for a couple of days raised my level of confidence about the future. I suspect I just met some of the people who will be changing our lives for the better in the very near future.
Friday, April 16, 2010
Goldman Tarnishes Buffett's Image
Each year about this time, the media gears up for a major event: Berkshire Hathaway's annual shareholders' meeting. This year's meeting will be held on Saturday, May 1. As usual, everyone's interest turns to Berkshire CEO Warren Buffett, who is perhaps America's most-loved business executive. Not only is Buffett considered one of the world's greatest businessman, he is also thought to be one of the most ethical.
Because I wrote a book about Buffett, I am often asked about him. Usually, people want to know how he became so rich, what stock or company he might buy next, or what they should do to be like him.
About a week ago, Betty Liu of Bloomberg television interviewed me about Buffett. Her questions were a bit more sophisticated. She seemed particularly interested in his investment in Goldman Sachs. Given today's announcement that the SEC is suing Goldman Sachs for subprime mortgage fraud, her timing couldn't have been better.
Liu wanted to know if Buffett had tarnished his image by getting involved with an investment bank that is not exactly loved on Main Street. After all, Goldman's executives seem to exist in a world of their own. They have little in common with the ordinary "man on the street." These are people who think nothing of getting paid several million dollars each year. No doubt, some of them think they are entitled to more. In comparison, Buffett is one of the most underpaid executives. He gets just $100,000 per year to run Berkshire Hathaway. Despite Goldman's excesses, I defended Buffett's investment in the bank. Buffett felt he was getting a great deal, so he took it.
Over the years, Buffett has strongly criticized the investment banking industry. However, he has also made it clear that Goldman Sachs was the best of the lot. He often praised former Goldman executive Byron Trott. And during the recent financial crisis, Buffett invested $5 billion of Berkshire's money in Goldman Sachs preferred stock. Berkshire also received warrants to buy Goldman's common stock at $115 per share.
Today, after the SEC made its announcement, shares of Goldman plunged 13% to close at just under $161 per share. Berkshire lost a ton of money on paper. Although its warrants are still well in the money, Buffett's armor looks at least a little bit less shiny.
Because I wrote a book about Buffett, I am often asked about him. Usually, people want to know how he became so rich, what stock or company he might buy next, or what they should do to be like him.
About a week ago, Betty Liu of Bloomberg television interviewed me about Buffett. Her questions were a bit more sophisticated. She seemed particularly interested in his investment in Goldman Sachs. Given today's announcement that the SEC is suing Goldman Sachs for subprime mortgage fraud, her timing couldn't have been better.
Liu wanted to know if Buffett had tarnished his image by getting involved with an investment bank that is not exactly loved on Main Street. After all, Goldman's executives seem to exist in a world of their own. They have little in common with the ordinary "man on the street." These are people who think nothing of getting paid several million dollars each year. No doubt, some of them think they are entitled to more. In comparison, Buffett is one of the most underpaid executives. He gets just $100,000 per year to run Berkshire Hathaway. Despite Goldman's excesses, I defended Buffett's investment in the bank. Buffett felt he was getting a great deal, so he took it.
Over the years, Buffett has strongly criticized the investment banking industry. However, he has also made it clear that Goldman Sachs was the best of the lot. He often praised former Goldman executive Byron Trott. And during the recent financial crisis, Buffett invested $5 billion of Berkshire's money in Goldman Sachs preferred stock. Berkshire also received warrants to buy Goldman's common stock at $115 per share.
Today, after the SEC made its announcement, shares of Goldman plunged 13% to close at just under $161 per share. Berkshire lost a ton of money on paper. Although its warrants are still well in the money, Buffett's armor looks at least a little bit less shiny.
Tuesday, April 13, 2010
Special Situation Survey Ranked As One of the Best.
I'm happy to say that our stock picks in the Forbes Special Situation Survey have done extraordinarily well over both the short and long term. In fact, according to the Hulbert Financial Digest, we have generated a 17.8% annualized return (excluding dividends) over the past five years. In no small part, this is due to my crack staff of equity analysts including Taesik Yoon and Sam Ro. Mark Hulbert recently singled us out as a top-performing investment newsletter in an article he wrote for MarketWatch. This follows an article written by Peter Brimelow for MarketWatch about a year-and-a-half ago. WBBM radio in Chicago noticed our performance record and interviewed me about our stock picking strategy.
Based on our record, we have received a number of requests to manage money. That is not a service we offer at the present time, but it is something we may do in the future. I'll certainly keep you all posted if anything develops on that front.
Based on our record, we have received a number of requests to manage money. That is not a service we offer at the present time, but it is something we may do in the future. I'll certainly keep you all posted if anything develops on that front.
Monday, April 12, 2010
When Better-Than-Expected Isn't Good Enough
Earnings season is upon us again and, for the most part, analysts' forecasts are rather rosy. After all, corporations have slashed costs over the past two years. With some companies now seeing a pick up in sales, their bottom lines could see a nice jump.
Furthermore, as optimistic as the analysts are, their history in recent periods suggests caution. In other words, they have underestimated earnings more often than they have overestimated them. To some extent, they do this on purpose. After all, unless they are short, investors are more likely to get upset if a company falls short of the earnings estimate than if it beats it.
So we shouldn't be surprised if the majority of earnings reports for the first quarter come in ahead of the forecasts. The bigger question is how will the stocks react? Will beating the "number" by a penny or two be good enough?
The S&P 500 is up 7.5% year-to-date suggesting that investors are expecting stellar results for Q1. Given the strength of the rally, there is a good chance that stocks could sell off even if earnings beat the forecasts. I suspect this earnings season, "better-than-expected" will not be good enough.
Furthermore, as optimistic as the analysts are, their history in recent periods suggests caution. In other words, they have underestimated earnings more often than they have overestimated them. To some extent, they do this on purpose. After all, unless they are short, investors are more likely to get upset if a company falls short of the earnings estimate than if it beats it.
So we shouldn't be surprised if the majority of earnings reports for the first quarter come in ahead of the forecasts. The bigger question is how will the stocks react? Will beating the "number" by a penny or two be good enough?
The S&P 500 is up 7.5% year-to-date suggesting that investors are expecting stellar results for Q1. Given the strength of the rally, there is a good chance that stocks could sell off even if earnings beat the forecasts. I suspect this earnings season, "better-than-expected" will not be good enough.
Tuesday, April 06, 2010
A Review of "Investing Without Borders"
I've been reading a new book by Daniel Frishberg called Investing Without Borders: How 6 Billion Investors Can Find Profits in the Global Economy. Frishberg, a former Marine, is the founder of BizRadio Network and the host of the MoneyMan Report, a radio program I have been a guest on many times.
The foreword to the book is written by Arthur Laffer, the father of the so-called Laffer Curve, which is a graphical depiction of the relationship between tax revenues and tax rates. In fact, Frishberg credits Laffer in his opening chapter for his unique take on the classic tale of Robin Hood. As Laffer points out, if Robin Hood keeps stealing from the rich, the rich will simply avoid traveling through Sherwood Forest.
In general, Frisherg's book provides a refreshing take on investing and challenges much of financial theory. Frishberg is a man with a tremendous amount of common sense, a trait that has served him well over the years. For example, as Frishberg points out, financial experts would tell you not to try to time the market. In fact, they say no one can do this successfully over the long run. Frishberg, however, argues that you can and should time the market. The recent financial crisis showed us all how a buy-and-hold strategy will decimate your wealth. Furthermore, the experts say you should always hold an extremely well-diversified portfolio. Frishberg argues that you should not diversify too much. Instead, you should do your research, avoid the bad stocks, and buy only the good ones.
Frishberg is also a big fan of greater foreign exposure. He believes most American investors have too little exposure to foreign markets--especially the markets that will drive much of the global growth in future periods. This is not to say he is bearish on America. He isn't. In fact, Frishberg says, "The real long-term success of the United States is still ahead of us." However, he thinks it would be foolish to ignore the fact that the rest of world wants to be like us. They are catching up and there is a lot of money to be made by investing in those markets.
As the title of the book suggests, Frishberg wants you to think about investing in global terms. Traditional borders are becoming less of an obstacle than they once were. Entrepreneurs can set up shop almost anywhere. They will go where conditions are most friendly. Governments will have less ability to force consumers to buy overpriced products simply because they are manufactured at home. These are the trends that Frishberg thinks will dominate the future. They are also trends Frishberg says will make investors rich if they are smart enough to exploit them.
The foreword to the book is written by Arthur Laffer, the father of the so-called Laffer Curve, which is a graphical depiction of the relationship between tax revenues and tax rates. In fact, Frishberg credits Laffer in his opening chapter for his unique take on the classic tale of Robin Hood. As Laffer points out, if Robin Hood keeps stealing from the rich, the rich will simply avoid traveling through Sherwood Forest.
In general, Frisherg's book provides a refreshing take on investing and challenges much of financial theory. Frishberg is a man with a tremendous amount of common sense, a trait that has served him well over the years. For example, as Frishberg points out, financial experts would tell you not to try to time the market. In fact, they say no one can do this successfully over the long run. Frishberg, however, argues that you can and should time the market. The recent financial crisis showed us all how a buy-and-hold strategy will decimate your wealth. Furthermore, the experts say you should always hold an extremely well-diversified portfolio. Frishberg argues that you should not diversify too much. Instead, you should do your research, avoid the bad stocks, and buy only the good ones.
Frishberg is also a big fan of greater foreign exposure. He believes most American investors have too little exposure to foreign markets--especially the markets that will drive much of the global growth in future periods. This is not to say he is bearish on America. He isn't. In fact, Frishberg says, "The real long-term success of the United States is still ahead of us." However, he thinks it would be foolish to ignore the fact that the rest of world wants to be like us. They are catching up and there is a lot of money to be made by investing in those markets.
As the title of the book suggests, Frishberg wants you to think about investing in global terms. Traditional borders are becoming less of an obstacle than they once were. Entrepreneurs can set up shop almost anywhere. They will go where conditions are most friendly. Governments will have less ability to force consumers to buy overpriced products simply because they are manufactured at home. These are the trends that Frishberg thinks will dominate the future. They are also trends Frishberg says will make investors rich if they are smart enough to exploit them.
Sunday, April 04, 2010
FGI Commentary
The following commentary appeared in the April issue of the Forbes Growth Investor.
It seems that no amount of bad news will keep this market down. Stocks soared in March, a month that saw a horrific terrorist attack in Moscow, rising trade tensions with China, and the passage of a major government healthcare bill that will no doubt add to the national debt and deficit no matter how loudly Democrats insist that it won’t.
That’s not to say there was nothing to cheer. Housing prices appear to be firming and even rising in some parts of the country, state governments are projecting better-than expected tax revenues, consumer sentiment and confidence numbers appear to be trending higher, the IPO market is coming alive, M&A activity is picking up, economists are forecasting real GDP growth, and some corporations are finally seeing a pickup in demand and sales.
Yet there is still plenty to worry about. Most notably, employment is still a concern. Initial jobless claims are still too high even though the latest nonfarm payroll figures were encouraging. However, even if the economy creates 100,000 net new jobs per month, it would take seven years just to get back all the jobs we’ve lost since the recession began in Dec. 2007. And that doesn’t take population growth into account. As a result, the unemployment rate could remain elevated even as job creation strengthens.
In addition, the government is playing too large a role in the economy. The recent announcement that it plans to reduce its stake in Citigroup is welcome news, but what government gives with one hand, it usually takes away with the other. For example, chances are investors are underestimating the true cost of healthcare reform. Already, several major corporations have announced plans to take huge writeoffs as a direct consequence of the new healthcare law. Instead of applauding their executives for honest accounting, Democrats are accusing them of playing politics.
Investors are also underestimating the real possibility of a trade war with China. Last month, China tried and convicted an Australian national employed by Rio Tinto for accepting bribes. Because the trial was held behind closed doors, there is no way to know the extent of the evidence. The accused man may indeed be guilty, yet the lack of transparency during the trial makes global businesses wary.
Rio Tinto was not the only company to raise China’s ire. Google, one of the world’s largest companies, decided to pull out of China. Now it is trying to serve Chinese users from Hong Kong. Google was particularly upset about censorship issues and hacker attacks that appear to be government orchestrated. Google clearly decided that the possible rewards of doing business in China are no longer worth the risks. It remains to be seen how many other companies, if any, follow Google’s lead.
Another worry is the rising level of interest rates. The Fed insists that it won’t be raising the fed funds rate any time soon. However, it is planning an "exit strategy" that involves selling assets. Higher interest rates may be needed to entice investors to purchase those assets. Furthermore, recent government bond auctions raised worries as the yield on the 10-year note moved closer to 4%. China, a big buyer of U.S. debt, has reduced purchases in recent months. There is speculation it may cut back further; and not just to send the U.S. a message. As hard as it may be to believe, China is expected to report a trade deficit for March—its first monthly deficit in six years.
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.
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