The Republicrats are not an officially recognized party, yet for all intents and purposes, they might as well be. They represent, I believe, the symbiotic relationship between the Republicans and Democrats. In between the rhetorical maneuvers of “change” and displays of “patriotism”, lies a commonality that is evident to any impartial observer. This interaction would be quite comical if it were not for the fact that its consequence will prove grave for the entire nation. Sifting through the glib headlines and MSNBC/Fox News sound bites that have come to encompass the “issues”, the fact of the matter is that neither party proposes alternatives to treat the root causes of the problems that bedevil our nation. Hence the term Republicrats. I will take two issues to make my point.
The U.S. currently finds itself with a public debt of about $9.6 trillion; this does not even count the $5.4 trillion liability resulting from the de facto nationalization of Fannie Mae and Freddie Mac or tens of trillions in other unfounded government liabilities. Since the Reagan administration, Republicans have become intoxicated with spending. Hinging on their interpretation of supply-side economics, they believed that lowering taxes would increase government receipts (this is the famous Laffer Curve), thus giving them the ability to spend without little constraint. They have “reasoned correctly from this erroneous premise.” Democrats, on the other hand, have had an equally nefarious record. They will quickly point out and say, "hey, at least Bill Clinton reduce the budget deficit." Unfortunately, however, that's not entirely true. In fact, public debt increased during Clinton’s Presidency. According to Treasury Direct, an agency of the U.S. Bureau of Public Debt, Mr. Clinton’s administration added about $1.5 trillion public debt. Currently, our nation needs to borrow $2.5 billion dollars, primarily from foreign sources, on a daily basis to meet its bills. Making matters worst is the fact that the dollars backing the debt have been printed out of thin air—thanks to the U.S. Treasury Dept. and the Federal Reserve System. The excessive supply of dollars has not translated into higher prices in the U.S. because foreign governments have had an insatiable appetite to acquire them. If one assumes that the foreigners will always crave dollars, then the U.S. will continue to get a free ride. If one assumes the contrary, more unpalatable consequences are surely to come. Despite this ominous forecast, neither party has candidly addressed this issue. Instead they talk about more spending, giving more money away to other nations, and continuing to use government credit to bail out corporations.
On the foreign policy front, the theme repeats itself. Neither party has relinquished its imperial ambitions to embrace peaceful multilateral relations—an absolute must in order to foster international trade. Democrats offer “no imperialism without representation”; that is, a continued belligerent foreign policy, as long as there is world consensus. Republicans, well, it goes without saying that they are the party of “perpetual war for perpetual peace”. The U.S. Constitution gives authority to declare war only to Congress. Yet, hearing presumptive presidential and vice-presidential candidates these days one wouldn’t think that. In fact, rarely anyone mentions that Congress never declared war on Iraq; a resolution was passed but never a declaration. I can only come to the conclusion that continued breach of U.S. law will prevail. So as a net result, one party wants to take the U.S. citizen out to McDonalds while the other one proposes Berger King.
Monday, October 6, 2008
Wednesday, September 17, 2008
What is Seen and What is not Seen
John Kay, a Financial Times columnist, wrote the following article that in essence exemplifies the reality of the unseen consequences of financial regulation. Of course, in this environment where a calmed, tempered, and realistic assessment of our economy is replaced by ideological, fantastical, and sheer lunatic views Kay's argument may be lost or perhaps simply ignored. In the end, as one of my favorite analysts proclaims, "you don't get what you expect, you get what you deserve."
======================================================
Taxpayers will fund another run on the casino
By John Kay
Published: September 16 2008 19:48 | Last updated: September 16 2008 19:48
Fannie Mae and Freddie Mac were probably the world’s most heavily supervised financial institutions, subject to a specialist agency, the Office of Federal Housing Enterprise Oversight. The office employed 236 people at the time of its last annual report. OFHEO did not fail because it was understaffed or not well informed about Fannie Mae’s activities, but because it lacked authority. The entire staff earned less in aggregate than Franklin Raines, the aggressive chief executive who masterminded Fannie’s expansion.
Like Martin Wolf, I yearn for a world in which regulators would moderate the inherent instability of the financial system. But my yearning is tempered by modest expectations of what regulation can achieve. Martin’s realism, which I share, acknowledges that public expectations are much higher and politicians will claim to respond to these expectations. But the politicians will fail. The next financial crisis will be different in origin and the rules that will be introduced to close the doors of today’s empty stables will prove irrelevant.
It is easy to assert that the solution to any market failure is better regulation. If regulators were all-knowing and all-powerful; if they were wiser than the chief executives but willing to do the job for a fraction of the remuneration awarded to such executives; if they understood what was happening in the dealing rooms of Citigroup, Merrill or Lehman better than Chuck Prince, Stan O’Neal, or Dick Fuld; then banking regulation could protect us against financial instability. But such a world does not exist. Market economies outperform planned economies not because business people are smarter than civil servants – sometimes they are, sometimes not. But no one has enough information or foresight to understand the changing environment, so the market’s messy processes of experiment and correction yield better results than a regulator’s analysis.
In an imperfect world, the simple rules that Martin seeks have unanticipated and counterproductive consequences, as with the reserve requirements imposed under the Basel agreements. Reserve ratios were transformed from an internal discipline of prudent management to an external burden to be evaded when possible. Because these rules distinguished different asset categories, they opened the doors to regulatory arbitrage, fuelling the explosion of securitisation, which is at the root of current problems. Capital requirements proved ineffective in preventing banking failures and as soon as crisis struck, they proved counterproductive, forcing banks to constrain good lending to meet regulatory obligations. The proposed solution – of course – is further refinement of the regulations – to legislate against structured investment vehicles, to supervise the categorisation imposed by rating agencies and to introduce counter-cyclical reserve requirements.
In our debate in London last week, Martin used a forceful metaphor to describe the impact of the development of financial conglomerates – a utility is attached to a casino. The utility is the payments system that enables individuals and non-financial companies to go about their everyday business confident that they can make and receive payments, and lend and borrow to finance normal transactions. That activity needs to be protected from the consequences of the booms and busts that are an inevitable concomitant of securities trading in volatile markets.
There are two routes to this result. One is to separate the utility from the casino. Narrow banking prevents conglomerate institutions from relying on the assets of their unsophisticated customers as collateral for their highly sophisticated trading. Another approach regulates the casino sufficiently to ensure that failure there cannot jeopardise the utility. This latter outcome is not feasible and to come close to achieving it would end financial innovation.
The industry will successfully resist both the ring-fencing of everyday banking and the meaningful regulation of trading operations. Martin and I both recognise that in the next crisis, as in this, the taxpayer will step in to fund the casino in order to protect the utility.
======================================================
Taxpayers will fund another run on the casino
By John Kay
Published: September 16 2008 19:48 | Last updated: September 16 2008 19:48
Fannie Mae and Freddie Mac were probably the world’s most heavily supervised financial institutions, subject to a specialist agency, the Office of Federal Housing Enterprise Oversight. The office employed 236 people at the time of its last annual report. OFHEO did not fail because it was understaffed or not well informed about Fannie Mae’s activities, but because it lacked authority. The entire staff earned less in aggregate than Franklin Raines, the aggressive chief executive who masterminded Fannie’s expansion.
Like Martin Wolf, I yearn for a world in which regulators would moderate the inherent instability of the financial system. But my yearning is tempered by modest expectations of what regulation can achieve. Martin’s realism, which I share, acknowledges that public expectations are much higher and politicians will claim to respond to these expectations. But the politicians will fail. The next financial crisis will be different in origin and the rules that will be introduced to close the doors of today’s empty stables will prove irrelevant.
It is easy to assert that the solution to any market failure is better regulation. If regulators were all-knowing and all-powerful; if they were wiser than the chief executives but willing to do the job for a fraction of the remuneration awarded to such executives; if they understood what was happening in the dealing rooms of Citigroup, Merrill or Lehman better than Chuck Prince, Stan O’Neal, or Dick Fuld; then banking regulation could protect us against financial instability. But such a world does not exist. Market economies outperform planned economies not because business people are smarter than civil servants – sometimes they are, sometimes not. But no one has enough information or foresight to understand the changing environment, so the market’s messy processes of experiment and correction yield better results than a regulator’s analysis.
In an imperfect world, the simple rules that Martin seeks have unanticipated and counterproductive consequences, as with the reserve requirements imposed under the Basel agreements. Reserve ratios were transformed from an internal discipline of prudent management to an external burden to be evaded when possible. Because these rules distinguished different asset categories, they opened the doors to regulatory arbitrage, fuelling the explosion of securitisation, which is at the root of current problems. Capital requirements proved ineffective in preventing banking failures and as soon as crisis struck, they proved counterproductive, forcing banks to constrain good lending to meet regulatory obligations. The proposed solution – of course – is further refinement of the regulations – to legislate against structured investment vehicles, to supervise the categorisation imposed by rating agencies and to introduce counter-cyclical reserve requirements.
In our debate in London last week, Martin used a forceful metaphor to describe the impact of the development of financial conglomerates – a utility is attached to a casino. The utility is the payments system that enables individuals and non-financial companies to go about their everyday business confident that they can make and receive payments, and lend and borrow to finance normal transactions. That activity needs to be protected from the consequences of the booms and busts that are an inevitable concomitant of securities trading in volatile markets.
There are two routes to this result. One is to separate the utility from the casino. Narrow banking prevents conglomerate institutions from relying on the assets of their unsophisticated customers as collateral for their highly sophisticated trading. Another approach regulates the casino sufficiently to ensure that failure there cannot jeopardise the utility. This latter outcome is not feasible and to come close to achieving it would end financial innovation.
The industry will successfully resist both the ring-fencing of everyday banking and the meaningful regulation of trading operations. Martin and I both recognise that in the next crisis, as in this, the taxpayer will step in to fund the casino in order to protect the utility.
Tuesday, September 9, 2008
The FED & The U.S. Treasury Dept.
Occasionally, there is unvarnished and stark truth reported in newspapers about the very nature of the powers-that-be who claim to look out for the welfare of its citizens. I'm talking about the Federal Reserve System and its partner in crime...err, i mean the Treasury Dept.
Here is what the Financial Times said about our wonderful institutions, which in my opinion, they have it right. Pointing to the fact that private investors were reluctant to bail out Freddie Mac and Fannie Mae, the article claims that as a result the government had to play superman. Consequently, "the former investment banker [Hank Paulson] has in essence converted the Treasury into the US hedge fund of last resort (with the Federal Reserve as its prime broker)."
There you have it. Two sentences reveal the perverse aspect of institutions hailed as having saved the day. If anyone does not believes that, I have a bridge to sell them.
Here is what the Financial Times said about our wonderful institutions, which in my opinion, they have it right. Pointing to the fact that private investors were reluctant to bail out Freddie Mac and Fannie Mae, the article claims that as a result the government had to play superman. Consequently, "the former investment banker [Hank Paulson] has in essence converted the Treasury into the US hedge fund of last resort (with the Federal Reserve as its prime broker)."
There you have it. Two sentences reveal the perverse aspect of institutions hailed as having saved the day. If anyone does not believes that, I have a bridge to sell them.
Saturday, August 30, 2008
So Much For Obama's Change
The Financial Times issued the following report. The moral of the story: money talks and hmmm walks.
Lawmakers ignore special interests clampdown
By Stephanie Kirchgaessner in Denver
Published: August 30 2008 03:42 | Last updated: August 30 2008 03:42
On his path to winning the Democratic nomination, Barack Obama swore that he would change Washington by stamping out the influence of special interests who buy access and favours from the political establishment.
But there was little evidence that change was on the way in Denver. Despite the passage of ethics rules in Congress last year designed to curb the influence of lobbyists and other donors, the Democratic National Convention was funded almost entirely by corporations that pumped tens of millions of dollars into the event, using a loophole in campaign finance rules.
In restaurants and hotels, lawmakers mingled with lobbyists and other donors just as they do in Washington, out of the view of the general public, and seemingly unconcerned by Mr Obama’s stance against lobbyists – he has banned them from donating or taking paid positions on his campaign. Among the dozens of parties were JPMorgan’s salute to women governors, the Recording Industry Association of America’s concert featuring Kanye West, and a brunch hosted by Billy Tauzin, a former congressman who is chief executive of PhRMA, the pharmaceutical lobby group.
As the California delegation headed to a party thrown by AT&T on Monday to cap off the first day of the Democratic convention, they were greeted with goodies. Though these days, even gift bags come with disclaimers.
“We have been advised by counsel that we may not offer complimentary gift bags to public officials,” read a sign on one table.
Another sign said public officials might have to skip the nibbles because of ethics rules. The telecommunications group, a big sponsor of the convention, hosted another party attended by Steny Hoyer, House majority leader, who in June helped craft legislation that protected AT&T from lawsuits related to its alleged participation in the Bush administration’s warrantless eavesdropping programme.
Lawmakers seen at a party hosted by Washington lobbyists Heather and Tony Podesta appeared visibly uncomfortable when asked what they thought about Mr Obama’s stance on lobbyists.
Carl Levin, the Michigan senator, shrugged and said he had not followed the lobbying debate. “They are old friends of mine,” he said of the Podestas.
“The rules are the rules. But sometimes the rules defy commonsense,” said Steve Israel, a Long Island congressman who also attended the brunch. “A PAC [political action committee] can give a $5,000 contribution and discuss that member’s vote, but a $12 lunch where you are talking about the Mets is against the rules.”
Congressman Paul Kanjorski said with a smile that it would be better not to talk about it. For proponents of campaign finance reform, even more problematic than the parties was the corporate sponsorship of the convention itself, and the special access big party donors were given to Mr Obama’s speech.
Experts say that every election cycle raises the cost of access. When President George W. Bush ran for office in 2000, individuals who bundled donations on his behalf were given special status if they raised $100,000 (€68,000, £55,000). Today, campaign finance experts say, bundlers are raising as much as $500,000.
In all, private donations exceeding $112m will pay for about 80 per cent of the combined convention costs in Denver and St Paul, according to a study by the Campaign Finance Institute.
“Both candidates have talked a big game about reducing the influence of special interests,” says Massie Ritsch of the Center for Responsive Politics, which tracks political donations. “But they don’t seem to have done much to rein in their political parties and the corporate subsidies underwriting the conventions that nominate them.”
Lawmakers ignore special interests clampdown
By Stephanie Kirchgaessner in Denver
Published: August 30 2008 03:42 | Last updated: August 30 2008 03:42
On his path to winning the Democratic nomination, Barack Obama swore that he would change Washington by stamping out the influence of special interests who buy access and favours from the political establishment.
But there was little evidence that change was on the way in Denver. Despite the passage of ethics rules in Congress last year designed to curb the influence of lobbyists and other donors, the Democratic National Convention was funded almost entirely by corporations that pumped tens of millions of dollars into the event, using a loophole in campaign finance rules.
In restaurants and hotels, lawmakers mingled with lobbyists and other donors just as they do in Washington, out of the view of the general public, and seemingly unconcerned by Mr Obama’s stance against lobbyists – he has banned them from donating or taking paid positions on his campaign. Among the dozens of parties were JPMorgan’s salute to women governors, the Recording Industry Association of America’s concert featuring Kanye West, and a brunch hosted by Billy Tauzin, a former congressman who is chief executive of PhRMA, the pharmaceutical lobby group.
As the California delegation headed to a party thrown by AT&T on Monday to cap off the first day of the Democratic convention, they were greeted with goodies. Though these days, even gift bags come with disclaimers.
“We have been advised by counsel that we may not offer complimentary gift bags to public officials,” read a sign on one table.
Another sign said public officials might have to skip the nibbles because of ethics rules. The telecommunications group, a big sponsor of the convention, hosted another party attended by Steny Hoyer, House majority leader, who in June helped craft legislation that protected AT&T from lawsuits related to its alleged participation in the Bush administration’s warrantless eavesdropping programme.
Lawmakers seen at a party hosted by Washington lobbyists Heather and Tony Podesta appeared visibly uncomfortable when asked what they thought about Mr Obama’s stance on lobbyists.
Carl Levin, the Michigan senator, shrugged and said he had not followed the lobbying debate. “They are old friends of mine,” he said of the Podestas.
“The rules are the rules. But sometimes the rules defy commonsense,” said Steve Israel, a Long Island congressman who also attended the brunch. “A PAC [political action committee] can give a $5,000 contribution and discuss that member’s vote, but a $12 lunch where you are talking about the Mets is against the rules.”
Congressman Paul Kanjorski said with a smile that it would be better not to talk about it. For proponents of campaign finance reform, even more problematic than the parties was the corporate sponsorship of the convention itself, and the special access big party donors were given to Mr Obama’s speech.
Experts say that every election cycle raises the cost of access. When President George W. Bush ran for office in 2000, individuals who bundled donations on his behalf were given special status if they raised $100,000 (€68,000, £55,000). Today, campaign finance experts say, bundlers are raising as much as $500,000.
In all, private donations exceeding $112m will pay for about 80 per cent of the combined convention costs in Denver and St Paul, according to a study by the Campaign Finance Institute.
“Both candidates have talked a big game about reducing the influence of special interests,” says Massie Ritsch of the Center for Responsive Politics, which tracks political donations. “But they don’t seem to have done much to rein in their political parties and the corporate subsidies underwriting the conventions that nominate them.”
Investing the Templeton Way - Book Review
Chapter 1
The chapter is primarily biographical, which details John Templeton's (JT) philosophy of value investing was an extension of his overall lifestyle. It demonstrates how his background influenced his outlook in life. His father a true capitalist who lost all his fortune truly betting everything he had accumulated in the commodities market. His mother, on the other hand, taught him to be curious, self-reliant, and instilled a sense of a greater mission in life through the Christian faith. He was a firm adherer to thrift, believing it was a cornerstone to securing one's well being.
Chapter 2
It details the basic premise from which Templeton believed was the way to obtain bargain stocks. The chapter can be nicely summarized by his observation that "bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell." While this principle may appear easy to exercise, in fact human nature turns contrary to it. The psychological factors that affect markets are stressed nicely. Readers may resort to Nicholas Taleb's book, The Black Swan, which extensively explains these anomalies that shape people and markets.
Chapter 3
It stressed the salutary aspects of considering the universe of stocks, including those emanating from foreign sources. Although not expressing a strict number of different assets, Templeton believed that diversifying "was a good way to protect you from yourself." He emphasized a "bottom-up" approach to foreign investing. That is, once a particular company or companies were identified, one would then assess the macroeconomic environment. I found this advise helpful because my approach is the opposite: review the macroeconomy, spot areas or industries that may be depressed and are poised for a comeback, and then seek good companies. Templeton gives the reader a good rule of thumb on what to focus in terms of foreign economies. He esteemed unfavorably places where government was profligate, operating rules onerous for business, and prevented individual creativity from taking root (e.g. Venezuela).
Chapter 4
It details the analysis JT used that led him to invest in Japan before everyone else. He benefited from the general perception of the extreme pessimism and ignorant views of the country held by the market during the 1950s and 1960s. His analysis revealed that stocks were extremely undervalued in comparison to U.S. stocks. The chapters goes in further details of what made JT an impeccable stock picker: he scrutinized his assumptions and made his own decisions--not based on the "wisdom of crowds." Moreover, he used quantitative measures (e.g. price no longer reflects estimated worth) in comparison to an alternative when to sell a stock. This led him to reduce his Japanese exposure in the early 1980s, just when everyone was beginning to inflate the bubble. But more importantly, this practice prevents an investor to be married to a particular investment.
Chapter 5
Occasionally JT was asked where the best investment prospects lied, he pointed that one should rather ask "where is the outlook most miserable" to find the most promising stocks. This chapter goes into greater detail explaining this philosophy by focusing on how JT concluded that U.S. stocks demonstrated good value, despite that it had been declared that "equities were dead" in the early 1980s. JT used various yardsticks of value to make decisions (e.g. P/E, PEG, P/BK, Enterprise value). But beyond simply calculating these metrics, he relied on his learned acumen to pick apart the assumptions underlying them. One should continually think outside the box because quantitative decision metrics will "eventually cease to work when everyone practices them in unison."
Chapter 6
The chapter gives us a glimpse into the innate irrationality that seems to grip the market more frequently than recognized. JT was able to profit mightily from rightly timing the NASDAQ crash. He noted that "the point of maximum optimism was reached when there were no more buyers left in the market, and the sellers were about to take control"--the opposite logic with respect to the point of maximum pessimism. Thus, JT shorted 84 stocks, each position worth $2.2 million, which ultimately netted about $90+ million in profits. JT gives us his shorting methodology: 1) control your losses, 2) remember rule #1. In order to control losses, establish a a price ceiling, which could be in terms of percentage change, for the stock before covering your position. Similarly, you must establish a point where you'll take profits.
Chapter 7
This chapter is an extension of the previous one. It details the mindset of the "bargain hunter" when dealing with market crisis. Irrespective of its nature and present sentiment, market drops are an ideal situation to take advantage because fear is pervasive. When other are alarmed and panic selling, you must maintain your composure and buy good stocks. After 9/11, JT bought a set of airline stocks that met a certain criteria (one-day price drop of 50%) because he understood that the government would bail-out those firms. Indeed, his expectation came into fruition, and thus was able to make a handsome return on his investment. The last two chapters underscore JT's keep ability of politics and economics that went beyond crunching number. As a result, he was well prepared to take advantage of market volatility.
Chapter 8
In this chapter we learn the analytical process JT exercised when investing in the South Korean economy. Following his disciplines of looking for great bargains in markets that were weighted under pessimism, South Korea was a perfect candidate after the effects of the Asian Crisis. As the book repeats numerously, simply investing in depressed markets without doing your homework is akin to speculating. We are furthered exposed in this chapter to JT's uncanny ability to assess his environment beyond number in such a way that leaves the reader wondering about his/her intelligence. "Bargain hunters who understand history...can appreciate the fact that these patterns repeat themselves over time, again, and again." Indeed, the operative word is "understand", something that very few individuals are capable--irrespective of their training and longevity.
Chapter 9
In this chapter we are encouraged to exercise good judgment to profit in assets outside our immediate purview. While JT was an excellent stock picker, he demonstrates his dexterity in fixed income assets. We are told of his advice of buying bonds prior to the technology stock market crashing. He reasoned that the fall in the market would adversely affect the economy by way of lesser consumption due to a negative wealth effect. JT understood that the Federal Reserve would come to rescue the economy by lowering interest rates. As a result, he undertook a carry trade (i.e. borrow in a cheaper currency and buy an asset denominated in another currency) buying zero-coupon bonds. When the FED lowered the interest rate, the value of the bonds purchased by JT increased in value. We are reminded to look at all assets and position yourself in such a manner so as to benefit your expected market environment.
Chapter 10
This chapter introduces the reader to JT's view on "the sleeping dragon", that is China. At first we are given an a cursory overview of modern Chinese history. Given that JT believes that China will continue to grow, it is a market that one needs to look quite thoroughly. As any country that is growing tremendously, there will be times when valuations will be above and beyond what a bargain hunter feels comfortable. By the early 1980s, JT understood that the Chinese would continue to open their economy, away from communist hold. Indeed, he noted, politically the country leaves much to be desired; but in terms of economic policy, JT thought that in comparison to the U.S. the Chinese has more freedom right now. We are reminded of the extreme pessimism principle for bargain hunter, i.e. mostly sellers are in the market. Only during that time, the best values will be found. As JT stated, "bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria."
The chapter is primarily biographical, which details John Templeton's (JT) philosophy of value investing was an extension of his overall lifestyle. It demonstrates how his background influenced his outlook in life. His father a true capitalist who lost all his fortune truly betting everything he had accumulated in the commodities market. His mother, on the other hand, taught him to be curious, self-reliant, and instilled a sense of a greater mission in life through the Christian faith. He was a firm adherer to thrift, believing it was a cornerstone to securing one's well being.
Chapter 2
It details the basic premise from which Templeton believed was the way to obtain bargain stocks. The chapter can be nicely summarized by his observation that "bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell." While this principle may appear easy to exercise, in fact human nature turns contrary to it. The psychological factors that affect markets are stressed nicely. Readers may resort to Nicholas Taleb's book, The Black Swan, which extensively explains these anomalies that shape people and markets.
Chapter 3
It stressed the salutary aspects of considering the universe of stocks, including those emanating from foreign sources. Although not expressing a strict number of different assets, Templeton believed that diversifying "was a good way to protect you from yourself." He emphasized a "bottom-up" approach to foreign investing. That is, once a particular company or companies were identified, one would then assess the macroeconomic environment. I found this advise helpful because my approach is the opposite: review the macroeconomy, spot areas or industries that may be depressed and are poised for a comeback, and then seek good companies. Templeton gives the reader a good rule of thumb on what to focus in terms of foreign economies. He esteemed unfavorably places where government was profligate, operating rules onerous for business, and prevented individual creativity from taking root (e.g. Venezuela).
Chapter 4
It details the analysis JT used that led him to invest in Japan before everyone else. He benefited from the general perception of the extreme pessimism and ignorant views of the country held by the market during the 1950s and 1960s. His analysis revealed that stocks were extremely undervalued in comparison to U.S. stocks. The chapters goes in further details of what made JT an impeccable stock picker: he scrutinized his assumptions and made his own decisions--not based on the "wisdom of crowds." Moreover, he used quantitative measures (e.g. price no longer reflects estimated worth) in comparison to an alternative when to sell a stock. This led him to reduce his Japanese exposure in the early 1980s, just when everyone was beginning to inflate the bubble. But more importantly, this practice prevents an investor to be married to a particular investment.
Chapter 5
Occasionally JT was asked where the best investment prospects lied, he pointed that one should rather ask "where is the outlook most miserable" to find the most promising stocks. This chapter goes into greater detail explaining this philosophy by focusing on how JT concluded that U.S. stocks demonstrated good value, despite that it had been declared that "equities were dead" in the early 1980s. JT used various yardsticks of value to make decisions (e.g. P/E, PEG, P/BK, Enterprise value). But beyond simply calculating these metrics, he relied on his learned acumen to pick apart the assumptions underlying them. One should continually think outside the box because quantitative decision metrics will "eventually cease to work when everyone practices them in unison."
Chapter 6
The chapter gives us a glimpse into the innate irrationality that seems to grip the market more frequently than recognized. JT was able to profit mightily from rightly timing the NASDAQ crash. He noted that "the point of maximum optimism was reached when there were no more buyers left in the market, and the sellers were about to take control"--the opposite logic with respect to the point of maximum pessimism. Thus, JT shorted 84 stocks, each position worth $2.2 million, which ultimately netted about $90+ million in profits. JT gives us his shorting methodology: 1) control your losses, 2) remember rule #1. In order to control losses, establish a a price ceiling, which could be in terms of percentage change, for the stock before covering your position. Similarly, you must establish a point where you'll take profits.
Chapter 7
This chapter is an extension of the previous one. It details the mindset of the "bargain hunter" when dealing with market crisis. Irrespective of its nature and present sentiment, market drops are an ideal situation to take advantage because fear is pervasive. When other are alarmed and panic selling, you must maintain your composure and buy good stocks. After 9/11, JT bought a set of airline stocks that met a certain criteria (one-day price drop of 50%) because he understood that the government would bail-out those firms. Indeed, his expectation came into fruition, and thus was able to make a handsome return on his investment. The last two chapters underscore JT's keep ability of politics and economics that went beyond crunching number. As a result, he was well prepared to take advantage of market volatility.
Chapter 8
In this chapter we learn the analytical process JT exercised when investing in the South Korean economy. Following his disciplines of looking for great bargains in markets that were weighted under pessimism, South Korea was a perfect candidate after the effects of the Asian Crisis. As the book repeats numerously, simply investing in depressed markets without doing your homework is akin to speculating. We are furthered exposed in this chapter to JT's uncanny ability to assess his environment beyond number in such a way that leaves the reader wondering about his/her intelligence. "Bargain hunters who understand history...can appreciate the fact that these patterns repeat themselves over time, again, and again." Indeed, the operative word is "understand", something that very few individuals are capable--irrespective of their training and longevity.
Chapter 9
In this chapter we are encouraged to exercise good judgment to profit in assets outside our immediate purview. While JT was an excellent stock picker, he demonstrates his dexterity in fixed income assets. We are told of his advice of buying bonds prior to the technology stock market crashing. He reasoned that the fall in the market would adversely affect the economy by way of lesser consumption due to a negative wealth effect. JT understood that the Federal Reserve would come to rescue the economy by lowering interest rates. As a result, he undertook a carry trade (i.e. borrow in a cheaper currency and buy an asset denominated in another currency) buying zero-coupon bonds. When the FED lowered the interest rate, the value of the bonds purchased by JT increased in value. We are reminded to look at all assets and position yourself in such a manner so as to benefit your expected market environment.
Chapter 10
This chapter introduces the reader to JT's view on "the sleeping dragon", that is China. At first we are given an a cursory overview of modern Chinese history. Given that JT believes that China will continue to grow, it is a market that one needs to look quite thoroughly. As any country that is growing tremendously, there will be times when valuations will be above and beyond what a bargain hunter feels comfortable. By the early 1980s, JT understood that the Chinese would continue to open their economy, away from communist hold. Indeed, he noted, politically the country leaves much to be desired; but in terms of economic policy, JT thought that in comparison to the U.S. the Chinese has more freedom right now. We are reminded of the extreme pessimism principle for bargain hunter, i.e. mostly sellers are in the market. Only during that time, the best values will be found. As JT stated, "bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria."
Saturday, August 23, 2008
Panic of 1893: Another Example of Politicians Causing A Mess
"History doesn't repeat itself but it does rhyme." - Mark Twain
Indeed, looking back at the antecedents of the Panic of 1893 it seems as if we are reading in half measure the newspaper headlines over the last year. The economic hardship experienced during said depression was incomparable until then in the history of the United States. Politicians, who mascarade their ambitions for power in good intentions, were the progenitors of this economic mess.
During the 1880s, the U.S. economy was growing tremendously thanks in part to the economic shift from an agrarian to industrial society. The U.S. was becoming efficient in producing manufacturing goods that not only were sold locally but also were demanded internationally. The high economic growth and the coincidental increase in aggregate consumption led farmers to take on excessive debt to increase their productive capacity. In addition, the railroad industry had similarly overextended itself, as it believed demand would continue to expand from the people living west of the Mississippi. During this decade we witnessed something that today seems inconceivable: economic growth and deflation. Excessive debt in a deflationary environment, however, is a deadly combination for debt holders, because the value of money that is paid increases with time. Moreover, deflation meant that agricultural products became cheaper, thus producer's profit margins were squeezed. Nonetheless, for the industrialists (i.e. manufacturers) lower prices translated into a bonanza domestically and internationally resulting from greater demand for their products. During that time also, the U.S. (and the rest of the world in fact) operated under the gold standard, which meant that every dollar was backed gold. In other words, every dollar could be redeemed for that precious metal. This fixed exchange rate mechanism implied that monetary policy had limitations: money supply could not be manipulated by politicians without dire consequences. This is important to note because farmers (and other debt holders) wanted an inflationary monetary policy.
The government, seeking to please a voting block ahead of national interests, in 1890 passed the Sherman Silver Purchase Act, which required the federal government to purchase a fixed amount of silver with U.S. notes (i.e. dollars that were backed by gold). The net effect of this action caused the money supply to increase. Since gold had decrease in value relative to silver, widespread fear began to overtake the market that the U.S. would abandon the gold standard. Foreign and domestic holders of U.S. notes began to redeem them for gold. This generated a massive run on banks which ultimately led many to fail. The financial debacle spread to the real economy causing a number of bankruptcies. So the intentions of the government to help a special-interest group turned into a nightmare for everyone. It is estimated that during mid-to-late 1890s, unemployment ranged from about 11% to 18%. This anecdote makes us recognize that surely politicians will claim to exercise good judgment when using someone else's money to bailout others from the consequences of their actions. The notion that the 19th century was completely laissez fair does not hold under closer scrutiny. Today, nothing much has changed with respect to this aspect, as the U.S. federal government continues to want to manage economic expectations under the good stewardship banner. But as the old adage says, "the road to hell is paved with good intentions."
Indeed, looking back at the antecedents of the Panic of 1893 it seems as if we are reading in half measure the newspaper headlines over the last year. The economic hardship experienced during said depression was incomparable until then in the history of the United States. Politicians, who mascarade their ambitions for power in good intentions, were the progenitors of this economic mess.
During the 1880s, the U.S. economy was growing tremendously thanks in part to the economic shift from an agrarian to industrial society. The U.S. was becoming efficient in producing manufacturing goods that not only were sold locally but also were demanded internationally. The high economic growth and the coincidental increase in aggregate consumption led farmers to take on excessive debt to increase their productive capacity. In addition, the railroad industry had similarly overextended itself, as it believed demand would continue to expand from the people living west of the Mississippi. During this decade we witnessed something that today seems inconceivable: economic growth and deflation. Excessive debt in a deflationary environment, however, is a deadly combination for debt holders, because the value of money that is paid increases with time. Moreover, deflation meant that agricultural products became cheaper, thus producer's profit margins were squeezed. Nonetheless, for the industrialists (i.e. manufacturers) lower prices translated into a bonanza domestically and internationally resulting from greater demand for their products. During that time also, the U.S. (and the rest of the world in fact) operated under the gold standard, which meant that every dollar was backed gold. In other words, every dollar could be redeemed for that precious metal. This fixed exchange rate mechanism implied that monetary policy had limitations: money supply could not be manipulated by politicians without dire consequences. This is important to note because farmers (and other debt holders) wanted an inflationary monetary policy.
The government, seeking to please a voting block ahead of national interests, in 1890 passed the Sherman Silver Purchase Act, which required the federal government to purchase a fixed amount of silver with U.S. notes (i.e. dollars that were backed by gold). The net effect of this action caused the money supply to increase. Since gold had decrease in value relative to silver, widespread fear began to overtake the market that the U.S. would abandon the gold standard. Foreign and domestic holders of U.S. notes began to redeem them for gold. This generated a massive run on banks which ultimately led many to fail. The financial debacle spread to the real economy causing a number of bankruptcies. So the intentions of the government to help a special-interest group turned into a nightmare for everyone. It is estimated that during mid-to-late 1890s, unemployment ranged from about 11% to 18%. This anecdote makes us recognize that surely politicians will claim to exercise good judgment when using someone else's money to bailout others from the consequences of their actions. The notion that the 19th century was completely laissez fair does not hold under closer scrutiny. Today, nothing much has changed with respect to this aspect, as the U.S. federal government continues to want to manage economic expectations under the good stewardship banner. But as the old adage says, "the road to hell is paved with good intentions."
Wednesday, August 20, 2008
The Less You Read Newspapers and Watch TV, The Better Off You Are
That may seem counterintuitive, but in fact it is absolutely true. Fischer Black's seminal paper about market noise, written in the 1980s, gives a stellar explanation about this phenomenon (Journal of Finance, Vol 41, pgs 529-543). Noise represents large number of inconsequential events. This is contrasted with information, which relates to small number of significant events. People in general mistake one for the other, and thus make decisions that can ultimately lead to disastrous consequences--or alternatively to serendipitous results. Therefore "noise is what makes our observations imperfect. It keeps us from knowing the expected return of a stock or portfolio...it keeps us from knowing what, if anything, we can do to make things better." In this day and age, what will separate the relative success of one person from another will be predicated on the quality of information, not noise disguised as information. If you have ever walked in a securities trading floor, you will notice impressive databases that provide instantaneous information; much of it, however is simply noise. Traders undoubtedly will make buy and sell decisions supported by what they abstracted from these databases. This is the foundation that supports the view that daily stock price movements embody a voting mechanism. That is, market participants will buy/sell a stock as if casting a vote on the perceived price for a given amount of information (which is really noise).
I equate "noise" to the unfortunate human activity of gossip: There's a lot of it going around, but few of it deserves worthy consideration. However, people generally treat all gossip as credible information and act accordingly based on it. For the average person, irrespective of his or her condition (i.e. wealthy or poor), distinguishing noise and information can be a daunting task. As a result they will tend to gravitate to the "path of least resistance"; that is, to take whatever flashes in a screen from a "reputable" entity as reliable, without actually checking its veracity. Newspapers and television are primary culprits of disseminating it to the general public; so it is best for individuals to stay away from them as much as possible. I believe it is noise the fire that starts euphoric sentiments in the market. In other words, panic selling or ecstatic buying has its roots in discernment from this misinterpreted data. As a result, we become someone, as John Locke said, "reasoning correctly from erroneous premises." This analysis not only applies to stock markets but also to a wide array of human activity.
I equate "noise" to the unfortunate human activity of gossip: There's a lot of it going around, but few of it deserves worthy consideration. However, people generally treat all gossip as credible information and act accordingly based on it. For the average person, irrespective of his or her condition (i.e. wealthy or poor), distinguishing noise and information can be a daunting task. As a result they will tend to gravitate to the "path of least resistance"; that is, to take whatever flashes in a screen from a "reputable" entity as reliable, without actually checking its veracity. Newspapers and television are primary culprits of disseminating it to the general public; so it is best for individuals to stay away from them as much as possible. I believe it is noise the fire that starts euphoric sentiments in the market. In other words, panic selling or ecstatic buying has its roots in discernment from this misinterpreted data. As a result, we become someone, as John Locke said, "reasoning correctly from erroneous premises." This analysis not only applies to stock markets but also to a wide array of human activity.
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