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The Stingy News Quarterly (Q1/2008)
New @ StingyInvestor 5 Stingy Stocks for 2008 "I look for two qualities when hunting for bargain stocks: they must be cheap and relatively safe. Not surprisingly, it is often difficult to find stocks that are both cheap and safe." The Top 200 Canadian Stocks for 2008 "This is the fourth annual MoneySense Top 200 and we are pleased to say that connoisseurs have dined out very well on our past reviews. In each previous edition, we picked what we call All-Around All-Stars - stocks that score well on both our growth and value tests. Our All-Stars have consistently produced double-digit returns. The 2006 team achieved average returns of 16%, while the 2005 All-Stars gained 38%, and the 2004 squad soared an amazing 58%. An RRSP investor who put $10,000 into the 2004 picks and rolled his or her gains into the new All-Star team each subsequent year would now have $25,200. And those results don't include the generous dividends that we picked up along the way." Income 100 Update "Looking for a steady cash flow? We've rated the best Canadian stocks and trusts for income investors. We've assessed 100 income trusts and 100 income-generating stocks for their ability to provide generous income for a reasonable price. The top firms get an A; good ones land a B. Our grades are based on market capitalization, yield (how much they pay out), reliability (how safe is the payout), and value (lots of assets at a low price). Use our grades as a starting point for your own research. Like any investment screen, the Income 100 is intended to help you hit upon a few good ideas that may deserve a place in your investment portfolio." Canadian Discount Broker Commissions Updated "Our list of the commissions charged for online trades by Canadian discount brokers." Upside/downside calculator now with 2007 year-end data "Select a portfolio composed of up to 11 major asset types, then pick start and end dates. The calculator tells you how much you would have made or lost." The Best of Stingy Links Asset growth and stock returns "Asset growth rates are strong predictors of future abnormal returns. Asset growth retains its forecasting ability even on large capitalization stocks, a subgroup of firms for which other documented predictors of the cross-section lose much of their predictive ability. When we compare asset growth rates with the previously documented determinants of the cross-section of returns (i.e., book-to-market ratios, firm capitalization, lagged returns, accruals, and other growth measures), we find that a firm's annual asset growth rate emerges as an economically and statistically significant predictor of the cross-section of U.S. stock returns." Sensation seeking, overconfidence, and trading activity "This study analyzes the role that two psychological attributes - sensation seeking and overconfidence - play in the tendency of investors to trade stocks. Equity trading data from Finland are combined with data from investor tax filings, driving records, and mandatory psychological profiles. We use these data, obtained from a large population, to construct measures of overconfidence and sensation seeking tendencies. Controlling for a host of variables, including wealth, income, age, number of stocks owned, marital status, and occupation, we find that overconfident investors and those investors most prone to sensation seeking trade more frequently." Momentum and credit rating "This paper establishes a robust link between momentum and credit rating. Momentum profitability is large and significant among low-grade firms, but it is nonexistent among high-grade firms. The momentum payoffs documented in the literature are generated by low-grade firms that account for less than 4% of the overall market capitalization of rated firms. The momentum payoff differential across credit rating groups is unexplained by firm size, firm age, analyst forecast dispersion, leverage, return volatility, and cash flow volatility." The law of one price in financial markets "It is good for a scientific enterprise, as well as for a society, to have well-established laws. Physics has excellent laws, such as the law of gravity. What does economics have? The first law of economics is clearly the law of supply and demand, and a fine law it is. We would nominate as the second law 'the law of one price,' hereafter simply the Law. The Law states that identical goods must have identical prices. For example, an ounce of gold should have the same price (expressed in U.S. dollars) in London as it does in Zurich, otherwise gold would flow from one city to the other. Economic theory teaches us to expect the Law to hold exactly in competitive markets with no transactions costs and no barriers to trade, but in practice, details about market institutions are important in determining whether violations of the Law can occur." Why we have never used the BSM option formula "Options traders use a pricing formula which they adapt by fudging and changing the tails and skewness by varying one parameter, the standard deviation of a Gaussian. Such formula is popularly called "Black-Scholes-Merton" owing to an attributed eponymous discovery (though changing the standard deviation parameter is in contradiction with it). However we have historical evidence that 1) Black, Scholes and Merton did not invent any formula, just found an argument to make a well known (and used) formula compatible with the economics establishment, by removing the "risk" parameter through "dynamic hedging", 2) Option traders use (and evidently have used since 1902) heuristics and tricks more compatible with the previous versions of the formula of Louis Bachelier and Edward O. Thorp (that allow a broad choice of probability distributions) and removed the risk parameter by using put-call parity. 3) Option traders did not use formulas after 1973 but continued their bottom-up heuristics. The Bachelier-Thorp approach is more robust (among other things) to the high impact rare event. The paper draws on historical trading methods and 19th and early 20th century references ignored by the finance literature. It is time to stop calling the formula by the wrong name." ROIC patterns and shareholder returns "Three main points emerged from the analysis of ROIC patterns. First, analysts need to consider the lessons of history when modeling rather than approaching each model as unique. Analysts should view the experience of a large sample of companies as a rich reference class. Second, the empirical evidence shows ROICs tend to revert to the mean, a level similar to the cost of capital. Randomness plays an important role in the mean-reversion process. Finally, some companies do deliver persistently high or low results beyond what chance would dictate. Unfortunately, pinpointing the causes of persistence is a challenge." Stingy Links: Accounting Loophole lets bank rewrite the calendar "In its financial statements for 2007, the French bank takes the loss in that year, offsetting it against 1.5 billion euros in profit that it says was earned by a trader, Jerome Kerviel, who concealed from management the fact he was making huge bets in financial futures markets." Lenders face still more misery "A closer look at the books of big lenders reveals several weak spots that haven't yet shown up in the financial results. At many banks, bad loans are piling up faster than the amount of money they're setting aside to cover them. Meanwhile, housing lenders booked income on vulnerable exotic loans and mortgage securities before they collected the money - paper gains that may be reversed through writedowns. Plus the values of some troubled loans, which have been trimmed modestly so far and shown up in previous losses, could still be overstated. Why haven't these items hit lenders' bottom lines? Largely because of the ambiguity and complexities of the accounting rules. Banks have a lot of wiggle room when it comes to reporting the profits and values of complex loans and securities. For one thing, their earnings can far exceed the amount of cash coming in the door. At the same time, their losses aren't always based on hard numbers but rather on debatable judgment calls. With the housing market showing no signs of recovery anytime soon, it's becoming clear that some of their assumptions have been overly optimistic." Stingy Links: Behaviour What makes a tightwad "The researchers were surprised to find that despite perceptions that people always overspend, chronic underspending was far more widespread than thought, with tightwads outnumbering spendthrifts by 3 to 2. But researcher Scott Rick from the University of Pennsylvania said they found it wasn't the cost of an item or someone's income level that had an impact on their spending. Tightwads reported feeling an emotional pain when handing over their money. Spendthrifts, on the other hand, felt pleasure making a purchase." Why people believe weird things about money "Would you rather earn $50,000 a year while other people make $25,000, or would you rather earn $100,000 a year while other people get $250,000? Assume for the moment that prices of goods and services will stay the same. Surprisingly -- stunningly, in fact -- research shows that the majority of people select the first option; they would rather make twice as much as others even if that meant earning half as much as they could otherwise have. How irrational is that?" Stingy Links: Bonds Moody's, S&P defer cuts on AAA subprime "Even after downgrading almost 10,000 subprime-mortgage bonds, Standard & Poor's and Moody's Investors Service haven't cut the ones that matter most: AAA securities that are the mainstays of bank and insurance company investments. None of the 80 AAA securities in ABX indexes that track subprime bonds meet the criteria S&P had even before it toughened ratings standards in February, according to data compiled by Bloomberg." Stingy Links: Brokers Online brokers: Sizing up your RRSP options "Investors of all types can benefit from an online broker, be they conservative types who prefer bonds and GICs, aggressive stock traders or middle-of-the road types who want stocks, bonds and mutual funds. The challenge is to find the broker that best fits your needs. To that end, Portfolio Strategy has evaluated 13 online brokers to find the best choices in six areas relevant to RRSP investing." Online upstart stands out "An upstart online brokerage has bested the bank-owned competition in addressing one of the biggest complaints investors have about stock trading. Questrade Inc. will announce on Monday that clients can hold U.S. dollars in their registered retirement accounts. The industry norm is to allow only Canadian dollars in registered accounts, which means costly currency conversion charges are often unavoidable for investors who buy and sell shares listed on U.S. exchanges." Stingy Links: Buffett Berkshire Hathaway 2007 Letter "Some major financial institutions have, however, experienced staggering problems because they engaged in the "weakened lending practices" I described in last year's letter. John Stumpf, CEO of Wells Fargo, aptly dissected the recent behavior of many lenders: "It is interesting that the industry has invented new ways to lose money when the old ways seemed to work just fine." You may recall a 2003 Silicon Valley bumper sticker that implored, "Please, God, Just One More Bubble." Unfortunately, this wish was promptly granted, as just about all Americans came to believe that house prices would forever rise. That conviction made a borrower's income and cash equity seem unimportant to lenders, who shoveled out money, confident that HPA - house price appreciation - would cure all problems. Today, our country is experiencing widespread pain because of that erroneous belief. As house prices fall, a huge amount of financial folly is being exposed. You only learn who has been swimming naked when the tide goes out - and what we are witnessing at some of our largest financial institutions is an ugly sight." Gates no longer world's richest man "Warren Buffett is the richest man on the planet. Riding the surging price of Berkshire Hathaway stock, America's most beloved investor has seen his fortune swell to an estimated $62 billion, up $10 billion from a year ago. That massive pile of scratch puts him ahead of Microsoft co-founder Bill Gates, who was the richest man in the world for 13 straight years." Warren Buffett on Squawk Box part 1 "Buffett says there's been a lot of de-leveraging, and there's still more to come. In many cases, the de-leveraging is happening at crazy prices. People who were out on a limb are having the limb cut off." Warren Buffett on Squawk Box part 2 "Becky asks why he thinks U.S. now in a recession. He replies he sees lots of indicators, including sales at his businesses and the reduction in people's net worth. He's sure there is a recession, not sure how far it will go." Warren Buffett on Squawk Box part 3 "Joe Kernen asks about recent purchases of Glaxo and Sanofi? Why? Buffett says he made the decision to buy those stocks and that with drug companies he knows less specifically about those companies than, say, a candy company. Hard to make a bet on a specific drug company based on a drug that might be in the pipeline. "If you have a group" of drug companies, you'll "probably do OK." Would he buy a domestic drug company? Yes, but he does like earnings coming from abraod than earnings coming from the United States. Most big drug companies in the U.S. do get a lot of their profits from overseas." Snow White killed the 'triple-A' "Well, when a company issues a 14 per cent bond when US Treasuries are below 4 percent and it's rated triple-A, we've now seen the cow jumping over the moon." Berkshire becomes largest Kraft shareholder "Buffett, the second-richest man in the U.S., is often mimicked by investors who follow his stock picks. Using that strategy for the past 31 years would have delivered annual returns of about 25 percent, double the return of the Standard & Poor's 500 Index, according to an academic study." Buffett "huge bull on the U.S. economy" "The second step is just as relevant, given all the nail-biting about whether or not we're in a recession. Hagstrom writes that "if you find yourself discussing and debating whether the economy is poised for growth or tilting toward a recession, whether interest rates are moving up or down, or whether there is inflation or disinflation, STOP! Give yourself a break. Except for his preconceived notions that the economy inherently has an inflation bias, Buffett dedicates no time or energy analyzing the economy."" Warren Buffett makes news in Canada "Warren Buffett answered questions for almost 90 minutes yesterday during his appearance in Toronto to promote Business Wire's expansion into Canada. We focused on his credit, dollar and economy comments, but he made a lot of other news as well, including a revelation to Canada's National Post newspaper that he made "several hundred million dollars" owning the Canadian dollar, then sold, and now wishes he had kept his holdings in the Loonie." Business Wire: A conversation with Warren Buffett Business Wire Canada Opening Reception: A Conversation with Warren Buffett (1 Hour 30 Minute MP3) What would Buffett buy? "How does he do it? Author Robert Hagstrom tried to compile Buffett's key investing strategies in his 1994 best seller, The Warren Buffett Way: Investment Strategies of the World's Greatest Investor. With Hagstrom's book as a source, Standard & Poor's Portfolio Services devised a stock screen that picks companies using criteria similar to those that fit the legendary investor's growth-oriented style. S&P updates this screen on a semiannual basis, during February and again in August. Over the years, the screen has put in a pretty good performance itself. From Feb. 13, 1995, through Jan. 17, 2008, the screen had an annualized return of 14.9%, vs. 8.2% for the S&P 500. In 2007, the screen stocks gained 15.7%, vs. 3.5% for the S&P 500. (All results reflect price appreciation only.)" Stingy Links: Chou Chou's annual report for 2007 "We are long term investors and, in general, our bias has been to concentrate on stock selections and not worry about currency fluctuations. With years like 2007, the question arises as to whether there have been major disparities in annualized returns over the long term between a hedged portfolio and an unhedged portfolio; in other words, does one offer more advantageous performance results during currency fluctuations? Two studies, one covering the period from 1975 through 1988 and the other from 1988 through 2003, confirm that with respect to the long term there have been no material differences in returns." How value investor Chou wins with bonds "When you read about investment stars, portfolio managers who score high double digit and even triple digit annual gains, managers of bond portfolios usually aren't there. The reason - bonds are a different game, one where risk is less courted than avoided. But when the dust settles after big market busts, it's often the bond managers who are still standing. Francis Chou, 52, of Chou Associates Management Inc., is one of those survivors. His $90-million Chou Bond Fund (US$), established in the fall of 2005, soared to the No. 1 spot among 65 funds in the high yield sector with an average annual compound gain of 10.4 per cent for the two years ended Feb. 29, 2008, far above the 1.5 per cent average annual compound gain of peers in the period." Stingy Links: Crime The match king "If Birgitta is the patron saint of Europe, Kreuger was the patron saint of sinners; he was arguably the most brilliant and ambitious swindler who ever lived. In the first three decades of the 20th century, he built up an industrial empire founded on the most humble of innovations, the Swedish-made safety match, that lit a fire of speculative excess around the world creating, then burning through, fortunes that would be measured now in the billions." Inside a stock fraud "His signature moves involved purchasing public shell companies and manipulating their shares in what the industry calls a "pump and dump" operation. The scheme, one of the oldest forms of stock market fraud, is a favourite of con artists. In Mitton's version, he would find a shell company, set up a personal network of buyers and sellers, release "news" and then direct the network's trading in company shares. The idea was to artificially create investor interest and trigger a jump in the company's stock price. Network players would unload any shares they held and pocket the profits before regulators, brokerages and average investors realized anybody had duped them. In the aftermath, Mitton usually left a trail of misery for victims who suffered everything from financial ruin to family breakups and humiliation." Societe Generale reports EU4.9 billion trading loss "Societe Generale SA said bets on stock index futures by a rogue trader caused a 4.9 billion-euro ($7.2 billion) trading loss, the largest in banking history. Jerome Kerviel, 31, was the trader responsible, the Paris- based bank said today. Societe Generale plans to raise 5.5 billion euros from shareholders after the loss and subprime- related writedowns depleted capital. The Bank of France, the country's banking regulator, is investigating the alleged fraud." Stingy Links: Dividends Dividend growth beyond the TSX 60 "The best dividend growth for stocks beyond the TSX 60 can be found in the financial sector - similar to the blue chips of the TSX 60. From 1995 to last July, however, mid-cap financial dividend stocks posted annualized gains of 20.2 per cent, compared with 17.9 per cent for their large-cap financial peers, and 10.8 per cent for the TSX Completion Index. Those figures do not include dividends." Dividends: A world of smart yield plays "In the ongoing search for income investments, many U.S. investors are seeking yield instruments overseas. That's because foreign companies are increasingly initiating or boosting dividend payments. As of Feb. 13, the dividend yield on the S&P Euro 350 index was 3.2%, vs. a 2.1% yield for the S&P 500. And it's not just Europe. Stocks in Asia and emerging markets are also increasingly paying dividends." Rising dividends are great "We love dividends. When we're having a bad day, nothing warms our soul like a juicy dividend increase. We're shallow that way. But not so shallow that we can't tolerate some dissension from people who actually have the temerity to argue that dividend increases maybe aren't the best use of a company's capital. And then these same people have the nerve to back up their case with cold, hard facts. When we looked at the title of the Thomson Financial report - "Baby, we got your dividend: What company actions do investors reward most?" - we were certain it would offer a ringing endorsement of our favourite investing strategy: Buying shares of companies that increase their dividends. So imagine our shock when the report told a different story. As you'll see, it doesn't suggest that dividend increases, per se, are a bad thing, but it does indicate that investors should pay attention to more than just the amount of cash companies pay out to shareholders, for dividend hikes can sometimes be a smokescreen for companies that are digging themselves into a hole." Stingy Links: Dorfman Robot Portfolio displayed human frailties "Dorfman named his company Thunderstorm Capital in honour of those stocks that rise in popularity after a "frightening but temporary event that usually passes without lasting damage." The Canadian stocks we selected using his method each had a market value of more than $500 million. They had reported more than a penny of profit per share in the previous four quarters, and had more shareholder equity than debt. Their share price was low relative to recent earnings." Stingy Links: Economics Unintended consequences "One year from today, a new president moves into the White House. This president will be eager to carry out any number of plans . including, surely, plans to help the segments of society that most need help. Extending a helping hand, after all, is one of the great privileges and responsibilities of the presidency. But before charging ahead with such plans, the new president might do well to first ask him- or herself the following question: What do a deaf woman in Los Angeles, a first-century Jewish sandal maker and a red-cockaded woodpecker have in common?" Stingy Links: Economy Why your wallet feels thinner "The U.S. Federal Reserve has been slashing interest rates to stave off a recession. One potential risk to that strategy: inflation. The bad news is that prices for many everyday items had already been ticking up, according to data from December 2004 and December 2007 collected by the U.S. Department of Labor. During that period, the Consumer Price Index, which measures the average change in prices over time for a basket of consumer goods and services, grew at a 3% annualized clip. But prices for many everyday items are rising even faster--and that's making everyone's wallet feel a little thinner." Don't rerun that '70s show "Will the next president be the second coming of Jimmy Carter? Given Thursday's economic headlines, full of dire warnings about the return of 1970s-style stagflation, you might think so. Realistically, though, the parallels between the problems facing the U.S. economy now and those of the late-1970s aren't that strong. That's the good news. The bad news is that the economy probably will look similar to, but worse than, the economy that undid the first President Bush. And it's all too easy to see how the next president could suffer a political fate resembling that of both the elder Mr. Bush and Mr. Carter." Stingy Links: Funds Investing is about stacking the odds in your favour "I go to the office in search of one thing. An asymmetric bet. In other words, an investment or business strategy where, in my judgment, there is limited downside if it doesn't work, and big upside if it does. That is an investment manager's Holy Grail. In searching for such a situation, you won't see an investment professional buying a 'risk-free' investment, other than a government bond. That's because 'risk-free' or principal protected securities, are an asymmetric bet in the wrong direction. The odds are stacked against the purchaser." Money for old hope "Under the normal rules of capitalism, any industry that can produce double-digit annual growth should soon be swamped by eager competitors until returns are driven down. But in fund management that does not seem to be happening. The average profit margin of the fund managers that took part in a survey by Boston Consulting Group was a staggering 42%. In part, this is because most fund managers do not compete on price. Instead, they persuade their clients to select their funds on the basis of past performance, even though there is little evidence to show that this is a good predictor of future success. Nor can investors be sure that the intermediaries who sell the funds - brokers, advisers and bankers - will steer them in the right direction. These middlemen often get a cut of the fund managers' fees, so they have little interest in recommending low-cost alternatives." Dark days for hedge fund king "The steep losses have dealt a major blow to Asness, a University of Chicago-trained mathematician whose investing prowess catapulted him into the ranks of the super-rich, and his firm. Founded a decade ago with fellow Goldman Sachs alumni, AQR now faces the daunting prospect of employee defections, falling management fees, and credit problems." Stingy Links: Government Canadian budget in brief "Maintaining strong fiscal management and continuing to reduce debt. Planned debt reduction for 2007.08 is $10.2 billion, and a total of $13.8 billion over the budget-planning period (2007.08 to 2009.10)." California exodus turns to stampede "Based on data from moving companies, California had the second-highest domestic population out-flow of any state in 2005, according to the report, "despite the beautiful weather, beaches, and mountains." The bad news for California is that it faces a $14 billion deficit this year, despite boasting one of the highest tax burdens in the nation. The report, published by the American Legislative Exchange Council shows jobs are not just leaving the country - they are moving from state to state, with the population following. "States are in direct competition with each other for human capital and business investment. State governments that think they can attract jobs and people, and grow their economies, by taxing their citizens at a higher rate than their neighbors are sadly mistaken," said Democratic Arkansas state Sen. Steve Faris, ALEC's 2008 national chairman." Rich states poor states "State Winners and Losers, details the migration of thousands of Americans from areas with high tax burdens to places where they can experience greater economic freedom. States with a high propensity to tax and spend are fi nding their most wealthy and productive citizens moving across borders into areas that impose less of a financial burden." The Fed can't fix home prices "Where are the speculators, vultures and hedge funds? Where are the big money players willing to buy the exotic but still substantial mortgage-backed securities for which markets have ceased? The Fed's liquidity rush seems only to have convinced them the time is ripe for staying on the sidelines. To get to a real solution, speculators and investors need to believe that home prices are hitting bottom, that any mortgage debt they might buy today for 80 cents on the dollar today won't be worth 30 cents tomorrow. Then the vultures will pile in: The transfer of wealth from the overleveraged banks and hedge funds to those who kept cash handy will be shocking, ugly and cathartic -- but it will also be relatively quick. Credit markets will begin to function again. The economy will grow." Canada's total government fiscal performance "To enable international comparisons, the OECD publishes National Accounts data for the total government sector. For Canada, the figures include the federal, provincial-territorial and local government sectors, as well as the Canada Pension Plan and the Qu bec Pension Plan. Based on OECD data, Canada's fiscal position is stronger than that of the other G7 countries (United States, United Kingdom, France, Germany, Japan and Italy). *The OECD expects Canada to record the largest budgetary surplus as a share of GDP in the G7 in 2007, 2008 and 2009. *It projects that Canada's total government net debt-to-GDP ratio, which has been the lowest in the G7 since 2004, will continue to decline in future years. *Canada is on track to eliminate its total government net debt by 2021. By doing so, it will be able to count itself among the few OECD countries that are in a net asset position." Advice gets interesting "In the United States, with its plethora of tax-assisted vehicles, from 401 (k) to Individual Retirement Accounts to Roth IRAs, the calculation of where to put what asset to get the best after-tax yield has elicited some debate and a lot of actuarially inclined mathematics. Now it comes to Canada. A few years ago, when the capital gains inclusion rate was reduced the question became pointed: Why put assets that would yield capital gains in an account whose withdrawals would be taxed as interest? Still, it was a two-option universe, subject to asset allocation decisions: bonds inside and stocks outside. TFSAs change that simple calculation. Why not put interest and dividend-paying assets in the TFSA? There's no tax on withdrawals. What about stocks? As with an RSP, there's no potential for deducting capital losses. So the emphasis will be on finding steady performers with low volatility. This is where advice gets interesting is in determining the balance and types assets among all three accounts: open, registered and tax-free." Stingy Links: Gross Pyramids crumbling Bill Gross, Jimmy Stewart, and banking Stingy Links: Health Do we really know what makes us healthy? "The dangerous game being played here, as David Sackett, a retired Oxford University epidemiologist, has observed, is in the presumption of preventive medicine. The goal of the endeavor is to tell those of us who are otherwise in fine health how to remain healthy longer. But this advice comes with the expectation that any prescription given - whether diet or drug or a change in lifestyle - will indeed prevent disease rather than be the agent of our disability or untimely death. With that presumption, how unambiguous does the evidence have to be before any advice is offered?" Do cholesterol drugs do any good? "Yes, Wright saw, the drugs can be life-saving in patients who already have suffered heart attacks, somewhat reducing the chances of a recurrence that could lead to an early death. But Wright had a surprise when he looked at the data for the majority of patients, like Winn, who don't have heart disease. He found no benefit in people over the age of 65, no matter how much their cholesterol declines, and no benefit in women of any age. He did see a small reduction in the number of heart attacks for middle-aged men taking statins in clinical trials. But even for these men, there was no overall reduction in total deaths or illnesses requiring hospitalization - despite big reductions in "bad" cholesterol." Stingy Links: Law When OSC goes green, lawyers see red "The regulator says financial estimates must be provided to investors where quantitative information is "reasonably available," and the company should explain that the estimate is highly uncertain. It should also consider providing the upper and lower ranges of financial exposure, as well as an analysis of the likelihood the event will actually occur. Almost overnight, environmental liability has been escalated to a major governance issue. Public companies are being asked to come clean or risk a big legal mess. But at least one of the country's senior environmental lawyers says the OSC is asking for trouble." Stingy Links: Markets Panic of 1907 or not, trading stops on good Friday "The New York Stock Exchange is closed today, as it has been every Good Friday for almost 150 years, except 1898, 1906 and 1907. That last one was the same year as the infamous Panic of 1907, when the aggregate value of all U.S. stocks plunged by more than a third. Hence, a legend that persists 101 years later: Traders get to stay home the Friday before Easter not just because it's a Christian holy day but because of its association with one of history's great bear markets." Fat tails and nonlinearity "If you are involved in financial markets, you have gotten the memo about fat tails by now. But awareness of extreme events is not enough. Thoughtful investors must understand two interrelated aspects of the market. The first is the statistical properties of price movements, including important deviations from the bell-shaped distribution. Academics, risk managers, and quantitative investors have explored this aspect extensively. Researchers recognized decades ago that the distribution of price changes includes fat tails. The second aspect, and one often overlooked or misunderstood, is the mechanism that leads to the statistical imprint. Much of the work on the market's statistical properties is divorced from the propagating mechanism, while traditional theories of market efficiency assume the mechanisms. Crucially, understanding the mechanism provides insight into how and why markets fail." Global investment returns yearbook 2008 "This year's thematic studies are about momentum, a subject of importance to all investors, whether their investment style favours it or not. We show that momentum profits in equities have been large and pervasive across time and markets, and present findings from the longest momentum study ever undertaken. We also discuss how supply and demand as well as financing mechanisms can work as important multipliers of momentum for real estate and for commodity prices. Our focus throughout is on the practical implications for investors." How a bubble stayed under the radar "The failure to recognize the housing bubble is the core reason for the collapsing house of cards we are seeing in financial markets in the United States and around the world. If people do not see any risk, and see only the prospect of outsized investment returns, they will pursue those returns with disregard for the risks. Were all these people stupid? It can't be. We have to consider the possibility that perfectly rational people can get caught up in a bubble. In this connection, it is helpful to refer to an important bit of economic theory about herd behavior." Wall Street fears a big US bank is in trouble "Global stock markets may have cheered the US Federal Reserve yesterday, but on Wall Street the Fed's unprecedented move to pump $280 billion into global markets was seen as a sure sign that at least one financial institution was struggling to survive." Ambac cut to AA "Ambac Financial Group Inc., the second-largest bond insurer, was stripped of its AAA credit rating by Fitch Ratings after the company abandoned plans to raise new equity. Ambac Assurance Corp. was lowered two levels to AA and may be reduced further, New York-based Fitch said yesterday in a statement." Try, try again "The U.S. Federal Reserve has come up with yet another way to kick-start the credit markets, if only its innovations would start working already. On Tuesday, the central bank said it is expanding its securities lending operations, allowing big Wall Street firms to borrow for longer periods and, for the first time, exchange triple-A mortgages not backed by Fannie Mae or Freddie Mac for Treasury bonds. That is to say, the Fed will let the big brokerages offload their hard-to-sell mortgage holdings for easy-to-sell Treasury bonds." Hedge Funds reel from margin calls on treasuries "The hedge-fund industry is reeling from its worst crisis in a decade as banks are now demanding more money pledged to support outstanding loans even when the investment is backed by the full faith and credit of the United States." Stingy Links: Miller Bill Miller Q4 2007 "I believe equity valuations in general are attractive now, and I believe they are compelling in those areas of the market that have performed poorly over the past few years. Traders and those with short attention spans may still be fearful, but long-term investors should be well rewarded by taking advantage of the opportunities in today's stock market." Stingy Links: Montier The dash to trash "The US market is not priced for even a shallow recession - let alone a deep one. Investors are piling on the risk by blindly believing that they can tell 'true' growth stocks from the young pretenders - however, history suggests that a monkey throwing darts would generally do a better job! Investors with an ability to hold cash should consider this option. Waiting for the 'fat pitch' may be one of the smartest ways of dealing with the current juncture. For those who have to be invested, discipline will be key. Sticking with a proven process and focusing on the long- term should bring (long-term) rewards. Tilting towards large cap, dividend paying stocks or large caps with the resource to transform cash piles into dividends are likely to be the safest place to hide." Want higher returns? Don't take Prozac "Take it from Montier, a well known bear, pessimism is not an easy road, even though it may be a straight one. "Nobody likes a bear," he said. "As a career move bearishness is not a great idea, in a bull market nobody listens and in a bear market nobody will pay you."" Stingy Links: Real Estate Can't pay? Just walk away "Lenders are afraid that borrowers may find it's worth the hit to their credit scores, if they can drastically reduce their housing expenses. Someone with good credit and a $600,000 home in a town with cratering real estate prices could buy a similar house nearby for $450,000, and then let the other $600,000 mortgage go into foreclosure. The stage is set for this kind of thing particularly in California, where huge numbers of buyers used low or no-down deals to buy homes. The trend has even spawned at least one new business, San Diego-based YouWalkAway.com, which for a fee of $1,000 purports to guide clients through the process of ditching their mortgages. It launched in early January, and says it has already signed up 180 clients. California is a bit of a safe haven for these borrowers, since banks that repossess and then sell a foreclosed property for less than the mortgage that was owed on it cannot come after borrowers for the difference - as long as it's the initial mortgage, one that has not been refinanced. So if a borrower owes $200,000 and the bank sells the house for $170,000, the borrower comes out of it debt-free. And for many homeowners, the prospect of becoming debt-free is growing increasingly alluring." Housing meltdown "Brace yourself: Home prices could sink an additional 25% over the next two or three years, returning values to their 2000 levels in inflation-adjusted terms. That's even with the Federal Reserve's half-percentage-point rate cut on Jan. 30 While a 25% decline is unprecedented in modern times, some economists are beginning to talk about it. "We now see potential for another 25% to 30% downside over the next two years," says David A. Rosenberg, North American economist for Merrill Lynch (MER), who until recently had expected a much smaller slide. Shocking though it might seem, a decline of 25% from here would merely reverse the market's spectacular appreciation during the boom. It would put the national price level right back on its long-term growth trend line, a surprisingly modest 0.4% a year after inflation." Morgan Stanley, Lone Star stick taxpayers on defaults "The public's bill for maintaining foreclosed properties abandoned by lenders and investors may reach as much as $50 billion this year, according to Peter Sepp, vice president of the National Taxpayers Union in Alexandria, Virginia. The U.S. Congress is considering various bills to help cover some of the costs to towns and cities for securing and policing the empty homes, Sepp said." Appraiser exposes toxic debt tie to inflated values "Perez valued eight unfinished properties at the Deere Lofts development on April 2. Some were missing ceilings, cabinets or sinks. Each had been bought the previous week for $90,000 to $167,000. Perez said they were worth $177,000 to $330,000, according to the U.S. Attorney's Office in Atlanta." Subprime loans defaulting even before resets "During the boom, rapid price appreciation meant borrowers built up home equity quickly. That minimized defaults, since owners could draw from that equity to pay their bills - including their mortgages - through home equity loans. But prices fell starting in 2006,leaving borrowers with less home equity to draw upon when they run into financial problems. Median home prices fell 5.8 percent nationally, and by double digits in many areas. That, along with the deterioration in underwriting, changed the default math. Owners with mortgages worth more than their homes simply began walking away from their homes when costs become unmanageable." Getting Knocked Down by Prime ARMs "We've been reading a lot lately about how subprime mortgages have submarined the economy. Lenders and banks have been taken to the woodshed for irresponsibly giving money to home buyers with poor credit just so they could bundle up the mortgages and resell them as toxic residential-mortgage bonds. But, while there's no denying the subprime problem, on closer look it's clear that even prime borrowers were taking on more debt than they could afford. How bad is it? In Arizona, between the third quarters of 2006 and 2007, there was a 902% rise in foreclosures started against homeowners who had prime adjustable-rate mortgages, known as ARMs, according to the Mortgage Bankers Assn. ARMs, whether prime or subprime, are the real culprit in the housing crisis because they've allowed too many people to buy homes with almost no money down, with the hope that they could flip the properties or have rates drop before the loans reset. The rise in prime ARM foreclosure starts isn't isolated to a few states. Nationally, foreclosure starts related to prime ARMs jumped 253% in the third quarter of 2007 when compared to a year earlier." Home economics "Even without lending and borrowing excesses, though, our high rate of homeownership would likely create problems as the economy slows. To recover from recession, economies need prices to fall until they reflect genuine supply and demand. With certain kinds of assets, like stocks, these adjustments take place quickly, sometimes viciously so. Buying and selling houses, though, is a far slower process. The good thing about this is that housing prices never suffer crashes on the scale that you sometimes see in the stock market. The bad thing is that it can take a long time for housing prices to reflect reality. Homeowners, as economists have shown, tend to remain unreasonably optimistic about the value of their homes, and they hate to drop their asking price. As a result, existing-home sales in the U.S. are now at a nine-year low." Generational housing bubble "Communities in the United States face an historic tipping point. After decades of stability, we expect the ratio of seniors to working-age residents to grow abruptly, increasing by roughly 30% in each of the next two decades. We also expect that this change will make many more homes available for sale than there are buyers for them. The exit of the baby boomers from homeownership could have effects as significant as their entry, though with different consequences." Dirty deeds "Still, even with novel and aggressive tactics, the path to resolution for many properties in Buffalo can be tortuous and protracted. A house at 1941 Niagara St. - one of dozens of properties that Cooper examined as a graduate studenthas yet to see its final chapter, though it may be close. In 1998, Elizabeth M. Manuel obtained a $34,500 mortgage on the property from IMC Mortgage (since acquired by Citibank). By 2002, the loan had been sold into a securitization trust administered by Chase Manhattan (now JPMorgan Chase) as trustee. It also went into default, and Chase began foreclosure proceedings. In a court filing, Manuel (who could not be located for comment) said she left the home while the foreclosure action was pending. More than five years later, though, the title remains in her name. The house, although still standing, has become a fire-gutted wreck. In May 2007, Nowak issued a default judgment against Chase for $9,000. But these cases can be notoriously difficult to untangle. Thomas A. Kelly, a spokesman for the bank, notes that Chase sold its trustee business to the Bank of New York Mellon (BK) in October, 2006, and couldn't locate anyone at Chase able to comment. But he reiterates the industry view that Chase can't be held responsible for maintaining a property it never owned. He acknowledges that if a home didn't seem worth taking as collateral, the bank may have made a decision to "just walk away." The value of 1941 Niagara, estimate city assessors, is $4,500, of which $4,300 represents the value of the land. The home, Cooper says, is slated for "imminent" demolition." Preparing for a 'real estate apocalypse' "The year has not been off to a great start. In figures released last week, a blustery February knocked existing home sales down by 11 per cent for the month, while residential building permits were down by a significant 47 per cent in January. Growing uncertainty over the U.S. economy, where housing values have plummeted in some states, has also cast a long shadow over the Toronto market." Stingy Links: Schloss Experience: Walter Schloss "Walter Schloss has lived through 17 recessions, starting with one when Woodrow Wilson was President. This old-school value investor has made money through many of them. What's ahead for the economy? He doesn't worry about it. A onetime employee of the grand panjandrum of value, Benjamin Graham, and a man his pal Warren Buffett calls a "superinvestor," Schloss at 91 would rather talk about individual bargains he has spotted. Like the struggling car-wheel maker or the moneylosing furniture supplier. Bushy-eyebrowed and avuncular, Schloss has a laid-back approach that fast-money traders couldn't comprehend. He has never owned a computer and gets his prices from the morning newspaper. A lot of his financial data come from company reports delivered to him by mail, or from hand-me-down copies of Value Line, the stock information service." Walter J. Schloss Q&A 2008 "Mr. Schloss started his limited partnership in the middle of 1955. In 1963, he earned the Chartered Financial Analyst designation. Waller's son Edwin joined the partnership in 1973 and the fund changed its name to Walter & Edwin Schloss Associates. Over the period 1956 to 2000, Mr. Schloss and his son Edwin provided investors a compounded return of 15.3% compared with the S&P 500.s annual compounded return on 11.5%." Stingy Links: Stocks Wall Street losses partners never imagined "Less than a decade after Wall Street's last major partnership went public, stockholders are paying the price for bankrolling the industry's expanding risk appetite. Four of the five biggest U.S. securities firms lost about $83 billion of market value last year, almost 90 percent of their net income since 1999, data compiled by Bloomberg show. That cut the annual average return for Morgan Stanley, Merrill Lynch & Co., Lehman Brothers Holdings Inc. and Bear Stearns Cos. during those nine years to 9.7 percent from 16.8 percent. The private partnerships that once dominated Wall Street guarded their capital, used less leverage and limited their risk to trading blocks of stock for clients and shares of companies in mergers, said Roy Smith, a finance professor at New York University's Stern School of Business and a former partner at Goldman Sachs Group Inc. Since raising money from the public, many of the biggest firms have abandoned that caution." What Citigroup says isn't what it does "Real estate developer John Wimmer paid Citigroup Global Markets Realty Corp. almost $1 million last year to lock in a 5.6 percent mortgage rate on the refinancing of six commercial properties. At the November closings, Citigroup, citing plummeting demand for mortgage bonds, boosted the rate to 7.123 percent." JPMorgan buys Bear Stearns for $2 a share "JPMorgan Chase & Co. agreed to buy Bear Stearns Cos. for about $2 a share after a run on the company ended 85 years of independence for Wall Street's fifth- largest securities firm and prompted a bailout by the Federal Reserve." Bear Stearns gets emergency funds "Bear Stearns Cos., teetering on the brink of collapse from a lack of cash, got emergency funding from the Federal Reserve and JPMorgan Chase & Co. in the largest government bailout of a U.S. securities firm. After denying earlier this week that access to capital was at risk, Bear Stearns Chief Executive Officer Alan Schwartz said today that the 85-year-old company's cash position had 'significantly deteriorated' in the past 24 hours. The central bank agreed to provide financing through JPMorgan for up to 28 days, the bank said in a statement today." The complete guide to free stock screen tools "There are a growing number of free stock screen tools on the Web, but trying to decide among the many available could be the cause of a headache or two. It would help to have a guide. Hence, the following survey: It describes some of the better packages with the help of reviews and experienced users." Stingy Links: Taxes Dividend tax slides below budget radar "The status quo will hold in dividend taxation until 2010, when a three-year phased adjustment begins. Myron Knodel, manager of tax and estate planning at Investors Group in Winnipeg, illustrated how this will work with an example involving $100 in dividends paid by a bank. The current federal tax rate on dividends means you'd net $85.46, assuming you were in the top tax bracket. By 2012, your net take on the same $100 would be $80.68, a decline of $4.78, or 5.6 per cent." TFSAs could spawn untaxed pensioners "The Tax-Free Savings Accounts (TFSAs) announced in last week's federal budget could become so popular that within 30 years they could supplant RRSPs and create a generation of senior citizens that pay no income tax at all, says actuary Malcolm Hamilton, worldwide partner with Mercer's, the pension consultants." Same price, but fewer tax returns "QuickTax Standard for 2007 includes two returns for Canadians with more than $25,000 in income, compared with five returns in previous years." [Consider UFile instead] Curve balls raise red flags for CRA "When filing your tax return this year, be aware that your past tax filings may have an impact on whether the CRA will accept this year's filing position. Consistency can be a good thing." Stingy Links: Value Investing Watsa says credit squeeze still in 'early days' "Fairfax, which owns Canadian and U.S. insurers, said earlier today that fourth-quarter net income tripled to $563.6 million, or $30.15 a share, from $159.1 million, or $8.45 a share, a year earlier. Annual profit more than quadrupled to $1.1 billion, the Toronto-based company said. Fairfax had gains of $705.2 million in the quarter after the company bought credit-default swaps to profit from asset writedowns at U.S. banks. Losses and writedowns among the world's largest financial companies have risen to at least $146 billion after the subprime mortgage market collapsed amid record loan defaults. Watsa, 57, said there are more losses to come." Why it's fair weather for Fairfax investors "There was one reason Fairfax, a holding company with subsidiaries in the property and casualty and re-insurance business, landed in the company of the "recession-proof" fast-food restaurant and the seemingly unstoppable value investment vehicle run by the Oracle from Omaha Mr. Buffet: Credit Default Swaps. Analysts are twigging to Fairfax's portfolio of credit default swaps, with a "notional" value of US$18.5-billion against a purchase price of US$343-million, perhaps the perfect hedge against the economic turmoil that led to yesterday's dramatic stock market sell-off." Miscalculating the risks "Inside his boardroom, Prem Watsa keeps an unusual artifact: a bronze bust of Sir John Templeton, the 95-year-old legend of value investing. The item was a 50th birthday gift for the chairman of Fairfax Financial Holdings Ltd., but also serves as a source of inspiration. The Templeton principles, after all, underpin much of Fairfax's investment philosophy: Be flexible; search around the world for the best bargains; and above all else, go against the crowd - buy when others are pessimistic, and sell when optimism rules. It's the last of these that led Mr. Watsa - until recently one of the most beleaguered executives on Bay Street - to one of the most stunning investments of his career, and has given him a way to silence his many critics. Fairfax this week disclosed an annual profit of $1.1-billion (U.S.) for 2007, nearly four times what the insurance and investment company had earned in its best year the year before. Much of that was the result of a single, contrarian bet the firm made that the world had got it wrong about risk." Seth Klarman's talk at MIT "Many investors lack a strategy that equips them to deal with a rise in volatility and declining markets. Momentum investors become lost when the momentum wanes. Growth investors - who pay a premium for the fastest growing companies - don't know what to do when the expected growth fails to materialize. Highly leveraged investors, like some quant funds in the headlines, were recently forced to sell regardless of value when their methodology produced losses rather than gains. Counting on a government bailout for every market crisis seems a dicey proposition, especially when supposedly impossible events happen on Wall Street every few years. By the time the market drops and bad news is on the front pages, it is usually too late for investors to react. It is crucial to have a strategy in place before problems hit, precisely because no one can accurately predict the future direction of the stock market or economy. Value investing, the strategy of buying stocks at an appreciable discount from the value of the underlying businesses, is one strategy that provides a road map to successfully navigate not only through good times but also through turmoil. Buying at a discount creates a margin of safety for the investor.room for imprecision, error, bad luck or the vicissitudes of volatile markets and economies. Following a value approach won.t be easy for everyone, especially in today.s media-dominated, short-term oriented markets, in that it requires deep reservoirs of patience and discipline. Yet it is the only truly risk averse strategy in a world where nearly all of us are, or should be, risk averse." Patient Capital Q4 "The possibility of faltering earnings in a weakening environment coupled with a whiff of inflation has put market participants in a skittish mood. As a result, investors that were recently very optimistic are now frightened. We view economic contractions as a very normal part of the business cycle and welcome such times as an opportunity to purchase excellent businesses at very attractive prices." Stingy Links: Whitman Third Avenue Funds Q1 "Obviously, I feel good about TAVF's investment in MBIA. The Fund ought to do well under almost any scenario. By any objective standard, the MBIA investments are attractive ones with the insurance subsidiaries deserving of an AAA-Stable rating. Yet, there exists a sense of discomfort due to the dangers of Rating Agency subjective considerations and capricious regulators." Frugally Yours, Norman Rothery ISSN 1499-2787 | ||||
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