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The Stingy News Quarterly (Q3/2009)
The Best Stingy Links Stingy Links: Academia Risk and return in general "Empirically, standard, intuitive measures of risk like volatility and beta do not generate a positive correlation with average returns in most asset classes. It is possible that risk, however defined, is not positively related to return as an equilibrium in asset markets. This paper presents a survey of data across 20 different asset classes, and presents a model highlighting the assumptions consistent with no risk premium. The key is that when agents are concerned about relative wealth, risk taking is then deviating from the consensus or market portfolio. In this environment, all risk becomes like idiosyncratic risk in the standard model, avoidable so unpriced." Stingy Links: Behaviour The invisible hand, trumped by Darwin? "Smith's basic idea was that business owners seeking to lure customers away from rivals have powerful incentives to introduce improved product designs and cost-saving innovations. These moves bolster innovators. profits in the short term. But rivals respond by adopting the same innovations, and the resulting competition gradually drives down prices and profits. In the end, Smith argued, consumers reap all the gains. The central theme of Darwin's narrative was that competition favors traits and behavior according to how they affect the success of individuals, not species or other groups. As in Smith's account, traits that enhance individual fitness sometimes promote group interests. For example, a mutation for keener eyesight in hawks benefits not only any individual hawk that bears it, but also makes hawks more likely to prosper as a species. In other cases, however, traits that help individuals are harmful to larger groups." Cocksure "From an individual perspective, it is hard to distinguish between the times when excessive optimism is good and the times when it isn't. All that we can say unequivocally is that overconfidence is, as Wrangham puts it, 'globally maladaptive.' When one opponent bluffs, he can score an easy victory. But when everyone bluffs, Wrangham writes, rivals end up 'escalating conflicts that only one can win and suffering higher costs than they should if assessment were accurate.'" Believing everything you read "You shouldn't believe everything you read, yet according to a classic psychology study at first we can't help it." Trust "Being able to trust people might seem like a pleasant luxury, but economists are starting to believe that it's rather more important than that. Trust is about more than whether you can leave your house unlocked; it is responsible for the difference between the richest countries and the poorest." Hunches prove to be valuable "Everyone has hunches - about friends. motives, about the stock market, about when to fold a hand of poker and when to hold it. But United States troops are now at the center of a large effort to understand how it is that in a life-or-death situation, some people's brains can sense danger and act on it well before others. do." Thaler responds to Posner "The proposal that particularly draws Posner's ire is the idea that the Agency would designate a few types of "plain vanilla" mortgages and suggest that unsophisticated shoppers concentrate their search on those. The idea is very similar to the standard leases used in most rental agreements. The landlord can change the terms of the standard lease, but those changes are done in a way that makes them quite salient to prospective tenants, and the tenants are alerted to the fact that these terms are not the usual ones. The plain vanilla mortgages would all have the same terms (like the standard leases) and issuers who want to offer different kinds of mortgages would have to make their modifications clear. Only mortgages judged to be very dangerous would be banned." When good thinking goes bad "What do Apple, Inc.'s craziest fanatics, Wall Street, and the case of the Harvard professor and the police officer have in common?" What's your financial IQ? "These particular questions are the mental equivalent of optical illusions. They appear to be easy, but aren't. Tests of similar complexity which are more obviously difficult yield more correct answers so it's not simply a question of basic maths skills. Something else is going on here. Something, it turns out, that may completely screw up psychology's ideas about the way people think about finance." Stingy Links: Bonds Arithmetic returns for junk biased "junk bonds have not outperformed investment grade bonds since data on junk bonds really became available, around 1987. This is the real corporate bond puzzle, in direct contrast to the corporate bond puzzle most acaddemics address, which is the anomalously high return premium between BBB and AAA bonds (around 100 basis points annually)." Stingy Links: Brokers Do your legwork before hiring an adviser "There's a kind of investment risk that is statistically very rare, but crushing if it happens to you. It's called adviser risk and, thanks to coverage of the scheme allegedly perpetrated by Montreal financial adviser Earl Jones, we have a horrifying view of what it means. As much as $30-million to $50-million belonging to Mr. Jones's clients, many of them seniors, has allegedly disappeared. Some victims are looking at having to sell their homes, while others have had to rely on food banks to get by." Stingy Links: Buffett The greenback effect "The United States economy is now out of the emergency room and appears to be on a slow path to recovery. But enormous dosages of monetary medicine continue to be administered and, before long, we will need to deal with their side effects. For now, most of those effects are invisible and could indeed remain latent for a long time. Still, their threat may be as ominous as that posed by the financial crisis itself." What would Warren do? "More like the early Christians in pagan Rome than the millions of Muslims thronging Mecca, Buffett's hard-core 'value investors' are few, and in many ways, their entire lives run against the grain of the dominant culture. Only here in Omaha, for one weekend a year, are they a majority. The meeting, with its quasi-ritual speeches, canonical stories and jokes, and the fellowship of other value investors, helps to brace them against a society that almost actively rejects their austere financial philosophy." Berkshire profit on Goldman "Warren Buffett's option to buy shares of Goldman Sachs Group Inc., part of an agreement reached at the depths of the credit crisis, has earned a profit on paper of more than $2 billion, a return of about 44 percent." Buffett's $91,000 shares are a steal "Buffett sounded upbeat at Berkshire's annual meeting in May, saying he thought Berkshire stock could best the S&P 500 in the coming years. He noted that the stock hadn't kept pace with the growth in retained earnings in recent years. Asked whether Berkshire's competitive advantage would die with him, Buffett replied that Berkshire's strengths -- including a unique business mix and culture, long-term orientation and patient shareholder base -- will outlive him." Buffett recalculating his bets "After counseling Washington to rescue the nation.s financial industry and publicly urging Americans to buy stocks as the markets reeled, in he swooped. Mr. Buffett positioned himself to profit from the market mayhem - as well as all those taxpayer-financed bailouts - and thus secure his legacy as one of the greatest investors of all time." Berkshire without Buffett "Few things are guaranteed in the investment universe, but here's one: Whoever takes over from 79-year-old Warren Buffett as the head of Berkshire Hathaway will have a hard time filling his shoes." Stingy Links: Business Ramen profitable "Now that the term "ramen profitable" has become widespread, I ought to explain precisely what the idea entails. Ramen profitable means a startup makes just enough to pay the founders' living expenses. This is a different form of profitability than startups have traditionally aimed for. Traditional profitability means a big bet is finally paying off, whereas the main importance of ramen profitability is that it buys you time." Stingy Links: Cestnick Help with unwinding loved one's estate "We then started talking about the work that it can be to look after an estate after someone has passed away. Not the most uplifting conversation, I know, but Nancy had questions, because her mother had just passed away, leaving her and her brother to look after the estate. Here's a checklist of important financial issues to deal with when someone passes away." Stingy Links: Crime Las Vegas' medical mafia "Prosecutors charge that a group of top Las Vegas plaintiffs lawyers and doctors, with the 64-year-old Awand at its center, conspired in an audacious fraud. The participants appeared to act independently but instead colluded. Unwitting accident victims were recruited as plaintiffs and then persuaded to undergo serious, sometimes needless, surgeries. The procedures, in turn, helped inflate the size of personal-injury claims. The result was multimillion-dollar insurance settlements, even for dubious cases, and lucrative fees for the doctors, the lawyers, and, of course, Howard Awand." You've got blackmail "My advice: If AOL comes after you, then go after AOL." See no evil and pay no penalty "For years, Beazer Homes USA was much more than a builder of houses. It was a veritable crime wave. The company defrauded buyers, particularly poor people being sold homes they could not afford. It defrauded the federal government by getting government-guaranteed mortgages for those buyers. It created subdivisions now dominated by dozens of foreclosed homes. And while it was at it, Beazer lied to shareholders about how much money it was making. First, it lied by claiming it was making less than it was. Then it lied by hiding losses when the housing bubble began to burst. To keep the lies going, the government says, the company prepared fraudulent documents to mislead its auditors." Freedom Investment Club wavering on ruin "The Vancouver-based Freedom Investment Club has turned into a tar-pit for its 5,500 members. Far from providing them with financial freedom, it has bound them with debt, foreclosure action and the prospect of losing their entire investment." Stingy Links: Dividends Dividends and the frozen OJ syndrome "In light of the powerful historical evidence that companies can grow and still pay out somewhere around half their earnings as dividends, why is the demand for dividends today so small? If the theoretical case for high payout ratios is beyond dispute, why is the demand for dividends so small? In the wake of corporate and accounting scandals that one might expect to lift the demand for dividends, why is the demand for dividends so small? In view of the radical change in the taxation of dividends, why is the demand for dividends so small? As the King of Siam put it, 'It is a puzzlement.'" Stingy Links: Dorfman Homebuilders begin to appeal "Is it time to buy the homebuilders, which were market darlings in 2003 through 2005? The bullish case begins with the fact that the stocks had fallen so far. As a group, they plunged an astonishing 90 percent from July 20, 2005, through Nov. 21, 2008. That's comparable to the slide in Internet stocks in 2000- 2002. By some measures, the homebuilders had it worse. By the same token, homebuilding stocks are cheap. The question is whether they deserve to be." Amgen, Smucker, Steelcase have value "A stock that is rising while most are falling may be worth a look. If that stock is also inexpensive and has a good balance sheet, it might be an opportunity." Debt dogs of summer "Beware of the stocks leading the U.S. market higher this summer. Based on a sampling taken last week, I estimate that 90 percent of the top performers in the first three weeks of July were companies with debt greater than stockholders' equity. Less than one third of big, publicly traded U.S. companies carry such a heavy debt burden." 4 cheapskate stocks "I screened U.S. stocks with a market value of $500 million or more to find ones that are cheap by all of my favorite yardsticks. These stocks sell for less than 12 times earnings, less than one times book value (corporate net worth) and less than one times revenue. I also required that corporate debt be less than stockholders' equity. Of the more than three dozen stocks that passed the test, I recommend these four." Loving stocks the market left behind "Last week, using Bloomberg stock-screening software, I combed through the 61 laggards. I eliminated 30 because their debt was greater than stockholders. equity. I chopped off another dozen because they sell for more than 15 times earnings. In a blasted market with lots of bargains, why pay so much? That left 19 stocks to consider. Here are four that I believe could make up for lost time and show significant appreciation in the next year." Stingy Links: Economics Macroeconomist says macroeconomics successful "Macroeconomics is the triumph of hope over experience, and has been no more successful than sociology. I think it's great that some people are working on this, but let's not kid ourselves that there has been any progress. It is easy to think that merely because a lot of intelligent people have published peer reviewed articles, knowledge must be increasing. The bottom line is the data, and real time experience with macroeconomic models has been horrible as always. It is nice that some of the bad models of the past are now known to be wrong, but the set of wrong models is infinite, so that does not imply we are getting closer to the correct model merely by excluding more bad ones." An economics of magical thinking "The unreasonableness of this standard of rationality helps to explain why macroeconomists of all camps and finance theorists find it hard to account for swings in market outcomes. Even more pernicious, despite these difficulties, their models supposedly provide a 'scientific' basis for judging the proper roles of the market and the state in a modern economy. But incoherent premises lead to absurd conclusions" Efficiency and beyond "The efficient-markets hypothesis has underpinned many of the financial industry's models for years. After the crash, what remains of it?" How did economists get it so wrong? "To be fair, finance theorists didn't accept the efficient-market hypothesis merely because it was elegant, convenient and lucrative. They also produced a great deal of statistical evidence, which at first seemed strongly supportive. But this evidence was of an oddly limited form. Finance economists rarely asked the seemingly obvious (though not easily answered) question of whether asset prices made sense given real-world fundamentals like earnings. Instead, they asked only whether asset prices made sense given other asset prices. Larry Summers, now the top economic adviser in the Obama administration, once mocked finance professors with a parable about 'ketchup economists' who 'have shown that two-quart bottles of ketchup invariably sell for exactly twice as much as one-quart bottles of ketchup,' and conclude from this that the ketchup market is perfectly efficient." Krugman's critics go on the warpath "If you are inclined to believe that government should steer clear of any intervention in the economy, or stand with partisans who lean to the right-wing side of political economy debates, then you will likely agree with Donald Luskin that John Cochrane's riposte to Paul Krugman's "How Did Economists Get It So Wrong?" is "devastating."" Stingy Links: Economy America's disappearing millionaires "It hasn't been a good recession for the rich. The late boom was extraordinarily top-heavy, with the overwhelming majority of economic gains seemingly defying gravity and flowing to the top rung of the economic ladder. Now those with the most assets and income have the most to lose. Add together the declining markets, an imploding finance sector, a real estate rot that has eaten its way up from the ground floor to the penthouse, and the predations of Bernie Madoff and Sir Allen Stanford, millionaires who ripped off other millionaires, and, as my Newsweek colleague Robert Samuelson notes, these are tough times for the wealthy." Help desperately wanted "Here's a suggestion for people with a death wish. Stroll through Windsor, Ont., or a Newfoundland outport, and chat up the older residents about their employment prospects. After you've listened to their tales about massive layoffs in the automotive sector and dried-up opportunities in natural resources, tell them that Canada is facing a labour shortage. Then start running." Using garbage to measure consumption "The equity premium puzzle has been festering unsolved in economic circles since the 1980s. The puzzle is this: economists can.t adequately explain why investors demand such high-risk premiums to own volatile stocks over relatively steady bonds. The risk premium for stocks over bonds in the long term is about 6%. But 6% seems like too big a premium to economists. In theory, one way to explain the premium would be to look at consumption, a broad measure of wealth. People should demand a premium from an investment that goes down when consumption goes down." Overmighty finance levies a tithe on growth "The protracted debate over how to clean up after the financial crisis - and how to reform our accident-prone financial system to prevent another such episode - is stuck on the problem of how to regulate markets without undermining the benefits they bring. What is sorely missing is any real discussion of what function our financial system is supposed to perform and how well it is doing that job - and, just as important, at what cost." Stingy Links: Fun The cupcake bubble "In recent years, the response to a popped economic bubble has been to create a new one. The pierced dot-com/telecommunications bubble paved the way for the housing/credit bubble. That punctured bubble may be giving way to an alternative energy bubble. But I've got my eyes on a smaller, but no less revealing, one: the Cupcake Bubble." Bashing Goldman Sachs "America stands at a crossroads, and Goldman Sachs now owns both of them. In choosing which road to take, ordinary Americans must not be distracted by unproductive resentment toward the toll-takers. To that end we at Goldman Sachs would like to dispel several false and insidious rumors." Foreclosed homes threatened by hurricane "In what forecasters are predicting will be the largest, most devastating disaster to hit Florida since the national economy collapsed, a Category 5 hurricane neared the Gulf coast this week, threatening thousands of repossessed and long deserted homes. According to meteorologists, the incoming tropical storm could leave as many as 3 million residents every bit as homeless as they've been for the past year or so." Flipping out "Yet recent research into coin flips has discovered that the laws of mechanics determine the outcome of coin tosses: The startling finding is they aren't random. Instead, for natural flips, the chance of a coin coming up on the same side as it started is about 51 percent. Heads facing up predicts heads; tails facing up predicts tails." Stingy Links: Funds High turnover could be a red flag "Perhaps most significantly, funds that trade a lot can be hard on investors' wallets. That's because a fund incurs transaction costs each time its manager buys or sells a stock. Not only do funds pay commissions to buy and sell, but they also incur so-called market-impact costs. Large funds rack up market-impact costs because it might take them a while to buy or sell securities; as they're doing so, they may ultimately obtain a less advantageous price than a smaller, more nimble fund would receive. Shareholders ultimately foot the bill for these costs through lower net returns." Stingy Links: Government Fifty ways to kill recovery "It's easy enough, of course, to mock state governments nowadays, what with California issuing I.O.U.s to pay its bills and New York's statehouse becoming the site of palace coups and senatorial sit-ins. But the real problem isn't the fecklessness of local politicians. It's the ordinary way in which state governments go about their business. Think about the $787-billion federal stimulus package. It's built on the idea that during serious economic downturns the government can use spending increases and tax cuts to counteract the effects of consumers who are cutting back on spending and businesses that are cutting back on investment. So fiscal policy at the national level is countercyclical: as the economy shrinks, government expands. At the state level, though, the opposite is happening." The next great bailout "In Washington these days, the only topics of discussion seem to be how many trillions to throw at health care and the recession, and whom on Wall Street to pillory next. But watch out. Lurking just below the surface is a bailout candidate that may soon emerge like the great white shark in Jaws: Social Security." Federal pay continues rapid ascent "In 2008, federal worker compensation averaged a remarkable $119,982, which was more than double the private sector average of $59,909." The hazard of moral hazard "When someone insures you against the consequences of a nasty event, oddly enough, he raises the incentives for you to behave in a way that will cause the event. So if your diamond ring is insured for $50,000, you are more likely to leave it out of the safe. Economists call this phenomenon 'moral hazard,' and if you look around, you will see it everywhere." But who is watching regulators? "Senior regulators who stood idly by for years as financial firms built their houses of cards have been rewarded with even bigger jobs or are jockeying for increased responsibilities. The Federal Reserve Board, for example, wants to become the financial system's uber-regulator, even though its officials did nothing as banks made deadly decisions to lend recklessly and leverage themselves to the max. Awarding increased power to those who failed in their oversight duties flies in the face of all notions of accountability." America's future "Plenty of American states have budget crises; but California's illustrate two more structural worries about the state. Back in its golden age in the 1950s and 1960s, it offered middle-class people, not just techy high-fliers, a shot at the American dream - complete with superb schools and universities, and an enviable physical infrastructure. These days California's unemployment rate is running at 11.5%, two points ahead of the national average. In such Californian cities as Fresno, Merced and El Centro, jobless rates are higher than in Detroit. Its roads and schools are crumbling. Every year, over 100,000 more Americans leave the state than enter it." Why we'll leave L.A. "If New Yorkers fantasize that doing business here in Los Angeles would be less of a headache, forget about it. This city is fast becoming a job-killing machine. It's no accident the unemployment rate is a frightening 11.4% and climbing." The great public-sector pension rip-off "There is a lot of debate about the right discount rate to use, but the conservative approach is to take the cost of government borrowing. Use that rate, and the liability of American state and municipal pension schemes may be $3 trillion - three times the value of all the authorities' existing debts. In Britain the liability adds up to 85% of GDP." Henry Paulson's longest night "In 2006, Goldman Sachs C.E.O. Henry Paulson reluctantly became Treasury secretary for an unpopular, lame-duck president. History will score his decisions, but the former Dartmouth offensive lineman definitely left everything on the field. In private conversations throughout his term, as crisis followed crisis.Bear Stearns, Fannie Mae and Freddie Mac, Lehman Brothers, A.I.G., and so forth.Paulson gave the author the inside track, from the political lunacy and bailout plans to the sleepless nights and flat-out fear, as he battled the greatest economic disruption in 80 years." Stingy Links: Grant From bear to bull "Though we can't see into the future, we can observe how people are preparing to meet it. Depleted inventories, bloated jobless rolls and rock-bottom interest rates suggest that people are preparing for to meet it from the inside of a bomb shelter." Grant's summer break "This compilation of recent articles, the first annual Grant's Beachhead issue, is for you." Stingy Links: Health The checklist "In December, 2006, the Keystone Initiative published its findings in a landmark article in The New England Journal of Medicine. Within the first three months of the project, the infection rate in Michigan's I.C.U.s decreased by sixty-six per cent. The typical I.C.U. - including the ones at Sinai-Grace Hospital - cut its quarterly infection rate to zero. Michigan's infection rates fell so low that its average I.C.U. outperformed ninety per cent of I.C.U.s nationwide. In the Keystone Initiative's first eighteen months, the hospitals saved an estimated hundred and seventy-five million dollars in costs and more than fifteen hundred lives. The successes have been sustained for almost four years - all because of a stupid little checklist." The dark side of prostate cancer screening "Studies rolling in now show a very small benefit, at best, from PSA tests. Earlier this year, a major European trial found that PSA tests only saved a few lives: 48 patients had to be diagnosed and treated to prevent one prostate cancer death over nine years. A big American study found that PSA tests didn't lower the prostate cancer death rate at all." American health care killed my father "After the needless death of his father, the author, a business executive, began a personal exploration of a health-care industry that for years has delivered poor service and irregular quality at astonishingly high cost. It is a system, he argues, that is not worth preserving in anything like its current form. And the health-care reform now being contemplated will not fix it. Here's a radical solution to an agonizing problem." Stingy Links: Indexing Leveraged ETFs "In fact, some of the common myths and criticisms surrounding double ETFs are based on a simple misunderstanding of their intended exposures. While some have expressed frustration about the lack of tracking of holding period returns, it's important to realize that tracking holding period returns risks losing more than 100% of the original capital. BetaPro's structure, which is rebalanced daily, is needed to limit losses to 100% in a double ETF and provide investors with non-recourse exposure. When measured against their intended daily exposures, BetaPro double ETFs have seen excellent tracking of their target benchmarks. Longer holding periods, however, have been observed with good tracking of index holding period returns. Volatility and a couple of other factors, however, will ultimately determine tracking of holding period returns." Gone for a Burton "Over the 20 years to end-December, 68% of all active US large cap funds underperformed the S&P 500 index (over 10 years, it was 64%). The underperformance, relative to Vanguard's S&P 500 index fund, was around 0.9% a year." Tax plan could cripple industry "Exchange-traded fund companies are warning higher taxes could wipe out the $25-billion industry, as cost-conscious investors take their money to the U.S and buy the same products for less." The three-dimensional portfolio "Here's a mind-blowingly simple answer to the basic but crucial question of how many securities are required for a properly diversified portfolio. Three. You read that right. If you're portfolio building with exchange-traded funds (ETFs), three are all you need for a lifetime of diversified investing." Stingy Links: Law Crops, ponds destroyed in quest for food safety "For many giant food retailers, the choice between a dead pond and a dead child is no choice at all. Industry has paid more than $100 million in court settlements and verdicts in spinach and lettuce lawsuits, a fraction of the lost sales involved. Galvanized by the spinach disaster, large growers instituted a quasi-governmental program of new protocols for growing greens safely, called the "leafy greens marketing agreement." A proposal was submitted last month in Washington to take these rules nationwide." Stingy Links: Management Ego and the CEO "Which is the biggest red flag for a potential accounting fraud: Bad corporate governance, an overinflated share price or too many stock options? None of the above, according to a new study by researchers from three Canadian universities. They argue that the biggest risk factor for fraud is a CEO with a truly oversized ego." Are management consultants necessary? "Most people in the business world know there's a lot of phony expertise floating around. Most of it you can explain on anthropological rather than technical grounds: we have a very complex economy that requires management, and management needs legitimacy. It does this through credentials and so-called expertise, and creates a whole class of people who are accountable only to themselves. For me the problem is the idea there's a general field of management that applies across all different kinds of businesses. That's what I think is all baloney." Stingy Links: Markets Krugman wars with Ferguson over inflation "Henry Kissinger, who knows a bit about fights, both political and intellectual, once observed that the reason academic tussles were so vicious was 'because the stakes are so small'. And although that is true in one sense - it doesn't matter very much whether the professor from Princeton doesn't like his rival from Harvard - it is wrong in another. The stakes in this row are pretty high." The societal risk premium "Financial economists like to talk about the risk-free rate: basically, the time value of money sitting in a perfectly safe vehicle. From an historical perspective per se, the very use of the term is fascinating. After all, it implies a society that is strong and stable enough to support a risk-free investment. Living in what is likely the most secure political, social, and economic environment ever seen on the planet, we take the existence of a "risk-free investment" for granted. But this is not always the case." Free money! Honest "The financial world's attention may be on the high frequency trading programmes employed by numerous banks and hedge funds. But there is another story. Algorithmic trading, by eliminating the human touch, presents an uncomfortably tempting proposition to the retail investor. One area where this is clearly becoming evident is in the loosely regulated spot foreign exchange market. Scores and scores of products claiming to have the ability to make you money while you sleep, with no need for financial knowledge at all, are hitting the marketplace." The man who crashed the world "Is it really possible for one man to precipitate a global economic catastrophe? In the August 2009 issue of Vanity Fair, contributing editor Michael Lewis, one of the most insightful Wall Street critics writing today, investigates the central role of A.I.G.'s Financial Products division in the subprime-mortgage and financial crises that necessitated a $182.5 billion taxpayer bailout out the insurance behemoth." Rich Harvard, Poor Harvard "Only a year ago, Harvard had a $36.9 billion endowment, the largest in academia. Now that endowment has imploded, and the university faces the worst financial crisis in its 373-year history. Could the same lethal mix of uncurbed expansion, colossal debt, arrogance, and mismanagement that ravaged Wall Street bring down America's most famous university? And how much of the turmoil is the fault of former Harvard president Larry Summers, now a top economic adviser to President Obama? As students demonstrate, administrators impose Draconian cuts, and construction is halted on an over-ambitious $1.2 billion science complex, the author follows the finger-pointing." You can't handle the truth about stocks "Conventional financial planning has it all wrong, argues economist Zvi Bodie. If you need the high return of stocks to reach your goals, he says, then you can't afford to invest in them." GMO Q2 "A year is certainly a long time in markets, and so is a quarter. A year ago, equities globally - and everything else for that matter - were very overpriced, particularly if they were risky. A quarter ago, in mid March, prices everywhere were cheap. Now they have all - or almost all - converged for a few unusual moments at fair value. A year ago, it was very easy to know what to be: a risk avoider. It was not so easy reinvesting when terrifi ed, but most of us knew that we should have been doing more. But today? It's diffi cult to be inspired at fair value." Theory of games and economic misbehavior ""I refuse to accept however, the stupidity of the Stock Exchange boys, as an explanation of the trend of stocks," wrote John von Neumann to Stanislaw Ulam, on December 9, 1939. "Those boys are stupid alright, but there must be an explanation of what happens, which makes no use of this fact."" Computer trading is good competition "Stock specialists who consolidate retail orders to buy and sell have been ripping off customers since trading began. The first head of the SEC was Joe Kennedy, who was a master stock manipulator in the 1920's. He was a master of the stock pool (bucket shop), a then-legal stunt in which a few traders conspired to inflate a stock's price, selling out just before the bubble burst." Spending on food reaches historical low "In the entire history of the U.S., it's only been in the last eight years that the percent of income spent on food for Americans was in single digits - since 2000 it's been below 10%. In all previous years, spending on food was in double-digits, and in most years from 1929 to 1952 it was above 20%. Consider that in 1932, spending on food at home took almost 22% of disposable income, compared to the record low of only 5.6% in 2008. Food has never been more affordable than today, as a share of income." Total liabilities "Spotting a doomed bank, it seems, may only be possible once it is going to hell. Yet there was a common ingredient in most failures: an over-reliance on wholesale borrowing." Is the equity risk premium 0? "One of the most important constants in finance is the Equity Risk premium, that expected return on the signature risk asset, equities, over the risk free alternative (usually, long-term Treasuries). It's the one risk premium that is generally considered positive, too large even, which is a relief because in most areas the returns are decidedly negative for taking more risk. Estimates in the early 1990s were about 8%, now, around 3% annually." Flaw in markets: humans "Memories are short. Immediately after a severe flood, most people are reluctant to build on a flood plain. But land on flood plains is cheaper, and the prospect of short-term advantage quickly lures many to abandon their caution. That is why many jurisdictions adopt strict regulations against building on flood plains. The same logic dictates regulation to limit the damage caused by financial bubbles. The list of financial practices that merit regulatory scrutiny is long. But the most important first step is to limit leverage." Views on the economic crisis "I do not believe that deflation would be a problem with the stimulus in place, and if necessary, there will be more stimulus put in place. The current stimulus is enough so that the economy will stabilize and start recovering. Some people say stocks are not as cheap as they were in 1974 and 1982, which is admittedly true, but at the same time, there is much less competition today from cash and treasury bonds than there was then. If I owned treasury notes or bond, I wouldn't sleep too well at night. To some extent they are an accident waiting to happen." Does stock-market data really go back 200 years? "What, then, are the odds that stocks will continue to lag behind bonds for the long run? The sad truth is that history can't tell us the answer. The 1802-to-1870 stock indexes are rotten with methodological flaws. So we have only the period since then, or four distinct and complete 30-year stretches of stock returns, to base our long-term investment decisions on." Stingy Links: Montier Edwards and Montier ride again "However, we are less convinced that AMH is a terribly useful concept. As we understand it, the AMH provides a halfway house where sometimes markets are irrational and sometimes they are rational. We would argue that the amount of time that markets are rational is near negligible." Stingy Links: Real Estate New evidence on the foreclosure crisis "What is really behind the mushrooming rate of mortgage foreclosures since 2007? The evidence from a huge national database containing millions of individual loans strongly suggests that the single most important factor is whether the homeowner has negative equity in a house -- that is, the balance of the mortgage is greater than the value of the house. This means that most government policies being discussed to remedy woes in the housing market are misdirected." Tax appeals take rising toll on governments "Homeowners across the country are challenging their property tax bills in droves as the value of their homes drop, threatening local governments with another big drain on their budgets." Mortgages made simpler "In the past year, we have learned the hard way that when people take out mortgages they cannot repay, the entire economy can be disrupted. Fixing the problem is complicated. But a good first step is to make the mortgage lending process Homer-proof." Stingy Links: Retirement The looming retirement crisis "Wilful neglect leading to inevitable disaster is quietly cascading across Canada's entire retirement savings system. Many haven't made sufficient provision, and a bailout seems neither feasible nor likely." Stingy Links: Shiller Bob Shiller didn't kill the housing market "Two years into the housing bust, Shiller finally sees some faint rays of sunshine (that's just light, not green shoots yet). When the June Case-Shiller figures were released, he said they showed "striking improvement in the rate of decline." Asked to look ahead, he says, "My guess is that prices will continue to fall for a while, but at a slower pace, and then stabilize. We've become very speculative in our attitude toward real estate, so there could be another boom. But if so, it likely won't happen for another five to 10 years."" Stingy Links: Stocks Amazon's troubling reach "Last week, in a stunning display of public irony, Amazon.com remotely deleted digital copies of George Orwell's novels "1984" and "Animal Farm" from customers' Kindles after learning that the electronic publisher of these works, MobileReference, did not have the rights to them. For a couple of days, observers in print and on the Web outdid themselves, noting that in "1984," government censors rewrite history by consigning offending news items to an incinerator chute known as the memory hole. Orwell's technological vision might have been primitive, but he seems to have predicted something fundamental about the dangers of information systems." Toxic loans topping 5% "More than 150 publicly traded U.S. lenders own nonperforming loans that equal 5 percent or more of their holdings, a level that former regulators say can wipe out a bank.s equity and threaten its survival." Stingy Links: Taleb Betting on black swans "Hope is a good thing, and motivates a lot of hard work and creativity. But it would be foolish to think that the more improbable, the more speculative, the more derided by economists, the better the risk-adjusted return merely because of this. This tendency to buy into lottery ticket leads to all sorts of really bad investments" Stingy Links: Taxes A surtax on the top 1% "It seems almost certain at this point that whatever health reform legislation is ultimately enacted by Congress, its principal funding will come from a surtax on the top 1% or so of taxpayers. This is a very bad idea for reasons that have little to do with the economic effects of taxation." Farewell America "Our bank is in the process of recommending our clients to exit from all direct investments in US securities. This, on the grounds of the threat of inheritance tax coupled with the uncertainty as to whether one might not, one way or another, be turned into a US person." When work doesn't pay "Middle-class folks are finding that a raise or second paycheck doesn't always mean living better. Time to work less?" Marriage is a costly luxury "The working poor, by contrast, are in a highly undesirable position when it comes to marital status and taxes. It literally doesn't pay for working poor parents to marry. Instead, it costs them precious money in the form of lost tax credits. We researched the tax consequences in 2008 for two working poor individuals and their dependents and made some significant (some would say startling) discoveries." The small business surtax "Jason Furman owes an apology to Michael Boskin, the Stanford economist who wrote a year ago on these pages that Barack Obama would raise American income tax rates nearly to 60%. Mr. Furman, then in the Obama campaign and now at the White House, claimed this was wrong and that Democrats would merely raise taxes back to their Clinton-era level. House Democrats are now proving that Mr. Boskin had it right, and before it's over even he may have underestimated how high taxes will go." Stingy Links: Thrift Spend now, pay later "With noble intentions, much of what was advocated and popularized by the Woodstock generation involved an increased role for government in the economy. They argued that 'smart people' in the government would 'manage' the economy and 'protect' people from themselves. Government would run 'temporary' deficits and 'create' jobs. It was argued that society's prosperity needed to be shared through government-administered programs, regulations and taxes." Stingy Links: Value Investing Jean-Marie Eveillard interview "I'm old enough to remember when banking was a fairly simple, almost utility-type business, where the bank took deposits and made loans to the local businessman, to individuals, etc. And it was not a highly profitable business, and bank stocks sold cheaply, at book or slightly above or below book. They were looked at, I think, by most investors, a little bit like electric utility stocks, whereby you got a decent yield, there was not much growth, and the profitability was not great, but they were looked at as safe investments for widows and orphans. And then, as time went by, and I think beginning with a gentleman who used to run Citibank in 1970, when he said, "We're gonna grow our earnings per share 15% a year forever." Banks became something different in the past 10 years or more. They became disguised hedge funds because of the importance of proprietary trading, and for other reasons as well." Stingy Links: World The man who saved billions "Norman Borlaug, the man who saved more human lives than anyone else in history, has died at age 95. Borlaug was the Father of the Green Revolution, the dramatic improvement in agricultural productivity that swept the globe in the 1960s. For spearheading this achievement, he was awarded the Nobel Peace Prize in 1970." Think again: Asia's rise "Don't believe the hype about the decline of America and the dawn of a new Asian age. It will be many decades before China, India, and the rest of the region take over the world, if they ever do." Why Japan isn't rising "Japan's rise literally from rubble into an industrial powerhouse is one of the greatest economic stories of the 20th century. But a slow response to the bursting real-estate and stock bubbles of the 1980s consigned the country to a decade of economic slumber from which it has yet to fully awake." The ghost fleet of the recession "The biggest and most secretive gathering of ships in maritime history lies at anchor east of Singapore. Never before photographed, it is bigger than the U.S. and British navies combined but has no crew, no cargo and no destination - and is why your Christmas stocking may be on the light side this year." 'Peak oil' is a waste of energy "A careful examination of the facts shows that most arguments about peak oil are based on anecdotal information, vague references and ignorance of how the oil industry goes about finding fields and extracting petroleum. And this has been demonstrated over and over again" Peak oil as a behavioral problem "Reaching a peak in worldwide oil production has been largely discussed as a geological, economic, and political event. Missing from much of this discussion are behavioral aspects of peak oil. In the present paper I examine peak oil as a behavioral problem. At the outset the nature of peak oil is discussed, followed by a review of the projected date of the peak and the social and economic consequences of reaching a peak. Behavioral aspects of peak oil are then discussed, especially the challenges involved in responding effectively to a projected peak-oil future." The rule of law and the wealth of nations "Private factors thus provide the four elements of talent, capital, matchmaking, and accountability, and government sets these four basic rules for entry into and exit from certain activities, rights of investors, and the provision of a risk-free asset, the latter anchoring prices and negotiations." The growth illusion "When investors pick the countries they want to back, they tend to be guided by economic growth prospects. The faster an economy grows, they reason, the faster corporate profits will grow in the country concerned, and thus the higher the returns investors will achieve. Alas, this is not the case." Our big chance "For Canada, a country that has spent the better part of 20 years nervously wringing its hands over its perceived inadequacies, the dramatic reversal over the past year has been striking. Our banks were once seen as lacking innovation; now world leaders hail the boring Big Five as being among some of the safest and most profitable banks in the world. We fretted that our economy was overly reliant on commodities; now our rocks, oil and gas are seen as a natural hedge against havoc in the manufacturing sector. We worried that Canada's strict mortgage rules were a drag on our housing market; now we can brag that we don't put people into homes they can't afford. Almost any way you look at it, Canada is uniquely positioned. So as other developed nations struggle, the question is: will we squander this once-in-a-generation opportunity or take advantage of our good fortune to punch above our weight?" Cruel windfall "In modern economic thinking, peace and prosperity go hand in hand. However, there are good reasons why in pre-modern societies, the opposite relationship held true - war, disease, and urban death spelled high incomes. This column explains why Europe's rise to riches in the early modern period owed much to exceptionally bellicose international politics, urban overcrowding, and frequent epidemics." Fiscal ruin of the Western world beckons "No doubt Ireland has been the victim of a savagely tight monetary policy - given its specific needs. But the deeper truth is that Britain, Spain, France, Germany, Italy, the US, and Japan are in varying states of fiscal ruin, and those tipping into demographic decline (unlike young Ireland) have an underlying cancer that is even more deadly. The West cannot support its gold-plated state structures from an aging workforce and depleted tax base." It's still the one "Oil's very future is now being seriously questioned, debated, and challenged. The author of an acclaimed history explains why, just as we need more oil than ever, it is changing faster than we can keep up with." Frugally Yours, Norman Rothery ISSN 1499-2787 | ||||
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