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The Stingy News Quarterly (Q4/2007)
New @ StingyInvestor Is your index too active? "Index funds are increasingly popular with savvy investors seeking low-cost diversified portfolios. As an added bonus, they often outperform many mutual funds. Indeed, Warren Buffett said in his 1993 annual letter to shareholders, 'By periodically investing in an index fund, for example, the know-nothing investor can actually out-perform most investment professionals.' But there is an astonishingly easy way to beat the index at its own game. It turns out that indexes are too active. That is, they tend to buy and sell stocks too frequently which puts a damper on their performance." Graham's Simple Way "Warren Buffett's insurance company GEICO is currently running a series of humorous ads featuring the line, 'So easy even a caveman can do it'. In a curious twist of fate, Buffett's mentor Benjamin Graham developed a way to pick stocks that even cavemen would appreciate. Graham described his Simple Way in a 1976 article called The Simplest Way to Select Bargain Stocks that can be found in Janet Lowe's book The Rediscovered Benjamin Graham. Given its recent success, these days stock-picking cavemen are dining out on mammoth steak." So simple it works "Value investing is so easy that your grandfather can do it - that is, if he follows the advice of Ben Graham, the grandfather of value investing. Back in 1976, Graham, a Wall Street financier and Columbia University professor, developed what he called The Simplest Way to Select Bargain Stocks. Investors who followed his approach have been riding the gravy train ever since." The Top 500 U.S. Stocks for 2008 "Some extraordinary qualities are needed to make our list of top stocks. On the value front, all our chosen stocks pay a dividend and sell for modest price-to-sales and price-to-book-value ratios. On the growth side, they demonstrate strong increases in sales per share and earnings per share. In addition, most generate healthy returns on equity, carry relatively little debt, and enjoy rising share prices. Keep in mind, though, that these stocks are controversial. After all, strong growth is rarely to be had at rock-bottom prices without some risk." The Best of Stingy Links Stingy Links: Behaviour A short course in thinking about thinking "And some fifteen years ago or so, I started studying whether people remembered correctly what had happened to them. It turned out that they don't. And I also began to study whether people can predict how well they will enjoy what will happen to them in future. I used to call that "predictive utility", but Dan Gilbert has given it a much better name; he calls it "affective forecasting". This predicts what your emotional reactions will be. It turns out people don't do that very well, either." Of blind squirrels and flying pigs "The dollar is collapsing and global investors are dumping dollars so it will continue to fall. That in turn will lead to higher inflation and then the Fed will have to raise interest rates. Oil is closing in on $100 a barrel. We have the worst housing market since the Great Depression. There is a financial crisis caused by the subprime mortgage debacle. Banks are tightening credit standards. And if you needed more reasons to believe the stock market was headed south you could always throw in global warming. Given all of these obvious reasons to be bearish about stocks, what should investors do? The answer is nothing, except to adhere to their well-thought-out plans. There are many reasons for ignoring even what seems to be obviously bearish information. Let.s see why this is the case." From ants to people, an instinct to swarm "By studying army ants - as well as birds, fish, locusts and other swarming animals - Dr. Couzin and his colleagues are starting to discover simple rules that allow swarms to work so well. Those rules allow thousands of relatively simple animals to form a collective brain able to make decisions and move like a single organism. Deciphering those rules is a big challenge, however, because the behavior of swarms emerges unpredictably from the actions of thousands or millions of individuals." Are you really such a daredevil? "The point is to position your portfolio in a way that makes it less likely that your emotions will get the better of you in a sharp downturn, and to do so while giving up as little as possible of the long-term gains that stocks offer. There are several sensible ways to do that." Stingy Links: Bonds Junk mortgages under the microscope "It's getting hard to wrap your brain around subprime mortgages, Wall Street's fancy name for junk home loans. There's so much subprime stuff floating around - more than $1.5 trillion of loans, maybe $200 billion of losses, thousands of families facing foreclosure, umpteen politicians yapping - that it's like the federal budget: It's just too big to be understandable. So let's reduce this macro story to human scale. Meet GSAMP Trust 2006-S3, a $494 million drop in the junk-mortgage bucket, part of the more than half-a-trillion dollars of mortgage-backed securities issued last year. We found this issue by asking mortgage mavens to pick the worst deal they knew of that had been floated by a top-tier firm - and this one's pretty bad." Stingy Links: Brokers Qtrade wins again "Investors have the online brokerage business right where they want it. To start with, stock-trading commissions are plunging. After years of being stuck in the $24-to-$29 range, more and more brokers are charging just under $10 as long as your accounts have at least $50,000 to $100,000 in total assets. At the same time, these firms are giving clients more for their money with better tools for finding investments and managing their accounts." Stingy Links: Buffett Buying what Buffett buys on filings doubles S&P 500 "Buying whatever billionaire Warren Buffett bought, often months after his share purchases, delivered twice the return of the Standard & Poor's 500 Index during the past three decades. Investors would have earned an annual return of 24.6 percent by buying the same stocks as Buffett after he disclosed his holdings in regulatory filings, sometimes four months later, according to a soon-to-be-released study by Gerald Martin of American University in Washington and John Puthenpurackal of the University of Nevada, Las Vegas. The S&P 500 rose 12.8 percent a year in the same period." Imitation is the sincerest form of flattery "We analyze the performance of Berkshire Hathaway's equity portfolio and explore potential explanations for its superior performance. Contrary to popular belief we show Berkshire's investment style is best characterized as a large-cap growth. We examine whether Berkshire's investment performance is due to luck and find that beating the market in 28 out of 31 years places it in the 99.99 percentile; however, incorporating the magnitude by which Berkshire beats the market makes the ?luck? explanation unlikely even after taking into account ex-post selection bias. After adjusting for risk we find that Berkshire's performance cannot be explained by assuming high risk. From 1976 to 2006 Berkshire's stock portfolio beats the S&P 500 Index by 14.65%, the value-weighted index of all stocks by 10.91%, and the Fama and French characteristic portfolio by 8.56% per year. The market also appears to under-react to the news of a Berkshire stock investment since a hypothetical portfolio that mimics Berkshire's investments created the month after they are publicly disclosed earns positive abnormal returns of 14.26% per year. Overall, the Berkshire Hathaway triumvirates of Warren Buffett, Charles Munger, and Lou Simpson posses' investment skill consistent with a number of recent papers that argue investment skill is more prevalent than earlier papers suggest." Buffett wins the Pritzkers' prize "Marmon has improved its performance in recent years. The holding company, with more than 125 manufacturing and service businesses, hit a rough patch at the beginning of the decade as the economy softened. But in 2006, the company says revenue increased 24%, and now totals about $7 billion, while operating income surged 73%. (Because Marmon is privately held, it does not have to provide detailed financial statements to the public.) Marmon is owned by trusts for the benefit of the Pritzker family, which also developed the Hyatt Hotel chain. The Buffett deal is expected to close in the first quarter of 2008. Before the closing, Marmon will make a "substantial distribution of cash and certain assets to the selling shareholders," according to the statement." A Buffett investment that wasn't "Last week, it began to look as if CarMax, one of the pioneers of the used-car superstore, had become the next target. Legndary investor Warren Buffett was said to be buying in. Headlines like "Buffett buys major stake in CarMax" and "Buffett Buy Sends CarMax shares soaring" appeared. Copycat investors sent CarMax's stock price shooting up when the news broke on November 15. CarMax's stock jumped $1.62, up 7.5%. But the story as reported by many news outlets isn't accurate, because Buffett wasn't directly involved in the purchase. The stock was bought by GEICO, the auto insurer and a subsidiary of Buffett's company, Berkshire Hathway. There's a big difference, as I'll explain." Buffett testifies "Billionaire investor Warren E. Buffett sat in front of a video camera in Omaha, spelled his name for the record and minced no words as he testified for the government yesterday in its case against former Freddie Mac chief executive Leland C. Brendsel. Brendsel is accused of presiding over accounting manipulations and running Freddie Mac in a reckless manner. Buffett, one of the most successful and revered investors, sold a huge stake in the mortgage funding company before the manipulations came to light, and the government wanted him to explain why. Buffett said he was troubled in part by a Freddie Mac investment that had nothing to do with its business. "I follow the old dictum: There's never just one cockroach in the kitchen," Buffett said." Buffett predicts a long flight for loonie "At an invitation-only Toronto dinner Thursday for about 140 prominent investors, billionaire investor Warren Buffett said he expects the Canadian dollar to continue rising beyond the parity it recently reached with the U.S. dollar." Get buffed up "Convinced to attend university by his father, stock-broker-turned-congressman Howard Buffett, the young Buffett complained he knew more than his teachers. When he attended Columbia University's business graduate school (after being turned down by Harvard for being too young), he met Benjamin Graham, whose investment strategies would turn out to greatly influence Buffett's own business model. The prodigy was the only student to ever earn an A+ in one of Graham's classes." Interview with Warren Buffett "Nebraska's Warren Buffett is known as the Oracle of Omaha for the savvy stock market investments that have made him one the wealthiest people in the world. Through his holding company Berkshire Hathaway, Buffett, 77, has amassed a fortune investing in companies like Coca-Cola, famously shunning trendy, riskier bets like Internet and technology companies. His success has earned him a near cult-like following, evident each year at Berkshire's hugely popular Omaha shareholders' meeting, which Buffett once called Woodstock for Capitalists. But for all his riches, Buffett is equally well-known for his frugal and folksy ways, and lately for his philanthropy. In 2006 he said he would give away 85 per cent of his roughly $50-billion fortune, with the bulk going to the Bill & Melinda Gates Foundation in annual instalments that Buffett insists be distributed in the year they are received. His sister Doris is also involved in philanthopy and runs the Sunshine Lady Foundation, which often deals with personal entreaties for aid that Buffett receives." Video tour of Berkshire Hathaway "CNBC's Becky Quick traveled to Omaha, Nebraska recently to shoot additional material for her one-hour special focusing on Warren Buffett's whirlwind tour of Asia. While she was there, Buffett gave Becky an on-camera tour of the Berkshire Hathaway offices. He talked about some of the mementos he's collected and their personal significance to him, and to his investing style." Stingy Links: Christmas The Queen's 2007 Christmas message "The Queen used her 50th televised Christmas message Tuesday to urge people to spare a thought for the vulnerable and disadvantaged living on the edge of society." A Child's Christmas in Wales "Hear Dylan Thomas' recollection of the sounds and smells of a long-ago Christmas in the seaside town of his youth from the Harper Audio release "A Child's Christmas in Wales."" A Christmas Carol "I have endeavoured in this Ghostly little book, to raise the Ghost of an Idea, which shall not put my readers out of humour with themselves, with each other, with the season, or with me. May it haunt their houses pleasantly, and no one wish to lay it. Their faithful Friend and Servant, C. D." What I like about Scrooge "Here's what I like about Ebenezer Scrooge: His meager lodgings were dark because darkness is cheap, and barely heated because coal is not free. His dinner was gruel, which he prepared himself. Scrooge paid no man to wait on him. Scrooge has been called ungenerous. I say that's a bum rap. What could be more generous than keeping your lamps unlit and your plate unfilled, leaving more fuel for others to burn and more food for others to eat? Who is a more benevolent neighbor than the man who employs no servants, freeing them to wait on someone else?" The case for Ebeneezer "As I became older, I decided that Mr. Dickens had given Ebeneezer Scrooge an undeserved reputation for villainy, placing him in such company as Uriah Heep, Iago, Dr. Moriarty, or Snidely Whiplash, to name but a few. It is my purpose, in making this holiday defense of my client, to present to you a different interpretation of the story, that you will see the villainy not in my client's character, but in Charles Dickens' miscasting of the true heroes of the time of which he wrote, namely, the industrialists and financiers who created that most liberating epoch in human history: the industrial revolution." In defense of scrooge "It's Christmas again, time to celebrate the transformation of Ebenezer Scrooge. You know the ritual: boo the curmudgeon initially encountered in Charles Dickens's A Christmas Carol, then cheer the sweetie pie he becomes in the end. It's too bad no one notices that the curmudgeon had a point - quite a few points, in fact." Scrooge a man for our times "Christmastime is inevitably accompanied by allusions to Ebenezer Scrooge. As portrayed in Dickens' "A Christmas Carol," Ebenezer is a thoroughly disagreeable, curmudgeonly, miserly misanthrope. I sympathize. And not just because similar contentions are routinely made about me. Enough is enough. It's time to move on, as they say, from the conventional view of the man as "a squeezing, wrenching, grasping, scraping, clutching, covetous, old sinner! Hard and sharp as flint, from which no steel had ever struck out generous fire; secret, and self-contained, and solitary as an oyster." We as a society have come a long way in the 160 years since Dickens wrote his story. We're kinder and gentler and infinitely more accepting. Ebenezer would be perceived much differently today." Stingy Links: Crime Why white-collar crime team fizzled "Today when the enforcement team makes the news, it's usually because of its dismal track record. Instead of reaping glory, the vaunted police squad is becoming a public whipping boy in the debate about Canada's perceived tendency to let white-collar crime go unpunished." Why the OSC so rarely gets its man "Bruce McLaughlin took millions of dollars from the company he led to pay off personal debts. That was the conclusion of a court-appointed accounting firm that looked into suspicious transactions at Mississauga property developer Mascan Corp. The findings of the audit pressured the Ontario Securities Commission to take legal action on behalf of Mascan's minority shareholders. That was 23 years ago. The case is still on the OSC's books, listed on the commission's website under 'Current Proceedings.'" Canada's losing war against white-collar crime "The system is pretty much non-existent. You can fix something that is hemorrhaging, but if the body is already lifeless, you have to start fresh. We need politicians to admit that the system is broken from the top to the bottom. Canadians have to understand that we have a two-tiered justice system, where people with money can play the system. Show me a person who has gotten any sort of satisfaction from going to the authorities after being victimized by a white-collar fraud.who got their money back in a timely fashion and didn't go through a lot of grief. I can't think of a single person like that." Stingy Links: Debt A low, low interest rate of 396 percent "A payday loan is a small-dollar, short-term loan with fees that can add up to interest rates of almost 400 percent. They're generally taken out when the borrower is caught short on cash and promises to pay the balance back next payday. If it sounds like legal loan-sharking, it's not. "Loan sharks are actually cheaper," said Bill Faith, a leader of the Ohio Coalition for Responsible Lending. The industry portrays it as emergency cash, but critics say the business model depends on repeat borrowing where the original loans are rolled over again and again." Prisoners of debt "In a financial version of Night of the Living Dead, debts forgiven by bankruptcy courts are springing back to life to haunt consumers. Fueling these miniature horror stories is an unlikely market in which seemingly extinguished debts are avidly bought and sold." Borrowers face dubious charges "As record numbers of homeowners default on their mortgages, questionable practices among lenders are coming to light in bankruptcy courts, leading some legal specialists to contend that companies instigating foreclosures may be taking advantage of imperiled borrowers. Because there is little oversight of foreclosure practices and the fees that are charged, bankruptcy specialists fear that some consumers may be losing their homes unnecessarily or that mortgage servicers, who collect loan payments, are profiting from foreclosures." Stingy Links: Derivatives Anatomy of a panic "For three days in August, an obscure but massive investment class teetered on the brink of a meltdown, rescued only by the ingenuity of a small group of bankers and lawyers. The aftershocks have shaken the markets, destroyed reputations and frayed friendships" Stingy Links: Dividends The high dividend yield return advantage "There is an abundance of empirical evidence which suggests that portfolios consisting of higher dividend yielding securities produce returns that are attractive relative to lower yielding portfolios and to overall stock market returns over long measurement periods." Dividend index hides some dogs "We like dividends, particularly companies that raise their dividends regularly. For tax-efficient income and steady capital gains, it's hard to beat a basket of stocks that bump up their payouts every year. So, naturally, we were excited to hear that Standard & Poor's has launched a Canadian version of its "Dividend Aristocrats" index, with an exchange-traded fund expected to follow, possibly next year. Unfortunately, the more we learned about the index, the more glaring were its shortcomings." High-yield stocks for retirement "Ned Davis Research recently crunched the numbers for Money and found that a high-yielding portfolio launched at the worst time in the past 40 years - before the 1973-74 bear market - not only would have kept your income growing at the pace of inflation but would have increased in value eightfold (assuming an initial withdrawal rate of 4.5 percent). An S&P 500 portfolio, on the other hand, would have been used up by now. Over time, high-paying stocks also generate more income than government bonds. That's because while bond income is fixed, dividends aren't." Stingy Links: Dreman Seize the day "Thomas Jefferson once said that banks are more dangerous than standing armies. Certainly with Chairman Alan Greenspan at the helm of the Federal Reserve this was the case. Under his leadership the Fed was instrumental in creating two bubbles. The dot-com bubble of 1995--99 was followed by a grand loosening of credit that resulted in a second bubble, the housing mania of 2001--05. Still, when a bubble implodes there are always good opportunities for folks who have the courage to take risks. The credit crisis has been devastating to financial stocks. Banks, hedge funds and real estate investment trusts have incurred at least 800 publicly revealed writedowns of debt securities in the past year. Investors are running in fear from securities backed by, or in any way related to, mortgages or high-yield bonds. Both stocks and fixed-income securities have been knocked down to levels that are cheap even with worst-case assumptions about future defaults." Stingy Links: Fun The Long Johns: Subprime A fun introduction to Mr. Market. [video] The Long Johns: Meeting the adviser Northern Rock + Comedy = Priceless [video] Stingy Links: Funds The blow-up artist "On a wall opposite Victor Niederhoffer's desk is a large painting of the Essex, a Nantucket whaling ship that sank in the South Pacific in 1820, after being attacked by a giant sperm whale, and that later served as the inspiration for 'Moby-Dick'. The Essex's captain, George Pollard, Jr., survived, and persuaded his financial backers to give him another ship, but he sailed it for little more than a year before it foundered on a coral reef. Pollard was ruined, and he ended his days as a night watchman. The painting, which Niederhoffer, a sixty-three-year-old hedge-fund manager, acquired after losing all his clients' money - and a good deal of his own - in the Thai stock market crash of 1997, serves as an admonition against the incaution to which he, a notorious risktaker, is prone, and as a reminder of the precariousness of his success." Investor timing and fund distribution channels "We find that investors who transact through investment professionals using conventional distribution arrangements experience substantially poorer timing performance than investors who purchase pure no-load funds. Investors in all three principal load-carrying retail share classes (A, B, and C) significantly underperform a buy-and-hold strategy. Among all load funds, Class B investors suffer from the poorest cash flow timing, underperforming a buy-and-hold strategy by 2.28% annually, compared with annual underperformance of 0.78% for investors in pure no-load funds. No-load index funds are the only funds found to show no evidence of poor investor timing. Although investors are ultimately responsible for their own investment choices, these findings question the value being added by investment professionals who sell mutual fund shares through conventional distribution arrangements." Chasing performance hurts load fund investors "We find that investors who transact through investment professionals using conventional distribution arrangements experience substantially poorer timing performance than investors who purchase pure no-load funds. Investors in all three principal load-carrying retail share classes (A, B, and C) significantly underperform a buy-and-hold strategy. Among all load funds, Class B investors suffer from the poorest cash flow timing, underperforming a buy-and-hold strategy by 2.28 percentage points annually, compared with annual underperformance of 0.78 percentage points for investors in pure no-load funds. No-load index funds are the only funds found to show no evidence of poor investor timing." The code breaker "Simons, standing just under 5 feet 10 inches tall and weighing 185 pounds (84 kilograms), has trod an unlikely path. A former code cracker for the U.S. National Security Agency, in 1968 he became chairman of the mathematics department at Stony Brook University, part of the New York state university system. He built the department into what David Eisenbud, former director of the Mathematical Sciences Research Institute in Berkeley, California, calls one of the world's top centers for geometry. In 1977, frustrated with a math problem and eager for change, he abandoned academia to start what would become Renaissance, hiring professors, code breakers and statistically minded scientists and engineers who'd worked in astrophysics, language recognition theory and computer programming." Stingy Links: Graham My Hero, Benjamin Grossbaum "I am a frankly worshipful admirer of Graham's. I love him for his heart as much as for his head. Between 1929 and 1932, his investment partnership lost 70% of its value. Not until 1936 did it recoup all it relinquished since the Crash. Yet Graham persevered and, along with his partner, Jerry Newman, went on to achieve a brilliant long-term investment record - not excluding those three disastrous years. We have all heard the platitude, "The first rule of investing is not to lose money and the second rule is not to forget the first." Very helpful. Well, Graham shows that a debilitating loss is no reason to give up. . . . Never quit." Stingy Links: Grant Value's day once more "Is anyone happy? Well, value investors ought to be. To their way of thinking bear markets are heaven-sent. Of all people, the disciples of Benjamin Graham and David L. Dodd understand the investment appeal of everyday low prices. They like it when stocks and bonds go on sale. They are the Wal-Mart shoppers of Wall Street." Stingy Links: Gross What do they know? "Bernanke, however, may face a problem with this elevator-based ease in monetary policy. As I have pointed out in prior pages and Outlooks, globalization and financial innovation have enormously complicated the job of central bankers. Whereas in prior decades a "one size fits all" policy rate move has coincidentally and democratically affected households and corporations alike, the 21st century has ushered in an innovation revolution favoring corporations with global investment opportunities as opposed to individuals with daily bills to pay. The same 4.75% rate is not and cannot be "neutral" for both sides in today's U.S. economy. Whereas current yields are not restrictive for investment grade corporations with global opportunities, they are far too high for homeowner Jane Doe and two million of her neighbors facing higher and higher monthly payments on adjustable rate mortgages. Should Bernanke put on a brave face and freeze the elevator and rates in mid-descent, he risks exacerbating a housing crisis in the making. Yet, should he favor the homeowner over the corporation, he risks reigniting speculative equity market behavior, and - in addition - a run on the dollar." Beware our shadow banking system "The tangled web of subprimes has claimed more than its share of victims in recent months: homeowners by the hundreds of thousands, to be sure, but also those who created, packaged, insured, distributed, and ultimately bought what should have been labeled "junk mortgages" but which by a masterstroke of marketing genius received a more respectable imprimatur." Stingy Links: Growth Investing Luck, persistence, and what to do about it "Despite earnest and diligent study, analysts often produce company models that are wildly off the mark, usually erring on the side of optimism. Even analysts who consider ranges of value outcomes attach probabilities to favorable scenarios that are too high. Some researchers attribute this inaccuracy to overconfidence, but that is only part of the story. Another way to understand the challenge is based on what renowned psychologist Daniel Kahneman calls the inside-outside view. An inside view considers a problem by focusing on the specific task and the information at hand, and predicts based on that unique set of inputs. This is the approach analysts most often use in their modeling, and indeed is common for all forms of planning. In contrast, an outside view considers the problem as an instance in a broader reference class. Rather than seeing the problem as unique, the outside view asks if there are similar situations that can provide useful calibration for modeling. Kahneman notes this is a very unnatural way to think precisely because it forces analysts to set aside all of the cherished information they have unearthed about a company. This is why people use the outside view so rarely." Stingy Links: Indexing Why you're not a rational investor "We like to think we make investment decisions based on facts. But we often end up paying to express our beliefs, to acquire status, or to seem smarter than our peers." Stingy Links: Markets David Einhorn's Graham & Dodd breakfast speech "Without much fanfare the ratings agencies abandoned this practice of AAA meaning AAA and BBB meaning BBB. Instead for each type of bond, they use a different rating scale with different so-called 'idealized default rates' for each rating. The idealized default rate for a municipal bond at a given rating is less than the idealized default rate for a corporate bond, which is less than the idealized default rate for an asset backed security which is less than the idealized default rate for a CDO. As an example of the soundness in this system, Nomura securities pointed out that hypothetically, if you took a AA+ rated asset backed security and repackaged it all by itself and called the repackaged instrument a CDO, it becomes AAA, because the CDO has a higher idealized default rate than the asset backed security." The catastrophist view "Their bearish arguments come in many shapes and sizes, but here's the basic one: The past five or six years have been deceptively fortunate ones for the U.S. economy. That's because any troublesome developments - the surge in oil prices from $28 per barrel in 2003 to about $87 today, for example - have been papered over by rising home prices. Home equity has been used to buy flat-screen TVs, SUVs, and more homes. Wall Street bought up all this debt from lenders, thereby allowing them to lend more. The softening of real-estate prices in most parts of the United States put a crimp in this system, but it hasn't stopped it. The question is, what, if anything, will? What will bring on the apocalypse that Schiff and others believe is inevitable?" [Scary Halloween stories for adults] 1929 Redux: Heading for a crash? "Your predecessors on the Senate Banking Committee, in the celebrated Pecora Hearings of 1933 and 1934, laid the groundwork for the modern edifice of financial regulation. I suspect that they would be appalled at the parallels between the systemic risks of the 1920s and many of the modern practices that have been permitted to seep back in to our financial markets. Although the particulars are different, my reading of financial history suggests that the abuses and risks are all too similar and enduring. When you strip them down to their essence, they are variations on a few hardy perennials - excessive leveraging, misrepresentation, insider conflicts of interest, non-transparency, and the triumph of engineered euphoria over evidence." Credit crunch taking a toll, Bank of Canada says "The global credit crunch is taking a toll on Canadian banks' balance sheets, and has prompted lenders to curtail their credit, the Bank of Canada says. 'Canadian financial institutions are facing substantially increased funding needs,' the central bank said in its first full tally of the damage done by the recent financial turmoil. Canadian banks have been forced to hold high amounts of commercial paper of questionable value in their inventories, the central bank pointed out. Plus, corporate borrowers are calling on their banks to come through with funding arranged under pre-committed lines of credit, now that some market sources of funding are not as accessible. The Canadian banks are solvent enough to handle it, the central bank said, but they are reacting by tightening up credit conditions." After the money's gone "On Wednesday, the Federal Reserve announced plans to lend $40 billion to banks. By my count, it's the fourth high-profile attempt to rescue the financial system since things started falling apart about five months ago. Maybe this one will do the trick, but I wouldn't count on it. In past financial crises - the stock market crash of 1987, the aftermath of Russia's default in 1998 - the Fed has been able to wave its magic wand and make market turmoil disappear. But this time the magic isn't working. Why not? Because the problem with the markets isn't just a lack of liquidity - there's also a fundamental problem of solvency." Views on the Canadian dollar "Over the past year the Canadian dollar has appreciated from $0.85 to $1.02US or 20%. Admittedly, the Canadian dollar was undervalued at $0.70-$0.80 and at $0.85, in our opinion, it was fairly valued." The subprime in the schoolhouse "Nobody knows how much more pain is coming. State funds could lose hundreds of millions of dollars, says Lynn Turner, chief accountant of the U.S. Securities and Exchange Commission from 1998 to 2001. "If you're dealing with short-term money market funds, people expect those to have low risk and not be invested in these SIVs and other very high-risk instruments," Turner says. If public funds lose money, towns and local agencies could raise taxes, sell more debt or, more likely, trim budgets, Turner says. "Cutting spending usually means people losing jobs because someone else didn't do their job," he says." Stingy Links: Miller Bill Miller Q3 2007 "Where will the new leadership come from? The same place it usually does: the old laggards. I think the new leadership will be US, large-cap, dollar-based, and grow to encompass what no one wants to own today, especially financials and consumer. I also think so-called growth stocks will continue to do fine. When growth becomes scarcer and the discount rate becomes lower, growth becomes more valuable. More particularly, just as the right thing to do in 2002 was to buy what everyone was panicked about, I think the greatest gains over the next 5 years will be made in those securities people are panicked about today. For specific names, consult the 52-week new low list." Stingy Links: Montier The sources of value "The results of this further decomposition are shown in the chart below again for the period 1963-2006. The picture reveals show huge differences between value and growth stocks. Value stocks see hardly any growth in book value - not hugely surprising, they don't tend to invest large sums, in general they are more interested in cost cutting than investment. However, their is a very strong tendancy for convergence in price to book terms - that is to say their valuation rebound - although the decomposition is silent on whether this is the result of a bounce back in profitability or not. The same can not be said of growth stocks. They see an enormous amount of growth in book value - as they engage in large cap ex and M&A. However, they convergence is negative, they witness declines in price to book as their profitability erodes and valuations return to 'normal' levels." Stingy Links: Real Estate Home prices post record decline "Home prices fell 6.7 percent in October, compared with a year ago, according to the S&P/Case-Shiller 10-city home-price index. It was the largest drop recorded since the index began in 1987. It marked the 10th consecutive month of price depreciation and 23 months of decelerating returns. "No matter how you look at these data, it is obvious that the current state of the single-family housing market remains grim," said Robert J. Shiller, chief economist at MacroMarkets, in a statement. Case-Shiller's 20-city index fell 6.1 percent. Shiller noted that 11 of the markets in the 20-city index posted a record fall." For sale: 2 million empty homes "The number of vacant homes for sale rose in the third quarter, according to the latest government reading that casts new harsh light on the weakness of the housing market. The Census Bureau report puts the number of vacant homes for sale at 2.07 million in the period, up about 2 percent from the second quarter, and 7 percent above year ago levels." Pain Street USA: '08 housing outlook "The United States is deep in its worst housing slump since the Great Depression, and according to a new report, it's not going to get better any time soon. In a new survey, Moody's Economy.com says many metro areas will record losses of 20 percent or more during the downturn, with the national median price for single-family homes dropping 13 percent through early 2009. Factoring in discount offers from sellers, the actual price decline would be well over 15 percent. 80 of the 381 metro areas covered by the report will record double-digit losses, according to the report. Most of the worst-hit markets are in once high-flying areas such as California and Florida." Housing: that sinking feeling "For the first time, big builders are offering massive, often six-figure, price cuts in overbuilt developments nationwide, giving the industry a kind of shock treatment designed to move inventory off the books fast. It remains to be seen whether these radical measures will revive the market or deepen the slump, but it's certainly having an impact on the local communities." Lining up to invest? I'm inclined to look the other way "It is here that memories of gold buyers lining up before Deak Pereira in 1980 keep running through my mind, and bring up the nagging thought: Can this be the top of the million-dollar-condo bubble? It is, of course, possible that it's not, and that a four-room (as yet unbuilt) Toronto condo would be worth $10-million - maybe more - very soon, just as it was possible that an ounce of 1980 gold would be worth north of $800 soon after. But just as the gold of 1980 revisited its price only 27 years later, those lining up to buy downtown Toronto condos today may also find they must wait several years - perhaps many - before they get their money back." Stingy Links: Stocks A beautiful mind "If you believe that thinkers never accomplish much in the real world, you should meet Rob Morrison. He's a quiet, analytical man who started out as a competitive chess player before becoming fascinated by the world of money. Over the past 25 years, while working from his computer in his comfortable Toronto home, he has thought long and hard about how to invest well. By putting his ideas into practice, he has grown his personal portfolio from a few hundred thousand dollars to more than $10 million." Ever more fleeting? "There are still way too many analysts who expect too many companies to generate annual long-term earnings growth of 20% to 25% or more. Analysts pay too little attention to how easily such a rapid rate of growth can fade after just a few years. Research departments aren't shy about putting out lists of companies they expect to generate annual earnings increases of 15% or more for at least five years. One value of Leuthold's work is the reminder it provides that such high sustained earnings growth is truly rare." Citigroup: 'Gimme shelter' "This may sound silly, but let me ask you a question. Let's say that I maxed out my credit at Citigroup to speculate on a house whose market price is now less than what I paid. Citi wants its money, but instead I say, "Sorry, the house is selling for less than its true value. As soon as it sells for what it should, I'll send you a check." What do you think Citi's reaction would be? How about "Sir, where should I send the repo man?" Well, folks, Citi seems to have put itself in just such a fix by borrowing lots of money to buy assets that have dropped in market value. But instead of summoning the repo (as in repossession) man, some of the world's biggest hitters are trying to set up a huge fund to buy time for Citi and some other institutions with similar problems. " Freddie and Fannie's Achilles' heel "Mortgage giants Freddie Mac and Fannie Mae need capital - in today's credit crisis, there's no doubt about that. Freddie even said last week that it was "seriously considering" cutting its $2 annual dividend by half, a radical step indicating how strapped the company is. Freddie also reported it had hired two Wall Street firms to explore "capital-raising alternatives." And Freddie and Fannie are going to need some especially creative alternatives. Why? When either Freddie or Fannie attempt to build capital, they are handicapped by a peculiarity that very few investors know about: They cannot sell the most popular kind of preferred stock, the "cumulative" variety, because their regulator will not let these securities count toward capital." Bear Stearns' bad bet "The revelations shed new light on the murky dealings inside the booming $1.3 trillion hedge fund industry, which now accounts for up to a third of all daily trading on Wall Street. They seem to underscore critics' biggest complaint: that many hedge funds use astonishing amounts of leverage, or borrowed money, in sometimes reckless ways. The risks of "fair value" accounting, the practice that allows money managers to estimate the values of securities for which they can't find true market prices, are thrown into sharper focus as well. Coming soon, for better or worse: louder calls in Washington for more oversight of the largely unregulated hedge fund industry." Stingy Links: Taxes Fifteen ways to reduce your 2007 taxes "Fall is always a good time to take stock of one's tax situation. As several weeks remain before the end of the year, now is the time to review your 2007 transactions and make any necessary adjustments. Tax planning is always an issue, whether you work, are retired, operate a business directly or operate a business through a corporation. Here are fifteen ways, among others, to save on taxes for 2007." Tax reductions for Canadians "The goods and services tax (GST) will be reduced by a further 1 percentage point as of January 1, 2008, fulfilling the Government's commitment to reduce the GST to 5 per cent. The lowest personal income tax rate will be reduced to 15 per cent from 15.5 per cent, effective January 1, 2007. The amount that all Canadians can earn without paying federal income tax will be increased to $9,600 for 2007 and 2008, and to $10,100 for 2009." The many benefits of monetizing "But the story could help you to: lock-in accrued gains on an investment; defer tax on those accrued capital gains; create liquidity; diversify your portfolio; create a tax deduction for interest costs, and avoid margin calls on money borrowed to invest. These benefits could leave you laughing after all - all the way to the bank." Deductions failed the smell test "What about your tax planning? Does it pass the smell test? There are some court decisions where taxpayers have escaped the long arm of the Canada Revenue Agency by getting away with deducting certain costs, or gaining some other tax benefit, and I just conclude they got lucky. There are other cases where the taxpayer has lost the battle, and it comes as a surprise to no one. Here's a court decision that offers some valuable lessons in claiming tax deductions." A strategy to keep your prized stocks "William's advisers suggested that he consider an equity monetization strategy. Now, there are different strategies we could talk about. Today, let me share what is probably the most common." The skinny on pension splitting "Take the announcement last year about pension income splitting. Canadian taxpayers have had many questions about how this is going to work. The Canada Revenue Agency issued an announcement on July 18 that answered some of the more common questions. Let me share some highlights." Stingy Links: Thrift Is marriage a dumb move? "The decision to wed or not, of course, is between you, your intended and your conscience. But you should realize that from a coldhearted financial perspective, the U.S. tax code and Social Security rules don't necessarily come down in favor of marriage for people with a substantial amount of assets." Life and debt in suburbia "Assessing how the neighbors are doing financially and what that means about how we are doing is practically a national pastime. The guessing game starts off as harmless pillow talk and community pool chatter, an outgrowth of natural curiosity. Just how much money must Susie and Bob have to be able to afford that new kitchen, three cars and a family safari? Then too, every homeowner has a vested interest in the financial well-being of his or her neighbors. Homeowner associations have long understood that nothing raises the value of a home more than an expanse of trim lawn and well-kept homes on either side. But the finances of those around you affect more than just the perceived value of your property. They also, like it or not, help shape how much you spend and save and color your perceptions of your own financial well-being." Stingy Links: Value Investing The prince of value "If there's such a thing as an aristocracy of American investing, Christopher Browne is a full member. He's one of five managing directors of Tweedy Browne, a firm co-founded by his father, who brokered stock trades for Benjamin Graham, the creator of modern securities analysis. Later, when Graham's most illustrious pupil, Warren Buffett, wanted to take a controlling interest in a then sleepy textile company called Berkshire Hathaway, Tweedy Browne bought the stock. Given this lineage, it's hardly a surprise that Browne would become a spokesman for Graham's and Buffett's investing philosophy." 2007 Chou Lecture "Mr. Chou has operated two of the country's most successful funds, Chou Associates Fund and Chou RRSP fund, for the last 18 years." Patient Capital Management's Q3 2007 letter "Which asset class has performed better since PCM's inception in March of 2000; T-Bills or the S & P 500? T-Bills have outperformed the S & P 500 during the March 31, 2000 to September 30, 2007 period. The S&P 500 has generated a compound annual rate of return of only 1.92% compared to an average yield of 3.18% for T-Bills over the same period. This fact may be a surprise to many because of the strongly ingrained belief that equities always outperform fixed income instruments." He has never been more bearish "Mr. Watsa never lost his image as a skilled investor. Hamblin Watsa Investment Counsel, Fairfax's internal money management firm, earned 17.7 per cent returns, compounded annually, on its stock investments between 1997 and 2006. "If they can make 7 per cent [on the whole portfolio, including bonds], the earnings power is ridiculous," said Wade Burton, a portfolio manager at Mackenzie Financial Corp.'s Cundill Investment unit, which is one of Fairfax's largest shareholders. "They're in a really good place right now." Mr. Watsa suggested the decision to put 75 to 80 per cent of Fairfax's portfolio into government debt - "for the first time, I think, ever" - reflects his view that credit markets will take a long time to digest the problems in the U.S. real estate and mortgage business." A seasoned pro scoops up mortgage stocks "As mortgage insurance stocks have gone into freefall over the past month, speculation has been intense about whether a deep-pocketed investor would step in and start buying, in the belief that the stock prices had fallen too far. Old Republic International, a sleepy Chicago-based insurance company led for the last 17 years by Aldo Zucaro, has made that bet." Accounting for leverage "The B/P ratio can be decomposed into an enterprise book-to-price (that pertains to operations and potentially reflects operating risk) and a leverage component (that reflects financing risk). The empirical analysis shows that the enterprise book-to-price ratio is positively related to subsequent stock returns but, conditional upon the enterprise book-toprice, the leverage component of B/P is negatively associated with future stock returns." Stingy Links: Whitman 3 bargain stocks ""Safe and cheap" makes for a comforting mantra. Rather than timidity, though, Whitman's approach actually calls for remarkable fortitude. It requires the nerve to pick through distressed companies that others are ignoring and demands the conviction to see big gains come to fruition." Marty Whitman's big bets Whitman interview on CNBC. RDN, MTG, MBI, and ABK. Now that's distressed investing! Stingy Links: World Global warming delusions "Instead, like fashions that took hold in the past and are eloquently analyzed in the classic 19th century book "Extraordinary Popular Delusions and the Madness of Crowds," the popular imagination today appears to have been captured by beliefs that have little scientific basis. Some colleagues who share some of my doubts argue that the only way to get our society to change is to frighten people with the possibility of a catastrophe, and that therefore it is all right and even necessary for scientists to exaggerate. They tell me that my belief in open and honest assessment is nave. "Wolves deceive their prey, don't they?" one said to me recently. Therefore, biologically, he said, we are justified in exaggerating to get society to change." Shanghaied "The U.S. used to have absurdities like this--companies in effect declaring a profit from the rise in their own share prices. In the 1920s, that is. Fast-forward to Shanghai and the roaring 2000s. In two years the Shanghai Composite Index has quintupled and the Shenzhen Component Index has more than sextupled. Now China's combined market of 1,500 companies with A shares (the primary kind available on the mainland) is trading at 40 times earnings. Chinese companies' shares also have soared in Hong Kong and abroad, but not to the same degree. Circular ownership--with the potential for a pair of companies to prop up each other's share price and earnings--is not at all uncommon. "They actually support each other and increase the stock price. More and more companies are like this, particularly the big companies," says Xu Xianghua, a branch manager for First Capital Securities in Beijing." Stingy Links: Zweig How to lose $9 trillion in a bull market "Based on decades of data from 19 countries, Dichev thinks that the average investor incurs a "timing penalty" of 1.5 percentage points a year by buying high and selling low. Impatience will cost you dearly." Frugally Yours, Norman Rothery ISSN 1499-2787 | ||||
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