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The Rothery Report

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The Stingy News Quarterly (Q2/2008)

New @ StingyInvestor

Unbundling Canadian ETFs 2008
"It is easy to get a simple, low fee, and broadly diversified portfolio with ETFs. Most investors can safely stop here. But perhaps I can entice you to read on about a few specialized situations. When it comes to ETFs I like to consider two options for long-term investors. The first option is to purchase the ETF and hold on. The second option is to bypass the ETF and buy the stocks that it owns. At first glance, the choice between buying a low-cost exchange-traded fund that holds many stocks or buying each individual stock appears to be obvious. The exchange-traded fund is likely to be the better bargain. However, buying stocks directly may be a good choice for some investors because the Canadian stock market is very small and it is dominated by a few big names. By holding only a few stocks you can reasonably approximate, or even fully replicate, some ETFs."

How $10 trades change everything
"In the latest Wealthy Boomer video interview -- which went up today -- Norman Rothery of The Rothery Report comes to an interesting conclusion about online trading and $10 commissions (or $9.95, which amounts to the same thing.) With a full-service brokerage, exchange-traded funds (ETFs) are a convenient way to get access to multiple stocks with a single trade. But once you move from commissions in the multiple hundreds of dollars to $10 a trade, suddenly it becomes cost-effective for individual investors to buy each component stock in an index, or cherry-pick the better ones."

Value investors: Beware the value trap
"Norm Rothery, chief investment strategist at Windsor, Ont.-based investment research and counselling firm Dan Hallett & Associates Inc., recommends investors avoid value traps by using a nine-point system developed by Joseph Piotroski, professor of accounting at Stanford University. According to his system, returns on assets and cash flow from operations should be positive. Also, there should be momentum in fundamentals: For example, gross margins and debt should be changing for the better. Still, it's inevitable even the best of the value practitioners will stumble into value traps on occasion."

Find the right broker for you
"Your next stop is the Stingy Investor website. (Go to and search for Canadian discount brokers). It's run by Norm Rothery, chief investment strategist at Dan Hallett & Associates Inc. Here you can find up-to-date comparisons of the fees and commissions charged by 15 Canadian online brokerages (as well as phone numbers and email addresses). What you pay usually depends on how many trades you make per quarter or year, how many shares you buy at a time and how many dollars you have in assets at the firm."

The Best Stingy Links

Stingy Links: Academia

Long-term performance following rights issues
"This study finds evidence of significant long-term underperformance following rights issues made during 1986-95 in the UK. The findings are resilient to a number of methodological controls. In contrast, our results for a smaller sample of open offers made during 1991-95 show strong positive performance over a 5-year post-issue period, implying that firms making open offers had better growth prospects than firms making rights issues. During 1986-90, a period when open offers were rarely used, firms appeared to be making rights issues to exploit overvaluation. However, this was not evident for rights issues made during 1991-95, a period when open offers were more commonly used."

Sell in May and go away
"We document the existence of a strong seasonal effect in stock returns based on the popular market saying 'Sell in May and go away', also known as the 'Halloween indicator'. According to these words of market wisdom, stock market returns should be higher in the November-April period than those in the May-October period. Surprisingly, we find this inherited wisdom to be true in 36 of the 37 developed and emerging markets studied in our sample. The 'Sell in May' effect tends to be particularly strong in European countries and is robust over time. Sample evidence, for instance, shows that in the UK the effect has been noticeable since 1694. While we have examined a number of possible explanations, none of these appears to convincingly explain the puzzle."

Stingy Links: Accounting

Wall Street says -2 + -2 = 4
"Here's how it works, according to Richard Bove, an analyst at New York-based Ladenburg Thalmann & Co. A company decides to designate $100 million of its subordinated bonds as subject to mark-to-market accounting. The price of the bonds drops to 80 cents on the dollar from 100 cents. So the firm books $20 million on the 'presumed savings that you have on your liabilities,' Bove said. 'In the real world you didn't save a dime,' he said. 'You still owe the $100 million. It's another one of these accounting rules that basically takes you further and further away from reality.'"

Banks keep $35 billion markdown off income statements
"Banks and securities firms, reeling from record losses resulting from the collapse of the mortgage securities market, are failing to acknowledge in their income statements at least $35 billion of additional writedowns included in their balance sheets, regulatory filings show."

Decades lost
"As Canada moves toward adopting International Financial Reporting Standards (IFRS) as the accounting standard for public companies, it is preparing to turn its back on decades of progress shoring up financial reporting in this country. Any regular reader of this column will know that Canada.s current mix of loose accounting and deficient securities enforcement is wholly unacceptable for investors. The introduction of IFRS in its current form will only make the situation that much worse."

Pass the buck
"Statements such as .IFRS is already being used in most of the world.s major capital markets,. are clearly deceptions. Other claims, like that IFRS is .capable of consistent interpretation and application. around the world, contrast sharply with what the audit firms tell their clients in private. One large firm summed up IFRS as follows for its clients: More choice, less detail. Clearly, the private advice to clients is at odds with the public marketing efforts to investors."

Fair value accounting rarely fair
"Brooks added that,while FVA attempts to value investment vehicles by interpreting today's market value, proponents of this accounting standard fail to appreciate how the market works. "Fair value accounting will show a TSX sticker price for 3,000 shares the same as 300,000 shares - but the market shows us differently," explains Brooks."

Stingy Links: Behaviour

And behind door no. 1, a fatal flaw
"The Monty Hall Problem has struck again, and this time it's not merely embarrassing mathematicians. If the calculations of a Yale economist are correct, there's a sneaky logical fallacy in some of the most famous experiments in psychology."

Behind Monty Hall's doors
"Mr. Hall continued: "Now do you see what happened there? The higher I got, the more you thought the car was behind Door 2. I wanted to con you into switching there, because I knew the car was behind 1. That's the kind of thing I can do when I'm in control of the game. You may think you have probability going for you when you follow the answer in her column, but there's the pyschological factor to consider." He proceeded to prove his case by winning the next eight rounds. Whenever the contestant began with the wrong door, Mr. Hall promptly opened it and awarded the goat; whenever the contestant started out with the right door, Mr. Hall allowed him to switch doors and get another goat. The only way to win a car would have been to disregard Ms. vos Savant's advice and stick with the original door. Was Mr. Hall cheating? Not according to the rules of the show, because he did have the option of not offering the switch, and he usually did not offer it."

The meritocracy paradox
"In business, merit supposedly determines pay. But in fact, it's often the other way around, with pay determining merit. In controlled studies in which people were assigned random tasks with random pay, psychologists discovered people behave as if the higher-paid individuals have superior ability. And they do so even if they know that the pay scale was arbitrary. Outside of the laboratory the calculation of someone's ability is even more tricky."

Want to be rich? Don't get too happy
"University of Illinois psychology professor Ed Diener and others have established that while money won't buy happiness, happy people tend to earn more than sad people. A few years ago, however, investing legend John Templeton wrote Diener a letter that had the professor scratching his head. "Is life satisfaction always great?" Templeton asked. "Maybe a little bit of dissatisfaction is okay." "I started wondering," Diener recalls, "do you have to be happier and happier? How happy is happy enough?" Thus, a new study was born. Diener and his colleagues used data from the World Values Survey, which measures the happiness of respondents on a scale of 1 to 10 (with 10 the happiest). They found that income did indeed increase along with happiness but not at the very top."

It's mine, I tell you
"The endowment effect was controversial for years. The idea that a squishy, irrational bit of human behaviour could affect the cold, clean and rational world of markets was a challenge to neoclassical economists. Their assumption had always been that individuals act to maximise their welfare (the defining characteristic of economic man, or Homo economicus). The value someone puts on something should not, therefore, depend on whether he actually owns it. But the endowment effect has been seen in hundreds of experiments, the most famous of which found that students were surprisingly reluctant to trade a coffee mug they had been given for a bar of chocolate, even though they did not prefer coffee mugs to chocolate when given a straight choice between the two."

How thinking costs you
"Looking at data from every trade made by all investors in Taiwan from 1995 to 1999, Odean discovered that the "aggregate portfolio of individual investors suffers an annual performance penalty of 3.8 percentage points," which includes trading costs. If investors had simply bought the index and not traded at all, they would have done about 3.5 percent better. The amount of money lost was equivalent to 2.2 percent of Taiwan's gross domestic product."

Rebate psychology
"Changing the way that identical income is described can significantly affect how people spend it. In an experiment I conducted at Harvard with my colleagues Dennis Mak and Lorraine Chen Idson, participants were given a $50 check. They were told that this money came from a faculty member's research budget, financed indirectly through tuition dollars. Roughly half of the participants had this money described as a 'rebate,' whereas the others had it described as a 'bonus.' When unexpectedly contacted one week later, participants who got a 'rebate' reported spending less than half of what those who got a 'bonus' reported spending ($9.55 versus $22.04, respectively). We observed this same pattern in other experiments when participants were asked to keep a written record of their spending, as well as in experiments in which the participants were allowed to purchase items in the lab. 'Rebates' are understood to be returns from money already spent. A rebate, psychologically speaking, is the return of a loss of one's own money rather than a pure gain provided by someone else, so it is unlikely to be seen as extra spending money."

'Brainwashing 101 for dummies' (and investors!)
"Yes, Wall Street's got a great con game going, but it only works because America's 95 million investors are willing victims, love playing along, actually letting Wall Street get away with it! I call it "Brainwashing 101 for Dummies." Insiders use fancier terms like neuroeconomics, behavioral finance and the new "science of irrationality." But labels aside, you're being brainwashed. And Wall Street's laughing all the way to the bank at how easy it is to dupe gullible investors by using the 11 rules of "Brainwashing 101 for Dummies." We got them for you: Everything you'll ever need to know about the big con."

Stingy Links: Bonds

Student lenders stifled
"The collapse of the $330 billion auction-rate securities market has brought debt sales by U.S. public student-loan agencies to a halt. No municipal bonds backed by student loans were sold in the first quarter, the first time that happened in almost 40 years, according to Thomson Financial. The inability to obtain financing differs from states, cities, schools and hospitals, which sold $82 billion of bonds to fund public works and replace failed auction debt that stuck them with penalty rates as high as 20 percent."

Bye bye AAA
"The six remaining borrowers with the highest rating from both S&P and Moody's are: Automatic Data Processing Inc., Berkshire Hathaway Inc., Exxon Mobil Corp., General Electric Co., Johnson & Johnson and Toyota Motor Corp., according to data compiled by Bloomberg."

Stingy Links: Books

Are your stocks protected by moats?
"Thanks to The Rothery Report's Norman Rothery - with whom I had the pleasure of dining this week - I came across a copy of a book that is focused on the topic of economic moats. It's called The Little Book That Builds Wealth (Wiley, 2008), by Pat Dorsey, who is the director of equity research at Morningstar Inc. Morningstar is famous for its mutual fund ratings, but also rates individual stocks using an 'economic moat' rating system. The book divulges most of its approach to this system and makes for a fascinating read."

Fooling some of the people all of the time
"Now Mr. Einhorn has written a book. But instead of packaging the real or contrived "secrets" to his success - as cliche would have it - he has tried to do something less triumphant and far gutsier. In "Fooling Some of the People All of the Time," he turns the spotlight on a single, stubborn investment play that never made much money for him but created six years of headaches."

Stingy Links: Brokers

Beware: A 'safety net' full of holes
"Regardless of what they're called or the advantages they claim to offer, these products have two things in common: very high commissions for your adviser and, thanks to fees averaging about 2% to 3% a year, very low returns for you. And you often have to pay a surrender charge, or exit fee, of 6% or more if you want to withdraw the money in the first six to eight years. Another feature you'll commonly find with these safety nets is confounding complexity. I've had plenty of clients who signed disclosure forms stating that they had read and understood the 473-page policy, yet they still had no idea what they were buying."

Fee-only must mean just that
"Canadian financial planners should eliminate the ambiguity by scrapping the phrase "fee-only" when charging fees computed as a percentage of client assets. Instead, they should use the term "asset-based," which is far less confusing for clients."

London 'cityboy' unmasks world of analysts
"As a utilities analyst at Dresdner Kleinwort, Geraint Anderson was advising clients how to invest. At the same time, through an anonymous London newspaper column, he was telling readers how analysts wrote 'utter gibberish.'"

Stingy Links: Buffett

Woodstock for capitalists 2008 blog
"A shareholder asked how one can correct one's mind set away from a crowd mentality. Mr. Buffett said to read and re-read Ben Graham's The Intelligent Investor. He specifically said that chapters 8 and 20 are most poignant, but that the lessons from the book are as relevant today as they were when he first read Graham's book when he was 19 years old. He also said there are basically three lessons to take away from the book: (1) Think of stocks as owning parts of a business, (2) Use the market to serve you rather than instruct you, and (3) Always require a margin of safety when investing. In today's environment, these principles are critical, and I especially think the second one is important to remember, as, in my opinion, it can help investors tune out the rampant noise in the market, helping them improve their investment temperament over time."

Updates from the annual meeting
"Qwest Center Omaha is filled to the rafters with Berkshire Hathaway shareholders. More than 30,000 people were expected to hear Warren Buffett and Charlie Munger talk about the holding company that includes brand names like Benjamin Moore paints and Dairy Queen ice cream stores."

Interview with Warren Buffett
"CNBC's Becky Quick sits down with Warren Buffett to discuss the upcoming shareholder meeting, which starts Friday night and runs through Monday. Buffett refers to the annual event as "Woodstock for Capitalists.""

Warren Buffett deal interview
"I think we're in a recession. I mean, a recession is defined in a certain way by the National Bureau of Economic Research, but I think it's defined by the man in the street a little differently than whether there have been two quarters of reported (negative) GDP growth. And incidentally, when GDP growth is below 1% a year it's really falling on a per capita basis because our population increases about one percent. So even though the National Bureau uses an absolute figure, it's up one-tenth they don't count that as a recessionary quarter, but the GDP per capita has gone down in a quarter where the gain is half a percent or something of the sort. We are in a recession, unless you want to stick strictly to the technical definition, which I really don't think has much meaning to the fellow who has lost his job or is facing a money-market fund that isn't paying him out, or whatever it might be."

Warren Buffett - in 1974
"Stay dispassionate and be patient is Buffett's message. "You're dealing with a lot of silly people in the marketplace; it's like a great big casino and everyone else is boozing. If you can stick with Pepsi, you should be OK." First the crowd is boozy on optimism and buying every new issue in sight. The next moment it is boozy on pessimism, buying gold bars and predicting another Great Depression."

Stocks buffett would love
"Buffett hasn't asked for our help, but we've identified five companies to lighten his pocketbook. Even if he doesn't buy them, the stocks should appeal to mortals, too."

Economy in a recession, will be worse than feared
"'This is not a field of specialty for me, but my general feeling is that the recession will be longer and deeper than most people think,' Buffett said. 'This will not be short and shallow.' 'I think consumers are feeling gas and food prices,' he added, 'and not feeling they've got a lot of money for other things.'"

Mars agrees to buy Wrigley
"The purchase will be financed with $11 billion from Mars, $4.4 billion from Berkshire and $5.7 billion from Goldman Sachs Group Inc. Berkshire will also buy a $2.1 billion stake in the Wrigley unit once the purchase is completed."

Buffett's big bet
"Will a collection of hedge funds, carefully selected by experts, return more to investors over the next 10 years than the S&P 500? That question is now the subject of a bet between Warren Buffett, the CEO of Berkshire Hathaway, and Protege Partners LLC, a New York City money management firm that runs funds of hedge funds - in other words, a firm whose existence rests on its ability to put its clients' money into the best hedge funds and keep it out of the underperformers. You can guess which party is taking which side."

The next Buffetts
"We hope that the greatest investor of all time has many, many good quotes left. But we also have to acknowledge reality. Buffett is 77 and even his steady diet of Cherry Coke and hamburgers can't keep a guy going forever. Investors who would like to put their money into Berkshire Hathaway, Buffett's flagship company, have to deal with the unpleasant fact that Buffett may be on his last lap or two as champion of the stock market marathon. That raises a fascinating question: who is the next great Buffett-like investor going to be? He or she must be a great stock picker, of course. But that's just the beginning. What distinguishes Buffett is not only his stock market acumen. It's also his willingness to state his opinions in plain English, his independent turn of mind, and his willingness to treat investors as if they were his partners."

What Warren thinks...
"You know, I always say you should get greedy when others are fearful and fearful when others are greedy. But that's too much to expect. Of course, you shouldn't get greedy when others get greedy and fearful when others get fearful. At a minimum, try to stay away from that."

Meet the Buffetts
"Berkshire Hathaway's annual meeting happens May 3rd in Omaha and, once again, the company's billionaire chairman and CEO, Warren Buffett, will be in the spotlight. Last year, NBR brought viewers an interview with Buffett. This year, anchor Susie Gharib interviews Buffett's three children to find out what their father taught them about money and business."

Stingy Links: Chou

Is value dead?
"The cookie-cutter office building stacked amid high-rise condos and streetside retail is not where you'd expect to find the man who oversees $1.2 billion in funds, and who is said to be Canada's top stock-market bargain hunter. Taped to his door is a plain piece of paper that has been run through a printer: "Chou Associates Management Inc.," it reads, implying that nothing of much importance is happening here. The door is locked, but jiggle the handle of the door and out pops Francis Chou, whom I have come to ask about the strange decline in the once-dominant school of value investing. It's an investing style once described by the late, great value guru Benjamin Graham as the equivalent of rifling through a store's discount bin. In other words, if you are patient enough to search endlessly and smart enough to know the difference between a true bargain and a bad knockoff, then you can make terrific money."

Chou runs his fund the way he runs his life
"At lunch Francis lamented that "I've become a bond trader." He finds it is very time-consuming because "there is a lot of haggling that goes on." His days are now filled with calls from bond dealers who know that Francis is an interested buyer. He is on everyone's speed dial. In the 2002 Chou Fund report, Francis said "distressed securities involve companies that have one or more serious deficiencies including weak economics, stretched balance sheets, liquidity problems, incompetent management, accounting frauds, potentially mutant cockroaches - you name it.""

Stingy Links: Crime

Trader, father, veteran, convict
"As famous CEOs marched off to jail, so did lots of guys like Craig Gile. The Citigroup trader had a wonderful life - until the Feds decided to make an example of him. Was it fair?"

Stingy Links: DRPs

DRIPs a cheap way to invest
"There's no free lunch, even when investing on your own without an adviser. You still pay commissions to buy company shares, exchange-traded funds and income trust units. But you can get a free dessert (so to speak) if you reinvest the dividends to buy more shares, ETFs and trust units."

Stingy Links: Debt

Your lifestyle may hurt your credit
"Most borrowers know a late payment or high outstanding balance can hurt their credit. But what about frequenting a massage parlor, retreading a tire, or visiting a marriage counselor? Such activities count, too, according to a suit filed by the Federal Trade Commission in federal court in Atlanta on June 10 against card issuer CompuCredit"

You thought you had an equity line
"Reeling from losses on their wretched loan decisions of recent years, lenders are preventing borrowers with pristine credit and significant equity in their homes from tapping into credit lines that they paid dearly to secure. In the last 30 days, lenders have sent several hundred thousand letters advising borrowers that their home equity lines of credit are frozen"

Stingy Links: Derivatives

Triple-A failure
"Structured finance, of which this deal is typical, is both clever and useful; in the housing industry it has greatly expanded the pool of credit. But in extreme conditions, it can fail. The old-fashioned corner banker used his instincts, as well as his pencil, to apportion credit; modern finance is formulaic. However elegant its models, forecasting the behavior of 2,393 mortgage holders is an uncertain business. 'Everyone assumed the credit agencies knew what they were doing,' says Joseph Mason, a credit expert at Drexel University. 'A structural engineer can predict what load a steel support will bear; in financial engineering we can't predict as well.'"

Moody's ratings error probe
"Moody's Corp. plunged the most in nine years after the ratings company said it is conducting 'a thorough review' of whether a computer error caused it to assign Aaa rankings to debt securities that later fell in value."

Whither Black-Scholes?
"In fact, Black-Scholes may not be used that much in the markets to begin with. New research by veteran traders and best-selling authors Nassim Taleb and Espen Haug points in that direction. Clearly, a formula that isn't used can't have much of an effect on markets, let alone cause the massacre that began last summer."

Stingy Links: Dreman

Postcrisis bank stocks
"It is time to ask: How could the managers of so many banks and brokerage houses have thrown out the rule book on risk?"

Looking beyond the bailout
"The government rescue of overleveraged financiers and underwater homeowners is still only beginning, and the signs that it will get bigger are manifold. The Federal Housing Administration has spent $21 billion since September staving off foreclosures. The House Financial Services Committee has proposed letting the FHA underwrite up to $300 billion in loans to borrowers. The last time the federal government stepped so directly into the mortgage business was at the bottom of the Great Depression. Congressmen from both parties are working on legislation to provide tax breaks and other help to much of the stressed homeowner population. The Administration has been reluctant to get involved in anything it would consider a bailout, but the rapidly darkening credit situation may leave it with no choice."

Stingy Links: Funds

The folly of short term performance
"Investors often buy funds based on past performance, especially of the short-term variety. This is in part human nature--behavioural finance types might attribute it the tendency all of us have to try to impose order on chaos, even if it means attributing meaning to small patterns where there may be none. It may also be a matter of convenience--getting reliable information about fund holdings, management, and organisational factors such is incentive pay can be difficult. In the face of that difficulty, investors tend to place more weight than they should on easily available factors, such as short-term past performance."

Catch two-and-twenty
"But suppose that every institution handed its portfolio to hedge-fund managers. The average fund manager cannot earn more than the market. After costs, he must earn less. An individual pension fund or endowment might succeed in its search for higher returns. But because hedge funds and private-equity fees are higher than normal - often a 2% annual fee and a 20% performance fee - the effect of the shift would be to lower the average return of investors, not increase it. A 'catch two-and-twenty' is at work."

Why today's hedge fund industry may not survive
"The immediate response may be that so naked a scam is inconceivable. Well, imagine a fund that leverages investors. money by borrowing massively in short-term money markets in order to purchase higher-yielding paper. Assume, again, that the premium gives a correct estimate of the risk. With sufficient leverage, this fund, too, is likely to make profits for years. But it is also very likely to be wiped out, at some point. Does this strategy sound familiar? It certainly should by now."

America's hottest investor
"Henry, himself a long-time shareholder in Heebner's funds, says what first impressed him about Heebner was a little gambit he had going in finance class. Classmates would bring him silver dollars, which Heebner would exchange for dollar bills. Says Henry: "Ken was hoarding silver dollars on the idea that silver was going to keep appreciating, which would eventually force the Treasury to stop issuing new silver coins." And that's exactly what happened. "It was funny as hell - he'd be sitting there with piles of silver dollars on his desk - but Ken had it nailed," Henry says. "He saw something the rest of us didn't. That's Ken - that's always been Ken." Asked about the silver dollars, Heebner smiles and reveals that it was more than a lark for him. At one point he'd accumulated 13,000 silver dollars and had even taken out a bank loan to help finance his little venture. "The Treasury had these uncirculated silver dollars in bags in vaults. You could walk in with a thousand dollars, and they'd give you a bag of 1,000 silver dollars." It's still the best deal he's ever seen, he says: "You couldn't lose, but you could make a lot." Heebner figures he eventually netted around $15,000, but he was less successful when he tried to parlay his experience into a term paper about why silver prices were going up: "I didn't get a very good grade.""

Stingy Links: Gross

When I'm sixty-four
Mr. Gross advocates government measures that attempt to stop the slide in housing prices. Oh, and he's turning 64.

Stingy Links: Hallett

Dan on BNN
Dan cautions against Ticker Temptation. Read his articles over here.

Value investing is supposed to get ugly
"One of the tenets of value investing is there will be times when it's going to get ugly. Problem is, for a lot of established value firms, things have never looked uglier - leading some advisors to question the wisdom of the strategy. But fund analysts say there is merit to what value firms are doing right now and investors should wait before they write off their value holdings."

Portfolio dilution excessive in Canada
"Drilling down more deeply reveals that the worst dilution occurs in our own tiny stock market. Look at virtually any wrap program and find out where most of the funds or managers are focused. I'll bet it's on Canadian stocks."

Number twisting continues with fees
"It was almost two years ago when a draft research paper - Mutual Fund Fees Around the World - made waves by proclaiming that 'total shareholder costs' for mutual funds sold in Canada were the highest among the 18 developed countries studied. Industry critics and investor advocates ran with the paper's figures, without scrutiny, to pad their case that the fund industry regularly sticks it to investors."

Stingy Links: Health

Older and heavier need not apply
"General Mills has a model employer wellness program, according to the article. It issued a wellness mission statement that was distributed to all employees, saying: 'We would like every General Mills employee to have an active lifestyle, a healthy weight, a normal cholesterol level, normal blood pressure and to be a nonsmoker.' These are mostly euphemisms for thin and young. Evidence-based research to date has shown these health indices are primarily measures of genetics, aging and social stresses, and 'normal' levels have been redefined so low as to exclude most older, heavier or genetically predisposed people. The only way for most of these workers to meet these arbitrary benchmarks are to take controversial prescription drugs or engage in equally controversial and ineffective weight loss measures. It is exactly these discriminatory aspects of employer wellness programs, which reward and penalize workers based on arbitrary health indices, that caught the attention of the Department of Labor and lawyers earlier this year."

Stingy Links: Indexing

'Lazy Portfolios' for stagflation
"If you don't have a Lazy Portfolio now is the time to build your own using the eight models below. And remember, back in the bad old days of the 2000-2002 bear-recession, one of them, the Coffeehouse, was killing the S&P 500 by 15 percentage points each of the three years -- more proof passive investing beats action. You also don't need a lot of funds with this strategy. That's important if you're young, new at the game or just don't have a lot of money to invest and can't afford to plunk down the $33,000 for the initial investments in an 11-fund portfolio. So let's look at the smaller portfolios first to prove the point. Here's a comparison of the bottom lines of all eight Lazy Portfolios."

Stingy Links: Klarman

Seth A. Klarman's 2007 MIT remarks
"Institutional constraints and market inefficiencies are the primary reasons that bargains develop. Investors prefer businesses and securities that are simple over those that are complex. They fancy growth. They enjoy an exciting story. They avoid situations that involve the stigma of financial distress or the taint of litigation. They hate uncertain timing. They prefer liquidity to illiquidity. They prefer the illusion of perfect information that comes with large, successful companies to the limited information from companies embroiled in scandal, fraud, unexpected losses or management turmoil. Institutional selling of a low-priced small-capitalization spinoff, for example, can cause a temporary supply-demand imbalance. If a company fails to declare an expected dividend, institutions restricted to owning dividend-paying stocks may unload shares. Bond funds allowed to own only investment-grade debt would dump their holdings of an issue immediately after it was downgraded below BBB by the rating agencies. Market inefficiencies, like tax selling and window dressing, also create mindless selling, as can the deletion of a stock from an index. These causes of mispricing are deep-rooted in human behavior and market structure, unlikely to be extinguished anytime soon."

Stingy Links: Law

The siege of State Farm
"For State Farm Insurance - the nation's leading auto and home insurer - coping with once-in-a-lifetime disasters is everyday business. Risk analysis is what it does, and its actuarial staffs are prepared for every eventuality. Almost. When Hurricane Katrina struck the Gulf Coast in 2005, it infamously brought a storm surge the likes of which the nation had never seen, causing more flood damage in one event than all the storms combined for as far back as there was data (37 years). Even that risk State Farm had anticipated. What it hadn't foreseen was that the storm surge would gut the home of a plaintiffs lawyer named Richard F. "Dickie" Scruggs, as well as those of his family, friends, and neighbors in Pascagoula, Miss. Scruggs was someone who could render all of State Farm's actuarial calculations irrelevant, because he had the power and know-how to force it to rewrite its contracts retroactively. He had been the scourge of Fortune 500 companies for two decades, precisely because he tended to change the rules of any game he chose to play."

Stingy Links: Management

Corporate democracy is a myth
"We are in this situation because there is no leadership in the executive suite. Why did we get here? Because in corporate America there are no true elections. It is tyranny parading as democracy. It.s a poison running through the blood of corporate America. Perhaps, with enough public support, the lawmakers and regulators will take note."

All together now?
"In fact, corporate marriages only rarely end in bliss - many studies have found that most mergers and acquisitions do little for the acquiring company's bottom line. A KPMG study of seven hundred mergers found that only seventeen per cent created real value, and that more than half destroyed it. And a McKinsey study of mergers that took place in the nineteen-nineties found that less than a quarter generated excess returns on investment."

Rewarding failure
"You might suppose that the stars are in near-perfect alignment for major reform of CEO pay. The mammoth pay and disastrous performance of Countrywide Financial's Angelo Mozilo, Citigroup's Chuck Prince, and Merrill Lynch's Stan O'Neal should be enough to make the public furious. Each CEO departed with $100-million-plus compensation after misadventures with subprime mortgages. Now add the economic slowdown to the mix; ordinary Americans are worried about making ends meet while failed pooh-bahs rake it in. Then throw in one more element - a presidential election. Put it all together, and how could change not be imminent?"

Companies promise CEOs lavish posthumous paydays
"You still can't take it with you. But some executives have arranged for the next best thing: huge corporate payouts to their heirs if they die in office."

Stingy Links: Markets

Not so fast
"Research by the London Business School looked at 17 countries over 108 years. The countries with the slowest-growing economies (as measured by GDP growth over five-year periods) returned 8% a year; the markets in the fastest-growing economies, by contrast, returned just 5% a year. When a broader group of 53 economies, including many emerging markets, were examined, the tortoises beat the hares by a wider margin - 12% to 6-7%."

Has equity always earned a premium?
"Past performance is no guarantee, but history tells us that the equity risk premium has been persistent. This column shows that British investors enjoyed relatively high returns in the nineteenth century, though today.s UK market differs greatly from its formative ancestor."

Odd numbers
"Now in a new paper, M.I.T.'s Mozaffar Khan and Hai Lu of the University of Toronto show some compelling evidence that significant front-running does exist. Khan and Lu looked at the level of short sales between 2005 and 2007 surrounding days when a chief executive sold stock."

We ain't got to show you no stinking credibility
"In short, mortgage foreclosures and defaults are just now hitting their stride, and we are likely to observe a second round of credit fears as those losses mount. The U.S. dollar has enjoyed a brief rebound on tightening talk from the Fed, which is likely to quickly dissipate as soon as those credit concerns revive. Meanwhile, commodity price pressure is likely to diminish by the end of summer as the result of a continuing economic downturn coupled with a flight-to-safety which will reduce monetary velocity."

How the finance gurus get risk all wrong
"Your money is at risk. No matter what you've put it in - stocks, bonds, derivatives, hedge funds, houses, annuities, even mattresses - there's always the chance that you could lose it or miss out on a bigger opportunity somewhere else. Anyone who would tell you otherwise is either a fool or a huckster. Then there are those who do warn of risk but package it into a simple numerical measure that seems to put it within manageable bounds. They're even more dangerous."

One guy who has seen it all
"Today's trouble, the 89-year-old Mr. Bernstein says, is worse than he has seen since the Depression and threatens to roil markets into 2009 and beyond -- longer than many people expect."

Bernanke's bubble laboratory
"First came the tech-stock bubble. Then there were bubbles in housing and credit. Chinese stocks took off like a rocket. Now, as prices soar on every material from oil to corn, some suggest there's a bubble in commodities. But how and why do bubbles form? Economists traditionally haven't offered much insight. From World War II till the mid-1990s, there weren't many U.S. investing manias for them to look at. The study of bubbles was left to economic historians sifting through musty records of 17th-century Dutch tulip-bulb prices and the like. The dot-com boom began to change that."

A blunt former Fed chairman takes on Bernanke
"A few days ago an unusual event took place: Paul Volcker, the mythical U.S. Federal Reserve Board chairman from the Reagan years, criticized the policy of the current Fed chairman, Ben Bernanke, in a speech to the Economic Club of New York. Just so you grasp how extraordinary this was, you should first understand that normally a past Fed chairman scrupulously avoids saying anything at all about current Fed policy - for the simple reason that the current Fed chairman's words are one of his most important tools: They can sway markets. This ability does not fade entirely when a Fed chairman leaves. So when a past Fed chairman speaks, his words can clash with those of the present one and make that one's job difficult. Out of professional courtesy, past Fed chairmen therefore keep quiet; Mr. Volcker especially - the man who hiked interest rates to 20 per cent to kill inflation, at the cost of a deep recession. But last week Mr. Volcker spoke his mind bluntly. He said, in effect, that the current Fed is not doing its job."

Paul Volcker speaks in New York
"Former U.S. Federal Reserve Chairman Paul Volcker speaks in New York about practices leading to the current financial market crisis, the role of the Federal Reserve in preventing and dealing with such crises and the need for changes in market regulation."

Immoral hazard
"The idea that occasional economic setbacks might benefit the system in the long run was one of the early ideas to disappear. Yet if you prop up weak sisters who would otherwise fail and in failing present their more efficient competitors with extra growth, you must surely weaken the system. Desperation pricing from weak firms who simply should not exist can weaken the profitability of a whole industry, as it has for the airlines. The average efficiency of most industries is reduced with at least some effects on our global competitiveness. With a slightly lower average return on equity, the ability to reinvest drops so that, in this world of moral hazard where recessions are few and mild, GDP growth is a little less than it might have been."

Stingy Links: Miller

Overplaying their hand
"There are different kinds of investors in the world. One kind is a long-term patient type who runs mutual funds for the average Joe. A second is a risk arbitrageur - known on Wall Street as an "arb" - who speculates on pending deals. When a proposed takeover surfaces and the target's stock price runs up, Mr. Patience tends to sell to the arbs, happy to take his profit and letting the arbs bear the risk of whether the deal gets done and at what price. Recently, however, two of the biggest and best-known mutual fund investors - Gordon Crawford of Capital Research Global Investors and Bill Miller of the Legg Mason Value Trust (LMVRX) blurred the distinction between the investment and arb worlds, and their shareholders paid the price."

Stingy Links: Montier

Joining the dark side
"So we have covered three potential sources of short ideas. What happens if we put them all together? The parameters I used to define my shorts were a price-to-sales > 1, an F score of 3 or less, and total asset growth in double digits. This proved to be a powerful combination. Between 1985 and 2007 a portfolio of such stocks rebalanced annually would have declined over 6% p.a. compared to a market that was rising at the rate of 13% p.a. in Europe"

Remember, Cassandra was right
"Some are trying to argue that the mess in the US economy/housing market/credit market is an example of Taleb's black swan. Nothing could be further from the truth. Black swan events are inherently unpredictable. However, the events unfolding now are sadly all too predictable. They are following the standard pattern for a debubbling process. Numerous psychological barriers prevent us from listening to Cassandra, but it may pay to remember that her predictions were all too accurate."

The road to revulsion
"Indeed, one of the lessons that should be learnt from the Japanese experience is that the banks were second round losers, a point made by Albert Edwards recently. They didn't really begin to underperform the rest of the market until the second Japanese recession of its debubbling process. They really started to suffer when their consumers (Japan Inc) started to struggle."

Asleep at the wheel
"However, more importantly once earnings have peaked they often return to the low edge of the growth bands. This represents a 45%- 50% decline in earnings. This number holds for the US, Europe and the UK. So if you want to have a worse case scenario then a figure like this should be used."

Stingy Links: Munger

2008 Wesco notes
"Most assets are priced to a level where it is hard to get excited. It is hard to get 4% yield on a nice apartment, and it doesn't include replacing the carpets. Bonds of strong corporations are 4% yield. Corporate equities are paying 2% pa, growing 4% per year. Such a world isn't the one that made all of you able to come to the meeting. Last generation has been in hog heaven - some bumps, but it had easiest time getting ahead. In the eighteen years that preceded hog heaven, the purchasing power of Yale's endowment went down 60%. They were getting real investment return of 0%, negative. It is not at all impossible that brilliant investors like Yale get bad results in the future."

Stingy Links: Pabrai

Looking up to Warren Buffett
"Our brains are in sync with the speed at which the market is moving and totally out of sync with the speed at which a business is moving. It seems obvious: The market is repricing a company's stock very quickly. I can process very quickly; therefore, I make decisions based on that. You have to learn to dramatically slow your brain, which is very hard for most people. The reality is that you should make decisions based on how that business is changing, and that's a very slow process."

Stingy Links: Real Estate

Doubts raised on big backers of mortgages
"As home prices continue their free fall and banks shy away from lending, Washington officials have increasingly relied on two giant mortgage companies - Fannie Mae and Freddie Mac - to keep the housing market afloat. But with mortgage defaults and foreclosures rising, Bush administration officials, regulators and lawmakers are nervously asking whether these two companies, would-be saviors of the housing market, will soon need saving themselves."

Here comes the next mortgage crisis
"California should be the poster child for a mortgage-loan bailout. In few other places have so many taken on such onerous debts with so little equity. Unfortunately, the crisis in California is going to get much worse, and there is no bailout that will solve it. Why? Because if the first stage of the foreclosure crisis was about people who could not afford their mortgages, the next stage will be about people who have every reason not even to try to pay their mortgages."

Subprime outcomes
"Our second point is that house price depreciation - negative house price appreciation(HPA) - is the main driver of foreclosures. The easiest way to see this is to look at aggregate data. Figure 1 shows that periods of exceptionally high HPA in Massachusetts, as in 2002-2004, are associated with exceptionally low numbers of foreclosures, while periods of negative HPA, such as 1989-1991 and 2005-2007, are associated with high foreclosure rates. Cash flow problems at the household level, driven by job loss, for example, play a role, but only when HPA is low. For example, in 2001, a recession generated a record high number of delinquencies, a sign that many households had problems making monthly mortgage payments. During this time, however, there was a record low number of foreclosures in Massachusetts. Thus, the phenomenal levels of HPA in the early 2000s enabled many borrowers to either refinance or sell to avoid foreclosure."

Lenders swamped by foreclosures
"Banks are so overwhelmed by the U.S. housing crisis they've started to look the other way when homeowners stop paying their mortgages. The number of borrowers at least 90 days late on their home loans rose to 3.6 percent at the end of December, the highest in at least five years, according to the Mortgage Bankers Association in Washington. That figure, for the first time, is almost double the 2 percent who have been foreclosed on."

Through the floor
"As house prices in America continue their rapid descent, market-watchers are having to cast back ever further for gloomy comparisons. The latest S&P/Case-Shiller national house-price index, published this week, showed a slump of 14.1% in the year to the first quarter, the worst since the index began 20 years ago. Now Robert Shiller, an economist at Yale University and co-inventor of the index, has compiled a version that stretches back over a century. This shows that the latest fall in nominal prices is already much bigger than the 10.5% drop in 1932, the worst point of the Depression."

S&P/Case-Shiller home prices fell 15.3% in April
"Home prices decreased 1.4 percent in April from a month earlier after a 2.2 percent decline in March, the report showed. The figures aren't adjusted for seasonal effects, so economists prefer to focus on year-over-year changes instead of month to month."

Home prices take record drop
"Though prices have dropped overall, homes still have retained much of the value they gained in the housing run-up that began in 2003. And of course that is a good thing for owners of homes who want to hold on to the value of their investments. But there are those who look at the big picture and predict that the current decline won't end until house prices are again affordable for many more Americans. For that to happen, prices must fall to about where they were before the bubble began, the theory goes. If so, there's still considerable room to drop. Census Bureau figures showed the median price (half cost more, half cost less) as $227,600 in March, having retreated from last year's $262,000. But even that deflated figure is 22% above the median price from 2003."

About 1 in 11 mortgageholders face loan problems
"All told, about 8.8 percent of home loans were past due or in foreclosure, or about 4.8 million loans. That is up from 7.9 percent at the end of December. (About a third of American homeowners do not have mortgages.) Delinquency and foreclosure rates started rising from historically low levels in late 2006 and have picked up speed in nearly every quarter since. Analysts say at first past due mortgages represented mostly high-risk loans made to borrowers with blemished, or subprime, credit. Now, as the economy has weakened and home prices have fallen in many parts of the country, homeowners with better loans are also falling behind."

Lipstick On A pig
"Credit scores used by the mortgage industry are often supplied by credit-reporting agencies that also offer borrowers assistance in figuring out how to game the system. They use computer programs that suggest tactics that can lift scores for a few days or weeks. This credit gentrification occurs quietly at the beggining of the loan process, and like a summer-before-college nose job, nobody has to know."

You can't pay them enough to leave
"When the city of Youngstown, Ohio, proposed incentives to move people out of declining neighborhoods, it sounded like a good idea - in theory. The city hoped to lure holdouts living on nearly empty blocks and relocate them to more lively areas, as part of its plan to remake itself in the wake of the steel industry's departure and the foreclosure crisis. It's already cleared some lots for things like playgrounds. Now Youngstown wants to close entire streets and bulldoze abandoned properties so it can shut down city services like street lighting, police patrols and garbage pick-ups that it can no longer afford to maintain. To do this on a large scale, the city needs to get about 100 residents to relocate. Each is eligible for $50,000 in incentives - plenty, in this town, to buy a new home and move. The hitch: Youngstowners don't seem to want to leave their homes, no matter how blighted or abandoned the neighborhood may be."

New-home sales in the U.S. plunge
"Purchases of new homes in the U.S. plunged more than forecast in March to the lowest level in almost 17 years as stricter loan rules and falling prices caused buyers to hold off. Sales dropped 8.5 percent to an annual pace of 526,000, the fewest since October 1991, from a 575,000 rate the prior month, the Commerce Department said today in Washington. The median sales price slumped 13.3 percent from the same time last year, the most in almost four decades."

Downsizing the American home
"During the housing bubble, KB Home priced out first-time homebuyers by building bigger. Its new, more modest model provides a glimpse of what the return of the housing market may look like."

Mistaking consumption for investment
"During the housing bubble a lot of people confused consumption with investment, a fact now becoming painfully obvious in Britain as prices fall and businesses suffer. As in the United States, home owners helped inflate a wider bubble by plowing money into housing-related consumption, from granite kitchen countertops to living room furniture to under floor heating. The illusion, or justification, was that this consumption, often financed via mortgage debt, was actually investment in a can't-miss real asset. It wasn't, it's stopping and the impact on the economy will be considerable."

Housing bubbles collapse inward
"The trends that pushed housing demand toward distant suburbs and rural areas were not sustainable. Although housing in outlying areas was relatively less expensive, a few years of double-digit appreciation quickly made these homes unaffordable for most households, especially after the sub-prime mortgage crisis (which started in August 2007) shut down non-conventional lending. Speculators could only profit from flipping when prices were rapidly increasing. When prices stalled and started to fall in 2006, investor demand for residential properties evaporated, and many speculators left holding unsold properties were forced into foreclosure. There is also some evidence that household preferences for larger homes may be shifting. In part, this is simply because of sharp increases in commuting costs."

Subprime in sheep's clothing
"Unlike subprime folk with expired teasers who have been putting capital into their homes for months and perhaps years, many Alt-A borrowers with years left on their payment-lite teaser periods are going to wake up one day to homes that have hugely deteriorated in price and have little if any equity in them. That is the exact recipe for foreclosure that bank insiders and credit analysts are warning about. Mark Zandi of Moody's estimates that, by the end of June, 21.0% of all first-mortgage holders in the United States, or 10.6 million homeowners, will have zero or negative equity in their homes. For now, Alt-A loans are performing better than subprime mortgages. The risk, however, is that generally well-heeled Alt-A borrowers will adopt the same flippant attitude to paying their debts as lenders did in evaluating them. An additional pressure: 23.7% of Alt-A loans were not taken out for primary residences are often considered investments and have a higher rate of foreclosure. Only 8.7% of subprime mortgages were for absentee landlords, according to the New York Federal Reserve Bank."

Stingy Links: Retirement

How long will you live?
"The hardest question in retirement planning is the first one: How long do you expect to live? I'm afraid recent developments are making that question even harder to answer. But it's unavoidable, so what's the smart way to think about it now?"

Defined benefit vs. 401(k) plans
"This most recent comparison finds that between 1995 and 2006, DB plans outperformed DC plans by an average of 1 percent per year. Earlier studies also found that, over time, DB plans attained higher returns than did 401(k) plans."

Study finds pension-plan returns top 401(k)s
"Pension-plan returns outperformed 401(k) retirement accounts from 2003 to 2006, the most recent bull market, according to a study. Pension plans beat 401(k) plans by 1.7 percent in 2003, 2 percent in 2004, 1.1 percent in 2005 and 1.6 percent in 2006, said the survey released today by Watson Wyatt Worldwide, a global consulting company based in Arlington, Virginia. Looking at a broader period, 1995 to 2006, pensions outperformed 401(k)s by 14 percent, the study said."

Wealthy? Here's some good news
"When wealthy Canadians look at how much money they'll need to save up for retirement, they can be in for a shock. The latest report from the mutual fund industry recommends that you replace 80% of your working income when you retire. That means if you make more than $100,000, you'll need to save up two or three million bucks. Luckily, says actuary Malcolm Hamilton, if you're wealthy, you don't need anything close to an 80% replacement ratio to maintain your standard of living." [The table at the bottom of the page is the interesting part of this mini-article.]

Stingy Links: Stocks

Bank failures to surge in coming years
"Only three banks have failed so far in 2008. But that number is set to surge as the credit crunch slows economic growth and hammers some lenders that grew too fast during the recent real-estate boom, experts say. The roots of today's banking crisis grew out of the boom and bust in the real estate market."

The Texas ratio and Canada's big banks
"Back in the recession of the 1980s, when the oil market was in the tank and banks in Houston and Dallas were dropping like rain in April, Gerard Cassidy and his team of bank analysts at RBC Dominion Securities came up with a way to predict the likelihood of any given bank failing. They took the total of a lender's non-performing loans and divided it by the sum of its tangible equity capital plus its loan-loss reserves, yielding the Texas ratio. It's a nifty idea. What Mr. Cassidy and his team discovered was that when a bank's Texas ratio got to 100 per cent, or one to one, it was likely to become toast. The ratio was an accurate predictor of Texas bank failures and also worked a treat with troubled New England banks in the next recession in the early 1990s. Applying it to today's U.S. banking scene, MarketWatch says Mr. Cassidy and his colleagues predict that at least 150 U.S. banks will go bust in the next two or three years, and if the current economic slump morphs into a recession as deep as the ones in the 1980s and 1990s, that number may get as high as 300."

Stingy Links: Taleb

Taleb: the prophet of boom and doom
"For the non-mathematician, probability is an indecipherably complex field. But Taleb makes it easy by proving all the mathematics wrong. Let me introduce you to Brooklyn-born Fat Tony and academically inclined Dr John, two of Taleb's creations. You toss a coin 40 times and it comes up heads every time. What is the chance of it coming up heads the 41st time? Dr John gives the answer drummed into the heads of every statistic student: 50/50. Fat Tony shakes his head and says the chances are no more than 1%. 'You are either full of crap,' he says, 'or a pure sucker to buy that 50% business. The coin gotta be loaded.' The chances of a coin coming up heads 41 times are so small as to be effectively impossible in this universe. It is far, far more likely that somebody is cheating. Fat Tony wins. Dr John is the sucker. And the one thing that drives Taleb more than anything else is the determination not to be a sucker. Dr John is the economist or banker who thinks he can manage risk through mathematics. Fat Tony relies only on what happens in the real world."

Stingy Links: Taxes

The drawbacks of your assets being jointly owned
"The term "joint ownership" is used to loosely describe one of two common legal relationships: Tenants in common, or joint tenancy with right of survivorship (JTWROS). Tenants in common owners each hold separate ownership interests that can generally be sold or transferred without the consent of the other owners. But JTWROS is more common. In the case of JTWROS, the survivorship feature means that when an individual dies, the deceased person's interest is automatically distributed to the remaining joint tenants. Think of this as a "winner takes all" game. The asset will pass to the surviving owners outside of the deceased's estate. The result? Probate fees are avoided."

Canadian Tax Freedom Day: June 14
"The latest Tax Freedom Day in Canadian history was recorded in 2005, when it fell on June 25. Since 2005, Tax Freedom Day for the average Canadian family has steadily decreased. Tax Freedom Day dropped to June 23 in 2006 and June 18 in 2007. This year, Tax Freedom Day arrives four days earlier than in 2007. While recent Tax Freedom Days show a slight reduction in the tax burden, it is nevertheless a fact that Tax Freedom Day this year is over 40 days later than it was 47 years ago. In 1961, the earliest year for which the calculation has been made, Canadian Tax Freedom Day was May 3. By 1981, it had advanced to May 30, and in 2008 Tax Freedom Day will, as noted, fall on June 14."

Stingy Links: Thrift

How to retire on $12,000 a year
"The solution is social. It is called sharing, having enough social skills to multiply your effective income to a level far greater than it could be made with ordinary cash. The prosperity of the past 50 years has raised our expectations. We want to own our house, to have our own bedroom, our own bathroom, our own car, our own phone (preferably mobile) and our own TV, and we want to eat what we want for dinner, not what everyone else is having. That makes life very expensive. The productive social alternative is sharing. Economists call it "economies of shared living." Most of us think about it in regard to marriage."

Stingy Links: Tweedy

Value investing and behavioral finance
"My partners and I at Tweedy, Browne have in the past been skeptical of academic studies relating to the field of investment management primarily because such studies usually resulted in the birth of financial paradigms which we believe have no relevance to either what we do or to the real world. A whole body of academic work formed the foundation upon which generations of students at the country's major business schools were taught about Modern Portfolio Theory, Efficient Market Theory and Beta. In our humble opinion, this was a classic example of garbage in/garbage out. One could have just as easily manipulated the data to show that corporations with blue covers on their annual reports performed better than corporations with green covers on their annual reports. Although none of the three of us was fortunate enough to have studied under the late Dr. Benjamin Graham when he taught at Columbia Business School, we were fortunate enough to have observed some of his best students who either worked at or were customers of Tweedy, Browne from the late 1950s through the present. Tom Knapp, who was a partner at Tweedy, Browne from 1958 until the early 1980s, both studied under Ben Graham and worked for Ben's investment firm, The Graham-Newman Corporation. Walter Schloss, another alumnus of Graham-Newman, has made his office at Tweedy, Browne since he set up his private investment partnership in 1955. Still going strong at 84 and still housed at Tweedy, Browne, Walter has what we believe is the longest continual investment record of any individual in our field. Among others, Warren Buffett was a frequent visitor to Tweedy, Browne in the 1960s and early 1970s. My father was the primary broker for Warren in his purchase of stock in Berkshire Hathaway, and I can remember posting trades in Berky at $25 per share when I started working in 1969. Our exposure to these legendary investors whose investment principles were based on the teachings of Ben Graham, was the reason for our skeptical view of more modern investment theories."

Stingy Links: Value Investing

Rising from the stock market rubble
"The lock that commodities have on the Canadian market has made mutual funds with a value strategy a singularly awful investment in the past few years. But the Celestica story is a reminder that well-chosen value stocks do offer potentially fantastic rebound potential. What beaten-down Canadian stocks might be ready to pop? Let's nose around the portfolios of some of the country's top value fund managers and see what they're holding."

Conventional wisdom, foiled again
"It is widely assumed that a stock.s price will rise when it is added to a major stock market index. As is often the case with conventional wisdom about the stock market, however, the truth is more complicated. In fact, a new study has found that over the long term, stocks that are dropped from an index generally outperform those that are added."

Feast with the vultures
"A more rewarding approach may be to invest in companies such as Leucadia. Like Berkshire Hathaway, these are publicly traded holding companies run by managers with histories of sniffing out value. Yes, the risks are more concentrated. But returns, on average, exceed those of the typical value fund over the past decade. Patience is crucial, since returns can fluctuate unpredictably, rising in years when managers sell profitable investments and stagnating when they hold a lot of cash. Because of the stock market sell-off, share prices of many of these players are cheap vs. historic norms. And after largely sitting on the sidelines during the bull market, many of the companies are flush with cash. They are positioned to take advantage of lower stock prices as well as a projected spike in the default rate for U.S. speculative grade bonds."

Crossing the rubicon
"In light of the above comments, the partners of FPA came to a unanimous conclusion that the recent Federal Reserve actions and the potential new Congressional policies under consideration are likely to lead to a significantly higher level of long-term inflation in the U.S. We are more than disappointed in the substandard decision making that has taken place within the Federal Reserve and other governmental entities these last several years. The misguided monetary policies of the former Chairman of the Federal Reserve, Alan Greenspan, created an era of 'too big to fail' that has led to two major asset bubbles. With each successive bubble, the policy actions available to the Federal Reserve to reduce financial system risk have been systematically reduced. The extraordinary actions taken by the Bernanke Federal Reserve reflect acts of desperation rather than long-term policy solutions. The rapidly changing events within the capital markets are forcing the Fed to adopt policies that have the potential of long-term negative consequences."

Patient Capital Q1
"In fact we strongly believe that there is more trouble to come. Historically, there has never been a time when real estate values have declined dramatically without serious economic fallout."

Leucadia's 2007 letter
"One of us has been mumbling about Credit Armageddon for years and it seemed earlier this year that his fears were to be realized. At least for the time being, this nightmare has been avoided by strong government intervention. Unfortunately, we suspect that the wizards of Wall Street have not only made mischief in the mortgage market, but in all other loan markets as well and that the full effect of this is not yet visible. It seems that almost all financial institutions and investors have mispriced risk, and many financial institutions have found themselves carrying assets on their balance sheets at amounts considerably higher than market or their intrinsic worth. Recently, and often at the behest of regulators, financial institutions have been forced to sell these assets or to recognize the mark to market losses, all of which erodes net worth, forcing them to raise new equity capital and/or to reduce leverage, a process that has come to be known as deleveraging. It may take quite a while for the scrubbing of balance sheets and the unwinding of leverage to come to an end, and we suspect that not all will survive."

How fund manager didn't lose a bundle
"As for where Mr. Rodriguez is betting now? He's still bearish. He's on a "buyer's strike." But he is considering his next moves. He views the recent partial bailout of Bear Stearns as "a short term positive but a long term negative . for the dollar and for inflation." The reason? Once again those who behaved irresponsibly or worse are sticking everyone else with the tab. "This has expedited the socialization of risk and moral hazard, exponentially," he says. Stay tuned."

Credit crunch prepares feast for value hunters
"Value investors look at measures such as price-to-earnings and price-to-book ratios to find stocks that are trading at bargain prices. A key premise of value investing is that markets often overreact to negative news, pushing stocks below their true worth. The idea is to buy the stocks when nobody else wants them, so you can profit when the market comes back to its senses. Sound simple? It isn't. Buying stocks others are ditching requires a strong contrarian streak and loads of patience while you wait for the price to recover. Sometimes it takes years; sometimes it never happens."

Doubling down in financials
"Do clients ever get upset with you? They read the paper and then see that their money manager is busy buying the financials. The single most common question I get: 'Don't you read the newspaper? What is wrong with you?' So does the Pzena client need a strong stomach? Of course. We try and educate the clients before they open an account. We promise them that we will have these bad periods. Every single client, before they sign up, knows how badly we did in the last cycle. In the Internet bubble, the market was going up 30% a year, and we were going down. We were 60 percentage points behind the market, underperforming it for 10 consecutive quarters in '98, '99 and the first couple months of 2000. Now, that was extreme. The Internet bubble was extreme. We don't have such an extreme bubble today. But this is what we do: We buy bargains."

Fixes for bad timing
"Investing too early is one of the more common sins of value investors. Watching as that well-researched idea you loved a few months ago falls 20% to 30% can be painful and nerve-racking. Bruce Berkowitz, of the highly successful Fairholme fund, calls it "premature accumulation." Getting your timing wrong is inevitable -- especially in today's market, in which stock prices continue to plumb new depths in a wide variety of industries."

The economic skies might be falling
"Investors around world saw sunny skies yesterday, but Prem Watsa is still prepared for a hard rain. The chair of Fairfax Financial Holdings Ltd. boasts that Canada's top-performing financial-services company of the past year is sitting on a billion-dollar life raft of cash and marketable securities - in case North America has the perfect economic storm."

Stingy Links: Whitman

Third Avenue Q2 2008 letter
"One of the important lessons from the Bear Stearns debacle for TAVF is to avoid owning common stocks where the businesses need to have relatively continuous access to capital markets in order to survive as going concerns."

Stingy Links: World

Malthus, the false prophet
"Given the fear that a new era of chronic shortages may have begun, it is perhaps understandable that the name of Thomas Malthus is in the air. Yet if his views were indeed now correct, that would defy the experience of the past two centuries."

The question of global warming
"It is likely that biotechnology will dominate our lives and our economic activities during the second half of the twenty-first century, just as computer technology dominated our lives and our economy during the second half of the twentieth. Biotechnology could be a great equalizer, spreading wealth over the world wherever there is land and air and water and sunlight. This has nothing to do with the misguided efforts that are now being made to reduce carbon emissions by growing corn and converting it into ethanol fuel. The ethanol program fails to reduce emissions and incidentally hurts poor people all over the world by raising the price of food. After we have mastered biotechnology, the rules of the climate game will be radically changed. In a world economy based on biotechnology, some low-cost and environmentally benign backstop to carbon emissions is likely to become a reality."

The hidden costs of fuel subsidies
"Why should China keep domestic fuel prices at about half of the global average? The usual answers are to keep inflation in check and stave off social instability that could result if prices were to rise too quickly. But by distorting fuel prices, China is encouraging fuel consumption and discouraging the use of new energy. Since the Chinese still live in an $80-a-barrel oil environment, demand for anything from cars to chemical products will spiral higher and raise the risks of economic overheating. Increasing subsidies on fuel will crowd out more investment in other areas, such as education or health care, to name two possibilities."

Why oil prices will tank
"In a normal oil market, the cost of producing the last, most expensive barrel of oil needed to satisfy worldwide demand sets the price for every barrel the world over. Other auction commodity markets work much the same way. So even if Saudi Arabia produces at $4 a barrel, if the final, multi-millionth barrel required to heat houses and run cars costs $50, and is produced, for argument's sake, at a flagging field in West Texas, the world price is $50. That's what economists call the equilibrium price: It's where the price that customers are willing to pay meets the production cost, including a cushion, naturally, for profit or "the cost of capital." But today, the sudden surge in demand and the production bottlenecks have thrown the market radically out of balance."

An old enemy rears its head
"Even as America's economy teeters on the brink of recession and many European economies are slowing, central bankers in rich countries fear rising inflation. Yet the risks they face are smaller than those in emerging economies, where inflation has risen far more over the past year to its highest for nine years. There are also an alarming number of similarities between developing economies today and developed economies in the early 1970s, when the Great Inflation took off. Are the young upstarts heading for trouble?"

Hijacking the Hermitage Fund
"Corruption, intimidation, robbery, violent assault, forgery, large-scale fraud. No, not the subject of the latest John Grisham novel, but sensational allegations, made public Apr. 4 by Hermitage Capital Management.until recently the largest foreign portfolio investor in Russia. In a detailed and damning report, titled Criminal Justice.Russian-Style, Hermitage alleges the fund's Russian subsidiaries have fallen victim to an elaborate con designed to defraud the fund of hundreds of millions of dollars. The most sensational part of Hermitage's allegations is that the attempted larceny was carried out with the direct connivance of officials in the Russian police. Hermitage alleges the police seized documents and equipment that were instrumental to the attempted fraud, which involved bogus court cases based on forged documents, the aim of which was to sue Hermitage subsidiaries for hundreds of millions of dollars. "The most shocking thing is not that there are corporate raiders in Russia who attempt to steal your shares," says Jamison Firestone, managing partner of Firestone Duncan, Hermitage's law firm. "The shocking thing is that the police worked hand-in-hand with them, and actually performed the theft of the documents so that the corporate raiders could then do their work.""

From communism to environmentalism
"My deep frustration has been growing exponentially in recent years due to the facts that almost everything has already been said, that all rational arguments have been used and that global warming alarmism is still marching on. The whole process is already in the hands of those who are not interested in rational ideas and arguments. It is in the hands of climatologists and other related scientists who are highly motivated to look in one direction only because a large number of academic careers has evolved around the idea of man-made global warming. It is, further, in the hands of politicians who maximize the number of votes they receive from the electorate. It is also -- as a consequence of political decisions -- in the hands of bureaucrats of national, and more often of international, institutions who try to maximize their budgets and careers regardless of the costs, truth and rationality. It is in the hands of rent-seeking businesspeople who are -- given the existing policies -- interested in the amount of subsidies they receive and look for all possible ways to escape the positive, general welfare enhancing functioning of free markets. An entire industry has developed around the funds these firms are getting from the government."

Dead end for free trade
"The long-ago promise of the Canada-U.S. free-trade deal was about dismantling barriers - tariff and otherwise - along the world's longest undefended border. But those benefits are being slowly eroded as companies absorb ever greater costs - anything and everything to keep trade moving. Just-in-time inventory management has evolved into just-in-case. Companies are stockpiling inventory in both countries to cope with the increasingly unpredictable border, wiping out many of the efficiencies of integrated supply chains, according to recent studies by the Conference Board of Canada as well as the Canadian and U.S. Chambers of Commerce. Stockpiling isn't the only coping mechanism seeping into everyday business. Disturbingly, businesses are reverting to behaviour that was common before free trade, a trend that is eroding the benefits of Canada's open access to the U.S. market, the Conference Board concluded."

The wonder fish
"Our oceans are being drained of food. Doctors tell us to eat more fish; it's good for the brain and good for the heart. We yearn for our weekly sushi fix. And increasingly so do our friends in China, India, and elsewhere in the developing world. To meet this growing appetite, commercial fishermen are scooping up everything that's edible (and a lot of what's not). Couple that trend with the effects of global warming, and the situation has become so dire that some scientists think seafood stocks will totally collapse by 2048."

Spanish property auction flop
"House prices began their surge in 1998 spurred by falling interest rates as Spain prepared for euro membership. Spain has built about 5 million new homes since then, attracting immigrant labor from Eastern Europe and Latin America to fuel a boom that peaked in 2006. Now the turmoil in global credit markets is cutting demand. The world's biggest financial companies have reported about $232 billion in credit losses and writedowns since the start of 2007 and the credit shortage is filtering through to Spain."

Frugally Yours,
Norman Rothery
ISSN 1499-2787

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