surviving the end of civilization

In his 2008 bestseller, "Wealth, War and Wisdom," hedge fund manager Barton Biggs warns that investors must "assume the possibility of a breakdown of the civilized infrastructure."

And to prepare for a breakdown of civilization, "your safe haven must be self-sufficient and capable of growing some kind of food ... It should be well-stocked with seed, fertilizer, canned food, wine, medicine, clothes, etc." Bloomberg Markets suggested that by "etc." he meant guns, as Biggs added "a few rounds over the approaching brigands' heads would probably be a compelling persuader that there are easier farms to pillage."

That warning's not from a hippie radical. Biggs was a respected Wall Street guru at Morgan Stanley for 30 years. As the chief global strategist Institutional Investor magazine put him on its "All-America Research Team" 10 times. Smart Money said: "Biggs is without question the premier prognosticator on the international scene and a mover of markets from Argentina to Hong Kong."

Behavioral economists have answers. But your gut's also good at predicting. So here's what you'll likely do:

You'll go see the new disaster film, "2012" about the end of the Mayan calendar. After all, it's by the same director who "destroyed" the earth in "The Day After Tomorrow," "Independence Day" and "Godzilla." No new investment strategies, but a must-see film, a great catharsis and distraction.

What will Main Street investors do? Here again, even with the planet's survival threatened, they'll go watch "2012," be entertained, experience a catharsis, feel relieved, and afterwards, have dinner, slip back into denial. And later, they'll vote against anything that offers solutions to future problems, especially if it raises taxes.

Why? Very simple: Our "Brains Aren't Wired to Fear the Future," writes New York Times columnist Nicholas Kristof. We're wired to respond to crises, while pushing off the real big problems (health care, Social Security, etc.)

That's basic behavioral economics: Over tens of thousands of years, evolution has programmed our brains so that collectively we will behave counter-productive with the future, making an "End of Civilization" scenario inevitable, a foregone conclusion, a self-fulfilling prophecy ["Mr. Anderson"]. Why? Because our brains are handicapped, we are literally incapable of acting soon enough to solve the problem.

[via pbo]

unemployment rate dips, stock market goes up

The American economy has shed 6.7 million jobs since the start of the recession, but workers got a bit of good news this morning: the unemployment rate dipped for the first time in more than a year. It now stands at 9.4 percent, down from 9.5 percent. The U.S. Department of Labor reported this morning that employers still cut payrolls in July, but the total job losses were far lower than expected: 247,000.

"The worst may be behind us," President Barack Obama said outside the White House today.

The Dow Jones industrial average climbed 113 points to close at 9,370, closing off another straight up week on Wall Street.

The Standard & Poor's 500, the broadest index of the nation's corporate economy, rose 1.3 percent to close at 1,010, a 10-month high. The Nasdaq rose 1.37 percent today to close at 2,000.

With the pop Friday, the S&P 500 index is up 14.9 percent in only four weeks and 49.4 percent from a 12-year low in early March.

* * *

So I'm guessing if the unemployment rate resumes rising on the next report, expect a market dip.

The Lottery Effect

One way optimism in security selection is evidences is by the lottery effect. Investors seem driven to investments as having the potential for large gains, such as biotech companies working on cancer cures or mutual funds investing in developing countries. Behavioral researchers have found their decision-makers tend to overweight the strength of information signals (i.e. return potential) and underweight their probability of occurrence (i.e. likelihood of success).

Simply stated, investments perceived as having high return potential tend to be overvalued.

-- Greg Forsyth, OnInvesting, Summer 2007

federal tax revenues plummetting

WASHINGTON (AP) -- The recession is starving the government of tax revenue, just as the president and Congress are piling a major expansion of health care and other programs on the nation's plate and struggling to find money to pay the tab.

The numbers could hardly be more stark: Tax receipts are on pace to drop 18 percent this year, the biggest single-year decline since the Great Depression, while the federal deficit balloons to a record $1.8 trillion.

Other figures in an Associated Press analysis underscore the recession's impact: Individual income tax receipts are down 22 percent from a year ago. Corporate income taxes are down 57 percent. Social Security tax receipts could drop for only the second time since 1940, and Medicare taxes are on pace to drop for only the third time ever.

The last time the government's revenues were this bleak, the year was 1932 in the midst of the Depression.

Now comes August

The Dow Jones Industrial Average ($INDU) had its best monthly performance -- up 8.6% -- since October 2002 and its best July since 1989.

The Standard & Poor's 500 Index ($INX) and the Nasdaq Composite Index ($COMPX) were up 7.4% and 7.8%, respectively -- their best July performances since 1997.

Now comes August, which can be a problematic month, which is followed by the always dangerous September. Since 1987, August has been one of the stock market's weakest months of the year, the Stock Trader Almanac says. August also typically sees low volume as many traders and investment professionals go on vacation.

August 2008, however, was benign: The Dow was up 1.5%, with the S&P 500 up 1.2% and the Nasdaq up 1.8%. But the market literally crashed in September 2008.

The Cheshire Multiple

When a growing number of people buy stocks—and from one another, remember—prices are driven up because buyers outnumber sellers. And as brokerage statements indicate the last selling price of the stock, investor portfolios become inflated.

The economy can get into big trouble this way. You can’t buy the same stock back and forth numerous times, inflating its price, and think that you’re creating real dollars. Yet that’s just how many investors behave.

To illustrate, say that 10 million investors each own 100 shares of stock in a company. Then I pay $1 more than the last fellow for a share. As a result, the stock price goes up by $1, and all 10 million shareholders see their portfolios rise by $100. But did I create $1 billion of wealth, the total of that increase? Of course not.

This apparent $1 billion was generated by what I call the “Cheshire multiple” (after the disappearing cat in Lewis Carroll’s Alice’s Adventures in Wonderland). It exists mostly in the imagination.

Only a small percentage of investors can sell their shares at the price on their brokerage statements. As soon as sellers outnumber buyers, the price will fall and portfolios will shrink due to that same multiple. It works both ways. So most of this so-called money simply vanishes. No one gets it.

cash still king

NEW YORK (AP) — That old saying "cash is king" certainly rings true these days. Investors can't seem to get enough of it, which ultimately could be bad news for the stock market and the economy.

In the past, investors would cling to cash until the market's prospects brightened and then money would pour back into stocks. That's just what the bulls today are hoping will drive a surge on Wall Street in the months ahead.

But the shock of the financial crisis — which have made leverage and risk-taking dirty words — may be changing all that. Even with today's minuscule returns, cash seems to have become a sought-after asset class among investors who intend to keep it as a part of their portfolios for the long term.

Historical data he has crunched shows that whenever assets in money market mutual funds — which are low-risk, highly liquid investments — exceeded 25 percent of the market capitalization of the Standard & Poor's 500 index, stocks have rallied over the following two years.

This ratio jumped to an almost-unheard of level of more than 60 percent on March 9, almost triple the median level in the early years of this decade, for two reasons. Money market fund totals have surged 30 percent since the stock market peaked in October 2007, and by early March the S&P 500's market cap had plunged 57 percent from its high point in 2007.

Today, that ratio has narrowed to about 45 percent, primarily because of a recent rebound in stocks. There is $3.7 trillion sitting in money market mutual funds right now, and the market cap of the S&P 500 is about $8 trillion, up from a March low of $5.9 trillion.

Principles of Economics

translated by Yoram Bauman (video)

[via wstr75, 12/31/08]

Q&A with Joel Greenblatt

(GuruFocus, June 30, 2009) Back in early June, when we became aware of Investment Guru, Joel Greenblatt became the strategist for the money management firm FormulaTrading.com, we reached out and requested an opportunity for our users to ask Joel questions. To our delight, the good professor (Joel is also an Adjunct Professor with Columbia University) agreed.

* * *

Comments on the interview

* * *

Steve Forbes interviews Greenblatt

Expanding the Magic Formula

anchoring bias

In a famous paper from 1974, behavioral scientists Tversky and Kahneman describe this bias in the following manner:

In many situations, people make estimates by starting from an initial value that is adjusted to yield the final answer. The initial value, or starting point, may be suggested by the formulation of the problem, or it may be the result of a partial computation. In either case, adjustments are typically insufficient That is, different starting points yield different estimates, which are biased toward the initial values. We call this phenomenon anchoring.

Tversky and Kahneman observed this behavior in a number of experiments conducted in the early 1970s. In the most well-known of these studies, the researchers asked participants to estimate the percentage of African countries in the United Nations. The results indicated that people anchored their answer to completely arbitrary numbers presented by the researchers. For example, the median estimate of people who were given 10% as a starting point was 25% and the median estimate of people who were given 45% as a starting point was 65%. Specifically, people became anchored to the percentage suggested to them by the question even though that number had nothing to do with the actual percentage of African countries in the UN. Having no knowledge of the exact percentage, people subconsciously took their cues from the numbers presented in the questioning despite the fact that those numbers were randomly generated.

Now, how does this bias manifest itself in the investing world? I think the main way in which investors can fall prey to this pitfall is by paying too much attention to the past prices of securities. The two most prevalentnumbers that people seem to anchor to are the 52 week high and 52 week low for a stock. Setting aside technical analysis, in my young career I have observed a marked tendency for people to assume that a stock has potential to get back to its 52 week high but not breach its 52 week low. I think this is a reflection of the eternal optimism that exists in the market. On some level even short sellers believe that the market’s trajectory over the long run is more likely to be up than down. The problem with this thought process is that it assumes that those numbers are an indication of value and are not just random outcomes based on the whims of the market. In the end the value of a stock should be based on its earnings potential, a value that at certain times may have absolutely nothing to do with the current stock price. A quick look at the ride the Nikkei Stock Exchange has had over the past 20 years provides a sobering reminder that previous highs may never be reached again and stocks can stay at low nominal values for a protracted period.

* * *

I dunno. Since anchoring exists, technical analysis must work too. In the sense that people do look at previous levels which must act as some form of resistance and support, regardless of the fundamentals.

The 0% Tax Rate Solution

The federal income tax code is now so mangled that we can probably increase federal revenues with a 0% income tax rate for a majority of Americans.

Long before President Barack Obama took office, the bottom 40% of income earners paid no federal income taxes. Because of refundable income tax credits like the Earned Income Tax Credit (EITC), in 2006 these bottom 40% as a group actually received net payments equal to 3.6% of total income tax revenues, according to the latest Congressional Budget Office data. The actual middle class, the middle 20% of income earners, pay only 4.4% of total federal income tax revenues. That means the bottom 60% together pay less than 1% of income tax revenues.

This actually resulted from Republican tax policy going all the way back to the EITC, which was first proposed by Ronald Reagan in his historic 1972 testimony before the Senate Finance Committee on the success of his welfare reforms as governor of California. Besides calling for workfare, Reagan proposed the EITC to offset the burden of Social Security payroll taxes on the poor. As president, Reagan cut and indexed income tax rates across the board and doubled the personal exemption. The Republican majority Congress, led by former House Speaker Newt Gingrich, adopted a child tax credit that President George W. Bush later expanded and made refundable, while also reducing the bottom tax rate by 33% to 10%.

President Bill Clinton expanded the EITC in 1993. But it was primarily Republicans who abolished federal income taxes for the working class and almost abolished them for the middle class. Now Mr. Obama has led enactment of a refundable $400 per worker income tax credit and other refundable credits, which probably leaves the bottom 60% paying nothing as a group on net.

* * *

I find this hard to believe since everybody I know pays income tax. Since I actually pay income tax, does that mean I make more than 40% of Americans? Or more like I have less exemptions than they.

[Just supposing] I'm trying to look at it as a closed system where money is circulating from producers to consumers back to producers etc. The minority rich become rich because in general they're getting money from the majority poor (or middle-class). In other words, the poor are consuming the products of the rich. That's the way a capitalist society works (in my mind anyway).

But you don't want the poor to become too poor, otherwise they become a burden to society. You want them to be functional so they can continue to circulate money to keep the system running.

The problem is how to do this. How? By taking (taxing) the rich to supplement the poor. Like welfare? Which doesn't seem to be working too well. Or buy lowering taxes on the rich so that they can expand their business and provide jobs to the poor.

But one might ask how making the rich richer can make the poor richer too, when there's only so much money to go around. I think the idea is that it'll increase the velocity of money so it'll circulate better.

I don't know (obviously). But I think most people think of these things on one level and not as a system. If they think about it at all.

stocks underperform bonds

As of June 30, U.S. stocks have underperformed long-term Treasury bonds for the past five, 10, 15, 20 and 25 years.

Still, brokers and financial planners keep reminding us, there's almost never been a 30-year period since 1802 when stocks have underperformed bonds.

These true believers rely on the gospel of "Stocks for the Long Run," the book by finance professor Jeremy Siegel of the Wharton School at the University of Pennsylvania that was first published in 1994.

Using data assembled by other scholars, Prof. Siegel extended the history of U.S. stock returns all the way back to 1802. He came to two conclusions that became articles of faith to millions of investors: Ever since Thomas Jefferson was in the White House, stocks have generated a "remarkably constant" average return of nearly 7% a year after inflation. (Adding inflation at 3% yields the commonly cited 10% annual stock return.) And, declared Prof. Siegel, "the risks of holding stocks decrease over time."

There is just one problem with tracing stock performance all the way back to 1802: It isn't really valid.

* * *

[7/15/09] Jeremy Siegel responds (sort of).

The short answer is that stocks are still the best long-term investments. As bad as the past decade has been, there have been other 10-year periods during which stocks have recorded even bigger losses. Yet over periods of 20 years or longer, stocks have never lost money, even after inflation. Including the latest bear market, stock returns have averaged 7.8% per year over the past 20 years and 11% annually over the past 30.

After periods of sluggish returns, stocks tend to regain their oomph. Stock returns over the past five and 10 years have fallen to the bottom quartile when measured against all five- and 10-year periods since 1871. But history shows that after reaching such a low, stocks' average return for the next five years has been almost 9.5% annually after inflation.

Furthermore, once stocks have plunged 50% from their highs, which they have done during the current bear market, investors have always been rewarded with winners over the next five years -- and that includes the Depression decade of the 1930s. In December 1930, stocks were 50% off their highs of September 1929. Yet, over the next five years -- when the economy was experiencing the greatest contraction in its history -- investors were rewarded with an annual return of 7% after inflation.

Zacks Strategies

[an ad from Zacks]

Zacks Investment Research specializes in the coverage of corporate earnings. And more importantly, how to profit from this information. So, today I'm going to share with you 3 proven strategies to profit from earnings announcements.

Strategy 1: Four Leading Indicators of Positive Earnings Surprises

I figured its best to get the most obvious strategy out of the way first. The 4 leading indicators I refer to are the 4 factors of the Zacks Rank. Before you skip this section, let me share some information with you that you may not have known.

In the mid-1970s, Len Zacks took his mathematical skills to Wall Street, where his job was to discover stock picking strategies that would beat the market. He had a simple theory that was the precursor to what became the Zacks Rank.

Len focused his research on finding stocks that were more likely to have a positive earnings surprise and jumping on the news. The journey led him to what we know as the 4 factors of the Zacks Rank. Each individually increases the odds of owning stocks that will enjoy a positive earnings surprise. However, when you combine them together inside the Zacks Rank, it becomes an almost obscene advantage for investors. (Learn more about 4 Factors of the Zacks Rank, in this video.)

Strategy 2: Stop the Bleeding

This second strategy is so simple, yet so hard for most investors to do. So, I'm going to beat it into your head...for your own good of course ;-)

Sell All Companies with a Negative Earnings Surprise

Yes, sell it immediately. Even after it falls at the open. Even if it is for a substantial loss. Why? Better to take a 10-20% loss in the short run than a 20 to 40% loss in the long run.

Strategy 3: Buy High and Sell Higher - Most Profitable Strategy

I saved the best for last. This strategy has proven to be the most profitable way to harness earnings surprises. This proprietary metric is called the Price Response Indicator, or PRI.

The PRI is amazingly accurate at saying which stocks will rise in the days following an earnings announcement and which won't. Proving the truism "Buy High and Sell Higher."

The scoring system for the PRI correlates the percent earnings surprise and short-term price reaction preceding the announcement. The model scores stocks from A to E with A's and B's being the most likely to increase in price in the days following the surprise. These signals are produced by our systems within hours after the company reports earnings.

At this time, the daily feed of PRI signals is only made available to our institutional clients. However, the Zacks Surprise Trader service filters down all the PRI signals with additional variables to find the 2% that have historically provided the best returns. From there we hand pick the signals, turning down 5 out of every 6 to provide our subscribers with a phenomenal opportunity to beat the market.

How phenomenal? Since inception in May 2006, Surprise Trader has generated a +16.0% return versus a devastating loss of -24.1% for the S&P 500. Just imagine how well it will perform when we finally leave this bear market behind.

Today is the perfect time to learn more about the Surprise Trader. Why? First, earnings season is coming into full swing. Second, the service has grown so popular that it closed to new members. We've reopened it briefly to give Zacks.com investors one more chance to get in. But we're closing the service again at midnight Saturday, July 11, 2009. This is your chance to avoid the Waiting List and also enjoy a substantial savings.

Learn more about Surprise Trader special offer >>

[closed to new subscribers]

Cap and Trade

Warren Buffett carries plenty of weight in any debate -- even when he gets it wrong.

So as the Senate digs into the climate-change bill that passed the House of Representatives last month, it’s worth taking a hard look at how Buffett’s views on the bill went off course.

[via iluvbabyb]

Wells Fargo sues itself

You can't expect a bank that is dumb enough to sue itself to know why it is suing itself.

Yet I could not resist asking Wells Fargo Bank NA why it filed a civil complaint against itself in a mortgage foreclosure case in Hillsborough County, Fla.

In this particular case, Wells Fargo holds the first and second mortgages on a condominium, according to Sarasota, Fla., attorney Dan McKillop, who represents the condo owner.

As holder of the first, Wells Fargo is suing all other lien holders, including the holder of the second, which is itself.

"The primary reason is to clear title and ownership interest in a property to prepare it for sale," Waetke said in an email exchange. "So it really is not Wells Fargo vs. Wells Fargo."

Yet court documents clearly label "Wells Fargo Bank NA" as the plaintiff and "Wells Fargo Bank NA" as a defendant.

[via chucks_angels]

Pompous Prognosticators

1927-1933 Chart of Pompous Prognosticators

[via brknews]

Toyota vs. Ford

A Japanese company (Toyota) and an American company (Ford Motors) decided to have a canoe race on the Missouri River. Both teams practiced long and hard to reach their peak performance before the race.

On the big day, the Japanese won by a mile.

The Americans, very discouraged and depressed, decided to investigate the reason for the crushing defeat. A management team made up of senior management was formed to investigate and recommend appropriate action.

Their conclusion was the Japanese had 8 people rowing and 1 person steering, while the American team had 207 people steering and 2 people rowing.

Feeling a deeper study was in order; American management hired a consulting company and paid them a large amount of money for a second opinion.

They advised, of course, that too many people were steering the boat, while not enough people were rowing.

Not sure of how to utilize that information, but wanting to prevent another loss to the Japanese, the rowing team's management structure was totally reorganized to 4 steering supervisors, 2 area steering superintendents and 1 assistant superintendent steering manager.

They also implemented a new performance system that would give the 2 people rowing the boat greater incentive to work harder. It was called the 'Rowing Team Quality First Program,' with meetings, dinners and free pens for the rowers. There was discussion of getting new paddles, canoes and other equipment, extra vacation days for practices and bonuses. The pension program was trimmed to 'equal the competition' and some of the resultant savings were channeled into morale boosting programs and teamwork posters.


The next year the Japanese won by two miles.

Humiliated, the American management laid-off one rower, halted development of a new canoe, sold all the paddles, and canceled all capital investments for new equipment. The money saved was distributed to the Senior Executives as bonuses.

The next year, try as he might, the lone designated rower was unable to even finish the race (having no paddles,) so he was laid off for unacceptable performance, all canoe equipment was sold and the next year's racing team was out-sourced to India.

Sadly, the End.

Here's something else to think about: Ford has spent the last thirty years moving all its factories out of the US, claiming they can't make money paying American wages.

TOYOTA has spent the last thirty years building more than a dozen plants inside the US. The last quarter's results:

TOYOTA makes 4 billion in profits while Ford racked up 9 billion in losses.

Ford folks are still scratching their heads, and collecting bonuses.

IF THIS WEREN'T SO TRUE IT MIGHT BE FUNNY

[via chucks_angels, 12/3/08]

What Makes Fidelity Tick?

Fidelity's culture is defined by paradox. It invests heavily in its investment capabilities, but it's also a marketing machine. It's a leviathan, yet it encourages individuality. It hires some of the best and brightest analysts and managers, but it too frequently shifts them from fund to fund, making it difficult for investors to benefit from their talents.

Ultimately, Fidelity's greatest strength is its individualistic ethic. It's not a place where you'll find many cookie-cutter personalities. Instead of imposing rigid, one-size-fits-all constraints, Fidelity managers have latitude to implement their own investment strategies. And unlike many overly buttoned-down investment organizations, Fidelity tolerates offbeat, and even eccentric, personalities--so long as they put up the numbers. While more buttoned-down investment organizations might push conformity, Fidelity encourages creativity. It could well be that the reason that great investors like Peter Lynch, Will Danoff, and Joel Tillinghast emerged from Fidelity is because they had the freedom to think and invest differently.

TARP Payback

The banks that got the green light to pay back their Troubled Asset Relief Program funds aren't wasting time returning money to the government.

Capital One Financial (COF, news, msgs) late Wednesday confirmed that it paid back the $3.75 billion it received last fall amid the financial market turmoil. JPMorgan Chase (JPM, news, msgs) repaid $25 billion, and Goldman Sachs (GS, news, msgs) and Morgan Stanley (MS, news, msgs) each paid back $10 billion.

BB&T (BBT, news, msgs) said it paid back $3.1 billion in loans it received from the government. The bank now has "a singular focus on the business of serving clients," Chief Executive Officer Kelly King said in a statement.

American Express (AXP, news, msgs) returned $3.4 billion, U.S. Bancorp (USB, news, msgs) paid back $6.6 billion, State Street (STT, news, msgs) refunded $2 billion, Bank of New York Mellon (BK, news, msgs) gave back $3 billion, and Northern Trust (NTRS, news, msgs) paid back $1.6 billion.

"Over the long term . . . this is a very promising sign that things are getting back to normal," Uri Landesman, of ING Investment Management, told The Wall Street Journal.

Combined, the 10 banks are repaying $68 billion in TARP funds less than nine months after the Treasury Department introduced the $700 billion fund.

But the banks still have to deal with the warrants the government holds -- the banks want to buy them back. The warrants had given the Treasury the right to buy common stock in the banks for up to 10 years, in the hopes that they could benefit from a rebound in their stock prices.

Earlier this month, Treasury said that banks can buy back the warrants at "fair market value"; an announcement on how they will be priced is expected Friday.

Citigroup (C, news, msgs) and Bank of America (BAC, news, msgs), which each received $45 billion in government loans, have not yet received Treasury's clearance to pay their funds back.

The bankruptcy of General Motors

General Motors (GM $0.60) filed for bankruptcy this morning and is the third-largest in US history and the largest-ever US manufacturing failure, according to Reuters. GM will receive an additional $30 billion in taxpayer funds to aid the restructuring of the 100-year-old automaker and the government plans to convert most of its $50 billion in loans to assume a 60% stake in the company. GM will be put through a "fast-track bankruptcy," which is expected to result in a new company in about 60 to 90 days. The Canadian government will contribute $9.5 billion in aid in exchange for a 12.5% stake in the automaker. GM plans to close 11 facilities and idle another 3 plants. President Barack Obama is set to speak on the announcement at 12 p.m. ET.

Following the bankruptcy of GM, two of the "big three" automakers will be in court-ordered restructuring and yesterday a bankruptcy judge approved the sale of nearly all of the US assets of privately-held Chrysler to a group led by Italian automaker Fiat (FIATY $11).

In related news, General Motors and Citigroup (C $4) have been removed from the Dow Jones Industrial Average and will be replaced with insurer Travelers Companies (TRV $42) and tech bellwether Cisco Systems (CSCO $19). Shares of TRV and CSCO are nicely higher. Additionally, the New York Stock Exchange said trading in GM shares will be suspended prior to the opening of trading tomorrow.

[Charles Schwab Midday Market View, 6/1/09]

Super Rich Friends

Warren Buffett and his friend Bill Gates reportedly joined with David Rockefeller Sr. to invite a group of the world's richest people to gather in one room earlier this month.

The agenda wasn't world domination. It was making philanthropy more effective.

Among the other well-known, and very wealthy names, attending the meeting on May 5 in New York City: Michael Bloomberg, Peter Peterson, George Soros, Ted Turner, and Oprah Winfrey.

Former Gates Foundation Chief Executive Patty Stonesifer tells the Seattle News:

"It wasn't secret. It was meant to be a gathering among friends and colleagues. It was something folks have been discussing for a long time. Bill and Warren hoped to do this occasionally. They sent out an invite and people came... This was about philanthropy and this group sharing their passions their interests. They each learned from each other about what could really make a difference."

John Berman at ABC's Good Morning America light-heartedly compared the event to a gathering of cartoon super heroes, specifically the Saturday morning "Super Friends" of the 1970s and 80s.

[via brknews]

The Zen of Investing

Once upon a time, there was a man. Like many men, he held some shares in a few companies. Every week, he would gather with his friends at a local diner.

Grantham was buying in March

JG: We think a fair price for the S&P 500 index is 900. By sheer divine intervention we bought into the market on Mar. 6, the day it hit the recent low of 666. It’s likely, but far from certain, that we’ll go back and make a new low. You aren’t going to get to buy at the absolute low unless you have a time machine.

SM: Anything else besides U.S. stocks?

JG: U.S. stocks were nicely cheap, and frankly, the rest of the world was even cheaper. In early March, when we bought, we invested only in stocks we thought would have a 10 to 14 percent average annual return after inflation. That’s magnificent. We haven’t seen anything like that in 20 years. It was somewhat disappointing that prices moved up so fast in just a couple of weeks. The odds are a bit more than 50-50 that we will go back and test that low.

SM: So you’ve made a quick buck. Now what?

JG: You have a set of possibilities. First, if the market nosedives, it’s easy: You buy. The second is confusing, when the market just goes sideways, between 700 and 800. The market is irritatingly cheap then, but not supercheap. The longer that goes on, the less probability we will set a new low, so we’ll ultimately put money each month into the market.

SM: What if stocks keep rallying?

JG: If the market goes higher, above 950, and then starts moving sideways, between 950 and 1050, we probably do very little. Then the market is moderately overpriced.

[via twitter]

10 Who Will Be Missed

Memorial Day is a time of remembrance for those who gave their lives in the name of their country—often on battlefields thousands of miles away from the towns they called home. These observances can be traced back over 140 years to the Civil War. Over time, however, the holiday has evolved for many Americans into a chance not only to honor fallen heroes, but also to pay respect more broadly to family members, friends and colleagues who have passed away.

In that spirit, SmartMoney presents this look at some prominent figures in the financial world who died over the past year.

Sir John Templeton / Investor, Philanthropist

Betty James / President, James Industries

Bill Seidman / Former chairman, FDIC; Television commentator

Jack Nash / President, Oppenheimer & Co.; Founder, Odyssey Partners

Rocky Aoki / Founder, Benihana

Irvine Robbins / Co-Founder, Baskin-Robbins

Kenneth Macke / Former chairman, Dayton Hudson (forerunner of Target)

George Keller / Former CEO, Chevron

Helen Galland / Former president, Bonwit Teller

Jack Dreyfus / Founder, Dreyfus Fund

India up 17%

India's stock market surged an unprecedented 17 percent, forcing trade to close for the day, after the Congress Party's definitive victory in national elections set the scene for long-delayed economic reforms.

In just seconds of trading, the Bombay Stock Exchange's benchmark Sensex vaulted 2,110.79 points, or 17.3 percent, to 14,284.21, triggering the historic shutdown Monday.

[5/18/09, posted 6/6/09]

The worst decade

investors have suffered through the second worst decade for stocks on record — a record that includes the Crash of 1929 as well as the Great Depression. In fact, even if the market produces satisfactory returns for 2009 (and it is certainly not off to a good start), it is highly likely that the 10 year period ending this coming December will prove to be the worst decade ever, as it will no longer include the 21% return of 1999. Given that the market has lost 3.6% per year for the last nine years versus the 1.7% annual loss suffered between 1928—1938, currently the worst decade on record, this is not a bold prediction.

the pattern of recession

The economic events of 2008 were unusually severe, but they fit a historical pattern. Since 1945, the U.S. economy has experienced 12 recessions—about one every five and a half years1—and each recession has been followed by a period of expansion.

Painful as they may be, recessions help set the stage for the recoveries that follow. Economic contractions typically serve to correct issues that become problematic during periods of growth. For example, American companies took on huge amounts of debt during the 1990s as the U.S. economy enjoyed nearly a decade of strong growth. The economy slid into recession in 2001—and the Federal Reserve responded by cutting short-term interest rates to 40-year lows. Lower interest rates allowed companies to refinance debt, improve balance sheets, and position themselves for growth as the economy strengthened.

Similar forces are at work in the current recession. During the last economic expansion, burgeoning global growth led to enormous demand for energy and raw materials, causing prices to skyrocket. Oil prices, most notably, which had bottomed out at $10 a barrel in 1998, soared to $147 a barrel by early July 2008. Oil is an essential expense for most businesses, so higher prices squeezed profits for companies ranging from pizza delivery chains to airlines. But the current recession has acted as a pressure-release valve for oil and materials prices. Demand for oil has dropped, pushing prices down to $50 a barrel as of mid-March. While businesses face a host of challenges in this recession, high costs for energy and materials are not among them for the moment.

The current economic crisis also is forcing corporations to clean up their balance sheets, much as the 2001 recession did. Companies across the country are becoming more efficient and eliminating unprofitable lines of business. Those that can’t compete are being absorbed by competitors or simply going out of business—a Darwinian process known as “creative destruction” that eventually makes the economy more efficient.

Financial markets historically have responded to recessions in relatively consistent ways. Stocks typically have turned down before recessions, continued falling during recessions’ early stages, and rebounded strongly before the recessions ended.

When investors anticipate a recession, they tend to sell shares of economically sensitive companies while holding on to shares of firms that provide essentials such as food, electricity, household staples, and health care. This trend held true in the fourth quarter of 2008, when defensive sectors declined the least, as shown in the chart below. “When the going gets tough, people tend to eat, drink, smoke, and go to the doctor,” says Sam Stovall, chief investment strategist for Standard & Poor’s. “Industrials, technology, financials, and consumer discretionary shares generally take the biggest hit.”

Just as stocks usually start declining in advance of a recession, they typically rise well before the recession ends, as investors start anticipating a recovery. Indeed, in 10 of the last 11 complete recessions, the market rebounded before the recession’s end.6 (The exception: the bear market between 2000 and 2002, which had to work through extreme valuations and the bursting of the Internet bubble, in addition to economic weakness.) “The market trends up when things still feel really awful to a casual observer,” Hofschire says.

Recessionary rebounds tend to be dramatic. Stovall notes that the S&P 500 has gained 46%, on average, during the first 12 months of a bull market. As the economy turns around, investors typically gravitate back into economically sensitive equities, he says—in particular small cap stocks and cyclicals such as industrials, technology, financials, and consumer discretionary sectors. “Investors anticipate that things will improve, so they seek out the areas that are likely to improve the most,” says Stovall. Likewise, an improving economy typically draws investors away from bonds and toward the greater growth potential of equities.

Value investing over the years

over what period of time should we evaluate a long-term approach like value investing in order to believe that it is a reliable guide for future behavior? There is good data for prices and earnings for the New York Stock Exchange going back to the 1870s. I looked at every month from 1881 to 1998 and identified it as a High-P/E (> 15 P/E) or Low P/E (<15 P/E) market. I then looked at the annual inflation-adjusted returns (without dividends) for an investor who purchased a representative basket of stocks in that month, held it for ten years and sold it. For each decade for the 1880s to the 1990s, I calculated the simple average returns for this investment strategy in Low-P/E markets and divided it by the simple average returns for this investment strategy in High-P/E markets. This, in essence, created a simple measure of the advantage created by investing in Low-P/E markets for that decade.

I looked at several variants of this analysis (20-year returns, different P/E cut-points, etc.), and the relative advantage of investing is low-P/E markets is always higher in the post-WWII period than in earlier periods.

[In other words, value investing didn't work very well from 1890 to 1919. But it has done well since, or only about the last 50 years.]

-- via gurufocus

We've Been Here Before

[Todd Sullivan writes] Looking at the data from the 1929-1934 market, there were plenty of times during that market it rallied for prolonged periods but one thing remained the same, the underlying fundamentals of the economy were lousy, just like they are today. The FDR government underwent a massive spending plan designed to "boost growth", just like today (it did not work, just like today). Markets will rise on the hope "things will be better soon" as folks want to be in on the bottom. As it rises others come rushing in, not wanting to be late for the party, and the market bursts higher.

Then, things do not get better and a market that looked cheap just a few months ago based on the hope people had now looks grossly overvalued based on today's reality. Then comes the slow selloff as reality sinks in. If you look at the time frames in the above chart you see the trend. Violent rallies up followed by slow painful selloffs.

Remember, this market decline started in October 2007 after it peaked. It gained speed in September 2008 and then again in February 2009. The recent near 30% rally has taken less than a month. We cannot sustain the rally and turn the corner until the economy does, period.

[via brknews]

One Page

Everything You Ever Really Needed to Know About Personal Finance On Just One Page (and 48 more).

-- via twitter

How bad is the economy?

Cats are so dramatic

[email forward from raynette]

GDP down, spending up

Advance Gross Domestic Product , the broadest measure of economic output, fell at an annualized rate of 6.1% in 1Q, much worse than the Bloomberg forecast of a 4.7% decline, and only slightly better than the 6.3% decline in 4Q. The measure is the first reading on economic activity in 1Q, and is likely to be revised in future readings. Personal consumption rose 2.2%, much better than the 0.9% expected rise, after declining 4.3% in 4Q. Personal consumption spending was led by a 9.4% jump in durable goods purchases. GDP was negatively impacted by a drop in exports and business investment spending, which fell 30% and 37.9%, respectively. Real final sales, which exclude the 2.8% impact from a decline in inventories, fell 3.4%.

Pricing pressures gained steam, with the GDP Price Index rising 2.9%, compared to a gain of 0.5% in 4Q and the forecast of 1.8%. The core PCE Index, which excludes food and energy, rose 1.5%, just above the estimate of 1.3%, and the rate sits between the Fed's implied target of 1-2%. Treasuries remain higher after showing little reaction to the data.

Despite the worse-than-expected decline, the market is taking solace in the report, due to the 2.2% rise in spending by consumers, who represent nearly 70% of GDP. Negative impacts of falling inventory (down 2.8%) and government spending (down 4.0%) are expected to be reversed in the future, as the fiscal stimulus kicks in and low stocks of inventories combined with increasing demand imply the need to rebuild inventory in the future. There is some question as to whether the resumption in consumer spending is sustainable in light of high consumer debt levels, and whether the 1Q spending was a temporary blip that resulted from having a few extra dollars in consumer wallets. As Schwab's Chief Investment Strategist Liz Ann Sonders, and Director of Market and Sector Analysis, Brad Sorensen, CFA, discuss in their latest Schwab Market Perspective: Do Tough Earnings = Higher Market?, when the crisis took another leg down following the Lehman Brothers bankruptcy last September, consumers went into hibernation and corporations began destocking inventory to align with falling sales. However, the steep fall in spending and manufacturing was so dramatic that it simply could not be sustained and some pent-up demand built up. In 2009, consumers have benefitted from mortgage refinancing, a decrease in gasoline prices versus a year ago, and tax refunds now up 17% from 2008. However, the economy is still contracting and it is probable that the path to recovery will not come in a straight line. Read more on their market perspective at www.schwab.com/marketinsight.

[via Schwab]

[4/28/09] The Consumer Confidence Index rose from an upwardly revised 26.9 in March to 39.2 in April, well above the estimate of 29.9. Along with the improved overall reading, consumer confidence about the present situation and expectations for the next six months improved. The report suggests the recent signs of life in the economy and the preceding rally in equities may be beginning to repair some of the damage in confidence that stemmed from the sharp deterioration in the employment picture and destruction of consumer net worth via the collapse in housing and the severe drop in equity prices in the past two years. However, Schwab's Chief Investment Strategist Liz Ann Sonders, and Director of Market and Sector Analysis, Brad Sorensen, CFA, caution in their latest Schwab Market Perspective: Do Tough Earnings = Higher Market?, the excess supply of homes available for sale will continue to pressure prices, and we expect prices to fall another 10%-15% before finding stability. However, sales typically turn before prices, and once home sales begin to rise, that could boost confidence and get others off the sidelines.

4-1/2 sounds better than 25

HISTORICAL stock charts seem to show that it took more than 25 years for the market to recover from the 1929 crash — a dismal statistic that has been brought to investors’ attention many times in the current downturn.

But a careful analysis of the record shows that the picture is more complex and, ultimately, far less daunting: An investor who invested a lump sum in the average stock at the market’s 1929 high would have been back to a break-even by late 1936 — less than four and a half years after the mid-1932 market low.

How can this be? Three factors have obscured this truth from investors: deflation, dividends and the distinction between the Dow Jones industrial average and the overall stock market.

By MARK HULBERT
Published: April 25, 2009

Alice Schroeder on Warren Buffett

Q How has your experience with Buffett changed or shaped your way of thinking, both financially and personally?

A Big topic. Yes, it has. This would be a separate interview if we had the time. I’ll just say that he prods people that he is friends with to lift their aspirations and expecations of themselves. He did that for me. At the same time, when you’re around him, you see how hard he works and you realize that you should not be out there trying to invest by yourself. You should buy an index fund.

All of these books that say you can get rich by investing like Warren Buffett, it’s a bunch of baloney. You can’t do it. He’s not only brilliant, but he works like a demon from morning until night and he’s been doing that for 70 years. So, when you see him and you’re around him, you realize the futility of trying to replicate his achievement. It can’t be done. But, at the same time, he lifts your aspirations in many other areas, including being extremely good at whatever it is you are good at. He made me far more focused in my career. He convinced me I could write. I didn’t know I could write.

[via brknews]

Jim Rogers and the two Cs

The legendary investor is sticking for now with the two Cs: China and commodities.

WELL, BANK EXECUTIVES and investors can breathe a sigh of relief: Jim Rogers has covered the short positions on financial stocks he put in place ahead of last year's massive meltdown.

But just because this influential investor isn't betting that big banks will fall much further doesn't mean he's confident they will stage a lasting rally either. He feels similarly about U.S. stocks in general.

"I am skeptical about the rally, and the world economy for the next year or two or three," he says. "But if stocks go down, I can make money with commodities."

Rogers, now 66, gained fame as George Soros' hedge-fund partner in the 1970s and 1980s. After retiring from professional money manager in his late 30s, the Alabama native tooled around Europe, Asia, Africa, and Latin America visiting emerging markets, one by one. His resulting book, Investment Biker, helped to popularize emerging market investing at the outset of a bull market for the sector.

He also helped to popularize commodity investing, which for decades was the province of niche investors. In the 1990s, he developed commodity indexes based on futures contracts that in recent years have been turned into exchange-traded funds available to all investors. His 2004 book, Hot Commodities, came ahead of a surge prices for energy, metals, and agriculture.

Since its inception in July 1998, the Rogers International Commodities Index has gained 158%, while the S&P 500 has fallen 23%. And that gain for the commodities index comes despite the fact that it's lost more than half of its value since last July. At these levels, Rogers has been a buyer.

These days, Rogers, now 66, is sticking close to home in Singapore with his wife, Paige Parker, and two small daughters. He's about to release his latest book, A Gift to My Children: A Father's Lessons for Life and Investing (Random House), in which he encourages other people's children to travel widely and learn Mandarin so they can reap the rewards of China's economic boom.

Recently, Rogers talked to Barrons.com by phone from his Singapore home.

Q: When you last did a lengthy interview with Barron's magazine a year ago (see "Light Years Ahead of the Crowd," April 14, 2008) you were lightening up on emerging markets investments. Well, you called that one right. But now that many of those markets have fallen from their highs of recent years, are you more optimistic?

A: No. I've sold all emerging markets stock except the ones in China. I bought more Chinese shares in October and November during the panic, but I have not bought China or any other stock markets including the U.S. since then. I'm not buying anything in China right now because the Chinese market ran up maybe 50% since last November. It's been the strongest market in the world in the past six months and I don't like jumping into something that has been that run up. Still, I'm not thinking of selling these stocks either. I think if it goes down I'll buy more. I think you will find that it's the single strongest market in the world since last fall.

Q: In your latest book, you talk of China as the great investment opportunity of the 21st century, just as the U.S. was in the 20th century. What percentage of a typical American investor's portfolio should be in China?

A: If they can't even find China on a map, I don't think they should have anything in China. They should know something about China before they invest there. If they have the same convictions that I do then they should probably have a lot. If you asked me that question in 1909 about the U.S. stock market, I would have said to put 100% of your money in the U.S.

Q: Might it make sense to have a greater weighting in a diversified mix of Chinese stocks than in U.S. stocks?

A: Well yes. Just as in 1909, if you were German or Chinese, you should have had the largest percentage of your money in the United States. The idea of investing is to make money, not to have some sort of political agenda.

Q: That being said, you currently think Chinese stocks are bid-up now, so you're not buying at these levels. So what have you been buying lately?

A: I have been buying commodities through the Rogers commodity indexes I developed because my lawyer won't let me buy individual commodities. I recently bought the all four Rogers indexes – the Elements Rogers International Commodities Index (ticker:RJI) as well as the three specialty indexes, the International Metals (RJZ), the International Energy (RJN), and the International Agriculture (RJA.) That's how I invest in commodities and that's what I bought last week. I have been buying these shares since last fall and up to last week.

Q: Though you got out of emerging markets last year before they fell hard, you seemed be caught by surprise by the fall-off in commodity prices last year. Is that right?

A: Yes, I was surprised. I did not expect commodities to go down that much and in retrospect it was a period of forced liquidation for many (professional) investors. You know AIG went bankrupt, which was huge in commodities. Lehman Brothers was big in commodities.

But at least I was shorting the investment banks at the time and other financials such as Citigroup and Fannie Mae. So I was hedged by being long commodities and short the other things such as financials and as you know most of them were down from 80% to 100%, so I more than made up on my shorts than I lost on my longs. So thank God for (the stock decline in) Citigroup and thank God (for the decline) in Fannie Mae.

Q: Now despite the recent stock-market rally that started in March, many U.S. stocks are trading well off their 2007 highs. How come you see no value to this market?

A: I am not buying U.S. companies mainly because I think we may have seen a bottom but I don't think we have seen the bottom. I am skeptical about the rally, the world economy for the next year or two or three. But if stocks go down, I can make money with commodities. In the 1970s, commodities went through the roof even though stocks were a disaster. In the 1930s, commodities rallied first and went up the most long before stocks pulled it together.

Q: Can you summarize the reasons for your bullishness about commodities?

A: It depends on the supply and demand. And we have had a dearth of supply. Nobody has invested in productive capacity for 25 or 30 years now. The inventories of food are the lowest they have been in 50 years and you have a shortage of farmers even right now because most farmers are old men because it has been such a horrible business for 30 years. And as for metals, nobody can get a loan to open a mine as you know. Who is going to give you money to open a zinc mine? It takes at least 10 years to open a mine so it's going to be 15 or 20 years before we see new mines come on. Nobody has been opening mines for 30 years and they are not going to. And in the meantime reserves are declining. As for oil, the International Energy Agency came out recently with a study showing that oil reserves worldwide were declining at the rate of 6% or 7% a year.

That does not mean that if suddenly the U.S. goes bankrupt that everything won't collapse in price. But I would rather be in commodities because it's the only thing I know where the fundamentals are improving. They are not improving for Citibank or General Motors but the supply situation in commodities is such that when demand comes back, then commodities are going to be the best place to be in my view.

Q: What do you think of bonds?

A: I am anticipating shorting bonds -- the U.S. long bond. It's about the only real bubble around that I can see right now -- other than the U.S. dollar. I am not shorting bonds at this moment because I've shorted plenty of bubbles in my day, and I have learned that you better wait because they go up higher than any rational person can anticipate. But my plan is to short the long bond in the U.S. sometime in the foreseeable future.

Q: I've read that you think the penchant of the last two presidential administrations for bailing out failing U.S. companies is a big mistake and will contribute to prolonging this recession. You argue that it's best to let these companies all go bankrupt. How bad can the economy get?

A: Yes, politicians are making mistakes. In Japan, the problem has lasted for 19 years. I hope that it doesn't last 19 years in the U.S. The approach that works is to let them (U.S. banks and automakers) collapse and clean out the system. The idea that phony accounting is the solution (through changes in mark-to-market rules) is ludicrous. And the idea that a debt problem and an excessive spending problem can be cured with more debt and more spending is ludicrous.

It's laughable on its face, but politicians think they've got to do something. Unfortunately, they are doing the wrong things and they are going to make it worse.

***

[10/13/09 more..]

The 21st century belongs to China

According to Rogers, the 19th century was the era of the British Empire and the 20th century was the U.S.’ heyday. But the 21st century is China’s (though the rest of Asia is definitely going to get a boost too).

Jim Rogers is not a Ben Bernanke fan

Yep, it’s a fact. No “Team Bernanke” shirts for Jim Rogers (who said to scattered applause during the Q&A session that if he was in charge of the U.S. economy he would “abolish the Fed and resign.”).

Rogers is appalled by the government’s actions—Bernanke’s in particular. The U.S. government’s strategy calls for the debasement of the dollar, he says, calling it a “horrible policy.” While he concedes it can work in the short term, it NEVER works in the mid- or long term.

“He’s going to run those printing presses until we run out of trees, because that’s the only thing he knows,” Rogers said of Bernanke.

Add that on top of the country’s rapidly growing astronomical debt, and Rogers believes you’ve got a recipe for disaster.

Commodities, commodities, commodities

OK, as mentioned before, there are 3 billion people in Asia, most of whom are aspiring to play the home version of the American Dream game show. And let’s face it: American society is largely about consumption. We like stuff―we buy it, we wear it, we eat it, we flaunt it, we sometimes even bedazzle it (yeah, Google that). So that’s a lot more consumption on the global level. Rogers notes that while consumption is expected to increase exponentially, not a lot of capacity has been added in the last few decades for a lot of commodities. Meaning, not a lot of new refineries have been built, and not a lot of new resources have been discovered or excavated for a variety of commodities.

U.S. government bonds are the next big bubble

Well, would you lend money to us? Rogers says short-term bonds are probably OK, but he advises getting out of anything with a longer maturity. He calls it “inconceivable” that anyone would lend money to the U.S. for 30 years at the going rate, and notes that the U.S. was a creditor nation as recently as 1987.

“Now the U.S. is the largest debtor nation in the history of the world,” he said.

Margin of Safety by Seth Klarman

by Saj Karsan

In the next few weeks, we'll be doing a chapter-by-chapter run-down of Seth Klarman's sought after book, Margin Of Safety. We've discussed Klarman on my website before, as he has consistently demonstrated an ability to generate market beating returns over a long period of time. You can find Klarman's limited edition book selling on ebay for hundreds of dollars.

Chapter 1
Klarman starts out by distinguishing investing from speculating. He uses a Mark Twain quote to illustrate the two times in life when one shouldn't speculate: "when you can't afford it, and when you can!". Speculators buy in the hopes or assumptions that others will want to buy the same asset (be it a painting, a baseball card, or a stock) later, while investors buy the cash flow the investment returns to its owner. (As such, a painting can never be an investment by this definition!)

Chapter 2
What's good for Wall Street is not necessarily good for investors, according to Klarman. Because of how Wall Street does business, it has a very short-term focus. For example, Wall Street makes money up-front on commissions (not from long-term performance), therefore the Street will always push for churn and will always push "hot" investments.

Chapter 3
In this chapter, Klarman discusses how the investment world has changed over the last several decades, and how understanding these changes allows investors to earn superior returns. From 1950 to 1990, the institutional share of the market rose from 8% to 45%, and institutions comprise 75% of market trading volume. But the institutions are hampered by a short-term mindset, and Klarman attempts to explain why.

Chapter 4
In this chapter, Klarman examines the junk bond market in depth to illustrate how Wall Street can create investment fads, only to leave investors much poorer when the tide goes out.

Chapter 5
In the previous four chapters, Klarman focused on describing how investors go wrong. Chapter 5 is an introduction to the second part of the book, where Klarman describes the philosophy of value investing.

Chapter 6
This chapter is dedicated to describing the philosophy of value investing and why it works. The terms used to describe value investing don't require any accounting or finance background, making this an easy read for beginners looking to learn about value investing.

Chapter 7
Klarman introduces what he calls the three central elements to a value investing philosophy:

1) A "bottom-up" strategy
2) Absolute (as opposed to relative) performance
3) A risk averse approach

Chapter 8
Business value cannot be precisely determined, Klarman asserts. Not only do a number of assumptions go into a business valuation, but relevant macro and micro economic factors are constantly changing, making a precise valuation impossible.

Klarman discusses what he believes to be the only three ways to value a business. The first method involves finding the net present value by discounting future cash flows. The second method is Private Market Value. Finally, Klarman discusses liquidation value as a method of valuation.

Chapter 9
Sometimes, there are so many value investments available that the only constraint on the investor is a lack of funds. Most times, however, Klarman finds it difficult to find value investment opportunities. Investors can spend a lot of time reading through financial reports, research reports, and other financial news and end up finding nothing but fairly valued opportunities. Therefore, it is important that the investor look in the right places.

A few of the places Klarman suggests finding investment opportunities include the new-low lists and the largest percentage-decliners lists which are published by major news sources. Klarman also finds that companies whose dividends have been cut or eliminated can also be unduly punished by the market, leaving investment opportunities. Of course, just because a stock shows up on one of these lists does not make it a buy; one still has to go through the valuation process described in previous chapters in order to determine whether it trades at a discount to its fair value.

Chapter 10
This chapter contains of a plethora of value investing examples. Klarman details a number of securities where investors who paid attention to fundamentals (e.g. strong businesses masked by unprofitable divisions, or companies trading at discounts to cash etc.) reaped enormous profits.

Chapter 11
This chapter examines opportunities at the time of writing that value investors had in the banking sector. In the mid-1980s to early 1990s, many banks were selling for less than book value. During the recession of the early 90s, many thrifts had to be bailed out by the government due to some of the high-risk loans they had offered and due to the general downturn in the US real-estate market...remind you of today?

* * *

Value-Stock-Plus page

***

[12/1/09] Currently, Seth Klarman is very popular in the value investment community. He is particularly popular on Gurufocus.com, where people are literally watching every move he makes.

One of the biggest mysteries about Klarman is what is he is actually holding in his portfolio. You can see his stock and convertible bond holdings and their value filed under the 13-F. In Baupost's 13-F for Q3, total securities listed are $1.36 billion dollars. Klarman stated that he had 30% of his portfolio in cash which is not listed on the 13-F.

Now, here is the shocking part. I called up Baupost and they informed me that they had slightly under $20 billion assets under management. Let us assume that they are managing about $18 billion because that is slightly under the amount they named. That means $6 billion is in cash and $1.36 billion is in stocks and convertible bonds. That leaves more than 50% of their assets or about $10.6 billion not listed in their 13-F.

This $1.36 billion is not an insignificant number, however it is clear that most of his return are coming not from the $6 billion in cash or even the $1.36 billion in stocks and convertibles. Most of his return is coming from his bond holdings. In fact, we would not even know that he had $6 billion had the notes not leaked out from the Baupost meeting. Without these details, all one would know is that Baupost had $1.3 billion in convertibles and stocks and about $17 billion unaccounted for.

One important thing to remember is when you see that Klarman has posted 20% returns annually, you might think you can achieve the same returns by coping him. However, this is not necessarily the case since most of his gains are coming from his bonds (which are not reported). This does not mean that Klarman is not an amazing stock investor or that his stock investments should be ignored. In fact, he has achieved some spectacular results from his stock portfolio, including a recent 75% return in one day from his holding in Facet Biotech Corporation. The significance of the above information is one must realize before trying to mimic Klarman is that you are only seeing a small fraction of the full picture. I doubt we will ever know what Klarman’s full holdings truly are.

***

[9/12/10] Seth Klarman interviewed by Jason Zweig

[12/1/11] Seth Klarman interviewed by Charlie Rose (video)

[4/19/12] Notes to Margin of Safety

[4/28/13] The real secret to investing is that there is no secret to investing. Every important aspect of value investing has been made available to the public many times over, beginning with the rst edition of Security Analysis. That so many people fail to follow this timeless and almost foolproof approach enables those who adopt it to remain successful. The foibles of human nature that result in the mass pursuit of instant wealth and effortless gain seem certain to be with us forever. So long as people succumb to this aspect of their natures, value investing will remain, as it has been for 75 years, a sound and low risk approach to successful long term investing.

—Seth Klarman, The Baupost Group [from the Art of Value Investing]

How cheap are U.S. stocks?

Using trailing average five year earnings through 2008 to calculate the S&P 500 earnings coupon, U.S. equities are the cheapest they have been since the Depression when compared to the 10-year Treasury yield. Because this calculation encompasses the financials’ losses reported in 2007 and 2008, one could argue that the attractive 7.7% earnings yield is artificially low.

Academicians Eugene Fama and Kenneth French recently published a study that found that value stocks have declined two years in a row only five times: during the Great Depression in 1929-32; at the beginning of WWII in 1939-41; during the Arab oil embargo of 1973-74; when the Internet bubble popped in 2001-02; and now as the housing bubble deflates. Following the four prior periods, stocks snapped back by an average of 60% in the next 12 months.

-- Longleaf Partners, 2008 Annual Report

stock pros who survived the depression

IRVING KAHN SITS AT HIS CLUTTERED DESK, PEERING AT his computer screen through thick, dark glasses. The Dow inched up 38 points today, a small move in light of its 332-point drop earlier in the week. But Kahn has made a career of betting on beaten-down stocks, and he’s hard at work poring over annual reports and studying balance sheets looking for companies that have lots of cash, not much debt and good long-term growth prospects. General Electric has a solid business and looks pretty good at these prices, he muses. General Motors? Not so much.

Like a lot of us, Kahn has seen good times and bad, bull markets and bear markets, recessions and recoveries. But he’s also seen something most of us haven’t: the Great Depression. Kahn, who still shows up at work every day and puts in a good six hours, worked as a stock analyst and brokerage clerk on Wall Street in the 1930s. He’s 103 years old.

Charles Allmon still in cash

Mark Hulbert's column in Barron's

WOULD BEN GRAHAM'S famous value-stock investment strategy have protected you in the bear market that began 18 months ago?

The surprising answer, I have found, is "yes." And that's remarkable, since virtually all of the most popular stock-picking strategies, including those that ostensibly fit into the category of "value investing," lost nearly as much as the overall averages during the recent bear market -- if not more.

Ironically, however, few investors actually benefitted from the protection that Graham's strategy could have afforded. His approach fell out of favor several decades ago, when the bull market of the 1980s and 1990s further and further divorced stock prices from fundamental value.

One of the ancillary benefits of the recent bear market, therefore, may be to reacquaint investors with the advantages of paying attention to value.

That would represent a fitting 75th anniversary present to the value school of investing. Back in 1934, Graham (along with David Dodd) wrote what has become the definitive textbook on value investing -- Security Analysis, now in its sixth edition. In fact, this book not only ushered in value investing, it provided the blueprint for fundamental analysis of stocks.

Perhaps not surprisingly, given that Graham developed his approach to investing during the Great Depression, his definition of value was very strict. Instead of defining value in relative terms, as do most value managers today, Graham defined it in absolute terms. That in turn meant that there would be times when few, if any, securities were considered to represent genuine value.

It took exceptional discipline to adhere to Graham's approach in a bull market that was causing stock prices to soar into the stratosphere, and few value managers possessed it. As their clients left them in droves, many value managers chose instead to define value in relative terms: So long as a stock's price-to-earnings or price-to-book ratios were lower than that of most other stocks, a stock satisfied this modern, more liberal definition of value.

That approach may have afforded value managers the possibility of participating in the bull market. But it left them vulnerable as never before to the downside.

Consider two hypothetical portfolios, one of growth stocks and the other of value stocks, constructed by Eugene Fama and Kenneth French, finance professors at the University of Chicago and Dartmouth College.

The value portfolio contained the approximately 30% of stocks with the lowest price-to-book ratios, while the growth portfolio contained the 30% of stocks with the highest such ratios. At the bear-market low earlier this year, the value portfolio was 57% below its peak in the fall of 2007, while the growth portfolio was "just" 42% below.

If value is not defined in relative terms, then how can it be defined? Graham employed a number of criteria, but his primary one was to compare a company's stock price to its net current assets per share. (Net current assets are total current assets minus total current liabilities, long-term debt and the redemption value of preferred stock.) Graham believed that a stock should be bought only if it was trading for less than two-thirds of its per share net current assets.

At the depths of the Great Depression, hundreds of stocks on the New York Stock Exchange satisfied this demanding criterion. That number fell in subsequent decades, however. By the late 1980s and 1990s, there were many occasions in which not one common stock on the NYSE was able to satisfy it. An adviser who stayed true to Graham's criteria, therefore, would have had no choice but to build up an increasingly large cash position in his portfolio.

To those who think that this would have hopelessly handicapped long-term performance, consider the model portfolio contained by Growth Stock Outlook, a newsletter edited for the last 44 years by Charles Allmon. Though Allmon has not purely adhered to Graham's definition of value, he has come closer over the years than any of the other newsletter editors that the Hulbert Financial Digest (HFD) monitors.

Allmon in fact claims almost apostolic succession from Graham, according to Peter Brimelow, in his book on the investment newsletter industry titled The Wall Street Gurus (Random House, 1986). Brimelow quotes Allmon as saying: "'Graham called me on the phone, as I recall in 1969, maybe 1970. He said, 'I've got a copy of your Growth Stock Outlook, and I've been very intrigued by what you're doing here. How are you spotting these values?' I said, 'Mr., Graham, I'm taking a lot of your own criteria and trying to crank in my own for value relative to growth potential.' And he said, 'Well, it's a very intriguing idea. I think if I were young again, that might be the course I would take. It sort of speeds things up a bit'."

True to Graham's legacy, Allmon began building up a large cash position in 1986. With no more than one or two exceptions since then, his model portfolio has been more than 80% cash. Thanks in no small part to the recent bear market, Allmon's newsletter is now in first place for risk-adjusted performance among all HFD-monitored newsletters since 1980, when the HFD began monitoring the newsletter.

What would Graham be advocating now? You might think that he would be increasing his equity exposure, since the number of stocks selling for less than two-thirds of per-share net current assets is starting to grow. But Allmon, at least, remains firmly in the bearish camp, continuing to recommend that subscribers have more than 80% of their equity portfolios in cash.

He wrote recently that "our country appears to be on the brink of the biggest financial firestorm in our 220-year history." Expressing little confidence that the government will get us out of this mess, he adds that "the trick now is to avoid being scalded in a sea of nonsense."

Of the three stocks that Allmon's newsletter portfolio currently owns, the biggest holding is Newmont Mining Corporation (ticker: NEM); he is forecasting "5% to 15% U.S. inflation," which will in turn lead gold bullion to trade over $1,800 an ounce.

The two other stocks that his model portfolio owns are Altria Group (MO) and Philip Morris International (PM).

We can only wonder whether Graham would have approved.

* * *

[This is interesting to me as I have that book The Wall Street Gurus and used to own Allmon's fund until it became Liberty All-Star back in ... 1995.]

David Dreman fired from own fund

NYTimes.com

By FLOYD NORRIS
Published: April 9, 2009

David N. Dreman was a star mutual fund manager. Then he bought bank shares and held on as the financial crisis grew.

Now he has been fired from the flagship fund that bears his name, despite what remains a good long-term record. The fund’s name will be changed, and the fund will take fewer risks. A drab industry will become a little drabber.

In the past, the firings of once-celebrated fund managers have sometimes provided a market signal of its own — that the trend that led to their poor performance was about to end. If that were to happen this time, there could be a revival for so-called value stocks, and particularly for the beaten-down and almost universally disdained financial stocks.

“The success of contrarian strategies requires you at times to go against gut reactions, the prevailing beliefs in the marketplace and the experts you respect,” Mr. Dreman wrote in his best-selling 1998 book, “Contrarian Investment Strategies.”

Mr. Dreman rose to fame in the 1990s, when the fund he began in 1988 amassed an impressive long-term record. But he had been preaching, and practicing, the gospel of investing in unpopular stocks with low price-earnings ratios since the late 1970s. He has been a columnist for Forbes Magazine.

As the fund industry concentrated, the Dreman fund family was bought by Kemper, which was bought by Scudder, which was bought by Deutsche Bank. Last week the fund board installed by Deutsche quietly filed with the Securities and Exchange Commission a disclosure that Mr. Dreman’s firm would no longer manage what is now called the DWS Dreman High Return Equity Fund.

On June 1, Deutsche will take over the management, and assign the job to a team of managers based in its Frankfurt office. The fund will become known as the DWS Strategic Value Fund. Mr. Dreman’s firm will continue to manage three smaller Deutsche funds, but don’t be surprised if those relationships eventually end.

Mr. Dreman, who is 72, did not sound bitter when I spoke to him this week. “The board of directors is obviously entitled to do what they did,” he said. But neither was he repentant. “Low P/E has worked well over time,” he added. “There will be years that we are very out of favor, but we make it up.”

You wouldn’t have known that the fund’s long-term record remained better than the market from reading what Deutsche officials had to say. “We had seen very weak performance for the fund over every major time horizon,” David Wertheim, the bank’s project manager for equities, told Bloomberg News. He declined to speak to me.

Those time frames are one year, three years and five years, the periods that are used by fund raters like Morningstar and Lipper. Just now they are dominated by last year, which was a horrid one for the Dreman fund. Even so, it still has a superior long-term record.

There are few celebrity mutual fund managers any more. Fund groups prefer to promote themselves rather than a manager who could leave to start a hedge fund. In an age when holding on to assets is the way for a fund family to profit, they may well prefer a fund that sticks close to its peers. The new fund managers plan to own more stocks, with less concentration in any one stock, and a broader definition of value investing. They are far less likely to stand out from the crowd.

Mr. Dreman often stood out. I checked the fund’s last 14 annual reports, each of which showed its performance relative to Lipper’s group of equity-income mutual funds. In seven of those years, it was in the top quartile. In four of them, it was in the bottom quartile. Only in three of the years did the fund end up in the middle 50 percent of funds.

The recent bad performance has been costly for Deutsche Bank, as well as the fund investors. Because of a combination of poor performance and investor withdrawals, the fund had $2.4 billion in assets on March 31, down from $8.3 billion in late 2007.

What went wrong? You can get a hint from part of the fund’s most recent annual report, for the year that ended last November. “The cornerstone of our contrarian value investing philosophy is to seek companies that are financially sound but have fallen out of favor with the investing public,” it said.

With too many financial companies, among them Washington Mutual, Citigroup and Fannie Mae, Mr. Dreman and his colleagues did not realize until too late that the companies were not financially sound, no matter what their books seemed to say.

Buying stocks with low P/E ratios can make sense only if the earnings — the “E” — are real. “The E was much worse than anyone thought,” Mr. Dreman told me. “The banks themselves had no idea of how bad the E was.”

He still thinks his strategy will work, and told me he thinks the market may well have hit bottom. As that last annual report put it, “The last few months have provided many opportunities to buy strong companies with good long-term prospects at the lowest prices we have seen in many decades, and we have taken advantage of what we regard as incredible bargains.”

Kiplinger Magazine archives

While browsing through twitter (KipTips), I see that Kiplinger Magazine has been archived at Google. Issues go all the way back to 1947!

passing the test

The New York Times is reporting that regulators say all 19 banks will pass the stress tests, although some still may require more aid. Quoting officials involved in the examinations, they say this is a test a bank simply cannot fail, if the examiners determine that a bank needs "exceptional assistance," the government will provide it. There is said to be a wide range of results among the institutions.

Cramer vs. Roubini

TORONTO (AP) — CNBC's Jim Cramer has another feud on his hands.

Just weeks after "The Daily Show" host Jon Stewart took Cramer to task for trying to turn finance reporting into a "game," famous bear economist Nouriel Roubini criticized Cramer on Tuesday for predicting bull markets.

"Cramer is a buffoon," said Roubini, a New York University economics professor often called Dr. Doom. "He was one of those who called six times in a row for this bear market rally to be a bull market rally and he got it wrong. And after all this mess and Jon Stewart he should just shut up because he has no shame."

Cramer recently wrote in a blog that Roubini is "intoxicated" with his own "prescience and vision" and said Roubini should realize that things are better since the stock market bottom in March.

Roubini said in 2006 that the worst recession in four decades was on its way. He has attracted attention for his gloomy — and accurate — predictions of the U.S. financial market meltdown.

Roubini said the latest surge is just another bear market rally following the pattern of other rallies after the government intervened. He expects the market will test the previous low because of worse than expected macroeconomic news, disappointing earnings and because banks will fail after the stress tests come out.

"Once people get the reality check than it's going to get ugly again," Roubini said.

Roubini said Cramer should keep quiet.

"He's not a credible analyst. Every time it was a bear market rally he said it was the beginning of a bull and he got it wrong," Roubini said in an interview with The Associated Press.

Cramer isn't shutting up. On CNBC, the "Mad Money" host shot back: “We got that guy Nouriel Roubini and he attacked me today, which I regard a great badge of honor."

best five-week run

Stocks rallied Thursday, ending a holiday-shortened week on a high note after Wells Fargo forecast a nearly $3 billion quarterly profit, adding to hopes that the banking sector is stabilizing.

It was the fifth straight week of gains for the markets. In that time the Dow rose 22%, for its best five-week run since May of 1933, when it gained 31%.

The Dow Jones industrial average (INDU) gained 246 points, or 3.1%. The S&P 500 (SPX) index rose 31 points, or 3.8%. The Nasdaq composite (COMP) gained 62 points, or 3.9%.

With today's rally, the Dow regained all of its losses from Monday and particularly Tuesday, when it fell 186 points. The finish will give the blue-chip index a 67-point gain on the week, or 0.8%. The S&P 500 ended with a 1.7% gain for the week and the Nasdaq a 1.9% gain.

The Dow is down 7.9% for the year, with the S&P 500 off 5.2%. The Nasdaq is up 4.8%, with the Nasdaq-100 up 10.6%.

The market rally that began on March 10 has now pushed the major indexes up 23% or more.

Twenty-eight of the 30 Dow stocks were higher on the day, along with 445 S&P 500 stocks and 91 Nasdaq-100 stocks.

Mike Mayo goes biblical

SAN FRANCISCO (MarketWatch) - Bank analyst Mike Mayo went biblical on the sector Monday, predicting loan losses will probably exceed Great Depression-era levels as the industry is punished for succumbing to the seven deadly sins of gluttony, greed, lust, sloth, wrath, envy and pride.

Mayo, a former Deutsche Bank analyst now with Calyon Securities, passed judgment on the banking industry with an underweight rating.

Shares of Bank of America (BAC 8.82), Citigroup (C), J.P. Morgan Chase (JPM), Wells Fargo (WFC), PNC Financial Services (PNC) and Comerica (CMA) will underperform, the analyst foretold.

Mayo commanded investors to sell shares of US Bancorp (USB), SunTrust (STI), Fifth Third (FITB), KeyCorp (KEY) and BB&T (BBT).

"We are initiating on U.S. banks with an Underweight sector rating given the ongoing consequences of increased risk taking by banks in seven different areas," spaketh Mayo in a note to investors.

"The seven deadly sins of banking include greedy loan growth, gluttony of real estate, lust for high yields, sloth-like risk management, pride of low capital, envy of exotic fees, and anger of regulators," quoth Mayo.

"A key implication is that loan losses (to total loans) should increase to levels that exceed the Great Depression," the analyst foretold. "While certain mortgage problems are farther along, other areas are likely to accelerate, reflecting a rolling recession by asset class."

Loan losses to loans will likely increase from 2% to 3.5% by the end of 2010 given ongoing problems in mortgage and an acceleration in cards, consumer credit, construction, commercial real estate and industrial, the analyst warned.
At the peak of the Depression, in 1934, loan losses reached 3.4% of total bank loans, Mayo noted.

[4/6/09, posted 4/23/09]

buy and hold the original Dow?

The Dow is a price-weighted index as opposed to a cap-weighted index. Does that make a difference in performance? Specifically, does it affect how the Dow has performed since it was expanded to 30 names in 1928?

The Dow Industrials was expanded to 30 names from 20 on October 1 of 1928. Today, only nine names of the original 30 remain in the Dow. The committee at Dow Jones has replaced the other names as the companies grew out of favor, were merged into other stocks, were considered too small, or the committee felt that other companies better represented the industrial prowess of the US economy.

What if we went back to the original 30 stocks and simply bought them and held them until today? Good, bad or indifferent, what would the results be?

So, the question of the day: would you have been better off investing in the index, or buying the 30 stocks and holding them? Further, would it make any difference if you price-weighted them or equal-weighted them (explanations below)? What about inflation? And how does that compare to the S&P 500?

And before you answer, remember that one stock, Bethlehem Steel, went bankrupt. You would be stuck with Chrysler, which was removed in 1979 for IBM, which itself had been taken out in 1939 for AT&T. There have been 55 changes in the components of the Dow over the last 80 years. Some of the original 30, listed below, we would all recognize. But our kids might not remember Victor Talking Machines or Nash Kelvinator (Nash Auto).

The market is at a crossroads

There are signs of both a potential market recovery (the beginning of a larger bull rally), and signs that this recent 20%+ run-up was nothing more than a bear market rally.

The good news is that there will be plenty of opportunities going forward, regardless of which of the above scenarios plays out.

Best four-week gain since 1938

Stocks weathered a very bad unemployment report on Friday and not only finished higher for the day but enjoyed their best four-week gain since 1938. The finish was quite bullish: The Dow Jones industrials ($INDU), which had been down as much as 80 points in the morning, recovered to close up 40 points, or 0.5%, to 8,018, their first close above 8,000 since Feb. 10. The Standard & Poor's 500 Index ($INX) was up 8 points, or 1%, to 843, and the Nasdaq Composite Index ($COMPX) was up 19 points, or 1.2%, to 1,622.

The market finished with its fourth weekly gain in a row. The Dow's total gain since March 6 is about 21%, with the S&P up 23.2% and the Nasdaq up 25.3%.

The Dow's 21% gain in the four weeks since March 6 is its biggest since 1938. If you measure the gain only against four-week periods where each week finished higher, it’s the best since the four weeks that ended on May 12, 1933.

stocks vs. bonds

During the past 25 years, the total return for U.S. equities has been lower than for U.S. 10-year government bonds: –47% in real (inflation-adjusted) returns for stocks vs. +71% in real returns for bonds. With the 10-year Treasury yield currently at 2.7%, the bar has been set quite low for stocks to outperform bonds prospectively.

[4/6/09] For the past 40 years too says Bill Gross

[2/18/10] Most people would consider 40 years to be the "long run." So, it is rather disconcerting, or shocking as Rob puts it, to find that not only have stocks not outperformed bonds for the last 40 plus years, but there has actually been a small negative risk premium.

How bad is it? Starting at any time from 1980 up to 2008, an investor in 20-year treasuries, rolling them over every year, beats the S&P 500 through January 2009! Even worse, going back 40 years to 1969, the 20-year bond investors still win, although by a marginal amount. And that is with a very bad bond market in the '70s.