Thursday, August 13, 2009

Links, Video and a Personal Anecdote

I got a call bright and early this morning at 7:30am PST from a representative at TD Ameritrade, the online broker I use when I want to lose money due to being overly bearish. Being based in New York he didn’t know that I was now on the west coast so I can’t fault him for the early call. I was up in any case trying to come up with interesting things to write about. The reason I am mentioning this call is that I believe our discussion is a microcosm of just about everything that is wrong with the institutional advisers.

I had spoken to this gentleman previously and had indicated to him that while I am in school I will be focusing on an index and ETF-based strategy when it comes to my own investing. Before you get ready to delete the bookmark to my blog and start on email with the subject line “hypocrite,” hear me out. Active management of a stock portfolio is a FULL TIME job. You have to diligently keep up with the companies in your portfolio to a degree that I do not believe will be possible as a full time student. I believe that my two years at Anderson should be spent honing my investing skills, meeting new people who can offer unique perspectives, and searching for the right value-based asset manager to work for when I graduate. Therefore, I’m not sure where scrutinizing the 10Qs and listening to the conference calls of all of the companies in my portfolio would fit in. I think even Buffett would agree that if you don’t have the time or the skill to manage an individual stock portfolio, indexing is really the best route to take.

In any case, I surmise that the reason this man from TD called me is that I hadn’t been doing much trading in my account. I have been trimming my positions in individual companies over the past 8 months in anticipation of becoming an out of the closet indexer. Of course when I was more active I didn’t hear much from my account representatives at TD. They were making money as I tried to navigate my way through these tough markets. But, fortunately for this guy, my current investment strategy happens to fit quite nicely with his specialty. Apparently, he originally called to sell me an Amerivest asset allocation product that focuses on ETFs and offers automatic rebalancing. In his eyes this product is perfect for me as I grudgingly become a more passive investor.

Not to my surprise, he started the conversation off with the assertion that most economists think the recession is over and this automatically implies that it is time to buy stocks. I’m sorry but I couldn’t help but laugh. I wasn’t trying to be rude or arrogant but reading from a script to someone who spends his entire day trying to ascertain the potential for recovery struck me as sort of ludicrous. When I told him that I thought stocks were overvalued and that they were discounting an economic recovery and return to levered profit margins that were unlikely, he carefully explained to me that the stock market is a discounting mechanism that reflects the future of the economy. There was no discussion of earnings, valuation, margins or any fundamental factors; just the assumption that this is the US and stocks should and will grow to the sky. When I told him I was more cautious he said that well of course they offer something that caters to my views as well: a treasury bond-focused product. But what if I don’t want to tread water or merely protect my capital if the market tanks? What if I want to actually make money by (gasp) being short the market?

My guess is that you aren’t shocked when I tell you that they don’t have any bear market products. See, these guys don’t really make money when stocks go down. In fact, aside from generating trading fees as people flee the market with reckless abandon, outflows and decreases in customers' net wealth are not positive things. Obviously I understand his bias. Although he swore to me that he didn’t make money on commissions, I know that the more people buy stocks the better off he and TD will be in the long run. The fact that they don’t even have a bear market product even though there are ETFs that could (if they tracked the market better) comprise such an offering reminds me of the rating agencies. If we pretend that housing prices can never go down then it won’t happen, regardless of the consequences suffered by our customers if we are wrong. Similarly, if TD and Amerivest don’t offer bear market products to their customers then maybe stocks will never go down. This is the kind of wishful thinking that leads to asset bubbles and mispricing of risk. Even worse, these people are the ones in charge of helping normal retail investors save for retirement. With this kind of bias, blindness and unwillingness to offer products that make money in all markets, retail investors might be better off playing poker or investing with Bernie than trusting the perma-bulls that work for institutional advisers.

Thank you, thank you. I will now step down from my soap box and cease ranting.

Now, without further ado, onto today’s links:

Lessons not learned: I found the link to this article by Harvard economics professor Rogoff on Seeking Alpha. In assessing the lessons learned by the broader market from doing a post-mortem on Lehman Brothers, Rogoff argues that the conventional wisdom is seriously flawed:

Unfortunately, the conventional post-mortem on Lehman is wishful thinking. It basically says that no matter how huge the housing bubble, how deep a credit hole the United States (and many other countries) had dug, and how convoluted the global financial system, we could have just grown our way out of trouble. Patch up Lehman, move on, keep drafting off of China’s energy, and nothing bad ever need have happened.

The fact is global imbalances in debt and asset prices had been building up to a crescendo for years, and had reached the point where there was no easy way out. The United States was showing all the warning signs of a deep financial crisis long in advance of Lehman, as Carmen Reinhart and I document in our forthcoming book This Time is Different: Eight Centuries of Financial Folly.

Instead of Lehman Brothers being the cause of the meltdown, Rogoff and many others see Lehman as a symptom of a much more severe problem: too much leverage. The problem, of course, is that leverage has not come down by that much in the household or corporate sector. If you don’t believe me take a look at the most recent data on corporate leverage discussed here by Tyler Durden of Zero Hedge and data on consumer debt highlighted here by Karl Denninger. Not only do we have a lot more de-leveraging to do as a country, but as Rogoff points out, the idea that the big banks are too big to fail is even more prevalent as a result of the revisionist history that concluded that saving Lehman would have solved all of our problems. Here is my humble attempt to channel Nassim Taleb: leverage adds to complexity and when you combine complexity and fragility there is potential for a disastrous outcome. How did that sound?

Speaking of Taleb: Hat tip to The Pragmatic Capitalist (add this site to your blog roll if you have not) for posting this link to Taleb and Roubini (aka the Black Swan and Dr. Doom) speaking on CNBC. For those of you that follow Taleb, there is not a whole lot of new insight here. However, that does not diminish the value of his views. He continues to harp on the idea that we have entrusted our economic recovery to those who did not see the housing bubble or the dangerous amount of leverage building up in the system. He always compares Bernanke and Geithner to people who were driving a bus blind folded and crashed the bus but are now still driving the bus. As you can imagine Taleb thinks this is a bad idea. This theme continues to come up in what I read and listen to. I know not everyone is living the life of a student, but I implore you to take some time to listen to some of the interviews from King World News. What surprised me was that investors such as Jim Grant and Jim Rogers were willing to categorize Bernanke and Geithner as “dangerous.” Not incompetent. Not over matched. But dangerous. Whether you agree or not that is a scary adjective.

Latest view on China from Andy Xie: I got the link to this piece from Andy Xie on from The King Report. Andy has been sounding the alarm regarding China’s property and stock markets for months now. If you want granularity on what is going on in China you should read everything Xie writes. He envisions a nasty crash at some point, maybe when the dollar strengthens versus the Yuan. But in the meantime he likes to highlight how far asset prices have diverged from income levels:

The most basic approach to studying bubbles is to look at valuation, and the most important measures for property are price-to-income ratios and rental yields. China's nationwide average, per-square-meter price is quite close to the U.S. average. U.S. per capita income is seven times urban, per capita income in China. Yet the nationwide average price for a square meter in China is about three months' salary -- probably the highest in the world.

As far as I can tell, a lot of properties can't be rented at all, and those that are rented bring a 3 percent yield, barely compensating for depreciation. The average yield from rentals, including those that can't be rented out, is probably negligible. China's property prices don't make sense from affordability or yield perspectives. Some argue that China's property is always like this: Appreciation is the return. This is not true. The property market fell dramatically from 1995 to 2001 during a strong dollar period.

Obviously, there are a lot of people warning on China right now. All the liquidity that they have thrown into the property and stock markets at least has the potential to create unsustainable bubbles. Accordingly, you only want to listen to those who have knowledge, experience and credibility regarding the Chinese fundamentals. I would argue that Xie has all of those:

Many would argue China isn't experiencing a bubble. They say high asset prices simply reflect China's high growth potential. And it's true that one can never make an ironclad case to pin down an asset boom as a bubble. But an element of judgment based on experience can help one distinguish a market boom from a bubble, and I've have had a reasonably good record at calling bubbles in the past. I wrote my doctoral thesis arguing that Japan's market was a bubble in the late 1980s, a long report for the World Bank in the early the 1990s arguing that Southeast Asia had a bubble, research notes at Morgan Stanley in 1999 calling the dotcom boom a bubble, and numerous research notes from 2003 onward arguing that the U.S. property market was a bubble. On the other hand, I've never called something a bubble that turned out not to be a bubble.

Maybe if I keep saying it someone will listen: Hat tip to Zero Hedge for posting this video of Elizabeth Warren being interviewed on MSNBC. I have to admit that I have a little bit of a crush on her. I think she is very articulate and continues to highlight issues in the banking system that I often I write about. Specifically, she has been jumping up and down about the impending commercial real estate crisis. As she points out, the bust may not occur until 2011 or 2012 when a large number of these loans will have to be refinanced, but that does not mean we shouldn’t worry about it. It is so refreshing to see someone who has ties to the US government and is not regurgitating CNBC-like bullish sentiment. I know the government is concerned about consumer confidence, but I don’t see that as an excuse to obscure the truth. We never have that problem with Warren who consistently presents a very sober and realistic view of the state of the financial system.

(Picture of Nassim Taleb courtesy of

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