Wednesday, December 30, 2009 0 comments ++[ CLICK TO COMMENT ]++

Business Leader of the Decade: Steve Jobs



Look at the design of a lot of consumer products — they're really complicated surfaces. We tried to make something much more holistic and simple. When you first start off trying to solve a problem, the first solutions you come up with are very complex, and most people stop there. But if you keep going, and live with the problem and peel more layers of the onion off, you can often times arrive at some very elegant and simple solutions. Most people just don't put in the time or energy to get there. We believe that customers are smart, and want objects which are well thought through.
— Steve Jobs, On the design of the iPod
as quoted in Newsweek (2006-10-14)



Sometimes, paying management some ridiculous amount in compensation to take over a sinking ship does not work. Once in a while, though, it works spectacularly well.

Some people also criticize the fact that some C-level executives make hundread times an average person's salary. Well, I hope the following example of Steve Jobs at Apple shows why people like me feel it is justifiable.

This is a story of the best of capitalism. We aren't talking about the case of someone making a billion for shareholders, while earning himself or herself a hundread million, just because commodity prices rose. Nope, it ain't that. This also isn't the story of someone gambling the house's money and earning himself a few hundread million just because the bet worked out (don't ask what happens if it blew up.) Nope, it's not quite that. What we have here is someone who, along with fellow employees, rescued a firm that may well have ended up like the dodo bird and created new, revolutionary, products in the process.

# # #



I remember, about a decade ago, when Apple paid a fortune to Steve Jobs just so that he could come back and take over management duties. I believe I was in university at that time and I was more into the tech industry so I was thinking to myself that this is one huge gamble. Admittedly Apple fell off a cliff at that time and was just a bit player—sort of like how Sun Microsystems or AOL are now.

It appeared to be a huge gamble to me because Apple was paying what seemed like a fortune just to have Steve Jobs. It's hard to measure the true compensation because most of the wealth transfer was in the purchase of NeXT, which was mainly owned by Steve Jobs. My wild guess is that Apple paid several hundread million more than what NeXT was worth to get Jobs (such schemes are common in the corporate world. Recall how Citigroup paid Vikrim Pandit a fortune to buy out his hedge fund in order to get him to come and work for them.) Steve Jobs received a boatload of Apple shares and although Apple shares were out of favour and possibly on its way towards corporate death, and Jobs was only paid a salary of $1, it was still a large compensation package.

In the end, the gamble paid off in a big way. It worked so well that even bullish Apple shareholders in early 2000's probably wouldn't have dreamed of how it turned out.

# # #


My interest in life is not to climb the corporate ladder. This means I don't really follow stories about management. I generally skip articles talking about the best CEOs or the worst ones. So it is a bit bizarre for me to be writing an entry about the best business leader of the decade. I have to admit that I don't really follow executive behaviour closely. However, I decided to write something after reading a Fortune article.

A few weeks ago, Fortune magazine selected Steve Jobs as the CEO of the decade. I thought a bit about different leaders that came to mind, across differing industries, and I think it's hard to argue against that call. I'm not a fan of Apple and don't really own any of their products so this isn't a fanboy selection. In fact, the more I think about it, the more I realize how broad his impact has been. Not only did he have a bit impact in computing and music delivery, he also played a key role in revolutionizing computer animated films.

# # #


When Apple was rumoured to enter the smartphone market, I didn't quite get it. I neither follow the industry nor Apple but I knew a bit about the industry. I didn't think they would make it. After all, the mobile phone market consisted of highly competitive products with very short lifespans with a lot of power held by the giant telecoms. How was Apple supposed to break into the market yet alone survive with no prior history (although the development of Newton provided crucial engineering and marketing experience)?

I also didn't understand why Apple was spending a fortune on the iPhone, while pushing their Leopard OS to the background. Now, in hindsight, it all makes sense to me. What I didn't realize what how much the iPhone was a defensive move as much as an offensive attack. The more I think about it, the more I realize that Apple's iPod could easily have been surplanted by a mobile phone with similar capabilities. I dno't know if we are quite there but it wouldn't surprise me if, within a few years, mobile phones replace stand-alone music players like the iPod.

In the end, it was a spectacular introduction by Apple. The product was revolutionary and the build quality even appeared to surpass many of the smartphones with long history in the market. Perhaps the most subtle, yet significant, impact was on smartphone pricing. Apple introduced the iPhone at $499 for the cheaper version which radically altered the pricing structure in the industry. All of a sudden, many of the existing smartphones, as well as high-end (non-smartphone) mobile phones, looked really expensive compared to their capabilities. Steve Jobs isn't a techie but more of a businessman. You can tell this by how well he and his marketing team prices products.

# # #


I think Steve Jobs deserves the title of the Business Leader of the Decade - 2000 to 2009 for the following key reasons:


  • Rescued Apple from declining into oblivion and turned it into one of the leading consumer technology companies in the world. Apple appears wildly overvalued right now but, nevertheless, he has somehow managed end up with a market cap of $190 billion right now.

  • Apple looked to have completely lost its position in the desktop PC and notebook markets but Steve Jobs somehow resurrected the products. This is much harder than it seems because it's hard to get software and hardware developers to support an operating system if it keeps losing market share. The over-priced NeXT acquisition was somehow put to use in the new Mac OS for the desktops and notebooks.

  • Totally revolutionized animated films with his involvement in Pixar. Most of the credit should go to the creative players but Pixar wouldn't be what it was without Jobs' involvement. A lot of the key events happened in the prior decade but Pixar was still influential in the 2000's.

  • Completely altered the music industry with the introduction of the iPod and stole the portable music player crown from Sony. Quite frankly, the iPod wasn't as revolutionary as it seems. The idea was nothing new—even a dumb guy like me was waiting for devices like that to materialize—but the execution by Apple was flawless. Can't give better marks for marketing. iPod became cool and the rest was history. The popularization of the iTunes story perhaps put an end to the music CD business. People still buy CDs (I mostly buy CDs) but young people don't.

  • Revolutionized mobile phones with the introduction of the iPhone. Introduced capacitive touch mobile phones and altered the mobile phone power structure. Few would have expected the phone manufacturers to dictate so many terms to a carrier but Apple somehow shifted the balaned to the phone manufacturers.


I hope one day, you or I, end up half as influential...

# # #


I'll finish off by linking to some interesting information...

Here is a nice timeline of the events from Fortune.

The main Fortune story awarding Steve Jobs the CEO of the Decade title can be found here.

Steve Jobs' Stanford Commencement Speech from 2005:





I didn't know Steve Jobs had a tough childhood (listen to the speech above to see what I mean.) It's good to see him succeed against tough odds.

I also like how he points out that seemingly irrelevant things can help you later in life. He mentions the example of him taking caligraphy classes, which seemed like the most useless thing, yet it ended up having a huge impact on the computer industry. The font design he learned from his caligraphy class influenced Mac's font system, including its inclusion of proportional fonts. People, especially parents of kids, who trash the arts and other seemingly useless fields should keep that in mind (yes, I'm a defender of the arts and other fields that many on the Right consider as useless to society :) ).

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Tuesday, December 29, 2009 3 comments ++[ CLICK TO COMMENT ]++

Update on the potential real estate bubble in China

The Globe & Mail has a piece on the potential real estate bubble in China. I think China is sitting on a large real estate bubble (although it isn't as serious as its potential manufacturing bubble) but many do not think so. As far as I'm concerned, real estate bubbles are due to the lack of affordability, whereas many keep claiming real estate cannot be in a bubble if there is demand—tell that to the American real estate investors in 2005, when demand was so strong that people were lining up for days to buy condominiums in Miami.

The trials of a young couple trying to find affordable housing may not sound like gripping television fare, but with real-estate prices spiralling out of control in China, Snail House was a hit when it went on the air in July. The gritty plot – revolving around two sisters trying to establish themselves in a fictional city that looks a lot like Shanghai – hit so close to the bone that Chinese authorities cancelled the show after only 10 episodes. It quickly found a new life online, where some 30 million people have viewed it.

The runaway popularity of the show highlights a dark undercurrent to what has otherwise been a successful year for the Chinese economy.

...


The high cost of urban housing has become public issue No. 1 in the world's most populous country in recent months. A recent university graduate recently became an Internet celebrity after pictures were published online of the home she had made for herself in the washroom of the office building where she works. An online poll of more than 10,000 people on the Sina.com Web portal found that 47 per cent of respondents would have an extramarital affair if it would help them get a big-city apartment.

Despite a building boom in recent years, real-estate prices in China's crowded cities are increasingly out of reach for most ordinary Chinese. Average housing prices recently hit $2,200 (U.S.) per square metre in Beijing, one-third of the average annual income in the capital, and developers have been reporting record profits even as newly built skyscrapers and vast shopping malls sit partially or completely vacant around the city.

According to one report by a government think tank, half of the property purchases in Beijing are made by people who live outside the city, and 20 per cent are for investment purposes only, with the buyer having no intention of actually using the property. In Shanghai, prices are even higher, having shot up 60 per cent since last year.

“In Beijing, about 90 per cent of homes are hardly affordable to ordinary people,” said Yi Xianrong, a member of the Institute of Finance and Banking at the China Academy of Social Sciences.


It looks like Chinese real estate, at least in the major cities, are far worse than what I would have ever imagined. Keep in mind that the median household income in China is several magnitude lower than developed countries so these quoted price per square meter numbers are totally out of this world. The quote above mentions one square meter costing 1/3 of an yearly salary. This isn't a single outlier case; it is supposedly the average! I wasn't following the situation back then but these numbers may be approaching the 1990-Tokyo numbers if adjusted for income (if you don't adjust for income then these numbers are nowhere near the stratostrophic Japanese numbers.)

If the average citizen can't afford to buy homes then prices are unsustainable. It may take a while for things to correct but the free market price will be a lot lower.

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Monday, December 28, 2009 1 comments ++[ CLICK TO COMMENT ]++

Sold: Guest-Tek (GTK)

I have been busy with non-investing duties so I missed the following transaction that occured in early December to one of my legacy holdings, Guest-Tek (TSX: GTK). Guest-Tek, a leading supplier of wireless Internet solutions to the hospitality industry, was one of my first investments—my 3rd purchase to be exact, and before I started this blog—and was a tiny holding in my portfolio.

Management offered to buy out Guest-Tek at $0.50 and take it private, and shareholders appeared to have voted in favour of it (I was aware of the offer but didn't follow the voting situation closely.) Fundamentals of the company had been deteriorating for years and its share price declined significantly over the last 3 years.

Shares were delisted on December 4th of 2009. I took a loss on this investment (-23.75%).


Sale Price: $0.50
Total Return: -23.75% (-17.94% annualized)


Post-Mortem

History

I was more of a newbie back in 2004 when I bought this stock. I had very little money and it was the 3rd stock I bought. I remember being scared a bit when I bought this because it was a risky company. It's kind of funny how life is: I was scared and thinking hard for a few weeks about this investment (before I made it) but the size of the investment was so tiny compared to the present.

At that time, the company was the largest wireless internet solutions provider for hotels and motels and just went through an IPO. Its shares fell around 40% from the IPO price and that is what made me look at it (I was scanning the worst IPO performers on the TSX and decided to look into this.) I was basically betting on a turnaround of a struggling company.

I bought it because it seemed to have some moat (a tiny one) and appeared to have good relations with customers in the hospitality industry. I figured it was hard for competitors to establish similar relationships with the hotels. The financials looked ok (not terrible but nothing spectacular either.) I was more of a growth investor back then so I was also investing primarily on the prospect for increasing wireless network services in hotels.

The company kept sliding—share price and profitability—and just couldn't turn things around. Part of the problem was that their margins were too small and they were highly vulnerable to currency fluctuations. Furthermore, it seemed like their operations were not efficient and management seemed incapable of improving the situation.

About an year or so after my investment, the stock had fallen maybe 20% or 30% (don't remember exactly) and it looked like this was a big mistake. Out of blue, a Japanese company showed up and offered to buy out a majority stake. The offer price was around 20% above my purchase price (in terms of taxes, roughly half was counted as capital gains while half was counted as a special dividend.) I tendered all my shares but it was oversubscribed and I only got my pro-rated share of my allotment. I was able to tender roughly 50% of my holding so I was left with 50% of my original investment.

Final Outcome

I didn't follow the company closely, partly because it was a small holding, and the share price collapsed after the tender offer and take over by the Japanese company. In late 2009, insiders offered to take the company for private and shareholders accepted it at a really low price. I wasn't following the company close enough to discern whether the buyout price was "reasonable" or not. I suspect it was a take-under but the company wasn't that great to begin with.

Ultimately, I ended up with a loss :(

Lessons Learned

I made a big mistake in becoming complacent after the tender offer. It's a small company so it doesn't make the news. One really needs to follow it year in, year out, and I never did that. This was a mistake on my part because the stock price kept declining during that period. If I had followed the company, I would have been able to sell out with a profit when it looked like things were falling apart.

Situations like this have made me become more of a concentrated investor. It's just too difficult to follow more than 3 or 4 companies. Actually, following the companies is not hard; what is hard is staying interested in those companies!

Anyway, ever since this debacle, my goal has been to follow companies more closely.

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Sunday Spectacle XXXXI



Bull Wins
Hope you were on the right side this year!

(Unknown source. Downloaded from here.)

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Friday, December 25, 2009 2 comments ++[ CLICK TO COMMENT ]++

Happy Holidays

Happy Holidays!
Have an Enjoyable Christmas and
All the Best to You and Your Loved Ones


(Image source: I took this picture of minature models in a Seattle mall in 2006.)

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Monday, December 21, 2009 0 comments ++[ CLICK TO COMMENT ]++

Sunday Spectacle XXXX


Wanderer Above the Sea of Fog
(Caspar David Friedrich, 1818)



That is how I feel right now...

That is also my favourite painting of all time (I'm a newbie so still need to see/read more.) The image shown here is slightly darker than the actual painting.

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There is a reason this blog has been dead for a while... I was laid off recently :(

(This post has nothing to do with investing. It's mostly to do with my personal life.)


I remember posting a pic recently pointing out how Dubai was fading to black. Well, my life faded to black slightly. It's flikering like crazy. A few crazy weeks for sure.

I was just let go by my employer last week (due to lack of work and not because of anything bad.) Never a pretty sight knowing that you may never walk into that office ever again. Management telegraphed the situation a while ago so it wasn't a shock. Nevertheless, it's dissapointing for it to occur (especially when I don't have another job :( )

I am not as disgruntled as I otherwise would have been since it was inevitable. I work in market research—job is data/statistical analysis—and half of our clients are in the tourism industry (mostly US state governments and public-private partnerships.) Anyone following the economic environment would be aware how badly the state governments are doing, and how the tourism sector has fallen off a cliff (if you are a traveler it has been a great year though, with Las Vegas and Carribean destinations almost literally giving away everything for free.) My former employer is very small, with only 10 to 15 employees, and it had to downsize. My productivity wasn't that great since I hit my peak and got bored a while ago (nowhere to move since the company is small.) So the decision was inevitable. I made one of my biggest mistakes of my life by not leaving earlier on my own.

There is good and bad to this...


It's Always Bad...

The bad news is that I am out of a job. I started looking for a job a few months ago but never found one. I almost had a job lined up but I don't know what happened in the end. I may have been rejected at the last stage or something. I'm dissapointed that I didn't get that particular job because it would have been a perfect transition, with me leaving before I was let go. I also made a newbie mistake and ratched down my job hunting when it looked like I was close to getting that job. This was totally dumb and I think one should always assume that prospective employers don't care about you regardless of what they say or how close to the final stage you are. I guess I'm too naive.

Another bad thing is that—I hate to say it—I'm not career-oriented and I have too many diverse interests. I hope no Human Resources person reading this will hold that against me but that's the reality. Some people out there know exactly where they want to work. Others, even if they don't know where they would like to be, are driven by money and hence target high-paying jobs. Some also know what they want based on their need for fame or power. I really don't belong anywhere. I'm a jack of all trades and employers, particularly human resource professionals, completely hate people like me :( Oh well, that's me and I just have to deal with it.

A big negative about searching for a job without having one is that you are almost forced to accept the first decent job that you get (this is essentially true if you don't have a high-end job, aren't rich, or don't have a big severance--all pretty much describe me.) I wish I was searching for a job one or two years ago when I had one and was in a stable situation because I could have skipped jobs that didn't fit me well or I didn't like. In contrast, right now, I'm really forced to seek out almost anything that is remotely connected. By being laid off, I have lost my "skip" card, that lets me skip situations I don't like.

Finally, I don't really have good social networking skills—too much of a loner—and the most painful statistic for me is to always hear that, something like 70% of jobs are through contacts. It was always like that and there is nothing wrong with it—for instance, many new jobs are created by small and medium businesses and they just don't have HR budgets to advertise, filter through resumes, etc—and I just have to deal with it.


...But There is Always Something Good

Glass is always half full, right?

I need to move on to a more challenging job, that is more aligned with my interests and skills. So, now I am forced to leave my current job. I was going nowhere in my current job—company is too small and wasn't growing even during the best of times—and, hopefully, I can get a job that is better suited to me and will be more challenging. I am actually excited to have the opportunity to pursue new opportunities elsewhere. It was time to go. I am pretty flexible, still single, and don't care about money so I can pursue many things; hopefully I get something that I like rather than taking a job for the sake of a job.

I also got bored of the environment I was at and am looking forward to different companies. Unless you have a senior position and/or are in it for the money, a 10-employee firm can get boring really quickly (imagine the Christmas parties!) I also want to join a company that is more dynamic, or at least has youtful enthusiasm. If I'm not getting paid much, which was the case at my prior job, at least I want to work on something fun, or have the opportunity to accomplish something.

I might be the biggest loser on earth since I still live with my parents but at least this is a good thing in the current situation. It's not as painful as if I was all alone out there. So the job loss isn't as bad as it appears.

Depending on where I end up, it will alter my life forever. I am actually looking forward to it. In fact, some possibilities are exciting. I was thinking that I might need to buy a car if I get a job in a suburb. Unlike most men, I am not into cars and can see myself living without one for my whole life. But if I need it for a job, I think it's kind of fun to have one. But it's very expensive for a cheap guy like me. Anyway, I have been researching cars and it's kind of exciting to think about owning a car. It'll be my first car—kind of late for someone my age; I'm 32—so it's kind of neat if I do end up with a job in the suburb.

I haven't done much on the investment front lately due to these issues (possibility of losing a job (actual loss now), money needed possibly for a car, possibility of moving to another town (trying to stay near Toronto as best as I can), etc.) I have been extra cautious lately. The caution isn't from the risk of losing money but, rather, from the possiblity being illiquid (i.e. I might need a lot of money really quickly.) Nearly all my money is in my investment accounts, although I'm something like 50% cash right now.

For you guys & gals, all of this probably means that I'll blog more ;) I enjoy writing stuff and am interested in this stuff so I'll be doing more of it now. It'll be a good break from job hunting and keep my spirits up... I hope...

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Monday, December 14, 2009 0 comments ++[ CLICK TO COMMENT ]++

Paul Samuelson passes away

A Young Paul Samuelson - 1950(source: Yale Joel for Time & Life Pictures, Getty Images.
Downloaded from New York Times, Dec 14 2009)



Paul Samuelson was before my era—I wasn't even born back then—but he is arguably the most influential Keynesian other than Keynes himself. A left-leaning economist who is not shy to tackle the establishment, he was heavily influential in the field of economics. He, like Keynesian economics in general, was very influential in the 1950's and 1960's, but fell out of favour in the 1970's and 1980's. With the re-emergence of Keynisianism after the recent collapse of Monetarism, I suspect Samuelson will end up being more influential than even during his peak.

The New York Times has a good article, written by Michael Weinstein, summarizing Samuelson's influence on economics. Here is an excerpt:

His most influential student was John F. Kennedy, whose first 40-minute class with Mr. Samuelson, after the 1960 election, was conducted on a rock by the beach at the family compound at Hyannis Port, Mass. Before class, there was lunch with politicians and Cambridge intellectuals aboard a yacht offshore. “I had expected a scrumptious meal,” Mr. Samuelson said. “We had franks and beans.”

As a member of the Kennedy campaign brain trust, Mr. Samuelson headed an economic task force for the candidate and held several private sessions on economics with him. Many would have a bearing on decisions made during the Kennedy administration.

Though Mr. Samuelson was President Kennedy’s first choice to become chairman of the Council of Economic Advisers, he refused, on principle, to take any government office because, he said, he did not want to put himself in a position in which he could not say and write what he believed.

After the 1960 election, he told the young president-elect that the nation was heading into a recession and that Kennedy should push through a tax cut to head it off. Kennedy was shocked.

“I’ve just campaigned on a platform of fiscal responsibility and balanced budgets and here you are telling me that the first thing I should do in office is to cut taxes?” Mr. Samuelson recalled, quoting the president.

Kennedy eventually accepted the professor’s advice and signaled his willingness to cut taxes, but he was assassinated before he could take action. His successor, Lyndon B. Johnson, carried out the plan, however, and the economy bounced back.

...


In the classroom, Mr. Samuelson was a lively, funny, articulate teacher. On theories that he and others had developed to show links between the performance of the stock market and the general economy, he famously said: “It is indeed true that the stock market can forecast the business cycle. The stock market has called nine of the last five recessions.”

His speeches and his voluminous writing had a lucidity and bite not usually found in academic technicians. He tried to give his economic pronouncements a “snap at the end,” he said, “like Mark Twain.” When women began complaining about career and salary inequities, for example, he said in their defense, “Women are men without money.”

Remarkably versatile, Mr. Samuelson reshaped academic thinking about nearly every economic subject, from what Marx could have meant by a labor theory of value to whether stock prices fluctuate randomly. Mathematics had already been employed by social scientists, but Mr. Samuelson brought the discipline into the mainstream of economic thinking, showing how to derive strong theoretical predictions from simple mathematical assumptions.



One the ideological followers of Samuelson, Paul Krugman, made an interesting blog entry today, quoting some text from Samuelson's 1948 textbook (I took out some text and bolded some text):

But here’s Paul Samuelson, from pages 353-4 of his 1948 textbook:

[paragraph edited out by Sivaram]

By increasing the volume of their government securities and loans and by lowering Member Bank legal reserve requirements, the Reserve Banks can encourage an increase in the supply of money and bank deposits. They can encourage but, without taking drastic action, they cannot compel. For in the middle of a deep depression just when we want Reserve policy to be most effective, the Member Banks are likely to be timid about buying new investments or making loans. If the Reserve authorities buy government bonds in the open market and thereby swell bank reserves, the banks will not put these funds to work but will simply hold reserves. Result: no 5 for 1, “no nothing,” simply a substitution on the bank’s balance sheet of idle cash for old government bonds. If banks and the public are quite indifferent between gilt-edged bonds — whose yields are already very low — and idle cash, then the Reserve authorities may not even succeed in bidding up the price of old government bonds; or what is the same thing, in bidding down the interest rate.

Even if the authorities should succeed in forcing down short-term interest rates, they may find it impossible to convince investors that long-term rates will stay low. If by superhuman efforts, they do get interest rates down on high-grade gilt-edged government and private securities, the interest rates charged on more risky new investments financed by mortgage or commercial loans or stock-market flotations may remain sticky. In other words, an expansionary monetary policy may not lower effective interest rates very much but may simply spend itself in making everybody more liquid.



Paul Krugman correctly observes that this is very close to the current situation. Bank reserves have been skyrocketing, just like during the Great Depression. Krugman follows up with this chart, which has been beaten to death in the blogging world (interestingly both the deflationists and inflationists argue that the skyrocketing reserves supports their stance), showing the current state of affairs.

IANAE (I Am Not An Economist) but I don't share Samuelson's latter point where he suggests that yields on high quality bonds won't decline. (Do note that I am not criticizing Samuelson per se since I might be taking his words out of context (I'm referring to tiny portion which was quoted by Krugman, which came out of a book that may be referring to some scenario that doesn't correspond to what I'm talking about.))

I haven't taken any position but I'm pretty much in the camp that believes US government bond yields will decline. During the Great Depression, the yields did decline (although there was a fake sell-off in government bonds in the middle of all the chaos in 1931.) I think the mistake Samuelson makes—a mistake made by many left-leaning individuals—is that he is expecting the government to influence the market participants. I, although left-leaning, on the other hand, do not think the government needs to influence anyone; market participants will bid up government bonds on their own due to market forces. If asset prices fall (i.e. deflation), market forces will bid up high-quality government bonds (contrary to some out there, US government bonds are still the highest quality bonds of any large, liquid, issuer.)

In any case, this is going way off topic but it does show how intelligent Samuelson was, if his writings in 1948 eerily parallels the present market behaviour. As recently as two years ago, nearly everyone would have considered it ludicrous if one said that American banks would be sitting on one trillion dollars of excess reserves. Yet it has happened—this in the land of capitalism where American banks were considered to be some of the best on the planet.


For those that missed it, you may want to check out this interview by The Atlantic that I linked to a while ago. Great stuff, especially if you are left-leaning. Interestingly Samuelson is related to Lawrence Summers but liberals like me respect Samuelson but not a big fan of Summers.

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Sunday, December 13, 2009 0 comments ++[ CLICK TO COMMENT ]++

Sunday Spectacle XXXIX

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Monday, December 7, 2009 5 comments ++[ CLICK TO COMMENT ]++

The bear case for China by Pivot Capital

In a recent blog entry, Yves Smith of Naked Capitalism referenced a very good report by Pivot Capital, outlining the bearish case for China. In China’s Investment Boom: the Great Leap into the Unknown (dated August 21, 2009), Pivot Capital goes over why they believe China's boom, largely led by investment, is bound to slow down or, in the worst case, blow up. It's a very good report and I recommend the report to anyone interested in China or macro issues.

Here is an overview of the report:

In this report we describe the background to and the extent of the capital spending bubble in China and identify factors that will precipitate its deflation. We focus on Chinese capital spending firstly because it is the single most important driver of current Chinese and global growth expectations and, secondly and more importantly, investment-driven growth cycles tend to overshoot and end in a destructive way.

We conclude that the capital spending boom in China will not be sustained at current rates and that the chances of a hard landing are increasing. Given China’s importance to the thesis that emerging markets will lead the world economy out of its slump, we believe the coming slowdown in China has the potential to be a similar watershed event for world markets as the reversal of the US subprime and housing boom. The ramifications will be far-reaching across most asset classes, and will present major opportunities to exploit. There are three key reasons why we take this view:

China’s expansion cycle surpassing historical precedents:

Policy actions not sustainable into 2010...

Overcapacity and falling marginal returns on investment...




Whenever I encounter a new source, I usually check their history. No one is perfect and everyone gets things wrong but a strong track record on core issues sort of indicates skill. Since I am attracted contrarian views, one of the worst mistakes I could make is to blindly follow so-called "contrarians," perma-bears, perma-bulls, or a related "ideologies." There are many who appear right simply because they are permanently bearish on central banks; or permanently bearish on US$; or permanently bearish on technology stocks; or premanently bullish on gold; and so on. Needless to say, these guys are next to useless for investment purposes. It makes for fun entertaining reading but it's difficult to invest off them.

One of the reasons I like Hugh Hendry is because he was somewhat prescient with the credit bust call all the back in 2003 in a Barron's article. I took a quick look at Pivot Capital, and they seem to have had the right reasoning back in 2006 (refer to the reports at the very bottom of this page.) Note that this was before Bear Stearns and before it was obviously that a crisis was unfolding. So it's worth paying attention to these guys.


The Pivot Capital report elaborates on reasons I have remained bearish on China, and very cautious on commodities. The conclusions are in-line with my thinking. In particular, there appears to be very large overcapacity in manufacturing and a potential real estate bubble. Furthermore, the report describes what I have mentioned in the recent past about China's employment issues. Namely, China has to switch to a service-oriented economy or else they are going to have serious unemployment problems (and, consequently, political problems.)

The report concludes by saying:

Although we see a high probability for a slowdown in 2010, the main issue facing investors is when markets will start discounting that slowdown. In this sense we are back to a situation similar to 2006-2007 as the sub-prime and credit booms were approaching their end. In view of the governments’ clear commitment to safeguard the recovery there is certainly a risk of multiple false breakdowns before a top has been reached. Nevertheless, the markets should experience a major growth scare sometime in H1 2010 at the latest.

Anything that is cyclical and dependent on Chinese investment demand would obviously be the most vulnerable to a Chinese growth disappointment. That would include industrial commodities as well as equities and credit of industrial and consumer cyclicals. There would also be a general rotation into more defensive areas taking place across most asset classes. The biggest uncertainty relates to what China means for the debate on deflation versus inflation. In principle, a Chinese slowdown should initially be deflationary, especially given the overcapacity currently building up in various Chinese industries. This should be negative for credit in general and also for most equities. However, depending on how aggressive the policy response will be in China and elsewhere, investors may very well start focussing on the inflationary risks again.


This is a very weak close. The report builds a case for deflation and then closes by saying inflation may be likely depending on government policies. Obviously such views cannot be acted upon. If we get deflation, stocks (in general) will get killed; but if we get inflation, they will rise (even if they don't post good real returns, they will likely post positive nominal returns.)

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Sunday, December 6, 2009 0 comments ++[ CLICK TO COMMENT ]++

Sunday Spectacle XXXVIII



Central Bank Employees



The responsibilities and power of central banks vary across countries so this chart is more complicated than it seems. Charts like these probably say more about the structure of politics than economics. For example, the fact that China has very few central bankers for such a large economy pretty much nails home the point that their monetary policy is either useless or, more likely, driven by politicians. USA, with around 20,000 Federal Reserve employees, appears quite low for such a large and important economy.


(source: "In the Bank," The Economist. December 4, 2009)

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Thursday, December 3, 2009 3 comments ++[ CLICK TO COMMENT ]++

Burj Dubai marks the peak--literally



One of the best investment history books I have read was Jim Grant's The Trouble with Prosperity. I didn't quite finish it—had to return it to the library and never got around to signing it out again—but it was amazing to read how the worst excesses (in terms of commercial real estate) were completed just as the Great Depression was unfolding. In particular, the Chrysler Building* was completed in 1930 (the book focuses on a different building but it does mention the building.)

Well, the Burj Dubai, a spectacular building being built in Dubai, reminds me very much of all those New York skyscrapers from the 1930's. Like the American counterparts, the Burj Dubai will stand the test of time. It will outlive me. It may even outlive some nations. But it will be financial disaster for anyone that came close to it.

The Globe & Mail has a story summarizing the building:

When work began in 2004 to build the world's tallest tower, Dubai's confidence also was sky high with a host of megaprojects on the drawing board or rising from the sands.

That swagger seems positively old school these days. It's been tripped up by a debt crunch that has humbled Dubai's leaders and exposed the shaky foundations of the city-state's boom years – leaving the planned Jan. 4 opening of the iconic Burj Dubai with a double significance of hello and goodbye.

It will be both a debutante bash for a new architectural landmark and a farewell toast to Dubai's age of excess.

The Burj Dubai – a steel-and-glass needle rising more than 800 metres – may be the last completed work from Dubai's time of the giants.


...

It's not the first time a skyscraper has gone up as the economy swooned.

New York's 102-story Empire State Building was designed as the world's tallest building just before the 1929 stock market crash and opened in 1931 as the Great Depression was taking hold. In 1999, the Petronas Towers in Kuala Lumpur, Malaysia, officially opened to claim the world-tallest crown – two years after the financial meltdown of the once-soaring Southeast Asian economies.

...


A barrage of statistics – vital and trivial – are pouring out as the $4.1-billion (U.S.) building gets its finishing touches: more than 160 storeys topped by a spire that reaches a reported 818 metres, well above the runner-up skyscraper, Taipei 101 in Taiwan, at 508 metres. The Burj has even pushed past other giant structures taller than Taipei 101 such as the CN Tower in Toronto and the KVLY-TV mast in North Dakota.

The Burj – designed by the Chicago-based architectural firm Skidmore, Owings&Merrill – is billed to have the world's fastest elevator at up to 64 kph and can be seen as far as 95 kilometres away. It takes three months just to clean all the windows.


Reading Grant's account of New York city towers circa 1930's, I get the feeling that one of the most innovative accomplishments were the elevators. Without major innovations in elevator technology, the New York skyscrapers wouldn't have been so high. Burj Dubai no doubt has some fancy elevators. But my feeling is that the big accomplishment will be the window cleaning systems. The official site (check out fact & figures, facade maintenance) says that there are 3 machines, each able to service 36 meters x 45 meters, and able to clean the whole building in 3 to 4 months under normal conditions. Just imagine the size of each machine, with arms spanning 15 meters when folded in the storage position. That's a machine that is 5 stories high! Needless to say, these machines will be working overtime for the rest of their "lives" given the dust and sand in that region of the world.


Burj Dubai is a great accomplishment; but like most architectural wonders, a complete waste of money in the short to medium terms.




SIDE NOTE:

* I have fond memories of the Chrysler Building. Nowadays, I appreciate its unique Art Deco style. Apart from that, when I was a kid, I had a big puzzle set—1000 pieces or something—of the New York city skyline. Needless to say, the Chrysler Building was one of the standouts—other buildings all looked similar but not this—and was one of the key sections that was easy to complete.

** Don't quote me on that because I don't remember exactly. All I remember was that it took a long time for the original projected rents to materialize. If it wasn't the 80's, then it was something like the 60's, which was still 30 years after the completion of the building.


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Portfolio diversification

Jason Zweig, whom you may remember as the editor of the latest edition of The Intelligent Investor, writes a good series for The Wall Street Journal called The Intelligent Investor. It's generally avaiable for free so I check out his articles once in a while.

Zweig appears to be a passive investor; I'm an active investor. Like most passive investors, he also favours wide diversification; in contrast, I'm trying to master concentrated investing. So, I really don't agree with most of what he says and don't find his articles aligned with my thinking. But I still read them for a reason: Zweig generally throws in some unique insights or results of some academic research that is worth pondering regardless of the investment strategy you are pursuing. His article from November 26th is one such case. In it, he mainly talks about how wide diversification is the best strategy and I don't share the same view. But he also mentions something interesting (as usual edits such as bolds are by me):

Don Chance, a finance professor in the business school at Louisiana State University, asked 202 business students to select one stock they wanted to own, then to add a second, a third and so on until they each held a portfolio of 30 stocks.

Prof. Chance wanted to prove to his students that diversification works. On average, for the group as a whole, diversifying from one stock to 20 cut the riskiness of portfolios by roughly 40%, just as the research predicted. "It was like a magic trick," says Prof. Chance. "The classes produced the exact same graph that's in their textbook."

But then Prof. Chance went back and analyzed the results student by student, and found that diversification failed remarkably often. As they broadened their holdings from a single stock to a basket of 30, many of the students raised their risk instead of lowering it. One in nine times, they ended up with 30-stock portfolios that were riskier than the single company they had started with. For 23%, the final 30-stock basket fluctuated more than it had with only five stocks in it.


I haven't looked at the study being quoted but it appears that risk is being measured based on volatility (i.e. standard deviation.) If so, that's not my view of risk but let's not quibble over definition of risk because that's not the main point.

The key point I wanted to highlight is how the overall average of a set of investors may appear as one thing (in this case, low volatility/risk) while individual investors experience something completely different (in this case, high volatility.) This is something that is very important for you to consider if you diversify heavily, look at quantitative studies (or follow quantitative strategies) or do a lot of back-testing. Studies may concluce, almost always based on overall averages, one thing but it may turn out to be different for individuals.

Why does this happen? Zweig presents some theories:

What accounts for these odd results? Leave it to a professor called Chance to show that even a random process produces seemingly unlikely outliers. Thirteen percent of the time, a 20-stock portfolio generated by computer will be riskier than a one-stock portfolio.

Humans are even more fallible. Prof. Chance's students started by picking companies they were familiar with: Exxon Mobil, Wal-Mart Stores, Apple, Starbucks, Nike and the like. But after a handful or two, they ran out of household names. By the fifth company, they were picking stocks that had less than half the market capitalization of the one they started with. Adding these riskier small stocks made their portfolios more volatile. And one in five students picked 1-800-Flowers.com as a top holding, perhaps because Prof. Chance happened to schedule the assignment near Valentine's Day, when they may have had bouquets on their minds. (They weren't just picking from the top of an alphabetical list; almost nobody chose 1-800 Contacts.)

These results are no surprise to Allan Roth, a financial planner at Wealth Logic in Colorado Springs, Colo. "Humans can't think randomly," says Mr. Roth. "Once people think of Exxon Mobil, they're a lot more likely to think of Chevron or another oil stock. For a lot of investors, diversification is like doing a word-association game."

Gur Huberman, a finance professor at Columbia University, points out that investors tilt toward stocks that match their own beliefs about risk. People who regard themselves as risk-averse will assemble portfolios of highly similar stocks that all seem to be "safe." The result, paradoxically, is a risky portfolio with every egg in one basket. As bank-stock investors learned last year, owning a greater number of the same kind of company isn't diversification at all.


So, according to one professor, the flaw seems to be the complex pattern-matching out brain pursues. The prof suggests the notion of "pattern matching" which is very common in human behaviour. In other words, we may perceive an investment as random when in fact it isn't.

The second theory being put forth by the other professor revolves around people sticking to their perceived risk profile and inadvertenly concentrating in certain industries. As newbies, like me, know full well, risk is the hardest thing to analyze. What one perceives as high risk may not be so; and vice versa. The example cited with financial stocks is a good one. The vast majority of investors would have considered financial companies to be rock-solid and safer than, say, wildly fluctuating technology companies like Amazon or Ebay. Yet, the low-risk financials turned out to be a disaster.


I purposely don't diversify but even with the few stocks that I contemplate investing in, I worry about issues like this. Namely, I am always worried that I'm unconsciously biased in some way. One's circle of competence (knowledge, interest, etc) will drive decisions but what about unconscious psychological decisions beyond that?

I don't delve into psychological issues pertaining to investments very much on this blog because I'm still in the newbie stage where I'm trying to figure out valuations, understand the nature of businesses, etc. But at some point, if I were to become a successful investor, I have to ensure that I overcome psychological weaknesses present in almost all humans. Being unconsciously biased is one such issue.

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Wednesday, December 2, 2009 14 comments ++[ CLICK TO COMMENT ]++

Opinion: The US govt should re-appoint Ben Bernanke

Resistance is mounting for the re-appointment of Ben Bernanke to the Federal Reserve chairperson position. Those in favour of re-appointment heavily outweigh the dissenters but I sense a shift in the mood. MarketWatch reports that a senator is attempting to block the re-appointment:

Sen. Bernie Sanders placed a hold Wednesday on the nomination of Ben Bernanke for a second four-year term as chairman of the Federal Reserve, saying it's time for a change in economic policies.

Sanders' hold could delay the vote on Bernanke's confirmation, but likely won't derail it. The hold means the Democratic leadership would need at least 60 senators to agree to bring the nomination to a vote, instead of the 50 needed without the hold.


As I have said many times before, Ben Bernanke is not perfect but he is the right person for the job right now. If USA is indeed undergoing a deflationary bust as I suspect, Bernanke is one of the most qualified people out there. This doesn't mean that he will make all the right decisions but I am not too fond of other candidates that have been floated around.

Americans have a right to be wondering about all the central bank policies—a lot of amounting to transferring huge quantity of wealth from taxpayers to bondholders of financial institutions—but blocking the appointment is not going to accomplish much.


I also don't like the fact that the US government is attempting to strip the Federal Reserve of some powers and shift it towards the government. I am not too knowledgeable about government agencies and American laws but I do think some changes can be made. Clearly the FedRes didn't regulate the banks properly! However, some of the wide-ranging proposals being floated around would significantly strengthen various government agencies at the expense of the central bank—I don't like these plans at all.

The fact that the Federal Reserve is largely independent and is partly owned by private owners* (essentially private banks) causes problems and damages society at times. However, this is also what makes monetary policy in America much better than most other countries. The Federal Reserve has acted independently and largely gone against the government (the most recent example was in the 80's when the FedRes tightened monetary policy substancially against the wishes of most politicians.)


FOOT NOTE:

* I'm not an expert on banking but my impression is that the Federal Reserve is very unusual. Unlike other central banks, such as Bank of Canada or Bank of England, the Federal Reserve's shareholders are private banks such as Citigroup. This creates an interesting (largely theoretical) situation whereby foreigners can have sizeable impact on the monetary policy of USA. For instance, the biggest shareholder of certain leading private banks have been foreigners at times, and hence they, indirectly, influence the FedRes. However, as far as I know, the private banks only hold shares in one branch bank (USA is divided into regions and have branches representing regions) so the influence is quite limited.

In any case, the power of the private banks are limited. The US government has powerful oversight, such as deciding who to appoint as FedRes chairperson, and controls the currency and banking laws. And, of course, the government controls the military and hence, the FedRes, even if privately owned, is a subordinate of the government, which in turn is a servant of the voting population... or at least that's how I think a democracy is supposed to work.

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Tuesday, December 1, 2009 4 comments ++[ CLICK TO COMMENT ]++

Gary Shilling maintains his views

In an interview with Robert Huebscher of Advisor Perspectives, one of the true deflationists, Gary Shilling, sticks with his views. In particular, he says the recession may not end until 2010, which is contrary to the consensus view that the recession has already ended. Who knows if he is right since I lean towards deflation, and since Gary's views are contrarian, I pay attention to him.

As he has said in the past, Gary Shilling repeats his view that the US government will likely enact a second major stimulus plan. Again, this is completely opposite most people's thinking. The market not only does not expect this, but believes that there is too much stimulus. I am not too confident with this call but I do think that the second stimulus view is probably correct.

I'm not going to quote much from the interview since most of it has been covered on this blog before; the only thing I wanted to highlight was Gary Shilling's investment suggestions (long only.) The article also mentions some areas to avoid but many of those ideas have been marked down quite a bit already and I think it may be a bit risky. You can read the linked article if you are interested.


Gary Shilling's Long Ideas

Robert Huebscher points that Shilling never went into whether the following assets are overvalued or not so that is something to keep in mind; these are just general ideas without considering present valuations.

(my comments are in square brackets)

Shilling identified nine areas as buy candidates:

1.Dividend-paying stocks. With 2% projected real GDP growth and 2% deflation, Shilling forecasts no nominal GDP growth. Since corporate profits historically correlate with nominal GDP growth, Shilling expects the bulk of equity returns to be in dividends rather than capital gains.

[I am not sold on dividend-oriented stocks. My concern has to do with the fact that they are not contrarian. Just like how everyone was sold on the idea that blindly buying stocks and real estate were the path to retirement—needless to say, these two ended up being two of the worst assets in the last decade—I get the feeling that everyone has been sold on dividend-oriented stocks. This is particularly common with passive investors who appear to be overloaded with them... Another issue I have is that companies once used to pay dividends with cash they didn't need. Nowadays, they try their best to maintain their dividends at all costs, including long-term damage. This was very evident with financial companies, particularly Canadian banks, who were issuing equity and preferred stock at high yields while refusing to cut their common dividends. I am also starting to see companies laying off a lot of workers, cutting R&D and marketing, in order to maintain their dividends.]

2.High-quality bonds, especially Treasury bonds. Shilling forecasts 30-year rates to decline from 4.3% to 3%.

[I have been looking seriously at the long bond. Shilling 4.3% to 3% decline basically implies a potential return of 20% to 30%—but this is spread out over several years.]

3.The dollar. The dollar’s decline will end as its importance as a safe haven increases.

[I have been bullish on the US$ and completely wrong for several years now. This is a very difficult call to make. On the one hand, the US$ should strengthen due to the vaporization of huge quantity of US$-denominated debt; and capital flees from risky regions. On the other hand, US$ should weaken given the American current account deficit. Deflationists obviously lean towards the first view but, if the current account deficit doesn't dissapear, the bullish US$ call is not a given... On a side note, if the US$ starts strengthening, it is likely that gold will get crushed big time.]

4.North American energy. The US and Canadian energy industries will benefit from political stability relative to other parts of the world and from renewable energy policy initiatives.

[I don't share the same view since I am not bullish on energy. Relatively speaking, North American energy is probably better but, overall, I can see someone losing money. If economies of the world remain weak, and if the US$ strengthens, energy or commodities in general are not the place to be.]

5.Consumer staples and food. Deflation and slow growth will not impede consumer purchases of necessities, such as toothpaste.

[I agree but I think this is priced in. Consumer staples appear to be trading at above-market multiples and didn't suffer much during the crash.]

6.Investment advice and asset management. Growth will come because consumers need help with financial advice, provided that fees are commensurate with the value provided.

[I completely disagree with this. My impression is that asset management is strongly correlated with asset performance. Asset managers appear to do well when we have strong bull markets. I suspect that they will do poorly if we are in a bear market or a low-return market. After getting burned badly, I suspect the baby boomers, who basically own most of the wealth (excluding super-rich), will think twice about "creative" investment schemes. I actually expect huge flows into basic assets, like government bonds, which require limited financial advice. I really don't get Shilling's stance.]

7.Factory-built housing and rental apartments. These sectors will benefit as consumers no longer think of housing as an investment.

[no comment... don't know much about real estate, especially factory-built homes]

8.Healthcare. This will benefit from Obama’s initiatives and from its ability to employ people with diverse skills and backgrounds.

[Don't follow healthcare that much but I suspect he is right. On top of this, a lot of the baby boomers, who also hold most of the wealth outside the super-rich, will be ageing and willing to spend on health.]

9.Productivity enhancers. Without inflation pushing up revenues, reducing costs is the way companies will improve profits.

[Yep... covered this before but to reiterate, Shilling believes that companies will pay for productivity gains and has suggested that some technology fields will do well. I have been researching technology companies and haven't found anything but I would like to make a major investment in one.]

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Monday, November 30, 2009 2 comments ++[ CLICK TO COMMENT ]++

Credit card delinquency rises in China

MarketWatch is reporting that credit card delinquency rate in China has risen:

Credit-card debt at least six months overdue rose 126.5% for the first three quarters of 2009 compared to the same period last year, Xinhua news agency reported, citing People's Bank of China data.

By the end of September, China's banks had issued 175 million credit cards, a 33.3% increase from last year, according to the report -- which said that the central bank has warned of potential risks of mounting overdue credit-card debt.

Accounts overdue by six months or more made up 3.4% of China's total credit-card debt outstanding at the end of the third quarter, a 0.3% increase over the prior period, the report said.


I know very little about credit card debt metrics. I have no idea if a 3.4% delinquency rate is high for China.

I don't know anything about USA's credit card statistics either but Googling produced a TransUnion press release suggesting that the "national credit card delinquency rate (the ratio of bankcard borrowers 90 days or more delinquent on one or more of their credit cards) dropped to 1.10 percent in the third quarter of 2009." According to this somewhat dated Reuters news story, "Equifax, which provides credit data to businesses like banks, credit card issuers and retailers, said the average delinquency rate in Canada as of June 30 was 1.56 percent..." The time periods for the US and Canadian numbers (90+ days) differ from the Chinese one I highlighted above (180+ days) but it should givea a very rough idea.

Also, unlike America or Canada, I suspect that credit card debt is a small portion relative to the total economy (differing collection methods, bankruptcy laws, etc., also make direct comparisons meaningless.) So, I am simply using this news to gauge the situation over there and observe if things are improving or getting worse.

If there is a debt implosion in China, it will have little to do with credit cards (since their usage is limited.) Instead, the big risk in China is real estate. The Chinese government has very strong financial resources (i.e. good foreign reserves and savings) so they can absorb losses as long as it isn't catastrophic (they can't absorb Japan-like losses but I have little reason to suspect a bubble, if it actually exists, is anywhere near 1990 Japan.) However, any large losses will cause huge political problems. Just like how Dubai appears to have lost power and is now thought to be under political control of UAE, which is heavily influenced by Abu Dhabi, a similar thing can materialize in China (my wild guess is that the current "faction" controlling the national government won't survive such a crisis.)

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Rationalism vs Empiricism - Can knowledge be advanced through rationalist thought?

(This post has nothing to do with investing and deals with philosophy)


Rationalists vs Empiricists


I ran Alex Hutchinson's thought-provoking article, "Mind Over Matter," in The Walrus recently and, perhaps due to various events unfolding in my life right now, I was reflecting upon something I studied in university. The thoughts in the article deal with the philosophical battle between rationalism and empiricism. The main debate occured a few hundread years ago and one side won and has been influencing society ever since.

Roughly speaking, rationalists believe that additional knowledge can be gained simply by thinking. In contrast, empiricists believed that you can only gain knowledge through your senses (i.e. by testing observations of nature.) As the picture above illustrates, the prominent rationalists were Descartes, Spinoza, and Leibniz; while the main empiricists were Locke, Berkeley, and Hume.

One side won and the debate sort of died off.

The side that won was empiricism. Modern science, which some don't realize is a branch of philosophy, essentially developed out of empiricism. If you look back to your high school days, you'll remember that the core tenets of science revolve around developing a hypothesis and testing it out in real life. That is what empiricist thought entails.


One of the philosophy electives I took in university dealt with this exact topic, of the battle between rationalism and empiricism. I didn't do too well in the course—it was low on my priority list given my other subjects—but it was very influential on me. I havne't done much reading in philosophy but, given how my life is messed up from a career point of view, a part of me says that I should have done that in school. When I studied this topic matter, I was so sure that empiricism was the way. I didn't see what rationalism could provide that empiricism couldn't. Since I was heavily influenced by science, I felt 'reality' depended on real-life experiments.



After reading Alex Hutchinson's article, I am starting to look at this whole debate quite diferently. I wish my prof had mentioned this example:

“At one point, the teacher offhandedly presented Galileo’s argument for why all bodies have to fall at the same rate,” Brown recalls. It’s a classic thought experiment: consider a cannonball, which Aristotle had argued would fall much faster than a light object made of the same material, like a bullet. Now glue them together. If Aristotle were right, the bullet would act as a drag on the cannonball, slowing down the composite object; on the other hand, since the composite is heavier than the cannonball alone it should fall faster. It’s a contradiction that can only be resolved if the two objects fall at the same rate.”

...


But is this really new knowledge? Some critics argue that thought experiments are simply logical arguments whose conclusions follow from previous experience; others see them as ordinary experiments that, thanks to our intuitions, can yield results without being executed. Brown stakes out the extreme Platonist position, holding that thought experiments like Galileo’s give us new a priori knowledge about nature.

...


For an example that is less easily dismissed, though rather more complicated to explain, Brown looks to mathematics. In a 1986 experiment by set theorist Chris Freiling of California State University, San Bernardino, we are asked to imagine throwing darts at a board to select, with infinite precision, a pair of numbers between zero and one, leading us eventually to a conclusion that violates the continuum hypothesis articulated by Georg Cantor in 1878. What’s unique here is that the continuum hypothesis can’t be proven or disproven with conventional mathematics (a fact that, itself, can be proven), so Freiling’s darts offer the only route to a resolution. That means that if you accept the result, you have to join Brown in believing that knowledge can arise from the armchair.


Here is the wikipedia entry about the continuum hypothesis. This is an example of something that requires a rationalist approach.

I still think empiricism will be dominant for a few hundread more years, but I have a feeling that rationalism (or some other related thought process) will re-assert itself. We will likely hit a diminishing curve for empiricial observations and then we probably have to pursue alternative thought systems. As pointed out in the above quote, there may be things that are unprovable by physical evidence or an empirical test. If rationalism gains prominence, it may result in the end of science as we know it.

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Sunday, November 29, 2009 0 comments ++[ CLICK TO COMMENT ]++

Sunday Spectacle XXXVII



Dubai...


...Fades to Black




(source: Top image uploaded to Flickr on May 21, 2008 by Bu_Saif; Bottom image uploaded to Flickr on July 24, 2008 by Bu_Saif)

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Saturday, November 28, 2009 0 comments ++[ CLICK TO COMMENT ]++

Japan Redux

The World Looked So Different in 1980


From The Economist ("Land of the setting sun." Nov 12th 2009):

IT LEFT American executives quaking in their loafers and cheered a generation of Japanese salarymen. “The extent of Japanese superiority over the United States in industrial competitiveness is underpublicised,” trumpeted Ezra Vogel of Harvard University 30 years ago in “Japan as Number One” (see article), which became one of the most-discussed business books of its time.

The world’s second-largest economy had surpassed America in gross national product per person according to some measures, and looked on course to overtake it. “Vogel’s book helps explain why Japan is the most dynamic of all modern industrial nations,” gushed Foreign Affairs. America was mired in stagflation, with an unemployment rate nearing double digits. Japan seemed to be the better bet.

Yet things didn’t quite work out the way Professor Vogel expected. Japanese industrial production rose by 50% in the decade after 1980—a remarkable trajectory for a country crammed into an area the size of Montana. But growth was driven by financial leverage and overinvestment. Property and share prices bubbled, rising as much as sixfold.

The bubble’s collapse, beginning 20 years ago this December, led to almost two decades of economic doldrums. It took 15 years for industrial production to surpass the 1991 peak. In the current crisis it collapsed to levels last seen in the 1980s. In time America’s fearful “Japan bashing” gave way to sniggering, then indifference. Last month a poll of market professionals by Bloomberg, a news provider, put Tokyo last among several big cities as a financial capital. In the 1980s all of the world’s top ten banks measured by deposits were Japanese.


History never repeats... but it does have a habit of rhyming...

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Thoughts on the Dubai default situation

Writing, I'm sure on a dreary March 6th of 2008, with at least one spelling mistake I now notice, I wondered if Dubai, what I termed the city of fortune, was an illusion.

Well, now we know the answer. A lot of it was indeed an illusion. However, the unfolding events appear to be a shock to the investment community. It shouldn't be.


The most overrated story out there is the Dubai situation. The default has been blown out of proportion given the economic impact. The amount involved, if we ignore any potnetial derivatives, off-exchange contracts, and other dubious bets, appears to be very small. Some analyst peg total exposure well under $100 billion. There are some implications but they have little to do with economics and more to do with politics.


If I'm not mistaken, this is the first sovereign default since Argentina so some are shocked. However, sceptics like me have warned about a potential emerging markets bond bubble. I have less confidence in this call (since emerging markets did improve their credit worthiness e.g. Brazil) but it made no sense to me back then, and it still does not, how emerging market bond spreads were so low (refer to the 2nd part of this post to get an idea of how low EM bond spreads fell relative to US Treasuries (note that the chart only goes up to end of 2007 so the situation has changed a bit since then.) Historically, EM bonds were very risky yet investors started treating them as low-risk bonds. Dubai is not an emerging market (I think it is counted as developed) but it resembles an emerging market.

Besides, what did the lenders expect when you build more real estate than is required by the entire population of Dubai and some of its surrounding countries? Build it and they will come? At least other potential bubble regions, like China, have population to back up the need (however, do note that the vast majority of Chinese can't afford the buildings unless you assume real estate always goes up i.e. guaranteed capital gains.)

So the negative economic impact will be minor. In fact, as I had suggested in the past, these buildings will stand for decades or centuries so there may still be some use out of them.


The real negative impact of the Dubai situation is largely political. It's probably not surprising that the business media glosses over this because, well, they only care about money.

The unfortunate thing about the Dubai default is not the losses; rather, it is the fact that UAE will seize control of Dubai. I'm not a fan of Mohammed bin Rashid Al Maktoum, the leader of Dubai, but by Middle Eastern standards, he is very liberal. In a region of extreme religious conservatism, Mohammed bin Rashid Al Maktoum was able to develop a multi-ethnic city with (largely) open travel, bars, nightclubs, hotels, and so forth. So, Mohammed bin Rashid Al Maktoum's planning skills and exuberence may resemble Donald Trump, but at least he had, what I view as, very positive and significant, social impact. Unfortunately, the default is going to roll back all of that.

Once the leadership in UAE takes control, I wonder how Dubai is going to end up. So, maybe I was mistaken; I said this is the final chapter of Dubai (at least for the next decade) and I may never write about it again, but perhaps not. It seems there is still one final chapter left—that being the outcome after UAE takes over.

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Thursday, November 26, 2009 0 comments ++[ CLICK TO COMMENT ]++

Final chapter in the Dubai saga - Default

This is the final chapter in the Dubai story. The ending is pretty similar to all other bubbles: default. If Dubai defaults, it will also be the first major sovereign default in a while. MarketWatch reports:

Fears of a potential default in Dubai sent shock waves through financial markets Thursday, weighing on European and Asian equities, lifting government bond prices and pulling the U.S. dollar off of recent lows as investors sought out safe havens.

Dubai late Wednesday said it would restructure Dubai World and announced a six-month "standstill" on repayments of the state-run wide-ranging conglomerate's debt. Ports operator DP World and its debt is excluded from the standstill plan. Read about Dubai World's sprawling empire.

Analysts said Dubai's woes were a blow to sentiment, serving as a reminder that potential trouble spots remain in the world economy.

"I don't see this as a massive issue but it's another warning to where the world got itself last year with loose monetary conditions [and] loose lending," said Naeem Wahid, market strategist at Lloyds TSB. "And, in a few cases, the problems are still out there and we could continue to see these kinds of nasty surprises" in the future.

Government-owned Dubai World is a conglomerate with interests in real estate, ports and the leisure industry. The firm carries around $60 billion in liabilities. Credit agencies Moody's Investors Service and Standard & Poor's downgraded the debt of a range of government-related firms, including DP World, after the restructuring announcement, news reports said.


This always begs the question, who are the losers? Well, the big loser would be the government of Dubai and its autocratic ruler. It appears that UAE will now be calling the shots over Dubai. Apart from that, Middle Eastern banks may take big losses. It also seems that European banks are exposed:

European banks could have as much as $40 billion of exposure to Dubai after helping to arrange a string of bonds and loans linked to the Middle East city-state, according to analysts at Credit Suisse.

The broker said it's identified $10 billion of bonds issued by the government's Dubai World investment vehicle just since 2005, along with a further $26 billion of syndicated loans.


The key thing to remember is that the cited numbers are likely to be maximum exposure. It also does not mean that is the same thing as a loss because there will be recoveries on the bonds and loans. In all likelihood the banks have unloaded a big chunk of them off to smart money (aka wealthy investors, pension funds, hedge funds, etc.) The cited article suggests that banks retain 10% to 15% of the underwritten securities but that may be hedged. I don't think the losses will be significant for the European banks.

This is probably my last post on Dubai for a while. The ending was clear when I wrote my first post on Dubai a few years ago. (I hope I am wrong but if China is indeed furthering a real estate bubble as I believe, the end will be similar to here—except the losses will overwhelm anyone that is even remotely exposed.)

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Monday, November 23, 2009 8 comments ++[ CLICK TO COMMENT ]++

Hugh Hendry CNBC Europe Appearance on October 16, 2009

Thanks to AdvisorAnalyst.com for bringing to my attention the following Hugh Hendry CNBC Europe segment (dated October 16th of 2009.) The following videos essentially cover the material in his November 2009 fundholder letter (topics include deflation, US$, China, Russia, metals, central bank policies, world economics, and Japan.) I'm not going to summarize the videos since I went over the fund manager letter in extensive detail.



Part I


Part II


Part III


Part IV


Part V


Part VI


Part VII


Part VIII




I'm becoming a fan of Hugh Hendry—hopefully it's because he is insightful and not because his views agree with mine :| —but I notice that he dodges questions about his performance. As one may expect of anyone skewed towards deflation, his portfolio has performed poorly this year (he is posting around -7.5% YTD vs +22.4% for MSCI World, as of last published info.) Someone challenging your poor performance is always difficult to tackle in public but I'm curious to see how humble he is. I respect those who admit mistakes and, although Hendry does say he can't predict the future and can be wrong, I wish he was a bit firmer about his incorrect calls. Anyway, great contrarian thinker and we'll see if he can post good results going forward.

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Gold enters bubble phase



As far as I'm concerned, gold has finally entered the bubble phase. A special report on a mainstream site like MarketWatch (with 8 articles on it) probably portends to its popularity.

None of this means that this is the peak but I have a feeling fundamentals—if there is such a thing for gold—has been thrown out the window.

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Opinion: Good investors not necessarily good at personal finance

Many probably assume that good investors are very good at personal finance. After all, if you know something about financial or economic analysis, you would be good at managing your finances too, right? I don't think so. My view shouldn't be that surprising.

It's kind of like how a good mechanical engineer may have skills to design a car but that doesn't necessarily mean that they have the skills to be a mechanic.

You'll notice what I am saying when you look at blogs. I feel that there is almost two seprate ecosystems: one dealing with investing, and another dealing with personal finance. I rarely see much of an overlap in the participants. The investment-oriented bloggers almost always seem to deal with finance, economics, and capital markets. In contrast, the personal finance bloggers all seem to be passive investors and I see very little work dealing with stockpicking, financial statement analysis, macroeconomic theories, and so forth.

Anyway, the best example of what I am saying is Bill Gross. Many in the investment world hold Bill Gross to be, perhaps, the best bond investor of the last 30 years. I don't have such high regard of him but I'm not in the consensus. In any case, I came across the following situation from his latest commentary:

Perhaps remarkably, during the week surrounding the Lehman crisis in September of 2008, yours truly frantically called my wife Sue to empty our two local bank accounts into apparently safer Treasury bills.


Imagine if every American had done what Bill Gross did in September of 2008. Every bank in America would have collapsed. Thankfully, the population isn't as panicky as him.

I'm assuming that, given how he is a billionaire (Forbes pegged his net worth at $1.3 billion in 2007), he is way over the $100,000 (at that time) FDIC limit. So it makes sense to liquidate all your cash above $100k.

But the bigger point, though, is, what was he doing with so much money sitting in a bank account? We don't know how much money he had in the bank accounts but given his panicky withdrawls, I am assuming it is a lot of his liquid cash. That, in my eyes, is horrible management of one's personal wealth. It just goes to show how a billionaire, who apparently is a good investor, can be caught off-guard by misallocating his savings.


Since most people who read this blog are investors, I think all of you, including me, should pay more attention to our personal financial matters. A lot of spend an inordinate amount of time on the investing side but I suspect most of us overlook personal finance and are making mistakes.

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