Articles for the week ending 8/8/2009

The markets hit an yearly high this week, with the Dow up around 43% off its lows from March. This is a massive rally but not unexpected to anyone with knowledge of history. As usual, it's difficult to say if we have entered a new bull market.

The good news for the bulls is that the market is climbing a wall of worry. Although sentiment is very bullish right now, it wasn't so for most of the rally a few months ago. The rally also resembles the 1933 rally, where the market rose 100%+ in a short period of time, after the election of a new President, and with bad news all around. Just like in 1933, the market is rallying strongly while the economic picture is very poor.

The bad news is that the market is not cheap anymore. I don't believe it was ever cheap, even near the March/April lows, and it is definitely not cheap right now. The future has to be quite rosy to justify current valuations of some companies (I may be biased but I believe some of the commodity businesses look really expensive.) The biggest rallies have been in low quality, junk, stocks and bonds. This is not surprising since they have been hit the hardest and are very sensitive to the economy. But it also implies a speculative rally. Some investors (who knows what their track record is) think junk bonds may come crashing down. The bonus oil-consuming nations received from a fall in oil prices last year has reversed and it remains to be seen how negatively this impacts the economy.

If you are a bottom-up investor, just keep looking for undervalued stocks; if you are macro-oriented, I say sit and wait (everything looks frothy.) As is common in most years, the 4th quarter, especially the dangerous September/October time frame, will probably determine the final outcome for the year for the indexes.

I haven't invested in anything all year (except special situations) and, hence, completely missed the rally. I am also getting killed due to the sharp appreciation in the Canadian dollar (most of my portfolio is in US stocks) so I will probably underperform the broad indexes this year, if the year closes at current levels.

Although I may not show it, I have been doing a lot of reading, including some old articles and essays, and have taken preliminary looks at many securities. I haven't found anything that really attracts me, except Lexmark (but Lexmark is kind of dangerous and is the type of company that can go to zero very quickly.)

I haven't done a round-up of articles in a while so here are some...

• Canadian farmland price performance since 1995 (Toro's Running of the Bulls): Supposedly Canada's farmland prices are up 5.% in real terms since 1995. Needless to say, it varies by location. Jim Rogers likes farmland and Marc Faber liked it at one point too (not sure what his view is now) but I am bearish. A lot of the gain in farmland prices likely come from urban development (i.e. selling farmland to developers or industrial companies) than from any agriculture (you can see this by noticing how Quebec has seen bigger increases even though nothing major is happening on the agricultural front there.) Given the real estate bust (admittedly Canada hasn't seen any major bust yet), I suspect farmland prices will head down.
  
• (Recommended) Tarnishing of Warren Buffett's legacy (Option Armageddon at Reuters): In the linked article, Rolfe Winkler questions Warren Buffett's ethics given some deals executed in the last couple of years. Unlike some who attack Buffett without doing the homework, Rolfe details the case against Buffett. I agree with most of what Rolfe Winkler is saying. I have attacked Buffett in the last year over these same issues (the worst is actually Bill Gross of PIMCO literally threatening the US government to bail out the GSEs; the Chinese threatening the US over the GSE debt is also another dubious action last year.) Warren Buffett benefitted immensely from the government bailouts. Positioning yourself to profit off government actions is fine. So is acting on behalf of shareholders to transfer as much money from taxpayers to shareholders. Where people like Wolfe, and me, have a problem is when Buffett promotes certain policies in the name of public good when he simultaneously profits off this. Totally unethical! He even went so far as to suggest (in his annual shareholder letter) that some companies are benefitting from cheap government funding while others aren't (the implication being that he wasn't benefitting when in fact, some of his companies would be trading at the same market cap as AIG if it weren't for the government aid.) This is Bill Gross, or possibly even Mohamed El-Erian (don't know much about him but I suspect he follows PIMCO's usual modus operandi), territory! Buffett always made himself out to be someone who is far more ethical. I can see Buffett sticking up for Wells Fargo—it's his ship and he will live and die with that, and I respect that. But his deals with Goldman Sachs and GE are highly questionable. My philosophy in life is that you can support a policy but don't profit off that while passing yourself off as neutral. Highly unethical in my eyes. Buffett, as well as some Buffett fans I have debated, obviously do not share my view. They think, whether you profit or not, it's all the same. I think the public shares my philosophy and you are going to get tarred and feathered. That's what's happening here. I still think Warren Buffett is one of the more ethical Americans I have encountered but he is losing it. (There is also a video interview of the author discussing his views.)
  
• David Dreman expects high inflation in a few years (CNBC via GuruFocus): Dreman, like many others, got killed last year and was actually terminated as manager of a fund named after himself. Nevertheless, he is always worth listening to. In this interview, he suggests that high inflation is likely in a few years and hence favours stocks and real estate.
  
• New York Times review of two financial books (The New York Times): Eugene Fama is said to have said “actual market prices are, on the basis of all available information, best estimates of intrinsic values.” This essentially separates those believe the intrinsic value of an asset is best determined by the market pric—the efficient market followers—and those who do not believe in it. The New York Times reviews Justin Fox's A History of Risk, Reward, and Delusion on Wall Street and Charles Morris' Warren Buffett, George Soros, Paul Volcker, and the Maelstrom of Markets. The former appears to be a run down of the history of finance, which has largely been influenced and controlled by efficient market theorists for the last 50 years. Charles Morris' book seems like a biography of three prominent individuals and anyone interested in those three may want to check out the book—after reading the review of course :)
  
• A "blank cheque" company - CoSine Communications (Greenbackd): I don't know what the official term for these companies are (blank cheque? SPAC?) but CoSine (OTC: COSN) is a company that is attempting to buy a business. According to Greenbackd, COSN has a market cap of around $18m and has NOLs of around $500m ($353m federal and $213m state). There is an activist investor on board but the company appears to have done nothing in the last 3 years. The stock ran up a lot this week and is trading around 10% below liquidation value (but you can probably pick it up at much lower prices in the future.)... Looks interesting...downside is that this is very small so it won't be able to purchase any decent sized business. But then again, small opportunities like this provide an advantage to small investors.
  
• Wide Moat Investing's review of Berkshire Hathaway annual letters (Wide Moat Investing): I can't remember if I linked to these before but Wide Moat Investing has been running a series reviewing Buffett's shareholder letters of the past.
  
• (Highly Recommended) Book excerpt of Tim McElvaine's interview (Controlled Greed): John at Controlled Greed hasn't posted much in the last few weeks—although he seems to have joined the dark side (or is it the light side?) and embraced the barbarous relic ;)—and this is a spectacular find. John has been talking about Tim McElvaine, an obscure value investor from Canada, over the years and this is the first time I have seen a detailed interview of him. Tim, like most value investors, got killed last year but had a great record prior to that (given the smallcaps and microcaps that Tim deals in, it's possible that many stock price collapses were quotational losses and not permenanent impairments&mdahs;although it is likely the market has premanently marked down the valuation (i.e. a p/e multiple of 12 may have been good a few years ago but that is equivalent to 10 now.) Even if you don't care who Tim McElvaine is, you should check out the interview. Although the interviewer jumps around and some topics are not fleshed out enough, I found the overall excerpt extremely valuable. There are many little insights that one can gain from a true value investor. As I have said many times before, there is literally nothing for me to learn from someone like Warren Buffett; but I do learn from someone like Tim McElvaine. I will probably write a full post on this interview at some point.
  
• Squandered decade (Economics Unbound at Businessweek): Lost decade is too strong of a concept—I think GDP has to be around 1% for that—so I'm going to call it Squandered Decade to describe how the last 10 years has been the weakest economic growth in the post-war period. The 2nd weakest is supposed the 10 years that ended in 1Q of 1983. As usual the starting point can skew the data but it still shows the terrible decade in America. After the weak decade that ended in 1983, the economy bounced back strongly but, unfortunately, the same may not happen this time around. Americans significantly increased their debt in the last decade, which was not the case in the decade ending in 1983, and the debt needs to be paid back (or the losses absorbed by someone.) (for reference, Japan has posted around 1% real GDP growth during their lost decades, with most of the positive number coming from deflation.)
  
• Inventory bounce? (Bronte Capital): John Hampton describes an inventory bounce for a manufacturer of a consumer discretionary item. To put in context for long term investors, what matters is whether this bounce will be maintained or not. Newbies like me are totally confused about consumer demand right now. One of the reasons I haven't invested in anything in an year (except special situations) is because I can't tell what will constitute "normal" demand going forward. Of the mid-cap and large-cap companies, I have looked at companies ranging from Diageo (liquor), 3M (diversified industrial/consumer products), Expedia (travel), and, more recently, Lexmark (printers). Unit demand has seen wild swings and I have a hard time telling what's the new normal.
  
• Ever wonder how the job of a skyscraper window cleaner feels like? (Toronto Star): (this is a somewhat old post I never got around to mentioning on this blog) I always walk by buildings and see the workers cleaning windows way up in the sky. This story takes a brief look at the risky job of window cleaners in Toronto...interesting part about peregrines (a hawk) being a threat—for once the bird is a threat to humans rather than the other way around ;)
  
• (Recommended) China's $300 billion bullet train system in development (Fortune): Remniscent of Japan, or even USA in the 1850's, China is spending $300 billion over the next decade to build a bullet train system. Some critics, including me, are skeptical of China's infrastructure spending, but projects like this make sense to me. Unlike the money funnelled into real estate or (seemingly) unneeded factories, this can help the country in the long run. On top of improving transportation, trains are more environmentally friendly and are the only feasible solution for a highly-populated country like China. (There is also a slideshow and brief audio commentary that accompanies the article.)
  
• Chinese entrepreneurs returning home (BusinessWeek): While on the topic of China, here is the first part of a blog series dealing with Chinese entrepreneurs who are returning home.