Thursday, October 29, 2009 0 comments ++[ CLICK TO COMMENT ]++

USA posts a 3.5% GDP growth

Very strong GDP numbers for America... MarketWatch reports:

The U.S. economy expanded at a 3.5% annual pace in the third quarter, as massive government stimulus helped drag the economy out of the longest and deepest recession since the 1930s, the Commerce Department estimated Thursday.

Along with improvements in key monthly figures on output and sales, the rise in real gross domestic product means the Great Recession is likely over in a technical sense, even as further job losses occur. A formal call on the end of the recession isn't expected for months. Read more about recessions.


In the past year, the economy has contracted 2.3%. The economy shrank 0.7% annualized in the second quarter and 6.4% in the first quarter. The figures are seasonally adjusted and adjusted for price changes.

Growth was broad-based in the third quarter, with final U.S. sales rising at a 3% annual pace, the fastest in more than three years.

Third-quarter growth was due to higher consumer spending, a slowdown in the reduction of inventories, an increase in residential investments, and robust government spending.

Home building contributed to growth for the first time in nearly four years.

Business investment declined as a small increase in capital spending on equipment and software was overwhelmed by another large drop in investments in structures.

Foreign trade subtracted from growth in the quarter. A big jump in exports was offset by an even larger rise in imports.

IANAE but I like to think that anything over 3% real for a developed country as strong growth. This probably marks the end of the recession.

However, as quoted above, a lot of the growth is driven by areas that are unsustainable. For instance, homebuilding and government spending contributed to growth but I highly doubt that can be maintained.

The strong GDP growth numbers also mark how my macro call was incorrect. I was thinking that America wouldn't recover until 4Q09 or 1Q10 but it appears I was incorrect. I also thought that the stock market rally would be coincident with the economic recovery—this is rare; most of the time the market rallies 6 months to 9 months ahead of recover—but was wrong. As in the past, it appears that the stock market correctly "forecast" a recovery well ahead of time.

Having said all that, I'm still maintaining my view that the US economy will be in a mild slump, with GDP growth around 2% for the next few years. We'll see how correct that call ends up being.

Wednesday, October 28, 2009 1 comments ++[ CLICK TO COMMENT ]++

What is the future of Taiwan?

People always talk as if America—or Canada or other developed countries—have the biggest difficulty adjusting to China's economic prowess. Yet, what these countries face is very minor compared to the challenges faced by someone like Taiwan.

Taiwan has been struggling mightily—it saw one of the biggest plunges in exports of any country during this crisis—and I'm not sure how its future will unfold. There are two big problems for Taiwan.

Firstly, China is located close to Taiwan, and, hence, is a direct competitor in almost every industry. Given the huge discrepancy in wealth between the two countries, it is very difficult for Taiwan to compete with China on costs. Americans and Canadians complain about China's low costs but at least you have shipping costs and cost of time—time is money after all—to act a barrier. But imagine if you are situated right next door to China and costs are as little as 1/10th.

Secondly, Taiwan's biggest wealth generator in the last few decades has probably been its manufacturing sector. In particular, semiconductor and electronics manufacturing. China, needless to say, is a manufacturing powerhouse with very low costs. Taiwan has to compete directly and it's not clear what strategy it can pursue. In contrast, although people in America complain about the loss of manufacturing, it only employs 11% of the population (do note that there are many more indirect jobs created.) The loss of manufacturing in America has moderate impact but that is not the case in Taiwan.

Mark MacKinnon of The Globe & Mail has a good summary of the issues I have discussed above. Let me excerpt some of the key points but do check out the article if you are interested in investing in Asia:

Manufacturing, for decades the basis of the island's success, is moving to cheaper and less-regulated places like China and Southeast Asia. Taiwan is still a leader in research and development, but outside of laptop computers, little of what it produces reaches consumers directly. Many items that once reached store shelves in North America and Europe branded “Made in Taiwan” now have the final touches put on them in China or Vietnam instead.


It hasn't turned out as dire as predicted, but 2009 will nevertheless go down as the worst year in the island's history.

The economy is now expected to shrink by a painful 4 per cent. And unemployment recently soared above the 6-per-cent line for the first time since the Kuomintang conceded the Chinese mainland to the Communists and set up its government-in-exile here back in 1949.

Exports, which account for more than two-thirds of the economy, fell an astonishing 41 per cent in December and 44 per cent in January, when the economic storm raged last winter. While those figures have started to look better (exports were down 12.7 per cent in September, the slowest pace of decline since the crisis began), many believe the game will have changed completely by the time the recession is over.

According to the U.S. Department of Labour, average compensation costs in Taiwan's manufacturing sector were $6.58 (U.S.) an hour in 2007, a figure slightly higher than Hong Kong's $5.78. In comparison, compensation costs in China were estimated in 2006 to be $0.81 an hour.

The Taiwan situation shows how easily investors can be badly burned with unpredictable outcomes. If you were investing in the mid-90's, Asian Tigers roamed the investing world, although not quite to the degree of the presently ubiquitous BRICs, and many would have considered Taiwan a sure-fire bet to be one of the leading countries in a few decades. Well, it did rise and generate a lot of wealth for its citizens and its companies. However, if you invested for 20 years, you would have done poorly. If you look at the TSEC Taiwan index on Yahoo! Finance, you'll note that it has literally gone nowhere since 1998. The chart is price-index only so, if you include dividends, you would have posted slightly higher returns (perhaps 1% to 2% annualized) but it's still nothing to write home about. (note: the chart goes from late 90's but if you invested in the early to mid 90's, you would have done better, but still not great.)


Opinion: California may set global precedent by legalizing marijuana

(This post is not related to investing)

In 1933, the government of Franklin Delano Roosevelt did something remarkable that changed American history. FDR's government was famous for a lot of 'firsts' but this was unimaginable to conservatives. The government did the unthinkable and legalized alcohol. Thus ended The Noble Experiment. The "experiment" was a total failure from almost day one, with alcohol being widely available in most cities but, nevertheless, the conservatives held sway until the day Roosevelt, and subsequently, Congress, legalized alcohol.

Similar to The Noble Experiment, America has been pursuing the War On Drugs for several decades now. It is debatable when the policy was started but, apparently, the concept was first unleashed by Richard Nixon. Nixon was also responsible for establishing the largely incompetent, and somewhat corrupt, Drug Enforcement Agency (DEA). My opinion is that the War On Drugs really got going under the Ronald Reagan government with the militarization of the drug war.

It looks like USA has also lost control over the drug war in Mexico, particularly along the US-Mexico border. I have no proof but it is possible that US government agencies have been infiltrated by drug traffickers. In particular, the three Department of Homeland Security agencies that were created out of the former agency responsible for immigration and border control, Immigration and Naturalization Service (INS), may be unreliable.

Like all terrible policies, we may be close to the abolishment of the War On Drugs. Similar to 1933, economics may be driving policy more so than moral battles.

Writing for The Globe & Mail, Barrie McKenna reports that the State of California is contemplating legalizing marijuana. It is still in the very early stages but I have a feeling it may happen. Other media sources, as well as opinion sites, have suggested the possibility earlier but my impression is that we may be witnessing a pivotal change:

Governor Arnold Schwarzenegger says he welcomes the debate about legalizing marijuana as the state struggles to avoid insolvency. A recent poll shows 56 per cent of Californians want pot legalized. A major push is on to put the issue to statewide referendum next year. And yesterday, state lawmakers held an initial hearing into a proposed law to end California's 96-year-old pot ban.

“I think it's time for a debate,” acknowledged Mr. Schwarzenegger, who as an actor portrayed a drug fighting undercover police officer in Kindergarten Cop.

A spokesman for the governor insists Mr. Schwarzenegger is opposed to legalization.

The move could generate as much as $1.4-billion (U.S.) in new tax revenue and save the state “tens of millions of dollars” in prison and police costs, state officials told the California Assembly's Public Safety Committee. They based their estimates on a $50-per-ounce levy.

“It is time to take our heads out of the sand and start to regulate this $14-billion industry,” said committee chairman Tom Ammiano, who is sponsoring the legalization bill. “By doing so, we can enact smart public policy that will bring much-needed revenue into the state and improve public safety by utilizing our limited law enforcement resources more wisely. The move toward regulation is simply common sense.”

California could use the cash by taxing pot, just as it does cigarettes and alcohol. But legal experts, economists and law enforcement officials who testified Wednesday before a state committee warned that the proposal is fraught with unknowns.

And chief among them is how the U.S. government would react.

Possession, distribution and sale of marijuana remains a federal crime. And while California can eliminate state penalties and charges, it can't fully legalize.

In terms of finances, the biggest benefit is not necessarily the additional tax revenue. Rather, the biggest financial impact is likely to be a reduction in prison and law enforcement costs. America spends a fortune on its jails with seemingly little benefit.

Given how California is dominated by liberals, I think legalizing it within the state isn't as difficult as it seems. However, as the article suggests, the US government still views it as illegal so it requires federal government policy change as well. We may be seeing the initial stages of a battle between the State of California and the Government of the United States of America. I'm not sure how the courts will rule. I am hopeful that US courts, which tend to be very libertarian, will rule against the federal government but I'm not knowledgeable about legal matters and am not sure if it will be tested by the Supreme Court; it's possible that the federal government has absolute say over state policies in this case.

Some other countries, such as The Netherlands, has experimented with legalization of marijuana in limited regions but they have minor impact. If California does it, it's huge! And if America does it, it's monumental!

Speaking as a Canadian, I think it's about time Canada followed a similar path and legalized marijuana. There will be some initial side-effects but it will be benefitial in the long run. The conservatives will fight tooth and nail but they are very close to completely losing the war. If California legalizes marijuana, I say the Liberal Party should make it a party platform (a minor one) and try to influence the public.


Galleon insider-trading case spreading to leading technology companies

As I was speculating a few weeks ago, the Galleon insider-trading case appears to be entangling many leading companies and prominent individuals. In fact it appears to be the largest insider-trading case in American history*. The latest leak seems to imply that Hector Ruiz, former CEO of AMD, the 2nd largest microprocessor manufacturer in the world, was a key insider leaking information to the accused. MarketWatch reports:

Shares of Advanced Micro Devices Inc. fell sharply Wednesday as the chip giant reeled from reports of insider-trading allegations involving its former chief executive, Hector Ruiz. The allegations could even cost him his current job.

AMD stock plummeted more than 6% at $4.83, as some analysts said the revelations could cause a short-term shock, but likely won't have any longer-term impact on the company or on GlobalFoundries -- the new company spun off from the Sunnyvale, Calif.-based chip maker earlier this year.

Ruiz, who serves as chairman of GlobalFoundries, was named in a Wall Street Journal report as the source of confidential information about AMD in the Galleon Group insider-trading case that has resulted in five arrests and has rocked the investment community.

Impact on AMD and GlobalFoundaries is likely to be limited given how (i) Ruiz hasn't been charged with any wrongdoing, and (ii) although influential, Ruiz hasn't had much success at AMD in the last decade and it's doubtful he is as critical to GlobalFoundaries as it seems.

There are many others at leading firms, such as Google, that are also implicated in this affair. It remains to be seen how far the authorities will take all of this. One of the problems for law enforcement is that the actions of Raj Rajaratnum seems to have been common in Silicon Valley, and, some argue, on Wall Street in general. Rajaratnum clearly crossed the line—especially when he knowingly acted on inside information—but I'm not sure if analysts and executives knew they were leaking confidential information. Therese Poletti recently remarked how the Galleon case is not suprising to long-time Silicon Valley players:

"Raj was incredibly brilliant," said Dan Hutcheson, chief executive of market research firm VLSI Research Inc. in Santa Clara, Calif., who knew him as a Wall Street analyst. "He was always pushy, he was always trying to get that last ounce of data. He would push you right to the edge of client confidentiality."

In speaking with several people in Silicon Valley who knew Rajaratnam during the go-go years of the 1990s, most of whom would not be quoted by name, a common theme emerged. Rajaratnam started his career in the "Wild West" of tech investing, where the rules were different, everyone wanted an edge, and many lines were crossed. And in 1997 Rajaratnam started his own fund, Galleon, in the pre-Enron, pre Reg-FD world.

"Before Reg FD people skirted the line a lot more," said Bradley Alford, a principal at Alpha Capital Management, a hedge fund in Atlanta, referring to the SEC rule known as Regulation Fair Disclosure, implemented in 2000, requiring companies to disclose material information to all investors at once. "But it's tightened up since then."


Information has always played a huge part of investing, but in the late 1980s and 1990s, when Rajaratnam was starting out, looser practices reigned. Computer trades PC Week and Computer Reseller News fostered gossip columns in the back of their magazines that analysts rushed to read, often making calls and writing up research notes based on rumors leaked to Spencer Katt and Shadow Ram. Company insiders won T-shirts and invitations to elite parties hosted by the magazines at the Comdex show for leaking tips.

Leaking information for T-shirts and VIP invitations seems like the dumbest thing ever but what do I know? This is a good lesson in crossing ethical (and sometimes legal) boundaries. It's easy to do so when no one is looking but it will come back and haunt you.


(* Something to keep in mind is that most people don't generally adjust for inflation when comparing historical events to the present. Furthermore, insider trading was rampant and ignored by the authorities (what is illegal now was not back then) so it shouldn't be surprising to see, what appears as, more serious cases in the present period, when in fact the situation was even wore in the early 1900's.)

Monday, October 26, 2009 4 comments ++[ CLICK TO COMMENT ]++

Smithers says stock market 40% overvalued (according to Q ratio)

I ran across a Bloomberg article quoting Andrew Smithers as saying that the stock market is overvalued by 40%:

The U.S. Standard & Poor’s 500 Index is about 40 percent overvalued and headed for a drop as central banks pull back on securities purchases that pushed up asset prices, according to economist Andrew Smithers.

Declines are likely because banks will need to sell more shares to raise capital, the economist and president of research firm Smithers & Co. said in an Oct. 23 interview at Bloomberg’s Tokyo office. The closing price on Oct. 23 of 1,079.6 was 40 percent above 771.14, a level last seen in March, according to data compiled by Bloomberg.

“Markets are very vulnerable to an end of quantitative easing,” said Smithers...

Andrew Smithers, for those familiar with him, is famous for maintaining and evaluating market valuations based off the q ratio. The following chart, courtesy Smithers & Co, shows the current state of affairs:

(source: Smithers & Co)

The CAPE (aka cyclically adjusted P/E ratio; aka Graham-Dodd 10 year P/E ratio) also suggests that the market is overvalued by 36.5% as of September 17 of 2009.

Valuations measures such as these are why I have stayed away from the market. However, you need to keep in mind that these valuation measures move very slowly. If you strictly followed these measures, you may remain out of the market for a long time—possibly even decades. Smithers appears to have remained out of the market since the late 90's and only came into the market in the last year, and that is extremely difficult for most people.

Furthermore, the overvaluation does not necessarily mean that the market will plunge; it is possible that the market goes sideways for five to ten years.

Smithers also had some interesting comments about Japan in that Bloomberg article:

Not all equity markets are as overpriced as the U.S., Smithers said. Japan may be the world’s cheapest major market though he doesn’t forecast short-term gains from betting on the nation’s stocks.

Profit margins at Japanese companies are likely to improve as companies invest less, lowering depreciation costs, he said. Depreciation eats up about two-thirds of earnings in Japan, compared with less than half for U.S. corporations, according to Smithers. Firms plan to cut capital spending 10.8 percent this year, the Bank of Japan’s quarterly Tankan survey released this month showed.

“It’s quite likely that Japan is the only significant market in the world that is not seriously overvalued,” he said. “When investment comes down, depreciation comes down.”

Japan has a bunch of other issues that may weigh it down—in fact some bears are claiming that the Yen is going to collapse due to their high debt levels—so it's not clear how much this investment/depreciation issue matters. In any case, it's an interesting thought.

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Sunday, October 25, 2009 0 comments ++[ CLICK TO COMMENT ]++

An energy plan that depends 100% on renewable energy?

(This post is not related to investing)

Is it actually possible to generate 100% of the world's energy from renewable sources such as wind, water, and solar? We are not talking about some futuristic society but the present.

No doubt this is as utopian a premise as any.

Yet Mark Jacobson, a civil and environmental engineer, and Mark Delucchi, a research scientist, suggest that it can be done. In the November issue of Scientific American, they detail how the world can use wind, solar, and water to power 100% of our needs (note that this excludes nuclear; it would be easy if you include nuclear.)

You can access the article from the official Scientific American website (requires purchase.) I also Googled and found it freely available here. It's an interesting read. Thanks to Globe & Mail reader Alan Burke for bringing the article to my attention.

Key elements of the plan, as cited at Scientific American's website, are the following:

  • The authors’ plan calls for 3.8 million large wind turbines, 90,000 solar plants, and numerous geothermal, tidal and rooftop photovoltaic installations worldwide.
  • The cost of generating and transmitting power would be less than the projected cost per kilowatt-hour for fossil-fuel and nuclear power.

Mind you, the suggested plan requires total dedication—think of the American space program or American military manufacturing during WW II—but I'm surprised it is even feasible. I am not too knowledgeable about alternative energy but had always felt it was not usable on a large scale (I'm not counting nuclear, which is quite doable.) So it's interesting to me that, as remote as it may seem, humans can actually get away with renewables. There are some pitfalls, such as potential shortage of rare materials, but it's not as out-of-reach as I had thought.

Although I'm not a believer in Peak Oil, Global Warming, or other mega-disaster low-probability scenarios, I still think about them occasionally. So, knowing that humans can get away with renewables in some extreme scenario—say we run out of oil in 50 years—is reassuring :)


Sunday Spectacle XXXII

Moody's/REAL Commercial Real Estate Index (CPPI)

This chart doesn't have data for the last few months but is the latest I could find on the MIT site. Commercial real estate peaked later than residential real estate and is still weakening. It should also be noted that the data isn't as statistically significant as residential real estate since commercial real estate involves fewer transactions, often with very high transaction sizes.

Source: Most up-to-date chart is apparently published first by Moody's with a possibly delayed chart you can find at at MIT.

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Saturday, October 24, 2009 7 comments ++[ CLICK TO COMMENT ]++

Articles for the week ending October 23rd of 2009

Some articles I found interesting...

  • (Highly Recommended) When insiders act against shareholders - The VaxGen case (Greenbackd): Special situation investors, as well as microcap investors, should study this situation when they have some time. VaxGen was a potential liquidation that was very close to liquidation but the board of directors decided to enter into a questionable merger with another company at a low price. Depending on the purchase price, a special situation investor investing on the basis of a liquidation is looking at huge wealth destruction regardless of whether the merger goes through! (Further comment below)

  • Going for the trifecta of stocks, bonds & gold (Buttonwood at The Economist): The buttonwood tree is always interesting and so is the Buttonwood column at The Economist: "Gamblers dream of achieving a trifecta: picking the first three horses, in the right order, in a given race. The payout is huge but so are the odds against success. The same could be said, in financial markets, of a strategy that backed equities, gold and government bonds. The three asset classes do not tend to perform well at the same time...The bet has paid off this year, however. According to Dhaval Joshi of RAB Capital, a fund-management firm, the three asset classes have all produced double-digit returns over the past three months. That has occurred only twice before in the past 50 years." Something is amiss and someone is going to get killed, probably next year. Most people think it will be (government) bond investors but I have a feeling it will be gold investors or stock holders.

  • Another conspiracy theory about Bear Stearns (Rolling Stone; h/t fk at GuruFocus): When it's all said and done, Matt Taibbi will probably end up being Wall Street's public enemy #1. Just like how Michael Lewis was spilling the dirty secrets in the 80's and 90's, it looks like Taibbi has taken on that role now. The only problem I have is that his views are based on wild speculations, rumours, and possibly disinformation from enemies of fingered firms. The truth in the last few years is murkier than usual.

  • (Recommended) GuruFocus interview with Donald Yacktman and Brian Yacktman (GuruFocus): I am so bored to death of these interviews with prominent investors...but this one was actually insightful. I liked it a lot.

  • Gary Shilling maintaining his bearish views (Forbes; h/t GuruFocus): Gary Shilling, the uber bear, thinks stocks are in a bubble. I'm surprised to hear that he is maintaing his $40 earnings call for the S&P 500. Shilling had one of the lowest estimates early in the year and even with the earnings beats by many businesses (I forget the number but I think companies are beating earnings by around 70% vs past average of around 60%) he is sticking with his views.

  • Slideshow - China's top 10 companies (Fortune): Many of them are banks or SOEs.

  • Value investors & the technology sector (Rational Walk via GuruFocus): Ravi Nagarajan has a good article recapping the dilemma faced by value investors who look at the technology industry. Many value investors skip the technology sector for several reasons and, in doing so, miss out on roughly 25% of the American economy. (Further comment below)

  • (Not related to investing; Canadian Econopolitics) It's time the public sector started sharing the pain of government deficits (The Globe & Mail): Eric De Cloet of The Globe & Mail has a nice opinion piece calling for the public sector to start curbing their compensation schemes in light of the debt problems in Ontario and Canada at large. I left several comments to the article supporting his view. The fact of the matter is that the public sector has seen continuous wage increases while the private has seen essentially flat compensation for more than a decade now. In addition, the government workers get great pensions while most private sector workers don't even have a pension. I am a somewhat-typical liberal and am generally ok with a large government—in contrast, many on the right are outright hostile to government workers—but they cannot keep paying more and more while running up their debt. My view is that the pensions and wages are an illusion similar to how GM compensated its workers over the decades. The promises and salaries look real but they are paid with debt (borrowed money) and hence isn't sustinable.

  • A brief look at the fall of Communism (The Star): Karl Marx is one of the greatest economists of the last 500 years but good riddance to the end of so-called Communism. The monster that was unleashed was so bad that it even makes fascism, another horrible totalitarian system, look mild in comparison.

  • India's last remaining Maoists (The Globe & Mail): Great journalistic work by Stephanie Nolen of The Globe & Mail in covering the Maoists in Eastern India. The prior link might imply Communism is dead but not quite. The reason it is hard to overcome these problems is because the so-called capitalists on the other side are just as corrupt as the Maoists who are popular. Add in the mix of a poor region—many parts of India are poorer than many African countries—with little hope and it's a not a pretty sight.

When A Potential Liquidation Blows Up

Although I read the Greenbackd blog quite a bit, I didn't look into the potential liquidation of VaxGen (I'll mention why below.) But reading what happened in the last week, this looks like a good lesson for special situation investors. I think microcap investors should also study this case. I am always concerned about microcaps because insiders can transfer wealth to themselves (this can happen in any company but much harder when the media and regulators are watching you, as is generally the case with large companies) and this is a good example of that.

To recap quickly, VaxGen (VXGN) was very close to liquidation—basically no operations and only 5 employees—and there were even some activist investors attempting to liquidate the firm. But all of a sudden, management, with the backing of the board of directors, entered into a deal to merge with another firm at a value that appears way below the liquidation value. The deal requires shareholder vote but VaxGen automatically pays a sizeable amount to its proposed merger partner if the deal is cancelled. So, not only are the shareholders of VaxGen being ripped off, the other merger partner gets paid some money even if the shareholders reject the deal.

This is a classic case of insiders (management and board of directors) transferring shareholder wealth to themselves: the company is essentially dormant and the insiders are simply happy to collect their salaries for not doing anything, and the longer this goes, the better it is for them. Shareholders have launched several lawsuits but the downside to the insiders appear low (insurance, as well as VaxGen, will probably foot all the costs even if the court rules against the insiders.) In some cases, insiders carry out some illegal actions and they can be held liable and event sent to jail for that. However, everything seems legal here. It's just that it is all unethical rather than being illegal (I'm not a legal expert and this is just my distant opinion.)

The lawsuits may have also damaged VaxGen's net worth. Value Investor, a reader at Greenbackd, speculates that VaxGen may be worth far less than the current share price (or any prior liquidation estimate) given the lawsuits. It may even be worth zero, although that's hard to say. On top of the legal fees, it's possible the company may have to pay out huge sums if a court rules against the insiders.

Vetern investors know how companies can be seriously hurt by shareholder lawsuits, even when the fault lies with illegal activities of insiders. I remember when Nortel, a leading Canadian telecom equipment manufacturer, and one of the largest in the world, had to pay out several billion due to criminal actions by management. Nortel had to raise billions on the stock market (by issuing shares; it may also have taken on debt, not sure) to pay out to its own shareholders and this clearly didn't help its already-weak balance sheet. In the case of VaxGen, a tiny company, there is no way outside shareholders are going to inject money into it so all the money will have to come from what little cash it has. You can easily see how there may be serious damage to the net worth of the company if a court rules against management and the board. Of course, the lawsuits may be withdrawn but that's uncertain.

Anyone investing in small companies should think about what just happened here. This doesn't mean you should avoid them but do factor in the risk somehow. I am always scared of small companies for reasons like this, where the insiders loot wealth without breaking any laws.

(On an unrelated note, I mentioned I skipped VXGN and let me explain why. This is just my strategy and it isn't something that is "right" or "wrong." I have a problem doing liquidations with biotech (or similar) companies. VaxGen was basically near a dormant state but many other biotech companies that Greenbackd and other liquidation investors have pursued make no sense to me. These companies tend to sit on cash and have no earnings, or often lose money for a long time, so they look like good liquidation candidates. After all, the role of a capitalist is to turn around money-losing operations, and as a last resort, liquidate the firm and hopefully re-deploy the capital back into the economy into a different venture. But the thing is, these companies are start-ups researching new products and hence have no profitable products or services. In fact, the perpetually-money-losing nature of these businesses is essentially the nature of their business. I'm sure that many investors of these companies are ok with what is happening (i.e. constantly losing money with little visibility into future products) because that is what they were investing into. They are investing on the hope of a major drug development or some medical advance. I don't really know if liquidation investors should be getting involved in them. I don't really see the merit in liquidating these firms. There are some exceptions with firms that are near "death" and shareholder wealth should be preserved by liquidating as quickly as possible. But how many such companies are there? Probably not many. Anyway, that's my thinking and why I automatically ignore these as liquidation investments. Anyone else have a dissenting view? Am I wrong in my thinking?)

Value Investors & Technology

I'm not a pure value investor so I am not hostile to the technology sector. In contrast, many value investors automatically rule out the sector.

Depending on whether you look at sales, profits, market value, number of employees, or growth, the technology industry probably represents around 25% of the American economy. If you include certain businesses that may or may not belong under the technology umbrella&mdas;an R&D-focused retailer like Amazon for instance—technology is probably as influential on the American economy as autos and radio were in the 1930's. So one is missing out on a big chunk of the economy.

As Ravi Nagarajan points out, there are several valid reasons value investors are uncomfortable with technology. One reason I believe is that, as Warren Buffett has remarked, 'he didn't grow up with it and doesn't understand it.' This is definitely the case with some elderly investors who have no idea how technology ties into general life. Note that you might use some technology but not understand it, either from a product point of view or its business usage in society.

But the main reason tech is ignored, again as Buffett has mentioned, and Ravi summarizes, is because long-term earnings and industry structure is unpredictable. I think there are only two ways around this latter problem.

One solution is to invest in established companies with clearly visible competitive advantages (e.g. Microsoft, Oracle or Intel.) Microprocessor and semiconductor technology may change but it is really hard to see how Intel will fall apart within 10 years at a minimum.

Another strategy which I like but is probably unproven and not widely followed is to adopt Bill Miller's thinking about technology. I have been influenced by Bill Miller's thinking that one should not look at the products/services of technology companies. Instead, one hsould look at their market share! In other words, products and services change so rapidly that it seems everything is unpredictable. However, Miller has suggested that the market share of companies do not change very much. There is actually a moat but you won't see it if you look at the product line.

Sticking with the Intel example, who knows how chip technology will change? Maybe there will be greater emphasis on memory on the microprossor instead of processing power. Maybe the CPU will become less prominent. Or maybe the microprocessors, which are mostly used in computers, will be used more in mobile devices, tablet devices, and other products not even invented yet. The point I'm making is that the individual products that Intel sells can change radically. The life span of their products may be a few years—or even a few days, in a futuristic society with extremely low costs.

But if you look at Intel's market share, I'll bet it will still be pretty strong in 10 or 15 years. The products look volatile but the market share is not. Sure, Intel can gain a bit or lose a bit, but it largely looks similar to what it was 10 or 15 years ago. Some companies will go bankrupt and this is where you, as a stockpicker, need to do good analysis. But in the grand scheme of things, the company's revenue is not as volatile as one may imagine.

What I presented above is what I have learned from Bill Miller and how I look at the technology industry. The earnings of many companies are more predictable than it seems.

Having said all that, as Ravi Nagarajan points out, start-ups and early-stage companies are a completely different game. None of what I said applies to them. On top of lack of decent financial history, these companies have no market share to speak of. Many haven't even generated enough sales to survive.

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Thursday, October 22, 2009 0 comments ++[ CLICK TO COMMENT ]++

Galleon informant not reliable... plus Galleon has Madoff-like returns

It looks like the Galleon case is not as fool-proof as it seemed. The Huffington Post picks up a New York Times story revealing one of the major moles is Roomy Khan, apparently a California-based ex-employee of Galleon.

A problem for the prosecution is that she apparently had financial problems and appears to have turned on Raj Rajaratnum when he refused to let her back into his firm. This sounds like some desperate move and who knows if she attempted black mail before co-operating with law enforcement so I'm not sure what a judge or jury will think.

Furthermore, it appears the Khan family has had two prior legal problems, including a now-settled lawsuit with a housekeeper. They apparently also defaulted on a loan by Deutche Bank, which was settled after being paid with interest.

So, it appears, at least to me, that the Khan family is very shady and unreliable. This doesn't let Rajaratnum off the hook—the government has other informants as well—but the case is not as strong as it seems.

Now, moving onto Galleon, The Huffington Post also picked up a blog entry by The Pragmatist Capitalist, where the author suggests that Galleon was posting unbelievable, Madoff-like, numbers:

Reader DanH was nice enough to forward us a recent copy of Galleon Groups performance going back to 1992. It turns out that the fund was Madoff-like in its performance. These guys just couldn’t lose. Whether the market was up or down they cranked out 25% returns like they were printing money. It makes you wonder just how long these guys were trading on insider information?

I have run the risk adjusted returns on hundreds if not thousands of portfolios throughout my career and I have never seen numbers like these. NEVER. There is virtually ZERO downside volatility in these figures. Their largest one month drawdown was -6.19%!* That is simply unheard of for a portfolio with such high returns. Gauging from the returns I would be willing to bet the insider trading was going on for most of Galleon’s existence and was likely much more rampant than currently reported:

* Correction – Galleon’s worst month listed here was a -8.54% decline in October of 1997. In other notes, it’s interesting to see that Galleon posted just 5 months of 4%+ declines in a total of 186 months listed. Unbelievable.

Although it's easy to say this is all from illicit gains, do keep in mind that many hedge funds post spectacular returns. In fact, Warren Buffett ran a hedge fund that would have been like this (except he would have higher volatility because value investing is not optimized to minimize volatility.) There are many quantitative hedge funds that apparently have a record better than Warren Buffett during his peak with lower volatility. Hedge Funds run by Bear Stearns apparently posted good returns too (although they blew up in the end, imagine if they shut down the fund before it blew up.) I have heard rumours that some of Goldman Sachs funds have spectacular long-term returns as well (but I'm not sure if these are true hedge funds or something related to their trading desk.) So, it's hard to say how much of this is due to fraud or some illegal activity, and how much is real.


Two contrarian views: Ambrose-Evans Pritchard very-long-term bullish on US$; Andy Xie very concerned about real estate in China

Here are two radically contrarian views. Of course, as always, what is contrarian depends on the crowd you hang out with. I measure it against the mainstream masses (i.e. institutional investors and Wall Street as a whole.) The views I present below aren't that new to me but they go against the Street.

US$ To Remain Dominant

This is a very long-term call so it's not really actionable for most of us (unless you are willing to invest for 20 years and not touch your money.) Ambrose-Evans Pritchard, a journalist at The Telegraph, makes a widly bullish call on the US$:

The dollar will still be the world’s dominant reserve currency in 2030, sharing a degree of leadership in uneasy condominium with the Chinese yuan. It will then regain much of its hegemonic status as the 21st century unfolds. It may indeed end the century even stronger than it was at the start.

Why, you might wonder, could someone say the US$ would be stronger in 20 years:

The aging crisis in Asia — and indeed the outright demographic implosion in Japan and China, not to mention China’s water crisis — will soon be obvious to everybody. Talk of Oriental supremacy will start to sound overblown at first, and then preposterous.


The UN expects America to add roughly 100m people by 2050, keeping its age balance in relatively good shape through a mix of immigration and a healthy fertility rate — now 2.12 live births per woman, still above replacement level. This compares to: Taiwan (1.13), Korea (1.2), Japan (1.22), Ukraine (1.25), Poland (1.27), Spain (1.3), Italy (1.3), Russia (1.4), Germany (1.41), China (1.77), Britain (1.96), and France (1.98). Some of this data may be slightly out of date, but the picture remains valid.

Professor Becker said a collapsing birth rate is extremely hard to reverse, and the cultural effects are insidious. Old societies are status quo. They are slow to embrace new technologies. Young minds are the source of hi-tech invention.

I agree with most of the speculation. In fact, it is quite hard to argue against them because they are basic facts. As suggested, it is also very hard to reverse demographics trends. I'm sure most are aware of massive socio-political battles fought in Japan over the decades between the "old" and the "young" with the old easily winning out—they simply outnumber the young by a wide margin and are unwilling to endorse any policies by younger people.

However, I personally do not believe the demographics situation in China is as bad as most people assume. I am of the opinion that China will eliminate its so-called one-child policy within 10 or 20 years. Although having no control over population—like India, Bangladesh, Brazil, and other heavily populated countries—has big negative side-effects, I am too libertarian to let the government dictate an individual's personal reproductive choices. In any case, even if one wasn't quite so liberal and quite so libertarian, I am sure the Chinese leadership will reverse the state-dictated reproductive policy. I haver zero faith that any government, let alone a so-called Communist-capitalist government, can control the population properly and I suspect the Chinese government itself is coming around to the view that it doesn't know what it is doing.

So, overall, China isn't as bad as it seems. Its demographic situation still doesn't look that great, and would be worse than USA's, or some other country like India, but it isn't as bad as most analysts are projecting.

To sum up, Ambrose-Evans Pritchard, who admittedly isn't an investor and doesn't have a great record based on my random observations, thinks the US$ will remain strong throughout the early part of this century, and perhaps beyond. I share the same view.

China's Real Estate Bubble

Andy Xie is an interesting fellow. I respect anyone who was fired by their Wall Street employer for saying what is likely truth. I was familiar with his writings from a few years ago, when I was also reading more of Stephen Roach (both of them were freely available on the Morgan Stanley website), but my view has always been that Xie isn't that good with his macro calls. His timing is off and some of his opinions seem contradictory with his other opinions. Where Andy Xie excels, at least in my eyes, is with his brash, controversial, calls. He is sort of like Marc Faber, except he is rooted in reality whereas Faber is just ridiculous at times. Andy Xie oftens says stuff that no one will publicly say. Even if some of his views are wrong, I often gain some insight.

Bloomberg recently conducted an interview with him and it is worth checking out if you are into China.

The key concern Andy Xie raises is that real estate is driving a huge chunk of China's growth (about 10% of GDP) and it is questionable how healthy this is in the long run. Then there is the totally ridiculous affordability ratios but it's hard to understand that ratio (this is due to many reasons including one raised in the interview: it is not uncommon to see families consisting of adults, parents, and even grand-parents pooling money to buy property. This also happens in other developing countries like India, but it is rare in developed countries like USA. Another reason it is difficult to understand affordability is because many real estate transactions are cash transactions, which technically means the buyer can "afford it". In contrast, most transactions in USA involve debt, with only the super-wealthy buying homes for cash.)

Overall, a somewhat bland interview but I did gain some insight. For instance, Andy Xie pointed out how the Chinese central bank controls monetary policy through qualitative measures (i.e. orders to banks) whereas in developed countries, it is mostly done by fiddling with the short-term interest rate. As Xie points out, the interest rate in China is largely useless when looking at monetary policy. The central bank hasn't done much with the interest rate in the last few months yet lending has been shrinking, solely because the government "told" the banks not to lend. Such a thing cannot happen in America—it may even be illegal in America.

I share similar views as Andy Xie and am concerned with a potential real estate bubble in China. In fact, I'm even more worried about a broader bubble in all fixed infrastructure.

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Chris Anderson's Free Model and a short Globe & Mail interview on it

David Armano's Interpretation of Chris Anderson's Free Model
(source: Graphic by David Armano of Logic+Emotion)

The Globe & Mail conducted a short interview with Chris Anderson, the editor of Wired magazine and a technology visionary from America, and I thought I would quote some of his thoughts and inject my opinion. I have always had high regard for Chris Anderson. One of the reasons I like listening to him is because he is good at synthesizing business, technology, and science, while presenting it in an easy-to-understand manner. For instance, I really like how he takes advances in technology and tries to explain the impact on business models. There are many, especially those who come from a business background, who attempt to do the same thing but end up failing (in my eyes) because they don't understand science or technology. In contrast, Anderson was educated in physics and apparently wrote for Nature and The Scientist, as well as The Economist.

Anderson's latest book deals with a new business model that is developing, particularly on the Internet, around the concept of "free."

I really feel that the so-called free model is extremely important for investors to understand but I don't have time to write up much, but hopefully will do that in the distant future. It is important because it is very disruptive and we may not have seen anything like it since the Industrial Revolution—yes, I mean that! All sorts of businesses are being turned upside down and it's important to realize what may happen. I haven't read Anderson's books or haven't read enough of his thoughts on his thoughts about "free" but, so far, I think Chris Anderson's thinking on the "Long Tail" is revolutionary but his views of "Free" seem a bit too muddled and uncertain. In any case, it's something to contemplate.

The Globe & Mail interview was short but it touched on some useful issues. Here are some issues that were discussed...

How Small Businesses Can Benefit

Dave M, Globe and Mail: Here's a question (and answer) that came in earlier this morning:

Mr. Anderson, can you give us a quick overview of the ways small businesses in particular are making use of the "free" strategy?

Chris Anderson: Small businesses use the "free" concept both as consumers and producers. For small businesses as consumers, technology has never been cheaper than it is today. Open-source software, hosted ("cloud") computing and special free forms of enterprise software mean that small businesses can get access to world class technology on a credit card budget.
For small businesses as producers, free is the best form of marketing. Small businesses who offer online products and services can offer a free version of their goods to show, not just tell, what they can do. And in the process they can save a fortune in advertising.

The barriers to entry for entrepreneurs in many industries has never been lower. This doesn't mean everyone will be successful but at least the average guy off the street has a shot. Even once-expensive customer relationship management systems, accounting software, inventory management systems, and so forth, can be rented or purchased for very low cost nowadays. Direct mail advertising costs on the Internet are also a fraction of what they were in the real world.

Impact on Shrink-wrapped Software Vendors Like Microsoft

Dave M, Globe and Mail: Chris, what do you think will happen to Microsoft as the "free" software trend continues? How can they adjust their business model to adapt?

Chris Anderson: Microsoft has been competing with free for three decades (they're even a chapter in the book). First getting people to pay for software in the first place (software used to be something you got free with a computer), then competing with piracy, free bundled software in new PCs, then open source, and now software as a service online. In each case, they had a different strategy, from moral suasion to lawsuits to releasing a free form of their software (Microsoft Works) to now moving their software online and offering free versions. Microsoft Office will be available as a free online version, and you can get all of their enterprise software for free today if you are a small business (under $1m in revenues and under three years old) as part of their BizSpark program. It's classic Freemium: free software to help companies get started cheaply, then convert them to paid once they're able to afford that.

A lot of people, including investors, think that a company like Microsoft is vulnerable to emerging "free" or "freemium" models. I beg to disagree. As Chris Anderson points out, Microsoft has been competing against various notions of free for 30+ years. If you go with the thinking of someone like Peter Drucker, who has suggested that the two functions of a business are design and marketing, then it's hard to see too many others who excel at both like Microsoft (sure, someone like Apple is even better on both counts right now but historically it has been an un-even effort.) A lot people focused on technology, or too young and unaware of the 90's, don't realize that Microsoft basically dominated because of marketing (the design portion was good but not spectacular.) For instance, MS SQL Server, a big portion of revenues now, only became dominant with Microsoft marketing.

I think the most vulnerable companies to the Free model are the enterprise software companies like SAP, Oracle, and the like. Although nothing is going to happen for many years, possibly decades, these companies can easily fall apart if someone starts renting or offer low-cost enterprise services (off a cloud or some future networking scheme.) There are issues with security, performance, speed, etc, but once those are worked out, I just wonder.

Anyway, it remains to be seen what comes of shrink-wrapped software companies.

How Do Some Make Money?

There was a question about how companies that give away stuff for free make money:

[Comment From Diana_G Diana_G : ]
I have a question from a consumer's point of view, there are websites such as that offer users free stuff for searching the internet using their website or search bar. I was wondering how these companies made money? (I use this site a lot and was wondering is there a catch). Also, are there any other sites that offer users free things just for using their site?

Chris Anderson: Diana, although I'm not familiar with that site, those kinds of companies are usually doing some sort of advertising arbitrage (they make more from advertising than they pay you) or using an affliate model where they get a percentage of anything you buy from an advertiser. As for others, I do talk in the book about things being "cheaper than free", which is to say they pay *you*. This is usually done to gain market share or otherwise grab customers from free competitors, and Microsoft among others have paid customers to use their search engine. Ideally, the things they pay you with don't have a real cost (free access to otherwise paid digital services) or discounts on other products, but I've seen the whole range of experiments out there as people try new pricing models.

It remains to be seen how many of these companies can actually survive and sustain their business model. I think there are two categories here.

The first category, as Anderson alludes to, consist of companies "arbitraging" some pricing scheme. This is the easiest to implement but I wonder about their sustainability. If the arbitrage-type opportunity dissapears—say the businesses that they are arbitraging reduce their prices and match the lowest cost—then I don't think these companies will survive.

The other category involves companies that capitalize on market prices that are higher than their costs. This ties in more to the concept of the Long Tail in my opinion, and is common in digital products or services. For instance, the cost of selling music online may be very tiny. Storage costs, bandwidth costs, etc are very low and continuously falling; and you don't have printing costs, CD pressing costs, and so on. This allows some companies to give away products without actually losing money per se. In other words, the variable costs are very low, so once you cover the fixed costs, the product is near-free.

Anyway, I'll cover some of these concepts in the future...

Wednesday, October 21, 2009 2 comments ++[ CLICK TO COMMENT ]++

Warren Buffett interview...calls for downside in compensation schemes... plus my rant

In an interview covering the payments industry, Warren Buffett today called for Wall Street to implement downside penalties into their compensation scheme. Thanks to New York Times' DealBook for bringing it to my attention. You can access the video interview here.

The compensation problem is not an easy problem to fix for two reasons.

First of all, shareholders of financial institutions have shown themselves to be happy with the current scheme. I mean, can anyone think of too many shareholders, even the majority shareholders who lost massive fortunes, of companies like Citigroup or AIG, complaining about compensation schemes? I have been following the markets a lot during the financial crisis and I haven't seen any strong calls for compensation reform. As far as I'm concerned, it is up to the owners, which means shareholders for public corporations, to control compensation. They are the ones that pay the employees and if they can't control their own compensation policies and the compensation consultants they hire, no one else can. Certainly the government can't control compensation (the govt also should not get involved too much or else you will end up a system where politicians will dictate business and we end up looking like a quasi-totalitarian state where the political class rules.)

Secondly, many financial institutions on Wall Street, especially the investment banking side, are more akin to casinos than a bank. These firms are run for their employees. That is how they have been historically; that is how they are now; and that is how they will be in the future. Investors in such firms are simply along for the ride. There is no way anyone, including Warren Buffett, can know what is going on in Goldman Sachs (Buffett was making a political bet and even said so himself—he said he wouldn't have invested if the government didn't backstop the company or provide literally unlimited low cost funding by allowing them to be a bank.) Neither could any shareholder have known what was going on in Bear Stearns. Or Lehman Brothers. Or Morgan Stanley. Or you-get-the-point. Some might argue the bears and short-sellers knew something but even that is not fully correct. Many who profitted off the collapse of some of these firms had no idea what was going on. Even short-sellers who are given credit, such as David Einhorn with Lehman Brothers or William Ackman with the monolines, completely misjudged the situation.

So, I think the two issues are intertwined. The reason, I believe, shareholders don't crack down on compensation for poor decisions is because they are 'in for the ride' and will lose their seat at the casino if they did. My impression is that the skewed bets are intrinsic to Wall Street and cannot be fixed. Investment banks and related businesses will always be run for the benefit of employees and, shareholders who wish to participate, need to shut up and watch. If things work out, shareholders make a killing—many financial firms had very high ROE in the 90's and 2000's—but if things blow up, well, shut up and walk away with your losses...


It remains to be seen how far-reaching the Rajaratnum investigation will be

The Rajaratnum case that I was referring to in my prior post has the potential to be a spectacular blow up for Wall Street. Depending on how far the government takes it, we may be looking at the largest criminal investigation ever conducted on Wall Street. Unlike other popular criminal cases, such as the Bernie Madoff case, Enron, or Worldcom, this insider trading scheme appears to impact many firms and involves a huge network of insiders. Let me quote the thoughts of Michael J de la Merced, a New York Times reporter:

As I report in the Times article, the case is fascinating on multiple levels. The sheer size of the purported network, riddled with unnamed co-conspirators and tipsters, is tantalizing. Who was the unnamed investor-relations employee who allegedly illegally spilled the beans on Google’s quarterly earnings? Who was the Akamai executive who did the same? The Moody’s Investors Service analyst who divulged that Hilton Hotels was about to be acquired by the Blackstone Group ahead of the formal announcement? Prosecutors haven’t said yet.

These aren't some backwater penny-stock companies; these are some of the largest companies in the world. For example, the fact that some Google employee was leaking quarterly earnings is kind of disturbing if you think about it. As I remarked yesterday, these leaks have little impact on long-term investors like me, but imagine the traders and other short-term investors who live and die with short-term moves.

We also have the case of some director (very senior) at McKinsey spilling confidential details. Given how employees of McKinsey have knowledge of sensitive, very secretive, information about their clients, this isn't some minor side-issue. No doubt this has the potential to seriously tarnish the reputation of McKinsey & Co. Although not a fraud and hence the company won't blow up, this situation can ruin the reputation of McKinsey—sort of like Arthur Andersen earlier in the decade.

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Tuesday, October 20, 2009 0 comments ++[ CLICK TO COMMENT ]++

Opinion: The Fall of Raj Rajaratnum and the Ways of Wall Street

Behind every great fortune there lies a crime

—Honore de Balzac
Passage in Le Pere Goriot (aka Father Goriot)
very loosely translated*

Honore de Balzac is credited with the saying in the above quote and, although I don't feel is accurate in a country like America, I do think it applies very well to the period Balzac was living in (18th and 19th centuries) and to modern day developing and undeveloped countries with non-existent or corrupt legal systems.

I never even heard of Raj Rajaratnum before the scandal broke late last week. I never even knew a Sri Lankan Tamil was a billionaire—he's the same ethnic group as me grr :(—let alone some major Wall Street player in technology investing. Although it's too early to say for sure, and I'm reserving judgement until the courts rule, it does appear that Rajaratnum was involved in a major insider trading ring. Law enforcement used techniques typically used to bring down organized criminals, including extensive wiretaps. Assuming the wiretaps weren't fabricated, they indicate that Rajaratnum and others involved in the scheme knew what they were doing. The New York Times reported the following last week:

Recorded conversations between Mr. Rajaratnam and Ms. Chiesi appear to show they were aware their information was far beyond what the market knew. “If the two of us weren’t close to the company as we are, would you be long the stock?” Ms. Chiesi asked Mr. Rajaratnam on Aug. 26, 2008, referring to A.M.D. “No. I wouldn’t be,” he responded. She added that she would not have touched the company with a “10-foot pole.”

The two also showed concern about the consequences of their schemes being discovered. On Aug. 27, Ms. Chiesi told an unnamed co-conspirator: “I’m dead if this leaks. I really am and my career is over.”

Ironically, Danielle Chiesi worries about her career when she should have been worrying more about prison. Career is the least important aspect of anyone's life. High performers don't realize it but other things, like family or freedom, are far more important.

Although the insider trading charges amount to a profit of $20 million, one wonders if the billion in wealth—Rajaratnum claimed his wealth was somewhere around $200m in court, perhaps due to the stock market collapse last year—was earned through nefarious ways.

The fact that law enforcement is willing to use stronger techniques for white-collar crime should improve transparency in investing. Another question is whether Raj Rajaratnum was doing something unique or whether his techniques are more wide-spread on Wall Street. Writing for The New York Times, Alex Berenson wonders the same thing (text bolded by me):

The most precious commodity on Wall Street is information, and savvy players will do almost anything for it.

Raj Rajaratnam, the billionaire hedge fund manager who was arrested Friday on accusations of insider trading.

Some investment funds canvass doctors to scout out blockbuster drugs. Others pay meteorologists to forecast weather that will affect the price of oil and wheat. And still others hire corporate executives to provide an inside view of companies and industries.

But now some of Wall Street’s biggest hedge funds are watching nervously as prosecutors say that Raj Rajaratnam, a billionaire fund manager, went too far in this relentless quest for a trading edge.


A close reading of the two criminal complaints filed so far, and an associated civil complaint filed by the Securities and Exchange Commission, suggests a web in which hedge fund managers, analysts, corporate executives, and consultants and other people outside Wall Street traded tips — sometimes for money, sometimes for other tips, and sometimes for little more than the promise of unspecified future favors.


At other times, Mr. Rajaratnam received information from an unnamed witness who is cooperating with the government investigation. But the complaint does not state whether Mr. Rajaratnam knew the ultimate sources of the information he received from the witness. Nor does it allege that Mr. Rajaratnam paid the witness for the information.

Still, the existence of a cooperating witness — along with the fact that prosecutors wiretapped some of Mr. Rajaratnam’s conversations — gives them a great advantage in the case, said David S. Ruder, a law professor at Northwestern University and a former chairman of the S.E.C. The conversations may help show that Mr. Rajaratnam knew the information was valuable and that he should not be trading on it, Mr. Ruder said.

“It gets you around the mens rea, or state of mind question,” he said. “If you know it’s coming from an insider, or if you have strong reason to believe it’s coming from an insider, you’re in trouble.”

There are very few lessons for most readers of this blog, whom, like myself, are small investors and don't work on the Street. We don't even have a rolodex ;) However, some readers may work in on the Street and face competitive pressures so this case should be a good lesson for all of you. In particular, pay attention to the bolded last paragraph in the quote, where the law professor says that you are culpable if you know information is coming from an insider—even if you suspect it's an insider, run away.

On a positive note for most readers of this blog, if you are a long-term investor or a fundamental or macro investor, you won't be vulnerable to insider trading. The so-called "insider tips" are next to useless in the grand scheme of things, and will appear as tiny little bumps on a long-term chart. The only thing that is going to make you successful, if following these strategies, is correct evaluation of long-term trends or business fundamentals.


(* The actual passage is supposedly, ""Le secret des grandes fortunes sans cause apparente est un crime oubli , parce qu' il a t proprement fait." In English, that translates as: "The secret of a great success for which you are at a loss to account is a crime that has never been found out, because it was properly executed." [source here])

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Monday, October 19, 2009 3 comments ++[ CLICK TO COMMENT ]++

David Einhorn bets big on a currency crisis

It's hard to tell how good David Einhorn is with his macro calls. I don't give him the same respect as many others, when it comes to his macro views. In any case, it looks like Einhorn is making some bold calls. MarketWatch reports that he is expecting a major currency crisis (interestingly not in USA):

Greenlight Capital is betting on the possibility of a major currency collapse and a surge in interest rates, the hedge-fund firm's manager David Einhorn said Monday, citing ballooning government deficits in some of the world's most developed countries.


On Monday, he said Greenlight has added new trades to this investment theme, buying long-dated options on much higher interest rates in Japan and other developed regions -- effectively giving the firm the chance to make big profits from a jump in rates. The options, bought from major banks, are tied to interest rates four to five years out, Einhorn noted.

"Japan may already be past the point of no return," he said during a presentation at the Value Investing Congress in New York.


"When the market refuses to refinance at cheap rates, problems emerge," he said, adding that this could trigger a "currency death spiral."

Interest rates have been very stable in Japan for years, so the options on higher rates that Greenlight bought were relatively cheap. Einhorn said the "asymmetry" of that trade was interesting: If rates were to jump suddenly in Japan, Greenlight stands to make "multiples" on its positions.

So many people have been burned badly by Japan over the decades. It is very difficult to call—in any direction!

I personally don't share Einhorn's view of Japan. I can see bond yields rising but I don't forsee any currency crisis. Although the government of Japan, as well as the JCB, influence Japanese bond yields, it is largely the free market that is setting the long-term yields. They are very low because the market is willing to accept it. This makes sense given how earnings yields on stocks are very low in Japan, and the economy has continuously experienced mild-deflation/low-inflation.

Regardless of what happens, one thing is for certain: Japan cannot continue increasings its government debt. But I don't think there will be a currency crisis.

Rolf Winkler also covered the story—and also provides this link to his David Einhorn's speech—and he quoted Einhorn's thoughts on gold:

I have seen many people debate whether gold is a bet on inflation or deflation. As I see it, it is neither. Gold does well when monetary and fiscal policies are poor and does poorly when they appear sensible. Gold did very well during the Great Depression when FDR debased the currency. It did well again in the money printing 1970s, but collapsed in response to Paul Volcker’s austerity. It ultimately made a bottom around 2001 when the excitement about our future budget surpluses peaked...

I have been mistaken with Einhorn's bet on gold. I thought he was betting on inflation but it appears he is betting on fiscal policies being "poor." I'm not sure what that means but I'm curious to see what happens to gold.

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Sunday, October 18, 2009 0 comments ++[ CLICK TO COMMENT ]++

Sunday Spectacle XXXI

I Love Liberty
(Roy Lichtenstein, 1982)

("I Love Liberty" by Roy Lichtenstein (1982). Being sold during Lehman Brothers liquidation art sale.)

Saturday, October 17, 2009 1 comments ++[ CLICK TO COMMENT ]++

The Elevator Pitch

(This post has nothing to do with investing. Skip this if you are not developing your communication skills.)

In 1994, Barnett Helzberg, Jr. was walking by The Plaza Hotel in New York City when he heard a woman hail Warren Buffett. Helzberg approached the legendary investor and said, "Hi, Mr. Buffett. I'm a shareholder in Berkshire Hathaway and a great admirer of yours. I believe that my company matches your criteria for investment."

"Send me more details," Buffett replied. A year later, Helzberg sold his chain of 143 diamond stores to Buffett.

Helzberg's story is a classic example ofa powerful elevator pitch. An elevator pitch gets its name from the 30second opportunity to tell-and sell-your story during a three-or four-story elevator ride. The 3D-second parameter is based on the typical attention span, according to the book How to Get Your Point Across in 30 Seconds or Less by Milo O. Frank. It's one reason why the standard commercial or television "sound bite" lasts 30 seconds.

While elevator pitches are often associated with funding requests, they can be valuable every day. Job interviews, networking events, public relations opportunities, presentations to executives, and sales all demand the ability to successfully deliver a quick and concise explanation of your case.

—Nick Wreden
How to make your case in 30 seconds or less

The elevator pitch! I thought only salespeople used it but have now changed my mind. The example isn't as good as the author suggests—knowing Warren Buffett, I think he would look at all business deals—but it still presents the type of opportunities that may arise.

I have been searching for a job lately, partly to advance my career and partly because my company isn't doing too well, and have been spending a lot of time on career-related activities. So far no luck, but the future is mysterious as always. I am not very career-oriented and, unfortunately, never put much effort into my career. For the first time in my life, I am actually thinking more about my future, where I belong, what my skills are, and so forth. Perhaps as Peter Drucker has remarked, most people discover their career in their late 20's or early 30's, which describes my state. This has meant that I ignored in the past—such as how to write a good cover letter, sell yourself, and the like.

My intention is not to bore you to death with my state of affairs but to quote an interesting article I read recently. This topic belongs on my personal blog—with readership approaching 5, rounded up ;)—but I thought others may benefit from what I am about to say.

I was searching for tips on writing better cover letters and performing better during job interviews and I came across the following article: "How to make your case in 30 seconds or less" by Nick Wreden. You can purchase this very-short article for $4.50 from Harvard Business Publishing. I signed out the thin booklet, Face to Face Communications for Clarity and Impact, from my library, which also contains this article.

Given how short this article is, I hope I'm not going to break fair-use laws but quoting it and summarizing it below. As with most of my posts, there are two reasons for it. Firstly, as always, some readers may learn something (they may not get around to reading the full article, particularly if you live in a foreign country and don't have access and can't pay.) Secondly, it's for my own reference. I would like to revisit this in the future and a blog post is more accessible and permanent than anything on my computer (I did scan this article though.)

The Elevator Pitch

As with most aspects of communications, it is a liberal art. There is nothing to say that Nick Wredon's thoughts are absolutely correct. Some may also find what I'm about to quote, very commonsensical, boring, and lame. In any case, I found it insightful.

The elevator pitch is not just for salespeople. It is something that may help you in other activities, such as presentations, interviews, trying to influence others, and so on. Nick Wredon gives the following tips:

  • Know the Goal: "The goal of an elevator pitch is not to get funding, a job, or project sign-off It's to get approval to proceed to the next step, whether it's accepting a phone call, a referral to the right person, or a chance to send additional information."

  • Know the Subject: "Do you know your topic well enough to describe it in a single sentence? It's harder than it sounds. As Mark Twain pointed out, 'I didn't have time to write you a short letter, so I wrote you a long one.'" This is a serious problem for me. As you can tell by my writings on this blog, I am, at times, too verbose. I definitely need to learn to be more conscise. I don't know how my speaking skills are and I may need to improve my verbal skills as well. Nick Wredon continues, "The issue, as always, is less what you do, and more what you can do for somebody. "I'm a real estate agent" is not as powerful as saying "I am a real estate agent who specializes in helping first-time buyers like you buy great homes in this town."

  • Know the Audience: "...he tailors his elevator pitch to match his audience's requirements. "If people don't hear a benefit for them, they won't listen to you," says Yancey." This is something I have been trying much harder with my resumes and cover letters. There was a time, perhaps due to arrogance or lack of understanding of the world, when I didn't tailor my words towards my audience.

  • Organize the Pitch: "Typically, elevator pitches start with an introduction, move into a description of the problem, outline potential benefits for the listener, and conclude with a request for permission to proceed to the next step in the relationship." If you have very good pusuasive skills—have charisma, can talk well, look good, and are convincing—then you can be more free-flowing.

  • Hook Them from the Opening: Quoting from the article, "You have to make an immediate connection with the audience. This connection signals that it's worth investing valuable time to hear what you have to say. Weiss suggests starting with a provocative, contrarian, or counterintuitive statement that will rev pulses. One example: "Quality doesn't matter.""

  • Plug into the Connection: "Clarity is more powerful than jargon. Use analogies the audience can relate to. Power once had to explain a new technology called "strong authentication." He held up an ATM card. "Every time you use this card With a PIN code, you are using strong authentication," he said. The audience instantly understood that strong authentication involved multiple levels of security. Personalize your message by relating your solution to audience needs. Emotional appeals are also powerful."

  • Presentation Matters: The article suggests that you watch your tempo. Don't talk too fast. The author also suggests timely pauses.

  • Incorporate Feedback: The author suggests videotaping yourself. I think this is more applicable to situations where the speech matters a great deal—say a public presentation, or a sales presentation. Another alternative that is suggested is to ask for the opinion of someone who is not familiar with your work. Most people can probably use their friends, spouses or loved ones to accomplish this task.

Although intuitive, I find the suggestions useful to me. I certainly have learned something and plan to incorporate more of these ideas. For instance, I never knew that the goal is not to close a transaction, but to get permission for the next step.

I hope some people, perhaps even those Googling this 10 years from now, will benefit from my summary of Nick Wredon's article.


Jean-Marie Eveillard on Japan

Thanks to GuruFocus for bringing this Bloomberg interview with Jean-Marie Eveillard to my attention. It deals with Japan, which I'm sure is of high interest to contrarians and deep value investors. Japan, for those living in the cave for a few decades ;), has been in a 20-year bear market. That alone should warrant a look from contrarians. It is rare for equity markets to go into such long bear markets in the modern era.

Nothing new in the interview but I always like to hear the thoughts of successful investors. Even if there are no new stock suggestions, I like to get a feel for their thinking. For instance, Jean-Marie mentions how he was in Japan an year ago and they seem slightly more open towards immigration.

I don't want to beat the horse to death, since I have repeated these points many times, but here are some reasons to be cautious of Japan:

  • Horrible corporate governance: Shareholders basically don't own the companies except in name (I might be exaggerating a tad bit but Japan watchers are probably nodding their head in agreement with me.)
  • Inefficient Businesses: As I keep repeating, Warren Buffett remarked about a decade ago how Japanese companies are very inefficient. He pointed out how, even during their peak when Japan Inc was taking over the world, they did not create much shareholder wealth. I look at the economy in a simplistic manner on par with how Adam Smith, Karl Marx, and others viewed it—namely, profits accrue to workers or capitalists or government—and Japan has basically been a so-called "capitalist" society where the profits never accured to capital owners. A really bizarre society.
  • Too Cyclical and Sensitive to a Strong Yen: Since I am not in the weak Yen camp, this is a big issue. I can see the Yen remaining strong, or even appreciating if the Renminbi's peg is removed, so the export-oriented Japanes industry will have difficulties. A large chunk of the Japanese econmy is made up of export-oriented businesses so it's not easy to invest if you are concerned about this. On top of this, as Jean-Marie alluded to, with respect to Fanuc, it's not clear how well the Japanese industrial companies will perform against Chinese companies.

Having said all that, I like Japan as an opportunity. I have been following it for several years now and the equity market has gone nowhere during that time. I invested in one Japanese company, Takefuji, a subprime lender, with horrible results (poor stock selection) but I'm still looking to invest. At some point a blind macro bet may be worth considering.

Friday, October 16, 2009 3 comments ++[ CLICK TO COMMENT ]++

How not to invest: Harvard and its dubious bet on interest rates

I'm not the only one you should be using as an example of how not to invest ;) You should add Harvard University's endowment fund to that list as well. Readers may recall the numerous problems Harvard's fund faced last year so it shouldn't come as a surprise when Bloomberg reports that Harvard paid $500 million, plus another $425 million over 40 years, to cancel interest rates swaps:

Harvard paid $497.6 million during the fiscal year ended June 30 to get out of $1.1 billion of interest-rate swaps intended to hedge variable-rate debt for capital projects, the report said. The university in Cambridge, Massachusetts, said it also agreed to pay $425 million over 30 to 40 years to offset an additional $764 million in swaps.

The transactions began losing value last year as central banks slashed benchmark lending rates, forcing the university to post collateral with lenders, said Daniel Shore, Harvard’s chief financial officer. Some agreements require that the parties post collateral if there are significant changes in interest rates.

“When we went into the fall, we had some serious liquidity management issues we were dealing with and the collateral postings on the swaps was one,” Shore said in an interview today. “In evaluating our liquidity position, we wanted to get some stability and some safety.”

Harvard sold $2.5 billion in bonds, in part to pay for the swap exit, even as the school’s endowment recorded its biggest loss in 40 years, the Harvard report said.


Harvard has frozen employee salaries, slowed hiring, cut staff and offered other workers early retirement as part of a cost-cutting program to compensate for losses in its endowment. The fund, which dropped to $26 billion in value over the fiscal year from $36.9 billion, paid 38 percent of the school’s bills during that time, the report said.

If liquidity was a concern, Harvard probably had no choice in attempting to exit these contracts. Nevertheless, these contracts may end up being canceled at the worst possible moment. Although I am not expecting it, one shouldn't rule out the possibility of interest rates rising. If they do rise, Harvard would have done the equivalent thing to what some panicked investors do: sell near the bottom.


Huge insider trading charges for a technology-focused hedge fund

MarketWatch is reporting that the founder of of Galleon Group, a large technology-focused hedge fund, is being charged in federal courts with insider trading:

Galleon Group's billionaire founder, Raj Rajaratnam, was charged Friday in a sweeping insider-trading case, according to court documents filed in Manhattan by federal prosecutors and the Federal Bureau of Investigation.

Rajaratnam and five others allegedly involved in the scheme have been arrested. A phone message seeking comment that was left at Galleon's New York headquarters Friday morning wasn't returned.

The other defendants are: Rajiv Goel, a managing director at Intel Capital, a unit of Intel Corp.; Robert Moffat, a senior vice president at IBM Corp.; Anil Kumar, a director at consulting firm McKinsey & Co.; Danielle Chiesi, portfolio manager at $1 billion hedge-fund firm New Castle Partners; and Mark Kurland, a senior managing director and general partner at New Castle, which was the equity hedge-fund group of Bear Stearns Asset Management.

"This is not a garden-variety insider trading case," Preet Bharara, U.S. attorney for the Southern District of New York, said during a press conference, adding that it was the largest hedge-fund insider trading case ever charged.

All the defendants were "caught" using wiretaps, according to Bharara, "powerful investigative techniques that have worked so successfully against the mob and drug cartels"


"Raj Rajaratnam is not a master of the universe, but rather a master of the rolodex," Khuzami added in a statement. "He cultivated a network of high-ranking corporate executives and insiders, and then tapped into this ring to obtain confidential details about quarterly earnings and takeover activity."


The charges allege that Galleon made almost $17 million trading on inside information about Polycom, Hilton, Google, Clearwire, Akamai and PeopleSupport regarding upcoming corporate results, acquisitions and reorganizations.

This is important for two reasons. First of all, this is the largest hedge fund—AUM of supposedly $4 billion—being accused of insider trading. Although a crime is a crime, it is surprising to see such a large firm being embroiled in apparently illegal activities.

Secondly—I wasn't going to post about this except for this—it is interesting that the government is charging somewhat senior officials from various firms such as Intel (a microprocessor company), IBM (a computer services company), and McKinsey (a consulting company). It is possible that there is some grand conspiracy at work, as the government seems to be implying. However, I wouldn't rule out the possibility that the senior employees at these firms didn't know they were giving out material information (yes, I realize that it's still your fault if you give out material information without realizing it, but I'm just wondering if these guys at Intel or whatever were really in this accused scam.)

Finally, as always, everything I have said here, and the government has said, have not been proven in a court of law. We shouldn't assume any one is guilty until proven as such.

Sunday, October 11, 2009 2 comments ++[ CLICK TO COMMENT ]++

Dubai may need a bailout

The Globe & Mail, via a Reuters story, is reporting that S&P is concerned that Dubai may be insolvent:

Dubai has “insufficient” funds to pay back billions of dollars worth of debt coming due, an analyst at credit rating firm Standard & Poor's said Sunday, putting added pressure on the struggling city-state to raise additional cash.

The sheikdom and its network of state-controlled companies amassed at least $80 billion (U.S.) in debt on projects like manmade islands and opulent high-rises during a multiyear building boom that saw the city-state craft itself into the Middle East's financial, trade and tourism hub.

About $50 billion worth of that debt needs to be covered over the next three years, said Farouk Soussa, S&P's head of Middle East government ratings. A lack of government information has left investors wondering how it all will be repaid.

I haven't mentioned Dubai in a while given the crises that have unfolded elsewhere but it looks like the Dubai boom, largely driven by real estate and attractions targeted at wealthy individuals, may have been fictitous wealth creation. One positive thing is that construction projects have a long lifespan and can be used in the future (assuming they don't become obsolete or too expensive to maintain.) However, a big negative for Dubai is that a lot of residents are foreigners who can easily flee the country, never to return. In such a case, there may be huge overcapacity in real estate.

Overall, Dubai won't completely implode because UAE will come to its rescue. Unfortunately, such a rescue will have big political implications. Dubai is socially more liberal (although nothing like the West or Latin America) whereas the leaders of UAE appear to be socially conservative.