Sunday, February 28, 2010 21 comments ++[ CLICK TO COMMENT ]++

Newbie Thoughts: Closed-end funds are a good playground for amateur investors

If you only look at the mainstream, easily accessible, investment vehicles out there, closed-end funds tend to be one of the most mispriced assets out there. This means two things. If you are a skilled investor, it is an area where there may be great opportunity to earn high returns. Conversely, if you are a newbie, it's probably one area where you can get burned badly.

For those not familiar, a closed-end fund (CEF) is a fund that has a fixed numbers of shares; whereas an open-end fund (such as a mutual fund or an ETF) creates and destroys (redeems) shares over time. CEFs are generally listed on an exchange and traded daily whereas mutual fund shares are not listed on any exchange (but ETF shares are listed.) Shares of open-end funds tend to track the underlying assets closely but CEF shares may not. There is no natural way to arbitrage price discrepancies in CEF shares (other than through influence of fund managers.)


Sunday Spectacle XXXXIX

(Image source unknown)

The solution to the Greek fiscal problems are obvious to me. However, execution is very difficult. As far as I'm concerned, the problem is that Greek citizens don't pay their taxes. Stories of surgeons making 700k Euros per year and paying almost nothing sort of hints at the reality (here is a Time story that touches on the issue.) Countries with similar tax collection problems early in the decade, like most ex-Soviet republics, as well as Russia, overcame the problem by implementing a flat tax. However, a flat tax is a regressive system and will cause a greater discrepancy in wealth between the have and the have-nots (this is a mounting problem in Russia right now and the consequences will likely be felt in a few decades when the poor demographic trend comes into play.) A flat tax will also probably cause tax revenue to decline in Greece (in Russia and others tax revenue went up because almost no one was paying taxes after the collaspe of USSR whereas the problem in Greece appears to be partial tax-dodging.)

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Wednesday, February 24, 2010 6 comments ++[ CLICK TO COMMENT ]++

Anyone listen to podcasts/audiobooks/etc on their commute?

I commute to work by car now, with 45 min to 1 hour trips each way, so I was thinking of listening to investment/business news/etc audio broadcasts during the drive. I used to commute by public transportation before and I used to spend my time reading, which was very invaluable to me (a lot of the blog entries and my investment ideas are due to that time.) But, now that I have to drive a car, I want to utilize the time so I have a question for all of you that commute (note that the following applies even if you commute by public transportation while listening to audio):

Do any of you listen to any worthwhile investment (or business) audio broadcasts on your ride to work or school? I'm thinking of regular podcasts, audiobooks, and things like that. Anyone have any suggestions?

Even if it costs some money, I don't mind paying for a regular broadcast subscription of some sort. The obvious answer is a radio station of some sort but (i) I haven't found any that are good, and (ii) they don't give you the ability to skip material one is not interested in.

Right now, I'm thinking of audiobooks (kind of expensive if you buy a lot and won't absorb as much info as reading but an obvious choice), Audible news sources (such as New York Times and the Wall Street Journal), and audio edition of The Economist (kind of expensive but has professional audio and decent length (around 6 hours of audio per week.) Anyone have any experience with these (especially the Audible version of WSJ or NYT? I'm not sure if they mostly cover general news??)

Sunday, February 21, 2010 2 comments ++[ CLICK TO COMMENT ]++

Jim Chanos' China bear case

You may recall Jim Chanos, a short-selling specialist, making the news a few weeks ago when he was quoted in a New York Times article laying out the bear case for China. What's interesting about the China bear vs bull fight is how many of the tradtional bears and contrarians are actually bullish on China. Strategists such as Marc Faber and Jim Rogers, not to mention the countless perma-bears who seem bearish on everything, are actually bullish on China (usually through heavily leveraged bets on China-sensitive commodities.) So, even though the China bear case is quite signficant (we aren't talking about some minor asset class or security from the middle of nowhere), there are very few bears. Jim Chanos, as well as Hugh Hendry, appear to be the only prominent ones that are on the bear side.

Jim Chanos gave a great presentation a few weeks ago, outlining his China bear thesis. Some of you may have already seen it but I just got around to watching it fully (it's almost an hour.) Thanks to Business Insider for pointing me to this view (h/t The Big Picture for bringing it to the attention of the Business Insider.) The sound quality isn't good but the content in this video is quite good. I recommended it if you are interested in macro matters or China.

Click through for a video presentation by Jim Chanos, followed by a Q&A.

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Sunday Spectacle XXXXVIII

World's Exports - 1999 to 2009

Charts like these can be grossly misleading if the start and end points are not representative of a typical year. Given how many countries saw major declines in 2009, I'm not sure how representative the 2009 rankings are. Some of these countries may be ranked low simply due to a temporary drop in 2009. In any case, what is likely to be an accurate representation is the compound growth rate from 1999 to 2009 (bottom-right chart.)

The most notable thing, which shouldn't be surprising to anyone, is the spectacular export growth in China. It's amazing to think that China posted 20% per year growth in exports in the past decade. I'm not too knowledgeable about distant history but it is possible that no (sizeable) country has ever done that in the last 500 years. Some countries like USA in the late 1800's and Japan in 1970's had high export growth but I doubt it was 20% per annum.

I haven't looked up the exact numbers but China's real GDP grew around 10% per year in the last decade and its nominal GDP probably grew around 15% per year (if we assume 5% inflation in China—the inflation number in China is debatable.) This shows how China's development was almost solely due to export growth.

I'm surprised to see that countries like Belgium and the Netherlands had strong export growth. I didn't realize those countries were doing well when it comes to exports.

Even with booming commodity exports, Canada comes up last on that list. Exports appeared to have grown only 2.7% in the last decade. I thought we did better but it looks like the strengthening Canadian dollar has killed off exports. Canada's manufacturing exports have been dying and my province isn't doing so well :(

(Source: "A Shift in the Export Powerhouses," By Floyd Norris, The New York Times. February 19, 2010)

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Saturday, February 20, 2010 5 comments ++[ CLICK TO COMMENT ]++

Opinion: GE's problems appear to be a bit worse than I thought

When it came to the financial crisis, one of the most shocking things for me was when industrial giant, GE, ran into liquidity problems. It is not wholly surprising that companies like Lehman Brothers, Bear Stearns, Citigroup, Fannie Mae, and others, faced serious problems given their business involved mortgages. But I was truly surprised when it looked like GE, which I had perceived as very strong (I think it was even rated AAA—but don't remember), looked like it was toast.

GE's profitability had been strong for the last 20 or 25 years (with some moderately-sized issues along the way) and it is one of the few firms that consistently matched market expectations. I didn't know a huge chunk of its profits in the last decade was from their financial operations but even then, most of its assets were pretty solid.

When the commercial paper market locked up, only then did I learn that GE relied heavily on short-term debt. In any case, my impression was that GE's problems started after the fall of Lehman Brothers. Yet, after reading a summary from The Economist of Henry Paulson's latest book, “On The Brink: Inside the Race to Stop the Collapse of the Global Financial System,” it appears that GE started having problems long before the Lehman Brothers bankruptcy. There were rumours of problems but, until now, I didn't realize that GE was in such a bad state that it had to get the US government to support it, even before the really bad results from the Lehman Brothers bankruptcy materialized! GE is apparently denying Paulson's recollection of the events but my feeling is that Paulson is telling the truth here:

On September 8th that year, a week before Lehman Brothers filed for bankruptcy and triggered the market meltdown, “Jeff Immelt called to tell me that his company was having problems selling commercial paper. This stunned me,” writes Mr Paulson. “If GE couldn’t sell its paper, what did that mean for other US companies?” A week later, on the day of Lehman’s bankruptcy, the book says Mr Immelt stopped by the then treasury secretary’s office at 6pm, “following up on a phone call from the week before when, just after the takeovers of Fannie Mae and Freddie Mac, he’d mentioned that GE was having problems in the commercial-paper market. His report had alarmed me then.”

On October 12th, says Mr Paulson’s book, Mr Immelt voiced his support for a Treasury programme to guarantee bank debt that did not extend to GE, only to change his mind overnight, asking for the company to be included in the programme after all, because “I’m worried about my company and our ability to roll over paper in the face of this.”


Mega Brands places units into Chapter 15 bankruptcy

The only investment opportunity I have been researching lately is Mega Brands (TSX: MB). I'm still not clear on the merits of the company but am paying close attention to it. I never heard of Chapter 15 bankruptcy but apparently Mega Brands is placing some of its units into chapter 15. The Globe and Mail reports the following:

Toymaker Mega Brands Inc. and nine affiliate units have filed for Chapter 15 proceedings in a Delaware court.

The filing is a precautionary measure taken by non-U.S. companies that want to pre-empt creditors from filing lawsuits or tying up U.S. assets.

The move is part of the financially troubled Montreal-based company's recapitalization plan aimed at slashing almost $300-million of debt.

Also part of the previously announced restructuring is a plan to raise about $100-million through an equity issue and $121-million in a private placement.


Mega Brands said in a press release Friday that – so far – holders representing 72 per cent of the senior secured debt have agreed to support the proposed recapitalization. A special meeting of shareholders and secured debt holders has been scheduled for next month. Two-thirds majorities from shareholders and debtholders are required for the plan to go ahead.

On top of trying to understand the company and its industry, a key question, if I were to proceed with an investment, is to figure out a reasonable valuation. As one of the blog readers, Parker Bohn, once asked (I'm paraphrasing,) 'what makes one think that their valuation estimate is more correct than the professionals working on this case?' Unlike a typical stock purchase, this situation involves share issuance at prices below the current market price. If I went and purchased the shares, it would be above the deal that Mega Brand cut with its creditors and outside investors. I need to be sure about my valuation if I'm going to be buying it above the price of those (proposed) transactions.


US core CPI declines for the first time since 1982

Most of you probably saw this already but I think it may be important. As recently as three years ago, very few would have thought it was possible, but the core CPI in America actually declined in January. Like most events in the last couple of years, this was an unusual occurrence with it having occurred before in 1982—more than 25 years ago. Marketwatch provides some details:

With shelter costs dropping sharply, U.S. core consumer prices fell a seasonally adjusted 0.1% in January, the first measurable decline since 1982, the Labor Department estimated Friday.

Core prices, which exclude food and energy costs, are considered a good indicator of underlying inflationary pressures. In January, prices fell for hotel rooms, home ownership costs, new cars, airfares and clothing.

Overall, the consumer price index rose a seasonally adjusted 0.2% in January for the fifth straight month, the Bureau of Labor Statistics said. Higher energy and medical costs more than offset the largest decline in services prices since 1982. Read the full report on the BLS website.

Inflation was weaker than expected by economists surveyed by MarketWatch, who were forecasting a 0.3% increase in the overall CPI and a 0.1% gain in the core CPI

The overall CPI was up 0.2% but the core was down 0.1%. The decline was due to shelter-related components. IANAE, but like nearly all economists, I think core inflation is what matters. However, inflation is a lagging indicator so it is more of a test of one's past views than the future.

The decline is to be expected but the question is whether it will persist. Calculated Risk points out that 'owner's equivalent rent' is the biggest component of CPI and their expecation is for it to continue to decline. IMO there is also the possibility for commodity prices to decline as central banks shut off liquidity.

Wednesday, February 17, 2010 0 comments ++[ CLICK TO COMMENT ]++

China starting to unload some US debt

The amount in question is still small but I'm not sure if this is change of strategy or a short-term blip:

Foreign demand for U.S. government bonds and Treasury bills tumbled by the largest amount on record in December, according to monthly data from the U.S. Treasury Department. And China led the way, cutting its holdings by $34.2-billion (U.S.) and relinquishing its title as the world's largest holder of U.S. government debt to Japan.

In recent months, top Chinese officials have expressed growing unease about the ability of the United States to finance its swelling debt, without triggering a major devaluation of the dollar.

China has now cut its holdings of Treasuries by $45-billion over the past five months, or “a long enough period to hint strongly at a trend,” Alan Ruskin, chief international strategist at RBS Securities Inc., said in a research note.

And while China was pulling out of U.S. Treasuries, many other Asian countries were adding to their holdings. Japan boosted its Treasury investments to nearly $769-billion, up $11.6-billion. Hong Kong, a special administrative region of China, boosted its holdings by $6.7-billion to nearly $153-billion. Canada, Britain, Singapore, Thailand, and Australia also added to their holdings.

And overall foreign demand for U.S. long-term securities remains strong, with net purchases of $63.3-billion in December.

Although the buyers and sellers may change, the asset price hasn't moved much in over 6 months. The following chart plots the 10 Year US Treasury bond yield (note that bond yield is inversely related to bond price.) As one can see, the yield isn't as low as it was in early 2009 but it is nowhere near what it was in 2007 either. The current yield of 3.742% was roughly the average in 2008 (post-real-estate-bust but pre-Lehman.)

Monday, February 15, 2010 6 comments ++[ CLICK TO COMMENT ]++

Articles for a holiday Monday--at least in Ontario, Canada

Finally catching up on investment articles and here is a long list of items you may not have run across.

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Sunday, February 14, 2010 0 comments ++[ CLICK TO COMMENT ]++

Sunday Spectacle XXXXVII

(Graphic by The Economist, "Putting in money," February 12, 2010.)

Friday, February 12, 2010 10 comments ++[ CLICK TO COMMENT ]++

Central banks lag the market

A couple of days ago, Phil, a reader of this blog, left a comment challenging my view that a "central bank has far less control of the economy" than many assume. I want to present a view that is completely radical that it may alter your thinking. This blog might be the worst investment blog known to man ;) but hopefully I make you think (but do note that I can be wrong.) I didn't come up with the idea I'm about to present (I'm just repeating others' views) but it completely changed my thinking a few years ago. In fact, it altered my view so much that, these days, I don't believe a central bank can "save" an economy no more than it can "boost" the economy (in the long run.) None of this is to say the central bank is useless—indeed, it plays a very powerful role, as many Keynesians would suggest, when it acts as a lender of last resort (usually during wars or economic calamities)—but the vast majority of the time a central bank really doesn't control much.

Before I present the view, I should make some exceptions. Central banks are very powerful under totalitarian regimes. So none of this applies to them. In addition, what follows probably doesn't apply to central banks that do not follow "modern" (developed-world) economics or are based on some "primitive" economic systems. For instance, I am sure that none of what I say applies to the central bank of Afghanistan (assuming it even exists.)

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Berkshire Hathaway enters the S&P 500

Throughout his life, Warren Buffett has tried to isolate Berkshire Hathaway's stock from the daily swings in the market place. Like an ideal marriage or job contract, he wanted his shareholders to have a long-term focus. Buffett is also one of the few individuals who would rather have smaller investors own his company than the large institutional funds.

One of the main ways he has attempted to shield Berkshire Hathaway shares is to purposely avoid satifsying the requirements for entry into major indexes. In contrast, most executives and shareholders attempt to get their companies into major indexes. Entering an index provides greater visibility, improves prestige, and likely lowers the cost of capital. Berkshire Hathaway has been one of the largest publicly-listed companies in America for decades but never made it to the S&P 500.

Well, all that came to an end after trading today.

Berkshire Hathaway underwent a split, as part of its acquisition of Burlington Northern Santa Fe, that, finally, allowed it to meet S&P requirements for entry into the S&P 500. The history books will record Berkshire Hathaway as having entered the S&P 500 after close of trading on Friday. Not that it matters in the long run but it appears the market has given a thumbs down, with a (minor) sell-off Berkshire Hathaway shares—down 0.3%—during heavy after-hours trading.

Some might argue that Buffett had no choice and the entry into the S&P 500 was needed to complete the BNSF acquistion on good terms (Buffett apparently wanted to let everyone, including small shareholders, complete a tax-free transaction.) I personally don't share that view and believe that Buffett threw in the towel. This isn't necessarily a bad thing. Berkshire Hathaway was essentially Mr. Warren Buffett. When Buffett is not available to run the company, it will simply be another giant corporation, albeit with pretty good management culture.

I get the feeling that Warren Buffett is converting his company into a more mainstream company. Although I have always been critical of Warren Buffett at times (something Buffett followers never do,) I do think he is very honest and acts in the interests of shareholders he will never know or has any incentive to care about. Therefore, on top of his amazing performance, it is easy to see why many shareholders would be willing to invest their life savings with his company and take a long-term view. In the future, without Buffett, I suspect the loyalty will be difficult to maintain.

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Lennar enters the real estate asset management game

An obscure story but I thought it may be monumental. Lennar, a prominent homebuilder in America, has cut a deal with the FDIC to buy back some distressed loans. MarketWatch reports:

Lennar has positioned itself to benefit further from a real estate recovery through a distressed-land transaction with the FDIC to purchase a 40% stake in bank loans with a combined unpaid balance of about $3 billion.

Late Wednesday, the Miami-based company said it closed transactions with the FDIC to buy two portfolios of loans for $243 million.

Lennar subsidiary Rialto Capital Advisors will conduct the daily management and workout of the portfolios, the company said.

This wouldn't be much of a story except for two things.


European bank exposure to PIGS

You may be familiar with the mounting sovereign debt problems emnating from Greece in the last few weeks. Major european governments, led by Germany, are trying to hatch up a deal to avoid either a sell-off of the Euro and/or the disintegration of the EU bloc. There are various conflicting goals and I'm not sure what sort of deal will be cut. For instance, France has, in the past, indicated that they would prefer a weak Euro (likely to protect their manufacturing, tourism, fashion, and similar industries) so a mini "run" on the Euro is probably not a bad thing in their eyes. In contrast, several others have said they don't like a weakening Euro.

Regardless of national interests, I'm sure the EU members do not want its membership to disintegrate. The Euro, as a common currency, is probably facing its biggest threat since it was introduced. Bears like Jim Rogers have suggested in the past that the Euro will collapse and it can't be held together. It remains to be seen how the members handle this mounting crisis.

In any case, countries such as Germany are working out a deal to mitigate any potential debt crisis in Greece. Although seemingly altruistic, there is more to this story. Some of the biggest losers from any default would be the banks in countries like Germany. I ran across the following chart from Bloomberg, summarizing major European bank exposure to so-called PIGS (Portugal, Ireland, Greece, and Spain.) Some people also use the term PIIGS, which includes Italy.

The numbers aren't that large but, nevertheless, a million here and a million there, adds up. I'm guessing but I suspect the assets backing the claims shown on the chart are nowhere near as bad as the dubious real estate assets in America. So, the Greece situation is more of a political threat—calling into question the whole EU membership structure—rather than a financial crisis per se.

Sunday, February 7, 2010 4 comments ++[ CLICK TO COMMENT ]++

Some articles of interest

Here are some articles you may find insightful...

  • Japan = 1930's USA? (Greenbackd): This is a topic that has been beaten to death on this blog but the question still stands: are we looking at a once-in-100-years buying opportunity in Japan? At certain points over the last few years, as many as 50% of the listed companies have traded below book value, with quite a few below NCAV (most of them are microcaps and smallcaps though.) So is this a value investor's dream? Greenbackd references some work by Dylan Grice of Societe Generale tackling this issue. If you are interested in Japan, this post is worth checking out... As cheap as Japan seems, their companies are not shareholder-friendly. As Warren Buffett has said, Japanese companies weren't very good investments even when Japan Inc was taking over the world. They were market leaders, dominant, technologically advanced, with impressive financials, but they weren't very profitable for shareholders. The present is no different than the 80's and it is impossible for shareholders to improve their companies.
  • (Highly Recommended) Value investing-oriented videos (h/t IgnoreTheMarket at GuruFocus forums): A list of various videos from value investing superinvestors. I haven't seen all of them and don't remember them very well but there are some great ones that are listed here.
  • The "Netscape moment" for electric cars? (The Economist): Investors are willing to finance electric car development so are we on the cusp of a great revolution?
  • Potential European debt crisis (The Economist): A few years ago, there were many sovereign bond bears who thought some of the weaker European nations were going to face serious problems. Well, they have been wrong for several years but this year is not starting off well for some countries. Looming debt problems in Greece is starting to generate some ripple effects. I am most curious to see if the US$ rallies against all assets (including commodities) if some European nations run into problems.
  • (Recommended) China's financial system explained (The Economist): A good overview of who the power players are in the Chinese economy.
  • Jeremy Grantham January 2010 GMO Quarterly Letter (GMO; h/t IgnoreTheMarket): Jeremy Grantham provides a brief overview of the thinking at GMO. Possibly worth paying attention to are the 7-year asset return forecast and the lessons learned during the decade. When it comes to asset return forecasts, little seems to have changed from the earlier forecasts of last year. Grantham still pegs "US high-quality" as the most probable asset class to outperform (potential return of 6.8% real.) As I have noted before, do keep in mind that he also forecasts other US asset classes, such as US large-caps and US small-caps to post mediocre returns (less than 1.5% real.) If you go with his strategy, this means that US-focused investors really need to figure out the defintion of "high quality." Contrary to many others on the Street, GMO is forecasting lower returns for foreign markets (but these have higher standard deviation.) The only other asset class that comes anywhere near the forecast for US high-quality is managed timer, with an expected return of 6% real.
  • Alan Greenspan attempts to resurrect his reputation (Fortune): I'm not a fan of Alan Greenspan but I do respect him for admitting his mistakes. After taking some hits, he is now attempting to polish back his tarnished reputation. For what it's worth, I do not believe Greenspan is as responsible for many of the problems as many believe. The central bank has far less control of the economy, let alone manias and crashes, than many assume.
  • (Recommended) What happens if China's bubble pops? (Fortune): Interesting piece that tries to speculate on what happens if China's bubble pops. I'm kind of bearish but who knows if there is actually a bubble; still it's worth pondering what may happen. I kind of agree with some of the items mentioned in the article. For instance, any bust is unlikely to be like USA, or even Japan in 1990. Several key elements in China, particularly the whole banking system and the media, is tightly controlled by the government, so they will behave quite differently. As one of the analysts interviewed speculates, economic damage is likely to be managed but the really serious stuff is the political damage. This is also one of the few articles that speculates on the possibility of China dumping goods on the world's markets if it runs into problems. This is plausible given how China seems to have massive overcapacity in almost anything related to manufacturing.
  • Fifteen ways for retirees to slash spending (BusinessWeek): Not sure if any retirees read this blog—if you are, do not follow any of my risk investment suggestions!—but here is a basic checklist to control spending for those in, or approaching, retirement.
  • Henry Paulson's book, On the Brink - BusinessWeek review, Washington Post review, ABC News book excerpt, WSJ book excerpt: There are so many books about the financial crisis but this one, an inside account by Henry Paulson, is sure to be one of the most interesting ones. I probably won't get around to reading any book on the crisis for a few years but I like checking out reviews and excerpts.

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Sunday Spectacle XXXXVI

Source: Yuriko Nakao for Reuters (via Yahoo! News)

Tuesday, February 2, 2010 0 comments ++[ CLICK TO COMMENT ]++

American retail investors continue to shift their portfolio from stocks to bonds

Crazy week for me. I actually went down to a small town in Pennsylvania to buy a used car. Nothing fancy but I wanted a particular car with specific features and it looked like I could save a few thousand so I did it. The trip only took a few days but it felt like I had been gone for a month. I haven't gone on any vaction in several years so that's probably why. Anyway...

Retail investors in America have been shifting their portfolio towards bonds over the last couple years and a Scotia Capital analyst comments that cash held by mutual funds is at multi-decade lows:

...Strategist Hugo Ste-Marie is out with a report Monday that shows what’s known as the liquid asset ratio at U.S. mutual funds - that’s cash holdings in plain English - is at the lowest level seen in decades. Mr. Ste-Marie said that data is “signalling that equity portfolio mangers no longer have cash to redeploy. If new inflows don’t kick in soon, the equity rally will sputter.”

Scotia Capital also took a look at where American investors are putting their savings. Despite last year’s rally, retail investors are steering clear of stocks. Mr. Ste-Marie said: “U.S. equity mutual funds sales declined for a second year in 2009. Money continued to flow out of stock mutual funds last year as withdrawals reached $8.84-billion (U.S.), after the massive $234-billion outflow of 2008.”

“ Although equities performed well last year, retail investors continued to pour money into bond funds, which attracted almost $375-billion in net new cash flow,” said Scotia Capital. “From an asset mix perspective, equity funds account for 47 per cent of total U.S. mutual funds assets compared with 41 per cent in 2008 and a peak of 60 per cent in 2006.”
It looks like retail investors have stayed away from the stock market, all throughout the big rally over the last year. If this trend continues, this may signal a permanent change in retail investor sentiment. What was once thought of as a sure bet—stocks—may not be seen as such anymore.

The big question to me is whether pension funds will start shifting their asset mix as well. My view is that they have to. They hold too many illiquid and possibly risky assets—such asssets look great when times are good but are a disaster at other times (it's sort of like investing in microcaps.)