Articles to peruse - October 17th of 2010

Some articles I checked out over the last few weeks, that you may find worth reading...

• (Recommended) Strong bounce from the lost decade for stocks? (New York Times): One of the arguments made by long-term bulls is that the stock market will post strong returns over the next decade because the last decade was extremely poor. That mean reversion has actually been true throughout history. However, what is ignored by bulls is the fact that valuations now are still high and way above what prior averages. This is an excellent article that touches on why we may not see strong returns over the next decade. I concur with some of the analyst comments in the article and think that US stocks will probably post around 7% per year (nominal) going forward. This, as anyone who has studied compounding would know, is a massive difference from 10% per year that stocks haver returned over the last 80 or 90 years.
• (Recommended if macro-oriented) Timber investment primer (Advisor Perspectives): In this June 29, 2010 article, Charlie Curnow goes over investments in timber. I don't know much about timber and I would probably stay away from it given my knowledge of the problems faced by the forestry industry (housing bust, decline of newspapers, etc). Nevertheless, this is a good newbie article and I think it's worth reading it to understand the market so that we can contemplate an investment in the future.
• Charles Brandes on Benjamin Graham (Advisor Perspectives): Check out this interview with value investing money manager, Charles Brandes. There is a video version of the interview available here.
• The downsizing of Japan's ambitions (New York Times): This is the first in a series of articles from The New York Times, examining how Japan has coped with deflation. I find it interesting that some investors, such as Guy Spier of Aquamarine Capital, are bullish on Japanese equities. Japan has always been an enigma and a pardox—both on the way up and on the way down—and its future is as unpredictable as ever.
• Kyle Bass bearish on Japanese government bonds (Fortune): Kyle Bass of Hayman Advisors, whom I am not familiar with, is taking a bearish bet on Japanese bonds. Namely, it appears he is buying out-of-the-money call options on interest rates. The downside is capped and the upside is very large (you are looking at up to a hundread times the return on the upside versus a maximum -100% loss). This is similar to the investment being made by Hugh Hendry (I was writing a post about Hugh Hendry's thoughts from several months back but just couldn't get off the article. You might want to refer to Hugh Hendry's fundholder letter from early in the year too. Hendry is actually betting on corporate bonds but all yields are likely to rise together.) I think the interest rate call seems almost too easy. After all, are interest rates likely to rise from their present near-zero level in Japan (short-term rates near-zero while long-term rates are a few percent)? Or are they going to fall even lower? Obviously they can't fall much further (ignoring the possibility of the central bank setting rates at a negative rate, which, as far as I know, has only been a (Keynesian) theory and I don't believe any government has ever done it in history.) But as someone who respects the free market, all this begs the question: why is the free market pricing the interest rate options at such seemingly-low prices if rates are unlikely to fall much further below the current levels? In other words, who is on the opposite side of the trade? What are they thinking? It's something to ponder. Another item to keep in mind with bets like this is that the free market can adjust unsustainable economic scenarios using the currency exchange rate. As any deflationist can attest, if a country faces a debt crisis, it is quite possible for us to end up with a deflationary bust. Such outcomes are very rare under non-hard-currency environments—inflationary busts are more common—but it would not surprise me if Japan sees severe deflation, way beyond what they have experienced in the last few decades, if they face a debt crisis. In such a scenario, it would not shock me if the Yen appreciated significantly. You could easily get wiped out with currency losses even if your main thesis appears right. For example, many commodity bulls, who were generally bearish on the US$, got killed in the last few years because the US$ acutally appreciated even though USA was running a big current account deficit, its economy was contracting, and it was experiencing a massive real estate bust. I am speculating here but it is quite possible that what happens in Japan in the next 20 years may something radically different from anything the modern world has ever seen. Yes, such a statement cannot be proven but I just get the feeling that we are in for something new, and very different!
• (Recommended) A look at the bullish and bearish side of the China story (Institutional Investor): Even if you don't have much time to read this article, the last part is highly recommended for China followers: it covers both the bullish and bearish views of whether the financial institutions will be impacted if there a real estate bust. China followers may know that Chinese banks faced huge NPLs (non-performing loans) in the late 90's/early-2000's but they survived through that. The question is whether they can repeat if real estate cools.
• (Recommended) The state advances and private companies in China retreat? (Bloomberg Markets magazine): Is China Inc turning into Japan Inc? OK, I admit it's kind of silly to equate China Inc to Japan Inc, but nevertheless, investors who have looked at Japan's history (or even Korea to some extent) may see some parallels in what is happening in China. It appears that the Chinese government is bent on strengthening the power of SOEs (state-owned enterprises) in certain industries. In Japan, during the 1980's, what seemed like successful and powerful Japanese companies turned out to be companies with weak profits and run by government-influenced bureaucrats, more interested in keeping their jobs and placating to the leaders than in innovating or advancing their companies. A development where government-owned companies crush private companies such as Baidu (Internet services) or BYD (automobile & parts) is probably not a good for China in the long run. Some of the investors quoted in the story love investing in the SOEs but that's because these are state-backed monopolies or oligopolies. The country would obviously be worse off with monopolies and oligopolies running around.
• Gold vault demand increasing (The Globe & Mail): "With the global appetite for precious metals surging, along with the rise of exchange-traded funds that hold gold and silver bullion in reserve, demand for large, secure, vault space is on the rise around the world."
• Commodity bubble? (Fortune): Howard Penney of Hedgeye suggests we are witnessing a commodity bubble. I have been bearish on commodities for years but I don't think one can call the present situation a "bubble." Although some of the commodities he cites are trading at multi-year, or in some cases, multi-decade, highs, I don't think it is as big of a bubble as it was in 2008. The CRB index is still below what it was in late 2007 (while the US$ is roughly where it was in late 2007). I also don't think the FedRes policy is the one (mainly) driving the commodity prices. My view, as it was back in 2007 and 2008, is that the main driver is China. I would avoid all commodities (except maybe some beaten down ones like natural gas) from a contrarian point of view (i.e. the time to buy them was in early 2000's) but I don't necessarily feel that commodities need to collapse like in 2008. Having said all that, since I'm bearish on China and if China does slow down (say GDP growth gets cut from 9% to around 6%), commodities will fall like a rock—under such a scenario, it would make no sense for, say, copper to be trading near the 2008 levels when most of the developed world is in a slump-of-sorts.
• The Tea Party & American business (Bloomberg Businessweek): A lengthy article chornicling the unease some business owners have with the Tea Party movement. It'll be interesting to see what comes of all this. On the one hand, some of the ideas of the Tea Partiers will probably help America in the long run. In another sense, though, some of the wild ideas such as dismantling the Federal Reserve, Environmental Protection Agency, cutting taxes further and exacerbating the deficit, stricter immigration, tariffs on imports, etc will hurt America in the long run. The Tea Party movement, which started off very libertarian, has morphed into a paleo-conservative, reactionary, movement. It probably poses more problems for the Republican party than the Democrats at this point.
• King of American coal (Bloomberg Markets magazine): Coal is dirty and I'm not a fan of it but it is the cheapest energy source and powers a big chunk of America's electricity generation (it's also huge in China, which is one reason for the heavily polluted cities over there.) Chris Cline bet big on high-sulfur, dirty, coal and he became a billionaire.
• (Recommended) OldSchoolValue's Jae Jun being interviewed by the Kirk Report (Old School Value): A lengthy interview detailing Jae's history and his thoughts about investing.
• Nokia's new phone not earth-shattering (Bloomberg): I have been following Nokia a bit more closely lately and it seems their latest high-end phone is still behind the competition. This opinion piece is just one man's opinion but it still shows how far behind Nokia has fallen. The Nokia situation also shows why some Buffett-like value investors avoid new technology stocks. Although Nokia had been sleep-walking for a while now, all of its problems happened within a very short period of time. This is a good example of how a seemingly strong company (in 2005) could so easily lose its crown and run into problems within a few years. The way I look at it, they missed two product cycles and it ended up in significant loss of their high-end market share. Their decision not to compromise to wireless carriers, as is common in USA, is also a strategic decision that appears to have hurt them badly. Unlike some struggling players like Motorola or LG, who have been cutting workers due to weak cash flow, you can't give the same excuse for Nokia given its huge cash flow and high R&D spending.
• David Einhorn's short thesis for St Joe (VIC 2010; h/t GuruFocus): I'm not a Graham-type investor and don't really understand asset-oriented investments but it's always interesting when a successful investor takes a position against another successful one. In this case, David Einhorn of Greenlight Capital makes a bearish case for St. Joe Company (JOE), a Flordia real estate company. On the bullish side stands Bruce Berkowitz of Fairehomle Funds, owner of around 30% of the company.
• Bullish case for St. Joe (h/t http://www.gurufocus.com/news.php?id=109366#109688): Don't know anything about Broyhill Asset Management or their track record but they make a bullish case for St. Joe.
• Short sellers get caught up in the for-profit education vs non-profit education lawsuits (Fortune): Short-seller, Steve Eisman of Frontpoint Partners, gets caught up in the battle over for-profit education.
• (Recommended) Alice Shroeder 2008 speech about Warren Buffett (ValueWalk): I may have linked to this before but in case I didn't, I thought it was important to record it for future reference. An interesting speech from someone who probably knows more about Warren Buffett than almost any other public figure. Most importantly, unlike many others who come into contact with Warren Buffett, Alice Shroeder holds no punches back and is willing to be totally open (I haven't read her book, Snowball, yet but it appears to be interesting.)
• (not related to investing) Benoit Mandelbrot passes away (The New York Times): Famous for popularizing fractals, Mandelbrot passes away at the age of 85. From the story,

• "Dr. Mandelbrot traced his work on fractals to a question he first encountered as a young researcher: how long is the coast of Britain? The answer, he was surprised to discover, depends on how closely one looks. On a map an island may appear smooth, but zooming in will reveal jagged edges that add up to a longer coast. Zooming in further will reveal even more coastline. “Here is a question, a staple of grade-school geometry that, if you think about it, is impossible,” Dr. Mandelbrot told The New York Times earlier this year in an interview. “The length of the coastline, in a sense, is infinite.” "

• (not investing-related) Japan's micro-homes slideshow (Bloomberg Businessweek): Yikes... I don't think even a dog could fit in these homes ;)