Friday, December 30, 2016 0 comments

Jamie Dimon Interview with Economic Club of Washington DC (Sept 2016)

As always, David Rubenstein does a very good job with this interview of Jamie Dimon at the Economic Club of Washington, DC. Conducted in September 2016, it clearly illustrates why some consider Jamie Dimon to be a natural for politics (even though Dimon has said he isn't interested and doesn't think he will have much success in it). I don't think businesspeople are very good in politics--business is all about maximizing profits and doing anything including discriminating against customers, whereas politics is almost the opposite with the goal of satisfying all stakeholders and funding something for the very-long term irrespective of what "profits" may appear to be. But I think Dimon, unlike most bankers and wealthy individuals, has a very good understanding of society at large and what is happening at the street level--hence I think he can probably do a good job.

I neither follow nor know much about the financial services industry but from what little I have read, Dimon is probably one of the top bankers in the last few decades and maybe one of the top in the last century. He sort of  reminds me of a larger version of Ed Clark in Canada, CEO of the successful TD bank--someone who has a good feel for the retail and business customers of the bank, manages risk very well, and has created a lot of wealth for shareholders and employees.




I still think that Dimon underplays the role of banks in the financial crisis and the huge amounts of wealth transferred to the financial firms from other sectors of the economy and from citizens. Like almost all bankers, I feel like he blames regulations and government policy too much. The reason we ended up with so much regulation is precisely because of the huge debt problems. In fact, in this interview he downplays the potential problems in the banking sector in Europe and China. Dimon basically suggests that European banks would do better if regulators were easier on them, when in fact European banks have their problems due to their higher leverage (too much debt relative to American banks even pre-crisis) and the lack of a diversified economy from which wealth can be transferred to the financial sector. Similarly, Dimon suggests that Chinese banks have huge earning power, which is true but as shareholders, employees and customers of Bear Stearns and Lehman Brothers found out, small changes in assets can completely wipe out financial firms due to leverage (for those not familiar, financial firms have massive leverage compared to non-financial firms). I remain bearish on China and I don't see how the banks get out of this without big impairments.

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Monday, December 26, 2016 0 comments

Sunday Spectacle CCVI

December Christmas Shopping Declining?

In developed countries, shopping during December for Christmas, which is the largest and most important shopping period for retailers, has been declining. In most countries (except Italy and Japan below*), annual retail spending is higher than it was in the past--at a minimum, rising population and inflation results in higher spending over time--so it doesn't mean people shop less. The Economist posits several possible reasons for the December declines (from The Economist's Daily Chart, Dec 25 2016):
There are at least three explanations for the recent decline in holiday cheer. First, the growth of e-commerce has made it easier for consumers to shop for seasonal items year-round. Second, the rise of gift cards—which are not recorded as sales until they are redeemed by the recipient—has shifted holiday consumption into January or later. Finally, younger shoppers may be dragging down end-of-year sales at many traditional brick-and-mortar retailers. Surveys show that millennial consumers are eschewing “stuff” in favour of experiential gifts like travel and entertainment.

(source: "Holiday shoppers are not spending like they used to," Daily Chart, The Economist, December 25, 2016)



(* You could sort of tell the health of a country by looking at the trend in retail spending. If you had no other information and had to make a blind bet based on the charts above (right side), I would say Japan and Italy are going to be tough environments for investors, as well as workers and society in general. The fact that retail sales are same now as it was 2010 doesn't signal good things. In contrast, you can easily tell that USA and Britain, and to some degree Germany, have clearly trended up and businesses in these countries likely have an easier time... Having said that, elements not reflected in the charts do influence things: low inflation does make the situation a bit better than it seems (such as in Japan); and whether the retail sales are funded by unsustainable debt (possibly in USA and UK more so than Germany??) can present misleading figures. But I think the trend is more important than those two elements for these countries. Japan and Italy do seem way worse off.)


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Friday, December 23, 2016 0 comments

Jim Chanos on Donald Trump and Current Events

I ran across a very good interview with Jim Chanos by the Institute of New Economic Thinking that I found interesting (h/t Naked Capitalism). It is mostly about politics and very little to do with investing per se. I excerpted some of his points below but you should read the whole thing if you are interested in econopolitics. (As usual, bolds are by me.)

source: "Chanos: Is a big change underway in global capitalism?" by Lynn Parramore for the Institute for New Economic Thinking, Dec 21 2016.

Lynn Parramore: What about the rise in bank stocks since the election? Are banks anticipating deregulation?

Jim Chanos: Almost all stocks are going up, mostly because of the belief of lower taxation. But after Obama’s election, most stocks went down and kept going down until the following March — and then they tripled! So I wouldn’t read a lot into the first month or two.

It could be that banks are anticipating deregulation, but so what? Deregulated to what end? They’re still going to have the capital requirements, which are international. Putting capital standards on them is the biggest way in which they were regulated.

In the bigger picture, if you think this is an uncertain presidency and we’re not quite sure where he’s going and how events will conspire, it’s not that important to get too worked up because things will happen and you’ll have to react. If, however, this is a once-in-a-fifty-year change in global thoughts about capitalism, then you have to pay attention.

I think the rumour of lower corporate taxes, including the possibility of overseas repatriation tax holiday, certain plays a role in the rally. But I still don't understand how stocks can be rallying while bond yields are rising and US$ is rising. Corporate profits should go down if US$ rises (makes US companies less competitive and their overseas earnings are worth less) and rising bond yields is also generally negative (increases cost of debt financing and also, theoretically, the discount rate has risen and the value of the firm should decline).

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Tuesday, December 20, 2016 0 comments

Investors Podcast Audio Interview with Bill Miller

I thought Bill Miller retired but apparently not. I thought he wouldn't get a chance to try again but now that he is trying to get his firm going, it looks like he is spending his time on investing (hard to tell what his co-portfolio managers do and how he fits into the decisions). Anyway, I'm still a fan of him and it's always good to hear his thoughts.

One thing I like about him is that he is very frank and open; very honest. He speaks his mind and explains his processes and his stock picks. In contrast, there are numerous investors, including those such as Warren Buffett and Seth Klarman, who never give any details into their analysis and newbies like me can't really learn the basics from them (after a while, it all sounds repetitious and very philosophical--good to know but doesn't help you with securities analysis or the mechanics of investing). As I have said numerous times, I have not seen any value-oriented investor tackle technology companies as successfully as Bill Miller (here was my thoughts on him from 2011).

Investor's Podcast recently had a good audio interview with Bill Miller. If you are a fan of him, check it out. If you are contrarian, definitely check him out.

Original source here (click on embedded audio near the top). Alternate audio is embedded below via Stitcher.


As usual, Bill Miller is very optimistic--hence vulnerable to downturns--but it's good to hear his insights on technology stocks such as Amazon, Apple, and Tesla. A lot of growth investors and momentum investors invest in these companies for totally different reasons but value-oriented examination is very rare (although companies like Google are broadly owned by everyone these days and isn't what they were).

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Sunday, December 18, 2016 2 comments

Current Thoughts on Risk Arbitrage

I was writing a long post on risk arbitrage and how it seemed attractive but didn't finish it after things changed rapidly and got scary real fast after the Trump election. Spreads used to be somewhat large (5%+ for somewhat "safe" deals; right now spreads for similar deals appear to be around 1-2%)  and I believe spreads were attractive a few months ago due to:

  1. Peaking credit cycle/private equity/buyout/merger cycle: M&A is very cyclical and I had charts clearly illustrating how they peak (usually very close to stock market peaks). It seemed like we were getting close to a peak--sort of reminded me of 2007 when I was blogging and investing--with almost everyone buying each other for ridiculous prices, including numerous massive mergers/buyouts. Usually risk arbitrage appears to produce larger spreads (hence good for risk arbitrageurs) near the peak and it seemed like that time was now.
  2. Possible capital shortage for risk arbitrage: Merger spreads are usually very tight (1% of deals with moderate "risk" that are about to close within 6-12 months) because arbitrage funds and investors are always seeking out abnormally large spreads. Right now, due to the number of deals, including some mega-deals--basically deals you will see once in your life in those industries--there were some articles suggesting that there isn't enough risk arbitrage capital. I can't be certain but it seems plausible that capital may have been tight given numerous $15 billion+ mega-deals in the agrochemicals, pharmaceuticals, and technology industries were underway. Even if funds had capital, they would have been reluctant to allocate a lot to a few deals--risk arbitrage for professionals is based on entering a lot of deals and spreading out the risk, duration, etc.
  3. Underperformance by big risk arbitrage funds: Sort of tied into the prior point, it is possible that some blow-ups and severe underperformance by big risk arbitrage funds may have kept capital away from some attractive deals. John Paulson, who is famous for his short-selling of real estate but his expertise is really in risk arbitrage, was down something like 18% in his special situations fund (it deals with risk arbitrage as well as things like spinoffs but his losses appear to be mostly from risk arbitrage).
So, spreads seemed wider a few months ago. The election of Trump changed the landscape quite significantly and I would caution small investors pursuing risk arbitrage to be careful for a few reasons:
  1. Bond yields are rising rapidly: I think many expected yields to rise but the pace (without any adverse economic event i.e. no recession/no crash/etc) has been surprising  to me. Rising yields means companies are going to have a harder time financing deals. Those that entered deals may try to back out of them if the situation gets bad. Although not comparable to then but during the financial crisis, there were many companies that tried to back out of mergers. I think this risk is increasing by the minute and you need to be really careful.
  2. US$ is rising rapidly: Situation is different if you are American but if you are a foreigner, risk arbitrage becomes less attractive as US$ increases in value--assuming you don't hedge the currency. Except for a portion of my savings held in a US$ account, most of my investments are from C$ and unhedged. Given how risk arbitrage deals have very small returns (usually 5% to 10%), rising currency can wipe out most of your gains. Unlike when you own stocks for the long term, you won't get a chance to make it back since the deals close quickly (whereas currencies have very little impact for long-term investing).
  3. Incoming US government possibly taking hard stance against foreign investment: Although it is hard to read Trump--he says a different thing depending on who his audience is--I think the US government is going to be strict when it comes to foreign investment. I think many deals where foreign firms are buying US firms are very risky right now. I think you need to be careful with any deals that involve China. I am invested in the Syngenta buyout by ChemChina and I think the risk has increased that the US government will block that deal somehow (Syngenta is a Swiss company but does a lot of business in American agricultural states); similarly, I am not sure if the Bayer buyout of Monsanto will pass easily (Bayer is German but I think Trump administration is negative towards European companies as well).
  4. Potential stock market correction or crash: Impossible to predict a stock market correction but US stocks have been rallying with very little reason in my opinion. I see all sorts of conflicting signals (how could bond yields rise and stocks still go up? Wouldn't a strengthening US$ lead to lower US corporate earnings? so on) and until they are resolved, risk arbitrage seems riskier than usual. In theory, risk arbitrage is uncorrelated with the market. However, companies will try to weasel their way out of deals if things go wrong (this is what happened during the financial crisis; some will try to re-negotiate a lower price if the firm being acquired's stock falls; otherwise will try invoking MAC (material adverse clause) for all sorts of dubious reasons including deteriorating profitability of the firm being acquired; etc). I feel like the spreads need to be wider to get involved now.
As always, one should just watch and wait for the right opportunity. Right now, I'm not finding good risk arbitrage deals.

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Sold/Merger: Virgin America

The Virgin America-Alaska Airlines merger closed successfully and I was cashed out on December 16th. This is one of those deals that seemed like it had high chance of being completed but the return was low (unless you are a professional arbitrageur who uses leverage and has positions in numerous mergers at the same time). The spread was somewhat wider a month ago and I thought about increasing my stake but it seemed scary.

Sold/Merger Cash-out: US$72.00
Total Return: 5.37% (annualized: 54% (meaningless--too short of a holding period))

Good luck to all parties involved, especially the employees and customers who are impacted, and we will see if Alaska airlines can develop into a major national airline in the future (right now it is a west coast one).



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Sunday Spectacle CCV

History of American Retail Stores
(select sample)

(source: Internet Trends 2016 - Code Conference, Mary Meeker, KPCB. June 1 2016)

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Saturday, December 17, 2016 0 comments

Articles for the week ending December 16, 2016

Some stuff I found interesting... in no particular order...

  • (Recommended) "Napoleon Is Dead! Wait. That's a Stock-Market Scam." (Barry Ritholtz, Bloomberg, Dec 16 2016): Everyone has heard of fake news, which are more easily spread on the Internet, potentially having a political and social impact, but, believe it or not, it extends into the investing realm as well. Probably doesn't impact long-term investors that much but still something to watch out for. In fact, how many of you have heard of the fake-news-driven Great Stock Exchange Fraud of 1814?
  • "China Halts Trading in Key Bond Futures as Panicky Investors Sell Securities" (Yifan Xie and John Lyons, The Wall Street Journal, Dec 15 2016): Not a major story in itself but something to watch and see if it is a trend... There have been several stories in various media of emerging market bonds selling off (due to rising US$ and rising US interest rates). Some macro investors speculate that emerging markets will underperform and some may even face debt crises (especially those with US$-denominated bonds). The thing about China is that its currency is pegged (within a tight range) and capital is flowing out right now (government is trying to block that flow but having a hard time right now).
  • Tim Hortons/Burger King deal possibly hitting peak (Tara Lachapelle, Bloomberg, Dec 14 2016): Restaurants are definitely outside my circle of competence and they are always puzzling to me. I remember a lot of money being spent trying to integrate Tim Hortons and Wendy's a decade ago and it didn't really do too well (they split up eventually, although they still share some locations in Canada). Now 3G capital has been trying to generate synergies between Tim Hortons and Burger King and I wonder how it is going to pan out in the long run. They may be hitting a peak. For what it's worth, Tim Horton's is still very popular in Canada and very dominant (haven't seen any negative impact from their cost cuts).
  • "The Russian App That Has Destroyed Privacy Forever" (Bloomberg, Dec 6 2016): "Imagine a smartphone app that lets anyone take a picture of anyone and then find that person on social networks." I am generally pro-technology but stuff like this is definitely a bit scary and something few would have imagined 30 years ago. In any case, contrary to what is generally portrayed in science fiction, I think governments utilizing such technology are more of a threat than individuals or businesses. Like most things in life, I think humans will adapt if  things start getting out of control. For instance, Internet technology is way more secure now than when it first became popular (e.g. email used to be plain-text and easily intercepted and read by anyone but nowadays they are encrypted; credit card authentication used to be so simple (anyone could pay for things) but now transactions get rejected if they don't fit complex user profiles (someone using your credit card from a different country is generally blocked)).
  • (Recommended) "Hack Brief: Hackers Breach a Billion Yahoo Accounts. A Billion" (Lily Hay Newman, Wired, Dec 14 2016): The biggest hack in human history was just confirmed when Yahoo disclosed that a billion accounts were compromised (Yahoo apparently had 800 million monthly active users in 2013 so the number of individuals is probably closer to 800 million). An Internet Services company with such poor security raises a lot of serious questions. It's surprising Yahoo didn't focus on security given how it doesn't have meaningful tangible assets and almost the entire worth of the company is due to customer relationships and brand--it's sort of like a food products company not caring about food safety or product tampering. Management and Board of Directors are truly asleep. Rumour is that Verizon is re-thinking its Yahoo takeover given the potential long-term liabilities (adverse impact of losing email addresses, birthdates and phone numbers won't be known for years--since that information is also used to partially authenticate other non-Yahoo services (such as bank accounts, online shopping, etc)).
  • "The Inside Story of Apple's $14 Billion Tax Bill" (Gaspard Sebag, Dara Doyle, and Alex Webb, Bloomberg, Dec 16 2016): Detailed look at how Apple was avoiding taxes by routing them through Ireland. This is a problem and I think quite a number of companies are going to end up with big tax bills (mostly in the technology, biotechnology, and pharmaceuticals industries). This is a situation where what's legal and what's moral is wide apart. People like me who believe in taxes don't want anyone paying low taxes, whereas others who believe in low taxes believe anything legal is fine. Companies like Apple are probably doing what is legally ok (don't quote me on that; I'm not a lawyer) but highly questionable. It's somewhat akin to the argument of whether it is ok for individuals to be investing their assets through low-tax jurisdictions such as Bahamas, Cayman Islands, etc--clearly legal but questionable given that if everyone did that, there won't be enough taxes to pay for government services.
  • "Nokia’s next chapter" (McKinsey Quarterly, Dec 2016): I was close to investing in Nokia about 5 years ago but good thing I never pulled the trigger on that disaster. Interesting to see how things are evolving at the company after it exited the mobile phone business.
  • (Highly Recommended) "A Dozen Things Warren Buffett and Charlie Munger Learned From See’s Candies" (Tren Griffn, 25iq.com, Nov 25 2016): Very good blog post examining See's Candies. A good analysis of a company that doesn't really grow--quantity sold only doubled in 35 years--but has increased its sales significantly with very little additional capital. Unfortunately, unless you are smallcap or microcap investor, I don't think you will run into companies like this. Most companies have much higher unit growth, or have declining quantity; others who do grow very little in terms of output (say mature industries like food products) tend to require capex investment or are commodity businesses with no pricing power. The best Warren Buffett investment to examine in my opinion is Geico (or possibly American Express when he bought it in the 70's), or if you are not into financials then Washington Post (Buffett at his best and probably my favourite investment of his).

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Friday, December 16, 2016 0 comments

Warren Buffett & Bill Gates Video from 1998

Here is a good video of Warren Buffett & Bill Gates Q&A from University of Washington from 1998. It is a bit more tech-oriented and it's always interesting to hear younger Buffett and Gates. Given that Gates was running Microsoft at that time and Buffett is a value investor (who doesn't invest in technology stocks), it's good to hear the contrasting opinions on some issues.

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Wednesday, December 14, 2016 0 comments

Valuations Seem High... Market Looks Dangerous

If you are a value investor or a contrarian of any sort, it's a tough time to invest right now. I don't have much experience and was away from investing for about 5 years but I did start serious investing a few years before the financial crisis but it seems worse right now. It is really difficult right now to find anything attractive. Everything seems overvalued and the market is rallying unexpectedly (at least in my view).

I was going to write a post on market valuation but ran across an excellent article by John Mauldin that captures my feelings quite accurately so I'm going to quote his work below. I don't always agree with Mauldin and definitely don't share his right-leaning political views but this was a great piece. If you are macro-oriented, I would highly recommend that you read his article, "The Trump Rally Will Morph" (Dec 11 2016), which contains more graphs and thoughts than my post.

"The P/E ratio spent most of the last century between 10 and 25. The times it went below 10 correlate with market bottoms, i.e. “undervaluation,” while the times it spiked over 25 were “overvalued” manic tops.

You might think that the P/E would be a pretty good timing indicator. That’s true for very long periods. The problem is that P/E ratios can stay undervalued or overvalued for years. They can also go to extremes well below 10 and well above 25 and stay there for uncomfortably long spans. Keynes had it right when he said, “The market can stay irrational longer than you can stay solvent.”

Presently, all three P/E versions are near or above 25, indicating overvaluation. This doesn’t mean the end is near – though it could be. But it does suggest that we are not at the beginning of another long-term bull market. The next chart illustrates the past and present trend in a different way."
Mauldin is referring to the S&P 500 P/E ratio above, which has rarely been above 25. Right now it is around 25. The thing is, the P/E ratio has been high for most of the last 15 years so one can't be sure it won't go higher for many years.

Some people argue that the P/E ratio is high because bond yields are low. That certainly is playing a role but the relationship isn't very clear. For instance, bond yields were very low in the 1940's--somewhat akin to now, the FedRes was carrying out unusual activities; basically monetizing debt on a grand scale--but P/E ratios were nowhere near what we have now.

The Wall Street Journal provides a nice summary of the P/Es and dividend yields of the major US indexes and I look at that once in a while. This page also provides the forward-looking P/E which can be useful sometimes. Right now the forward P/E on S&P 500 is 18, which is a forecast of almost 30% higher earnings next year and seems unlikely. Typically the forward P/Es are unreliable.

The S&P 500 and NASDAQ P/Es are about 10% higher than last year, while the DJIA is about 20% higher and the DJTA is a little under 20% higher.

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Monday, December 12, 2016 0 comments

5-Year Industry Performance and My Ideas

Being a contrarian, I like to look at underperforming industries*. There are many different ways of approaching this but one simple method I use is to look at under-performing industries over 5 and 10 years.

If you are looking at 10-year underperformance, you need to be really careful with industries that are becoming obsolete and possibly on their way to a zero. Something like the newspaper industry is a good example of one that has done horribly over 10 years. Having said that, if you are into deep-value investing, distressed investing, or something along those lines, 10 year lows are a good place to look.

Given how the current bull market has lasted almost 8 years--2009 to almost 2017--I think 3 to 5 years is a good time period to look. Depending on what you are trying to do, you don't want to use starting points at the trough of a bear market or a peak of a bull market (for instance, I would avoid any period that started in 2008 or 2009).

In the past, I often looked at the 5-year top and bottom industry performers from the WSJ website. This uses the Dow Jones industry classification and I had no specific reason for using it other than the fact that it was freely available and detailed. You can use alternate indexes and time periods as you see fit. The data can be influenced by the starting point so you should just use this as a rough guide to what has risen and fallen. Here are the best & worst 5 year performers (figures are cumulative % return):


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Sunday, December 11, 2016 0 comments

Sunday Spectacle CCIV

Spending Trend over a Century


In rich countries like America, one of the big changes over the century has been the amount of money spent on food & clothing has declined significantly. In contrast, in many poor countries, the average person still spends a huge chunk of their income on food & clothing. The amount spent on housing/shelter has increased slightly in America to 25% (as of 2002, based on a select sample).

Overall, it's amazing that food, clothing and housing, which was about 80% of a typical household's budget in 1901 has declined to about 50% (in 2002 but probably same now). I don't think anyone living in 1900 could have imagined such a thing. The increased savings on food & clothing has generally gone to leisure activities (such as travel and entertainment). The big beneficiary in rich countries have been the leisure sector. Only the wealthy used to travel in the early 1900's but now almost anyone can.

From a business and investment perspective, one of the biggest opportunities in developing countries is the leisure sector. Industries such as airlines, tourism, media, and so forth will likely grow spectacularly.

For developed countries, I wonder what the future holds? Living in Canada, I feel like we are already "maxed out" on tangible "stuff." People just have too much of the basics. In contrast, healthcare is one area where developed countries are spending a fortune and I am almost certain we will spend less (as a % of total income) in 50 years than now. I also wonder what new societal developments await that we can't even imagine...


(source: "100 years of Family Spending in the US," Visualizing Economics, Dec 5 2013.)

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Sunday, December 4, 2016 0 comments

Sunday Spectacle CCIII

Bitcoin You Say?


Still not sure what to think of Bitcoin (for those not familiar, it is the original and most popular cryptocurrency). It has the potential to change financial transactions as we know it. Numerous authorities are against it and have been trying to regulate it for years. Some private investors are bullish--most notable are the Winklevoss twins from Facebook lore who suggest it is the gold for the modern age. Wall Street and some Main Street banks have been trying to get into the action. Matt Levine of Bloomberg, one of the top business journalists I have come across (that is freely accessible), isn't sold on the idea yet. Whatever it is, you definitely need stronger, more secure, and more professional Bitcoin financial institutions before the public will get involved to any large degree (the $400M+ loss at Mt Gox a few years ago probably set back Bitcoin by years--who the hell would want to get involved in such an amateurish operation (and that was the top Bitcoin exchange too)).

Bitcoin in US$
(source: Bitcoincharts.com. Downloaded Dec 3 2016.)

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Articles for Week Ending December 3, 2016

Not in any order, here are some articles I ran across recently that you may find interesting... I often link to old articles so if there are stock suggestions or macro speculations, pay attention to the date (thesis may have changed by now).

  • The Oscars of Paper Currency (James Tarmy for Bloomberg Businessweek, Dec 1, 2016): Didn't know some entity actually gave out award for best currency design. Kind of fun to see the artistic style of various currencies.
  • Horizon Kinetics presentation on indexation and ETF problems (Steven Bregman, Horizon Kinetics, for Grant's Fall 2016 Conference - Oct 4 2016): Pretty good presentation on some issues with ETFs and indexation. If you invest in ETFs, check it out.
  • Bear case presentation on Home Capital Group (Marc Cohodes for Grant's Fall 2016 Conference - Oct 4 2016): Bearish thesis on Canadian mortgage lender. If the Canadian housing market falls, HCG might be one of the first ones to get hit badly.
  • Contender for the worst trade of all time? Snowball interest rates swaps (Matt Levine for Bloomberg, Mar 7, 2016): I have been working my way through Matt Levine's articles on Bloomberg. He is one of the top financial journalists that is freely accessible, with his background and focus being legal issues. All of his articles are excellent and often presents some contrarian views on various corporate activities. You probably won't improve your investing by reading him but if you are interested in knowing how Wall Street operates, they are great reading. I don't agree with everything he says but he makes me think... The linked article refers to a swap deal that Portuguese train companies entered into with Banco Santander, a mega-European bank. The companies have lost $1.43 billion and decided to take legal action to get out of the trade. It's a fascinating look at the notion of risk and how improbable events can materialize and end up threatening your existence (incompetence also played a role but let's leave that aside for now). On top of the idiotic cumulative spread feature (where spreads are added to prior quarter's), what seems to have killed the company is the fact that Euribor floating rate dropped below 2% after the financial crisis whereas the companies probably assumed it never would (it has never been below 2% in its history). If you are a macro-oriented investor, you should always think about what happens at the extremes that seem impossible.
  • (Recommended) Underwriters and the IPO process (Matt Levine for Bloomberg, Nov 25, 2016): I didn't care so much for the article itself, but found this piece insightful in regards to the description of the whole IPO process. I certainly didn't know about the mechanics of 'stabilization' or how the underwriters are short the stock for a period of time. I would recommend reading the first 5 or 6 paragraphs to learn what happens in an IPO.
  • (Highly Recommended) "Michael Dell Bought His Company Too Cheaply" (Matt Levine for Bloomberg, Jun 1, 2016): Unlike the prior two Levine articles, this one is relevant to small investors. This article deals with the lawsuit against Michael Dell for his management buy-out of Dell, a large computer company famous for pioneering mail-order build-to-order computer sales. Some argued it was a take-under. I liked the almost-philosophical question raised about the true price or value of a company. I liked how the article provided some insight into how parties with differing interests approach things.
  • Subprime auto loan delinquencies rise (Rachel Beals for Marketwatch, Dec 3, 2016): Looks like subprime auto loans are starting to concern some. However, higher quality auto loans seem to be doing ok. Recent economic numbers indicate stronger employment and wages so it remains to be seen if this means anything.
  • "The 2016 Daily Journal Meetings Notes: February 10, 2016" (The Charlieton): Can't remember if I linked to this already but anyway, it is Charlie Munger at his greatest.
  • China's attempt at mass control via online tracking (Josh Chin and Gillian Wong for The Wall Street Journal, Nov 28, 2016): Although in the early stages and success uncertain, it's amazingly scary how close to Orwell's 1982 we are. China is attempting to build a social profile for each citizen (somewhat akin to a credit rating but for social activities) and to reward or penalize citizens based on their social profile. I wonder if, in a few decades, companies like Facebook and Google and their future counterparts, who have huge amounts of data on people, will succumb to their temptations and government strong-arming and enable such a thing to take place in the West--I really hope the people running these companies don't roll over every time the government tells them to. (article requires registration; can paste title in Google and click on link for free access)
  • Trump picks Bill Walton (Max Abelson for Bloomberg, Nov 29, 2016): Cited this in a prior post but amazing how Trump administration is surrounding itself with some shady characters. In this case, Bill Walton was the CEO of Allied Capital, the company profiled by David Einhorn in his book.
  • (Highly Recommended) "How Should We Read Investor Letters? Considering the correspondence between C.E.O.s and shareholders as a literary genre." (John Lanchester for The New Yorker, Sept 5, 2016; Book review of "Dear Chairman: Boardroom Battles and the Rise of Shareholder Activism"): Essay that looks at shareholder activist letters as an art form. The book "Dear Chairman..." looks interesting and I'm going to put it on my list of books to buy at some point.
  • "World Chess Has a Big Problem" (Carol Matlack for Bloomberg, Nov 28, 2016): Pretty good profile of the current state of the major chess federation, including some insight into the dark side it is entangled in.
  • (Recommended) "The Amazon Tax" (Stratechery, Mar 15, 2016): Ben Thompson talks about the toll-road-like web services business that Amazon is developing.

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Saturday, December 3, 2016 0 comments

Opinion: You Can't Build a Society with Flat Taxes

Libertarians, classic conservatives and many on the right* love flat taxes and always seem to be in favour of flat taxes but I have never seen it ever last. I thought I would comment on it after reading that Estonia has started to abandon its flat tax. Apparently the first country to introduce flat tax in Europe, Estonia is starting to back off the flat tax.

In my opinion, you just can't build a society with flat taxes. If anything, history seems to indicate that as societies advance, their taxes become more progressive.

The flat tax helped a lot of ex-Communist states after they gained independence when no one was paying taxes and the system was completely dysfunctional, but it is hard to build a society with such a system. Wealth grows exponentially and hence accrues to the top few disproportionately--most investors probably know that 80% of the American stock market is owned by around 10% of the population--and it's hard to do anything at the societal level if most of the wealth in society only pays a small amount of it in tax.

Having said that, what Estonia is doing to implement a progressive tax system is the wrong way to do it: it appears to be simply introducing credits. This just complicates the taxes and creates inefficient tax collection authority. Simplest is to have practically no credits (except possibly to those that society determines shouldn't be burdened (those with serious health issues, etc)) and just have an escalating rate based on income or something. Introducing credits is the dumb way to build a bullet-proof system. It is that way because lawyers are the ones who run politics but if it were up to a more rational person (ie. scientific-thinking), you wouldn't have so many credits and special clauses, with so many potential line items on a tax form.

I think the only time flat taxes make sense for a large society--it may be ok for small islands, city-states, etc--is if it is undeveloped/developing or the government is dysfunctional. It made sense for the ex-Communist states after the collapse of their societies, as Estonia was in the 90's. Similarly, I think it makes sense in most of Africa and South Asia. It will probably work better than what they have right now in countries like South Africa, Congo, India, Pakistan, and so forth. Countries with high tax avoidance and a general distrust of government, such as Greece, might be better off with a more flat tax as well.


To sum up, natural state of human affairs is probably towards more progressive tax as societies advance. Of course, I can't prove it and you can't disprove it, so humans will probably argue about the ideal taxation system for another hundread years.


(* Some on the right support flat taxes but not because they want a simple one-tax system or want to improve the efficiency of the tax system, but rather because they want to shrink the government. They will argue the opposite but the reality is that flat taxes result in less government tax income and consequently less government services. This will result in a smaller government in the long run. [I'm a typical liberal in that I support progressive taxes and "high taxes" but I do think governments are too big and should be shrunk. Governments should not be engaged in some activities they are presently involved in and spend a lot of money overseeing.])

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