Year-end 2010 has brought us to a particularly spirited rendition of the portfolio dressing, tax-loss selling histrionics that always seem to characterize December. We are having one heck of a Santa Claus Rally. It also brings us to what seems to have become seasonally affected hostilities over the appropriate expression of the holiday that is December 25. The god haters and various others of the vinegar-hearted persuasion want to tamp down if not snuff out the customary pleasantries that most of the rest of us enjoy. On the other side is that strain of Christians who insist that we all dial down the festivities and keep the focus on “the reason for the season.” I would like to suggest that both sides should back off and let the rest of us enjoy a festival that is deeply rooted in that foundational edifice we call Western Civilization. To the former, I would ask, what part of peace on earth and Goodwill to men (an admittedly dated expression signifying all of humanity, both in the abstract and in the often much more difficult to stomach particularity of the individuals who cross our paths and otherwise disrupt our selfish agendas) do you have a problem with? And to those Christians who insist on being heirs to the very caricature of the Puritans, described by one wit as “distressed by the very thought that somebody, somewhere might be enjoying himself”, I would suggest that you have 365 days per year to honor your Lord, but the rest of us only get to celebrate Christmas once a year. The Christ you say you want to share with everyone else has a compelling proposition all by Himself (“a new heart”, “Life, in full”). It doesn’t need to peddled at every possible opportunity.
It is hardly surprising that a culturally mandated festivity found its way on to the calendar on or about December 25. We all know about solstice, although perhaps the less we know about how some of our ancestors marked that occasion, the better off we might be. Even with all our modern comforts, especially those light bulbs that are about to be mandated out of existence, short, dim days, long nights, and inhospitable weather grow wearisome as the weeks grind by. Imagine not having anything but fire to light things up, and only a few folks having much of anything to burn. Now consider the effect of latitude on this condition, how far north so much of European West that defines our cultural heritage is located. Sunny Venice is as far north as Burlington, Vermont. That wellspring of western thought that was Edinburgh? Follow its latitude line far enough and it clips Alaska. Our ancestors knew about cold, dark and hungry for weeks at a time. They might have been illiterate, bellicose, superstitious, and intolerant of anyone not from the same clan or tribe (but then again, perhaps the weren’t. So much of what we call history is largely guesswork), but they weren’t stupid. The idea of a little communal gathering to fortify themselves against nature’s siege was not exactly rocket science (or even tin smithing!). So as far as we can tell, there has not been a time when people in the parts of the world that, thus far, have mattered most, have not had a celebration of some sort on or about what has come to be denoted as December 25.
And not just them. Where, save but redoubts of the most pathetic personality cults and ideological fads (e.g., North Korea) has the custom of making at least a little merry with Christmas not spread? Despite dogged efforts by generations of missionaries, not even 1% of Japan identifies as Christian, and yet it is not hard to find evidences of the celebration of Christmas in any of its major cities (and not just by the purveyors of consumer electronics). And wasn’t that Dubai, in the heart of the United Arab Emirates, that just set the record for the glitziest Christmas tree ever? Share a Bible and go to jail, but something about Christmas is larger than any faith, and they all want in on it. Christmas is something that everyone can have a piece of, if only in the same measure as folks in, say, Albany NY, might embrace Cinco de Mayo as an excuse to duck out of work early and go pound down some margaritas. With so much at work in the cosmos to divide and alienate people groups, right down to the very fallenness of the human condition, Christmas seems to be one thing pulls in the opposite direction.
I find that with each passing year, the very music of Christmas becomes an ever stronger tether across time, an antidote to that malaise triggered by tempus fugit and the tyranny of the immediate Now. In a world that at least seems to be more and more defined by constant change, there is solace in things that evoke permanence. Christmas music connects us not only with celebrants from generations past, but also with celebrations when we were the young ones instead of the older ones. This is a good thing, worth doing. This year, the meaning of Christmas, or at least a meaning that I think all “men of goodwill” could embrace, came to me in the words of a familiar carol. In “Oh, Holy Night”, we hear the words:
Long lay the world, in sin and error pining
Til He appeared and the soul felt its worth.
Now the meaning of words will be deepest for those who have experienced what it is to know Christ, the One who put the “holy” in “holiday”, but one need not take that step of faith to want to celebrate the legacy received as a result of this turn of events. Because, indeed, the world did lay in sin (in the Greek of Scripture, hamarteo, or “missing the mark” like an arrow flying off course) and error (something anyone who practices the craft of investing becomes painfully familiar with). And indeed pining, if we are to believe the Greek philosophers and their Roman proteges. 2010 years ago civilization, which is to say humanity having organized itself enough to have designated note-takers, had been around for a very long time, at least twenty times as long as the 234 years that our experiment in ordered liberty has endured. There was peace, but it was of the iron-healed, nail you to a tree if you piss us off variety: Pax Romana. It has been credibly observed that it was as if the project that was humanity had exhausted itself and rolled over in despair. (See G.K. Chesterton.) And yet somehow, in a most unexpected (prophesied, but only recognized much later) way, something Transcendent entered into humanity, and things were never the same. That this singularly influential person entered what we call Hi(s)story is a fact of record, no longer in dispute. A hundred years later, the changes wrought by His brief life were scarcely recognizable outside of a few enclaves, but a couple of hundred years after that, it had toppled the Roman order. Why? Because somehow, for the first time ever, “the soul felt it’s worth”, and the power of the Presence that makes this happen kept growing and growing. It would be many more centuries before this notion would crystalize into the idea that we are “endowed by their Creator with certain inalienable rights” (by what power, what sovereignty, could they possibly be deemed inalienable?). This idea, coupled with a few innovations like printing and ability to tap motive power from something besides wind, water or muscle, is what jarred the trajectory of what we like to call progress (or at least used to, before “progressive” got highjacked into a term antithetical to liberty) in way that rushed us to our present lofty, unspeakably prosperous heights.
Compared with even the most splendid aspects of all the interminable centuries leading up to the event we celebrate as Christmas, a great and growing portion of the world is an unimaginably free and prosperous place. And as if that were not enough, there is the reminder of blessings can emanate out of the most inexplicable circumstances. For this pivot point in human destiny was not on some grand stage (complete with tele-prompter). It was peasants, quite possibly teenaged and illiterate, enduring one of life’s most difficult to endure moments, in a stable, in a backwater town. We are told, in accounts whose reliability has withstood the tests of time and criticism, that there were evidences of divine activity on that night, but subsequent events indicate that these were quickly forgotten. In any case, after that night, humanity had a new hope, and things would never be the same. And for this, all of us, regardless of creed or with no creed at all, should be thankful. Our hearts should swell in merriment if we consider just how much this event has blessed us. And so I say, “Merry Christmas!”
Thursday, December 23, 2010
Friday, December 10, 2010
Ride the Tide
Texas this time of year swings between northerly blasts almost cold enough to freeze the pipes in the well house and flows off of the Gulf that have us right back in tee shirts and flip-flops, if only for an afternoon. Last week I jumped on a few days of benign weather and strong tides to enjoy the coastal flats. The Market’s anticipation of an intriguing political development (i.e., what appears to be compromise on taxes between the Administration and the Republicans, heralding paroxysms of dismay, disgust and debilitating skulduggery within the Democratic camp) was inflating my net worth in that exuberant sort of way that makes it kind of hard to buckle down and work (tax cuts as disincentive to work, oh my!) One result of this trip, besides a nice bag of sea trout filets, was a couple of reflections that I think have bearing on how we want to be invested as we enter the New Year.
The first of these would be a reminder that however grim the economy, as measured by the statistics we use to denote “normal”, there is still a tremendous amount of economic activity going on. There is a sense in which the patch of ground I covered, the drive through San Marcos, Seguin, Stockdale, Karnes City, Kenedy, Beeville, Skidmore, Ingleside and Aransas Pass is not particularly blessed, bleak. The soil is meager at best, though there are a few spots where wells or tanks indicate hydrocarbon deposits. The heat is oppressive for most of the year, drought is not infrequent and hurricane season is a “might have to get up and leave for a while” reality. Flora leans to species like pin oak and mesquite, fauna to things that bite or sting (or both!). Many of the towns seem to have outlived whatever motivated their settlement, though all but the dinkiest of them have a Dairy Queen siphoning a nonstop flow of $$$ into the pockets of the Sage of Omaha (the contribution margin on a $2.39 dipped cone? No wonder he bought it.) But when compared to the torpor of most of the vast sweep of human experience across time and rest of the globe, this patch of ground that so many just fly over and marvel at its emptiness, if they consider it at all, was throbbing with economic activity.
On the drive down, countless herds of cattle give way to vast flats that whose ideal crop appears to be sorghum. The oil wells and ancillary activities that support them seem a little more so ever time I make the trip, as do the wind farms. Along the coast, petrochemical plants like where Dupont makes what must be a very large share of the world’s refrigerant are lined with miles of railcars. Out on the water, I can see a steady stream of ships moving up and down the coast, and a more erratic procession of shrimp boats coming and going in their eponymous channel. The yards where offshore drilling equipment gets built stretch off towards Corpus as far as the eye can see. Towns like Aransas Pass, which in summer months are overrun with vacationers but then quickly empty out, are starting to fill up again with winter Texans, refugees seeking escape from the scraping of ice, the shoveling of snow and at least some of the ache and pains of advancing years. And all this co-exist with an amazingly resilient ecosystem. Whatever ecological damage was done here by the petrochemical industry is a thing of the distant past, now sanded, silted or barnacled over. Early one morning I was treated to velvety sound of geese winging just over head as I was unloading my kayak, the roar of 10,000+ ducks taking off at once as I was dragging said kayak across too-skinny-to-paddle flats a few hours later, and the startling blast of a porpoise’s blow hole, just a few feet astern, as I was making my way up the channel a few hours after that. The human sounds that day consisted of the highway until I was 1000 or so yards away, a passing power boat now and then, a steady stream of USN training aircraft making their way back to NAS Corpus Christi, and some occasional thundering clangs from miles-away ship (or rig) yards.
What I take away from all this is that however much that construct we call the economy is underperforming its estimated potential, however much collateral damage from the near death experience of Q4 08 still needs to be repaired, we are still a rich and vibrant economy. The heartland has not rolled over and died. Work is being done, resources are being extracted and rendered more valuable, and oh by the way, the ecosystem is getting healthier all the time. To open one’s senses up to all this, and then wonder how many other similarly empty-seeming slivers of our vast country are similarly blessed, is to make short work of disregarding the doomsayers who write and talk as if they never get out of the office or the studio.
The other takeaway from this intra-coastal adventure had to do with tides, ebbs and flows that are inexorable, somewhat predictable and can really effect the risks and rewards of one’s endeavors. The tides in this area are nowhere as strong as what I recollect from the littoral adventures of my youth some twenty degrees further north and now going on a half century ago. A swing of 30” low to high on this trip was unusually strong, on the last trip it was on the weak side at about 4”. Even when it is running strong, one has to look beneath the surface to notice it (unless one has neglected to anchor their boat before getting out, then it gets real obvious in a hurry. This happened to me a couple of years ago, with nearly fatal consequences.) A moment at a time, the tide barely makes its presence known, and yet it can be hugely important. It is usually what stirs up the food chain in ways that register as fish “biting”. Disregarded, it can be a real day-changer for power boat operators, especially at the speeds they seem to want to go. (Kayakers, too, as in the difference between paddling in 4” and dragging in 3” of water, especially if the bottom is muddy.)
Tuning into the the tide reminds one that ebbs and flows are very much a part of the created cosmos, and this extends into matters human as well. Markets ebb and flow. There seems to be a norm for the time we have data for (the last century or so) that the stock (liquid, proportionate representations of ownership) rise in value along with their underlying, aggregate value. Every 3-4 years or so (the variability being wrought by shocks like war) this upward trend is interrupted for (usually) a major fraction of a year in a corrective phase we call a Bear Market. Once a generation or so, a larger rhythm makes its presence felt. As if to reflect the departure or diminished influence of those who learned the harsh lessons of the last time around, this cleansing flood overruns it normal banks and chastens us all (see 1929-38, 1973-82, 2000-2009).
I suspect this is well understood by many investors, at least those who have studied the craft seriously and practiced it for more than a few turns of the four-or-so year cycle. But pondering tides (a subset of the challenge of cracking the code on the elusive redfish) got me thinking about another phenomenon that has vexed investors in recent years: the pathetic underperformance, relative not just to other asset classes but to the commercial performance of the enterprises they represent, of so many large cap stocks. This has been well remarked on now for going on a half a decade. As I was experiencing how lunar pull causes huge quantities of water to slosh around the Gulf of Mexico and intricately varied basins and channels that make up the coastal bend of Texas, it got me thinking about other kinds of flows. How when an awful lot of something flows in a closed system for a very long time and then starts to flow the other way, it will probably run for a very long time. So it was with stocks like INTC or MSFT. How many years did they spend getting over-owned by what old time chart or tape followers called “weak hands” (e.g., no-brainer portfolio fill, generic index funds held simply to “own domestic equities”)? These are but two stocks that represent companies that have performed more than credibly over the past decade, have unsurpassed financial flexibility and solid, at least moderate, growth prospects, and yet as stocks they have become “dogs” (no offense to our canine friends).
What I think has been missing from the discussion of this enigma (a discussion usually couched in terms of the brighter prospects of other enterprises who all but certainly are in need of investment bank services) is a very basic principle of stock price appreciation: Stocks don’t go up simply as a function of how ardently investors want to buy them. It also matters how readily owners will come forward and meet that demand. Reasons to sell are much more extensive and quite often much less well considered (e.g., inherited, change of account manager, simple impatience). Every stock that trades is a use of funds for some and a source of funds for others. The trouble with stocks like INTC or MSFT is that the result of spending nearly two decades to achieve “must own” status among a vast array of investors made them widely owned sources of funds for a considerable period thereafter. This disappointment was not obvious right away. They traded down in quite reasonable fashion when the Tech Bubble burst. It was once the recovery commenced, and not-particularly astute investors who had been conditioned to think of them as “sure things” started underperforming in them that the “source of funds” designation became the proverbial immovable object. It may have been specific to the stock itself (“Sell the INTC”) or a function of the dumping of generic index funds to buy something a little more au courant, but in any case it aggregated into a seemingly bottomless well of supply to meet whatever demand there has been for these stocks.
The good news here is that no tide runs forever. This one, this undoing of the biggest “must owns” circa December 1999, is probably about down to its lees. I strongly suspect that Intel’s protracted hiatus in share repurchase activity, just recently ended, was less about economic uncertainty (at least after the first few months) than it was about facing up to this reality. I am also strongly suspecting that as long as the economy doesn’t get blindsided, many of these gone-nowhere-forever big caps are going to surprise. With the “weak hands” mostly gone, the supply will no longer soak up demand so easily. This will register as indications of price momentum, which will trigger the usual self-perpetuating consequences. The no way to predict exactly when this tide turns (actually it does so one stock at a time) or how long or how high it will go. But just as a huge flood (1982-99) set the stage for this excruciatingly protracted ebb tide that has run for going on eleven years, its consequences will surprise all of us, frustrate those who ignore it and exasperate, if not destroy, those who are foolish enough to fight it. Fish On!
The first of these would be a reminder that however grim the economy, as measured by the statistics we use to denote “normal”, there is still a tremendous amount of economic activity going on. There is a sense in which the patch of ground I covered, the drive through San Marcos, Seguin, Stockdale, Karnes City, Kenedy, Beeville, Skidmore, Ingleside and Aransas Pass is not particularly blessed, bleak. The soil is meager at best, though there are a few spots where wells or tanks indicate hydrocarbon deposits. The heat is oppressive for most of the year, drought is not infrequent and hurricane season is a “might have to get up and leave for a while” reality. Flora leans to species like pin oak and mesquite, fauna to things that bite or sting (or both!). Many of the towns seem to have outlived whatever motivated their settlement, though all but the dinkiest of them have a Dairy Queen siphoning a nonstop flow of $$$ into the pockets of the Sage of Omaha (the contribution margin on a $2.39 dipped cone? No wonder he bought it.) But when compared to the torpor of most of the vast sweep of human experience across time and rest of the globe, this patch of ground that so many just fly over and marvel at its emptiness, if they consider it at all, was throbbing with economic activity.
On the drive down, countless herds of cattle give way to vast flats that whose ideal crop appears to be sorghum. The oil wells and ancillary activities that support them seem a little more so ever time I make the trip, as do the wind farms. Along the coast, petrochemical plants like where Dupont makes what must be a very large share of the world’s refrigerant are lined with miles of railcars. Out on the water, I can see a steady stream of ships moving up and down the coast, and a more erratic procession of shrimp boats coming and going in their eponymous channel. The yards where offshore drilling equipment gets built stretch off towards Corpus as far as the eye can see. Towns like Aransas Pass, which in summer months are overrun with vacationers but then quickly empty out, are starting to fill up again with winter Texans, refugees seeking escape from the scraping of ice, the shoveling of snow and at least some of the ache and pains of advancing years. And all this co-exist with an amazingly resilient ecosystem. Whatever ecological damage was done here by the petrochemical industry is a thing of the distant past, now sanded, silted or barnacled over. Early one morning I was treated to velvety sound of geese winging just over head as I was unloading my kayak, the roar of 10,000+ ducks taking off at once as I was dragging said kayak across too-skinny-to-paddle flats a few hours later, and the startling blast of a porpoise’s blow hole, just a few feet astern, as I was making my way up the channel a few hours after that. The human sounds that day consisted of the highway until I was 1000 or so yards away, a passing power boat now and then, a steady stream of USN training aircraft making their way back to NAS Corpus Christi, and some occasional thundering clangs from miles-away ship (or rig) yards.
What I take away from all this is that however much that construct we call the economy is underperforming its estimated potential, however much collateral damage from the near death experience of Q4 08 still needs to be repaired, we are still a rich and vibrant economy. The heartland has not rolled over and died. Work is being done, resources are being extracted and rendered more valuable, and oh by the way, the ecosystem is getting healthier all the time. To open one’s senses up to all this, and then wonder how many other similarly empty-seeming slivers of our vast country are similarly blessed, is to make short work of disregarding the doomsayers who write and talk as if they never get out of the office or the studio.
The other takeaway from this intra-coastal adventure had to do with tides, ebbs and flows that are inexorable, somewhat predictable and can really effect the risks and rewards of one’s endeavors. The tides in this area are nowhere as strong as what I recollect from the littoral adventures of my youth some twenty degrees further north and now going on a half century ago. A swing of 30” low to high on this trip was unusually strong, on the last trip it was on the weak side at about 4”. Even when it is running strong, one has to look beneath the surface to notice it (unless one has neglected to anchor their boat before getting out, then it gets real obvious in a hurry. This happened to me a couple of years ago, with nearly fatal consequences.) A moment at a time, the tide barely makes its presence known, and yet it can be hugely important. It is usually what stirs up the food chain in ways that register as fish “biting”. Disregarded, it can be a real day-changer for power boat operators, especially at the speeds they seem to want to go. (Kayakers, too, as in the difference between paddling in 4” and dragging in 3” of water, especially if the bottom is muddy.)
Tuning into the the tide reminds one that ebbs and flows are very much a part of the created cosmos, and this extends into matters human as well. Markets ebb and flow. There seems to be a norm for the time we have data for (the last century or so) that the stock (liquid, proportionate representations of ownership) rise in value along with their underlying, aggregate value. Every 3-4 years or so (the variability being wrought by shocks like war) this upward trend is interrupted for (usually) a major fraction of a year in a corrective phase we call a Bear Market. Once a generation or so, a larger rhythm makes its presence felt. As if to reflect the departure or diminished influence of those who learned the harsh lessons of the last time around, this cleansing flood overruns it normal banks and chastens us all (see 1929-38, 1973-82, 2000-2009).
I suspect this is well understood by many investors, at least those who have studied the craft seriously and practiced it for more than a few turns of the four-or-so year cycle. But pondering tides (a subset of the challenge of cracking the code on the elusive redfish) got me thinking about another phenomenon that has vexed investors in recent years: the pathetic underperformance, relative not just to other asset classes but to the commercial performance of the enterprises they represent, of so many large cap stocks. This has been well remarked on now for going on a half a decade. As I was experiencing how lunar pull causes huge quantities of water to slosh around the Gulf of Mexico and intricately varied basins and channels that make up the coastal bend of Texas, it got me thinking about other kinds of flows. How when an awful lot of something flows in a closed system for a very long time and then starts to flow the other way, it will probably run for a very long time. So it was with stocks like INTC or MSFT. How many years did they spend getting over-owned by what old time chart or tape followers called “weak hands” (e.g., no-brainer portfolio fill, generic index funds held simply to “own domestic equities”)? These are but two stocks that represent companies that have performed more than credibly over the past decade, have unsurpassed financial flexibility and solid, at least moderate, growth prospects, and yet as stocks they have become “dogs” (no offense to our canine friends).
What I think has been missing from the discussion of this enigma (a discussion usually couched in terms of the brighter prospects of other enterprises who all but certainly are in need of investment bank services) is a very basic principle of stock price appreciation: Stocks don’t go up simply as a function of how ardently investors want to buy them. It also matters how readily owners will come forward and meet that demand. Reasons to sell are much more extensive and quite often much less well considered (e.g., inherited, change of account manager, simple impatience). Every stock that trades is a use of funds for some and a source of funds for others. The trouble with stocks like INTC or MSFT is that the result of spending nearly two decades to achieve “must own” status among a vast array of investors made them widely owned sources of funds for a considerable period thereafter. This disappointment was not obvious right away. They traded down in quite reasonable fashion when the Tech Bubble burst. It was once the recovery commenced, and not-particularly astute investors who had been conditioned to think of them as “sure things” started underperforming in them that the “source of funds” designation became the proverbial immovable object. It may have been specific to the stock itself (“Sell the INTC”) or a function of the dumping of generic index funds to buy something a little more au courant, but in any case it aggregated into a seemingly bottomless well of supply to meet whatever demand there has been for these stocks.
The good news here is that no tide runs forever. This one, this undoing of the biggest “must owns” circa December 1999, is probably about down to its lees. I strongly suspect that Intel’s protracted hiatus in share repurchase activity, just recently ended, was less about economic uncertainty (at least after the first few months) than it was about facing up to this reality. I am also strongly suspecting that as long as the economy doesn’t get blindsided, many of these gone-nowhere-forever big caps are going to surprise. With the “weak hands” mostly gone, the supply will no longer soak up demand so easily. This will register as indications of price momentum, which will trigger the usual self-perpetuating consequences. The no way to predict exactly when this tide turns (actually it does so one stock at a time) or how long or how high it will go. But just as a huge flood (1982-99) set the stage for this excruciatingly protracted ebb tide that has run for going on eleven years, its consequences will surprise all of us, frustrate those who ignore it and exasperate, if not destroy, those who are foolish enough to fight it. Fish On!
Tuesday, November 23, 2010
More Than a Little Thankful This Year
This edition of Musings finds us at the onset of the holiday season that begins with Thanksgiving Day taking stock of our manifold blessings. After all, there are life-enhancing and occasionally palliative effects to be had from having an “attitude of gratitude”. And even if this should be a more or less daily habit, having a holiday designated to focus us in that direction, and so near the end the year no less, is not a bad idea. So I have come up with a list, over and above the usual items that come to mind each year, that pertain to this oh so quickly used up year.
Yes, I am thankful not only that I was born in what is all but certainly the greatest country ever, but have lived a life that has enabled me to see so much of it. My life’s work made it possible for me to be able to visit nearly all fifty states, usually in a rental car down highways and by-ways rarely traveled by tourists. It is a vastly sprawling, intricately marvelous place. The “going out and meeting real people who do real work”, tapping into the passions of not a few of the individuals out there who make material progress possible, was perhaps the best part of my long working life. That said, based on what I am reading, I am glad I am not traveling as much as I used to. If what we are reading about recent “enhancements” to airport security is reasonable accurate, the allure of such adventure has been seriously diminished. To be honest, I was not particularly vexed with the security regimen as implemented post 9/11. While the phony posturing to avoid the appearance of profiling has been annoying, how bad was it to take off one’s shoes and belt and otherwise add about ten minutes to an hours-long journey that for most of human existence would have been fraught with danger and taken days if not weeks, if it were possible at all? But now it appears that even though the terrorists have, in 9+ years since the incident that finally got our attention, managed to successfully target an aircraft exactly, umm, not even once, we have take it up a level. This latest spasm of mindless risk aversion is not how you wear down a determined foe. It is more like how a brand new public employees union asserts its place at the trough. We should all be thankful come Thanksgiving 2011 if Congressional oversight reels these clowns in, and re-directs what passes for a war of terrorism (just because the Administration won’t refer to it as such doesn’t mean that isn’t what it is.) in more efficacious directions.
And speaking of Congress, this was a year to be thankful that however corrupt it often seems, the electoral process can still send clear signals of voter discontent. Indeed, for as long as any of us can remember, the invulnerability of Congressional incumbency has been one of those noxious things that everyone laments and no one expects to ever change. Not so much in 2010! With the dismemberment of “news” oligopolies, this diminished security for incumbents looks to be a durable trend. We should be profoundly thankful that the “system” has once again proven to be not nearly as corrupted as we have been tempted to believe. Of course, gerrymandering and set-asides being what they are, there will probably be at least 100 of the 435 seats that even a corpse could keep. We should not be surprised to see the Progressive Caucus as a percent of Congress continue to approximate the just under 20% of voters who self-identify as Liberal. The Red/Blue map should remain about the same, with red taking up far more space but blue holding onto its enclaves of dependency large and small. (Blue seems to dominate where water transport or power once provided economic advantage and so established the sort of quasi-feudal power structures that can hang on by cultivating a culture of dependency.)
This consideration of the national map brings us to an item that I am each year even more thankful for, that I was able to exit the “happening place 150 years ago but its been downhill ever since” that was the Hudson Valley and move to the great Republic of Texas. There are very good reasons, having nothing to do with oil wells, that Texas, which is really like a whole country, has held up much better than so much of the rest of the country these past few years. It also doesn’t hurt that November can be denoted by picking the last of the melons, planting cool weather crops and taking my grandson swimming in the river. However, thinking about how good we have it here in Texas gets me thinking nervously of evolving notions of federalism. I find myself suddenly sympathetic towards Germany, another State that has gotten things relatively right and finds itself digging deep to have to bail out the likes of Greece and now Ireland (a not so long ago bucolic land now badly debauched by a dozen or so wise-guys). Who the heck knows how long California can live of Revenue Anticipation Notes? It is not hard to see traditional notions of federalism being strained as the 45 or so most responsible states get dragged into the role of enablers of the five or so most profligate. We should be very thankful at some future Thanksgiving if the new Congress manages to shape our federalism in ways that minimize the degree to which the rest of us have to share in consequences of perpetually-adolescent fiscal behavior.
As I shift my focus to the recent “commoditization” of the Markets, I find myself intensely grateful that I am not one of the poor saps who have to manage sourcing for the world’s sweatshop we call China. It has never been easy to manage the planning and acquisition of material inputs to support even moderate growth. The problem for China is not so much the rapidity of its growth, much of which is coming from the inclusion of activities that didn’t get counted or simply didn’t happen in the subsistence portions of the economy (e.g., basic hygiene, light bulbs and the electricity they use). What is really making it tough for the folks who have to keep the factories going and the trucks running is the recent emergence of such vast pools of risk capital that by virtue of instantaneous communications and computing power stand ready, willing and able to jump onto or off of anything their algorithms tell them might be a trend. In light of how much this “speculative interest” seemed to aggravate things the last time the global economy boomed and then hit a bump, this should concern us all. For all the song and dance around “financial reform”, the power of the algo to vex purchasing managers, jazz the price of tortillas in Mexico and otherwise unleash torrents of unintended consequences seems to have been unaffected by our collective near death experience of 2008. That so many asset classes are correlating so tightly has not gone unnoticed, but the price we all seem to pay (as consumers and participants in the “real” economy) when the tail that is speculative interest starts to wag the dog that is the economy seems to have been quickly forgotten. I’ve got a hunch that if the bets I currently have on, mostly around Web 2.0 and the aerospace cycle, do not live up to my expectations it will have had something to do with the increasingly difficult task of acquiring commodities for actual use in production.
That said, however disruptive market forces can be when they get out of hand, we should be thankful indeed that the animal spirits that drive the dance between price and value are alive and well. How alive and well was amply demonstrated this past week by the reception accorded the IPO of Government Motors. It was kind of fun to watch, if one was willing to let one’s cynicism off its leash. The bankers and the publicists all played their parts and yet despite some very ominous references along the lines of “lack of internal financial controls” and a going on eleven year experience with equities that you would think would produce distaste if not revulsion, the public waddled up to the trough and dug in. This “fear of missing out on something” is elemental to the human condition, never really going away but more or less evident as “herd” factors ebb and flow. It bolsters my sense that a decade past when the last Tech Bubble popped, we are in the early stages of yet another silly season for Tech (buzzwords: apps, cloud, advertising).
That animal spirits short circuit what would otherwise be powerful forces of informational efficiency is what makes it possible for adept investors to buy low and sell high, and for this we need to be grateful. It’s like thanking God for the sun and rain and the turn of the seasons, and so much else so easily taken for granted. Sure, that (hopefully) once-in-a-generation stampede of roughly two years ago put me in a seemingly precarious place. (When I got blown out of a job much earlier in life, I took consolation that “at least I wasn’t one of those 55 year olds!”) Despite the untimely loss of what I had thought would be the last job I would ever need and the severe erosion inflicted on retirement accounts that were pretty much 100% in equities, it wasn’t the end of the world. Indeed, the freedom of action made possible by said job loss allowed me to make a few decisions that have since made our financial situation better than ever. A major element of this would be the subject of the last subject of gratitude I will mention before I head off into holiday mode, one of those lessons in investor mental hygiene that need to be occasionally re-learned. To wit, not getting too caught up trying to buy at the exact bottom or sell at the exact top, and not beating oneself up for being what only feels like being way too early (as long as one has kept some buying power in reserve). This was driven home by one of my stocks getting a takeover bid this past week. I have followed Ladish Corp. (LDSH) for a very long time and felt fairly confident paying $13+ back in early 2009 that unless the world really was coming unglued, it was worth a lot more than that. I had the opportunity to buy more at around $10. By time I was adding even more at about $7.50, I was feeling at least a little chastened about the impulsive initial buy and second guessing myself. Fast forward about eighteen months, and a bid valued at about $48 from long time supplier Allegheny Technologies (ATI -$50) makes all that self recriminating agita about markedly less than perfect execution seem silly. Especially considering that half of the consideration that is ATI stock is likely to at least double in value over the next few years, in my estimation.
So many things to be thankful for, but who’s counting? Having a happy holiday.
Yes, I am thankful not only that I was born in what is all but certainly the greatest country ever, but have lived a life that has enabled me to see so much of it. My life’s work made it possible for me to be able to visit nearly all fifty states, usually in a rental car down highways and by-ways rarely traveled by tourists. It is a vastly sprawling, intricately marvelous place. The “going out and meeting real people who do real work”, tapping into the passions of not a few of the individuals out there who make material progress possible, was perhaps the best part of my long working life. That said, based on what I am reading, I am glad I am not traveling as much as I used to. If what we are reading about recent “enhancements” to airport security is reasonable accurate, the allure of such adventure has been seriously diminished. To be honest, I was not particularly vexed with the security regimen as implemented post 9/11. While the phony posturing to avoid the appearance of profiling has been annoying, how bad was it to take off one’s shoes and belt and otherwise add about ten minutes to an hours-long journey that for most of human existence would have been fraught with danger and taken days if not weeks, if it were possible at all? But now it appears that even though the terrorists have, in 9+ years since the incident that finally got our attention, managed to successfully target an aircraft exactly, umm, not even once, we have take it up a level. This latest spasm of mindless risk aversion is not how you wear down a determined foe. It is more like how a brand new public employees union asserts its place at the trough. We should all be thankful come Thanksgiving 2011 if Congressional oversight reels these clowns in, and re-directs what passes for a war of terrorism (just because the Administration won’t refer to it as such doesn’t mean that isn’t what it is.) in more efficacious directions.
And speaking of Congress, this was a year to be thankful that however corrupt it often seems, the electoral process can still send clear signals of voter discontent. Indeed, for as long as any of us can remember, the invulnerability of Congressional incumbency has been one of those noxious things that everyone laments and no one expects to ever change. Not so much in 2010! With the dismemberment of “news” oligopolies, this diminished security for incumbents looks to be a durable trend. We should be profoundly thankful that the “system” has once again proven to be not nearly as corrupted as we have been tempted to believe. Of course, gerrymandering and set-asides being what they are, there will probably be at least 100 of the 435 seats that even a corpse could keep. We should not be surprised to see the Progressive Caucus as a percent of Congress continue to approximate the just under 20% of voters who self-identify as Liberal. The Red/Blue map should remain about the same, with red taking up far more space but blue holding onto its enclaves of dependency large and small. (Blue seems to dominate where water transport or power once provided economic advantage and so established the sort of quasi-feudal power structures that can hang on by cultivating a culture of dependency.)
This consideration of the national map brings us to an item that I am each year even more thankful for, that I was able to exit the “happening place 150 years ago but its been downhill ever since” that was the Hudson Valley and move to the great Republic of Texas. There are very good reasons, having nothing to do with oil wells, that Texas, which is really like a whole country, has held up much better than so much of the rest of the country these past few years. It also doesn’t hurt that November can be denoted by picking the last of the melons, planting cool weather crops and taking my grandson swimming in the river. However, thinking about how good we have it here in Texas gets me thinking nervously of evolving notions of federalism. I find myself suddenly sympathetic towards Germany, another State that has gotten things relatively right and finds itself digging deep to have to bail out the likes of Greece and now Ireland (a not so long ago bucolic land now badly debauched by a dozen or so wise-guys). Who the heck knows how long California can live of Revenue Anticipation Notes? It is not hard to see traditional notions of federalism being strained as the 45 or so most responsible states get dragged into the role of enablers of the five or so most profligate. We should be very thankful at some future Thanksgiving if the new Congress manages to shape our federalism in ways that minimize the degree to which the rest of us have to share in consequences of perpetually-adolescent fiscal behavior.
As I shift my focus to the recent “commoditization” of the Markets, I find myself intensely grateful that I am not one of the poor saps who have to manage sourcing for the world’s sweatshop we call China. It has never been easy to manage the planning and acquisition of material inputs to support even moderate growth. The problem for China is not so much the rapidity of its growth, much of which is coming from the inclusion of activities that didn’t get counted or simply didn’t happen in the subsistence portions of the economy (e.g., basic hygiene, light bulbs and the electricity they use). What is really making it tough for the folks who have to keep the factories going and the trucks running is the recent emergence of such vast pools of risk capital that by virtue of instantaneous communications and computing power stand ready, willing and able to jump onto or off of anything their algorithms tell them might be a trend. In light of how much this “speculative interest” seemed to aggravate things the last time the global economy boomed and then hit a bump, this should concern us all. For all the song and dance around “financial reform”, the power of the algo to vex purchasing managers, jazz the price of tortillas in Mexico and otherwise unleash torrents of unintended consequences seems to have been unaffected by our collective near death experience of 2008. That so many asset classes are correlating so tightly has not gone unnoticed, but the price we all seem to pay (as consumers and participants in the “real” economy) when the tail that is speculative interest starts to wag the dog that is the economy seems to have been quickly forgotten. I’ve got a hunch that if the bets I currently have on, mostly around Web 2.0 and the aerospace cycle, do not live up to my expectations it will have had something to do with the increasingly difficult task of acquiring commodities for actual use in production.
That said, however disruptive market forces can be when they get out of hand, we should be thankful indeed that the animal spirits that drive the dance between price and value are alive and well. How alive and well was amply demonstrated this past week by the reception accorded the IPO of Government Motors. It was kind of fun to watch, if one was willing to let one’s cynicism off its leash. The bankers and the publicists all played their parts and yet despite some very ominous references along the lines of “lack of internal financial controls” and a going on eleven year experience with equities that you would think would produce distaste if not revulsion, the public waddled up to the trough and dug in. This “fear of missing out on something” is elemental to the human condition, never really going away but more or less evident as “herd” factors ebb and flow. It bolsters my sense that a decade past when the last Tech Bubble popped, we are in the early stages of yet another silly season for Tech (buzzwords: apps, cloud, advertising).
That animal spirits short circuit what would otherwise be powerful forces of informational efficiency is what makes it possible for adept investors to buy low and sell high, and for this we need to be grateful. It’s like thanking God for the sun and rain and the turn of the seasons, and so much else so easily taken for granted. Sure, that (hopefully) once-in-a-generation stampede of roughly two years ago put me in a seemingly precarious place. (When I got blown out of a job much earlier in life, I took consolation that “at least I wasn’t one of those 55 year olds!”) Despite the untimely loss of what I had thought would be the last job I would ever need and the severe erosion inflicted on retirement accounts that were pretty much 100% in equities, it wasn’t the end of the world. Indeed, the freedom of action made possible by said job loss allowed me to make a few decisions that have since made our financial situation better than ever. A major element of this would be the subject of the last subject of gratitude I will mention before I head off into holiday mode, one of those lessons in investor mental hygiene that need to be occasionally re-learned. To wit, not getting too caught up trying to buy at the exact bottom or sell at the exact top, and not beating oneself up for being what only feels like being way too early (as long as one has kept some buying power in reserve). This was driven home by one of my stocks getting a takeover bid this past week. I have followed Ladish Corp. (LDSH) for a very long time and felt fairly confident paying $13+ back in early 2009 that unless the world really was coming unglued, it was worth a lot more than that. I had the opportunity to buy more at around $10. By time I was adding even more at about $7.50, I was feeling at least a little chastened about the impulsive initial buy and second guessing myself. Fast forward about eighteen months, and a bid valued at about $48 from long time supplier Allegheny Technologies (ATI -$50) makes all that self recriminating agita about markedly less than perfect execution seem silly. Especially considering that half of the consideration that is ATI stock is likely to at least double in value over the next few years, in my estimation.
So many things to be thankful for, but who’s counting? Having a happy holiday.
Saturday, November 6, 2010
Buy the Rumor, Buy the News?
The Market showed just how strong it is this week. Having sat through more instances of “buy the rumor, sell the news” than I care to remember, I was fully prepared to see something of a pullback given this week’s Trifecta. We had the electorate rendering its verdict against the despotism that calls itself Progressivism, the Fed announcing the terms of its latest truckload of monetary easing, and the culmination of another earnings season that showed the global economy still gaining traction. It seemed more than plausible that a 20%+ surge in the NDQ in nine or so weeks had more than adequately discounted all this, that somewhere along about Wednesday or Thursday, “sell the news” should have kicked in. On the surface, there was nothing all that surprising in any of these developments, other than maybe the $600B being higher than what we take to be the consensus estimate. But no, instead of a “pause that refreshes” that normally occurs when something so enthusiastically anticipated gets cleared up, there was almost imperceptible hesitation before the Market tacked on Thursday’s big gain and then refused to pull back from that on Friday. What’s up with that?
The election outcome really was hardly surprising, though a highly encouraging sign did appear in the aftermath. Who, save that 20% of us living in that parallel universe we might call the Progressive Bubble, could possibly be surprised that there would not be a rightward shift in the legislative branch caused by a felt need amongst a plurality of the other 80% to send a message to an arrogant and dangerously out of touch executive branch? Musings saw the seeds of this clear back on March 25, 2009:
It occurred to me that this time, the collective efforts of this crew had thus far been so amateurish, so evocative of Commencement Day at Clown College and so presumptuous of success as to perhaps set a land speed record for blowing one’s political wad. One of the reasons the Market didn’t seem to mind that which was objectionable about the Clinton Administration was that it, too, rapidly squandered its ability to render things like “health care reform” and had to spend the rest of its years triangulating and otherwise playing it safe. The Market doesn’t seem to mind nickel-dime changes that actually happen so much as the prospect of Big Change with even bigger and grossly unknowable unintended consequences. One also senses enormous tensions building up among the acolytes and variously sordid hustlers who are impatiently awaiting a payback for helping bring all this into being, the sort of tensions that invariably corrode the efficacy of the endeavor. The wheels might not have come completely off of the Hope-N-Change Express, but I think we have heard at least a few lug nuts clattering down the highway. The Market has breathed a sigh of relief that all that talk of radical change looks to be just that, a lot of talk. Damage will be done, to be sure, but nothing like what was in mind as pundits were setting their sights on DJIA 5000.
Imagine the odds I could have gotten had I thought this through at the time and found a casino willing to take a bet against the Republicans regaining the House in 2010! What I think might have been incremental about the election was that, unlike in 1994, the resurgent opposition is not taking their victory as a sign that it is time to ram through a mandate and otherwise run the table. No, they are calculating the percentages and playing the longer game. They will put the Progressive element even more on the defensive by offering incremental improvements that would be political poison to oppose. For example, that “file a 1099 for every purchase over $600” provision that got secreted into the Health Care bill. Can we please have the name of the tone deaf dimwit who stuck that in there? This is a tremendous impediment to jobs creation not just because of the quantifiable compliance burden it imposes but the signal that it send to every business owner, large and small, as to just how intensely involved their “partners” in government might try to get in the months and years ahead. You get a clear and vivid sense of this by talking to any business owner about how they feel about it, but that’s not something that anyone in the Administration seems capable of doing. It is a wet blanket smotherer of entrepreneurial spirits of the highest order. The good news is that it and measures like it are easy targets that fit well in the Republican game plan. How many Democrats, having witnessed the slaughter of November 2, are going to vote against measure to repeal this monstrosity, especially those 23 Democratic Senators who are up for re-election in 2012? So I think that investors at the margin got a little more confident that not only have the enemies of ownership been routed, but that either at least a few of the most egregious enterprise dampeners will be addressed in the weeks ahead or there will be an even more pronounced stampede to the right in two years.
In terms of substance, the Fed action strikes me as a nonevent, like a kid jumping in front of a parade so he could tell his folks that he led them across town. This sentiment is rooted in what the earnings season told us, a development that was only surprising if you believed that the summer slowdown was anything more than an inventory adjusting speed bump. As previously noted, knocking a few more basis points off of lending rates is not going to stimulate borrowing and so hiring by either the cash rich or barely-hanging-on enterprises that make up most of the economy. To the extent that rates drop, the greater impact will be a negative one on savers. What QE2 does seem to have done is send a signal to those who unleash tsunamis of buying or selling on a daily basis that “risk on” is, for the time being, much more prudent than “risk off”. So on more days than not, money pours out of safe havens and into just about anything that has the potential to go up in price. At least for now.
Also lending impetus to the upward bias in equity prices is the calendar. The number of weeks until every money manager’s 2010 performance get indelibly printed is rapidly dwindling, and not a few of them are wishing they had been more fully invested. This alone makes me think that the intermediate up-leg that commenced in earnest on September 1 will continue for a few more weeks at least. And as we look to 2011, I see a global economy not only gaining traction but perhaps even shifting gears. While large swathes the US economy continues to face dreadful obstacles, the export oriented portions are thriving. What will likely put 2011 in a much better place than 2010 will be that construction activity appears poised to swing from being a drag on the aggregate (declining) to being at least a slight positive. It is also likely that while lay-offs by state and municipal entities will continue, the rate at which these necessary cuts are made will slow. It adds up to more spending power coursing through the economy, more discretionary spending on things that millions of households have underspent on for the past four years. The resultant improvement in GDP and earnings should be such that we should not be surprised to see the Bull Market tack on a third year. That said, I believe the intermediate trend that commenced on September 1 has advanced to the point that thinking about selling, harvesting a few positions around the edges in order to insure that one has buying power the next time the Market goes into one of its periodic swoons, probably ought to be taking precedence over thinking about adding new positions. But that is a tactical consideration in what remains a positive long term outlook.
The election outcome really was hardly surprising, though a highly encouraging sign did appear in the aftermath. Who, save that 20% of us living in that parallel universe we might call the Progressive Bubble, could possibly be surprised that there would not be a rightward shift in the legislative branch caused by a felt need amongst a plurality of the other 80% to send a message to an arrogant and dangerously out of touch executive branch? Musings saw the seeds of this clear back on March 25, 2009:
It occurred to me that this time, the collective efforts of this crew had thus far been so amateurish, so evocative of Commencement Day at Clown College and so presumptuous of success as to perhaps set a land speed record for blowing one’s political wad. One of the reasons the Market didn’t seem to mind that which was objectionable about the Clinton Administration was that it, too, rapidly squandered its ability to render things like “health care reform” and had to spend the rest of its years triangulating and otherwise playing it safe. The Market doesn’t seem to mind nickel-dime changes that actually happen so much as the prospect of Big Change with even bigger and grossly unknowable unintended consequences. One also senses enormous tensions building up among the acolytes and variously sordid hustlers who are impatiently awaiting a payback for helping bring all this into being, the sort of tensions that invariably corrode the efficacy of the endeavor. The wheels might not have come completely off of the Hope-N-Change Express, but I think we have heard at least a few lug nuts clattering down the highway. The Market has breathed a sigh of relief that all that talk of radical change looks to be just that, a lot of talk. Damage will be done, to be sure, but nothing like what was in mind as pundits were setting their sights on DJIA 5000.
Imagine the odds I could have gotten had I thought this through at the time and found a casino willing to take a bet against the Republicans regaining the House in 2010! What I think might have been incremental about the election was that, unlike in 1994, the resurgent opposition is not taking their victory as a sign that it is time to ram through a mandate and otherwise run the table. No, they are calculating the percentages and playing the longer game. They will put the Progressive element even more on the defensive by offering incremental improvements that would be political poison to oppose. For example, that “file a 1099 for every purchase over $600” provision that got secreted into the Health Care bill. Can we please have the name of the tone deaf dimwit who stuck that in there? This is a tremendous impediment to jobs creation not just because of the quantifiable compliance burden it imposes but the signal that it send to every business owner, large and small, as to just how intensely involved their “partners” in government might try to get in the months and years ahead. You get a clear and vivid sense of this by talking to any business owner about how they feel about it, but that’s not something that anyone in the Administration seems capable of doing. It is a wet blanket smotherer of entrepreneurial spirits of the highest order. The good news is that it and measures like it are easy targets that fit well in the Republican game plan. How many Democrats, having witnessed the slaughter of November 2, are going to vote against measure to repeal this monstrosity, especially those 23 Democratic Senators who are up for re-election in 2012? So I think that investors at the margin got a little more confident that not only have the enemies of ownership been routed, but that either at least a few of the most egregious enterprise dampeners will be addressed in the weeks ahead or there will be an even more pronounced stampede to the right in two years.
In terms of substance, the Fed action strikes me as a nonevent, like a kid jumping in front of a parade so he could tell his folks that he led them across town. This sentiment is rooted in what the earnings season told us, a development that was only surprising if you believed that the summer slowdown was anything more than an inventory adjusting speed bump. As previously noted, knocking a few more basis points off of lending rates is not going to stimulate borrowing and so hiring by either the cash rich or barely-hanging-on enterprises that make up most of the economy. To the extent that rates drop, the greater impact will be a negative one on savers. What QE2 does seem to have done is send a signal to those who unleash tsunamis of buying or selling on a daily basis that “risk on” is, for the time being, much more prudent than “risk off”. So on more days than not, money pours out of safe havens and into just about anything that has the potential to go up in price. At least for now.
Also lending impetus to the upward bias in equity prices is the calendar. The number of weeks until every money manager’s 2010 performance get indelibly printed is rapidly dwindling, and not a few of them are wishing they had been more fully invested. This alone makes me think that the intermediate up-leg that commenced in earnest on September 1 will continue for a few more weeks at least. And as we look to 2011, I see a global economy not only gaining traction but perhaps even shifting gears. While large swathes the US economy continues to face dreadful obstacles, the export oriented portions are thriving. What will likely put 2011 in a much better place than 2010 will be that construction activity appears poised to swing from being a drag on the aggregate (declining) to being at least a slight positive. It is also likely that while lay-offs by state and municipal entities will continue, the rate at which these necessary cuts are made will slow. It adds up to more spending power coursing through the economy, more discretionary spending on things that millions of households have underspent on for the past four years. The resultant improvement in GDP and earnings should be such that we should not be surprised to see the Bull Market tack on a third year. That said, I believe the intermediate trend that commenced on September 1 has advanced to the point that thinking about selling, harvesting a few positions around the edges in order to insure that one has buying power the next time the Market goes into one of its periodic swoons, probably ought to be taking precedence over thinking about adding new positions. But that is a tactical consideration in what remains a positive long term outlook.
Friday, October 22, 2010
Yet Another Pseudo-Crisis
The Market’s climb up the wall of worry continues. Earnings season has put “double dip recession” back into its coffin, as company after company has shown that recovery in spending for electronic devices, air travel and, in some parts of the world at least, infrastructure barely hesitated during the long, hot, now behind us summer. We find ourselves wondering what the Market will do for an encore once the earnings announcements have run their course and the US electorate has rendered its much anticipated verdict (“buy the rumor, sell the news”?), but the economic underpinnings are still “good enough” to carry the Market higher into 2011.
One recently re-animated element of that nettlesome wall has been the foreclosure mess, the one that has brought “robo-signer” into the national conversation. A whole lot of huffing and puffing suddenly erupted around a “scandal” wherein nobody who has been making their payments has come anywhere close to losing their home, but rules are being bent and “fraud” is being perpetrated by overworked, understaffed attorneys offices. The big scary sounding numbers (“100,000+ foreclosures in September”) are back. I had thought that the passage of time was well along in its inevitable process of healing bad accidents like this one (the aftermath of the blow-off phase of a generation-long Bull Market in real estate). As we shall see, the numbers aren’t nearly as big as they seem. It has been three-plus years (i.e., about half the average duration of home mortgages) since the lenders went from delirious to catatonic and the flippers bailed like a school of spooked mullet. And how did that horrific sounding re-set crisis, the one that was supposed to render millions of adjustable rate mortgages unaffordable, turn out? Who knew that refinance would be the salubrious opportunity it turned out to be for so many home owners? There is no gainsaying that on the level of personal and anecdotal, much hardship, much life-wrecking, character building or destroying crisis has been wrought. But here lies the rub: even a plethora of anecdotal, individual crises does not necessarily add up to a macro crisis. The foreclosure “disaster” has not swamped us after all. We seemed to manage through it, but now all of a sudden its back in the news. What’s up with that?
The first thing to do when confronted with a “crisis” involving big (or in some cases, small) seeming numbers is to put it into perspective. What purports to threaten us today is the prospect of a few million homes changing ownership on terms that almost none of parties are happy with. So, is 100,000+ foreclosures in a month a big number? Compared with past experience, absolutely, but how surprising, given what we have lived through in the past decade, is that? But if we are trying to decide if all these micro crises add up to a macro Crisis, we should cast the number in macro terms. Let’s go to the Census data. 100,000, or even 1,000,000 is not so big in the scheme of a population of 310,000,000. In fact, it’s miniscule. Boil that down to 130,100,000 households and its still tiny.
Once we enter this realm of Census data, we find a few more clues as to how scary this foreclosure mess deserves to be. It appears that the threat of mass contagion is a bit less than was advertised. Some 36,000,000 of those households are renters. All this foreclosure mess means for them is that landlords find themselves in a less favorable position than in the past as “what’s available” got a lot more so. This means downward pressure on rents, a good thing if you are a renter. Of the 76,400,000 households that are owner occupied, roughly a third are owned free and clear. So what does a foreclosure “crisis” mean to them? Probably nothing more than the fact that the gain they would realize, IF they were to sell, on the house they bought a long time ago would not be quite as gargantuan as it would have been four years ago. That leaves about 50,000,000 household with one or more mortgages. But not all of these, indeed, only a small slice of these, got to the dance so late as to have missed on the appreciation which preceded the bust AND whittled down the size of the loan. Some 6,200,000 of these mortgages have a loan to value of >90% LTV, of which 5,800,000 were >100%, or “underwater”.
Even within that barely afloat situation, a little clarity is in order. Much has been made of the threat of “strategic default”, homeowners walking away. This is indeed a problem, of the micro sort, for holders of any such mortgage, but is it really a crisis? It needs to be remembered that there is underwater and there is underwater. For everyone bona fide disaster (stretching one’s means to buy an expensive house at the very top in a hot market) there are no doubt many other situations that are merely disappointing. For example, house bought for $500K and sold ten years later for $450K. A pretty crappy investment, to be sure, but probably far from fatal. Such a home could be thought of as having ended up costing an extra $416/month. Not what you wished for, but hardly a “disaster”. (F.D. I have been “underwater” a couple of times, including after buying in NJ in July 1990. It’s a lousy place to be, but not unbearable. And the passage of time made everything turn out okay after all.) Home ownership is about far more than an investment, and one suspects that most of the remaining “underwater” borrowers will suck it up and learn to live with the realization that not ever investment turns out as expected. It is also quite likely that a vast preponderance of those unfortunate borrowers are in it for the home as opposed to the investment. That proverbial house flipper we got to know so well in 2006 is long gone. Finally, it also looks like to the extent this deserves to be called a crisis, it is very localized. A handful of counties (Dade, Henderson, Maricopa) seem to dominate the news. The 80/20 Rule comes to mind, but with a twist. It’s not 80% of the foreclosures in 20% of the counties out there. We can probably get pretty close to 80% of the likely foreclosures in not much more than twenty counties. Of course, foreclosures will occur in virtually every county every year, but in terms anything that might deserve to be considered a macro crisis, it has been contained to a smattering of blotches on the map.
So why is this pseudo crisis being resurrected? Before we address this, let’s be clear that there is a whole lot of crises, in the micro, personal sense, out there. It just doesn’t deserve to be trumped up into an excuse to crawl under your bed and hide. Anyone who was counting on home price appreciation is experiencing what it is like to buy a stock on margin and then have it go down and not up. Similarly, there are a lot of inadvertent mortgage lenders out there (direct or indirect owners of mortgage backed securities) who just might have a problem if they really need the return on those investments to live up the sales pitch. (Of course, investors have had at least 25 years to learn the pitfalls of buying MBS “yield”.) And just because we are now several years into a profound re-set on the notion of home-as-investment does not mean that the psychic toll is even close to wearing off. (F.D. I know what it’s like to have “How are we going to keep the house?” be the first and last thoughts of one’s day, but again, we got through it.)
I see this “crisis” being resurrected for a couple of reasons. There’s the politic: class struggle that will not quit. The Political Class tries to garner support by catering to a Victim Class. Anyone who feels threatened by foreclosure is in a sense a victim, if only in terms of peace of mind. So declaiming “fraud” because an overtaxed system (remember, most of these foreclosures have to be processed through a very small number of courts) prompted some processors to short cut some technical procedures is yet another way to keep the Big Bad, Eager to Screw You Bankers narrative going. Then there is the matter of not enough ambulances to chase, too many lawyers grubbing after too few fees. As the needed safeguards against unjust foreclosure morphed into an arcane pile of rules and regulations, a “game” inevitably developed. Many of the “victims” of foreclosure we are reading about have been gaming this system, in some instances living rent free for upwards of two years. Not surprisingly, some lawyers have figured out that they can leverage a bit of expertise here (which is at least a bit more than most homeowners have) into a nice fee producing activity. And at least a few of these guys think big, and have the rhetorical flourish to gin a few bruised rules into scandal. That’s really all we have here.
Expect these aftermath of the Great Twentieth Century Real Estate Bubble to resume fading into oblivion in the months ahead, and for something similarly disingenuous to take its place in the wall of worry which we must contend with if we are to take advantage of those mega mood swings we call Bull Markets.
Tuesday, October 5, 2010
A Bubble? Not Really
What a few weeks back we might have deemed a “stealth rally” has gotten bit less stealthy of late. Indices spurt upward when the news is “good” (and even not so good, as when the Market soared following AMD’s trimming of its outlook) and then just kind of go through the motions on the inevitable “pull back & rest” days. This powerful upswing could reach something of a short-term climax around the upcoming earnings season coinciding with the “buy-the-rumor, sell-the-news” aspect of the November 2 election, but longer term it still has far to go. What I see as the motive force behind this expectation is, in effect, the subject of this Musings. It seems that whatever progress equities have made off of their March 2009 lows, it has been despite a raging flow of funds in the direction of fixed income. This torrent has been so profound as to stir something of a national conversation as to whether we are experiencing a “bubble” in bonds.
Musings takes the position that while there is certainly some of the attributes of classic asset bubbles in play, what is going on in bonds should not be considered a bubble. As the elephant would say, “Just because it has a trunk and birds like to rest on it does not make it a tree.” To call what has gone on in bonds of a late a bubble is yet another example of this age’s pernicious tendency to stretch and so mangle the meaning of words until they are nearly useless and certainly powerless. (What has become of “hate” in recent years comes to mind.) Sure, there is that lemming-like rush, characteristic of bubbles as their inflation picks up speed, by parties who don’t seem to be thinking very hard about it. That is indeed a sign of a bubble, but it is just a sign. I don’t see a bubble here because the basic motivation is Fear and not Greed, and because of the extreme unlikelihood of widespread, ruinous consequences that always follow real bubbles. The clamor for bonds is fear-based, an acting out of a preference for assured outcomes, however piddling, as opposed to blithely taking on more risk than one understands there to be in pursuit of a ticket to Easy Street. But it is the dearth of likely, adverse consequences of this phenomenon that make the misuse of “bubble” most apparent. Real bubbles end really ugly. Think of stocks that have one lap around the track and then implode to 5% of their peak value and never recover, or worse. Think condominium complexes and shopping malls that sit empty for years once the music stops, until they are so decrepit that bulldozing ends up being the most value producing option. Think gold coins purchased in 1980 and then sitting in your safe earning exactly nothing for the next twenty five years.
So what’s the worst that is going to happen to the moke who is willing to lend to the Treasury for ten years at only 2.5%? (Interestingly, as reported on 10/2 in the WSJ, the rush to bond funds has been very focussed on short to intermediate funds, with long funds seeing almost no net inflow.) Say three years from now inflation finally rears its ugly head, what’s he got then? Certainly not a worthless husk of nothing. He’s got a seven year note he paid 100 for selling at 90 or 85. In seven years, he get it all back at 100 and he will get that meager spurt of income every six months while he waits. A disappointment, sure, but hardly a disaster. Just ask the fellow who overstayed the Tech Bubble for more than a few weeks into 2000. This rush for specious certitude is a natural response to a couple of decades where the risks of ownership were soft pedaled and millions of householders got burned as a result. Now they are reacting in the opposite direction, and their stampede has enriched a clever few who saw (or guessed) correctly that a wave of cash would inflate the value of low-default-risk, income producing assets (i.e., another feature of bubbles, the emergence of a recognizable price momentum that becomes attractive in and of itself, if only for a season).
This phenomenon that some would call a bubble could go on for some time, but I suspect it is at the point where the leakage, the smart, early money starting to move on, starts kicking in. It will be very difficult (no, make that impossible) for bond funds to repeat in 2011 what they delivered in 2010. Besides, it has served its purpose. And what might that be? To ease the clear and present distress of certain borrowers at the longer term expense of certain lenders. By crunching short rates to where they are indistinguishable from zero, policy makers have actually inflicted hardship of the most risk averse of savers. They have made it easy for profligate states and municipalities to replace high cost debt (on which many retirees were subsisting) with lower cost debt (on which many retirees will be just getting by). Every week, debt issued before the Crash matures or gets called, and someone’s retirement income shrinks a bit. This is a “yield” problem for retirees, actual and prospective, that get worse almost every day. If such a saver was prescient enough to own longer term bonds, CDs or funds, the full impact of this squeeze has yet to register, in fact they might had a surprisingly good 2010, but the hurt will be upon them very soon.
The beneficiaries of this squeeze would seem to be the banks, municipal borrowers and the unions who are affixed to that set of teats we call the public sector (which needs to borrow heavily to keep their symbiotic scam going). And to be fair, they need all the help they can get. But who is paying for it? The patsy in all this is, once again, the unsophisticated saver just trying to get through life without doing too much harm. It is not hard to make out in this episode of record low interest rates a blatant transfer from one class to another. That’s not the narrative we get, but it seems to be the way the money is flowing. We are told that rates need to go lower to stimulate the economy and so create jobs, but how faux is that? Think about all the prospective corporate borrowers on a continuum that rates credit worthiness and the need to borrow. At one end you have all those companies that have record levels of cash. They might borrow more, indeed some have, if rates got ridiculously low, but does make them more vigorous, more expansive and so likely to hire? No, not really. Then at the other end of the spectrum are those entities that no lender in his right mind is going to lend to. They are just not credit worthy at any price unless they have portable, findable collateral. The $64 question then is “How much is left between these two categories, wherein lower rates have no impact, where lending and so expansion might actually occur if you lower rates?” My read is that it is a pretty small slice indeed. If so, this narrative about jump starting the economy by cutting rates is pretty bogus. Indeed, it is a dodge, a distraction from yet another transfer of wealth from those who don’t deserve what’s happening to them to those who don’t deserve the break their friends just delivered.
My confidence in the durability of the Bull Market that started in March 2009 rests in that pent up tsunami of safety-seeking money that has done okay for the past eighteen months but going forward is going to have to breathe deep and take a little more risk. Some households will be able to keep the belt tight and muddle on. Most others, one suspects, will simply have to find a way to get higher returns. As for pension funds, endowments, etc., or managers charging more than about 20 basis points, even more so. 2010 will probably end up being a moderately good year to have owned stocks. As the income from debt grinds inexorably lower, the trickle towards better options, like 3%+ yielding stocks of global corporations that can actually raise that dividend over time, will freshen and in time become a raging torrent. Along the way, this peculiar worry that has overtaken so much of Tech, that the fashion statement that is the handheld communicating & occasionally computing device is going to somehow undo the need for devices that can actually get work done, will dissipate as well. This will bring the valuations of many of those stocks back in line with their actual prospects. Then there is the unrelenting reminder that has been M&A: companies being taken out by entities that are going to have to live with them for a while at prices way above where the stocks had spent the past year. (Most recent example, see KEI, whose acquirer is hardly an ingenue in the acquisition game.) Put all these factors together, and it is plain to see that this Bull still has miles to go.
Tuesday, September 21, 2010
This Just In: The Aviation Aftermarket Cycle has Turned
The Market’s prevailing bias shifted out of neutral on September 1. Since then, a steady stream of economic indicators point to diminishing chances of any sort of meaningful slowdown. Setting aside the question of how these crude measures of vastly complex activity got to be so important (it reminds me of when “money supply”, at 4:05PM every Thursday, held the Market in its thrall. Then one day, no one talked about it anymore), it is sure starting to seem that there is at least enough traction to get us out of the soup eventually. The talking heads for the most part seem unaware that recovery lived a day at a time and referent to individual hardships that have entered our personal sphere of awareness is always painfully slow. I have not lived through one where the question, “How is it ever going to get better?” did not hang like a dank cloud over our thought processes for what felt like a very long time. And thus it ever was. The 1936 classic comedy, My Man Godfrey, opens with “forgotten men” sitting around their shanties in the city dump joking through gritted teeth about prosperity being “just around the corner”. (Many of the films of the late Thirties did a great job of portraying the crushing weight of Depression on the human spirit.) The recession that officially ended 15 months ago is certainly taking its time in edging toward the memory hole, but global economic growth is clearly sufficient to sustain appropriate (and bullish!) investment theses.
One such thesis for High Road would be that we have a heck of a commercial aerospace cycle stretching out just ahead of us. The big drivers are of course the well advertised order backlogs for aircraft both new (B-787) and not so new (A-320, 737). For well situated suppliers, these volumes will in time be nicely supplemented by defense programs like the F-35, the A-400M and who knows, maybe even a new refueling aircraft to replace the antique KC-135. These programs have slipped out in time even more than those of us who have gotten used to the way that “stuff comes up” in developmental programs had expected, but they will get here in the not too distant at all future (certainly not in terms of the number of years that some of us have worn ourselves down observing such goings-on.) There has been decent recovery in most of aerospace related stock since the dark days of Q1 09, but uncertainty prevails. Among the most troubling and least well understood of issues facing aircraft parts and service providers has been what we take to be a disappointing slow recovery in aftermarket demand. Here is the good news: not only is the inflection point in the commercial aviation MRO cycle upon us, but it is my belief that the very factors that caused the “trough” phase of the cycle to drag out in time will add strength to the recovery over the next two to three years.
There is a part to this MRO cycle (which drives demand for all manner of spare parts) that is relatively easy to understand and even predict, but there are also factors that defy quantification and might only be recognizable after the fact. It is a huge market that grows as a function of demand for air traffic, which is driven not only by global GDP but also by innate human predilection for novelty and adventure. It will tend to grow as long as economies are growing larger and more robust. Travel becomes a consumer good as more basic needs are secured. One does not have to be an art scholar to glean from artwork past that however fraught with danger and discomfort, people will travel when they get a chance, and for all kinds of reasons. Making it quicker, safer, and otherwise less stressful (i.e., bringing down the all-in cost) only make it that much more desirable. What the aviation industry has done to bring down the all-in cost to travel in our lifetimes has rendered it a luxury-bordering-on-necessity in all but the most meager of households in the developed world and for going-on-countless millions of others elsewhere. Such expense categories definitely take a hit in times like we just went through, along with dining out, outsourcing lawn care, etc., but they do come back, often in a “pent up” sort of way.
These factors (GDP, the LT growth in demand or air travel) account for the LT growth in MRO and its related parts consumption, but timing (how long, how deep a downturn before growth resumes) will be driven by a more nebulous set of circumstances. In every downturn, the owners and operators (O/O) of aircraft have a lot to sort out as to what the operating economics and so value of the aircraft are likely to be once they are out the other side. Only a few of the factors they have to consider are readily predictable (i.e., each A/C will be X years old in Year Y; demand for lift will recover). The O/O of all but the very newest and very oldest aircraft have to weigh likely fuel prices 5-10 years hence, increasing maintenance costs as aircraft age and the relative economics of newer technologies made increasingly available to marginal operators thanks to a proliferation of wannabe lessors (until maybe they don’t wannabe anymore). They then apply this tenuous stack of assumptions to a “manage through the downturn” game plan.
As I understand it, aircraft operators are bounded by somewhat absolute limitations in their ability to defer maintenance (cross that line and lose your business, or worse), but there is a significant “margin of safety”, or cushion, between these hard lines and normal practice. It is well understood that operators will eat into the cushion in response to a cyclical slowing or downturn, which makes MRO activity more volatile than air traffic. Less well understood is the role of fleet decisions involving aircraft that have been deemed surplus to current requirements and thus “parked in the desert”. Here, an O/O faces an interesting call. If after weighing a raft of factors it is deemed likely that the aircraft will have decent economics 5-10 years out, that plane might be “mothballed” in such a way that it can quickly be brought back into service. However, every program reaches a point where out year economics have dimmed to the point that more value can be realized by effectively using the aircraft up. This means cannibalizing some for spare parts to operate some others right up until they need a (very expensive) D check. Such a course of action, a liquidation of assets to hold down cash outlays through a downturn, would obviously have a depressing effect on demand for both spare parts and MRO services. However, it would also stealthily burn up capacity that might otherwise eventually return to service. How extensively this has gone over the past three years will definitely affect demand for new aircraft as well as replacement parts over the next three years, and in ways that will surprise analysts who are not thinking about it in these terms. (Bear in mind that while the owner of each individual parked aircraft probably has a pretty good idea how far from good-to-go that aircraft is, no one has a handle on how actually “available” the entire parked fleet is until well after the fact, if ever.)
This time around, the O/Os had an unusually tall order to deal with in making this call. First, there was that step change in fuel price assumptions that accompanied the same change in oil prices, c. 2007, to north of $70/bbl.. This all by itself is a real game changer for vintage 1984 aircraft. Then there was the most precipitous economic downturn in our lifetimes and its still lingering hit to the sense of well-being in so many households throughout the developed world. All of this is well followed and reasonably well understood. What’s not so well understood, I suspect, are a couple of factors distinct to “this time around”. One would be the sheer magnitude of programs that are of a vintage that the “liquidation” option is in play. For example, the 737 Classic. Produced between 1984 and 2000, there are 1984 of these “in service”. Am not sure if this is actually in service or also parked but assumed serviceable, but it is a very big program relative to past programs at a similar point in life in, say, 2003 or 1990. This venerable workhorse faces tough economics up against both the A-320 (the oldest of which is now 22 years old) and the 737-NG. The Classic was designed to improve upon the 737-200, mainly to use the CFM56 engine v. the JT8D, but other improvements were made. (Remember the 737-200 that was Aloha Airlines Flight 243.) We should not be surprised to find, a few years hence, that many of their operators have been squeezing all the juice they can get away with here, in this program and in other of similar vintage as well. This would translate into depressed demand for replacement parts of late, but also a diminished ability for an operator to accommodate growth without writing some big checks once the upturn is underway.
Another factor that I believe has protracted the “trough” but has probably reached its limits is improved capacity utilization by domestic operators over the past several years. Load factor (RPM/ASM or thereabouts) was for most of my years considered pretty high in the upper 70% and normally not quite there. 80%+ seemed like asking for trouble. All that has changed, with mid to high 80% looking to be a genuine “new normal”. Somewhere between better software, code-sharing and firm resolve on the part of managements, the airlines “found” additional capacity while managing through the cyclical downturn. We can never prove it, but that seeming increase in how often flights were overbooked sure looks to me like the airlines probing for just how far they could push this productivity step change. This adventure added to the pain of their parts & service providers (as well as not a few travelers), but the good news is that it appears to have run its course. Going forward, additional capacity to accommodate growth will have to come from more aircraft flying more frequencies.
The past few weeks have provided a few more glimmers that the aftermarket has started to turn. Esterline (ESL) noted on its July Q earnings CC some improved aftermarket sales in the Asia Pacific region. Parts and services titan AAR (AIR) opted on its call to reinstate its long term 10% operating profit goal (a goal that is only worth articulating during the growth phase of the cycle.) Airlines are showing improved traffic figures, with demand for premium seating starting to lead the way. Also telling, in my estimation, is the serial bump-up, contra the expectations of all but a few of us not so very many months ago, of planned narrow body aircraft build-rates at Boeing and Airbus. The fleet planners have seen the writing on the wall, as it were, with respect to wringing more capacity out of their existing fleets.
In June 2003, within weeks of the very bottom of a much uglier industry downturn, Musings described why demand for air travel would inevitably recover. The title said it all: Not Going Back to Greyhound. In the intervening 7+ years, the number of ready, willing and eager consumers of air travel and other goods made available by air transport has grown by many millions. Their manifold interests and relationships have spread out accordingly, in ways that buses, trains and even free-at-the-margin telecom simply cannot satisfy. A long and salubrious cycle for aviation parts and service is only now getting underway, and it will draw surprising power from activity rendered necessary by the actions that made the trough phase seem so numbingly long.
Saturday, September 11, 2010
Sharpen the Teeth, Hold the Gravy
So nine years have gone by since that awful morning. In some respects, it has come to seem very long ago and far away, yet for many of us it still bears the stamp of visceral reality. I don’t think I am particularly unique insofar as how easily imagery from that morning can stir me, as in feeling my hair stand up. The interminable “conversation” about its evolving meaning, the quixotic proposals to turn it into a Day of Service, will continue as a part of the background noise of life in our times, but it will a generation at least before it no longer freighted with meaning that is deeper than words can express.
As well it should, for who among us was not deeply touched by this monumental affront? We did not have to be there, or lose a loved one. This was one of those things that simply should not happen. It was in an important sense far worse than any natural disaster, for it involved the cold blooded marshaling of God’s great gifts, will and intellect, with the express purpose of inflicting as much pain and suffering as possible on innocent victims. It was an act that demanded, and got, a powerful response, a reordering of national priorities into actions whose results will only be understood in the long light of history. The passage of nearly a decade brings to light the question of how much longer expenditure for its prosecution (i.e., defense spending) might be expected to grow or even be maintained. This is especially pressing in light of competing claims on the national wealth that have seemingly exploded in the past few years. As we pause to reflect on losses suffered at the hands of a few who so resolutely hated us and everything we stand for, it would be prudent to consider, as objectively as we know how to, how that segment of the economy that is about responding to and deterring threats to our national existence is likely to fare going forward. This will be the subject of the bulk of this Musings, but first I want to expound on an idea that is about comparing, and making sense of, 9/11/2001 and 9/11/2010.
If it seemed at the time that an action such as the 9/11 attack was made possible by technological advances making the world a smaller place, the lead-up to the anniversary has reminded us of how inexorably this trend has continued. The cheap and easy transportation and telecommunications, not to mention that “connectedness on one’s one terms” we once called the World Wide Web, were all but certainly necessary to plan and execute such a grandiose scheme. Nine years later, the smallness of the world wrought by nearly cost-free connectedness is even more apparent. As recently as, well, 2001, garden variety tragedy and scandal was pretty much the purview on “local news”. As the “pipe” got fatter, the bit rates exploded and the number of channels grew beyond measure, we find it increasingly challenging to hide from a flow of “information” seemingly skewed to all that’s not well in the world. The climate isn’t changing so much as we are hearing about really bad weather in places we almost never thought about before this great “shrink”. The same holds for crime. So in 2010, a publicity seeking preacher, whether deep in bowels of lower Manhattan or way out in the weeds of exurban Florida, can command the global stage. Who would have imagined, twenty or so years ago, that a rube pastor of a tiny church out where gators roam could piss off so many adherents to the object of his stunt way off in upcountry West Asia, and get so many “dignitaries” (such a capacious term, no?) so lathered up in protracted bout of moral posturing? A more sensible, realistic world would have ignored him if they had noticed him at all. But such sense and connection with the real seemed to be irretrievably gone.
This brings to mind another recollection about 9/11/01 that was not about shock, grief or anger. There was the silver lining part of it, not the least of which was that sense of reconnection with reality. Much was written in the weeks that followed about change for the better in people all over the country but in and around NYC in particular. It was as if that spirit of our age that is not-so-enlightened self-interest got tamped down. It only lasted for a while, but it really did happen. Stark, brutal ugly reality can indeed blow away the unreality that pervades a culture that has been rolling along relatively unchallenged for the better part of a lifetime. We saw a side of humanity that gets hard to come by when peace and prosperity come to be taken for granted. One element of this is something we can call “neighborliness”. It is how people learn to get along when they have to live in close proximity without having to involve cops, lawyers or duels. It was much more in evidence in early 2002 than it was a year previously or in the years since. This is apropos today because its paucity explains the controversy around what some parties want to build a couple of blocks from Ground Zero. Simply put, such an act is a very unneighborly thing to do. It is not the act of someone trying to just get along and get through life. However subjective the “hurt” inflicted by the 9/11 attack might be, it is a very real pain, and not just for those who suffered personal loss. Even a modicum of neighborliness should be enough to sensitize us to this. But, no. So it seems that technology is bringing us ever closer together, and so ever more in need of that attitude or ethic of neighborliness, and yet there is little if anything the popular culture or the spirit of the age that prompts us in that direction.
If this is so, conflict is inevitable, be it flaring or just simmering. So as we look back on nearly a decade of warfare and contemplate how the priority that is national defense spending will evolve, we can be sure that the underlying “need” that drives demand is not going away. The question, if we are at all disposed to investing in those enterprises whose products and services address this need, is how much of a change is about to take place, and how much does it really matter to any specific company? Admittedly, from an investing point of view, this War on Terror has been the gift that keeps on giving. We knew that it was in a sense just a flare up of a centuries old conflict, but who expected that “combat operations”, as opposed to a still ongoing presence in Iraq, would stretch into 2010? Or that the war that in a model of Special Ops execution we seemingly won so quickly would flare back up again, with no clear end in sight? Still, however committed one is to meeting the threat of force with a poised and proven threat of even more force, a downshift in effort and so expenditure is eventually inevitable. While yet another conflict is always possible, it is increasingly unlikely, given the tremendous toll that has been taken on that sub-set of the so-called Arab “street” that might actually go and stand in harm’s way as opposed to just standing around talking about it. In other words, the ranks of those who are both susceptible to the promise of seventy virgins and man enough to act on it have had ample opportunity to do so. So a downshift in the tempo of this centuries old conflict is quite likely upon us, and priorities are changing accordingly.
This would seem to be an indication for investors to look elsewhere, but at this point in time it not quite so simple. To start with, it appears that the Market has been anticipating it for the last two years at least. The survivability of all but a marginal few of the publicly traded, defense related companies is hardly at stake. What matters is whether price appreciation, which as we know is a function of money flowing into a stock faster than it wants to flow out, is at all possible given the likely flattening if not outright decline in US defense spending. That the “pie” looks to shrink seems among the safest of bets and strikes me as something of an overwhelming consensus. Less well considered, however, is the degree to which evolving priorities might spell opportunity. Even if we assume a declining budget, there are programs and requirements that will grow and go forward. There is also plenty that can and will be cut to free up funds for priority programs. For example, reducing our presence in Iraq means no longer having to maintain an home away from home for tens of thousands of soldiers and contractors. And speaking of contractors, there is a ton of spending that got authorized before we took the measure of and then abraded the current threat that has been a a major driver of the booming Beltway. Not all of it was ever really necessary in the first place. This miles long gravy train will be trimmed back.
So what is likely to grow? The metaphor to keep in mind is the “tooth to tail” ratio. This construct describes how many assets, including people, military planners figure need to be in place to support one warrior who might actually engage the enemy. It tends to be a very high and nebulous number, varying from service to service (lower for the Marine Corps, higher for the Air Force) and over time as technology evolves. As such, when the tempo of engagement slows, cuts to “tail” will tend to vastly outweigh reductions in “teeth”. In point of fact, a conflict that has gone on longer than expected has caused the teeth to be badly in need of repair, if not replacement. Moreover, as planners work to anticipate if not deter the next threat, be it next year’s valedictorian of some Wazzupistan madrassa or the super power China intends to be in 2025, they will give top priority to sharpening said teeth. This brings us down to trying to identify those companies that can help the military do more with less, including repairing and upgrading a plethora of assets that have already performed more rigorously than they were designed to do.
My preference at this juncture is to avoid those entities that are predominately defense as opposed to having a good balance with commercial aviation. They might survive and the stocks are certainly cheap, but what is going to get the money flowing in faster than it trickles out? This dynamic (relative money flow) is especially pertinent with the larger companies, where the underlying commercial viability changes so little over time. (This notion has served to be the best way to “time” BA, but with that company there was a relatively predictable commercial cycle that prompted the marginal money flow. And its not just the inflows but the prospective diminution of inevitable outflows that matters.) Better to own those companies that have been waiting for the upturn in the commercial cycle, the pushed out 787 cycle that sucker punched so many investors in 2007. But won’t the dim prospects for defense spending offset this cycle? Not likely, in my estimation. Investors at the margin have been fretting about both for 2+ years already. The one gets better, a lot better, the other turns out not as dreadful as expected. The next cycle might run longer than 2003-07 (a big maybe), but it probably won’t be as huge, appreciation-wise. That last one started from a much scarier place and the defense side of demand went longer and stronger than could be reasonably expected in 2003. So maybe a punk outlook for defense outlays will take some zip off the ball, but there will still be outsized appreciation for those aerospace companies who have correctly positioned themselves with respect to evolving priorities (i.e, fix the teeth we have worn down, make them last longer with retrofit programs or replace them with more cost-effective teeth.)
With respect to the latter of these actions, it should be remembered that there are some very large and, owing to the wear and tear of the past nine years, badly needed aircraft programs in the not so distant future. Owners of defense stocks will be alarmed from time to time by program cuts, but such is the normal course of events. Not every program lives up to its billing, and sometimes the DoD gets it right when they pull the plug early. The question should not be, “What if they cut the JSF program?” It should be, “How much could they cut it so it’s not a great big program anymore, and how likely is that?” We dare not enter the next decade not being well along in transitioning away from reliance on antiques such as the F-15.
If we pause for only a moment to relive what overwhelmed and violated our very sense of decency nine years ago, we know that we cannot escape the burden of being the world leader capable of deterring such evil. Redirection and refocus are clearly in order, and this is the stuff of great opportunity for those investors willing to take the time and think it through.
Saturday, August 28, 2010
The Unintended Consequences of 401k
What the Romans called the Dog Days of Summer took an inordinate toll on investors psyches this time around. The traditional, pre-Labor Day miasma just might be ending on a promising note (witness the Market’s response on Friday 9/27 to objectively negative news re BA, INTC and Q2 GDP), but August certainly turned out to be a good month for investors to have their attention diverted elsewhere. We find ourselves trying to understand a seeming disconnect between what sure looks like “good enough” global economic growth and apparent equity valuations. Investors have been given a steady stream of reminders that based on what corporate acquirers are willing to pay, (the 3Par auction being quite the outlier from what looks like an “up 35%+” norm). Nonetheless, equities are undervalued and discouragement continues to rule the day. It’s beginning to remind me of the last time the world gave up on equities. This has me thinking about a very important change that has taken place over the intervening era, which is presently complicating what I still believe is inevitable recovery.
The “last time” I have in mind was in 1981, when I started in the business. There was palpable discouragement about the stock market back then. Most of the old hands (i.e., had lasted more than two years) at the brokerage firm would tell you it had been a very long time since they had enjoyed the business. This was because like today, equities had not delivered for upwards of ten years. Unlike today, investors could earn very high nominal rates on money markets, but otherwise it seemed like real estate and perhaps oil & gas partnerships were the only games in town. Commodities were in the late days of finding favor as well. These sentiments could not have been more wrong over the ensuing five, ten or twenty years. Yet here we are, thirty years later, with going on eleven years of disappointing returns having inflicted a quite similar funk.
I believe that this despond will pass, that at some point in the next few years money will begin to flow in earnest out of sterile assets like commodities or fully priced bonds and back into equities. It will happen as inexplicably as it did (sans the hindsight we now enjoy) through most of the 1980s. In a way, it simply has to, for a reason that is presently complicating our slow motion recovery. This complication revolves around a very important change that was implemented in 1980. That was when changes to the IRS Code, most notably Section 401k, took effect and began to shift the risks and uncertainties of retirement planning away from corporations and toward households. It had been correctly observed that a host of factors, most notably medical technology, were increasing life expectancies and so turning post-retirement obligations into open ended liabilities. A better way had to be found, and indeed it was. Over the ensuing decades, 401k and similar qualified plans would supplant defined benefits plans in most of the private sector. I can remember hearing Sir John Templeton, just a few years into it, predicting a sort of “people’s capitalism” coming to pass as a result. I can also remember wondering at that time what the unintended consequences of such a development might be. We are now very much in the throes of one such consequence.
What I have in mind is the mirror image, if you will, of another consequence as it played out a dozen or so years ago. It rests on the premise that these assets loom large in the psyche of a large and, in terms of consumption, very important segment of the economy. To the degree that defined contribution plans have grown to be something of a cornerstone of perceived financial well being in millions of households, “how the accounts are doing” will affect behavior, especially when it comes to discretionary consumer spending. This was readily observable during the Tech Boom. 40lks and other such plans burgeoned (along with home equity and, for a few, stock options). I would submit, though, that it is not just the value of the account but what the investor assumes to be a realistic return out into the future that affects behavior. When, in 1999, the retirement account was bigger than expected, it made households feel richer than they really were. Perhaps more importantly, the notion that said balance could realistic grow at 20% had a profound effect as well. If such growth was indeed possible, it meant that one really didn’t have to contribute to savings any more. What was the point if we were all going to be so fabulously rich anyway? Indeed, it was in many instances quite rational that one could spend 100%+ of one’s income from labor, as the expected asset value growth would more than make up the difference.
So here we are today living through an opposite sort of development. That 401ks and the like are not in 2010 as capacious as millions of households now with ten fewer years to work with thought they would be in 2000 is well advertised. Perhaps less well thought out is what has happened to the assumed return portion of the householders thought process. It has been a very long time since anyone who was not either extremely gifted or extremely delusional could muster much confidence at earning a return that was even close to double digits. This takes a toll on discretionary spending both subjectively (i.e., feeling less flush and so less inclined to feel like spending) and objectively, insofar as acting on the felt need to save more for retirement leaves less cash available. This brings us to the problem at hand. The confidence to spend on anything but necessities, to outsource all manner of household chores and all kind of decisions that make for a vibrant economy, has come to be very dependent on what households expect their retirement plans to earn “for the duration”. When this expectation, a fragile thing to begin with given the experience of the past decade, takes a hit as has since late April, this willingness to spend takes an even bigger hit. Not in every household, but in enough of them to effect the data in ways that scare the bejeebers out of those who seemingly live and die by economic data. That such fluctuations in expected returns (a highly subjective thing for most us, no?) would dampen spending and so economic activity and so create a bit of a destructive feedback loop has turned out to be something of an unintended consequence of the people’s capitalism that was set in motion in 1980.
I do not believe that this is any kind of definitive factor, that some kind of death spiral around retirement account values and consumer spending is going to drag us into an interminable recession. More likely, it is just one more thing that makes recovery what we all expected a year and a half ago: numbingly slow, but enough to keep the global economy expanding. But on the matter of qualified plans, I would note one other very important development that thirty years of evolution have brought us to. The changes wrought by Congress in 1979 fundamentally altered and improved Corporate America. The capital to fund so much of what was accomplished over the balance of the century would have been much more costly if a path away from such open-ended liabilities had not been created. But it only transformed part of the economy. While defined benefits and post retirement health care obligations by corporations have been eliminated or largely tamed (with a few notable exceptions, but even the auto industry reached something of an end game on this), the public sector is another matter entirely. The retirement obligations of state and local governments has been a very smelly elephant in a very crowded room for a very long time. (I can remember it posited as a looming crisis when living in New Jersey in the late 1980s.) Nonetheless, when times are good and asset values seem to trend inexorably higher, our ability to disregard smelly elephants knows no bounds. This is one of the things that ended when asset values crashed. Among other things, the Crash made stark the disconnect between those who, per the 1980 change in the rules, were rendered personally accountable for their retirement security (over and above SSI) and those who continue to enjoy a lifelong financial security on the taxpayers’ dime. Once reality was reimposed, egregious contractual obligations entered into by conflicted politicians could no longer be ignored. Life long health with no contributions, the opportunity to retire at 50 and then double dip, and all being paid for by increasingly insecure feeling taxpayers, this simply will not stand. There is no place for what the Governor of CA recently called a “protected class”. I see this issue, which by being about comfort and security in one’s old age, as well as basic fairness, is as viscerally as they get, as being at the very fault line that defines political struggle du jour. It is energizing what has turned into a class based conflict, and the “not-so-protected” class is a lot bigger and a lot more worked up.
How this sorts out over the next decade or so will get a few degrees clearer in November, as blessedly, we seem to be able to work these class struggle thingys out with ballots as opposed to bullets. In the meantime, the Market will continue to exasperate us if we watch it too closely. But as time goes by, as households reliquify and most importantly, as the last bit of juice gets wrung out of a fixed income market that has feasted on that clamor for specious certitude, money will start to flow back into equities. Either that or the savers and investors are ready to settle for next-to-nil returns “for the duration”.
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