Piranha-proofing the Shark Tank

While the nearly-over earnings season has had a very salubrious effect on share valuations, this week has certainly reminded us that, however spindled and mutilated, those of the bearish persuasion are still very much among us. Company results have been almost uniformly encouraging, driving yet another set of nails into the coffin of “double dip recession”. One has had to scratch hard to find exceptions. Tuesday’s swoon was triggered by rating agencies having finally caught on that the dysfunctionality of certain Euro-backwaters is more or less as persistent as it was a century or so ago. This air pocket was really not all that surprising, considering how frenetically some swathes of the Market (e.g., the Russell 2000) have been trading over the past few weeks. It also seems that those money pools who thrive on exacerbating disappointment seem to have less clout than they did a quarter ago, as if a more optimistic conviction has hardened in the minds of the unwashed masses their depredations are intended to intimidate. There is clearly a wolf pack of opportunists running screens each morning for anything resembling a “miss”, then gang banging the bids in hopes of jump starting a stint of negative momentum, but it rarely seems to be good for more than a few hours of high jinx. There is simply too much evidence of an on-the-mend global economy, and more to the point, too much money, badly in need of a greater than “risk-free” return, finding its way into US equities. This is a very tough time to be a bear, even if you didn’t bet that “Palm will go out at $1”.

As vivid as the earnings fireworks have been, we have been distracted by what amounts to a Potemkin (as in, put-up fakery) show trial (as in, politicians raking their cronies over the coals) on the Senate floor. What a surprise that the SEC serves up the staggering revelation that sharpies sometimes get hosed down by other sharpies just as the D.C. Power Grab turns its sights on the financial markets. All that’s really going on here is an effort to make something gamey even gamier (as in, advantage accrues to those politically connected enough to game the system.) Wall Street will become that much more a cash cow for funding Permanent campaigns. The occasional public floggings will continue, but with even more winking acknowledgement that such debasement is a small price to pay to have everyone think of you as a Master of the Universe. I suspect that whatever rules get crafted will make it harder for non-financial enterprises to extend credit. It will probably have some impact on marginal predators well down the financial services food chain. The “too big to fail” predators will take up the slack. Expect to what might be regarded as piranhas (e.g., small time finance companies) lose share to the Great White Sharks (GSC, et al).

All this is being foisted on us to prevent something that is very unlikely to happen anyway. We are being told that future panics/meltdowns, whatever are inevitable if we don’t “do something!”. This is true enough in the sense that as long as there is at least a modicum of freedom, and fear and greed are still part of human nature, there will be accidents, bad days for those who didn’t see it coming. What is misleading, though, is the implied likelihood that such inevitable upsets will be of a magnitude of what we just lived through. I would submit that “the black swan” flew due to conditions that were decades in the making. 2008 was “once in a generation” because it takes decades to aggregate widespread credulity into overripe systemic delusion. The scariest part of the scariest part of that episode was that nobody, even those of us who had lived through some pretty scary patches, had seen anything quite like it. It fell as hard as it did because the delusion of “real estate as impregnable in the aggregate” that underpinned it all was largely the result of policies that had been metastasizing for decades. However appropriate these policies started out (increasing home ownership was undeniably a worthy aspiration in the 1920s, by 2000, have succeeded so wildly, not so much), they were thoroughly corrupted by the time real estate became the designated engine to pull us out of the 2002 recession. The good news is that these blowups are a lot like forest fires. If the woods have been growing for a very long time without a fire, there is lots of “fuel” lying about. No one is expecting it, and so when it happens, it burns out of control. In doing so, however, it makes it much more difficult for a fire of any consequence to happen any time soon. In the financial world, the same thing happens. Lending standards swing from practically non-existent to CYA tight. The suspect mortgages of a few years back run off or are refinanced, and are replaced, bit by bit, day by day, with much more scrupulously sourced cash flows. The “fuel” for the next conflagration simply is not there like it was in 2006, nor is the complacency wrought by a rating system that had never really been tested. So yes, there will be failures, headline grabbing, day ruining upsets, but nothing with the sort of systemic risk that calls for handing more power over to those who would game the system.

“Too big to fail” seems to be one of the most intractable challenges we face, but it really doesn’t have to be. It could all be sorted out with a simple policy that if you get the guarantee that comes with FDIC, you don’t do take casino bets. Enterprises that want to be hedge funds can be hedge funds. Those who want to take deposits can act like banks in the sense that “bank” is akin to “bunker”, a putting safety ahead of opportunity. To the degree that what constitutes a casino bet is difficult to sort out (so many derivatives being rather benign ways that companies dial down their commodity or forex risk), a bit of behavior modification might be called for. How awful would it be to have a policy where if the government has to facilitate a change of control to protect depositors or prevent systemic shock waves, the hurt goes beyond the equity holders and reaches the ones who made it happen? We could fix this problem if, in the event of such failure, any compensation above some nominal threshold, say $90K/year, in the five years leading up to the event gets clawed back to help pay for the redeployment. This would include former as well as current employees, no exceptions. It would includes salary as well as bonuses, deferred or long since spent. Skin in the game, just like the share holders and, it would seem, many of the bondholders. There would seem to be a lot of unfairness in such an outcome, but one suspects that such a prospect would change an awful lot of behavior, and it would likely be a very long time before “risk taking with other people’s money” brings us to such a pass.

Season's Greetings

The season wherein that which has lain dormant and desiccated springs to life is most definitely upon us. The Texas Hill Country is having one of the best wildflower seasons ever, as so much verdant energy, long suppressed by drought, has been unleashed by a half a year of relatively cool, wet weather. The cattle and wildlife seem to be more abundant, and much less stressed than in that awful period, and for the past few weeks most of the afternoons have had that soft, warm breezy feel that one guesses might be the temperature of Heaven. It has been anything but heavenly for allergy sufferers, though, as apparently all those frolicking photosynthesizers have been spewing record quantities of pollen.

Spring also brings the highest of Holy Days for the great faiths of the West, and almost as predictably, yet another tediously recycled attack on the papacy and all that it stands for. It is as if every Easter, an abuse scandal take turns with yet another “rediscovery” of some Gnostic Gospel that supposedly changes everything (until someone points out that it has been “rediscovered” and discredited more times over the past few centuries than anyone can remember) in trying to crash the party and spoil the occasion. This time around, the “scandal” seems to pose the question as to whether the present Vicar of Rome was incompetent or indifferent in the execution of his administrative duties some thirty years ago. It is as if the CEO of one of the world’s largest corporations were being taken to task because of claims that back when he was in his first managerial job he made some mistakes. Anyone who has managed much of anything for longer than a few hours, especially within an enterprise which systematically challenges its young managers so as to see what they are made of, will recognize how fallacious this is. It is Monday morning quarterbacking, akin to listening to analysts who have never managed anything taking a management to task for not living up their (the analyst’s) estimates. (Could it also be a misperception regarding whatever Papal infallibility means?) As others have ably pointed out, there are not a few bottom feeders who have an acute pecuniary interest in keeping this “abuse” narrative going. My sense is that just like Stalin’s “how many divisions does this Pope have?” outcome, a good man we call Benedict XVI will be remembered and respected long after the erstwhile “paper of record” is nothing but another signifier amid the digital archives, and its editors and publishers long forgotten as well.

Of course, the season most on our minds (unless we are ardent baseball fans) at this time is the earnings season that had just kicked off. Intel’s big “beat” certainly added heft to what was already a rather extended, anticipatory advance. It should be noted that no small amount of credit for blowing by all that collective brainpower, as manifested in 40+ analyst estimates, goes to Intel itself. They got my attention a few years back, when conventional wisdom had it that “AMD was kicking Intel’s ass”. That episode managed to blow away whatever hubris might have crept into the atmosphere at Intel, and the company set to work to reassert its dominance. There were a few promising signs just before the Big Panic interrupted, but with a resurgence of more normal demand, Intel is looking leaner and meaner than ever. They are also riding a global wave that they helped trigger, brought about by a step change in the value of mobile communication. So the answer to whether this latest “beat” by INTC was because they were lucky (as in at the right place at the right time) or smart (as in good fortune being the result of one’s own diligence) is: Both.

This is probably not quite 1994/Wintel driving what by 1999 burgeoned into the Tech Bubble of a lifetime. Let’s just say that History is not about to repeat itself, but as Mark Twain (who I understand lost a bundle on a Tech investment, i.e., a new system for typesetting that likely “came in second” or was a little ahead of its time) would have put it, it is setting up to rhyme. The onset of this latest earnings season has me feeling very good about the rather big bet I have made on Web 2.0 (see the List, that is upwards of 44% of my investable assets in companies that have been making that happen). Somewhat sane, somewhat rational niches within the Tech sector have been a very long time in coming. The valuations are still as if evolution-to-the-good within an industry never happens. Decrepitude is, of course, out there in time, but not just around the corner. The next few years are going to be a wonderful time to own a lot of the stocks that crashed and burned a decade ago. This does not mean our patience will not be tested. We should be surprised if 2010 does not include another correction at least as meaningful as that which marked January. It might even start before this earnings season has run its course. It will probably be a good idea to trim some marginal positions in the days and weeks ahead if there is any doubt about having flexibility when the inevitable correction arrives, but my sense is that we are in the very early innings of what just might end up being the Web 2.0 Bubble.