Archive for February, 2010

  • “You need 3-4 Good Companies to Invest in Over Ten Years”
    , February 24th, 2010 at 9:54 am

    I came across this interview with Peter Lynch, the legendary former manager of Fidelity’s Magellan fund. Here’s an excerpt:

    Against that, there’s the argument that less than 15% of investment managers beat the index, and the rest lag behind it.
    “At Fidelity, we had countless funds that beat the indices over periods of tens of years. In the past ten years, the market has been difficult, but I believe that in the next ten years, active fund managers will produce a better return than index funds and ETFs.”
    As for other veteran investment managers in the US market, for Lynch too the latest crisis was the worst he had experienced in his years in the industry. Despite the severity of the crisis, Lynch believes that it was only an exceptional, random event, and that, in the long run, the markets will get back on track.
    Asked to share his lessons from the crisis with us, Lynch pauses for a moment’s thought, and responds, “I’ll tell you the same thing I would have said 10 or 20 years ago as well. To predict the market’s direction in any given year is a completely random act. You can’t know what the markets will do in a period of six or twelve months.
    “On the other hand, you do know that, over the past 40-50 years, company profits grew at good rates, and in my view they will continue that way in the coming years too. I estimate that corporate profits will double themselves every ten years. If you add to that the dividends that the companies distribute, you get an excellent return,” adds Lynch. “You have to believe that, in general, companies in the US will continue to grow. Naturally, along the way some of them will disappear and some new ones will join.
    “When you participate in company profits, the most important point is whether you believe that they will be higher in another ten or twenty years or not,” Lynch insists. “If not, then perhaps it would be better for you not to be exposed to them, not in an ETF, not in an index fund, and not in a managed fund. When you look at the alternatives for investment, the choice for investors today is between a money market fund, that produces a zero return, Treasury bonds, that yield 3.8%, or some exposure to the stock market that, over time, yields double that on average.”
    After leaving Magellan 20 years ago, Lynch reduced the scope of his activity in the markets. In the two decades since then, great changes have taken place in the financial industry and in the markets, one of the most prominent being the technological developments that now enable investors all over the world to be exposed to a far larger amount of information, and in real time. Lynch himself sees no difference between 20 years ago and today in the way investors need to approach the markets.
    “In the course of my work at Magellan, I bought small companies that grew over the years. This is a strategy that worked, and still works today,” he says. “I bought companies whose performance was weak and that turned their businesses around. This method still works today. If you invest in companies whose assets are worth more than their market cap, you have found a great investment opportunity.”

  • How to Make 25.2% Annualized
    , February 23rd, 2010 at 4:49 pm

    Go back in time to June 1938. Buy a brand new Action Comics #1 for 10 cents. Then sell it yesterday for $1 million.
    Over 71-3/4 years, that’s a return of 999,999,900% which works out to about 25.2% a year.

  • Consumer Confidence Plunges
    , February 23rd, 2010 at 12:03 pm

    The market is getting smacked around this morning thanks to an awful report on consumer confidence.

    The Conference Board, a New York-based research group, said its Consumer Confidence Index fell to 46.0 in February from 56.5 in January.
    According to a consensus survey, economists expected the index to fall slightly to 55.0 from 55.9. The index, which is based on a survey of 5,000 U.S. households, is closely monitored because consumer spending drives two-thirds of the nation’s economic activity.
    The overall index remains at historically low levels and is the lowest since April 2009. A reading of above 90 indicates a stable economy, while 100 or greater is an indication of strong growth.

    The present situation index hit a 27 year low of 19.4. I can’t say exactly why but I’m very skeptical of this report. I realize I sound like a person who refuses to believe the data that counters his bias, but this report just doesn’t ring right. It’s too much of an outlier.
    The market seems to agree with me. Stock prices are down but nothing dangerous. These consumer confidence reports are subject to revisions, and revisions of the revisions. I’ll need to see more data before I’m fully convinced that were headed back down the drain.

  • 23-F: 29 Years Ago Today
    , February 23rd, 2010 at 9:01 am

    It’s hard to believe that there was a fascist coup attempt in Western Europe just 29 years ago but today is the anniversary of the Francoist attempt in Spain. The botched coup is known as 23-F. Like 9/11 it’s named after its date. Here’s some video:

    Incidentally, these guys aren’t fascists is the modern sense meaning American politicians you don’t like. These boys are the real deal. Franco had been dead only six years. The Monty Pythonesque looking figure at the center of things is Lieutenant Colonel Antonio Tejero.
    The national assembly was in the midst of electing a new prime minister when Tejero comes barging in. The very brave defense minister is the one standing up to him. Tejero had about 200 national guardsmen with him. The plan was that high ranking generals would join in. Only one did, the top general in Valencia.
    King Juan Carlos went on television, in his military uniform, and said in no certain terms that the coup was unconstitutional. The deputies were freed the next morning. Tejero was arrested and thrown in jail for 15 years.

  • Gary Gorton on the Financial Crisis
    , February 23rd, 2010 at 8:52 am

    Yale professor Gary Gorton has an excellent Q&A on the financial crisis. I highly recommend it. It’s long but readable and very thorough.
    Here’s the WSJ:

    It’s wrong to blame this crisis on subprime mortgage lending, he says. Rather, this crisis is best seen as the latest of a series of banking crises throughout history. Banks borrow (or take deposits) short-term, promising to give money to their customers if they want it. They invest that money long-term, lending to businesses and consumers. This “intermediation” process is vital to the smooth functioning of the economy. But if depositors or others from whom banks have borrowed short-term demand their money back — a demand often sparked by panic — banks can’t instantly respond, and bad things ensue. In the old days, these runs were prompted by anxious depositors. Deposit insurance helped solve that problem. In our time, banks were reliant on short-term borrowing known as repurchase agreements — and the folks who held those panicked.

    Tyler Cowen has more.

  • Medtronic Beats By a Penny and Narrows Range
    , February 23rd, 2010 at 8:27 am

    Medtronic (MDT) just released a decent earnings report. After charges, earnings for their fiscal third quarter came in at 77 cents a share which was a penny higher than the Street. Sales rose 10% to $3.85 billion. More importantly, Medtronic narrowed the range of their 2010 estimate to $3.20 to $3.22 per share from $3.17 to $3.22 per share. The Street had been looking for $3.18. This means the stock is now going for 13.6 times 2010 earnings. Not bad.

  • Geithner Refuses To Come Down Off Capitol Dome
    , February 22nd, 2010 at 6:32 pm


    WASHINGTON—Three days after a sulking Timothy Geithner climbed to the top of the U.S. Capitol dome, the treasury secretary remained steadfast Monday in his refusal to come down. “You all hate me,” said Geithner, his arms crossed as he shouted at the crowd of onlookers gathered on the Capitol lawn below. “What do you care if I stay up here? You’ll just make fun of me if I come down anyway. Well, I’m not coming down—not ever!” Federal security teams monitoring the situation said they believed Geithner might be planning an extended stay atop the dome, as evidenced by what appeared to be a burlap sack containing various snacks, a six-pack of root beer, and several copies of The Economist.

  • A Conspiracy of Ignorance
    , February 22nd, 2010 at 2:59 pm

    I’m not very impressed by the various people who now claim to have predicted the credit crisis. The point I like to make is that if a person really thinks they predicted it then they probably don’t understand what happened. The complex nature of the credit crisis prevented itself from being predicted. And no, predicting a crisis every year or saying that housing was a bubble doesn’t qualify as predicting the credit crisis.
    Far too many people want to see the credit crisis as the result of a massive conspiracy engineered by Goldman Sachs or the Fed or George Soros or the Illuminati or who knows what else.
    Actually, you could say there was a large conspiracy in one sense. No one—not the government, not the banks, not investors—had any idea of the consequences of their actions.
    Jeffrey Friedman writes:

    Given the large number of contributory factors — the Fed’s low interest rates, the Community Reinvestment Act, Fannie and Freddie’s actions, Basel I, the Recourse Rule, and Basel II — it has been said that the financial crisis was a perfect storm of regulatory error. But the factors I have just named do not even begin to complete the list. First, Peter Wallison has noted the prevalence of “no-recourse” laws in many states, which relieved mortgagors of financial liability if they simply walked away from a house on which they defaulted. This reassured people in financial straits that they could take on a possibly unaffordable mortgage with virtually no risk. Second, Richard Rahn has pointed out that the tax code discourages partnerships in banking (and other industries). Partnerships encourage prudence because each partner has a lot at stake if the firm goes under. Rahn’s point has wider implications, for scholars such as Amar Bhidé and Jonathan Macey have underscored aspects of tax and securities law that encourage publicly held corporations such as commercial banks — as opposed to partnerships or other privately held companies — to encourage their employees to generate the short-term profits adored by equities investors. One way to generate short-term profits is to buy into an asset bubble. Third, the Basel Accords treat monies set aside against unexpected loan losses as part of banks’ “Tier 2” capital, which is capped in relation to “Tier 1” capital — equity capital raised by selling shares of stock. But Bert Ely has shown in the Cato Journal that the tax code makes equity capital unnecessarily expensive. Thus banks are doubly discouraged from maintaining the capital cushion that the Basel Accords are trying to make them maintain. This litany is not exhaustive. It is meant only to convey the welter of regulations that have grown up across different parts of the economy in such immense profusion that nobody can possibly predict how they will interact with each other. We are, all of us, ignorant of the vast bulk of what the government is doing for us, and what those actions might be doing to us. That is the best explanation for how this perfect regulatory storm happened, and for why it might well happen again.

  • Business at AIG Is Stabilizing
    , February 22nd, 2010 at 11:11 am

    It’s amazing what $183 billion will do.

    American International Group Inc., the troubled financial firm that threatened to bring down the U.S. economy, is showing stable revenue for its insurance units and improving its ability to repay taxpayers 17 months after a bailout that swelled to $182.3 billion.
    AIG property-casualty businesses, contributing more than a third of the company’s revenue, posted sales increases in three straight quarters last year after plunging 23 percent following the company’s near-death experience in September 2008. Life insurance and retirement-products sales, AIG’s other main operations, rose for the first time since the bailout in the three months ended September 2009. AIG gained 6.5 percent in New York trading today.
    “There are clear signs that AIG has pulled out of what could have been a death spiral,” said David Havens, managing director in credit trading at Nomura Securities International Inc. in New York. AIG’s insurance results have been improving “after dropping off a cliff following the bailout,” he said.

    Tim Geithner said that it’s possible that the government might in fact possibly lose some money on AIG depending, of course, on its eventual outcome.
    The GAO said we’re out $30 billion.

  • Wall Street Loves to Round Up
    , February 22nd, 2010 at 9:44 am

    Last week, the WSJ highlighted a fascinating study. Two academics looked thousands of earnings reports down to the tenth of a cent. They found an unusual dearth of earnings-per-share that fell on the 0.4 cent level. This implies that a larger-than-expected amount of companies were trying to round up their EPS to the next whole cent.

    (T)he overall effect is striking. In theory, each digit should appear in the 10ths place 10% of the time. After reviewing nearly 489,000 quarterly results for 22,000 companies from 1980 to 2006, however, the authors found that “4” appeared in the 10ths place only 8.5% of the time. Both “2” and “3” also are underrepresented in the 10ths place; all other digits show up more frequently than expected by chance.
    Companies tracked by Wall Street analysts are less likely to report “4s” in the 10ths place of an earnings-per-share figure particularly when their results are close to analysts’ predictions. Companies with high price-to-earnings ratios also report fewer “4s.”
    In their most intriguing finding, the authors found that companies that later restate earnings or are charged with accounting violations report significantly fewer 4s. The pattern “appears to be a leading indicator of a company that’s going to have an accounting issue,” Mr. Grundfest said.

    Missing earnings can be a big deal. As is often the case, the scandal isn’t that people are breaking the rules. The scandal is what the rules allow. Companies have enormous latitude with their earnings reports. This is one of the reasons why I stress investing in high-quality companies. I have much greater faith that companies like AFLAC (AFL) or Johnson & Johnson (JNJ) won’t abuse the rules.