• The Back-Dating Bubble Bursts
    Posted by on December 12th, 2007 at 1:12 pm

    Larry Ribstein of Ideoblog deserves some sort of blog award. Early on, he correctly called the back-dating brouhaha of 2006 what is was, a media-driven pseudo scandal. Now here we are in 2007 and the scandal bubble has burst.
    The one big fish the authorities got was Greg Reyes, the former head of Brocade. In August he was convicted of conspiracy and fraud. Ribstein said that Reyes was “trying to maximize shareholder value by recruiting the best people, not line his pockets, and where it’s unlikely any misstatements hurt investors.”
    Now it looks like they’re going to lose this case as well. Andrew Ross Sorkin reports in today’s NYT:

    A principal witness in the stock-options backdating trial that ended in a conviction of Gregory L. Reyes, the chief executive of Brocade Communications Systems Inc., has told associates her testimony may have been untrue, according to court documents.
    In affidavits, friends and associates of the witness, Elizabeth Moore, a Brocade employee who testified that Mr. Reyes deceived the company, said she had privately retracted her testimony.

    For uncovering the back-dating scandal, The Wall Street Journal won a Pulitzer Prize.

  • If the Market Is So Darn Efficient, Then Why Is this Blog Free? Wait, Don’t Answer That!
    Posted by on December 12th, 2007 at 11:57 am

    Megan McArdle, my favorite libertarian blogstress, has some thoughts about Michael Lewis’ Portfolio article and Efficient Market Hypothesis (see also here and here). Megan is a great blogger and I read her every day.
    I don’t want to get too deep in the weeds on this topic but I’m an EMH skeptic and I want to explain why. My main beef with it is that EMH suffers from theoretical overreach.
    OK class, let’s remember our scientific method. A theory is a logical explanation for natural phenomena. Well, EMH explains a whole lot, but there are still some holes. The wholes aren’t big, mind you, but they’re definitely there and can’t be ignored.
    Maybe some day, someone will come along with a better explanation for the market and those holes. I hope that day comes soon, but until then, EMH is the best we got.
    To me, the most significant hole is that value stocks have consistently outperformed the market and they’ve done it with less volatility. The data here is unambiguous. It goes back 80 years and it’s clear as a bell. Again, we’re not talking about a huge difference, but it’s there. There are others (Yahoo at $25?), but that’s the cleanest.
    Let me be clear: I think the market is very efficient, but the market can be consistently beaten. It’s not luck. It’s just very, very, very, very hard.
    As a practical matter, there’s a lot to be said for index funds. From my experience of investor behavior, more people ought to own them.
    It’s interesting that EMH defenders always say that the market can’t be beaten. They rarely defend the other half—the market can’t beat you. What can I say? I know people who have done a great amount of empirical research on this front and their results are, sadly, quite compelling.
    One final note: Please feel free to ignore the fact that this is a discussion of efficient markets taking place on free blog sites.
    Update: Megan has more today:

    I am being assailed by people pointing out that Berkshire Hathaway has done spectacularly, and therefore this EMH stuff is a bunch of hooey. I could point out that if you’d had a million guys flipping coins repeatedly for a year, at least one of them would have come up with a massive streak of heads. Even if you paid him $1mm for each heads flip, this would not actually be attributable to his awesome coin-flipping skill. Indeed, you’d have at least one cluster of guys who’d done well…perhaps fellows who’d gone to Harvard together, or people who’d all studied “Value Coin Flipping” under a master. There would be other outliers, and other groups of people who’d studied “Fundamentalist Coin Flipping” or “The Vincenzi Flipping Technique” who would not have done well. But no one would be looking to them for advice, so you would never have heard of them, and it would seem like a minor miracle that this guy, this technique had just produced such amazingly outsized returns.

    If superior performance were solely due to luck, wouldn’t we see more “successful” coin-flippers attribute their returns to arbitrary sounding strategies? You know, investing by astrology, the weather or charts patterns. Hey, if it’s all luck so the strategy shouldn’t matter.
    But that’s not what we see. If you go down the list of people who have amassed great long-term track records, each one credits Graham and Dodd style value investing. There’s Peter Lynch. There was Bill Ruane who met Buffett decades ago at a Graham conference. There are the guys who Leucadia National who have done even better than Berkshire. They espouse the exact same philosophy. The guys at Danaher. The Tisch brothers. Eddie Lampert. The list goes on and on.
    As far as I know, no technical analyst is on the Forbes 400 but there are lots of value investors.

  • Greenspan in Today’s WSJ
    Posted by on December 12th, 2007 at 7:53 am

    121207ag.jpg
    The Roots of the Mortgage Crisis
    By Alan Greenspan

    After more than a half-century observing numerous price bubbles evolve and deflate, I have reluctantly concluded that bubbles cannot be safely defused by monetary policy or other policy initiatives before the speculative fever breaks on its own. There was clearly little the world’s central banks could do to temper this most recent surge in human euphoria, in some ways reminiscent of the Dutch Tulip craze of the 17th century and South Sea Bubble of the 18th century.
    I do not doubt that a low U.S. federal-funds rate in response to the dot-com crash, and especially the 1% rate set in mid-2003 to counter potential deflation, lowered interest rates on adjustable-rate mortgages (ARMs) and may have contributed to the rise in U.S. home prices. In my judgment, however, the impact on demand for homes financed with ARMs was not major.
    Demand in those days was driven by the expectation of rising prices — the dynamic that fuels most asset-price bubbles. If low adjustable-rate financing had not been available, most of the demand would have been financed with fixed rate, long-term mortgages. In fact, home prices continued to rise for two years subsequent to the peak of ARM originations (seasonally adjusted).
    I and my colleagues at the Fed believed that the potential threat of corrosive deflation in 2003 was real, even though deflation was not thought to be the most likely projection. We will never know whether the temporary 1% federal-funds rate fended off a deflationary crisis, potentially much more daunting than the current one. But I did fret that maintaining rates too low for too long was problematic. The failure of either the growth of the monetary base, or of M2, to exceed 5% while the fed-funds rate was 1% assuaged my concern that we had added inflationary tinder to the economy.

    Notice how we’ll never know if we avoided corrosive deflation, yet Greenspan is confident that low rates weren’t a major factor in the housing bubble. Conveniently, he saved us from the event that never came and couldn’t protect us from the one that did.

  • Electability Update
    Posted by on December 12th, 2007 at 7:12 am

    I written about this topic before but one of the things I find fascinating about finance is how you can use markets for two items to create an “implied market” for a third. This idea is at the root of all the complex financial instruments that caused problems for so many hedge funds recently.
    I’ll give you a good example. At InTrade.com, the site where you can trade futures on real world events, you can buy contracts on which candidate will win his or her party’s nomination next year. There’s a separate contract for which candidate will win the presidency.
    Let’s break out some math, shall we?
    If you divide the latter by the former, you get an “electability” contract. For example, according to recent prices, Rudy Giuliani has a 41.5% chance (I’m using the last price) of getting the GOP nomination and an 18.4% of winning the presidency. Soooo…the market believes that if he gets the nomination, he has a 44.34% chance of winning (18.4% divided by 41.5%).
    (The only minor flaw is that could include a candidate winning but not getting the nomination, however, I’m content with dismissing that possibility as beyond remote.)
    What’s interesting is electability in the general election can have little impact on how well a candidate does in the primaries. Some people, myself included, think that Ronald Reagan would have had a better chance of beating Jimmy Carter in 1976 instead of Gerald Ford, even though Ford beat Reagan for the nomination.
    I should add that I don’t place a great deal of faith in these real world futures markets. I simply see them as fun games to enjoy, but not to take too seriously. Also, the markets aren’t very liquid. A minor change could have a big impact on the smaller-priced contracts.
    Having said that, here’s a look at some candidates and the market’s take on their electability (sorry Paulites and Edwards fan, your candidates were too low to get a useful meaure).
    Candidate………To Get Nomination….To Win…………Electability
    Hillary……………………..59.5……………….39.0………………65.55
    Obama……………………33.0……………….17.2………………52.12
    Giuliani……………………41.5……………….18.4………………44.34
    Huckabee………………..18.6…………………7.2………………38.71
    Romney…………………..18.8…………………5.9………………31.38

  • Important Tax Law Change
    Posted by on December 12th, 2007 at 6:52 am

    With the end of the year approaching, there will be several important changes in the tax code for 2008. For us stock addicts, the most intriguing is that the long-term capital gains rate for folks in the 10% and 15% tax brackets will fall to zero.
    That’s right…a Blutarsky. Zero point zero.
    A goose egg. Zippo. Naught. Zilch. The Null Set. The Void Coefficient. The Hobbesian State of Nature. The 2007 Miami Dolphins.
    As the law currently stands, the rate lasts through 2010. For 2008, the 15% rate maxes out at $32,550 for singles and $65,100 for married folks.
    That’s adjusted gross income, so if you find yourself just outside those numbers, it could be worth you while to do some advanced planning.
    Please consult a professional advisor (as in, not me) for more details.

  • The Huckabee Portfolio
    Posted by on December 11th, 2007 at 6:06 pm

    Nothing terribly interesting. Though on page three, he misspelled Procter & Gamble (PG). Also, the “e” in Home Bancshares (HOMB) is a bit faded. When I first saw it, I thought he owned Homo Bancshares.
    That probably wouldn’t help in Iowa.

  • “At Least”
    Posted by on December 11th, 2007 at 5:16 pm

    Shares of General Electric (GE) fell sharply today, even more than the rest of the market, after the company forecast earnings growth of 10% for next year.
    There was one widdle biddy problem. The press release left out the words “at least.”
    Oopsie!
    The stock dropped quickly 4.75% or roughly $18 billion.
    The company rushed to clarify that it’s looking to grow EPS by at least 10% next year, which makes more sense. Check out the words “or better” at the top of this press release. GE was playing the typical Wall Street game of lowering expectations.
    By the way, when you talk about GE’s numbers you’re really in a different universe. For Q4, GE is looking for 67 to 69 cents a share. Well, those two pennies translate to….
    **Dr. Evil Voice**
    Two Hundred MILLION Dollars
    Mwahahaha

  • The Fed Cuts By 0.25%
    Posted by on December 11th, 2007 at 2:15 pm

    Here’s the statement:

    The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 4-1/4 percent.
    Incoming information suggests that economic growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending. Moreover, strains in financial markets have increased in recent weeks. Today’s action, combined with the policy actions taken earlier, should help promote moderate growth over time.
    Readings on core inflation have improved modestly this year, but elevated energy and commodity prices, among other factors, may put upward pressure on inflation. In this context, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.
    Recent developments, including the deterioration in financial market conditions, have increased the uncertainty surrounding the outlook for economic growth and inflation. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.

    Frickin wimps.
    There was one dissension. Eric S. Rosengren wanted a 50-basis-point cut.
    Update: The market’s verdict is in and it’s not pleased:
    dow121107a.png
    Think you can tell when the rate cut was? I bet you can.

  • Derivative Trades Jump 27% to Record $681 Trillion
    Posted by on December 11th, 2007 at 11:16 am

    From Bloomberg:

    Derivatives traded on exchanges surged 27 percent to a record $681 trillion in the third quarter, the biggest increase in three years, the Bank for International Settlements said.
    Interest-rate futures, contracts designed to speculate on or hedge against moves in borrowing rates, led the increase with a 31 percent increase to $594 trillion during the three months ended Sept. 30, the Basel, Switzerland-based BIS said today in its quarterly review. The amounts are based on the notional amount underlying the contracts.
    Trading surged as investors bet on losses linked to record U.S. mortgage foreclosures and policy changes by the Federal Reserve and the European Central Bank to offset the credit slump. The Fed cut its benchmark interest rate by half a point to 4.75 percent in September, the central bank’s first reduction in four years.

  • UNH Hits 52-Week High
    Posted by on December 11th, 2007 at 10:14 am

    Here are some random thoughts I had this morning.
    Perhaps it’s me, but I seem hear a lot of commentators speaking as if the market were going through some great reckoning; as if years of wild speculation is finally being punished. Sure, folks who owned Citigroup (C) or Countrywide (CFC) or Fannie Mae (FNM) are going through rough times, but that’s hardly true for the market as a whole. Including dividends, the S&P 500 is up 8% for the year. That’s about spot on for the historical average. We’re only 3.5% off the all-time high reached two months ago. Swing by your local bank and see if you can find an 8% CD.
    I also see that UnitedHealth Group (UNH) finally made a new 52-week high. The stock is above $58 for the first time since March 2006. Man, what the hell took it so long? UNH generates two things, huge profits and awful headlines. Investors, apparently, only pay attention to one. Just a few weeks ago, UNH said it was projecting EPS for 2008 of $3.95 to $4. This isn’t buried news—it’s public information, yet it’s taking a long time to sink in.
    A Banc of America analyst just initiated coverage of Danaher (DHR) with a buy rating, a $100 price target and he called it his top buy in the sector.
    Lastly, here’s a great look at AFLAC (AFL) from Standard & Poor’s.