Felix Salmon Issues a Plea
Posted by Eddy Elfenbein on December 10th, 2007 at 11:07 am

As usual, Felix nails it:

Please can the punditosphere stop referring to the mortgage-freeze plan as a “bailout”? As Edmund Andrews says in his first sentence on the front page of the NYT today, it isn’t. The FHA’s FHASecure plan, which has existed for ages, might conceivably be considered a bailout. This one involves no government money or government guarantees, and there’s no transfer of funds from the taxpayer to anybody at all. So it’s not a bailout. Thank you.

He’s right. There’s zero public money at stake. The LTCM bailout of 1998 is also often referred to as a bailout. In fact, I just did. The Federal Reserve helped organize it, but no government money was involved. As someone who often criticizes the Fed, that’s exactly what they should have done.

Portfolio’s Scoop: There Are These Things Called Index Funds
Posted by Eddy Elfenbein on December 10th, 2007 at 10:16 am

I just finished a puzzling 7,000-word article by Michael Lewis for the December issue of Portfolio (The Evolution of an Investor).
The article is about efficient markets—the idea that it’s impossible for a stock-picker or mutual fund to consistently beat the market. Lewis uses the story of Blaine Lourd, a former stock-broker, as the vessel for his article.
The problem is, the idea of efficient markets was popularized 34 freakin’ years ago by Burton Malkiel in “A Random Walk Down Wall Street.” It’s only gone through about a gazillion printings. The original academic paper by Eugene Fama appeared in 1965. Everyone and his brother knows about it. What’s this article doing in a business magazine in 2007? It would be roughly the equivalent of an article on this new-fangled designated hitter rule appearing—mind you, not in Reader’s Digest or People—but in Sports Freakin’ Illustrated!
Does Portfolio think its readers are that ill-informed?
The article doesn’t even present the arguments for and against EMH in any real depth, which could be a more interesting article. In fact, an article attacking EMH would also feel at least 10 years out of date. Closer to 15.
Lewis doesn’t bother touching topics like the gradations of EMH (weak, strong and semi-strong). The frustrating part is that there are lots of interesting angles that could have been explored. Lewis could have discussed developments in fields like behavioral finance and their possible implications for EMH. Or the success of quant guys like Jim Simons. Fuck, even I wrote a post the other day about the astonishing success of momentum stocks, and I’m just an obscenity-using blogger. I mean, what the fuck?
Lewis also conflates the idea of being a good money manager with picking stocks. Money managers do a lot more than that. At least, they should. For example, they may help a client with an investment for a specific time horizon like a college fund. A money manager also helps decide an appropriate risk profile for the client, or how to keep taxes down, or how to plan for retirement. It’s a gross simplification to say these people are worthless because they can’t pick stocks. From personal experience, there were lots of times I talked clients out of exiting the market.
I also have issues with the story of Blaine Lourd, the stock-broker turned cynic turned EMH convert. I don’t think he’s lying, but I get the feeling that Lourd is overscripting his conversion story. Cynical people who grow frustrated by their industries don’t act as Lourd does. Put it this way: He managed his self-loathing well enough to hop to three more firm firms, then to open his own shop in Beverly Hills. If Lourd’s mission is to protect investors, then I wonder who’s covering his rent?
Lewis centers the article on the unusual training ritual (or indoctrination) of indexer Dimensional Fund Advisors. The firm has done very well over the years particularly by pointing out that most mutual funds don’t beat the market. But wouldn’t that mean that the firm’s success is due to a gross inefficiency in the market? Or is that too impolite to ask. Apparently, it is because Lewis never asks it. Nor does he ask any tough follow-up questions.
Later, Professor Fama, a DFA board member, makes an appearance:

Forty years of preaching has taught him that his audience either agrees with him or never will. And so he speaks dully, like a man talking to himself. But he makes his point. In his years of researching the stock market, he has detected only three patterns in the data. Over the very long haul, stocks have tended to outperform bonds, and the stocks of both small-cap companies and companies with high book-to-market ratios have yielded higher returns than other companies’ stocks.
These are the facts. The question is how to account for them. Fama’s explanation is simple: Higher returns are always and everywhere compensation for risk. The stock market offers higher returns than the bond market over the long haul only because it is more volatile and thus more risky. The added risk in small-cap stocks and stocks of companies with high book-to-market ratios must manifest itself in some other way, as they are no more volatile than other stocks. Yet in both cases, Fama insists, the investor is being rewarded for taking a slightly greater risk. Hence, the market is not inefficient.

Wait a second. High book-to-market stocks outperform with no more volatility but that’s due to higher risk? OK, so where is this risk? C’mon Michael, we just saw evidence disproving the whole point of the article. How does Fama support his assertion?
Lewis concludes the article with this:

Blaine still takes great pleasure in describing just how screwed up the American financial system is. “In a perfect world, there wouldn’t be any stockbrokers,” he says. “There wouldn’t be any mutual fund managers. But the world’s not perfect. In Hollywood, especially, people need to believe there’s a guy. They say, ‘I got a friend who made 35 percent last year.’ Or ‘What about Warren Buffett?’ ”
Then he pulls out a chart. He graphs for me the performance of one of D.F.A.’s value funds, which consists of companies with high book-to-market ratios, against the performance of Warren Buffett’s Berkshire Hathaway since 1999. While Buffett’s line rises steadily, D.F.A.’s rises more steeply. Blaine’s new belief in the impossibility of beating the market doesn’t just beat the market. It beats Warren Buffett.

That doesn’t prove any point. Buffett has still beaten the market as whole. It’s that value stocks have done much better. Why are we changing the thesis of the entire story and now comparing Buffett to a value fund? We’re not allowed to pick stocks but we can pick benchmarks? To reiterate my earlier point, what the fuck? Lewis’ article is presented to us as if it’s delivering some wise truism, yet it fails to ask any truly probing questions.
When Portfolio debuted, Elizabeth Spiers of DealBreaker said it “will be the Paris Hilton of business magazines: pretty but vapid, and unlikely to produce anything resembling an original thought.” Perhaps some forecasts do have value.

Hip Hop IPO
Posted by Eddy Elfenbein on December 10th, 2007 at 9:53 am

Luther Campbell, the creative force behind 2 Live Crew and some of their timeless melodies such as The Fuck Shop, Get the Fuck out of My House and I Ain’t Bullshittin, has taken his company public.
The New York Post reports:

The hip-hop legend – personally responsible for the “Parental Warning” on CDs thanks to the rebellious and outlandish lyrics on his group’s 2 Live Crew discs – has merged his entertainment and sports management company into a public shell company that’s now listed on Nasdaq.
Luke Entertainment Group, ticker symbol LKEN, started trading last month.
“Going public gives me more freedom and a better opportunity,” says Campbell, 46, who’s known in the music industry as Luke Skyywalker.
Campbell, who will serve as Chief Creative Officer, hopes to mimic other so-called 360 deals like the one Live Nation recently inked with Madonna. That is, to represent talent in more than just record deals but in concert promotion, tour management and in other areas.

Hmmm. I have to say I’m not terribly impressed by someone who adds an extra “y” to Skywalker being the Chief Creative Officer. The article notes that the stock closed yesterday at $1.
(Via: The Stalwart).

God, Money and the New York Times
Posted by Eddy Elfenbein on December 9th, 2007 at 3:04 pm

This is from the New York Times’ editorial on Mitt Romney’s recent speech:

Mr. Romney dragged out the old chestnuts about “In God We Trust” on the nation’s currency, and the inclusion of “under God” in the Pledge of Allegiance — conveniently omitting that those weren’t the founders’ handiwork, but were adopted in the 1950s at the height of McCarthyism.

That’s not quite right. The motto “In God We Trust” first appeared on U.S. coins during the Civil War. Although there have been periods when it was removed, the motto has appeared on all U.S. coins for nearly 100 years.
The motto was later added to U.S. paper currency in October 1957, which wasn’t exactly “the height of McCarthyism,” considering that the senator had been dead for five months.
The Treasury Department’s website has the details.

Prophet of Innovation: Joseph Schumpeter and Creative Destruction
Posted by Eddy Elfenbein on December 7th, 2007 at 3:35 pm

Brad Delong reviews Thomas K. McCraw’s Prophet of Innovation: Joseph Schumpeter and Creative Destruction:

Over the previous two and a half centuries, three different economic worldviews, in succession, reigned. In the late 18th and early 19th centuries, Adam Smith’s was the key economic perspective, focusing on domestic and international trade and growth, the division of labor, the power of the market, and the minimal security of property and tolerable administration of justice that were needed to carry a country to prosperity. You could agree or you could disagree with Smith’s conclusions and judgments, but his was the proper topical agenda.
The second reign was that of David Ricardo and Karl Marx. Their preoccupations dominated the late 19th and early 20th centuries. They worried most about the distribution of income and the laws of the market that made it so unequal. They were uneasy about the extraordinary pace of technological, organizational, and sociological change, and about whether an ungoverned market economy could produce a distribution of income — both relative and absolute — fit for a livable world. Again, you could agree or disagree with their judgments about trade, rent, capitalism, and machinery, but they asked the right questions.
The third reign was that of John Maynard Keynes. His agenda dominated the middle and late 20th century. Keynes’s theories centered on what economists call Say’s Law — the claim that except in truly exceptional conditions, production inevitably creates the demand to buy what is produced. Say’s Law supposedly guaranteed something like full employment, except in truly exceptional conditions, if the market was allowed to work. Keynes argued that Say’s Law was false in theory, but that the government could, if it acted skillfully, make it true in practice. Agree or disagree with his conclusions, Keynes was in any case right to focus on the central bank and the tax-and-spend government to supplement the market’s somewhat-palsied invisible hand to achieve stable and full employment.
B ut there ought to have been a fourth reign, for there was a set of themes not sufficiently explored. That missing reign was Schumpeter’s, for he had insights into the nature of markets and growth that escaped other observers. It is in that sense that the late 20th and early 21st centuries in economics ought to have been his: He asked the right questions for our era.

Looking Behind Today’s Jobs Report
Posted by Eddy Elfenbein on December 7th, 2007 at 10:34 am

The government reported that unemployment rate in November remained steady at 4.7%. One of the problems about the unemployment rate is that it only measures people looking for a job. If you’re not out there looking, you don’t count. Obviously, the worse the job market is, the more people stop looking for work.
At the beginning of the decade, around 67% of the population was considered part of the jobs market. Today, that number is closer to 66%. One percent is a big deal in a country this size.
If the labor market participation rate simply matched the peaked number from February 2000, then it would mean that nearly three million more people would be in the job market.
Here’s a more accurate picture of employment. This chart shows the number of people working as a percentage of the entire population.

It’s not horrible, but it’s hardly something to brag about either. Clearly, we’re far from our full potential. What I find interesting is the deterioration in the number this year. The good news is that today’s number is a small break in that trend. In November, we saw the largest increase in the percent of the population employed in over five years.

Nicholas Financial Is Now Trading Below Book Value
Posted by Eddy Elfenbein on December 6th, 2007 at 3:27 pm

Shares of Nicholas Financial (NICK) are now down to $7.20. According to the most recent 10-Q, the company’s book value is $7.50 a share.

It Was Only a Matter of Time
Posted by Eddy Elfenbein on December 6th, 2007 at 1:12 pm

Tired of those socially responsible funds? Well, Focus Shares gives us a sin-based ETF. You guessed it…the Sindex.
*Groan*
The ticker symbol is PUF.
*Double Groan*
Here are the stocks in the Sindex:
ABV UN AmBev -PN (ADR)
AOI Alliance One International Inc.
ASCA Ameristar Casinos
BF.B Brown-Forman Corp.
BTI UA British American Tobacco (ADR)
BUD Anheuser-Busch
BYD Boyd Gaming Corp.
BYI Bally Technologies Inc
CEDC Central European Distribution
CG Loews Corp. – Carolina Group
DEO UN Diageo (ADR)
HET Harrah’s Entertainment
IGT International Game Technology
ISLE Isle of Capris Casinos Inc
LVS Las Vegas Sands
MGM MGM Mirage
MO Altria Group, Inc.
MPEL Melco PBL Entertainment Macau Ltd.
PENN Penn National Gaming Inc
PNK Pinnacle Entertainment
RAI Reynolds American Inc.
SGMS Scientific Games
SHFL Shuffle Master
STZ Constellation Brands
TAP Molson Coors Brewing Company
UST UST Inc.
UVV Universal Corp.
VGR Vector Group
WMS WMS Industries
WYNN Wynn Resorts Ltd

High-Yield Defaults Could Quadruple
Posted by Eddy Elfenbein on December 6th, 2007 at 9:34 am

Here’s a stunning story. Moody’s says that high-yield bond defaults will quadruple next year, and that’s assuming the economy doesn’t go into a recession. If it does fall into a recession, defaults could rise tenfold.

The global default rate will rise to 4.2 percent by November from 1 percent now, the lowest since 1981, Kenneth Emery, director of corporate default research at Moody’s, wrote in the report e-mailed today. His forecast is based on an assumption the U.S. economy slows without falling into recession. In a recession, defaults may approach 10 percent, he said.
“We’re certainly looking for an economic slowdown next year and a pick-up in default rates,” said Simon Ballard, macro credit strategist at ABN Amro Asset Management in London. “Any default rate above 3.5 percent would require a very bearish outlook on the U.S. economy.”
More than one in 10 of the borrowers to which Moody’s assigns ratings are treated as “distressed” by bond traders, the highest proportion since global defaults reached 10.5 percent in 2002. At that time, bondholders charged as much as 11.4 percentage points above government rates to buy high-risk, high-yield debt, double the current average of 5.73 percentage points, according to Merrill Lynch & Co. indexes.

JOSB Same-Store Sales Up 15%
Posted by Eddy Elfenbein on December 6th, 2007 at 9:12 am

From MarketWatch:

JoS. A. Bank Clothiers Inc., (JOSB) the Hampstead, Md., retailer, reported that for November, same-store sales rose 15% while total sales increased 25% to $63.1 million from $50.6 million in the year-earlier month. A survey of analysts by Thomson Financial produced a consensus estimate of same-store sales up 2.2% in the month.