Thursday, April 29, 2010

The Greater Good

In between the bowing and genuflecting before the altar of the Oracles, here’s a question I hope someone asks Warren Buffett and Charlie Munger at this weekend’s Berkshire Hathaway lovefest: What is the right balance between acting in one’s self-interest versus acting for the greater good?

If any two people can provide the answer to this question and apply it specifically to economics, finance, and business (not to mention the current regulatory and legislative environment targeted directly at the financial services industry), it’s the Oracles.

Now, we know that the decision regarding self-interest versus the greater good has already been decided quite some time ago in certain realms. For example, the Vampire Squid was certainly acting in its own self-interest when it exploited its market maker position via its prop trading using what one of the Oracles called “financial weapons of mass destruction”. And, despite political posturing from semi-informed Senators, the Vampire Squid is certainly correct in arguing that the “sophisticated” investors on the other side of their prop trades know “buyer beware” applies at all times. Moreover, there is little doubt certain other squid-like entities with prop trading businesses share the same sentiments and philosophy.

Then there is the political realm, which is rife with self-interested behavior. For example, a Senator or Congressperson representing a state or district is elected to do the bidding of his/her backers – a little pork here, an earmark or two there.

Where it gets most intriguing is when the two realms – finance/business and politics – intersect a key moment in time. I am speaking of Senator Ben Nelson of Nebraska (the state within which Omaha and the Oracles reside) and his no-debate-on-financial-regulatory-reform-until-we-grandfather-key-derivativs-transactions vote.

On the surface, Senator Nelson appears to be acting for the sole benefit of a key constituent – Berkshire Hathaway. But is that action in the best interest of the state that Mr. Nelson represents? It’s citizens (beyond the Oracles and their local employees)? The country? What exactly does being elected to represent a state within a union mean?

This is what I hope someone will engage the Oracles for an answer. And I am not speaking of it in the obvious, narrow partisan political sense but in the larger context of individual self-interest and the greater (collective) good.

What is the right balance? What serves the greater good – acting in one’s own self interest even to the seeming detriment of the greater good or deferring (eliminating?) the self-interested benefits at potentially great individual expense (for the moment or longer) and thereby allowing others to gain?

Is the first approach solely about greedy behavior that serves no purpose beyond enriching those directly involved? Or is such a Darwinian/advocate/self-interest approach vital to growth, peace, and prosperity for more than only those directly and favorably impacted – in effect for the greater good?

Or is the second approach one that seemingly enhances the greater good at the expense of a diminished entrepreneurial spirit – a spirit that enabled homo sapiens to evolve out of the primordial swamp (the pleasure principle, writ large)? Moreover, will the second approach produce an arbitrage situation in which self-interested parties seek other outlets thereby damaging the greater good?

What Oracles Are For

These are kind of questions that Oracles are created for: To provide insight into the larger themes that impact all of us. To impart wisdom into areas that require it and that can enrich us in immeasurable ways.

Being in the presence of greatness does not make you great. You cannot gain wisdom and good judgment simply by viewing a work of art or by catching a whiff of a great man’s aftershave lotion. Rather, taking advantage of the collective wisdom of the Oracles is far more rewarding via challenging questions for great minds.

The pilgrimage to Omaha, at this specific point in time under these specific circumstances involving these specific parties, provides the ideal setting for all us mere mortals to derive the benefit of the wisdom of the Oracles. Wisdom that will hopefully serve the greater good.

Friday, April 23, 2010

Beyond the Sound Bite: An Interview with Dr. Rob Atkinson

We kick off our Innovation Series with an interview with the CEO of the Information Technology and Innovation Foundation and his pointed concern regarding the substantial decline in the US's standing in innovation, how it will impact the global competitive position of the US, and the issues involved competing with mercantilistic economic systems (e.g. China).

Beyond the Sound Bite podcast interviews can be found at
To listen to this interview, click here

Wednesday, April 21, 2010

Beyond the Sound Bite: An Interview with Philip J. Orlando, CFA

My third interview with Federated Investors' Senior Vice President, Chief Equity Market Strategist, Senior Portfolio Manager includes a constructive view for a sustainable cyclical economic recovery based on a successful handoff from government spending to private sector growth, pent up US consumer demand, benign inflation (for now), and solid global growth in manufacturing. The longer-term, more secular issues related to the explosive growth in government debt and what is the right balance for regulatory reform are also discussed.

Beyond the Sound Bite podcast interviews can be found at
To listen to this interview, click here

Tuesday, April 20, 2010

Re: Today's Blog Posting and Obama's Newfound Political Acumen

Advice from the movie "The Untouchables". Substitute Wall Street for Capone.

We’ve Seen This Movie Before

The dramatic news on Friday (re Goldman Sachs) has a more narrow impact (directly on Financials) and a far more limited impact on the broad market as the economic recovery and its sustainability are significantly more important to equity prices overall.

The limited broad market impact would be for Financials to begin to struggle and potentially produce a negative contribution to higher prices. However, the likely offset is a rotation away from Financials and into other sectors where less governmental activism exists. This is similar to what occurred with the Healthcare sector, as the debate became law. Healthcare stocks may have underperformed but the overall bull market remained intact. The same is very likely to occur going forward re Financials and the broad market.

Concerns re an activist government (greater regulation, lower profit margins) appear to be somewhat overblown. The Obama administration's axiom – “Don’t let the perfect be the enemy of the good” – demonstrates both a pragmatic approach to issues and no intention of destroying whole industries and the companies within, the histrionics of the right wing opposition notwithstanding. The price that is being asked to be paid (in the form of greater/tighter/smarter regulation) appears to be a very reasonable one given the economic debacle that succeeded the more laissez-faire approach to regulation.

What may be some concern to investors is the masterful manner in which the Obama administration has finessed their opposition. In a series of events that can only be viewed a classic Clintonian, consider what occurred the past week:

• On Wednesday (April 15, 2010), President Obama meets with congressional leaders at the White House to discuss financial regulatory reform.
• Senate Republican minority leader Mitch McConnell (providing an outstanding example of Pavlovian behavior) steps out of the meeting (fresh from his recent sojourn to the titans of Wall Street) to declare that President Obama is on the wrong side of this issue.
• On Friday, the Securities and Exchange Commission charges Goldman Sachs with investor fraud.

At this point, someone needs to hand Senator McConnell a towel to wipe the egg off his face.

This week, more bank earnings results will be reported, including those from none other than Goldman Sachs (Tuesday, April 20th). The results are sure to further inflame the public outcry re bank bailouts and buttress the efforts of the Obama administration and the Democrats to push through financial regulatory reform.

The consequences of a victory in financial regulatory reform will have repercussions in this fall’s midterm elections. Moreover, it is the manner in which Obama handled the Republicans this time around that is yet to be fully digested by most investors (think Bill Clinton and his famous triangulation strategy). It does appear that the Obama administration (and President Obama, in particular) have relocated their political voice and have combined that with a governing style that needs to better appreciated by investors.

Investment Strategy Implications

Right now, what matters more to equities is the global cyclical recovery. The challenge will be whether the economic handoff (from government spending to sustainable private sector growth) can truly occur. That is a question that still remains to be answered. Despite the solid earnings results of 4Q09 and thus far from 1Q10, it is hard to determine whether growth can be sustained without the life support mechanisms put in place by governments around the world. And the growth in debt, the extraordinary and inventive governmental actions (quantitative easing, for example) and the generous amounts of liquidity cannot go on indefinitely.

The longer-term structural problems (e.g. debt levels, consumer demand in emerging economies, imbalanced domestic growth policies in key emerging economies (notably China), the currency straightjacket on weak economies within the Eurozone, among others) along with the aforementioned Obama’s emergent political skill wait in the wings and may become the rationale for the long overdue market correction. These fault lines are to be monitored closely for signs that they will become the focal point for investors. This is where market intelligence earns it pay*.

In the meantime, the excess liquidity and encouraging cyclical growth remain center stage for most investors. A clear case of the cyclical over the secular. Accordingly, there is little reason for investors to move to the sidelines and adopt anything more than a cautiously bullish position. There will come a time for a more aggressively conservative view. That time does not appear to be now.

*The absence of traditional investors is also a worrisome sign as trading continues to be dominated by the fast money crowd. More on this in a future posting.

Friday, April 16, 2010

Beyond the Sound Bite: An Interview with Phil Roth, CMT

Is the bull done? "Not yet", says the Wall Street veteran and Chief Market Technical Analyst with Miller + Tabak. However, a period of an extended correction/consolidation (e.g. the late 1970s) is a good probability as is the risk of seemingly out-of-the-blue, sudden declines (e.g. January 19 to February 8 of this year). Making his fifth BTSB appearance, Phil also shares his views re the continuing absence of traditional investors in the current bull market, the recently elevated levels of investor optimism, and the importance of 4.25% in the 10 year US Treasury rate.

All Beyond the Sound Bite podcast interviews can be found at
To listen to this week's interview, click here

Wednesday, April 14, 2010

Beyond the Sound Bite: An Interview with Sam Stovall

Earnings season gets underway, companies don't disappoint, and stocks respond in kind. What does it mean? Making his fourth BTSB appearance, the Chief Investment Strategist with Standard and Poors equity research group applies the historical to the present putting the good economic and market news in context.

Beyond the Sound Bite podcast interviews can be found at
To listen to this interview, click here

Friday, April 9, 2010

Beyond the Sound Bite: An Interview with Komal Sri-Kumar, Ph.D.

If you are looking for a truly out-of-consensus view re the economy and markets, my interview with the Chief Global Strategist and Chairman–Comprehensive Asset Allocation Committee for TCW will not disappoint. The economic risks of a double dip (courtesy the slingshot effect), the uncertainty re the economic handoff (from government spending to sustainable private sector growth), and a stagflation (you read that correctly!) resistant portfolio mix are among the many interesting and challenging views expressed by my guest.

Beyond the Sound Bite podcast interviews can be found at
To listen to this interview, click here

Thursday, April 8, 2010

Earnings Season Is The Reason…

…not to sell your equity positions. At least not yet.

Based on the fact that a sufficient number of macro economic reports came in above consensus expectations during the first quarter, there is a high probability that 1Q10 earnings results will exceed earnings expectations in the coming weeks. And that appears to be more than enough of a reason for investors to sit tight with their equity holdings for just a touch longer.

Producing its second highest reading since being created one year ago, the Blue Marble Research proprietary Macro Economic Reports Indicator (MERI) registered a +8 for the first quarter of this year. The +8 number is second to the +12 reading for 2Q09, a quarter that resulted in well above consensus earnings reports for that quarter. Since most investors are of the bottom up stripe, waiting for the good earnings news should help restrain same investors from heading for the exits BEFORE the positive data is shared. The most immediate stock market relevance to the earnings reports is what happens to stock prices as the results are published. For those more bearishly inclined, the soon to be reported good news earnings season sets up a potential “buy on the rumor, sell on the news” scenario for stocks. However, on its own, such an occurrence is likely to NOT result in the long anticipated big correction (>10% in the US, >20% in higher beta markets).

Not Enough For The Big Enchilada

For something more substantial to occur to the downside in stocks, something more substantial needs to arrive on the scene to serve as the catalyst that brings into doubt both the sustainability of the bull market AND the economic handoff (from government spending to private sector growth) necessary for a sustainable economic recovery. There are many candidates capable of serving the role of stock market correction catalyst, with the leading prospect being rising long-term US interest rates. In this regard, the 10 year US Treasury rate is the prime suspect for the role.

As I noted in last week’s commentary, a rise in longer-term interest rates would produce a hit to valuation models that would be both direct and immediate. In its most simplistic form: rates up, P/E ratios down. Given the fact that so much of this bull market is anchored in the above average P/E ratio thesis (>15 times earnings, so justified due to low interest rates and low inflation), rising rates hold the potential of blowing a meaningful hole in that view – enough to take stocks prices down for the prescribed market correction amount (>10% in the US, >20% in higher beta markets).

What About Higher Growth Rates?

All fundamental valuation models identify two factors has having the largest impact on the present value of an asset – the discount rate (which includes interest rates) and the growth rate (of future cash flows/earnings). Accordingly, the offset to rising interest rates – rising growth rates – would most likely not occur as immediately as the bulls would argue due to concerns regarding the viability of sustained economic growth, as the aforementioned economic handoff will be brought into question courtesy the implications embedded in higher long-term interest rates. Regardless of what might be speculated re rising long-term rates, the very fact that rates are now on a upward glide path should be more than sufficient to raise the appropriate cautionary views toward equities.

Then there is the technical analysis hit to the market, as the upside move in rates would trigger a plethora of market technicians’ forecast of a major, multi-year head and shoulders bottom – with its measured upside move to 6%. As investors seek to make sense of the rising rate environment, market technicians will do their part in duly noting the message of the market – whatever it may be saying.

Our Old Friend The Shadow Banking System

Another equally important candidate for the catalyst role would be a global version of the Greek fiscal drama currently underway. As the lack of transparency in the sovereign and other debt markets (which I would include US states and other governmental municipalities throughout the world in that mix), just who is on the hook for what remains shrouded in the shadows (as in the shadow banking system). Such as point was noted quite articulately in yesterday’s FT commentary by Ken Rogoff.*

Investment Strategy Implications

To some investors, what I described above could easily be perceived as an attempt to squeeze out a few more basis points from the overvalued, long-in-the-tooth stock market stone. Such thinking may actually turn out to be correct. However, absent a catalyst it is hard to envision what could derail the bulls momentum.

Given the massive amounts of cash still sloshing around the world economy and financial markets, the strong economic health of most businesses, globalization damaged but not broken, and the global growth story still fairly intact, it appears logical that something more substantial will be needed to bring into doubt the bullish case. And that is what market corrections are all about – doubt that what was will resume.

For such doubt to arise, a catalyst is most likely needed to trigger the requisite angst that is the hallmark of a stock market correction. In this commentary, you have the two leading candidates for that role. There are others.

This is not a matter of if but when (and who).

*”Bubbles Lurk in Government Debt”, Financial Times, April 7, 2010.

Wednesday, April 7, 2010

Beyond the Sound Bite: An Interview with Joseph Battipaglia

My annual conversation with the Market Strategist/Private Client Group for Stifel Nicholas and Chief Investment Officer with Washington Crossing Advisors includes the prospects of an economic handoff to the private sector and a sustainable recovery, the risks of yet another jobless recovery, and the consequences of high corporate profitability and excess cash.

Beyond the Sound Bite podcast interviews can be found at
To listen to this week's interview, click here

Monday, April 5, 2010

Beyond the Sound Bite: An Interview with David Wanetick

With earnings season just around the corner, my conversation with the managing director of IncreMental Advantage provides an excellent introduction to understanding how to value intangible assets (e.g. patents), valuing emerging technologies, and identifying the most applicable methodologies to intangible asset valuations.

Beyond the Sound Bite podcast interviews can be found at
To listen to this week's interview, click here