Arguing with Paul Krugman - March 29, 2010
It has been far too long since I last made a posting on my website, so I figured what better way to come out of my hiatus than to argue with a Nobel Prize winner about…economics. As both regular readers of my website know, I recently recommended Paul Krugman’s book Depression Economics. I continue to be a fan of his commentary and I have found him to be one of the few consistent sources of rational, articulate debate among the sea of hyperbole surrounding the Great Recession and the subsequent fiscal stimulus.
Dr. Krugman has taken issue with many conservatives who have railed against the massive government stimulus. He has rightly argued that the debt resulting from the stimulus is well worth the benefit of avoiding a global economic depression. While it has become fashionable since the threat of a depression has passed to criticize the stimulus as excessive, Dr. Krugman has argued that it did not go far enough. I have not had any fundamental disagreement with him on any of these points, as it is inevitable that revisionists will downplay the likelihood of a threat after it has been (seemingly) averted.
Where I have some issues with Dr. Krugman is in the way he has characterized the apparent structural deficit that has been forming in the United States. Short term deficits to avert depressions and long-term recurring deficits are two distinct kettles of fish. Dr. Krugman has made the kind of articulate, well reasoned points one would expect of a Nobel Prize winner in his arguing the wisdom of large short-term deficit spending to prevent a global economic depression. His arguments in favour of the apparent ongoing structural deficit have been less impressive.
Dr. Krugman’s argument is that according to the Obama administration’s forecasts, the national debt by 2020 will be 70% of GDP and that is not that big a deal. He has stated that several European countries have gone as high as 100% of GDP and lived to tell the tale. I have two problems with this argument. First, the official government forecast in the year 2000 was for a large budget surplus in 2010, so how much faith can we have in a government (or anyone’s) forecast for 10 years from now?
The second issue I have with the argument is that other countries have managed greater proportional debt loads in the past. What I doubt about this argument is not its veracity but rather its relevance in the future. This same argument could have been used a very micro level to justify taking on a very large 40 year mortgage. Many people could have rightly said that other people had had larger mortgages in the past and things worked out. They could have said that interest rates are forecasted to stay low and that their incomes should rise in the coming years. There was nothing particularly wrong about the assumptions, but nevertheless, the assumptions turned to be wrong. What if there is a double dip recession? What if the global economy stays flat for next few years? Or more ominously, what if China has the kind of crisis that most Asian economies had in the late 90s and almost every emerging economy experiences at one point or another? What would happen to US interest rates if China could not buy US bonds and had to raise money itself? If yields on government debt went up, what effect would that have on the US economy and the Obama budget forecasts?
Paul Krugman may well be right that the concerns about the deficit are overblown, but I would like to hear some more Nobel Prize worthy analysis on the potential risks of long term structural deficits.
Are you nervous about flying? You wouldn’t be alone
even with all the statistics that say it is the safest form of
transportation and with all the new security and safety regulations.
The fact is there is a risk every time you fly no matter how skilled
and dedicated the pilot is. If you are one of the lucky ones who sleep
like a baby on airplanes, imagine for second the following scenario.
Imagine for a moment that there was a new cockpit that allowed pilots,
and only pilots, to survive even the most horrific crash. Imagine also
that airlines had a bonus plan in place for pilots based on how little
fuel they take off with. The less fuel the pilot takes off with, the
larger the bonus if he manages to land the plane. If he can cut it
really close, these bonuses can total more than 50 times his base
salary and he receives no penalty for the number of passengers killed
on the trip. How well would you sleep on that pilot’s plane?
That
scenario might sound a little farfetched, but that is pretty much the
current bonus system for investment bankers. In fact, it is even worse
than the example of the pilot in that bankers have an incentive to
cause crashes. The reason is that bonuses do not go negative. An
investment banker will have the same bonus whether his firm loses a
thousand dollars or a billion. On the other hand, there is essentially
no limit to what a banker can earn when things are going well.
When
the stock market is flat or slowly increasing over time, it is very
difficult for a trader or investment banker to make enormous gains, but
when they are volatile their earning potential increases exponentially.
When the market is hammered and stocks get driven down to rock bottom
prices (and provided the government is prepared to come in and clean up
the mess), virtually all traders will perform well. To steal a line
from Woody Allen, 95% of a trader’s performance after a financial
crisis is attributable to just showing up.
When it comes to
the topic of banker compensation, I admit that I am long on complaints
and short on solutions. Smarter people than me are still struggling
with this issue but this may be a case where increased government
involvement is necessary. I believe in free markets, but in the
financial services sector at least, the old balance of risk versus
reward has been turned on its head in that the government is now
prepared to accept the risks while bankers chase rewards. If bankers
want government involvement in their risks they should be willing to
accept some involvement in their rewards.
Dubai Rhymes with Bear Stearns - December 2, 2009
If
the past few years have taught me anything, it is that greed and fear
are the two most powerful drivers of the stock market. We were due for
some sort of market recovery simply because the market had been pricing
in the collapse of civilization in February, but it is the same
pre-recession greed that is driving the market back up towards
pre-recession levels. Just as in every other rally, investors are
worried about missing out on the gains so the more the market goes up,
the more money they put into it.
I have gained some personal insight into this phenomenon in recent
months as I have been experiencing this exact same feeling. While I
once felt smug for picking up some stock at the bottom, I have recently
begun cursing myself for not buying more when I had the chance as I
watch the market’s relentless move upward. I know that a wise investor
resists these temptations, just like an intelligent person does not
bother paying attention to salacious rumours about Tiger Woods’
personal life. I consider myself a wise investor and an intelligent
person, but I have recently failed on both accounts.
Mark Twain once said that history does not repeat itself but that it
rhymes. If that’s true then Dubai now rhymes with Bear Stearns. When I
first heard the Bear Stearns story I thought the market would
completely collapse the next trading day. Investors though were not yet
ready to believe that dark times were approaching and the market
continued along by inertia before the reality of the economic crisis
shattered the complacency like a 7-iron through an Escalade windshield.
After a day of jitters, the market decided it was not ready to believe
that the dark times are not completely behind us.
Just three days after Dubai announced that it is seeking to defer
payment on $90 billion in liabilities from state-run companies, the
market is back above pre-announcement levels. I can’t help but think
that investor complacency has something to do with that.
Mission Accomplished - August 31, 2009
Shortly after the fall of Baghdad, George W. Bush infamously stood on
an aircraft carrier in front of a giant Mission Accomplished sign and
declared that major combat operations in Iraq were over. Six years
later, the conflict still goes on and American soldiers continue to be
killed on a regular basis. In 2003, the first stage of the war was
indeed over. The Iraqi army had been defeated and the hard work of
rebuilding the country and creating stability was about to begin. Some
have claimed that the sign was never meant to suggest that the military
operations were over, but it is clear that the people who thought it
was a good idea to hang that sign had no idea how difficult the years
after the war with the Iraqi would be.
Some economists and central bankers have recently declared that the
global recession is now essentially over. I have not heard any
economists say that all economic problems have disappeared and the
world economy is about to begin growing by leaps and bounds.
Nevertheless, investors seem to have reacted to the end of the
recession much the same way the Bush administration reacted to the fall
of Baghdad; by assuming that all of the economic difficulties have
disappeared along with the recession. In the process, they have sent
the stock market on one of the best six month runs in history. The
market seems to have the same optimistic outlook to the recovery as
Dick Cheney had to the post-war reconstruction.
At the end of February 2008, I wrote that investors had a similarly
complacent attitude towards the initial credit crunch as Europeans had
to the invasion of Poland in 1939 and that much like the war, the worst
may be yet to come. In the fall of that year complacency suddenly gave
way to complete panic and I cannot help but feel uneasy at the
possibility that the current steady stream of good news and optimism
could come to a sudden halt.
I don’t want to give the impression that I am among the sceptics who
still think that there is a strong chance the world will still slip
into a depression. I believe that there is good long run value in many
stocks even after the run-up, but I can’t help feeling that there could
be some significant short term jitters once people begin to realize
that there may be a long road ahead of us as we come out of the
recession.
It almost seems like in the past two years there have only been two
types of investor sentiment; wildly optimistic greed and complete
panic. This has put me in the odd position of believing the
fundamentals may justify stock prices at these levels, but that it
isn’t fundamentals that are causing stocks to be priced as they are. I
am convinced that a fear of missing out on easy money is at least
partly driving this rally. I believe that because I get that same
feeling each day the stock market continues to go up.
The Price of Oil - July 26, 2009
My ability to forecast the price of oil has always been as dismal as my ability to predict the price of stocks, but I believe the current recession has provided investors with some valuable insights on the long term outlook for oil. In the middle of what has been popularly described by the financial media (and therefore true) as the worst economic downturn since the Great Depression, the price of barrel of oil is hovering around $70. It was only a few short years ago, as we were entering the bull market, when $55 oil was considered by many to be a bubble and unsustainable. The question investors should be asking is how high the price of oil will go during the economic growth cycle (I will go out on a limb and predict that the recession will end in my lifetime)?
I believe that the recession has been instructive in that it has illustrated the worst case scenario for oil. If we work off the assumption that the risk of a complete global meltdown has now subsided and we will not be going back to living in caves in the near to medium term, there are now two probable scenarios. One is that is that the global economy begins to quickly gain momentum in the near term and we see a surge in the demand for oil. The other is that the economy begins to stabilize and then slowly starts a moderate recovery.
One consequence of the crisis is that credit and financing all but dried up, particularly for risky projects like oil exploration. Less exploration today suggests there will likely be fewer sources of new production in the short term if there is a rapid increase in demand. That could easily lead to a spike to well over $100 and perhaps to the $140 level we saw during commodities boom (or bubble, depending on your agenda) of a couple of years ago. If the economy slowly recovers, investors can take comfort in the fact that the oil price should slowly but steadily increase along with it, which should provide some respectable stable returns in some major oil stocks.
In order to take advantage of rising oil prices, I have been doing a little research on a number of oil companies and recently added a few shares of Husky Energy to my portfolio. It pays a decent dividend while I am waiting and may also be a Chinese takeover candidate someday, but that is a topic for another day.
Cautious on US Dollar - July 6, 2009
Some time ago as part of a posting about Wal-Mart when the Canadian Dollar was worth about 95 cents US, I wrote that the US dollar would likely not stay that low in the long term and should help supplement the gains from holding US stocks. Since that time the US Dollar has indeed strengthened significantly, however, in light of numerous factors, not the least of which is the Federal Reserve printing money, I am no longer banking on any further gains from US dollars.
The US government is now doing much the same as consumers were doing in the run-up to the current recession. Unlike consumers, when it runs out of money the US government, with the help of the Federal Reserve, has the ability to simply print more. The government’s spending plans do not seem to have any relation to the amount of money that it brings in. No number is large enough to make headlines anymore. We seem to have reached a point where a trillion dollars no longer seems like a lot of money. The basic laws of supply and demand suggest that there will come a point where the supply of US government bonds will exceed the demand for them. At that point the government will either be forced to pay a much higher interest rate on the debt of the Federal Reserve will run the printing press and purchase the bonds itself.
There is no shortage of stakeholders with a vested interest in keeping the US dollar high, not least of which are China and Japan, whose economies depend on exports to the United States. These countries will happily buy US bonds as a short term solution to a financial crisis, but if such spending continues after the crisis and recession, it stands to reason that their willingness to buy trillions of dollars in long term government bonds will be severely tested. As much as I had once doubted it, we may be witnessing world’s global currency shift from the US dollar to the Euro, much as it once shifted from gold to the dollar.
There are many people out there who are constantly rooting against the United States and have always seen signs of the country’s imminent collapse. I am not one of those people and I am well aware that the country has always managed to recover from previous rough patches, not the least of which was the Great Depression. I am not discounting the ability of the United States to put its financial house back in order, but, I have modified my expectations regarding the US dollar. A year and a half ago, I was factoring in some long term gains in the currency; now I am factoring in a decline.
Ford versus Government Motors - May 7, 2009
If Ford is able to survive the current crisis without having to go to the government with cap in hand to ask for a bailout, I believe that it will not only surpass Government, I mean General Motors, but that it will become a serious competitor to Honda and Toyota. While its sales have been falling, its market share has been consistently increasing.
There are two things that should help Ford in the coming years. The first is relates to the growing “bailout fatigue” in the United States. Americans are understandably becoming fed up with the hundreds of billions of their tax dollars that are being used to bail out companies that have mismanaged their business and failed to prepare for the current recession. It stands to reason that as the only US automaker not to accept government money, Ford should experience a significant public relations boost. While it is not possible to quantify the effect this will have on sales, there will certainly be plenty of bitter taxpayers who will switch from GM to Ford.
The second, and by far the most important advantage that Ford will have is that government will have no say in how it runs its business. There is a popular myth currently being propagated by the media and Congress that the reason the US automakers are in such trouble is because they made too many pickups and SUVs. Now that government has essentially become the most powerful investor in GM, they will apparently try to correct this imaginary problem and in the process create new real ones for the company. All major car companies, Toyota and Honda included, sell the same classes of cars; they all sell compact cars and they all sell large SUVs. By far the biggest problem that the US automakers have had has been their significantly higher salary, benefits, and pension costs. The fact is that if the Big Three had the same labour costs and liabilities as Honda and Toyota, they would not need any government bailouts.
Instead of acknowledging and addressing this fact head on, the government is pretending that if GM can just hang on until it can figure out how to make an electric only car, all its problems will be solved. While electric cars will likely be common in the future, it will conservatively be a decade or two before they would make a significant contribution to a car company’s bottom line. For all the publicity it has generated, the gas/electricity hybrid Prius still makes up a tiny portion of Toyota’s sales.
I am going to make a bold prediction that the Chevy Volt, the electric car that we have heard so much about, will not hit the market on schedule, and when it does, it will initially be filled with glitches and be a money loser for years.
If you want an idea of the strategies that GM could come up with to satisfy its government overlords in the coming years, take a look at its initiative with Segway to produce a two wheeled electric car. Before investing any of your hard-earned dollars in General Motors, I strongly suggest that you spend five minutes staring at the following picture.
Time for high risk stocks - April 3, 2009
After a bear market induced hiatus, I have started watching BNN again recently. I don’t have any stats to back me up on this, but it seems to me that in general the recommendations so far in 2009 have tended to be more defensive than they were a year and a half ago when the market was riding high despite a looming credit crisis. I understand the logic, and even defensive stocks have the potential to deliver a nice return from the current levels, but I can’t help thinking that there might never have been a better time for higher risk stocks than right now. The recent rally offered a glimpse of the returns that can be made if the economy turns around.
I would not suggest that you should run out and start putting all your money in penny stocks, after all, my latest stock purchase was General Electric. There are two ways use a high risk strategy to take advantage of a market turnaround. One is to buy large, relatively high beta stocks (stocks whose returns are strongly correlated with the market returns). These are companies that could realistically double if the market turns around but are highly unlikely to go bankrupt or have its equity wiped out. I purchased General Electric because I thought it might be one such stock.
The other strategy is to be greedy and purchase smaller stocks that do have a legitimate chance of going bankrupt or having their equity completely diluted, but also have a chance of rising dramatically. In normal circumstances, a company’s future earnings are the biggest determinate of its stock price. Right now though, the biggest determinate of stock price is the likelihood of bankruptcy or insolvency. Investors are not looking down the road at earnings streams but rather around the corner at debt convents. Once investors feel comfortable that the company is not in immediate danger of bankruptcy, the stock should spike up even without a significant change in future earnings estimates. The stock could pop again if the company is able to capitalize on the economic recovery, if and when it occurs.
That is the rose coloured glasses scenario. Stock prices are factoring in a risk of bankruptcy because the risk is very real, and there are many companies out there that will not survive this recession. Before you try this strategy, it is important to remember a couple of things. First is that this type of strategy is in a grey area between gambling and investing. Just as you would not put retirement money in a slot machine, you would be well advised to not invest in these type companies if you cannot afford to lose the money. Secondly, if you decide to try this strategy but want to mitigate some of the risk, I would recommend dividing your money among a number of different, preferably unrelated (i.e. not all oil explorers) companies. That way there is less of a chance of getting completely wiped out. A couple of doubles or triples from the survivors should offset a bankruptcy or two. The fewer companies you divide your money among, the closer to gambling the strategy becomes.
I will restrain myself from saying that there is easy money to be made right now as making money in the stock market is never easy. Nevertheless, there has not been a time in recent memory when stocks have been so thoroughly stripped of any vestige of irrational exuberance.
End of an Era for Nortel - February 16, 2009
With the recent announcement that it was filing for bankruptcy, Nortel has solidified its title as the world’s all-time greatest wealth destroyer. It isn’t just the amount of wealth that Nortel destroyed, but the manner in which it went about it. This stock has been an unrelenting wealth destruction machine for almost an entire decade.
Often times a company will quickly go to zero after a major drop in price or stabilize at some point and then work its way back to respectability over time. Nortel lost most of its value right after the tech bubble burst, but then continued to lose half its value repeatedly over the remainder of the decade time until it effectively went to zero. Throughout its long road to perdition, Nortel repeatedly found believers who convinced themselves that it somehow had to recoup some of its losses at some point, as if collective faith could somehow turn the company around. Blind faith may be fine with religion but when it comes to the stock market, all successful investors are agnostic. I can think of nothing other than its name recognition and formerly high share price that justified this faith. Nothing the company has done over the past 8 years has given any indication that the company has a vision to turn the company around and become a clear market leader in any particular industry.
The reason I am writing about Nortel now is not just that I want to highlight one of the few things I got right in the past year (although that is certainly part of it), but because it has some valuable lessons for those brave enough to invest in today’s market. Investors in Nortel had a sound goal in mind; the problem was that investing in Nortel was the wrong way to achieve it. The idea is that if you invest in a good company during difficult times when its price has been beaten down, you can make a nice profit when things finally turn around. Unfortunately, this is much easier said than done. For this strategy to work, you need to find a company that still has the ability to maintain or win a leadership position in its particular industry; there needs to be a clear light at the end of the tunnel. General Electric is one such company that I currently have my eye on. The industries that it is in have all suffered during this bear market, but it is still a strong competitor in them. There is no reason to think that it will not be able to weather these current conditions or that it will not maintain its competitive position once the economy turns around.
When the economy turned around after last recession at the beginning of the decade, Cisco and other technology companies recovered along with it, but Nortel didn’t. That should have been a sign to walk away from the company for good. My goal over the coming months is to come up with a list of strong companies that should deliver a solid return when the economy recovers, whenever that may be.
Christmas is Over, Back to Work - January 20, 2009
On the odd chance that there is someone out there who looks forward to my postings, I apologize for going silent over the past couple of months. Like most people, Christmas is a hectic time for me, so since hardly anyone reads my website anyway, I decided to take a break and enjoy the Holiday Season. Now that I am out of excuses, I will be making posts on a weekly basis. Despite my break from writing, I have continued to periodically use my maturing GICs to purchase index funds over the past several months. My most recent purchase was today, when the market decided to disregard Barack Obama’s exhortation and chose fear over hope.
In a take on Stanley Kubrick’s Dr. Srangelove, over the past few months I’ve learned to stop worrying and love the recession. I didn’t buy my first individual stock until 2004 and didn’t really have any significant stock holdings until well into 2005. As this was already well into a bull market, I always resented those people who were able to pick up companies at ridiculously undervalued prices just a few years earlier. I had to study to do plenty of homework and take some gambles to have a chance at making some healthy returns, whereas a monkey throwing darts a few years earlier looked like a genius. Despite the carnage that this bear market has inflicted, for the first time in my investing life I am actually rooting against the market. Instead of fearing a drop in prices, I am now worrying about a speedy recovery before I am able to invest enough money in the market. I’ve found this to be a very liberating experience.
While many more individual companies will likely go bankrupt, I believe that in the long run, the market as a whole should provide a decent return. I plan to continue to methodically shift cash investments into index funds and will likely take a few gambles on some individual stocks in the coming months.
Financial Shock - book review, November 16, 2008
The reason I bought Financial Shock, by Mark Zandi, was because I wanted to read a book about the current financial crisis and this was the first book on the topic to appear in my local bookstore. In so far as it really is a book about the financial crisis, Financial Shock was not a complete disappointment. While it did make for a lively read, there are a number of major problems that prevent me from recommending this book.
The first problem is simply that the author is writing about a crisis that is still unfolding. I give Mr. Zandi full marks for being quick on the draw with Financial Shock, but no matter how talented the author, right now any book about the financial crisis is going to feel dated almost as soon as it is published. The situation is changing dramatically on a weekly, if not daily, basis. The book was written after Bear Stearns was taken over by JP Morgan but before Lehman Brothers went bankrupt. Mr. Zandi can be forgiven for surmising that the worst may be over, although the statement will no doubt be cringe inducing for any former investors in Lehman Brothers.
The primary drawback of this book, however, has nothing to do with timelines. It has to do with the author’s blatant conflict of interest. Mr. Zandi works for a subsidiary of the bond rating agency Moody’s. To his credit, he acknowledges his lack of independence on that issue and says that he will not be addressing the role of the ratings agencies. While he is absolutely correct that he would be conflicted in addressing the issue, it is impossible to write a proper analysis of the current financial crises without dealing with the ratings agencies. I believe that history will likely show that it was the ratings agencies and their conflicts of interest that were at the heart of the crisis. If the ratings agencies had not given these (now virtually worthless) securities an Aaa rating, most of the subsequent buyers would never have been allowed to purchase them in the first place. To put the author’s conflict in the proper perspective, it would be similar to the infamous analyst Jack Grubman writing a book on the tech bubble and saying that he would not address the role of telecom analysts because he has a conflict.
Mr. Zandi’s narrative flows well and does provide some interesting and relevant statistics, but his analysis, no doubt due to both his rushed timeline and inability to discuss ratings agencies, appears shallow at times. Many of his points are those you would hear on any business news program. If you asked Joe the Plumber or Tito the Builder to list the root causes of the financial crisis they would likely repeat most of those listed by Mr. Zandi, although Joe the Plumber might actually mention the rating agencies. I can’t help but think that some future author may be able to uncover some less obvious and more insightful contributing factors.
One example of his hurried and less than profound commentary is when he states that all asset classes had become overvalued. If the definition of overvalued is that they were higher then than they are now, then yes, everything was overvalued. But many of the largest, most actively traded companies in the United States were still trading well below where they were at the turn of the century. Many analysts would say that based on traditional fundamental analysis measures such as P/E and dividend yields that they were quite cheap by historical standards. The reason why many of these companies were so cheap is that the market was anticipating a slowdown of some sort due to the housing sector. Few investors were surprised that there was a decline in housing prices; what was surprising was the scale of the decline and the affect it had to the global financial system.
Mr. Zandi makes the well worn argument that a fundamental cause of the crisis was that nobody was doing the proper due diligence once banks began to move the mortgages off their own balance sheets and into pools of asset backed securities. This is not entirely correct. Because these mortgages were pooled and sold as bonds, it was the bond rating agencies who had responsibility for assessing the risk of these bonds. Banks did indeed become less diligent with their due diligence because they were selling off the mortgages, but what was the Bond Rating Agencies’ excuse for not doing the proper homework? I can think of only two causes. One would be that the rating agencies are largely incompetent at assessing these types of securities. The other is that they were perfectly aware that these securities were risky but classified them as investment grade so they could bring in more money, similar to the telecom analysts in the 1990s.
Despite its limitations, I did find Financial Shock to be an interesting read as the subject matter is so topical, but I suspect that if you are not planning to read a book about this in the next few weeks that you would be well advised to wait for the next expert to publish his or her take on the situation. The best book on this crisis will no doubt be written some time from now after the dust settles. This is too complex an issue properly analyze in a hurry.
Monkeys for Obama - November 2, 2008
I have been an admirer of John McCain for nine years, but in this US presidential election, I, along with my dedicated staff of monkeys, am endorsing Barack Obama for President. While I do believe Barack Obama is the best candidate for president, I do not get the same thrill up my leg that Chris Matthews and so many of Mr. Obama’s other supporters feel when listening to his oration.
Except for the “palling around with terrorist” nonsense, I agree with much of the criticism of Mr. Obama. Aside from his well documented lack of experience, his apparent unwillingness to clash with his own party is worrying given that the Democratic Party will not only have an iron grip on both Congress and the Senate but will also be frothing at the mouth to exact payback on the Bush administration and its policies. A certain amount of policy reversal is certainly warranted after 8 years of perhaps the most incompetent President in history, but there is a serious risk that the Democrats will go overboard. The President needs to act as a calming influence and a voice of restraint during this volatile time. While there are no clear examples of Mr. Obama challenging his Party as John McCain has challenged the Republicans, his rhetoric, notwithstanding some shameless union pandering regarding NAFTA, has been for the most part pragmatic, though clearly left of center. It is also worth pointing out that he has only been in the Senate for four years and half of that has been spent trying to secure his Party’s nomination for President, so he has not had much time or opportunity to take on his party. If he is elected by the wide margin that is expected on Tuesday, he will be in a much stronger position to chart his own course.
Whatever the risks of an Obama presidency, they are dwarfed in comparison to the risks of electing John McCain. His baffling choice of Sarah Palin for running mate suggests he may continue George W. Bush’s pattern of appointing woefully unqualified and incompetent people to the most important positions in the country.
Perhaps the single biggest reason why I can no longer support Mr. McCain is his temperament and judgment. The supposedly young and inexperienced Barack Obama has maintained a cool and consistent demeanor throughout the financial crisis, while the experienced John McCain has appeared to become discombobulated. Exhibit A would be his dramatic and bizarre announcement that he was suspending his campaign, which turned out not to be a suspension at all. Exhibit B would be his decision to make “Joe the Plumber” the focal point of his campaign. His inability to move on gives the impression that he has run out of ideas.
The John McCain who appears set to lose to Barack Obama is a much different person than the John McCain who lost to George Bush in the Republican Primary almost nine years ago. Someone who has only gotten to know John McCain through the current election would find it difficult to believe that he actually voted against the George Bush’s tax cuts. At the time he apparently believed that the country could not afford them. Instead of benefiting from being proved right by history, he is now proposing to cut taxes even further at a time when the United States is incurring the largest budgetary deficits in history. The John McCain of 2000 would have a great chance of winning this election. Unfortunately, the John McCain of 2008 may get blown out on Tuesday and deservedly so.
Market Massacre - October 16, 2008
Baron Rothschild once said that the time to buy is when there is blood in the streets. But that advice is much more difficult to follow when some of that blood is your own. In an earlier posting I discussed how the only investment I made this past summer was in a good set of golf clubs. I argued that golf clubs are probably one of the best investments you can make in a bear market. In a sign of how bad things have become, I looked at my golf clubs the other day and even they have dropped in value as I was missing my five-iron.
Investors are currently facing a difficult choice. The entire world may be on the brink of a serious recession and conceivably even a depression. If that is the case, the best thing any investor could do would be to hold cash. However, if the concerted efforts of Governments and Central Banks are able to get credit flowing again, this could turn out to be a once in a lifetime buying opportunity. A year from now you will look back on this and the correct decision will appear obvious. Unfortunately, hindsight always comes too late and it would take a mix of genius and clairvoyance to perfectly time the market right now. I will only point out that the markets are pricing in a very bleak future for the global economy. To put things in perspective, many major indices are worth about the same as they did almost a decade ago. If things turn out only slightly better than currently forecast you will likely make an enviable return over the next few years.
While the potential upside is much greater now than it has been in years, so is the potential downside. This is a classic illustration of the principle of investors expecting more return for taking on more risk. If you were to decide to roll the dice in this market, it should go without saying that you should not invest money that you might need in the next year or two. I would also suggest that you keep in mind that while many, and probably most, stocks will see a major price appreciation in the coming years from this point, many companies may not survive this crisis. To avoid the bad luck of picking one of the stocks that will not survive, it may make sense to purchase some index funds instead of individual stocks. In my own case, I will be using cash from some retirement account GICs that matured some time ago to purchase index funds. To smooth out the timing risk, I will be buying small allotments every couple of weeks over the course of the fall. Depending on how the market and my nerves are holding up in a few weeks time, I may also decide to take a chance on one or two individual stocks.
John McCain's Harriett Miers - October 7, 2008
Although my website is about investing, I am writing today about John McCain. That is one of the upsides of not having an editor to overrule you or readers to complain. I have been a devoted fan of John McCain since he first ran for president of the United States in 1999. I was attracted to him because he was unlike any other politician I had ever seen, and I have seen quite a few up close.
Whereas most politicians and even (perhaps even particularly) people who work for political parties are united in a common goal of self advancement, had proven himself to be someone who could put others ahead of himself even under the toughest of circumstances. There isn’t one politician in a thousand who would turn down release from a POW camp before those that have been there longer have been released. I had also never seen a politician be quite open and forthright about his own shortcomings and failings as McCain was in 1999. Unfortunately his straight talking style was not enough to defeat George W. Bush for the Republican nomination, to the great detriment of the United States and the world.
I have followed his campaign very closely this time around and initially my admiration for him grew as he took positions on immigration reform and the troop surge in Iraq that were initially unpopular. As he did in 1999, he appeared to stick to his principles and this time he was successful in becoming his party’s nominee for president.
Unfortunately, my support for John McCain has been steadily eroding the more I learn about, and the more I hear from, his choice for Vice-President, Sarah Palin. While John McCain did not call to ask my opinion, I had always believed that Mitt Romney would have been the logical choice. Even though the two did not get along well, with McCain showing a particular antipathy towards Romney, Romney would have been the perfect balance to his ticket as he has the in depth knowledge and experience with financial markets that Mr. McCain lacks. As someone who has been a public figure for years, and as the son of a former governor, there was little more the press could dig up on him that they did not already know.
Of all George W. Bush’s shortcomings, the most damaging was his judgement in selecting and replacing government officials. He showed a tendency to pick people he liked and who were loyal to him instead of those who were most likely to deliver results. When they did not perform, he remained loyal to them. While this may be admirable in a friend it is not in a president. Any company president who used that method would quickly begin to struggle, much like the United States has in the past eight years. The president’s disregard for competence was highlighted in his Quixotic attempt to nominate his own personal lawyer, Harriett Miers, someone with no experience as a judge, to the supreme court. That stood as the single most appalling human resources decision in history, until John McCain nominated Sarah Palin as his vice presidential running mate.
The point has been made repeatedly that with John McCain’s age and history of cancer, there would be a significant possibility of the Grim Reaper causing Sarah Palin replacing him as president should he be elected. While that is certainly a chilling thought, even if we knew with certainty that John McCain would survive the next four years, how could anyone have any confidence that he would do a better job than George Bush at filling important posts with qualified people? With all the current troubles awaiting the next president, the United States cannot afford another president who surrounds himself with incompetent people.
Efficient Market Plane Crash - September 17, 2008
As you would expect from someone with a website like Blindfoldedmonkey.net, I have long had a keen interest in market efficiency. The reason I created my website was not to argue for or against market efficiency, but merely to explore the question. That question may finally have been answered on Monday, September 8th, when Google, Bloomberg, and a newspaper with an impressive archive of news stories combined to shatter the efficient market hypothesis into pieces.
On the preceding Sunday, Google’s search algorithm dug up an article written in 2002 about United Airlines’ parent company UAL filing for bankruptcy protection in the archive of the South Florida Sun-Sentinel’s website. The exact sequence of events remains murky, but the article was highlighted by Google and was later circulated by Bloomberg and then picked up on by various news organizations. Once reputable news sources like Bloomberg were associated with the article, the stock immediately lost about 75% of its value in the first 15 minutes of trading. Trading was halted shortly thereafter and when it resumed the shares quickly recovered most of their losses.
What makes this story so incredible is that the article was never actually republished and apparently it was clear that it was published in 2002. It is also worth noting that this is not some small company that only has a few thousand shares trading in the run of a day. This is a high profile company with significant analyst coverage. If this can happen with a large company like UAL, one has to wonder what kind of wild inefficiencies occur in the stock prices of small companies on the venture exchange. Presumably there were investors out there who knew right away that the story was ancient history and made a killing on the stock in a few hours. If markets were efficient, it would be impossible to make such easy arbitrage profits on publicly available information.
An Almost Meeting with Robert Novak - August 30, 2008
This summer, my wife and I decided to take a trip to the United States that included a stop in Washington DC. Not wanting to take the chance of my favourite columnist suddenly suffering the same fate as my favourite author, I couriered a letter to Mr. Novak in which I asked if he would allow me to meet with him and autograph my copy of his autobiography. I was I was ecstatic when I received a call from his assistant the day after I sent the letter and she set up a time for me to meet him. Unfortunately, excitement soon changed to apprehension as the day I left on my trip Mr. Novak accidentally hit a pedestrian with his Corvette. Initially I thought that he might have to cancel our meeting because of some court date. In the end, I did not get to meet Mr. Novak but it was because of something much worse than a traffic ticket. That weekend he collapsed while visiting his daughter in Cape Cod and was diagnosed with a brain tumor. I stopped by his office to drop off a card and a bottle of wine to his assistant. She told me to leave my book there and he would sign it and send it to me on when he returned. Unfortunately, in the airport on the way home I saw that Mr. Novak had announced he was retiring and that his prognosis was “dire”.
Last week I received my book in the mail unsigned but with a note saying that Mr. Novak has been too ill to sign it and his condition was unlikely to improve in the near future. I remain hopeful that he will miraculously recover, but he has never been known for exaggeration or being overly dramatic, so I can only assume that his situation is every bit as dire as he says it is.
One of the few things I find more interesting than the stock market is politics and Robert Novak was able to write at least three columns a week for 45 years and always managed to provide some keen insight or inside information in every one. My own attempt to make a couple of postings on my website a month has given me an even greater appreciation for his talent and work ethic.
As big a fan as I am of his column, I am as much a fan of the man behind the column. Many people with only a passing knowledge of the man will know him from the controversy surrounding the leak of the identity of Joe Wilson’s wife, CIA employee Valerie Plame, and consider him to be just another right wing commentator. But in an era when political commentators tend to agree with everything one political party does and denigrates everything done by the other, Robert Novak has been able to maintain his independence and did what he felt was right, even if that made him some enemies from time to time, as in the case of the Valarie Plame affair. Mr. Novak sat in silence and listened to countless people state that he was used by Karl Rove to smear Joe Wilson, but Mr. Novak, who would not compromise his source, kept it to himself that it was actually Richard Armitage, very much a foe of the neoconservatives, who told him that Joe Wilson’s wife worked at the CIA. Furthermore, the conversation had been initiated by Mr. Novak. Nobody had called him to plant a story. He could have spared himself from a great deal of abuse by stating how he learned that Joe Wilson’s wife worked at the CIA but had too much integrity and pride in his job as an investigative journalist to reveal his source. The person whose reputation should have taken a beating in all of this is Richard Armitage, who let Robert Novak twist in the wind for well over a year even though he had told the special prosecutor, Patrick Fitzgerald that he had been Mr. Novak’s source.
People who depend on late night talk shows for their news likely believe that Robert Novak was a mouthpiece for the Bush administration, but they may be surprised to know that he was very critical of the Iraq war from the very beginning and was derided as a Paleoconservative by the neoconservatives who championed the war. In the years following the war he has often found himself treated as an outcast by both the left and the right.
Mr. Novak has on numerous other occasions taken positions that have stood in stark contrast to many of the traditionally core positions of the Republican Party. The best example of this would be his longstanding championing of the cause of the Palestinian people, in particular the beleaguered Christian minority in Palestine. Long before 911 few people in the United States had the interest or the courage to look at the Israeli-Palestinian conflict from the point of view of the Palestinians.
Regardless of how Robert Novak describes his prognosis, I am holding out hope that he will beat cancer and return to his column. The closer we get to the election the more I miss his column.
Golf Clubs: World's Greatest Bear Market Investment - August 19, 2008
At the beginning of this summer I made one of the smartest investments of my life; I bought a good set of golf clubs. In keeping with the spirit of diversification, I replaced my embarrassingly cheap and worn assortment of golf clubs with a Taylor Made driver, a set of Calloway irons, and a Goliath putter. I started playing more rounds of golf, practicing at the driving range, and spending more time on the putting green. Instead of watching BNN videos, I spent some time watching YouTube videos of PGA golfers’ swings.
While my golf game was improving, the market has gone through a severe bout of Schizophrenia. Early in July before going on vacation, I wrote a profile of ICICI Bank which was then trading around $28. Shortly after I wrote the profile news came out that Freddie Mac and Fannie Mae were in trouble and I was preparing to write an update to warn people to proceed with caution on the stock, and then within days it had skyrocketed to $37 as the worry eased. I thought I had once again missed out on a great opportunity to load up on the stock but here we are in mid-August and it is back below $30.
If I were just a little smarter and had a lot more time, I no doubt could have made some nice profits with some short term trading, but knowing my limitations I decided the most sensible thing someone like me could do was to just withdraw from the market altogether. The last trades I made were back in the spring when I took profits in Dianna Shipping and Scandinavian Minerals and I haven’t even logged into my online investment account in months.
Nearly all of the stocks that were on my watchlist in the spring have become significantly cheaper and less volatile in the past three months and I intend to add one or two of them to my portfolio in the next few weeks. I am not attempting to call a bottom on this market, but I believe that a disciplined investor should selectively add to his portfolio during bear markets. It isn’t easy, but it has generally worked better in the long term that rushing into the market when it is at its peak.
Altius Minerals - June 24, 2008
When the news broke the other day that one of Altius’ partners in Newfoundland Refining Limited was attempting to have the joint venture declared insolvent, I felt much like a parent whose honor roll son has just been brought to the door by the police for the first time.
While I have taken profits in Altius on two occasions, it remains one of the best investments I have ever made and I had every intention of maintaining a position in the stock for the long term. I had always had great faith in the company’s management and to this point they have never disappointed. For as long as I have followed the company, management has consistently over-delivered and has focused on creating real, long term value for shareholders instead of hyping their stock like so many other resource companies do.
Altius had made no secret that securing financing in the wake of the global credit crunch was the biggest obstacle in their attempt to build a state of the art oil refinery in Newfoundland, but news that its joint venture, Newfoundland Refining Limited, was on the verge of bankruptcy completely blindsided the market. For now I am holding onto my shares. After losing 42% in a day, the market is pricing in about a zero probability of the refinery being built and I still have sizable capital gain on the position, so I don’t see much point in selling at this time. Depending on what unfolds in the next few weeks, however, I may want to reconsider. A couple of things really bother me about this announcement. First of all, three days after the news broke, there had been no information released by Altius other than to say that the company is seeking bankruptcy protection and that they may need to write off its entire investment in the project. Presumably the company was not as surprised as I was by this announcement, given that they own almost 40% of the joint venture, so one would assume that they would have had some information ready for release on their options as soon as the news was made public. The official silence on the matter only encourages disappointed investors like myself to imagine a variety of worst case scenarios.
Even if the worst case scenarios in my mind do not come to pass and there has been no attempt by the company to hide anything or to intentionally deceive anyone, the question must be asked whether Altius has grown too quickly for its management team. It was only a few years ago that it was a small junior resource company that hardly anyone had ever heard of. Its management team, however brilliant they may be, may not have the necessary experience or skill sets to raise billions of dollars on the international market or to deal with the intense media scrutiny that goes along with such an undertaking. On the other hand, this could simply be a smart business decision to fend off anxious creditors while it continues down the road of securing financing.
I am not arguing that any of this is the case. What I am arguing is that these are the types of questions that an investor who has seen the value of his investment cut in half overnight should be asking. The answers to these questions will determine whether I choose to fold or double up on the stock in the coming weeks.
Inside Information – May 5, 2008
While there is no substitute for the analysis of a company’s financial statements, investors can often gain some insight on the true health of a company by actually trying to buy the product or service that is sells. Often times this information can be far more valuable than anything found in even the most transparent annual report. To take a simple example, if you were thinking about investing in a restaurant chain, it would be worthwhile having a meal there. If the food and service are terrible, you might want to reconsider your choice even if the numbers look good.
I was looking for a particular Blu-Ray movie a few weeks ago, and after coming up empty at Wal-Mart and Future Shop, I decided to stop by Zellers as I have heard that they are the last place to get sold out of a lot of popular items. When I first walked in it felt like the store was closed; I saw only a half dozen shoppers in the entire store. I went to the electronics department and looked around for a while without seeing any Blu-Ray movies. I asked a couple of older ladies who were working there if they had any Blu-Ray movies in stock and they looked at me like I was speaking Aramaic. They had never heard of a Blu-Ray movie, even though they were in the electronics department. Neither Zellers nor its parent, HBC, is a public company but if they were that visit would have helped me avoid falling into a value trap. If the people in your electronics department do not know what a Blu-Ray movie is 4 years into your turnaround plan, there isn’t much hope for the future.
This reminds me of the case of Circuit City which not too long ago had the brilliant idea of cutting costs by firing most of their highest paid salespeople. The fact that these were also their best salespeople didn’t seem to factor into the decision. Predictably, the company has suffered considerably from this decision and is losing money while its rival Best Buy continues to grow its sales by double digits. Because there is a lag of several months before deteriorating performance shows up on quarterly financial statements, a visit to Circuit City could have provided a hint that the strategy was a failure and would have allowed the investor to get out of the stock before the herd started stampeding to the exits.
Aside from the fact that it was simply overvalued, one of the reasons I have avoided buying Loblaw is that I so strongly dislike shopping there. For years I have driven past the Loblaw near my house to go to Sobeys because the service was so much better. Even with the longer drive I get back to the house sooner because there are more people working on the checkout. Despite all the talk of fixing their inventory problems, my wife recently went to Loblaw to buy some chicken breasts for a dinner party we were having and found they were all sold out and wouldn’t have any more in for several days. While the Sobeys up the road did not have as much lawn furniture or baby clothes, they did have all the chicken we wanted. While the stock has gotten cheap lately, I will not be investing money in the company if they cannot even keep chicken on their shelves.
I’m certainly not suggesting that investors should stop looking at financial statements of companies. In fact, one of the worst things an investor can do is to blindly invest in a company whose products they like. A great company does not necessarily mean it is a great stock, as anyone who bought Amazon, or even GE, back in 2000 has learned. Nevertheless, I do believe though that taking the time to sample a company’s products or services can be a fabulous source of supplemental information and can help investors make better decisions.
Risk of going to zero - March 24, 2008
Value investors, myself included, typically look for low price to earnings ratios to help them identify bargain stocks that can provide long term value. This has proven to be a very effective method in many instances as it can uncover stocks that have been driven down to unwarranted levels by fears in the market or companies that for one reason or another have not caught the attention of large investors. There is a danger, however, in focusing too much on P/E ratios to identify cheap stocks, particularly in the current environment. It is important to take into account the business risk of the companies behind the shares.
The share prices of US financial stocks like Citibank are not at their current levels because they are reflecting the revised earnings estimates. They are trading at this level because the share prices are factoring in the possibility that these companies may fail and either go into bankruptcy protection or get taken out at a fraction of its price such as what happened with Bear Stearns.
If Citibank is not destined to collapse, then the P/E ratio is telling the truth and the stock is very cheap, but that is a big if. If you buy Citibank under $20, there is almost no chance that the stock will be trading at the same level in two years. There are only two possible outcomes: you will have lost substantially all of your investment or you will have doubled your money or better. Last week Lehman Brothers reported a large drop in earnings but better than expectations and the stock soared almost 50%. This was only partly due to investors adjusting their value models based on the higher earnings. The biggest reason was that the risk of bankruptcy was believed to have been diminished.
The risk reward is probably in your favour right now, but investors should be careful not to confuse these stocks with blue chip conservative investments. I would suggest that investors treat these companies the same way they treat high risk high reward speculative resource companies and only invest money that they can afford to lose.
Phoney Bear Market? - February 29, 2008
When Germany invaded Poland in 1939, all of Europe’s worst suspicions of the Nazis were confirmed, justifiably causing widespread panic about what the future held. Shortly after the invasion, most countries in Europe were formally at war and their citizens braced themselves for the worst. But after Hitler had defeated Poland, there was a lull in the fighting from the fall of 1939 to the spring of 1940 and the fear began to subside, leading some to label it the “Phoney War”. Some experts postulated that Hitler was satisfied with his seizure of Poland and the Sudetenland and had no further territorial ambitions and the war for a time earned the moniker of the “Phoney War”. These hopes were soon shattered as the world was plunged into the most destructive war in history.
I can’t help but think there are some similarities with the stock market right now. All of the stock market bears’ most dire predictions seemed to have come true in the second half of 2007: there was a complete meltdown of the subprime mortgage sector, major banks have been caught up in a variety of risky structured investment vehicles leading to billions of dollars in write downs, the US dollar has devaluated, causing a spike in the price of oil and gold, housing prices are falling and growth has slowed to the point where the country may already be in a recession.
Investors initially panicked at all this news and the markets have certainly taken a beating, but there seems to be an eerie calm in the market right now. Although the economic indicators keep getting worse, there may even be some optimism creeping back in the market as investors wonder if their worries were perhaps overblown and we are perhaps in a “Phoney Bear Market”. This optimism is not entirely unwarranted, as both the congress and the Fed are doing everything they can to prop up the economy and in most sectors corporate balance sheets have never been better.
I do believe that anyone who has a very long time horizon is unlikely to get badly hurt with the type of stock market valuations we see right now, but there seems to be a few too many bulls in the market for my liking. Investors seem to be searching for any silver lining they can find in the storm clouds moving over the economy, but if we get a situation where the sky opens up and we get a downpour of bad economic data for a few days, the market could get hit with a blitzkrieg as the bulls run for shelter. This would not be pretty, but for those with plenty of cash and strong nerves it could turn out to be a great opportunity for some profiteering.
Are We Staring into the Abyss? - January 22, 2008
As I’ve stood by and watched the stock market get impaled by the subprime mortgage meltdown, I’ve been trying to be unemotional and consider whether I might uncover some once in a lifetime buying opportunities, but my longstanding faith in the United States economy is descending into agnosticism.
As a rare Canadian defender of the United States, I am becoming increasingly frustrated with the apparent incompetence of the people running the country, and after listening to some recent presidential debates, I have even come to doubt whether it is really impossible for the next President to be any worse than the Bush administration. Because voters still like to ask themselves if they are better off than they were 4 years ago, the Democrats have the clear advantage going into November and I have heard some frighteningly unintelligent statements from some of their leading candidates. A couple of nights ago I heard Hilary Clinton in a debate talk about how she would freeze interest rates on mortgages for five years. In all likelihood she is lying and only saying that to get elected, but it is still chilling to hear the most likely future president putting forward such economically reckless ideas.
I find myself asking why it is that the rest of the industrialized, and even the developing world, have figured out that huge budget deficits are not a good thing, but Americans have not. Can they really be as arrogant as the so much of the rest of the world thinks they are? Do they really think that because they are the United States that their currency must therefore remain the dominant world currency?
There appears to be a culture of debt that has emerged in the country, from individuals to the federal government. The drying up of liquidity in the debt markets is eroding this culture for individuals, but the President and Congress need to stand up and change this culture before the global currency markets do it for them. With their powerhouse economy, it should be straightforward to get them out of this mess, but the government keeps the country in huge budget deficits which continue to erode global confidence in the dollar.
How did their government go from being so good to so bad so quickly? All of the blame does not belong to President Bush, just like President Clinton was not solely responsible for good government of the 1990s. The Republican controlled congress in the 1990s was a driving force behind cutting government spending, getting people on welfare back to work, and eliminating the deficit. What happened to these people? Why did they destroy their own legacy? It baffles the mind.
My hope is that the people who are not running the country are far more competent and have enough influence through running and creating businesses to compensate for the incompetence of the federal government. Deep down I have faith that the entrepreneurial spirit and talent of the American private sector, which is still without parallel in the world, will be enough to prevent the country from sliding into the abyss, but I will still likely keep my powder dry for a little longer before putting my money where my mouth is.
Is the market out to lunch or is it me…? - September 20, 2007
As I watched Lionore Mining’s stock explode after I had given up on it, I told myself that the next time I owned a stock that I firmly believed was undervalued by the market that I would stick to my guns and tough it out until some semblance of market efficiency kicked in. Lionore Mining has now been reincarnated in my portfolio in the form of Talisman Energy.
I have been paying close attention to Talisman for some time now and for the life of me I cannot understand why it has been dead money for so long. The price of oil has gone up over $20 a barrel in the past few months and the price of the stock has gone down. If the market thought it was worth $21 three months ago when the oil was under $60 a barrrel, why does it think it is only worth $18 now when the price of a barrel is over $80? Although its last quarterly numbers were below expectations, due in part to its current restructuring, it generated a billion dollars in cash flow for the quarter. So if oil stayed just under $60 and production remained constant, they would be generating over $4 billion in operating cash flow every year. However, the price of oil has gone up dramatically since then, and the company is going to increase production significantly over the next few years. If these circumstances were to persist for a few years, the company would build the ultimate stock floor by having its entire market value in cash in the bank.
Another reason that leads me to believe the market is completely out to lunch on Talisman is that the stock seems to have been affected by the recent announcement that the government of Alberta may consider increasing the tax on oil sands producers, even though Talisman has almost no exposure to the oil sands these days. This may be due to investors selling oil sands-heavy ETFs and mutual funds that contain Talisman.
While I do believe the market is being inefficient right now, there is a danger in ignoring what the market is telling you. Whenever I start thinking that I am smarter than the market, I think of John Embry spending years talking about how the market was wrong about Southwestern Resources and how other brokers were conspiring to drive down the price, only to learn that the company, or large portions of it, was a sham.
Perhaps because of my emotional scars from Lionore, or maybe because I just finished reading Barbarians at the Gate (a book about the takeover of an undervalued company RJR Nabisco), I decided to put my money where my mouth is and recently added to my position, making Talisman my largest holding, ahead of ScotiaBank. If the price of oil remains at or above $60 a barrel, the only two outcomes I can see are that the market revalues the stock upward or it gets taken over. I suspect that the recent credit crunch may have something to do with the stock’s poor performance as it has long been viewed as a takeover candidate, but I don’t think that it really reduces the chance of a takeover. First of all, the cash yield on the stock is over 20%, so there would be more than enough cash flow to cover even the most unfavourable credit terms. Secondly, a company like Exxon Mobile, which would likely have a good appetite for Talisman’s diverse international assets, could buy the company with the cash in its back pocket.
I may very well end up losing money on my bet on Talisman as that is quite often what happens when investors try to outsmart the market. But if an investor really wants to take a shot at beating the average mutual fund, he has to go with what his research and analysis suggests, so that is what I am going to do. If this doesn’t work out, I may have to give up and just start following the advice of my blindfolded monkey. After all, he made a killing on LionOre last winter…
Cheap Stock or Train Wreck? - August 16, 2007
As I’ve watched the stock markets plunge in response to the sub-prime meltdown over the past few weeks, I’ve been wondering whether investors have perhaps missed, or at least misinterpreted, the lessons of the bankruptcies of Enron and Worldcom in 2002. It seems to me that investors viewed those bankruptcies not as business failures, but purely as frauds perpetrated against investors like some kind of common penny stock pump and dump. When viewed from that perspective, investors may consider those cases to by symptoms of a lack of regulation and oversight, which was then resolved by the Sarbanes-Oxley Bill and other regulatory changes that followed.
There is no doubt that fraud was committed at both Enron and WorldCom, but that is only half the story. Enron and WorldCom were both real companies. They were not sham companies set up to rob investors like something out of the movie Boiler Room. In both cases the main reason for the bankruptcy was not that management was looting the company, though they certainly were, but that the businesses themselves were doing poorly and could not cover its debt payments when times got tough. Many of the charges against management involved hiding these harsh facts from investors as the companies neared the brink. Irrespective of any new accounting and securities regulations that have been enacted in the past five years, nothing about the economy or the business landscape has changed in any way that would suggest that the risk of companies going out of business has been reduced.
A couple of weeks ago, when the stock market was just beginning to wobble, someone called in to Market Call and asked about a particular US housing stock and pointed out several indicators and long term patterns that indicated that this was a good time to be buying. The problem with this reasoning is that it is influenced by survivorship bias. If you look at the charts of all publicly traded companies, you will see that steep declines in stock price are almost always followed by healthy recoveries. What investors sometimes forget is that they are only looking at the charts of all the companies that have survived over the years. If they were to look back at all the companies that have been publicly traded, they would see that for most of these companies, sharp decreases in share price are followed by bankruptcy or a takeover by a stronger competitor at a bargain basement price.
I believe that this market panic, as with most market panics, may prove to be a great buying opportunity, but investors need to factor in the risk that some of these cheap companies may soon become worthless.
Beware the Nuclear Bubble - July 8, 2007
My inspiration for this posting came while watching Market Call on BNN a few nights ago. The guest was Rob Lauzon from Middlefield Capital who has been a regular guest on the program for years, and has always focused on income trusts. So I did a bit of a double take when I saw that his focus that evening was on uranium stocks. I can't criticize Mr. Lauzon for switching his focus, however, I do find it curious that someone could switch so quickly to an area that is arguably the most complex and difficult to comprehend sector of the market. While Mr. Lauzon may have provided the impetus to write this commentary, he is by no means the only securities analyst to be reborn as a uranium expert as the price of the commodity has increased exponentially in the past few years.
During his appearance, Mr. Lauzon made one great, if somewhat ironic, point about the uranium industry. He said that most people in the uranium mining industry do not have a solid background in uranium and that most of those who used to work in the field retired and nobody stepped in to replace them as the uranium market tanked. Many of the senior people in the uranium industry have a background in zinc or gold. If what he said about the people deeply involved in running uranium companies is true, what is the implication for the uranium experts in the securities industry? While I sometimes roll my eyes at John Embry’s conspiracy theories surrounding the price of gold and, at times, the price of Southwestern Resources, I have a great deal of comfort taking his advice on gold stocks as he is a true precious metals expert who has been in the business for years, even when gold was out of favour and at multi-decade lows. I cannot name a single analyst who has been talking about uranium before it was in fashion. The only regular guest on BNN that comes close to that is Paul van Eeden, and he is a bear on uranium right now.
The lack of experience on the part of uranium securities analysts is compounded by the fact that it is extremely difficult to quantify present, not to mention future, supply and demand of uranium. There is no freely traded market for uranium as there is for gold and oil, and the shortage that analysts speak of is not actually a present shortage, but a projected shortage several years from now. By the time these planned nuclear reactors get built, and it is far from certain that every planned reactor will be built; global production may be significantly higher than it is today. Keep in mind that until very recently, we had gone almost two decades with hardly any exploration due to the depressed price of the commodity. The current exploration boom will no doubt lead to a surge in discoveries and new production.
While some future increases in production are acknowledged by analysts, you are unlikely to hear much discussion of the fact that the reactors of the future are likely to be significantly more efficient than those built in the 1970s. Many of the planned reactors are so-called “fast breeder reactors” that, once it has been fired up, are supposed to require very little and very low grade fuel to maintain itself over the long term. There is also talk of reactors that can run on Thorium in addition to, or instead of, uranium.
To be clear, I have absolutely no idea how efficient, or even how feasible, a fast breeder or thorium nuclear reactor would be. The problem I have with the uranium market is that most of the so-called experts promoting these stocks have no idea either. I would strongly recommend to my readers (all 3 of them) that they try to get some answers to these questions before jumping on the uranium bandwagon.
Lament for LionOre - May 21, 2007
One of the first stocks I ever bought was LionOre mining. I did some research on the stock, I read several commentaries in various newspapers, I listened to talking heads give both positive and negative opinions on it, and they I came to the conclusion that this was an undervalued stock and picked up a few hundred shares at around five and a half dollars. After I bought it I continued to do my homework; I read annual reports and even though the stock could not get any respect in the market I continued to believe that I was right and the market was wrong. The company was valued at only a billion dollars, similar to many mining companies with zero production, even though it had a variety of producing assets around the world and a potential breakthrough technology with its Activeox refining process. When the stock shot up in the winter of 2005, I didn’t take profits, and when they had a cave in at one of their mines and the stock got hammered, I considered buying some more.
As the months wore on, however, I began get frustrated with the stock as it refused to break out. It seemed every time it went up it encountered resistance and came right down again. It seemed almost nobody had any faith in the stock and I began to question whether my faith in the stock had been misplaced. After Inco, which I also took profits on a little too early, was bought out and LionOre still refused to pop, I finally gave in. I put a sell order in at just over $7.60 and waited for a week or so to get taken out. I was thinking at the time that I might buy in again in the future at a lower price, but while the stock did pull back a little in the near term, it went on a relentless march upward that has culminated in a bidding war between Extrada and Norilsk Nickel.
I have lost money on stocks before. I have seen stocks that I was about to buy surge just before I was about to buy (Crystallex comes to mind). But in my experience nothing can compare to the anguish of watching a stock you owned and believed in for years skyrocket after selling out. It would be like a Toronto Maple Leaf fan switching allegiance to the Ottawa Senators only to see the Leafs win the Stanley Cup the very next year. If a story comes on the news about LionOre now I have to change the channel to keep from getting nauseous.
The lesson that I have taken from my experience with LionOre is the importance of staying disciplined and sticking with your strategy. While you should always challenge your assumptions and reevaluate your strategy periodically, it is always dangerous to abandon your better judgment and follow the herd. In the late 1990s, many value investors abandoned their investing strategy after watching tech stocks soar only to get hammered for buying into the bubble at the top. When investors switch investing strategies often, they tend to end up choosing the wrong strategies at the wrong time and dramatically. The investors who have been able to deliver superior results over the very long term, such as Warren Buffet and Benjamin Graham, owe their success to sticking with their strategies and methodologies irrespective of the market sentiment from one year to the next.
March 18, 2007
In many ways I resemble a classic gold bug. I view gold not as a commodity, but as another form of money. I believe in holding physical gold as a long term store of value. However, because investors are being inundated with pro-gold analysts and talking heads, I thought I would write a little word of caution for investors to consider before deciding to add gold to their portfolio.
What makes me most nervous about the increase in gold in the past few years has been that is not really those who believe in gold long term who have been bidding it up, but rather speculative investors and hedge funds. Once they are through with gold, they will not just exit it, but perhaps short it as well.
While I agree with most of the reasons analysts give explaining why gold will go up in value, most analysts grossly exaggerate the affect of these influences. The most commonly quoted reason is the huge budgetary and trade deficits in the United States. Analysts talk as if this was some sort of new phenomenon, when in fact the United States has had deficits for most of my 30 years on this planet. And while this current administration has been particularly irresponsible, it would be as foolish to believe that future administrations will continue to run huge deficits as it would have been to believe in 1998 that future administrations would continue to run surpluses in perpetuity.
Something that is often overlooked with gold is that, unlike virtually every other commodity, it is not used up. The vast majority of all gold produced over the past 500 years is still in existence today, be it in a bank vault or on someone’s finger. Commodities like oil and nickel have been driven up by the combination of greatly increased demand and a lack of supply. With gold, however, the increase is driven entirely by demand, not supply. Someone in need of gold can purchase a brick of gold mined in 1960, but you cannot purchase a barrel of oil produced in 1960 at any price, because it is gone forever.
The last point to consider is that even when oil spikes up, there are millions of consumers who simply cannot go without it in the near term. This is not so with gold. If gold were to spike to $1,000 in the near term, demand could evaporate overnight, leaving rash investors in the same predicament as those who paid $800 an ounce 25 years ago.
January 4, 2007
For the website’s first editorial, I would like to discuss briefly the idea of stock floors. I believe the lack of understanding of a stock’s floor price has been the single biggest contributor to poor investment decisions by investors over the years. Identifying floor prices will help you to identify solid investments and avoid wasting your money on overpriced, overhyped stocks.
A floor price is the price that a stock will trade at if company’s growth stops and the earnings stay at the current level or only grow around the rate of the economy as a whole. Given that you can buy a guaranteed investment like a government bond for around 5%, we can safely say that a stock will not trade below a price to earnings(P/E) multiple of 10, which implies an earnings yield of about 10%.
This concept is useful for investing in both high growth tech stocks and conservative widows and orphans type stocks. Many commentators like to say that the scariest words in the English language are “It’s different this time”, but I would disagree. The scariest words for investors are “The stock has always been expensive”. If you ever hear this phrase mentioned about a stock, you should immediately stop, drop and roll. This phrase is typically used for solid, well run companies that are trading way above their floor prices. An excellent example would be Loblaw (symbol L on the TSX), which traded at a multiple befitting a tech stock for years despite being a low growth grocery store. This supposed widows and orphans stock has plummeted from a high of $75 in April of 2005 to under $50, and it still has room to fall with a P/E of 18. If investors had been thinking about the stock’s floor, they could have seen this coming a mile away.
With growth stocks, a stock floor provides valuable perspective on the total amount to growth need to sustain a stock price. Some analysts talk about attaching certain multiples to certain growth rates, but I like to look at how much growth a company needs to deliver to get to a point where it will justify the current price after the growth period ends. To give an example, Google is currently trading at $460. While the company has been delivering great growth, it is important to keep in mind that it would have to have $46 per share in earnings to sustain its current price without growth. That means that if you were to purchase the stock today, you would have to believe that it will be able to increase its current earnings of $7.86 a share by 585%. It may very well do that, but I think too few investors have really stepped back and considered how much growth is actually factored into this stock. If you forget about stock floors when investing in growth stocks, you can find yourself in the position of investors in Wal-Mart and GE who have seen the stocks' earnings double of the last five or six years while the stocks have suffered double digit price declines.
It is important to keep in mind that a stock may never trade at its floor price, particularly if it gets good coverage from analysts and talking heads on television, but if you keep stock floors in mind, you can make money even when public opinion turns against your stock as real earnings are not influenced by public opinion.