Thursday, January 31, 2008

Exchange Bank Sold

One of the nice benefits of owning the small Exchange Bank of Santa Rosa was that I could read through earnings earlier than most shareholders by checking the FDIC Call Thrift Data instead of just waiting for the company to release it. Exchange Bank's 4th Quarter report was published with the FDIC yesterday and it showed that business had deteriorated- rapidly.

Below is what underwriting looked like before the current quarter.

Including the 4th Quarter results...

Within the span of three months, $13 million in loans had to be charged-off, and about $25 million in loans were added to delinquencies, mostly non-performing. One, that makes their total allowance of $24 million look weak. Second, this quarter calls into question whether EXSR's underwriting can be considered much better than average. If we adjust the income statement to take this into account, their earnings power is considerably reduced and the company is no longer very cheap.

Given that things seem poised to get worse in the credit markets and that I was given a golden opportunity, I decided to sell my holding at $113. I wasn't unscathed though, and I had to realize a loss of 16.3%, the first for the site.

Economist: China's Fear of Inflation

From The Economist: China's Fear of Inflation


Chinese policymakers are, in a way, victims of their own success. During the past few years China has enjoyed record current-account surpluses, which have allowed the central government to use ballooning foreign-exchange reserves to recapitalise sickly state-owned banks. Flush with cash, the banks have fuelled spectacular rallies in both property and stocks, which have sent even the prices of their own newly listed shares into the stratosphere.

In heated competition with each other to lend money, banks have flouted both basic risk-management practices and government regulations. They looked the other way when borrowers did not have all the paperwork. Since September buyers have had to make a 40% down payment for a second mortgage. But most banks interpreted the rule as applying only to individuals, and not to households. Thus, a large number of borrowers simply had their spouses or children take out mortgages and kept speculating in the property market. In other instances, CBRC officials discovered that local bank branches accepted false documentation showing proper down payments where none existed. Such lax lending has led to a Rmb1trn increase in housing loans in the first ten months of 2007, or nearly one-third of all new bank loans made during that period. Bank regulators have publicly raised alarm about these highly leveraged mortgages, which look uncomfortably like their sub-prime counterparts in the US.

On the stockmarket front, the CBRC has long-standing regulations forbidding the purchase of shares with bank loans. In reality, though, it is all but impossible to enforce how the money is spent once it leaves bank vaults. And in the great Chinese bull market of 2007, it did not really matter anyway because most people were making a killing on stocks and promptly repaying their loans. Indeed, Chinese banks were indulging their own speculative urges by investing in junk US mortgage-backed securities.


Reminding us that it wasn't just the U.S. which got out of hand..

Tuesday, January 29, 2008

Countrywide 4th Quarter Earnings

Remember a few months ago when Countrywide said: (source)
The company expects its earnings per share in the fourth quarter to range between 25 cents and 75 cents. It also anticipates its return on equity for 2008 to range between 10 percent and 15 percent.
Well, that didn't quite work out. Today, the company reported a loss of 422 million, or 79 cents per share. I'll report more about it once they file their FDIC call report.

Robert Cialdini

I am a big fan of Robert Cialdini's work on social influence and persuasion:
Research reveals that there are six basic principles that governs how one person might influence another. Those principles can be labeled as: liking, reciprocity, consistency, scarcity, social validation, and authority.
There is two great articles here and here that covers everything you really need to know about these concepts. (I highly recommend them- they are well worth the time) Essentially though, the principles which Cialdini identifies have an effect on the decisions we make. Some examples:
If you like someone, you are more likely to do something for them.
If you perceive something as scarce, you will assign to it a greater value.
If you are speaking to someone with authority, (say, a police officer) you are more likely to comply with what they say.
And so on. Unfortunately, people can manipulate these principles to their advantage, as the articles above describe. And, if you combine a few of these principles together, you get a 'lollapalooza' effect, as Munger would call it, where people can be convinced to do some real strange things. Over summer I quit working at a financial planning firm after three days because I quickly realized that they were abusing a lot of these tools. (To great success, I may add. Supposedly they are the fastest growing financial planning firm in the country) My job at the firm was based on commission, and my goal was to call up all my friends and relatives and set up a two hour meeting consisting of me, a senior employee, and the prospective client. This brought multiple principles into effect: The liking between me and my friends; the authority from a "senior" employee; consistency for saying they would help me out; commitment for the two hours already spent on the meeting; and reciprocity because the clients felt we were doing them a service.

In reality, the company was offering a terrible proposition. The annual commissions/fees on the mutual funds they sold were about 3.5%, plus there was an upfront commission. This, to invest in a stock market which over the long run generates 12% a year. This means the company was taking nearly one-third of their clients' future annual returns and seriously crippling their compounding of wealth. I felt bad for many of the new workers there, who were probably unaware of what a great disservice they were actually doing to their friends and family.

But these tools are not only meant to deceive. What I found real interesting was when I started asking, "how can I as a person genuinely benefit from these principles in my daily life- how could I be a 'lollapalooza' ?" This is what I came up with:

To benefit from liking, be kind and likable.
To benefit from reciprocity, always try to be helpful.
To benefit from consistency, always speak the truth.
To benefit from scarcity, always be doing something.
To benefit from social validation, treat everyone as a friend.
To benefit from authority, speak with power and conviction.

Tuesday, January 22, 2008

An Inverted Look At Wells Fargo

Wells Fargo currently has a market capitalization of around 87 billion, and ten year US Treasuries yield 3.44%. Let's say we wanted our investment in Wells Fargo to have worst-case, a 5 percent earnings yield on a very solid franchise. Then Wells Fargo would need to generate a minimum income of 5% x 87 billion, or 4.35 billion. And there is one more thing: We want to work with before-tax numbers, so adjusting for that means we want a minimum of 6.69 billion in operating income per year.

Now we can look at their most recent earnings report and see what level of losses they can handle while still giving us that minimum return. In their most recent quarter, they generated:

(numbers in millions)
9,242 interest income
-3,754 interest expense
= 5,488 net interest

+4,500 non-interest income (rounded down from 4717)
-5,900 non-interest expense

=4,088 quarterly earnings before credit provision and tax

We would need 1,673 million in quarterly operating income, so we can provision 2.4 billion a quarter while still earning a 5% earnings yield on a Wells Fargo common stock.

This means they can provision 9.64 billion a year, which is 2.52% in yearly charge offs. (Remember this is charge-offs, which is after recoveries from the sale of collateral) For comparison, Wells Fargo most recent quarter had an annualized loss rate of 1.28%, and going back to 1988 the worst rate was 1.66%.

So is this a market overreaction? This analysis does assume two things. First, that interest spreads between assets and deposits remain the same. With the recent interest rate cuts, it is likely that net interest margins will contract for financial institutions going forward. Second, it assumes company assets remain constant. Wells Fargo has a very long history of expanding assets, and factoring in future growth would result in a large boost to valuation. But near term a decline seems more likely, as wealth starts to disappear and place considerable stress on economic money supply. If things get really bad, then a sharp drop in assets is plausible from today's levels. These are two things I am still trying to get comfortable with before making my decision, but others might enjoy this fresh look for investing in financials.

Thursday, January 17, 2008

Another View on Oil

A few days ago I posted a commentary by FPA Capital regarding why they see future oil supply falling short of demand. Today I came across a different perspective:
World's Oil Fields Declining at 4.5%-CERA

Output from the world's oil fields is declining at 4.5 percent per year -- significantly slower than the 8 percent rate many analysts have assumed, according to a study by Cambridge Energy Research Associates released Thursday.
The study of more than 800 oil fields suggests that theories that global oil production may soon hit a peak due to steep declines at maturing fields may not hold water.
"Some of the more gloomy, pessimistic 'peak oil' views about the future of oil supplies that are current today result from an assumption of high decline rates," said CERA analyst Peter Jackson. "This new analysis provides the basis for more confidence about the future availability of oil."
The 811 fields included in the study account for two-thirds of current global oil production and half the proved and probable conventional oil reserves.
Jackson said world production capacity should reach 112 million barrels per day (bpd) by 2017, while demand will be about 100 million bpd.
Peak oil proponents argue its difficult to decipher whether Saudi Arabian oil production might be declining.
Jackson said some Saudi fields were included in the study including the giant Gowar field.
"Gowar does not contribute to the decline stats because it's not declining," he said.
CERA said peak oil theory overestimates decline rates but also underestimates advances in technology.
"The analysis also concludes that decline rates are a function of reservoir physics and investment strategies, and that there is a general historical trend toward lower decline rates in recent years which may be due to better reservoir management practices and the impact of new technology," Jackson said.
Who is right? I can safely say I have no idea. Luckily, I evaluated Harvest using a WTI Crude Oil price of $65.44 and found it was cheap then- today the price is at $90, giving me an additional 37.5% margin of safety in the future price of oil.

Monday, January 14, 2008

Deepwater Oil Production- the Key to the Supply Equation Puzzle

I came across this commentary by Rikard Ekstrand in FPA Capital's 3rd Quarter Shareholder Letter. It makes a nice analysis of future oil supply. (There is also an analysis of Circuit City included in the shareholder letter)
The energy sector is by far our largest investment area. We discussed the rationale for our energy investments in the September 2006 Shareholder Letter.We will expand on that discussion here by providing our thoughts on the deepwater segment, which is vital for future production levels. Before discussing deepwater oil, let’s sum up the current demand and supply equation for oil. Over the last four decades, worldwide oil consumption has virtually doubled from 45 million barrels per day in 1970 to 86 million barrels today. When comparing this to discovered oil volumes, the picture becomes bleak. Harry Longwell, a former Director and Executive President of Exxon Mobil Corporation, backdated discoveries to the time the find was made and built a chart that showed that global discoveries peaked around 1960, or almost five decades ago. This was when we were in the beginning phases of using 2D seismic technology. 3D seismic came a few decades later and now we’re using visualization technologies and real-time data when drilling. The diamond drilling bore technology came in the 1960s and revolutionized the oil drilling industry. Despite these large technological advances, global discoveries have declined from close to 60 billion barrels per year in the peak years of the 1960s to around 10 billion barrels today. Thus, after five decades of significant improvements in technology and understanding of where oil is, we are now finding a fraction of what we found five decades ago.

Due to this declining discovery trend, we are now relying on old fields for the majority of our supply. Eighty percent of global oil production today comes from fields discovered before the 1970s, according to 13D Research. How fast these older fields are depleting is of paramount importance. To appreciate the impact of depletion, the U.S. is one of the best case studies. Depletion of the U.S. oil reserves was first signaled by the drop in yield to exploration in 1940, as measured by barrels per foot drilled. But with enhanced technology, oil production kept growing for another 30 years despite a deceleration in yields. Then the inevitable happened; production peaked in 1970 and it has declined ever since. The decline rate has been slowed by incremental production in new areas such as Alaska and the deepwater Gulf of Mexico, without which the decline would have been much steeper and more serious. The U.S. is a good precursor for what is happening in the global arena. The world is now consuming approximately three times the volume of crude it is finding each year. Put another way, at current levels of oil consumption, we are using up and not replacing two thirds of our daily consumption. This is why we have focused our investment on oil drilling companies. Exploration and thereby drilling for oil must increase to keep production levels from declining over time, and this leads us to deepwater oil.

Deepwater oil is defined as oil found at depths greater than 400 meters, or 1200 feet. Remarkable technological achievements have extended the range of drilling from shallow waters to deep waters over the last decade and a half. This has allowed the mapping of where deepwater oil is in the world. It turns out that there are three main regions where it is prolific, the U.S. and the Mexican Gulf of Mexico, Brazil’s Campos Basin near Rio de Janeiro, and Africa’s Angola and Nigeria. The total proved and probable deepwater and ultra-deepwater resource today is 78 billion barrels according to data from Bank of America, of which 44 billion is proved according to IPC Petroleum Consultants. It is this large resource base that is allowing deepwater production to double from production levels of more than 4 million barrels per day in 2006 to over 8 million barrels by 2011, according to estimates from Bank of America and Wood Mackenzie, a consultant to the global oil industry.

However, by 2011, this data points to a sharply slowing and then flattening deepwater growth profile. The reason for this is that a proven resource base of 44 billion barrels is unable to support peak production in excess of 8 – 10 million barrels per day for any length of time since depletion rates would get too large. For example, 8 – 10 million barrels per day, or 2.9 – 3.6 billion barrels per year, of deepwater production implies a 6.6 – 8.3% depletion rate on a proven resource base of 44 billion barrels. The U.K. for example, an offshore province, has a depletion rate of 7.7% — according to Colin Campbell, a retired petroleum geologist who specializes in depletion — and its production peaked in 1999, or eight years ago, at lower depletion rates than currently.

The only sustainable way to get higher deepwater oil production is to prove up the probable barrels and to make substantial new discoveries. Extrapolating the falling deepwater discovery trend suggests that another 5 – 15 billion barrels of smaller finds can be made, according to Colin Campbell. Adding these possible barrels to the 34- billion-barrel probable reserves gives us 40-50 billion on top of the proven 44 billion. In order to continue growing deepwater production beyond the 2011 forecast, we would need to prove up and bring these barrels to production in the near future. However, the reality is that by the time these potential barrels are brought to production, declines in existing deepwater fields, and onshore fields, will eat up a
lot of these gains. Time will tell if substantially more can be found and economically produced in the deep waters around the world. We believe the impact on oil prices will be significant if we don’t find substantially more than the current discovery trend is suggesting; therefore, we remain of the opinion that, in the next decade, oil prices will likely be substantially higher than they are today.
Of course, this does not take into account the demand side of the equation. The general opinion is that future oil demand will soar as the rest of the world begins to develop. But technology can increase efficiency and reduce our demand for oil, easing the pressure from the lack of new supply. See this video by Amory Lovins- We Must Win the Oil End Game.

Sunday, January 13, 2008

Hoisington 4th Quarter Report

Hoisington Investment Management has released their 4th quarter report, in which they discuss their forecast for the upcoming year. They give a great analysis for why they see an upcoming recession lasting longer than most predictions. For the economic buff, this is a must-read. Summary below:

Normally back to back declines in quarterly GDP must occur to constitute a recession. However, in the 2000 recession, alternating quarterly contractions were observed. This pattern could well develop in 2008 since bloated inventories, the typical driver of consecutive quarterly declines, is not present. Also, the relatively stable private service sector constitutes a record share of the U.S. economy. Rather, a slow contraction of credit availability will cause the consumer to feel the impact of declining wealth from falling home prices, fewer employment opportunities, faltering wage gains, and a monstrous debt burden. This should cause the U.S. economy to rotate in a pattern of stagnant economic conditions, recessionary at times, and growth recessionary at others. The growing excess capacity of our capital structure, along with falling profits, will hinder capital spending increases, reinforcing slower consumption. Increases in federal government spending, along with improvement in our trade balance from shrinking imports, will provide stability in the aggregate economic statistics, while the domestic private economy contracts.
In this environment, short-term interest rates will continue to move downward, reinforced by several reductions in the administered Federal funds rate. The long end of the Treasury market will benefit from two factors. First, investor desire for risk-free assets will increase at a time when default rates will be soaring on other fixed income securities. Second, the overall reduction in credit market instruments will mean fewer alternatives for those desiring a fixed rate of return. By the end of 2008 we would expect new record low yields in Treasuries for this cycle.

Three Buffett Stocks Getting Cheaper

Three stocks Buffett has purchased recently have fallen from his purchase prices- USG, WFC, and BNI. All three are great businesses with competitive advantages, and they would be great places to begin doing research.
Regarding Burlington Northern, I've run across two reports in the past. The first is by the Texas Hedge Report and is entitled "Railroads: Following Buffett's Latest Move". This second one was posted on a message board: (hat tip ValueInvestorHaven)
Bottom line is the company has 29000 miles of track which costs about 3 million dollars per mile to "replace" . which totals about 87 billion

Land which is on the book at 1.7 billion dollars has a "conservative"average cost basis of about 50 years ( some of the purcahses are on books pre1900) at a 3% annual appreciation the land is probably worth more than 8 billion and chances are that number is UNDERSTATED.

The terminals probably are worth another 3 billion conservatively and the long term debt which includes leases is about 11 billion .So 100 billion dollars of assets -11 billion of debt is about 89 billion dollars.The whole company can be purchased for under 28 billion at todays closing price.
I can not attest to the validity of that analysis, but if that is accurate that would be an interesting place to start researching. Buffett also mentioned that as fuel costs rise, the comparative advantage of rail vs. trucking widens because fuel makes up less of rail's total costs.

I've been looking into USG recently, and I will post some information on that shortly.

Thursday, January 10, 2008

Pope and Talbot Sells Pulp Mills

Pope and Talbot, which filed for bankruptcy a few months ago, announced today the sale of their pulp business for $225 million, which includes $100 million of value from working capital which is not included in the sale. So, their three pulp mills were sold for $125 million. On the one hand, this is slightly disappointing- these are high cost pulp mills and if they were shutdown, it would improve the supply/demand situation in the pulp market. But what is very interesting is the purchase price of $125 million.

Pope and Talbot's Pulp Business
819,000 tonnes NBSK pulp
EBITDA for 6 Months ending June 30, 2007 = $-9,527,000
Value = $125 million

SFK's NBSK Pulp Business
375,000 tonnes NBSK pulp
EBITDA for 9 months ended September 31, 2007 = $+35,940,000
Implied Value = ???

SFK has only 46% of the NBSK production of Pope and Talbot, but it is also significantly more profitable than Pope and Talbot. (Pope and Talbot is currently bleeding money) I had expected their pulp business to be near worthless, but the fact that it received such a large sum is encouraging. I don't know what valuation that implies for SFK's NBSK business, but it would begin with something like this:

SFK Valuation
Current Enterprise Value = 330 million

Working Capital - all other liabilities = 73 million
NBSK Pulp Mills = ???
RBK Pulp Mills = ???

On Moats

Warren Buffett calls them "moats". These are strong, durable advantages which protect the company and its profits from the onslaught of competing firms. Mr. Buffett gives his executives just one goal: "expand the moat". Understanding competitive advantages (or lack thereof) is essential in any valuation of a company.

Of course, spotting a moat isn't always so easy. For a long time, people would tell you Starbucks was an excellent company with a strong moat. But it's moat mostly revolved around its brand image, and the Economist has covered how everything is not so frothy for Starbucks now.

...A tightening of purse strings has increasingly encouraged defection to fast-food chains such as Dunkin’ Donuts or Panera Bread. They sell reasonable coffee for as little as a quarter of the price of the fancy Starbucks brew.

The biggest of all fast-food chains is also about to launch a full frontal attack on Starbucks. This year McDonald’s will help customers to wash down its burgers by installing coffee bars with “baristas” dedicated to turning out the sort of Italian-style coffees that brought Starbucks its success, in nearly 14,000 American restaurants. The addition to its menu is the biggest diversification ever attempted by the burger giant. McDonald’s has already made smaller forays into providing decent coffee, and with some success. Last February Consumer Reports, a trade magazine, rated its filter coffee more highly than the same sort of beverage served up at Starbucks.

For some time, Starbucks managed to earn extraordinary returns because the Starbucks brand meant something to people. But there is often few advantages in retail- anyone can walk into your stores and copy what you are doing. Now that people have seen the great profits to be made in selling coffee, they are devising ways to steal a piece of the lucrative pie. That is bad news for Starbucks.

In contrast, here is a moat I came across while reading the WSJ- LVMH Bottles Up Champagne Market (subscription required-hat tip David Lau)
For revelers who toasted the New Year with champagne, the odds are about one in five that the bubbly was bottled by LVMH Moët Hennessy Louis Vuitton.

The conglomerate, controlled by French billionaire Bernard Arnault, has managed in recent years to lay claim to the largest share by far of the Champagne region's limited grape output. LVMH has done that by cultivating the independent growers who raise most of the grapes -- including by offering them free farming help.

The result is that LVMH, which owns six brands including Veuve Clicquot, Moët & Chandon and Dom Pérignon, dominates the $5.4 billion global champagne market. LVMH doesn't break out its champagne sales, but its wines and champagne revenue in 2006 totaled $2.2 billion. LVMH had 19% of the global market for champagne by volume in 2006, according to Impact Databank, a market-research firm. The company had more than two-thirds of U.S. champagne sales by value and about 62% by volume.

LVMH focused on the needs of independent grape growers, allowing it to secure a long-term supply.

As global demand for bubbly increases, LVMH's strategy leaves it in a unique position. Independent farmers own 90% of the vineyards in France's Champagne region -- the only source of grapes for bona fide bubbly -- and LVMH is the biggest buyer of their grapes. LVMH is also the single largest owner of vineyards in Champagne, possessing 1,650 hectares, or 5%, of the fields available. The French fashion-to-spirits company has achieved a rare agricultural feat: sewing up much of the world's supply of champagne grapes.

...By controlling brands and raw materials, the company is shielded from competition and wields greater control over prices than rivals. Fueled by champagne sales, LVMH's wines and spirits unit is expected to have grown more than 10% in 2007.


LVMH's hegemony in the region has met some resistance. By making champagne, a wine with rich tradition, part of one man's industrial portfolio, LVMH is creating a dependency that could undercut farmers' negotiating power in the future, they say.

"It's dangerous for the equilibrium of the champagne industry," vineyard farmers union leader Patrick Le Brun said in an interview during September's harvest. "The growers' hands will be tied." Yet for many in Champagne, LVMH's presence is a win-win situation...

A year ago, he began offering grape farmers a 25-year contract with the champagne house, the longest ever seen in the region until then. He is sweetening the deal with a 7% signing bonus to the grapes price, which is currently around $7.30 a kilo across the region.

Some union leaders, such as Mr. Le Brun, fear the new quarter-century contract will consolidate LVMH's supremacy in Champagne even further. Yet most growers are happy with the security it provides.

Here, we see a company which has control over the limited raw materials for its product-champagne. If LVMH is successful in securing enough 25-year contracts, that will be a very durable and enduring advantage. And if the demand for champagne continues to grow over that period, that will "expand the moat" by making those contracts more valuable. The profits will naturally follow.

Tuesday, January 08, 2008

Economic Articles of Interest

I ran into two interesting articles on economics today that I thought worthy of re-publishing here. The first is from the folks over at Calculated Risk, who were so kind as to publish their first subscription newsletter on real estate analysis for free. The article can be accessed here. It is kind of lengthy at 14 pages, but it is an absolutely fabulous summary of everything you need to know about the real estate market today.

The second is an (unconfirmed) transcript of a speech made by legendary investor Seth Klarman on leverage and the current credit crisis. (mega hat tip to Lincoln Minor) It was published over at the Motley Fool board, and based on the content appears to be legitimate. It is pasted below.
Some investors target specific returns; a Pension Fund for example might target an 8% annual gain, but if the bundle of asset classes under consideration fails to offer that expected result, they have the choice only to lower the goal, which for most is a non-starter, or invest in something riskier than they would like. The pressure to keep up with a peer group renders decision making even more difficult. That there is no assurance whatsoever that the incurrence of greater risk will actually result in the achievement of higher returns. The best investors don’t target return, they can first focus only on risk and then decide whether the projected return justifies taking each particular risk. When the herd is single-mindedly focused on return, prices are frequently bid up and returns driven down. This is particularly so when leverage is used. Leverage doesn’t have to be dangerous. Non-recourse debt on an asset can certainly make a large purchase more affordable. Taking out a non-recourse loan on an asset you already own can actually reduce risk since the borrowed funds return your capital while the risk of loss is transferred to the lender. But recourse debt, margin debt, is something else entirely. If you purchase some investments and then borrow with recourse debt to buy more, you are now vulnerable to marked to market losses on what you owe. Depending on the precise terms of the debt, the decline of the value of your holdings could force you to either put up more collateral – which you may not have – or to sell off some of the investments you purportedly like to meet margin calls. By borrowing you cease to be the master of your own fate and allow the lender, or actually the market, to be. How ironic to allow the market, which has dished up your current portfolio of opportunity, to dictate to you the need to sell your most attractive holdings in order to survive. The availability and use of margin or recourse debt is especially pernicious. Had you purchased an investment without leverage, which declined in price, you could have used any available cash to buy more. Alternatively you could sell another investment that did not decline or declined less to afford more of the now better bargains. This is in fact a healthy discipline forcing you to choose among investments to own what you like best and necessitates that you carefully decide when to hold onto cash and when to put it to work. Recourse leverage changes this equation as you can seemingly own all the investments you want simply by borrowing to buy them. There is no healthy portfolio discipline enforcing the desire to make new purchases or the anticipation that you may want to. There is also a bit of a slippery slope in the sense that if a little leverage is good, why isn’t more leverage better – when do you stop?

...during our parents’ lifetimes and our own, credit has become increasingly available and standards increasingly lax, to the point where credit cards and checks backed by credit lines arrive unrequested in the mail. Where your house can be used as an ATM, where people with dismal credit histories are eagerly sought after to provide them with loans, where investors flock to buy junk bonds and shady companies seek to issue them, and where investment funds are offered the opportunity to enhance their returns through structured products, derivatives and exotic finances, all of which enable high amounts of leverage. The moral imperative of repaying the banker, your neighbor, who granted you the loan across his imposing desk has been replaced by the moral vacuum of anonymous lenders using credit scoring who quickly resell your loan to someone you’ll never meet, who are actually comfortable with the actuarially determined probability that you may in fact default. Credit rating agencies have embraced the debt or-gy (offensive word detected) with lax standards and naïve models, brewing conflicts of interest and accepting healthy fees to label toxic waste as investment grade. A similar risk exists as a result of the burgeoning increase in capital allocated to alternative investments – venture capital, private equity and hedge funds. While returns start to come down as the pension funds have looked to alternatives to add excess return and diversification, they are hardly a panacea. Some alternative managers have historically added considerable value while for others the jury remains out. For alternatives in their entirety, high performance and management fees truncate upside potential – increased competition has forced many alternative managers to incur greater risk to achieve their accustomed returns. For some this means incurring greater credit risk while for others this means utilizing considerable amounts of leverage.

The pendulum may be starting to turn as recent developments in the mortgage and hedge fund markets suggest. Because the scale of today’s leverage so greatly exceeds historical levels , it seems possible that we are only at the early stages of the credit contraction. Not surprisingly, it may take time to work off these excesses. Intervention by the Fed, as it recently has, seems likely to give license to further speculation, while failing to address and perhaps even exacerbating the underlying problem of lax lending standards, poor credit quality and excessive use of leverage. Indeed, many market participants believe the solution to these problems of over-leverage and bad credit is more debt. Recently many funds have been formed to make leveraged purchases of loans that are expected to trade in the mid to high nineties instead of par, with 5x leverage or more, bringing the yield to a 15% or 20% return. It seems to me incredibly unlikely that the end to the debt crisis can be near at hand when the solution offered – more debt – is in fact what caused the problem in the first place. Many investors lack a strategy that equips them to deal with a rise in volatility in declining markets. Momentum investors become lost when the momentum wanes, growth investors who paid a premium for the fastest growing companies don’t know what to do when expected growth fails to materialize. Highly leveraged investors, like some quant funds in the headlines, were recently forced to sell regardless of value when their methodology produced losses instead of gains. Counting on a government bailout for every crisis seems a dicey proposition, especially when supposedly impossible events happen on Wall Street every few years. By the time the market drops and bad news is on the front pages, it is usually too late for investors to react. It is crucial to have a strategy in place before the problems hit precisely because no one can accurately predict the future direction of the stock market or economy.

Monday, January 07, 2008

Jack Canfield: Decide What You Want

I am currently researching into a company which I hope to post about shortly. In the mean time, I thought this article was fitting as we start a new year. (hat tip to David Lau)

In order to get what you want, you must first decide what you want. Most people really foul up at this crucial first step because they simply can't see how it's possible to get what they want -- so they don't even let themselves want it.

Don't sabotage yourself that way!

What scientists now know about how the brain works is that you must first decide WHAT you want, before your brain can figure out HOW to get it. Once you lock-in your desires, your mind and the universe can step in.

Are you ready to get started?

Be Willing to Dream BIG Dreams
As soon as you commit to a big dream and really go after it, your subconscious creative mind will come up with big ideas to make it happen. You'll start attracting the people, resources, and opportunities you need into your life to make your dream come true. Big dreams not only inspire you, they compel others to want to play big, too.

Set Goals That Will Stretch You
Another value in giving yourself permission to go after the big dreams is that big dreams require you to grow in order to achieve them. In fact, in the long run, that is the greatest benefit you will receive from pursuing your dreams -- not so much the outer trappings of fulfilling the dream (an expensive car, impressive house, loads of money and philanthropic opportunities), but who you become in the process.

As I've seen many times over, the outer symbols of success can all be easily lost. Houses burn down, companies go bankrupt, relationships end, cars get old, bodies age and fame wanes, but who you are, what you have learned, and the new skills you have developed never go away. These are the true prizes of success. Motivational philosopher, Jim Rohn advises that "You should set a goal big enough that in the process of achieving it, you become someone worth becoming."

Service to Others
Something else you'll discover is that when your dreams include service to others -- accomplishing something that contributes to others -- it also accelerates the accomplishment of that goal. People want to be part of something that contributes and makes a difference.

Turn Your Dreams into Goals and Objectives
Once you are clear about what you want, you must turn each item into a measurable objective. By measurable, I mean measurable in space and time -- how much and by when. For instance, if you were to tell me that you wanted more money, I might pull out a dollar and give it to you, but you would probably protest, saying "No, I meant a lot more money -- like $20,000!" Well, how am I supposed to know unless you tell me? Similarly, your boss, your friends, your spouse, your brain -- God, the Universe -- can't figure out what you want unless you tell them specifically what it is. What do you want -- exactly -- and when do you want it by?

Write Your Goals Down
Write your goals down in detail, and read your list of goals every day. This will keep your subconscious mind focused on what you want. For an even more powerful approach, close your eyes and focus on each goal and ask yourself, "What is one thing I could do today to move toward the achievement of this goal?" Write down your answers and take those actions.

I recommend writing down a minimum of 3 goals in each of the following 7 areas:

1. Financial Goals
2. Career/Business Goals
3. Free Time/Family Time
4. Health/Appearance Goals
5. Relationship Goals
6. Personal Growth
7. Making a Difference

To help your reticular activating system begin finding YOUR wants in unexpected places, take time now to decide what you want and start writing!

Friday, January 04, 2008

Tectonic Shift: Jared Diamond's Take

This is part of the ongoing series on the currently ensuing Tectonic Shift. We have been discussing how globalization and technology are leading to a balancing of wages as:

1. competitive pressures push developed world wages down, and
2. people in the developing world are being employed more productively.

The thesis is that this should lead to an increase in demand for basic necessities which are highly valued, such as food and energy. Meanwhile, more conspicuous types of consumption might start coming under pressure.

Robert Reich from The Work of Nations added:

The economic well-being of Americans no longer depends on the profitability of the corporations they own, or the prowess of their industries, but on the value they add to the global economy through their skills and insight. This is because today capital and goods can flow nearly uninhibited. So, corporations seek to invest where the skills they require can be attained for the lowest cost.

So, routine and repetitive labor services will face the most competition, while those who have built up education and human capital will be best able to protect an individual's standard of living.

Today, there has been some added insight on the matter from Jared Diamond, author of Guns, Germs and Steel, in his article - What's Your Consumption Factor? (hat tip Shai)

The estimated one billion people who live in developed countries have a relative per capita consumption rate of 32. Most of the world’s other 5.5 billion people constitute the developing world, with relative per capita consumption rates below 32, mostly down toward 1.

The population especially of the developing world is growing, and some people remain fixated on this. They note that populations of countries like Kenya are growing rapidly, and they say that’s a big problem. Yes, it is a problem for Kenya’s more than 30 million people, but it’s not a burden on the whole world, because Kenyans consume so little. (Their relative per capita rate is 1.) A real problem for the world is that each of us 300 million Americans consumes as much as 32 Kenyans. With 10 times the population, the United States consumes 320 times more resources than Kenya does.
Among the developing countries that are seeking to increase per capita consumption rates at home, China stands out. It has the world’s fastest growing economy, and there are 1.3 billion Chinese, four times the United States population. The world is already running out of resources, and it will do so even sooner if China achieves American-level consumption rates. Already, China is competing with us for oil and metals on world markets.
The only approach that China and other developing countries will accept is to aim to make consumption rates and living standards more equal around the world. But the world doesn’t have enough resources to allow for raising China’s consumption rates, let alone those of the rest of the world, to our levels. Does this mean we’re headed for disaster?

No, we could have a stable outcome in which all countries converge on consumption rates considerably below the current highest levels. Americans might object: there is no way we would sacrifice our living standards for the benefit of people in the rest of the world. Nevertheless, whether we get there willingly or not, we shall soon have lower consumption rates, because our present rates are unsustainable.

Real sacrifice wouldn’t be required, however, because living standards are not tightly coupled to consumption rates. Much American consumption is wasteful and contributes little or nothing to quality of life. For example, per capita oil consumption in Western Europe is about half of ours, yet Western Europe’s standard of living is higher by any reasonable criterion, including life expectancy, health, infant mortality, access to medical care, financial security after retirement, vacation time, quality of public schools and support for the arts. Ask yourself whether Americans’ wasteful use of gasoline contributes positively to any of those measures.

The world has only so much natural resources and increased demand has already caused the cost of basic commodities to soar (i.e. food, oil, metals, etc.). If the worldwide growth in living standards is going to continue, we need to see a more efficient use of the world's natural resources.

Tuesday, January 01, 2008

Kurt Vonnegut at Rice University, 1998

So what does this Methuselah have to say to you, since he has lived so long? I'll pass on to you what another Methuselah said to me. He's Joe Heller, author, as you know, of Catch 22. We were at a party thrown by a multi-billionaire out on Long Island, and I said, ''Joe, how does it make you feel to realize that only yesterday our host probably made more money than Catch 22, one of the most popular books of all time, has grossed world-wide over the past forty years?''

Joe said to me, ''I have something he can never have.''

I said, ''What's that, Joe?''

And he said, ''The knowledge that I've got enough.''

His example may be of comfort to many of you Adams and Eves, who in later years will have to admit that something has gone terribly wrong -- and that, despite the education you received here, you have somehow failed to become billionaires.

This can happen to people who are interested in something other than money, other than the bottom line. We call such people saints -- or I do.

Well-dressed people ask me sometimes, with their teeth bared, as though they were about to bite me, if I believe in a redistribution of wealth. I can only reply that it doesn't matter what I think, that wealth is already being redistributed every hour, often in ways which are absolutely fantastic.

Nobel Prizes are peanuts when compared with what a linebacker for the Cowboys makes in a single season nowadays.

For about a hundred years now, the most lucrative prize for a person who made a really meaningful contribution to the culture of the world as a physicist, a chemist, a physiologist, a physician, a writer, or a maker of peace, has been the Nobel Prize. It is about a million dollars now. Those dollars come, incidentally, from a fortune made by a Swede who mixed clay with nitroglycerin and gave us dynamite.


Alfred Nobel intended that his prizes make the planet's most valuable inhabitants independently wealthy, so that their work could not be inhibited or bent this way or that way by powerful politicians or patrons.

But one million dollars is only a white chip now -- in the worlds of sports and entertainment, on Wall Street, in many lawsuits, as compensation for executives of our larger corporations.

One million dollars in the tabloids and on the evening news is "chump change" in 1998...

Here is a direct link to the entire Rice speech. For those of who are big fans of Kurt Vonnegut (Author of Cat's Cradle, Slaughterhouse-Five, Breakfast of Champions), you can find a complete archive of his speeches, writings, biography and more at