Main Street, Internet Style

Is Amazon consuming the consumer?

It sure feels that way. Over the past five years they’ve grown and grown and grown, while traditional retailers like Sears, Radio Shack, and JC Penny have struggled. Office supply stores like Staples and Office have really been hit. In fact, foot traffic is down in all the malls:

Source: WSJ, 1/16/14

Retail is changing. It’s just more convenient to order stuff from the internet than to go to a store. As smartphones with shopping apps become more ubiquitous, buying becomes ever-easier. Online shopping is a massive flood that’s sweeping traditional retail away. The movie “You’ve Got Mail” now has an ironic twist: the mega-bookstore exec has no idea his anonymous email account will eat his job. Just look at what happened to Borders.

But it isn’t just retail. Facebook has become Good Morning America; Twitter what real-time journalism used to be; and Hulu and YouTube are devouring traditional TV.

The world is adjusting to the online environment by eliminating old jobs and adding new ones. 130 years ago thousands of cowboys lived in line camps, keeping the cattle from straying. The line camps went away when barbed wire made it a lot easier to manage the herd. But necessity is the mother of invention. Those cowboys found new work in a new, more productive economy.

The internet is doing the same thing today, making life more convenient for billions of consumers. I just haven’t figured out yet how to get a haircut with my iPhone.

Douglas R. Tengdin, CFA

Chief Investment Officer

Private Eyes?

What is private equity?

The Burger King / Tim Horton’s deal is being driven in part by Burger King’s majority shareholder, 3G Capital. 3G is a multi-billion dollar Brazilian private equity firm that focusses on iconic brands. They have significant stakes in Heinz, Anheuser-Busch, and America Latina Logistica, the largest railroad company in Latin America.

Private equity firms have direct stakes in the firms they own. Their shares aren’t traded publically. That means their investments can be locked up for years. It’s like investing in a friend’s business: you’re at the mercy of your friend and any other investors if you want to buy more or reduce your share. Usually private equity firms bring some kind of expertise with them—brand management, or financial savvy, or technological expertise. Firms sometimes accept private equity investment to get those skills onto their Board.

The advantage of private investing comes from its governance structure and accountability. Managers can’t control their Boards, since investors are independent. There are no issues of insider trading, so investors can ask whatever they want whenever they want. If managers behave badly in the morning, they can be gone by the afternoon. As with the Burger King deal, decisions can be made quickly.

But private equity is risky because it’s so concentrated. To have a meaningful impact on their investments, firms need to limit their focus. In equities, diversification reduces the volatility of returns. That’s part of the reason private equity funds are limited to accredited investors—who in theory can afford to lose it all.

Private equity funds provide one more way for institutions and wealthy individuals to put their money to work. But they’re not for everyone.

Douglas R. Tengdin, CFA

Chief Investment Officer

Doughnut Burgers?

Why is Burger King merging with Tim Horton’s?

The American fast-food restaurant Burger King and the Canadian doughnut shop Tim Horton’s are discussing a merger in which Burger King would shift its headquarters to Canada. In doing so, Burger King would save a lot in taxes. They’ll still pay 35% on US-source income; but if global growth is their goal, Canada’s territorial system and 15% Federal tax rate will allow them to sell burgers and coffee from Berlin to Beijing and not have to worry about Washington claiming its share.

The companies say that the deal isn’t about taxes, it’s about the synergies of merging two sister food companies. And that’s true, too. But this deal is a double-whopper. They can save money on taxes and improve operations as they seek to capitalize on the growth potential of the emerging middle class in the developing world. Neither company currently gets much of its income globally. The market certainly likes the concept: both companies closed about 20% higher after announcing their intentions.

But Washington doesn’t like inversions. Besides costing the Federal Government money, they call attention to the fact that only Chad and the United Arab Emirates have higher corporate tax rates than us. While corporate taxes in the rest of the world have been falling, they’ve been static here. Even with lower marginal rates, however, corporate taxes are a bigger percent of GDP up north.

Like it or not, though, there’s not much the authorities can do to stop two equal-sized companies from combining operations. The new headquarters have to go somewhere. We have extensive trade and finance treaties with our northern neighbor. Global competition means that companies are free to choose where to locate.

Douglas R. Tengdin, CFA

Chief Investment Officer

Icy Virus

What is the “Ice Bucket Challenge”?

The Ice Bucket Challenges involves getting filmed having a bucket of ice-water dumped on your head to promote awareness of ALS, or Lou Gehrig’s Disease. Someone nominates you to do this, and within 24 hours you have to get dunked or to buy your way out via a charitable donation. Often the person getting soaked makes a donation anyway. The phenomenon has gone viral: over 2.4 million videos have been posted, and the ALS Association has raised $53 million dollars in the last month, versus $2 million a year ago, from over a million new donors.

But why? What’s so special about getting soaked by a bucket of ice water? The CEOs of Facebook, GE, and Disney have been filmed, along with many sports stars, entertainers, and politicians. There are lots of worthy causes. Why should this effort be so successful?

A recent study outlines six elements that go into the most successful ad campaigns: social currency, emotion, public activity, stories, practical value, and triggers. This activity hits on the first four factors. Social currency makes us look good; the emotional appeal of ALS is obvious; the videos make it public; and each dunking has a unique story. The Ice Bucket Challenge doesn’t seem particularly practical, nor does it rely on current-event triggers—except that August is hot, and ice is cool. But an idea doesn’t have to hit all six. Four out of six, for a current, heart-tugging cause, seems to have been enough.

Social contagion is usually a negative phenomenon, associated with mobs, panics, and financial bubbles. It’s encouraging to see it applied here in such a positive way.

Douglas R. Tengdin, CFA

Chief Investment Officer


What will Janet say?

The Fed’s confab at Jackson Hole used to be a sleepy academic conference. At first blush, it’s not the most obvious location for a gathering of monetary policy mavens: it’s hard to get to, cell coverage is spotty, and bears can be a problem!

But it has the virtue of being remote. In fact, the striking scenery and remote location are reminiscent of the Bretton Woods global monetary conference of 1944, or even the 1910 meetings on Jekyll Island, South Carolina, where the architecture of the Federal Reserve was originally plotted. Off-site conferences have their advantages.

But getting away from the press is no longer one of them. The views of the mountains rising 6,500 feet above Jackson Lake may be breathtaking, but the conversations around meals and while hiking and fly-fishing are often most interesting to attendees. Sadly, for the rest of us, “Jackson Hole Rules” make these informal remarks off the record. Still, economic history has been made here. Alan Greenspan and Ben Bernanke both signaled major shifts in policy. But not always: last year, Bernanke didn’t even attend.

This year, everyone’s looking for clues as to when the Fed will start to raise rates. Will Dr. Yellen’s keynote provide them? We’ll just have to tune in!

Douglas R. Tengdin, CFA

Chief Investment Officer

Big Data, Big Issues

Can Big Data be abused?

Many folks are concerned about privacy when it comes to Big Data. And there are real issues. It’s a little creepy to be greeted by, “Hello, Mr. Tengdin. Did you like the shirts you bought last week?”— when I call a customer center. But that’s just efficient service. It makes sense for a retailer to know who’s calling. Most people like being greeted by name.

No, our online world creates other issues. With a little ingenuity, data scientists can know a lot more about you than you realize. Let’s just say on the front end that some things should be off limits. Discussions with lawyers about legal issues, conversations with doctors about medical issues, talks with pastors on spiritual issues—if it’s privileged in court, it should be protected from data miners. And of course hacking personal information—financial, educational, etc.—is criminal.

But there are other moral minefields that firms can stumble into. Facebook recently got in trouble for tweaking its users’ news feeds—altering which stories came up first. Now, I expect firms to find out what impacts their customers—like changing a store’s layout to improve sales. But other sites have run tests where they gave false information to users to see what happened. This is more than annoying: there are serious issues that arise when your experiments affect peoples’ lives.

At a minimum, companies using data science should have someone review what data they’re using and what tests they’re running from an ethical perspective. Someone has to be able to simply say, “This is wrong.”

Douglas R. Tengdin, CFA

Chief Investment Officer

Big Data, Big Deal

What is Big Data?

Big Data is any data set that is too large or complex to analyze via traditional means. Every day over 2 ½ exabytes of data are created. An exabyte is a billion gigabytes, and would require a stack of CDs 1000 miles high to store. That’s a lot more information than you can put on a spreadsheet!

All this data is coming from the smartphones, credit cards, store sensors, and highway monitors that are part of everyday life. Think you can get off the grid? You’d have to live in a log cabin in the Yukon to get away from the data collection, and no one can escape the implications.

Big Data can create big opportunities. Stores can analyze real-time information to run experiments, adjust prices, reorder hot items, and move merchandise around. By testing, bundling, synthesizing, and processing information from the sales floor to the corner office, businesses can become much better at what they do.

Data scientists are in demand. They command high salaries because they can add so much value. But it takes wisdom to transform information into insight. Besides technical issues of data quality and integrity, there can be ethical implications. Sometimes it’s just wrong to gather all the data you want.

Big Data analysis is part of the world we live in. It can make an enterprise more effective. But be careful! The first rule of data processing is, “Garbage in, garbage out.”

Douglas R. Tengdin, CFA

Chief Investment Officer

A Bad Bet?

What’s wrong with gambling?

I don’t mean morally, although many folks object an industry built on betting. I’m asking about the business: by the end of September four of Atlantic City’s 11 casinos will have closed or gone bankrupt. Gambling revenues in New Jersey have fallen to $2.8 billion from almost $5 billion. In Mississippi, revenues have fallen from $2.9 billion to $2.1 billion. Takings have even tumbled in Nevada, though not by as much.

Part of the problem has been the proliferation of casinos. 39 states now have casino gambling, up from 2 states—Nevada and New Jersey—25 years ago. Why should New Yorkers drive 2 ½ hours to Atlantic City when they can play the slots just a few minutes away in Queens? Also, many consumers are still skittish after the financial crisis. In spite of its high-roller image, more gambling earnings come from middle and low-income customers, and that segment of the economy is still stagnant.

But a big disrupter has been online gambling. If you don’t want to drive hours, why even drive minutes to get the buzz that comes from winning a wager? Internet sites and mobile apps provide immediate access. The same forces that are disrupting entertainment, publishing, banking, and many other industries are killing centralized gaming. It’s just more convenient to play online than to go to a casino.

Gambling is an industry with low barriers to entry and lots of internal competition. Margins are under continuous downward pressure. Sometimes the most successful investment in an industry is no investment. As the 1978 Kenny Rogers song says, you need to know when to walk away and when to run.

Douglas R. Tengdin, CFA

Chief Investment Officer

Taking Up Slack

Does our economy have too much slack?

Central to the debate about monetary policy is the question of economic slack. If there’s a lot of slack in the economy, Fed policy needs to be easy, and rates need to be low. If there isn’t enough slack, rates need to get back to normal, or inflation will pick up. Slack is a slippery concept—simple in theory, but hard to pin down. Policy errors in the ‘60s and ‘70s led to overly-easy policy and double-digit inflation. Nobody wants that!

Current data show a 5% output gap, based on the best estimates. But estimates can be revised. Based on the preponderance of the evidence, it’s unlikely that data on the economy will be revised upwards. Leading indicators are good, but not great. Capital spending by companies hasn’t been strong for a long time. And the employment/population ratio indicates that a lot of people could go back to work if the conditions were right.

So stagnant wages and low inflation will be with us for a while, even if the Fed is divided on the issue. Some may argue that rising asset prices are a form of inflation, but that is very different from rising consumer prices. Economists and market mavens will continue to look for patterns in the tea-leaves, but there’s nothing that indicates an overheating economy right now.

For the moment, low rates and good profit growth have given us a strong stock market. While tensions in Russia and the Middle East may make things interesting, they’re unlikely to make a significant dent in our economy.

Douglas R. Tengdin, CFA

Chief Investment Officer

Repos: No Place to Run

Finally, an official gets it.

Six years, 848 pages, and 280 Dodd-Frank rules later, a Fed official is getting to the heart of the Financial Crisis. Eric Rosengren, President of the Boston Fed, gave a substantive speech about the repo market three days ago. Repos—or repurchase agreements—are a critical part of our financial infrastructure. They’re how major broker-dealers fund themselves. And Dodd-Frank barely mentions them.

In a repo, a firm sells a security and agrees to buy it back a day or so later at a slightly higher price. Because the sale and purchase happen simultaneously, the transaction is considered borrowing, not selling. The difference in the price is accounted for as interest. If the selling firm goes bankrupt, the lending firm has the securities as collateral.

Repos are widespread because they seem so safe. So safe, in fact, that when I was first learning finance, it was assumed that repo lines would always be there. After all, why worry about your borrowers when you have their bonds—and below their market price, too. The “haircut” is 2% for Treasury bonds, more for mortgages or corporates. But for some reason, lenders don’t like to deal with losses, even if their loans are secured. When times got tough in 2008, repo lending dried up. First Bear Stearns faced a run, then Lehman, then all the brokers had their credit lines cut. The Fed had to step in and backstop the banks, or we really would have had a financial meltdown.

Well, all the discussion about the Volker Rule and Living Wills for banks doesn’t address the simple problem that the big brokers use a huge amount of short-term borrowing to fund their long-term bond inventories. In fact, it’s striking how little has changed in their liability structures, and all that overnight money is still subject to a run. In his speech, Rosengren outlines some ways policy-makers could address the issue. Several—such has higher capital standards—seem pretty reasonable, although they would all impact profits.

Our global financial system is still vulnerable. The big broker-dealers were at the epicenter of the earthquake of ’08. Fixing how they finance themselves is long overdue.

Douglas R. Tengdin, CFA

Chief Investment Officer