Private Markets and Public Innovation

Is the rise of private equity stifling our productivity and competitiveness?

Domenichino, “The Virgin with the Unicorn. Source: Wikipedia

20 years ago entrepreneurs all wanted to go public. The stock market was a way to make yourself and your employees rich. Start a company, develop an innovative concept, grow sales and profits by enough, and the equity markets could reward you. At least, that was the dream.

But now, companies want to stay private as long as possible. They don’t want the reporting requirements that come with a public company. They don’t want to deal with the latest regulatory fad from the SEC—Regs A, B, C, D, or Z-minus. They don’t want to be accused of insider trading because their dog barked at midnight. Going public isn’t a source of pride, it’s a nonstop headache. And there’s lots of private money available.

Private Equity Market Cap. Source: LPEQ

So they raise cash from venture capitalists and other institutional investors when they need to grow, exchanging shares on special nonpublic exchanges. You can buy or sell shares in Uber or AirBnB right now, you just have to have certain credentials. Senior management gets rich; average employees, not so much. Eventually, a big, mega-cap giant comes along and gobbles up the innovative startup, incorporating the disruptive technology into a lumbering, bureaucratic system—like Kodak and digital imaging. The profitability of film kept them from developing the technology, even though their scientists created a megapixel sensor back in 1986. Big companies are where new ideas go to die.

One reason public companies are hoarding cash right now is that it’s cheaper to buy upstart companies that could disrupt them and their industries than it is to invest in their own uncertain R&D. And this may be stifling productivity. Think how the world would be different if—rather than going public—Microsoft had been bought and buried by IBM. We’d all still have terminals plugged in to our Univac mainframes.

Univac Mainframe. Source: Wikipedia

Such is the cost of arbitrary, capricious prosecution by the SEC, and occasional, random accounting pronouncements by the FASB. Entrepreneurs don’t have to put up with the hassle. And the rest of the economy pays the price.

Douglas R. Tengdin, CFA

Chief Investment Officer

Super Bowl Silliness

The Broncos won. Is it going to be a bear market?

Photo: Stephen Luke. Source: Wikipedia

Every year around this time someone trots out the “Super Bowl Indicator” to discuss whether the stock market is going up or down this year. A seemingly strong correlation appears to exist between who wins the Big Game and how the market performs in the ensuing year. According to this theory, a win by the AFC heralds doom and gloom, while an NFC victory means happy days are here again.

This indicator has been on the money 39 out of 48 years (as measured by the Dow)—an 81% success rate. Most people know that the outcome of a football game has nothing to do with global capital markets, but now the thinking is that this indicator may involve mass psychology: if enough people believe the market will move one way or another, they will collectively transform their belief into a self-fulfilling prophecy.

Internet Poll. Source: CNBC

After all, the stock market seems divorced from reality at times. Earnings can be up, but they disappoint expectations, so the market goes down. Unemployment may rise, but it could raise the hopes for Fed easing, and the market rallies. Bad news can end up being good news. According to the legend, since the Broncos—an AFC team—won on Sunday, the market should go down. But sometimes—like in 2013, when the Ravens won—that prediction goes awry. That year the market was up 30%.

Correlation doesn’t equal causation. There is no credible mechanism to translate the result a sporting event into economic, financial, and market performance. In a list of 100 random variables, 5 of them will be statistically significant at the 95% level. And believing something to be so doesn’t make it so, any more than sprinkling pixie dust on you will allow you to fly.

The Super Bowl Indicator is specious, silly, and a waste of time. But it sure was a good game on Sunday.

Douglas R. Tengdin, CFA

Chief Investment Officer

On the Ground Game

The ground game is critical.

Photo: Gabor. Source: Morguefile

That’s what surprised me about Sunday’s Super Bowl. Both teams used a lot of time running the ball, trying to open up holes in the defense, pounding and grinding yards away from one another. As someone who grew up cheering for Fran Tarkington’s Vikings and rooting for the New England Patriots today, I expected shotgun formations and a lighting offense. Instead, we saw play after play dominated by running backs and rushing. Indeed, the only points scored by passing were a on a two-point conversion by the Broncos late in the fourth quarter.

The “ground game” also dominates discussions of the presidential primaries. Candidates are supposed to mobilize supporters–encouraging them to make phone calls and knock on doors. These “foot soldiers” have been the heart and soul of Presidential campaigns for a long time. This year some candidates think that by holding big rallies, scoring debate points, and blanketing the airwaves they can post impressive results. But that’s not usually how New Hampshire works. It takes targeted voter outreach to turn polling numbers into election day votes.

Photo: Charles O’Rear. Source: Wikipedia

Do you have an investment ground game? An investment ground game is found in the nitty-gritty details of asset allocation and financial planning. What are your investment goals—what do want to do with your money, besides pay this month’s bills? How much risk can you handle? How about your stocks: what do their revenues, margins, and earnings look like? With bonds, what is their credit rating, and how much interest do they pay? And how diversified are you—are you invested in different assets, industries, and countries? We don’t know the future: diversification limits our downside risk and allows our portfolios to grow where we might least expect.

In football and politics, the ground game isn’t very exciting. It requires a lot of preparation, a lot of work, a lot of determination. It isn’t glamorous. Often, it looks like three yards and a cloud of dust, over and over again. But you can’t ignore the fundamentals. The same holds true with investments.

Because it’s not about headlines and adrenaline. It’s about achieving your goals.

Douglas R. Tengdin, CFA

Chief Investment Officer

On The Lookout

Are we headed for a recession?

Photo: Dee Golden. Source: Morguefile

The short answer is, nobody knows. Recessions happen with surprising regularity in an advanced economy, but predicting them is challenging. Stocks are down right now, and this has people worried that the economy will turn down and stocks will fall even further. After all, stocks lead profits which lead the economy. So the equity market is a leading indicator, but stocks have predicted 9 of the last 5 recessions. They fell dramatically in 1998 and 2011, and a lot of folks panicked. That was a mistake, and when the market recovered to new highs, they got whipsawed. Equity prices are just too jumpy to use alone as an indicator.

On the other hand, some economic factors do lead the economy. For example, people don’t build houses or buy new cars when things look bad. When you combine financial and fundamental factors, you can get a sense of whether we’re headed for a downturn. The Conference Board’s index of leading economic indicators provides this kind of picture, and it’s been around for decades. What is it showing?

Leading Indicators. Source: Bloomberg

So far, the index is still turning up. It’s been a pretty reliable advance predictor of recessions; it turned down in 1999, in early 2000, and in 2005—well before the stock market crashed. And it didn’t break down in 1998 or 2011, the most recent market scares when there a lot of (what turned out to be) false sell-signals. If you had sold out at those times, you would have missed out on a couple years of double-digit returns.

So—based on this index—it looks like we’re going to be okay—that the latest turmoil in China or downturn in oil prices or rise in the dollar won’t knock the economy off track. That doesn’t mean that the market is fairly valued, or that we won’t see a period of low returns or that the Fed won’t get stuck with low interest rates. But it does mean that the chances are that the economic tide will keep rising.

And a rising tide should keep floating all of our boats.

Douglas R. Tengdin, CFA

Chief Investment Officer

The Search for Security

The Search for Security

Where can investors find safety?

Photo: Josh Rogan. Source: Morguefile

The answer to this question is far from obvious. In the past fifteen years we’ve seen spectacular failures among both large and small companies: Lehman, Fannie Mae, Quicksilver. And even more companies have fallen dramatically in price and never recovered, like Citigroup or AIG. Now the entire energy sector may be downgraded. When the giants fail, where do you go for safe, blue-chip growth?

The short answer is, there’s no such thing as safety. There were some spectacular failures 20 or 30 years ago, but our selective memories erase them—and the subsequent recovery—because, well, we just forget. Also, our minds tend to recall facts that have strong emotional associations. A tree falling in the forest a mile away isn’t as loud to us as a limb from the maple out front crashing down on our car in the driveway. And a growing tree doesn’t make any sound at all.

Stout Memorial Grove. Source: Wikipedia

Are small companies the answer? Small firms have less experienced managers and more volatile business conditions. They tend to be regionally focused, so local economies affect them more. Since they slip under the radar screens of many auditors, accounting fraud and malfeasance are more likely. As a result, business failures among small firms are much more common. They also grow at a faster rate, though, since expansion isn’t limited by the size of the economy. It’s easier for revenue to double from $5 million to $10 million than from $500 billion to $1 trillion.

So small stocks are more volatile. Investors who buy them need to pay close attention to their balance sheets, business plans, and manager integrity. But there are no sure things in investing. It’s all a matter of managing risk while you look for returns.

Douglas R. Tengdin, CFA

Chief Investment Officer


“Thar she blows!” “Where away?” “Three points off the lee bow, sir.” “Raise up your wheel. Steady!”

Illustration: I.W. Taber. Source: Wikipedia

It’s easy to become obsessed. Melville’s famous novel Moby-Dick describes Captain Ahab’s obsession with a giant albino sperm whale. On a previous voyage, the white whale had bitten off Ahab’s leg, leaving him with a prosthesis. Ahab goes on a mission of revenge, casting his spell over the rest of the crew. His fanaticism robs him of all caution. In the end, Moby-Dick destroys the ship and drags Ahab to the bottom.

When you’ve suffered a loss in the market, the best thing to do is to put it behind you. Sometimes it’s because the nature of the economy has changed. Sometimes there was an unexpected development—new management, or some external factor. Sometimes you simply miscalculated. Whatever the reason, it’s important to understand that markets are forward-looking. They take current circumstances and future expectations and try to discount all the expected cash-flows to a present value. That’s what market prices represent.

S&P 500 for the last 2 years. Source: Bloomberg

So when they move significantly, it’s because the outlook is different. A stock doesn’t know that you own it, and it certainly doesn’t care what the price was when you bought it. Investors can get obsessed with “getting out even.” But that’s a mistake. The only reason to worry about where you bought a stock is to manage your tax-liability.

In the midst of the conflict, Ahab was given a final chance to give up his fanatical quest, but he rejects this—to his doom. Investors need to be sure they’re thinking and planning rationally—and not obsessively.

Douglas R. Tengdin, CFA

Chief Investment Officer

[tags Moby-Dick, obsession, cost-basis

Comfortable Shoes

What do you need to survive these markets?

Photo: Louis Melancon. Source: Metropolitan Opera

When Birgit Nilsson, a famous Wagnerian opera singer, was asked what was the secret to singing “Isolde”—a notoriously difficult soprano role—her answer was unequivocal: “comfortable shoes.” She had a point. The first act lasts well over an hour, and the lead has to be on her feet—singing—for most of that time. Wagner was tremendously demanding of his soloists.

When investors face demanding times like the ones we are in, they need to be sure they are comfortable. Media will fill the airwaves with stories of the Chinese slowdown and commodity price slide and bad bank loans and the potential for a breakup of the Euro zone. Falling stock prices evoke memories of 2008 or 2001. It’s easy to panic: we don’t want to go through that again.

That’s why it’s important to have a portfolio you’re comfortable with. If it’s something you don’t think about—if you contribute to a 401(k) and don’t even bother to open your statements—then you can afford to own volatile assets that jump around: like small cap or emerging market stocks. Those tend to have the best growth. If you’re worried the next downturn will give you heart failure, then maybe you mostly need short term government bonds. If you want both—growth and stability—then a mixture is best: large cap, small cap, global securities, corporates, etc.

Asset Mixture Returns. Source:

The key to performing a challenging vocal role is to stay relaxed and to wear good quality clothes. The key to persevering in challenging markets is to have a quality portfolio. Because—if you can get through them—the returns, if not the applause, will make you smile.

Iowa Futures

Is Iowa typical?

Artist: Grant Wood. Source: Wikipedia

Iowa enjoys a funny place in American culture. Home to the first-in-the-nation political caucus, the state is often derided as quirky and out of touch—unlike big-city dominated states like Minnesota and Illinois to the north and east.

It’s true that the Des Moines metro area only contains about 20% of Iowa’s population, versus Minneapolis and Chicago that have over 2/3rds of their States’ people. It’s also true that the state has a small minority population, and fewer than 4% are recent immigrants. But Iowa has a diversified economy, dominated by manufacturing, biotech, and finance. Maytag had its headquarters in Newton, Iowa, as does Winnebago—the RV maker.

Actors John Wayne and Johnny Carson came from Iowa. So did Norman Borlaug, the father of the green revolution in plant genetics, whose scientific research may have saved over a billion lives, worldwide. The Iowa Writer’s Workshop is a literary treasure. Demographically and geographically, Iowa is in the middle of the country—ranked 30th in population and 26th in area. It’s in the middle economically, too, with a median income ranked 24th.

It’s easy to deride rural Midwestern states as “flyover country.” But that’s a mistake. Ethanol subsidies may be a foolish and wasteful economic policy—and something that politicians unfortunately kowtow to—but Iowa is more than corn and hogs. Dear Abby and Ann Landers were born in Iowa. It’s no wonder that the state leaves us with so many questions.

Douglas R. Tengdin, CFA

Chief Investment Officer

Fed To Markets: Never Mind

Fed To Markets: Never Mind

Photo: NBC Television. Source: Wikipedia

When I read the latest policy statement coming out of the Fed on Wednesday, I was reminded of how the character Emily Litella from Saturday Night Live would always close our her commentary: “Never mind.”

This is a critical time for the Fed. Their very legitimacy has been called into question. So they’ve been trying to guide the markets, to make sure we aren’t blindsided by a sudden action. Some Fed Ph.D. must have concluded that market volatility is associated with restrictive financial conditions. As a result, they’ve concluded that when it comes to monetary policy, the best surprise is no surprise.

But all this guidance is guiding us in different directions. Last summer they steadily prepared us for a rate liftoff. Then China’s market moves scared them, and they guided rates lower. Then employment growth picked up in the fall, and they guided rates higher, actually achieving liftoff in December. Stanley Fischer got excited, and told the markets that four rate hikes in 2016 was “in the ballpark.”

Source: Bloomberg

Now we’re right back where we started from. This time, the drop in oil prices scared the Fed, so they shaded the language in their statement. They said that household spending is moderate, not improving. They took out their “balanced” view of the risks to the economic outlook. And they added that they will watch the data and global markets closely.

Well, of course the Fed watches the markets and the data. This is news? What’s news is they’re telling us. What’s news is Mr. Fischer had to backpedal. What’s news is the Fed is guiding us lower again. Watching the Fed these days is like watching the surf when there’s been a storm offshore: some waves are big, some are little. It’s hard to tell what’s coming next.

For the past five years the Fed has been too optimistic about the economy. We’re stuck in a slow-growth, low-inflation cycle, where oversupply keeps the price of everything down. It’s clear that they’ve been “talking their book,” trying to be optimistic. After all, if we all get a little more optimistic, we’ll all spend more, right? Only it doesn’t work that way. We only spend more when we earn more.

If the Fed wants to reduce market volatility, they should be more consistent in their communication. But sometimes the best way to communicate is to stop talking.

Douglas R. Tengdin, CFA

Chief Investment Officer

Outcomes and Incomes

Incomes and Outcomes

Are you interested in scoring? Or winning?

Photo: Gabor. Source: Morguefile

Traditionally, companies are organized around their products. Proctor and Gamble sell shampoo; GM builds cars; Disney makes movies. But what people really want is to get a job done. They don’t want a car as much as they want transportation; they don’t want to make a phone call, they want to communicate. Understanding the difference can be life-changing.

20 year ago Cordis Corporation was a bit player in angioplasty devices. Those are the small balloons doctors thread into the heart to clear blockages and avoid a heart attack. But customers didn’t want angioplasty. They wanted healthy hearts. So Cordis talked to doctors, nurses, patients, and administrators to see how they could do things better.

The result wasn’t just incremental improvement, it was a totally new product. In their conversations, Cordis found that the biggest problem was that the blockages would come back. So they redesigned their device, eventually introducing stents as a way to keep the coronary arteries clear. They saw their market share grow from 1% to nearly 10% in the US, and a few years later, Johnson and Johnson acquired them.

Cordis Stock Price. Source: Bloomberg

Outcome-driven investing should follow the same approach. What does the client want? Income? How much income? How much growth? Typically, investors compared their portfolios to the S&P 500 or some other index to see how they’ve done. But that can be misleading. Beating the index is cold comfort if you need to earn a 4% income stream and the index only yields 2%. Conversely, if the investor’s goal is to double size of the portfolio over the next 10 years, generating current income isn’t a priority. Too often, we focus on the product or the process, rather than the ultimate objective.

An outcome-orientation can help you get away from the day-to-day ups and downs of the market’s latest obsession with Chinese industrial production or European Central Bank policy. What matters is what’s important to you, not some random fact about someplace you’ve never heard of.

In sports, the objective isn’t to score points, it’s to win. There’s a difference. With investing, the goal isn’t necessarily to earn more, it’s for your money to help you to live the life you choose. It’s our choices that really define who we are.

Douglas R. Tengdin, CFA

Chief Investment Officer

Douglas Tengdin's Global Market Update