Super-Size Me?

How big is too big?

Woodblock of a sumo wrestler in Japan. Public Domain Source: Wikipedia

80 years ago the Nobel Prize-winning economist Ronald Coase set out to explain why people organize themselves into businesses, firms, and corporations rather than just freely trade goods and services amongst one another. If Adam Smith’s “invisible hand” is so efficient, why don’t we all organize ourselves independently?

The economic answer has to do with efficiency. It’s cheaper to build a company around one product or service and aggregate the inputs and outputs needed to get the product to market, rather than everyone negotiating every little detail with everyone else. With a large and complex system like an automobile, there are millions of parts and systems, each of which must be designed and built to precise specifications. It would be too inefficient for the billions of transfers to be negotiated independently.

Transactions costs can be lowered dramatically by bringing them into a single firm. When this works, it works beautifully: an engaged workforce creates and produces something the sales-force can market effectively, gathering feedback from customers as they go, funneling this to an R&D group that solves problems imaginatively.

But nothing fails like success. Small firms that innovate effectively grow into behemoths that become caricatures of themselves: cubicle farms straight out of “Dilbert.” That’s partly why there’s investor skepticism around giant companies: no tree grows straight to heaven. Mega-firms create mega-administrations and bureaucratic nonsense: Soviet-style “republics” where meeting the plan and planning the meetings are far more important than innovation and customer service.

Efficiency then leads to inefficiency, creating opportunities for new competitors to enter a market and provide better products at cheaper prices. That’s why small cap stocks outperform large caps over the long run. The firms grow faster, but they’re also riskier. Money isn’t wasted on paperwork and corporate politics, but there isn’t as much of a safety net if things go wrong. The higher risk is the price investors pay for the extra return.

Stocks, Bonds, Bills and Inflation 1926-2016. Source: New York Life

Someone once asked Abe Lincoln how long a man’s legs should be. His answer was simple: long enough to reach the ground. In the same way, we might ask how large a company should be. The answer is equally simple: large enough to be efficient—and no larger.

Douglas R. Tengdin, CFA

Chief Investment Officer

Charter Trust Company

High (Financial) Anxiety

Do your finances keep you up at night?

Photo: Bhoj Rai. Source: Unsplash

Researchers have found that folks often fall into six common errors when they deal with their money: risk-takers, hoarders, retail-therapists, cash-splashers, controllers, and avoiders. Each of these mistakes is avoidable – and they typically stem from personal issues that have little or nothing to do with money. Instead, they may be compensating for some personal needs they have.

Risk takers have a bias towards action. Given a choice between waiting and doing, they almost always choose to do something. They tend to be overconfident, and trade frequently. Paradoxically, they don’t usually measure their performance in any tangible way. That’s because they’re focused on the next opportunity, rather than learning from the past. Trading fires up the endorphins in our brain; it can be addictive.

For hoarders, money represents security. They often stockpile cash rather than invest it. If they were raised at a time when money was tight, they may find security in a large bank account. While we all need an emergency fund, there’s no reason to let cash build up excessively. At a time when interest on bank deposits doesn’t even equal inflation, the real value of cash is steadily eroding.

Retail-therapists feel good about shopping: shopping makes them happy. They don’t even have to buy things for themselves. Just pulling out their credit card can boost their self-esteem. At the extremes, these folks resemble alcoholics—stashing bags of new purchases around the house, the way problem drinkers stash empty bottles. Both women and men can indulge themselves this way. These folks often end up with debt problems.

Cash-splashers are conspicuous consumers, and it’s the having, not the getting, that’s the thrill. They are likely to wave their checkbooks at charity auctions, and spend money on visible, frivolous things. They’re unlikely to quietly go to the front of a restaurant and quietly cover the tab. Rather, they’ll make an announcement that the meal is on them. Often, these people are motivated by wanting to be admired. But there’s nothing admirable about showing off.

Public Domain. Source: Pixabay

Controllers are obsessive about bank balances, credit card points, and comparison shopping sites. They want to keep on top of money matters, but sometimes this is because they have lost control in other areas of their lives. And – let’s face it – life can be unpredictable. While keeping on top of money matters is a good thing, controllers can make it too much of a good thing.

Finally, there are the avoiders: ostriches who bury their heads in the sand. Bills and bank statements lie unopened. Either they are easily distracted, or they don’t want to decide, because making no decision is always easier than the possibility of making the wrong decision.

The way to break out of these habits is to have a plan and stick to it. Start by keeping a money journal, and make entries for purchases and investments. Work into it gradually, starting by reviewing your finances for a half hour every week or so. This may be like shock therapy to a controller, but the rest of the people on this list need to address – not avoid – their money issues. Ultimately, you want to have a budget – one that includes long-term investments, as well as categories for day-to-day spending.

Photo: Michael Jarmoluk. Source: Pixabay

Because the most meaningful things for us come from experiences we share. And they don’t have to be expensive – like going to the park or the library with kids, or cooking a meal for friends. As Art Buchwald – the political columnist and satirist – once said, the best things in life aren’t things.

Douglas R. Tengdin, CFA

Chief Investment Officer

The Death of Retail?

“the report of my death was an exaggeration”

Photo: A.F. Bradley. Source: Library of Congress

 That’s how Mark Twain responded to a story that he was dying of poverty while on a visit to London. He was undecided whether to be annoyed or amused. He was just 62 at the time, and while a little frail, was in excellent health. A cousin of his – James Ross Clemens – had been seriously ill, and the papers confused the two. The report of Twain’s illness grew out of his cousin’s illness, who soon recovered.

 That’s how I feel when I read reports about the “death” of retail. Amazon and other online retailers have certainly taken a bite out of traditional stores. JC Penney is on bankruptcy watch. And Sears – with 1,600 outlets – is also in the retailing dead-pool. They’re projected to lose $2 billion this year. Their CEO, hedge fund executive Eddie Lambert, has been selling off well-considered brands like Craftsman to raise the cash they need to adapt to today’s internet marketplace. But it’s unclear whether he will run out of cash before they can adjust.

 The outlook isn’t good. Sears’ stock price has fallen to under $10 from almost $100 seven years ago. Revenues have dropped to $25 billion, while Amazon has sales over five times as large, with just 30% more employees. Comparable store sales fell 12-13% at Sears this Christmas. I did almost all my Christmas shopping online this year. It’s just so much more convenient than fighting holiday traffic and waiting in long lines at the checkout counter.

 But brick-and-mortar stores aren’t going away. There’s no law of nature that says Amazon has to be the only online retailer. Amazon appears to know this: their free-shipping membership, Amazon Prime, increasingly offers other services, like streaming music and movies and online photo storage, to keep customers loyal. And there’s this little detail: we want our stuff—now. Sellers have to have a way to get it to us as quickly as possible. Sears has 1,600 distribution points already. They just have to figure out how to make them profitable.



Retail has always been a fast-changing field. 20 years ago the big-box stores were eating the world, now it’s Amazon. A century ago catalog merchants – including Sears – revolutionized the industry. Now it’s online and mobile apps. CEO Eddie Lambert has been famous for his financial engineering, with rights offerings and trigger loans designed to get him the capital he needs, when he needs it. But Sears needs to answer a harder question: how to get us all the retail goods we want when we want them.

Douglas R. Tengdin, CFA

Chief Investment Officer

Join the Circus?

What happened to the circus?

Public Domain. Source: Pixabay

When I was a boy I loved going to the circus. The spectacle of the three-ring extravaganza coming to my city was something all the kids in my neighborhood looked forward to: the trapeze, the high-wire act, the clowns. And of course there were the performing animals—bears, big cats, and of course elephants. I still recall seeing 25 or thirty elephants standing on their hind legs in a ring, leaning their front legs on their neighbor’s back.

But all this may be going away. Feld Entertainment, which owns the Ringling Brothers and Barnum & Bailey Circus, announced that the show will end its 146-year run in May. In a statement, Ken Feld said that taking elephants out of its act last year has led to a dramatic drop in ticket sales—but that attendance had been declining for a long time before this.

 Travelling circuses have been part of the landscape for centuries. Before P.T. Barnum’s Museum, Menagerie & Circus, Dan Rice had a “One-Horse Show,” and the Canadian-born Victor Pepin built circus theaters from Montreal to Havana, using them for the first travelling show. The elephants at the circus became such a fixture that “Seeing the elephant” became an American figure of speech.

 But entertainment is changing. Attention spans are shorter. Amazing performances can be called up on demand on Youtube. Pyrotechnics are on display at any superhero movie, and death-defying stunts can be seen in a Red Bull commercial. And families – the mainstay of circus demand – are getting smaller.

 Without its animals – and especially, the elephants — Ringling Brothers’ circus has little to distinguish it from the many other competitors for our time. While an estimated 10 million people go to see a Ringling circus every year, it’s not enough. If you want to have an enduring product, you have to offer something unique.

 Photo: Alehandro Linares Garcia. Source: Wikipedia

 When I went to the circus, I hated it when the show finished. I wanted every performance to last forever. But as L. Frank Baum – author of the Oz books – once said, “Everything has to come to an end, sometime.”

Douglas R. Tengdin, CFA

Chief Investment Officer

On Cheating

Do business ethics matter?

Photo: Kristopher Psarakis. Source: Morguefile

People say they care about whether a business is ethical. But do they mean it? 2016 was seemingly a bad year for business ethics. Wells Fargo systematically signed customers up for accounts they didn’t know about, and then fired employees who complained about the practice. VW admitted that they criminally deceived emissions tests in their diesel vehicles – and may have been copied in this by Chrysler. Drug-maker Mylan hiked the price for its life-saving EpiPen by over 400%, provoking outrage.

But Wells Fargo still takes deposits; VW is still selling diesel cars and trucks; and Mylan is still selling their devices. Apart from some uncomfortable headlines and a temporary stock-blip, these cheaters don’t seem to be paying much of a price for their professional misdeeds. In the light of the Enron scandal, three quarters of American consumers said they would rather deal with an ethical company, even if it meant paying higher prices. But given our passion for rooting out bargains, this resolution probably lasted just until we saw an alluring price tag.

People may want to do business with ethical companies, but the difficulties of changing banks or selling your car or switching drugs make it hard to follow through. There’s a lot of inertia when it comes to our behavior. So do companies get a free pass? Are high ethical standards a luxury item—reserved for elite firms that can afford them?

The real cost of a bad ethical environment comes down the road. It’s hard to attract the best workers when you have a reputation for skating on ethical thin ice. We all need meaning in our lives: we want to work for something that’s bigger than ourselves, and we need to believe that what we’re doing is a force for good. Wells Fargo may not have lost many accounts due to their ethical shenanigans, but it’s a lot harder for them to hire good people, now. Top performers always have employment options. Aside from legal and career risks, why would you choose to work where you’re forced to feel bad about what you do? And if a company can’t attract talented employees, it’s in a bad place.

Photo: Gerd Altmann. Source: Pixabay

Ethical dilemmas are far from rare. Nearly half of American workers say that at some point they’ve had to choose between what their boss ordered and what they thought was right. Supreme Court Justice Potter Stewart once said that ethics is knowing the difference between what you have a right to do and what is right to do.

By building an ethical culture, companies are building for the future. In the long run, we all may be dead. But our ethical choices will have lasting consequences.

Douglas R. Tengdin, CFA

Chief Investment Officer

Rebooting Expectations

What’s happening in the global economy?

JP Morgan Global Manufacturing PMI. Source: Bloomberg

It’s no secret that the US stock market is approaching record levels. Business news reports seem to be obsessed with the Dow’s flirtation with the 20,000 mark – which first neared about a month ago. But far more important than Disney or IBM’s price – stock prices, after all, determine the level of the Dow Jones Industrial Average – is the status of the global economy. And the world economy has been improving for about 6 months now.

European industrial production has started to pick up, the US and Canada are doing much better, now that oil prices have stabilized, and – most significantly – China’s economy has been improving. The US and China are by far the two largest economies in the world: the US has an $18 trillion economy, and China produces $11 trillion of goods and services annually. Together, they constitute about 40% of the world’s economy.

For lots of reasons, it’s hard to measure what’s going on in China. Chinese economic statistics can be questionable. But one thing that can be measured fairly reliably is electricity consumption: as an economy grows, it tends to use more. And China’s power consumption has been growing around 7% per year, versus a year ago, when there was no growth.

China Electricity Consumption, Year-over-year. Source: Bloomberg

As a result, I think we can expect that our current economic expansion isn’t going to just fade away. It’s not based on sentiment or hope, but solid global economic performance.

Investors should always be prepared for something unexpected. That’s why diversification is important. But as long as the economy grows, equities will have a tail-wind—as will probably keep breaking records.

Douglas R. Tengdin, CFA

Chief Investment Officer

Failure to Launch

Failure to Launch

What is a market failure?

Photo: NASA

A market failure in economics happens when goods and services aren’t allocated appropriately—when people don’t get what they pay for, or when someone gets a free-ride. It’s like slip-streaming on the highway: if I follow a truck closely, I can benefit from the turbulence behind the trailer. But I can only do that if I follow so close that I can’t see hazards in the road ahead. There’s no free lunch.

Market failures can come from asymmetric information, like when you buy a used car—the seller knows more about it than you do. Or they can come from externalities, like various types of pollution. Polluters often aren’t charged enough to clean up their messes, and the rest of society pay the price—through health effects, contaminated food, or other problems. Or market failures may come from non-competitive markets, where there is only one seller or one buyer of a good or service. If there’s just one employer in a distinct region, they may not have to pay competitive wages.

There are various responses to market failures. Sometimes industries form self-governing bodies to address their problems. Sometimes new laws and regulations are called for. But folks have to be careful when they suggest a new rule or market intervention. The flow and bustle of the business world is a lot like a diverse ecosystem, with primary producers, secondary consumers, predatory behavior, and bottom-feeders. Adaptive systems have their own logic.

We need to remember Chesterton’s fence: G.K. Chesterton once commented that a reformer might say, “I don’t see the use of this fence; let us clear it away.” To which a more intelligent reformer might answer, “If you don’t see the use of it, I certainly won’t let you clear it away. Go away and think.”

Photo: Evelyn Simak. Source: Wikipedia

Doctors have the motto, “First, do no harm.” As we enter a new political season with prospects for regulatory reform and tax reform and initiatives regarding health care and banking and energy and other areas, folks would do well to remember that government failure can be just as pernicious as market failure. We need to be sure we don’t just replace one problem with another.

After all, as Mark Twain once wrote, our concerted action may just amount to raiding each other’s clothes-lines. And that won’t make anyone better off.

Douglas R. Tengdin, CFA

Chief Investment Officer


Does cold weather hurt the economy?

Icicles on a tree. Source: Wikipedia

On the face of it, it sure seems that way. Frigid temperatures keep people home and depress retail sales. They hurt agricultural output and can lead to injuries or even death from accidents and physical stress. There’s even some thought that the 16th century’s “little ice age” may have led to crop failures and witch trials.

Certainly extreme weather interrupts us. It’s hard to go shopping or plant crops when you have to shovel out. And storms, droughts, and cold-snaps affect short-term commodity prices. But the effect is local. Three inches of snow in Minneapolis is no big deal; in Washington, DC it’s enough to shut down the government.

But our economy has adapted to deal with minor disruptions. Telecommuting makes it possible for people to still work when they can’t drive to the office; insurance helps us put our lives back together after a big storm. There are also some surprising health benefits from cold weather, like reducing inflammation and killing off parasite-carrying mosquitoes.

Fashion retailers—like H&M or TJ Maxx—seem especially vulnerable to a big freeze. But sales of fleece pullovers and sweaters go up when the temperature goes down. They just don’t make up for lost spring-wear sales.

It’s disruption—not cold—that’s the real challenge. But the more diverse an economy is, the better we can all adapt.

Douglas R. Tengdin, CFA

Chief Investment Officer

Classical Investing: The Music of Orpheus

Can modern investors learn something from an ancient love story?

Orpheus among the animals. Source: Wikipedia

I’m a sucker for a good story, especially an ancient one. Many of our oldest tales tell us something about ourselves – about our hopes and dreams and fears and tendencies. The very fact that these stories have been preserved from antiquity tells us that they have a special relevance: they speak to us on many levels.

Such is the case with Orpheus. Orpheus was a musician, poet, and prophet who could charm people and animals and even stones with his music. He fell in love with and married Eurydice, a daughter of Apollo. She was bitten by a poisonous snake and died. Heartbroken, Orpheus travelled to the underworld. His music softened the iron hearts of Hades and Persephone, who said that Eurydice could return with Orpheus, but only if he led the way and didn’t look back. As soon as Orpheus reached the surface, though, he turned around to see wife. But she hadn’t crossed the threshold yet, and vanished—this time, forever.

Orpheus and Eurydice. Source: Wikipedia

The story is one of talent, and limits to that talent. Orpheus’s music was incredibly powerful. It could move others to do things that were far outside of their nature. His singing could even change the courses of rivers. Nothing could resist it. But after winning his way into hell and winning his love back from the dead, he couldn’t keep the one condition that Hades put on him. Whether it was because he doubted Hades word or he was so overjoyed when he reached daylight or – in other versions – Zeus throws a lightning bolt at him to frighten him, Orpheus looks back. And in that looking, he loses what he had worked so hard for.

In business and life we see folks who are overcome by issues in their own character – or just unfortunate circumstances. They lose what they’ve worked for, sometimes at the very threshold of success, when they can see daylight. To me, the tragedy of Orpheus comes from his being alone. He didn’t have anyone with him to keep him facing forward.

It’s not enough to be talented. We others around us to encourage us and help us and remind us of why we are where we are. Only then can we hope to reach our goals.

Douglas R. Tengdin, CFA

Chief Investment Officer

How Big?

How big is the market?

S&P 500 Market Cap. Source: Bloomberg

That depends on what you mean by the market. The US stock market is worth about $20 trillion. That’s the value if you add up all the shares traded times their market price – the market cap of the S&P 500. When you divide the market’s total value by the total earnings (and losses) produced by those companies, you get the market’s PE ratio—a basic measure of valuation.

A lot of folks are concerned that this ratio is getting stretched—that the market’s valuation is moving up towards levels we haven’t seen in long time—times we’d rather not go through again.

S&P 500 trailing PE ratio. Source: Bloomberg

But that may not be the best way to look at valuation. For one thing, it ignores the apples-to-apples issues we have with earnings. In the 1990s the accounting profession started to get a lot more aggressive about reporting on non-cash items. First there was the S&L crisis in the early ‘90s. Then there were a series of scandals involving swaps and other off balance sheet contracts. Finally, there was Enron and the prosecution—and destruction—of Arthur Anderson in 2001. There were good reasons for accountants to include more mark-to-market calculations in their figures.

As a result, the absolute valuation levels may not be comparable. But changes in valuation over time can still help us understand the market.

From 2000 to 2011 the general trend in valuations was lower. Part of this was the market coming off the excessive optimism of the late ‘90s. Part of this was the adjustment the market made to the 2001-2002 recession. And of course the market had to be cautious during the financial crisis, and later the Euro crisis. This conservative trend in valuations resulted in one of the lowest 10-year return periods for stocks ever. It made sense during that time for investors to be cautious.

But after having bottomed in 2011, PEs have moved steadily higher. Whether it’s been ultra-low interest rates or better earnings or new products or – now – optimism about tax and regulatory reform, the market has been more and more optimistic about corporate earnings. Valuations—as measured by PEs or price-to-book or some other measure—have all been trending upwards.

As a result, I think equity investors can be optimistic as well. The trend—hopefully—will be our friend. Until it ends.

Douglas R. Tengdin, CFA

Chief Investment Officer

Douglas Tengdin's Global Market Update