Bigger or Beggar?

Since they can have so many internal issues, why do we have big companies at all?

Pabst Brewery, Milwaukee, Wisconsin. Source: American Gardening

It’s not a trivial question. In theory, we could all be independent contractors, offering our labor in a great big market, with no bureaucracy. But we would have to devote a lot of time to finding markets for our work, negotiating prices, and getting paid—administrative tasks that aren’t productive. Those kind of transaction costs are like sand in the gears of an economy, and companies can reduce them to a minimum through their organization.

Still, it’s a paradox that big companies exist. After all, big government organizations can be massively inefficient. But big companies often pride themselves on their efficiency, with just-in-time manufacturing and modular shipping reducing costs to a minimum. So why are big companies effective, while big government is frequently a joke?

Long run average costs, across company size. Public Domain. Source: Wikipedia

The answer has to do with goals and accountability. In the U.S. our corporations have one explicit goal: to maximize the long-term financial return due to their owners. Their performance is constantly monitored, and if they fail to produce a return, their owners can reorganize or just shut down the enterprise and sell off the pieces. There’s a Darwinian process to eliminate inefficiency: it’s economize, or die.

By contrast, governments have multiple goals: law and order, national defense, enforcing contracts, regulation, education, maintaining a social safety net, and so on. With so many disparate goals, inefficiency is endemic to the enterprise. And finding more efficient ways to deliver services isn’t usually the highest priority.

That’s why people usually aren’t surprised by bureaucratic waste in government. And why we need to be careful with government-sponsored enterprises. Because what government gives, it can easily take away.

Douglas R. Tengdin, CFA

Online Monopoly?

Is Amazon a monopoly?

Source: Amazon

A monopoly exists when there is effectively only one supplier of a good or service. They can set the price, and anyone who wants what they’re selling has to pay it. There’s really no alternative. This was the case with Standard Oil in the late 19th century. They were an innovative oil refinery that bought out competitors in the oil products area, the integrated vertically with exploration and production enterprises to become the largest oil company in the world. In 1911 the Supreme Court ruled that they were an illegal monopoly, and broke them up.

Is Amazon a monopoly? It sure feels like it. When I want to buy something online, there’s really only one comprehensive alternative. Sure, I can go to individual retailers’ sites for specific purchases, or a manufacturer’s site, but for online shopping, it seems like Amazon is the only game in town. Last year, Amazon sold six times as much as Walmart, Target, Best Buy, Home Depot, Nordstrom and Macy’s did – combined. They also generated 30 percent of all the growth in US retail sales.

And it’s expanding into more and more areas. Amazon Web Services provides cloud-based computing; Amazon Video streams TV and movie shows and has started to produce its own content – just like Netflix; Amazon Publishing prints books. Jeff Bezos purchased the Washington Post, and if you have an Amazon Fire tablet, you can get the Washington Post for free. Now Amazon is in the grocery business.

In purchasing Whole Foods, Amazon acquires over 400 small distribution centers, spread out among some of the most Amazon-using neighborhoods in the US. It’s existing logistical network is already powerful. If you’re in a business that Amazon wants to get into, watch out.

Monopolistic pricing. Source: Wikipedia

There are two problems with monopolies. First, they can raise prices to extract as much as possible from consumers. That doesn’t appear to be happening here. Second, they subtly change management’s own incentives, from serving customers to building their empires. Monopolies can run afoul of government regulations, but a more pervasive threat comes from within, with all the politics, power-plays, and other distractions from business issues. Consider Amazon’s publishing dispute with Hachette a few years ago, where they turned sales of Hachette books on and off overnight.

Amazon may run afoul of antitrust regulators, but its greatest danger is the hubris and court-intrigue that come with empire. Jeff Bezos needs to remember: “Sic transit gloria mundi.” All power is fleeting.

Douglas R. Tengdin, CFA

Cold Blue Steel

Are restrictions on steel imports a good idea?

Photo: Třinecké železárny. Source: Wikipedia

The Trump administration is considering restricting steel and aluminum imports for national security reasons. It says that the lack of domestic producers could make it hard for us to provide weapons for our armed forces. After all, there’s a lot of steel in a tank division. The larger issue is for the US to maintain an industrial base, that, in times of war could be shifted to defense production.

But at what cost? The US is the largest importer of steel in the world, mainly from the western hemisphere: Canada, Brazil, and Mexico. We do this because we find it to be cost-effective. It costs less to import Canadian steel, and they’re a reliable trading partner. Officials have argued that overcapacity in China has hammered the US steel industry, but we’ve already imposed restrictions on imports of Chinese steel. Their steel imports have fallen by over 70% in the last two years, and China is no longer a major supplier.

Source: Econofact

The US has studied whether imports have hurt national security 55 times since 1962, when the President was given this authority. Only twice have we found that imports were a problem, and both time it was oil imports. The US produced 79 million metric tons of steel last year, and imported 30 million. The defense industry needed less than 5 million tons. It’s hard to imagine our defense contractors running out of steel.

On the other hand, we can imagine how importers can enhance our security. By forcing our domestic producers to be more efficient with the facilities they have, importers encourage innovation, research and development, and modernization. Competition keeps us on our toes.

If we impose import restrictions on our major trading partners, they could easily retaliate – the way tariffs multiplied on food products in the late ‘90s. And an expanding trade war wouldn’t be good for anyone’s security.

Douglas R. Tengdin, CFA

Getting Smarter?

Smartphones are everywhere.

Photo: Ben Kerckx. Source: Pixabay

Whether it’s for making phone calls or getting directions or buying t-shirts or checking whether we left the stove on, smartphones have inserted themselves into more and more of our lives. They’ve been around for only a decade or so, but the computers in our pockets have become indispensable. We use them to buy and sell stuff, entertain ourselves, and to help find our friends. They’ve altered the texture of everyday life almost everywhere. They’re often the first thing we look at in the morning and the last thing we see before falling asleep.

Not since the advent of television in the ‘50s has a cultural artifact become so dominant so quickly. They’re like an invasive species, like milfoil or kudzu, except that we want our smartphones to be our boarding pass and credit card and house key. Losing a smartphone is way more disruptive than losing a pocketbook or wallet. And as computing power continues to multiply and miniaturize, a higher and higher proportion of adults on the planet will be constantly connected to our global data web.

Howdy Doody. Photo: Volkan Yuksel. Source: Wikipedia

This has enormous implications. The apps and functions we rely on for everyday life are also gathering and using data on us: where we go, who we spend time with, how we shop, almost every aspect of our behavior. Ostensibly, they do this for our own convenience. If my phone knows where I’ve parked my car, I don’t have to waste time looking like a fool in the airport parking lot. But that data can be used in other, less benign ways. If Amazon knows how I shop and what I buy, it can tell its app on my phone to highlight items that generate higher margins. It’s no wonder Apple and Samsung have become two of the largest companies on the planet, or that all of the big five tech companies are intimately engaged with mobile computing.

After World War II, Winston Churchill wanted to re-build the House of Commons in its original form. He commented that “we shape our buildings, and afterwards our buildings shape us.” As smartphone networks become increasingly important to every aspect of our lives, we will shape our networks, and our networks will shape us.

Douglas R. Tengdin, CFA

Where the Vultures Gather

Where the Vultures Gather

What is vulture investing?

Turkey Vulture landing. Photo: Don DeBold. Source: Wikipedia

Vulture investing is a way to profit from poor management. A vulture fund typically invests the debt of troubled firms, then seeks to convert that debt into equity. They can also invest in distressed sovereign debt, then use the courts to bring actions against the issuer to force some kind of recovery.

The phrase “vulture capital” was originally coined as a derogatory term, meant to criticize investors who profit from someone else’s financial difficulties – in the same way that vultures live off dead bodies. But the legal actions that these firms bring also bring accountability into the financial system. Often they unveil corruption or other financial shenanigans. In this way, they are like their real-life counterparts.

Scavengers serve an important role in every ecosystem. They clean up carcasses and animal remains, and appear immune to the pathogens that multiply in dead bodies. Without their strong digestive systems, carrion would become a breeding ground for all kinds of diseases. Their strong sense of smell – rare among birds – allows them to locate and dispose of corpses that would otherwise generate problems. Not surprisingly, they have few predators.

In the same way, vulture funds have an important economic function, sniffing out and cleaning up financial pathogens. Recently, vulture funds have been in the news because they’ve invested in the sovereign debt of Argentina and Puerto Rico. Without their activities, investors would be at the mercy of managers and elected leaders who often take advantage of the fact that most people don’t have the resources to force a creditor to pay.

Photo: Dori. Source: Wikipedia

Turkey vultures and vulture investors each serve a critical role: cleansing the system of pathogens that might otherwise infect healthy members of their communities. They’re not my cup of tea, but in their own way, they can be quite attractive.

Douglas R. Tengdin, CFA

The Signal and the Noise (Part 5)

So how do you decide?

Photo: Sebastian Lühnsdorf. Source: Morguefile

When a news event occurs, is it a new signal, or is it just noise? The European Central Bank is maintaining a negative inter-bank rate – is it signal or noise? The Consumer Price Index just came out flat from the month before – was that signal or noise?

It’s tempting to label all these interim economic reports financial static. And a lot of them are. So much data comes at us from so many directions that it’s hard to decide what we should care about. Consider inflation: two government agencies report three different indices, each of which has dozens of sub-groups. Or employment: it’s measured two different ways, and each indicator has both leading and lagging elements. If you look too closely, you get spots in front of your eyes!

If you’re involved in the markets, your attention should be determined by your perspective. If you have a long time-horizon – saving for retirement while in your ‘20s or ‘30s, or establishing a young child’s college fund – you should perhaps keep an eye on broad trends, but that’s all. Regular saving through all the ups and downs will probably be your best approach.

Similarly, if you’re drawing regularly from your nest-egg and most of your assets are committed to short-term bonds, the market’s squiggles and jiggles also shouldn’t affect you much. But when you’re in the middle – still saving, but getting closer to needing the funds – then the news will have more impact. A change in the economy’s direction might call for a change in your tactical allocation. Still, even then, looking at the trends and averages makes more sense than trying to follow every tick and tock.

In the end, whether a report is signal or noise depends on your perspective. One investor’s warning sign is another’s annoying distraction. But even the Federal Reserve – our most economically sensitive agency – only reviews policy every other month. That’s more than enough for most investors.

Douglas R. Tengdin, CFA

The Signal and the Noise (Part 4)

We’ve talked about cutting out noise. Can we boost the signal, too?

Oscilloscope. Illustration: Brian Elliot. Source: Wikipedia

Looking at a signal-to-noise ratio is a good way to understand why we get so distracted. It’s the proportion in our lives of meaningful information compared to irrelevant data that bombards us all the time. It’s like the level of a radio station’s programming above the static background.

And there’s a lot of noise in our lives—diversions that make it hard to hear what’s important. So, one way to enhance this ratio is to reduce the noise, by having a quiet space or using un-networked computers – unplugging. But another way to improve how much information we receive is to amplify the signal.

We can do this with a checklist, to identify our priorities. Write down what’s on your to-do list and group the items into first, second, and third priority items: P1s, 2s, and 3s. P1s are absolutely essential stuff that has to happen today, P3s are things that are nice to get done, some day. And P2s are in-between – important, but not critical.

Some weeks you just have to keep afloat in the midst of the storm. Other weeks, there’s only one P1 on the list. Polish that off, and concentrate on your P2s. Then apply a time-budget. Give each item a specified amount of time and try to move on. Schedule your week and plan out your work. Then work your plan.

Photo: Rawpixel. Source: Life of Pix

If we don’t focus our energies, we’ll drown in clatter and clutter. Don’t just prioritize what’s on your schedule, schedule your priorities. A great manager once said that the main thing in life is to keep the main thing the main thing. Listing our priorities and planning our time is a good way to make this happen.

Douglas R. Tengdin, CFA

The Signal and the Noise (Part 3)

How can we stay focused?

Public Domain. Source: Wikipedia

We live in a distracting world. Email, Facebook, Twitter—they all cry out for attention. And it doesn’t help that our phones and tablets and computers beep and vibrate and flash at us with every new stimulus. Since companies like Google and Facebook make their living off advertising, they find ever more innovative ways to get ever more relevant advertising right in front of our noses, where we can’t ignore it.

But investing is a long-term process. The magic of compound interest doesn’t work overnight. It takes years—decades, really—of patient saving and investing for the average investor to build something significant. We need to concentrate on long-term issues even while short-term demands are literally in our faces.

One approach is to build a distraction-free space in our lives. One investor has a “library” where he retreats to read, write, and think. No electronic devices are allowed. Other people use headphones with light music or white noise to block out interruptions. We don’t have to get fancy: sometimes just going for a walk – with the phone turned off – is all we need. Whatever the approach, we can improve our signal-to-noise ratio by reducing the noise.

Blaise Pascal said that all our miseries derive from not being able to sit in a quiet room alone. Cutting out clutter is a good way to learn how to concentrate.

Douglas R. Tengdin, CFA

The Signal and The Noise (Part 2)

How can we tell what’s really happening?

Great Circus Parade, Milwaukee, WI. Photo: Royal Broil. Source: Wikipedia

When the newsreels stop rolling and the microphones go away, we’re sometimes left with the impression that a circus parade just rolled by. Did anything actually change, or did we just see a cavalcade of horses, camels, and clowns roll down Main Street? We’ve heard about news stories with an underlying agenda too many times.

When we read any important news item, something that always changes is our perception of the news. Our perceptions meld together into expectations, and those expectations get built into stock and bond prices. It doesn’t happen perfectly and it doesn’t happen all at once, but market prices then reflect the general news stream.

That’s why everyone was so downcast last winter. Several Fed Governors gave speeches where they said that the Fed planned to raise rates four times in 2016. That got investors scared: was the Fed “behind the curve”? By contrast, the sky-high sentiment we’ve seen lately among the software giants mirrors the expectation people have today that software will eat the world.

Market trends then tend to get overdone. Feelings investors have reinforce and feed on themselves. Black days or sunny skies look like they will stretch on forever. But they never do. We look back at those times and ask ourselves, “What were we thinking?”

It’s a fair question. Because when everyone thinks alike, everyone is likely to be wrong.

Douglas R. Tengdin, CFA

The Signal and the Noise (Part 1)

How can we concentrate on what matters?

Radio frequency doubler. Source: Wikipedia

Between Twitter and newspapers and talking-heads and junk mail proclaiming the next turn in the market, what’s a long-term investor to do? How can we stay focused on what we need to know without being distracted by all the noise?

The first step is to understand that most of what’s on the airwaves is static—background verbal clutter of no more consequence than elevator music. The real news that matters for your investing is the news you already know: you just had a child and need to start a college fund; you just turned 50 and can increase your retirement savings contributions; elderly parents needs to arrange their finances to reduce taxes.

Our most significant investment decisions should be driven by our life circumstances. And while those don’t usually make the 10 o’clock news, they’re what we need to concentrate on when we allocate assets, think about investment styles, and even pick stocks and bonds. An effective investment policy starts with the investor – their needs, constraints, resources, and personal concerns. This is what strategic investing is all about: strategies that are tailored to our personal needs.

Sunday morning talk shows may be important for public policy, but our evening kitchen-table-talk is what matters most for our investment policy.

Douglas R. Tengdin, CFA

Douglas Tengdin's Global Market Update