Biting the Fed’s Hand

How is the Fed doing?

In the idyllic setting of Jackson Hole, central bankers meet, greet, and eat. Between schmoozing, they listen to papers and presentations. This last week a London School economist gave Obi-Wan Bernanke and Don Kohn a serious dressing down.

Willem Buiter presented a 144-page paper, 143 pages of which were devoted to slamming the central bank for its handling of the past year’s financial crisis. He says the Fed overreacted to what is essentially a Wall Street problem and is now risking its long-term credibility for short-term financial stability. Many of his points are well considered.

It’s good to note that only a truly healthy institution can listen to deep criticism of its core assumptions. Buiter’s critique just proves the point that our economic system is adaptive and self-correcting. His sound criticism gives room for broad optimism.


Douglas R. Tengdin, CFA
Chief Investment Officer
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Show me the Money

Dividends are a good thing. So why have they gotten such bad press lately?

When you invest in a stock, cash that the company pays you is your dividend. All kinds of information about the company can be changed, but you know for sure what you’ve gotten back. And paying dividends requires management discipline.

So why are dividend-paying stocks doing so poorly? Over the past two years the market has returned only 2% per year, but a market-basket based on dividends has been down about 2% per year. Part of the reason has to do with financial stocks. Traditionally, banks have been more generous dividend-payers. But as housing prices have fallen, bank stocks have tanked.

In spite of their recent setback, dividends remain a solid indicator of a company’s financial health and its commitment to its shareholders. A stable and growing dividend is one of the best ways for management to show that they really care about the company’s owners.


Douglas R. Tengdin, CFA
Chief Investment Officer
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Party Time

Does it get any better than this?

Consumer confidence is down at depression levels. New  home sales are near all-time lows. Some of our largest financial institutions are looking at government bailouts. And the Cubs have the best record in baseball. Can Armageddon be far off?

This bad news is old news to the financial markets. The stock market has fallen by about 20% since last fall. That leads to bad feelings about the markets, the economy, and life in general.

But life goes on. People buy food and clothes. Kids go back to school. And improvements in the way we make and distribute things mean that companies can lower their prices and still make higher profits. An excessively negative outlook can lead to bargains in the stock market.

John Templeton once noted that bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. With pessimism about the economy reaching peak levels, it just may be time to buy.


Douglas R. Tengdin, CFA
Chief Investment Officer
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Going Swimmingly

Michael Phelps’ performance was amazing. The Olympian overcame a childhood fear of the water and the scorn of adolescent peers to win more gold medals than any person in history.

Often in investing we have to confront our fears and do what is unpopular. In fact, what’s ultimately most profitable rarely feels comfortable at the time. And what’s comfortable rarely ends up profitable. It’s like our brains are wired for failure.

This is part of the reason investing is so hard. Many adaptive instincts and feelings we get are a great help to us as we perform essential tasks. For example, our innate ability to recognize and extrapolate patterns is an essential language-learning skill. But it often leads us to see “pictures in the clouds” when we look at stock price behavior.

Some researchers recently noted that Michael Phelps’ victorious fist-pumping is another innate behavior. By taking uncomfortable, unpopular investment positions, we can all hope earn the right to express ourselves in the same fashion.


Douglas R. Tengdin, CFA
Chief Investment Officer
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Second (Citi) Thoughts

There are no bad investments. Only bad prices.

Citibank is facing some serious challenges. The company’s market value reflects this. Does that make Citibank a bad investment? Probably not.

The price has declined almost 70% over the last year precisely because the company is looking at so many issues. But many people now feel that the parts are now individually worth more than the whole.

Take their consumer business. Years ago they bought Diner’s club, Associates, and Macy’s credit cards and wove them into their integrated consumer lending operation. In the process, these disparate businesses were made more efficient and their risk management was taken up a notch. Now the US consumer is on the rocks, but these businesses are more valuable than they would otherwise be.

With the turmoil in the capital markets, Citi’s shares have been marked down to the point where their book value is higher than their market value. Given Citi’s diversified business mix and their potential for global growth, the stock just might be the real deal.


Douglas R. Tengdin, CFA
Chief Investment Officer
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The Citi That Never Sleeps

What’s wrong with Citibank?

The bellwether US bank has lost almost 70% of its market cap over the past year. The $2.2 trillion bank is at the epicenter of the sub-prime debacle and has written off $55 billion in bad debts so far.

It wasn’t supposed to be this way. When Sandy Weill pulled together a world-class investment bank, insurance company, wealth management group, and a commercial and international bank, the diverse product lines were supposed to support each other. But the synergies of working with colleagues across town seems to have intensified the risk, not reduced it.

Another problem is the failure of the Universal Bank. The idea was to have one-stop-shopping for all your financial needs. But with the internet and with bankers more mobile than ever, people can let the bank come to them. Citi has 10 years of mediocre performance to prove at least that the model isn’t a slam dunk.

With over half of the bank’s earnings coming from consumers, the bank’s destiny really rests with the fate of the economy. When you have to look outside for recovery, that’s not a good thing.


Douglas R. Tengdin, CFA
Chief Investment Officer
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Stimulating Questions

Was the economic stimulus plan a flop?

Marti Feldstein, a Harvard economics professor and former adviser to President Reagan, thinks it was. He figures that people only spent about 12% of their checks. The rest went into savings. Many dispute his methodology, but probably true that less than a quarter was immediately spent. The rest may have gone to pay bills or pay down credit cards.

If that’s the case, we sure didn’t get much of a bang for our $100 billion. But this analysis fails to consider how many people manage their money. If they paid off their cards in May, it’s likely that they’ll run them up again by November. They may have temporarily reduced their interest payments, but those balances will be coming back. If so, the stimulus checks could be the gift that keeps on giving.

These lagged effects are often missed when people try to figure out the economy. I think Professor Feldstein is wrong to give the stimulus a failing grade. At worst, it should get an incomplete.


Douglas R. Tengdin, CFA
Chief Investment Officer
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Successful Investing (Part 4)

Diversify, diversify, diversify.

That’s principle number four. Successful investors don’t “let it ride” and keep their bets on the same horse. They know that what goes up, comes down. And what goes around, comes around.

Take the most basic diversification of all—between bonds and stocks. Many long-term investors own 100% stocks, for the simple reason that this is the asset class that has the greatest growth potential. But if you add just a quarter of bonds to the mix, and consistently rebalance, your risk goes down by about half. That lower variance can be mighty comforting if you’re gonna need the cash within the next five to ten years.

The same goes for holding individual stocks. While seeing a stock multiply in value is fun, it’s more likely to wiggle and jiggle its way upward gradually. Better to own a portfolio that can cancel each other out. Then you’re less likely to panic and sell out when times are temporarily tough.

The main idea in real estate is location, location, location. With investing, diversification is just as central.


Douglas R. Tengdin, CFA
Chief Investment Officer
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Reversal

Two points.

That’s what wrestlers score when they get a reversal. And that’s what seems to have happened in the US stock market.

A month ago, higher energy prices had people worried that a dampened consumer would weigh on the housing market, which would lead to more foreclosures and additional banking writoffs, and maybe even more failures.

Now, lower energy prices have people expecting that a revived consumer will stabilize the housing market and lead to a financial recovery. That’s why financial and consumer stocks are leading this recovery.

Ironically, lower oil should lead to lower inflation, removing much of the need for the Fed to raise rates. And with many banks on the edge of capital needs, the Fed is likely to leave rates unchanged, at least for now. Financial companies need time to earn back many of their losses.

In wrestling, a reversal scores you points and puts you in control of the match. Let’s hope that the consumer remains on top, at least for this round.


Douglas R. Tengdin, CFA
Chief Investment Officer
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Already?

I knew it! Oil breaks $115 and the doom-mongers are already coming out.

Now that supplies are rising, speculators are leaving the market, and consumers are driving less, the gloomers are seeing storm clouds around this silver lining.

The theory is that the only reason oil prices are falling is because global demand is falling. And that’s because the world is entering a recession. But there are a lot of reasons why demand is down. Some is technological, as people drive smaller cars. Part is economic, as the developing economies remove their subsidies. And part is also behavioral, as people drive less.

But it’s also about supply. For five years oil has been on a tear. New college grads with degrees in petroleum engineering can get employment offers in six figures. And people who bought tankers full of oil and had them sail slowly into port are now in a rush to cash in.

Twenty years ago Time magazine ran an issue that said that cheap oil was both good and bad news. With the US importing about two thirds of its total oil needs, lower prices are good.


Douglas R. Tengdin, CFA
Chief Investment Officer
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