Pondering Pnzi

In light of the Madoff scandal, many people want to know, “Could it happen to me?” While no two scams are exactly alike, here are some questions to ask:
1. Does the strategy make sense? It’s been said that if you can’t describe an investment plan on a napkin in crayon, it’s probably too complex. Many investors walked away from Madoff because his approach wasn’t tenable on a large scale as he claimed.
2. Does the investment firm revolve around one central personality? “Success has many fathers,” goes the old saying. A reputable firm will separate investments, accounting, and operations. Even small shops will hire outsiders to handle their custody or bookkeeping duties. Madoff did most everything himself.
3. Are the returns realistic? When shysters offer to double your money in six months, most of us know to steer clear. But Madoff’s deception was more subtle: the consistency of his returns was the warning light. When returns appear overly smooth it’s not a sign of reduced risk, but of hidden risk.
If you think one or more of these factors applies, check it out. Because if ignorance is bliss, bliss can be very expensive.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Classical Investing (Part 5)

In Dante’s Inferno, the deepest region of hell is reserved for those who betray their country, family, and friends. It’s a frozen gelatinous ooze, where the cold is so intense that the tears of the inmates freeze before they can even cry.

Surprisingly, those consigned to this level of hell are unrepentant. They see their betrayals as justified, or at least ennobling in some way.

But Dante was on to something when he described treason in such execrable terms. All betrayal is personal. This seems especially pertinent when we consider the recent Madoff scandal. This man garnered contributions from friends, family, and institutions, all the while knowing that the returns he was reporting were wholly fictitious. His smiling, baseball-capped portrait has become emblematic of the man’s audacious fraud.

Madoff isn’t stupid. He must know that all Ponzi schemes end badly–for everyone. But one of the characteristics of liars is that they especially lie to themselves. That’s true in Dante and it’s true today. Madoff’s monumental self-deception has consigned him to investment infamy–a traitor to his family, his friends, and his profession. Hell, indeed.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Addicted to Oil?

It’s popular now to say that America is addicted to oil. But I’m not sure that this is helpful.

When gas prices go up, we drive less, buy hybrid cars, and turn down the thermostat. When prices go down, we change our behavior and consume more. That doesn’t sound much like an addict’s behavior.

When an addict uses something, it doesn’t really matter what the price is. It doesn’t matter who gets hurt. It doesn’t matter when he last got “fixed”; he just wants his next hit.

By contrast energy prices matter a lot to us. We care very much about the consequences of our oil consumption. And we’re not stopping at every gas station just to get a hit. What we do us consumer more of a resource when it’s cheaper, and less when it’s expensive. Pretty normal.

No, “addiction” doesn’t explain our oil usage. But the medical terminology allows some people to rationalize massive (government) intervention “for our own good.” And to avoid making rational economic arguments for alternatives.

Our use of energy resources is price-dependent, economically motivated, and utilitarian. When a more convenient, cheaper alternative to oil comes around, we’ll switch. Nothing addictive about that.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Boxing Day

Today is Boxing Day. It’s celebrated as a shopping holiday in most of the former British Commonwealth. In America, we pretty much ignore it, except if to remark on how alike but different we are from the English.

It has its roots in St. Stephen’s Day when it was traditional for Lords and Masters to give gifts to their servants and vassals. Christmas was for peers, St. Stephen’s for workers. This social role reversal had the useful effect tying the classes together. After all, it’s harder to plot against someone who’s just given you a gift.

In America, we’ve never really subscribed to the whole “class” thing. Our history is replete with Horatio Alger stories, where the destitute child picks himself up by his bootstraps to become a captain of industry. From Benjamin Franklin to Barack Obama, something in us resonates when an underdog rises from the ashes.

So we usually give our gifts on Christmas, implicitly declaring that we’re all social equals. This is part of the strength and genius of America, and why I remain confident that we will recover from our current troubles in an even more resilient form. The future is all before us.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Economics and Christmas

When you think of it, the Christmas story has a lot to do with economics.

First, Joseph and Mary were on the road because of a new tax regime. Apparently Caesar hadn’t heard of the dead-weight loss that arbitrary tariffs impose on an economy.

And the three kings were one of our first international trade delegations. They brought free samples from outside the Roman Empire to offer to a king-in-waiting.

The shepherds were managing an agricultural commodity. Perhaps energy prices had affected feedstock costs, and night pasturage was more efficient. In any case, the angels knew that they could find them on-the-job.
But at its heart, the Christmas story is about a gift-one that cost everything. Nothing economical about that.

Merry Christmas to everyone.

Douglas R. Tengdin, CFA
Chief Investment Officer
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You Get What You Pay For

The state-by-state labor data are pretty interesting.ch

It’s understandable that the “bubble” states—California, Nevada, and Florida—all have high unemployment. And of course the domestic auto industry’s troubles are clearly having a major impact on states like Michigan, Indiana, and Ohio.

But the Southeast has also been hit hard. North and South Carolina and Georgia all have above-average unemployment levels. It could be that cyclical manufacturers located in the heart of Dixie are suffering collateral damage from the automaker’s crisis.

Equally interesting are the success stories—states where unemployment is well below the national average. The Great Plains are doing pretty well. Agriculture is still strong. But New Hampshire is tied for the fifth lowest unemployment rate in the country. New Hampshire’s jobless rate of 4.3% stands in stark contrast to Rhode Island’s 9.3%

The distinctive features that make New Hampshire resilient in the face of a significant national recession—a balanced economy, strong educational infrastructure, and a low tax burden—are worth noting. As we face budget troubles like every other state, let’s not kill the goose that lays our golden eggs.

Douglas R. Tengdin, CFA
Chief Investment Officer
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The End of Capitalism?

The media are proclaiming the end of capitalism. Once again, reports of its death are greatly exaggerated.

In a recent Larry King interview Michael Moore said that capitalism was “over.” After all, capitalism gave us liar loans where we lent a million bucks to some poor guy making $15 / hour. Wall Street’s culture of greed combined with Washington’s lasses-faire attitude to give us the credit crunch. So goes the story.

Right now the government is engaged in a massive effort to fix the crisis—through bank capital injections, tax cuts, and spending increases. It even looks like we’ll lend some money to Detroit. But that’s not nationalization. Shoot, it’s not even Japan-style industrial policy. Right now it just looks like crisis management.

The overshoot and collapse that resulted in the current crisis is endemic to human society—capitalist or otherwise. This crisis won’t lead to the end of capitalism, any more than hanging chads in Florida in 2000 led to the end of democracy. Once more, the alarmists have it wrong.

Douglas R. Tengdin, CFA
Chief Investment Officer
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An Orderly …

The Bush Administration is considering a orderly bankruptcy for GM and Chrysler. By the end of this they may need an orderly to wheel them out of the room.

The auto industry is sick. The car-makers have made extravagant promises to their unions regarding pay, pensions, and health-care. Even in the best of times, those promises made it hard for the Big Three to sell cars profitably. With the economy in recession, those contracts almost guarantee that the companies will lose money.

But this is old news. GM, Ford, and Chrysler have been unprofitable for over a decade. Differing ownership hasn’t helped. New and better car-models haven’t done it. Even an economic expansion and consumer spending boom didn’t get them going. Now the tonic of choice is “reorganization.” But if the auto companies don’t want to leave the room feet-first, they need to get their costs down.

Whether it’s a judge, Congress, or the unions, someone has to help these firms stop the bleeding. Because every day lost is another day’s worth of losses. And at the end of the road is a place where no one wants to go.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Absolute Zero

In physical chemistry, everyday principles seem to be suspended as temperatures approach zero degrees Kelvin. It seems that as interest rates approach zero, the normal laws of finance get suspended as well.

When temperatures approach absolute zero gas volumes contract to a theoretical singularity, electrical components experience superconductivity, and perfect crystals can form. When interest rates approach zero banks no longer have any incentive to hold excess reserves at the Fed, there will be more and more transactional failures, and interest rates can no longer be lowered to stimulate demand.

All through the 90s Japan had a zero interest rate policy coupled with aggressive fiscal stimulus. We’ve called that period in Japan’s history, “The Lost Decade.” Let’s hope we’re not headed down that dismal road.

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

Aristotle’s Ethics has some pretty useful insight for investors.

Aristotle talked about the “golden mean.” He linked happiness and virtue to finding the balance between excess and deficiency in any particular trait. For example, the mean between cowardice and foolhardiness would be courage. In the investment context, Aristotle’s “golden mean” would advocate finding a “golden balance” in your portfolio.

Some have argued for “Stocks For the Long Run,” that your best returns over time are achieved with a 100% equity portfolio. But investing that way entails significant downside risk-something we’re seeing right now.

By contrast, a 50/50 portfolio that includes stocks and bonds that is rebalanced when either side gets out of whack-say, 10% away from the target-gives you most of the return with only half of the risk. That’s right: Aristotle’s “golden mean” can lead to gold. The returns on an actively managed balanced portfolio can almost equal those of a 100% stock portfolio, with a lot less risk.

Those dead Greeks were pretty smart. Too bad more people don’t apply what they had to say.

Douglas R. Tengdin, CFA
Chief Investment Officer
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