Back Home Again (Part 2)

It turns out home prices aren’t so far from coming back after all.

Yesterday I wrote how housing activity usually picks up before housing prices do. Well yesterday we got
housing price data too, and it was pretty encouraging. The Case-Shiller index of home prices reported that
prices actually rose, on average, in May versus April. This is the first actual rise in the index in almost
three years.

It’s hard to see how the index could be higher if foreclosure sales are pulling down prices. It’s hard to
see how the prices can go up if banks are just dumping their unsold inventory on the market. It’s hard to
see why people would bother paying up for a new home if dirt-cheap foreclosed properties are widely
available.

No, it must be that the combination of lower rates, government incentives, and consumer appetites are
creating enough demand to stabilize the market. And with the housing market stable, banks can value their
“toxic” assets and assess their true need for capital. The financial crisis may be nearly over.
And that, my friends, is also encouraging.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Health Care Express

Now that the House has reached a compromise on health care, we can all breathe easier.

That’s the theory, anyway. Congress believes that having portable health care that competes with insurance companies will enhance our productivity by freeing up workers who might not change jobs or start new ventures because they might not get health insurance But a major issue is preserving innovation. Our health care companies have been the most innovative in the world. Indeed, 14 of the world’s 20 biggest health care companies are American. Because competition provides significant financial incentives, new drugs, new devices, and new procedures are developed here first. That’s why rich people fly to America to get advanced treatment.

It’s not clear how the cost-trimming, public option, insurance mandating house bill will do this. If we squeeze our health providers to provide for the uninsured, they may just shrug their shoulders and walk away. And that won’t be healthy for anyone.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Back Home Again

Is the housing market finally turning around?

Yesterday the Commerce Department reported that new home sales rose 11 percent to an adjusted annual rate of 384 thousand units per year. With prices still falling, sales have now risen for three months in a row to their highest level since November.

Now, November was no great shakes. But now the data is headed up, not down like before. And while national new home sales don’t even add up to half of the total foreclosure activity in California, it’s striking that anyone is buying a new home at all with all the foreclosed homes on the market. Remember, new home sales are a leading indicator; foreclosure activity is a lagging indicator.

And housing activity precedes increases in home prices. So what do we see? Another link in a long chain of indicators that show that the economy is beginning to turn up. Not dramatically, and not without some bumps. But the direction is upwards.

And that, my friends, is encouraging.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Revenues? We don’t need no stinkin’ revenues!

Some people you just can’t make happy.

Like the proverbial rain that falls on a parade, a host of gloom-meisters are out dissing the current earnings season. Sure, earnings are way better than expectations. Sure, Ford, AT&T, and Caterpillar earned way more than anyone expected. Sure they’re in economically sensitive industries. But what about sales?

You see, most of these bottom-line gains have come from cost-cutting. If the economy remains in recession, a lower sales number will make future earnings growth really hard. So these perma-bears keep carping about revenues.

But this is what happens in recoveries. First the companies cut costs. Then revenues start to pick up. The lower cost structure allows margins to expand, and once the improved earnings picture is confirmed by increasing sales, the companies can begin to hire people back.

So why not wait for sales to pick up to invest? By then, the market will have already anticipated the recovery and gone up. In fact, that’s what’s happening now.
Even if some folks want to worry, it’s time now to enjoy the beginnings of the recovery.

Douglas R. Tengdin, CFA
Chief Investment Officer
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My Other Car is Also

These days, car trouble is a global business.

VW is looking to buy Porsche. The Chairman of VW is actually part of the Porsche family. A few months ago it looked like Porsche was going to buy VW, but when that deal fell apart, the head of Porsche and his deputy quit.

So now it looks like VW will be the buyer. Hey, VW has a strategy of purchasing distinct brands and managing them well. This acquisition should fit right in, with Porsche a niche product in the VW family.

Just don’t be surprised when VW consolidates. The world can make way more cars per year than needed, even during good times. Until capacity is reduced and factories are closed, it will be hard for any car-maker to turn a profit.

Ultimately, this is all part of the adjustment process that recessions require. Seeing VW gobble up Porsche just reminds us that Germans are capitalists, too.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Obi-Wan Speaks

From the halls of Congress to the pages of the Wall Street Journal, we’re getting an earful.

Fed chairman Ben Bernanke spoke to Congress yesterday about how the Fed intends to remove the piles of cash they’ve been throwing at our economic problems. The short answer is, they’ll raise rates. But not any time soon.

The larger question he’s facing is why we need an independent Fed at all. After all, the Constitution clearly calls for Congress to regulate our currency.

But Congress is subject to short-term populist pressures, while the benefits of lower inflation, like a conservative family budget, are long-term. So they’ve delegated monetary policy to the Fed. Call it the allowance syndrome: if the kids could vote themselves a higher allowance, the family won’t have enough set aside for heating oil next winter.

But that approach is an insult to our intelligence and maturity. There’s something distasteful about Congress protecting itself from voters by hiding behind its own law. At least now, with Bernanke speaking, we can understand what the Fed is doing.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Poor Little Rich Schools

Well that worked out well.

For the last ten years we’ve listened to Ivy League endowment managers discuss the value of timberland investments, private equity, and venture capital. While these approaches aren’t available to the average shareholder, many wondered if the combination of asset size and longer time horizons meant that school endowments weren’t working with a permanent advantage.

Well it didn’t work out that way. While the market is well off its March lows, private equity and real estate haven’t recovered yet. Many schools have been forced to borrow money and lay off staff. Nobel Laureate Robert Merton of Harvard wrote a paper outlining optimal investment strategies for endowments. It’s no surprise that he notes that the endowment should be considered along with all of the school’s assets, liabilities, income and expenses. Many of the wealthiest schools didn’t do this, and now they’re under water.

World class universities often have world class investments. But the discipline of the market is no respecter of class. Or institution.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Small Steps

That was some giant leap.

40 years ago Neil Armstrong became the first man to walk on the moon. Now astronauts fix clogged plumbing in orbit and orbital telescopes look for planets elsewhere in the galaxy. But without manned exploration there is little romance left in the space program.

Some blame a failure of imagination, and some blame budget cuts, but I think the real culprit is physics. Apollo missions took a couple weeks. Martian missions would take 2-3 years. The logistics are daunting, not to mention the adjustment in time zones.

In an era of massive deficits and bailout blues, spending hundreds of billions on the romantic notion of interplanetary travel seems frivolous. While they laughed at Columbus, his mission at least had a commercial goal. Until space travel can pay for itself, we will likely remain mostly earthbound.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Wait? Wait for What?

Lord, give me patience. And please, give it to me quickly.

That’s what many people are praying these days. Encouraged to wait patiently for the economy’s recovery, they’re compulsively tapping a foot. For a while it looked like all the data were improving. Then came last month’s employment setback. Now a raft of statistics look gloomy. Some are calling for a second stimulus program as a result.

But there are positive signs, like the leading indicators and production surveys. What they’re telling us is that the vicious inventory correction of the last six months is just about over. The data are mixed, and that’s what you expect when the economy turns around. If all the data started to look up, we’d be in a recovery, not a turning point.

Warren Buffet quips that a man can’t make a baby in a month by getting nine women pregnant. It took some time to get into this pickle. We should be patient as we see that we’re getting out.

Douglas R. Tengdin, CFA
Chief Investment Officer
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The Winds of Change

The wind farm is a blowout.

That’s what’s happening to T. Boone Pickens’ plan to use prairie winds to save America. Without a grid to transport the power, it can’t get from the Texas panhandle to where people live. And with energy so cheap, nobody wants to lend the money to build the power lines.

Things have changed since last summer when Pickens along with everyone else predicted that $100 oil was here to stay. The “Pickens Plan” was to use wind to generate electricity, freeing up natural gas to run big trucks, lessening our dependence on imports. But without government help, he can’t make it work right now.

Now he plans to build several smaller wind farms with the 687 turbines he’s ordered from GE. Not as showy as a 4 gigawatt project. But maybe more efficient. And just maybe another lesson on how markets need to be respected.

Douglas R. Tengdin, CFA
Chief Investment Officer
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