A Bad Bet (Part 2)

Foxwoods’ bankruptcy means trouble for more than just the State of Connecticut.

Foxwoods Casino is one of the largest gaming operations in the U.S. It now may become the biggest tribal company ever to default. In a recent email, Michael Thomas, a leader of the tribal council who is seeking reelection, told tribal members that they would be paid before banks or bondholders, if revenues run short.

That’s not very smart. Creditors can’t take over assets or operations on tribal lands, but what goes around comes around. If U.S. Corporate law suddenly doesn’t apply, lenders will just vote with their wallets and find better places to put their money to work.

This would be a disaster for the tribe. They still need up-front capital to build an attractive business. If the Pequots restructure and put the tribe ahead of the lenders, businesses on tribal lands across the country will have a hard time getting loans.

There hasn’t been a Native American uprising since the disaster at Wounded Knee in 1973. Everyone’s watching what the Pequots do. If they’re smart, they’ll bury the hatchet.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Classical Investing (Part 9)

In running a company, is it better to be feared or loved?

A recent study asked just this question. Are successful managers ones who focus on execution: budgets, goal-setting, accountability-or team-building: building consensus, having listening-skills, and developing mutual respect?

Ideally, you would have both: a goal-oriented boss who listens to his people respectfully and proceeds to get the job done: ahead-of-schedule exceeding the standards, with no drama. But often those skills are mutually exclusive. On a scale of being conscientious or agreeable, one side or the other will dominate.

The study evaluated 258 companies and rated their CEOs on 30 different items, from attention to detail to SAT scores. They then followed the performance of these companies over several years. And guess what? CEOs with “hard” skills tended to outperform those with “soft” skills.

This should come as no surprise. 400 years ago Machiavelli wrote that it is far better to be feared than to be loved. A prince ought not to mind having a nasty reputation, because he will provide, through strong leadership, a far more humane state than a chief who is too lenient and allows disorder or rebellion to go unchecked.

Thus, the “heartless” S.O.B. who leads a company to financial success is far kinder to his subordinates than the easygoing chief who allows his firm to stagnate or fail. Something to think about when we evaluate the management the companies we invest in.

Douglas R. Tengdin, CFA
Chief Investment Officer
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All That Glitters …

All that is gold does not glitter, the rhyme says. Now we have proof.

Economists have been studying the “resource curse” for years. Why is it, they ask, that countries endowed with abundant natural resources–like gold, oil, or minerals—grow more slowly than resource-poor countries?

They’ve come up with three reasons. First, a commodity-based economy is inevitably tied to the boom-and-bust cycle of that good. In the flush years, extra cash leads to overinvestment, wasteful spending, and too much debt. In the bust years, financial crises and budget-cuts overwhelm the economy

Second, the massive trade surplus that a resource-rich economy enjoys leads to an elevated exchange rate for the currency. This depresses the domestic economy because imports are so cheap. Protecting domestic industries paradoxically weakens them further, because those tariffs become items of political patronage.

Which leads us to the third and perhaps most important aspect of the resource curse: governance. All that cash derived from the commodity tends to corrupt the political system. It’s been shown that authoritarian resource-rich countries are far less likely to move towards democracy than resource-poor authoritarian regimes. And democratic institutions like education and a robust meritocracy are the surest ways to develop a country’s true source of wealth: the labor, management, and innovation of its own people.

Resource rich countries (and families) can only thrive if they assiduously nurture the potential of their people. That, as the rhyme says, is the greatest resource.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Making the Grade

Ben Bernanke has been re-upped as Fed Chairman. Now he won’t have to grade term papers for another five years.

By re-nominating the current chair, President Obama has made a sensible, risk-averse decision. After all, Bernanke has been a steady hand at the tiller of monetary policy, and has managed his way through the worst financial crisis in most of our lifetimes with few significant errors. In a tenuous time economically, it makes sense to keep the same person as Fed Chair.

But the conflict and confusion about the Fed’s role is unlikely to die off soon. Partly in reaction to last year’s crisis, President Obama has proposed that the Fed regulate the systemic risk in our institutions. Opposition to the proposal ranges from turf-fights to populist opposition to the whole idea of a central bank.
This populist / financier debate has been raging since the earliest days of the Republic. During George Washington’s first term, Hamilton squared off against Jefferson on the role of the national debt. Debate was rekindled when Andrew Jackson refused to re-authorize the central bank’s charter. It’s ironic that both Hamilton (the banker) and Jackson (the anti-banker) are now memorialized on our currency.

These struggles illustrate a key point: America needs a modern financial system, but we don’t naturally trust the financiers. Corruption has been too prevalent. While we surely must rationalize our regulatory structure, the details matter. Let’s hope that as he guides this reform through, Ben Bernanke can continue to get passing marks.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Back to School

With our kids heading back to college, I have one word to offer, just one word: statistics.

In the 1967 movie “The Graduate,” Mr. McGuire offers a word of advice to Dustin Hoffman’s character, Benjamin Braddock. That word was “plastics.” At the time, manufacturers were experimenting with plastic bikes, plastic trash cans, and plastic furniture. Mr. McGuire was trying to help Ben Braddock latch onto a growing field.

Well that field right now would be statistics. We live in a sea of data: from check-out slips to GPS-locations to web-clicks, we’re awash with information. But it takes intelligence to turn that information into knowledge. It takes understanding to distinguish items that happen to move together from those that are causally connected.

Statistical analysis can evaluate the effectiveness of a marketing campaign, help detect financial fraud, or evaluate traffic patterns in a big city. It converts ideas into intelligence, and that intelligence can make our lives better and our employers better-off.

While McGuire’s advice was parodied in the movie, my unconventional suggestion could make somebody rich. It certainly can’t hurt to look.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Gone Up to the Mountain

Last weekend the Federal Reserve held its summer conference in Jackson Hole, Wyoming. This is part of a grand tradition that goes back centuries. Ever since Moses came down from Sinai with those tablets, leaders have gone up to the mountain to receive wisdom and achieve enlightenment.

You see, economics is the new theology. There are competing sects: the monetarists, the Keynesians, the supply-siders. There are civil debates along with heretics and “flamings.” And we have a central authority charged with implementing received (monetary) doctrine.

Like their religious counterparts, the participants debate and discuss confusing concepts that still have significant real-world implications. “Too-big-to-fail” affects borrowers, depositors, and taxpayers just as much as liturgical reforms affect churchgoers.

The drawbacks are also similar. The Jackson Hole retreat is filled with academics, bank CEOs, and central bankers. There is little to connect the cool mountain air of Jackson Hole with the smoggy city heat of New York or LA. Sometimes the real-world implications of these high-level discussions aren’t appreciated as much as they might be by a manager making sales or a politician running for office.

Like all self-important conferences, you can expect pronouncements of great pomp and circumstance. In fact, the central bankers may break their arms patting themselves on the back. Just don’t expect a lot of enlightenment.

Douglas R. Tengdin, CFA
Chief Investment Officer
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The Wages of Virtue

“Socially Responsible” investing is based on the premise that sometimes you can do well by doing good. A recent study evaluated how well it performs.

There are two forms of socially responsible investing: “positive” screens that tilt portfolios towards companies that promote a diverse workforce, invest in their communities, and have vigorous consumer advocacy; and “negative” screens that exclude stocks of companies associated with alcohol, tobacco, or other factors.

The results were striking. Portfolios that tilted towards responsible companies outperformed the market, while portfolios that shunned certain businesses underperformed. From ’92 to 2007 the “positively” screened stocks added about 0.5% annually, while the negative screen lost about 3% per year.

This makes intuitive sense. By doing good, managers can help build up their businesses. But a company’s line of business may not make it a bad investment. And how we live is often more important than what we do.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Dollar Uber Alles

What happened in Zimbabwe?

Zimbabwe had the 30th hyperinflation episode in world history. The first happened during the French Revolution, when inflation topped 50% per month. In late 2008 Zimbabwe’s monthly inflation rate topped out at 79 billion percent.

The government had literally printed money to pay its debts. After Mugabe destroyed his economy through confiscation, they didn’t have the tax receipts to pay the army and other workers, and they couldn’t borrow. So they just printed what they needed. Prices inevitably rose. The currency fell apart when the government issued a 100 trillion Zimbabwe Dollar.

What happened next is unique. The economy spontaneously dollarized. People couldn’t be bothered to read all those zeros—there were 15 on that 100 trillion note—and they started to use dollars instead. Now prices are stable, in dollar terms. The economy is limping along.

What we learn is the economies are incredibly adaptive. And that just having more money doesn’t make you more wealthy.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Basket Case

Is the Dollar done?

That’s what some analysts think. After the Chinese publically worried about their Dollar assets and suggested moving to a basket of currencies, some concluded that a commodity-based basked might hold the future of global finance. Higher real rates for the greenback would inevitably follow.

But we’ve seen this movie before. It’s a short trailer with no plot. You can’t enact a currency by decree. Companies and countries need to issue debt in that currency, and they only do that if people do business in that currency. That way issuers can balance their income and expenses. Europe had a do-nothing basket for years, the Ecu. It went nowhere until countries abolished their local currencies and adopted the Euro.

Since the US has the largest economy with the most liquid markets, it’s the world’s reserve currency. The only way we’ll see the dollar retired is if the US unilaterally decides to put George Washington to sleep.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Grassy Highways

Everyone points to the Interstate system as the ideal infrastructure project. Sixty years ago, America was choking on roadway bottlenecks. Dwight Eisenhower once oversaw a coast-to-coast army convoy that took three weeks. As president, his highway initiative cut that time from weeks to days.

Now our highways facilitate commerce from around the world to every part of the country. Most places can be accessed in a matter of hours. This is an example of a productivity-enhancing government program. It’s what economists mean by a multiplier.

But imagine that money being spent 50 years earlier. Without a fleet of road-warriors to use them, those highways would have gone to seed and rotted away. The multiplier would have been zero. That’s why the kind and timing of infrastructure spending is so important. Ten years ago Japan tried to stimulate itself out of its funk, but it spent the money on wasteful projects like redirecting rivers and paving over mountains. No multiplier there.

So the stimulus money had better be spent right. Or we’ll end up with a lot of grassy highways.

Douglas R. Tengdin, CFA
Chief Investment Officer
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