Giving Thanks

What is Thanksgiving for?

Oh, I know that millions are inebriated with turkey and stuffing and potatoes and football, but why do we make a national holiday out of it?

Part of it has to do with celebrating our national legends, the self-image we have of pioneers carving out a life for themselves in the wilderness, We celebrate the initiative, ingenuity, and cooperation that enabled the early Pilgrims to come, learn, and grow in the New World.

Part of it is a celebration of family, both near and distant. Thanksgiving is a time of family gatherings and traditions. At a time of economic stress, family ties are more important than ever.

And simple pleasures have always been an important part of the holiday. College football; plain food, and family: there’s little controversial or divisive about these icons.

From the moment that Abraham Lincoln declared a “National Day of Thanksgiving” during the Civil War, Americans have paused in November to count their blessings. Sometimes the simplest pleasures are the best, and the best things in life aren’t things. As we look back at a crash and partial recovery and look forward at mixed prospects, let’s give thanks for how far we’ve come from a year ago, and where we might have been.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Lucky or Good?

Did we luck out by avoiding Dubai Ports?

Four years ago there was a political firestorm when a Dubai company proposed to take over a British port operator. That would have put Dubai Ports World in charge of services at 22 US cargo ports, included Boston, New York, Philadelphia, Houston, and New Orleans. Coast Guard officials raised the issue of security risks, and Congress voted to block the deal.

With controversy swirling, Dubai Ports sold American operations to a US company, and proceeded to close the rest of their deal.

Now Dubai is in the midst of an insolvency crisis. At the height of the real-estate boom, Dubai World invested heavily in residential and commercial real-estate, vying to become the main financial center of the Middle East. But the global financial downturn has hit high-end tourism and oil revenues especially hard, and Dubai World is seeking to restructure its debt, testing whether Islamic finance can protect property rights within a global framework.

So did the US dodge a bullet by squelching the Dubai Ports World deal? After all, having a bankrupt company manage our ports could be problematic. Except for one thing: which US company bought those port operations? AIG.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Training Wheels

Why did Warren Buffet pay so much for Burlington Northern?

Buffett’s price locks him into a 5% return on equity, half of his normal target. He does get a lot of previously invested capital, and a solid energy-efficient freight transport business. He didn’t invest in some pipe-dream high-speed passenger rail system guaranteed to lose money.

But it’s fascinating to consider the personal issues.

When Warren was a kid, he longed for a multi-track Lionel train set. He never got it. After he got rich, he persuaded a friend to build him a super-deluxe multi-level diorama HO-model set. It’s still there in his attic.

Certainly, there aren’t a lot more deals left. When you have so much money to put to work, you need a pretty big transaction to move the needle. And in these markets, often the deal you do is the deal you can do. There’s also the issue of Warren’s legacy and his cheerleading the US economy.

Berkshire’s Burlington Northern deal seemed so out-of-character for Buffett that many analysts went scurrying trying to find a justification. Maybe he made so much on his deals last year that he feels that he’s playing with house money. But that’s not the way Warren usually thinks.

It’s just not clear what his thinking is.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Inflation Nation

For now it looks like the inflation bugs have the upper hand.

Gold and commodities are soaring, Congress is calling for Geithner’s head, and all the commentary seems to be about oceans of liquidity driving markets higher.

The TIPs market is the latest red-flag. The real yields on short-term inflation-protected bonds issued by the Treasury have all gone negative. That means that buyers are locking in a yield to maturity that is less than the inflation rate on TIPs shorter than five years.

Either there’s an inflation panic out there, or there’s not enough bonds to go around. I’d guess it’s a little bit of both. In the short-run, Treasury could actually earn money by issuing a scad-load of short TIPs and T-Bills. Think of it—being paid to borrow! I don’t see why they shouldn’t get paid for satisfying the market’s irrational demands.

In the medium-term, the gold and commodities rally seems to be a bet that the dollar will fall. But it’s not clear to me that participants have thought this one through very well.

For the greenback to fall, it has to fall against something. Europe? They’re as weak as we are. Japan? Please. That leaves China. Yes, China is facing pressure to appreciate the Yuan, which would cause some inflation here. But China’s leaders are facing a lot of other pressures, too. And the approval of the G-20 leaders is probably pretty low on their list.

Gold’s rise this year reminds me of the oil boom last summer: buyers buying because buyers are buying. Bubbles like this rarely end happily.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Keeping Our Balance

Is the Fed out of balance? Are the “oceans of liquidity” they’ve created going to come back to bite us?

To be sure, Fed policy is easy. With the worst financial crisis in 50 years just behind us, it has to be. The popping real-estate bubble led to an insolvency crisis at the banks, and now the Fed is recapitalizing the banks by holding short-term rates close to zero. Hey, it worked for Greenspan in the early ‘90s.

But those zero short-term interest rates are causing trouble in any economy that’s linked to the dollar. Those countries essentially import our monetary policy while their economies chug along. Asian economies with booming markets are stuck. If they let their currencies rise they slow export growth at a time of slack demand; if they keep the peg, they engender a credit-driven bubble. And credit bubbles always end in tears.

And the Chinese are concerned about social tranquility at home. With 40 million more young men than women, civil unrest is never far from leaders’ minds. Appreciating the Yuan tightens Chinese money, slowing growth. It would take real guts to make that call.

But the Fed has made it clear that our monetary policy will be driven by domestic, not global, considerations. Global thinking may be part of the reason it took the Fed four years to tighten policy in ’03 through ’07, contributing to our bubble. Bernanke has told the Chinese that it’s our policy but the peg is their problem.

If the Chinese don’t appreciate, their economy will boom and bust. And the consequences won’t be pretty. Developing markets are all strong right now—you can’t afford to ignore them. The best approach is to maintain your discipline, ride the Dragon, and harvest your gains.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Exchange Traded Future

Why are ETFs growing?

Exchange Traded Funds are mutual funds that trade on an exchange. The concept has been around for decades. But in the past, what are now called “closed end” mutual funds almost always traded at a significant discount to the market value of their underlying holdings. This limited their appeal.

Open-ended ETFs began to appear a decade ago, and the concept really took off in the aftermath of the tech bubble. These funds closely track their underlying holdings because institutional investors can create or redeem new shares by delivering or receiving the underlying stocks. That keeps any discount to a minimum.

Investors have flocked to the investment vehicle. In October almost $700 billion had been invested in over 1500 US-based ETFs; a significant percentage of the $5 trillion mutual fund industry. Why have they done this?

Well, it’s easy to buy and sell them. Once you have a brokerage account you can purchase or sell the funds without disclosing your income, age, or favorite sports team. There are other advantages, but I think the “ease-factor” is the most important. Why do people buy ETFs? Because they can!

So the ETF industry is going to grow. Like any boom-town, this neighborhood will soon be populated by upstanding citizens, fringe weirdoes, and unsavory low-lifes. As with any investment, buyers need to ask questions and know what they’re getting. Because the Sherriff is a long ride away.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Rare Birds

Has Fed-watching become as arcane as bird watching?

Several years ago hundreds of enthusiasts traveled to Arkansas to capture a glimpse, or photograph, of the Ivory Billed Woodpecker, a species once thought extinct. In the same way, hundreds of Fed-watchers were on hand Monday to hear what Chairman Bernanke had to say to the Economic Club of New York.

And what did he say? That the economy is growing slowly, and that the Fed will be on hold for a while; absolutely nothing of note. Oh, he did make a passing reference to the Dollar, noting that the Fed would “continue to monitor” the greenback’s moves.

On that little aside the currency markets started to go nuts, bouncing up and down about one percent in the course of 90 minutes. At the end of the day, the Dollar ended up pretty close to where it started. But during the speech, the market was moving.

What does this tell us? First, the personality cult that attended the Greenspan Era hasn’t abated. In spite of the demonstrated fallibility of fine-tuning an economy based on a single person’s judgment, we seem ready to do it again.

Second, markets are looking for a reason to panic. The Fed’s zero-interest-rate policy has spawned a lot of investment schemes. When the Fed changes course, we’ll be in for some short-term volatility. But then it will probably be back to business-as-usual.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Foxes and Hedgehogs

“The fox knows many things, but the hedgehog knows one big thing.”

So goes the old saying. Some people are sorters: they see the world through one defining idea. This gives them focus and direction. These are the hedgehogs. Others are gatherers: they see things through lots of lenses. They’re always looking for new ideas, new analytical tools, and different perspectives. They’re foxes.

Which approach is best? Clearly, in an economy that rewards specialization, hedgehogs have their place. Neurosurgery and rocket science require focus. But a complex world requires intellectual flexibility. The broader perspective you bring, the better your chances.

In finance, there’s room for both types. Analysts need to focus on a company’s core competency; portfolio managers need to synthesize loads of information and bring it all to bear on a client’s total financial picture. Ideally, in a diversified team they work together.

One thing is certain: hedgehogs make better guests on cable news shows. The rock-star economists who predicted 10 of the last 3 recessions can always be counted on to say something outrageous. They’re fun to listen to. But studies show that in something as complicated as a modern economy, foxes make better predictions. They just don’t get as much press, because they can be boring.

Both foxes and hedgehogs have their place. They trick is knowing when, and how, to listen.

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

Did the banks make a deal with the devil?

In the story of Faust, the protagonist makes a deal: in exchange for his soul, the devil will get him whatever he wants: money, love, or power.

A year ago, the big banks would do anything to survive. Facing runs by institutional investors, banks sold pieces of themselves to the government in exchange for asset guarantees and access to the Fed. A Depression was averted and most of the banks survived.

But now they don’t like the deal so much.

Banks face special restrictions on compensation and populist rage regarding their bonuses. How will this turn out?

In the Faust story, there are two outcomes. The traditional version has the Devil come and drag Faust’s soul to hell, illustrating that every bill must be paid. In Goethe’s text an angel intervenes to lift his soul to heaven, showing that grace can overcome the foulest bargain.

So which will it be? Will we hold a funeral for the big banks, or celebrate their assumption? Like the Faust story, much depends on what the banks do with their special powers. Goethe’s Faust was saved, but only because he dedicated himself to human progress. Is that where the big banks are headed now? I wouldn’t bet my soul on it.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Buried Treasure

Chris Dodd unveiled an 1100 page bank reform bill. Are there any nuggets in there?

The Connecticut Senator is infamous for receiving sweetheart loans from Fannie Mae while overseeing the mortgage giant. But there are some sensible proposals in his bill.

First, it would limit the Fed’s power to overseeing monetary policy. In an era of mission creep and personality cults, limiting any institution’s power is a good thing. Most financial derivatives would be centrally cleared, avoiding a big element of systemic risk. And Municipal bond advisers would need to register with the government, removing a big source of pay-to-play conflict.

But it’s not all high-minded ideals, either. Dodd’s bill would require big banks to issue “reverse convertible” bonds that would turn into equity if their businesses went south. Nice for the insurance companies in Hartford who aren’t banks.

Significantly, Dodd’s bill would politicize the banking industry and establish an alphabet soup of agencies to oversee consumer lending, commodities trading, and hedge funds. It even establishes an educational arm to administer pork, er, federal grants to States for “financial literacy projects.” Wonder who’s gonna get that money?

The Senator from the Nutmeg State did indeed bury some treasure in this bill. But by making banking even more political, it seems to me that it’s leading in the wrong direction.

Douglas R. Tengdin, CFA
Chief Investment Officer
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