A Man on the Moon

Why is this so hard? Why can the Federal Government stem a financial meltdown but can’t balance its books? How can we bounce back from 9/11 but can’t shut down the Taliban in Afghanistan?

I call this the man on the moon question. Back in the ‘70s people would ask, if we can put a man on the moon why can’t we … and would fill in the blank. It’s a reasonable question. Space flight seems daunting. Fixing schools, or race relations, or government budgets appears mundane.

But appearances are deceiving. It’s always easier to focus on big problems than on little ones. Why is this? Big problems pay better, either in prestige or money, for one. The magnitude of the issue attracts the best minds who get a lot kudos and/or cash for their efforts. Also, big problems tend to focus our minds. Samuel Johnson once quipped that when someone knows he is to be hanged in a fortnight, it concentrates the mind wonderfully. You’re less likely to get distracted when a lot is at stake.

Also, in large crises the range of options is limited. It becomes easier to see which one is best. So I give Ben Bernanke less credit for managing the Panic of 2008 than for his addressing the current foreclosure crisis.

But most of life depends on the little things: in budgets, in business, in investing. As we look to finish out the year, let’s make sure we fix what we can, and let the man on the moon wait.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Recovering the Future (Part 2)

Motivation matters.

How can we get the economy out of its funk without going through a long slog? We need to unleash the entrepreneurial energy of our country.

Some European observers have noted that the US seems unusually dour. The usual can-do optimism seems lacking. And one way to change this is to change the structure of our taxes.

By altering the structure, I mean lowering the marginal tax rate while raising the effective tax rate. That way people pay more in taxes, but they also see that if they earn more they get to keep more. Look at it this way: if the total marginal rate is above 50%, you keep less than half of every extra dollar you earn. Or, if you take an unpaid vacation, the government pays for more than half of it. That’s discouraging.

That’s why there’s such a big fight about moving the top rate from 36% to 40%. With State taxes, Medicare taxes, and other items in the tax code, the total marginal is well above 50% level for folks in many states.

So how do you do this? Eliminate deductions and lower the marginal rates. You end up with less economic distortion and more economic activity. Want proof? Look at what happened in 1987 and 88: the years right after the Packwood/Rostenkowsky tax simplification. Fewer deductions and lower brackets led to a booming late-‘80s economy, so much so that Alan Greenspan had to take away the punch bowl.

Low rates with a broad base is smart tax policy. Let’s hope the next Congress can see this.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Recovering the Future (Part 1)

Is this the multi-tasking recovery?

GDP has passed its pre-recession high. Corporate profitability has never been stronger. Balance sheets are healthy and interest rates are low. So why does this recovery feel so lousy?

It feels lousy because of jobs. Back in the ‘90s, the joke went something like: “Did you hear that the economy created 300 thousand jobs last month?” “Yeah, and I’m working three of them.” The idea was that the jobs created by the recovery were substandard and didn’t provide enough income. We called that the “jobless recovery.”

The dynamic is different, now. Those of us working seem to be doing the work of three people. The technology of cell phones and laptops and global connectivity has expanded the workplace’s reach to every corner of our lives. As a result, we’re more productive and our employers don’t need as many workers. So their profits are better– much better.

Thus, while our pay hasn’t gone up much, our workloads have. And companies see little need to add staff, because high unemployment has depressed consumer demand. Also business investment is low because record productivity makes capital improvements seem unnecessary.

How does economy get out of this funk? Most economists see the recovery grinding away while unemployment gradually fall. That’s the “New Normal” that some bond guys from California keep talking about: a dismal, grey sky of diminished expectations. Blah.

Is there another way out? Sure, but it means working smarter, not harder.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Healthy Outcomes

Is the Health Care system on the rocks?

Reduced Medicare payments, lower payroll tax collections, and scandals among drug makers might make you think so. In the wake of the health care debates, the health care sector declined about 5%. Many investors have all but written off the entire industry.

But is that reasonable? Health care is an essential service. Sure, some optional procedures, like cosmetic surgery, have suffered during the recession, but overall, demand has been solid. Since the recovery began a year ago, expenditures on healthcare have grown 3.7%.

But will health care reforms impact the sector? Sure. The prospect of reduced Medicare reimbursement along with increased scrutiny of company profits has many predicting that health care would be the new tobacco stocks in the coming years. Remember that cigarette companies have had to pay out billions since the states sued them in the early ‘90s.

But what happened after that? Tobacco stocks were punished as investors questioned the industry’s long-term solvency, but they’ve done extremely well since then, returning 15-20% per year since the full settlement was worked out. A 10,000 dollar investment in Phillip Morris back then is now worth over 100,000 dollars.

Health care is an indispensable product that more people will buy more of down the line. In spite of the uncertainty, health care has a healthy future.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Saving Private Keynes?

If saving is a private virtue but a public vice, the Keynesians will hate this.

Citibank has teamed up with microlender Grameen Bank to provide financial services to thousands of residents from Queens and Harlem. While New York may be home to Wall Street and the $10 million walk-up apartment, it is also home to millions caught in a vicious cycle of poverty and dependence.

Key to breaking this is savings and enterprise. Microloans are 100-1000 dollar loans that allow people to start or invest in an income generating activity. Microsavings and microinsurance are minimal-fee financial products that allow people to form an asset that allows them to escape their poverty.

All people lead complex financial lives. Without microfinance, the poor often use wealth-depleting high-cost alternatives like payday loans or pawn shops. Grameen has over 30 years experience (and a Nobel peace prize) developing products that enable people to work, save, and invest their way out of poverty. The essential idea is to operate a “non-loss” business that can sustain itself while it lends money at reasonable rates.

But the poor are our best spenders, right? Keynesians claim that anything to encourage savings hurts the recovery, as more savings results in the paradox of thrift. That’s just ridiculous. If poor people are able to provide goods and services that others want, they’ll become middle-class consumers and we’ll all be better off: less money for loan-sharks and drug dealers, and more sales at the Dollar Store and Wal-Mart.

You can’t spend your way to prosperity. But anything that encourages enterprise wins.

Douglas R. Tengdin, CFA
Chief Investment Officer
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The Age of Austerity

Among policy wonks there’s a great debate raging: can a nation save its way to prosperity? But among the electorate, the issue seems to have been decided.

Economists have been divided over whether Britain’s new frugality will work. Most are skeptical: Keynesian orthodoxy would posit that a decline in government spending will multiply it’s way throughout the economy and lead to economic stagnation at best, if not outright decline. Cutting spending when the economy is fragile is dangerous.

But others aren’t so sure. They note how the stimulus program in the US didn’t exactly prime the pump here, and that other countries facing structural challenges have enacted austerity budgets with good results. Both Canada and Sweden eliminated their deficits in the mid-90s and ended up growing faster with tighter budgets than they had before their governments cut back. Both were just coming out of a recession, Sweden had also just experienced a nasty banking crisis.

But whatever the debate among economists, the electorate seems to have already made up its mind. If current polls are to be trusted, voters could send a host of fiscal conservatives to Congress this election. Contrary to the conventional wisdom, cutting spending seems to be popular.

It could work: reduced government deficits can “crowd in” private investment and lead to an economy more focused on savings and investment and less dependent on consumption and debt. The Age of Entitlement was about handouts; the Age of Austerity is about take-backs. Entitlement asks, “Did I get mine?” Austerity asks, “Do we really need that?”

Douglas R. Tengdin, CFA
Chief Investment Officer
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Think Globally, Invest…

Are the markets inside out?

Everyone says that Asia is the world’s new growth engine and that the US economy will be sluggish for years. So why are Asian markets struggling while our stock market seems to be buoyant? Isn’t China the world’s biggest creditor?

Yes, China has built it’s economy on exports and so it has amassed massive foreign exchange reserves. And yes, the further emergence of hundreds of millions of Chinese and Indian peasants will help the global economy. But it doesn’t follow that these markets are automatically good investments.

To have a basis for international investing, a country needs a well-articulated legal structure, a stable political system, a solid financial infrastructure, and a sound currency. All of these elements are necessary for successful foreign investing, and many developing nations have just begun to create these institutions, for all their improvement over the last decade.

But while these conditions are necessary, they aren’t sufficient. The timing also has to be right. At present many Asian economies are close to overheating, even while Western nations struggle with overcapacity. So their interest rates are rising, while ours are at the "zero bound." And rising rates reduce the present value of all financial assets, stocks included.

As a result, one of the first rules of investing is, "Don’t fight the Fed." With Asian central banks keen to take away the punch bowl, their stock markets could be in for a bumpy ride.

Douglas R. Tengdin, CFA
Chief Investment Officer
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OIMBY

People love their own institutions.

Ask someone what they think of the educational system in this country and you’ll probably hear that it’s a mess. Ask them what they think of their neighborhood school and they’ll likely tell you that it’s just fine, thanks. Their school is okay, it’s all those other schools they’re worried about.

A big problem is that of framing. We don’t know what we don’t know, and what we really don’t know are the standards and execution of other schools, even though we all have extensive experience inside the school system, either as public or private school students. Most folks are also quite indifferent to the educational standards in other states, except when they make the news because of some controversy about evolution.

That’s why it’s interesting that the Gates Foundation and NBC put together a website that allows people to compare their local schools with others across the state and around the nation. Every school district in every state is rated. It’s encouraging to see that New Hampshire and Vermont rank in the top 10% of all states for 8th grade reading and math.

I suspect that unless people have done a lot of research, they’re content with schools that seem clean and safe and allow a decent education. So it’s hard to gather the critical mass necessary for educational reform or some market-based initiative. People just don’t know better.

But the internet and social networking are changing many things. Websites like Great Schools and Twitter feeds are powerful tools. But only if people care.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Of Morals and Markets

Pay-to-Play isn’t a household word. But in the money-management business, it’s a business strategy used far too often that corrupts both the givers and receivers.

The poster child of pay-to-play is Alan Hevesi, the former New York State official who controlled the state’s $125 billion pension system. Any firm that wished to manage part of this fund had to contribute to Mr. Hevesi’s reelection fund and perhaps ingratiate itself with other gatekeepers.

Lots of folks got caught up in this scandal. The most prominent has been Steven Rattner, the "Car Czar" who oversaw the restructuring of the U.S. auto industry last year. (Mr. Rattner recently published his account of that effort in his book "Overhaul.") Rattner agreed to a multi-million dollar fine and severe restrictions on his involvement in the securities industry. He allegedly paid millions to a consultant to arrange access, and did professional favors for Mr. Hevesi’s family members.

While pension plans routinely use consultants, these usually help plan sponsors or boards with analytical tasks and other profession specialties. Paying a consultant for access, though, is deeply immoral. It corrupts the investment management process, because access is substituted for expertise, and relationships crowd out results. Over time the sponsor benefits personally while the beneficiaries get sub-par performance. It’s a breach of fiduciary duties.

In the long run, these schemes cannot succeed, because they aren’t based on financial return. And as the parent of any teenager knows, "Everyone is doing it," is no defense at all.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Music, RIP

The music industry is dead. Long live music!

New technology has always profoundly altered music. First it was the violin, an alternative to the violoncello that could “sing.” Then it was the pianoforte, a keyboard instrument that allowed Beethoven to pound out notes that even he could hear.

Then records, radio, MP3s and downloads. After every change, gloom-sters proclaimed in gravelly voices the end of music. Lately, the business has had trouble: since the 2001 deal with Napster file sharing sites have multiplied like rabbits on steroids and sales and downloads have fallen by some 40%.

But in spite of this royalty payments have been rising, even during the recession. The industry isn’t dying, but it is changing profoundly. Live music has been making a comeback. Ticket prices have more than tripled in real terms over the past 10 years, even as concert tours have multiplied. And what fans don’t spend on $170 tickets to Simon and Garfunkel is often plunked down for a t-shirt or baseball cap.

Music’s nostalgic pull has also drawn in corporate sponsors, from soft-drinks to mortgage companies. It’s no surprise that Miley Cyrus signed a Hannah Montana deal with Wal-Mart. But music’s biggest fan is the television. For background and also shows like “Glee” and “Dancing with the Stars” which are music shows in their own right.

The music industry isn’t so much dying as coming home. For centuries the way to artistic success was to perform in front of a live audience. The 20th century’s brief music-publishing experiment is over, destroyed by the digital copy. Some things can’t be downloaded. It’s back to business as usual.

Douglas R. Tengdin, CFA
Chief Investment Officer
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