Anonymous

Whatever happened to privacy?

During the initial days of the internet, anonymity was all the rage. A favorite cartoon pictured two Basset Hounds typing away on their PCs. The caption read, “On the internet, no one knows you’re a dog.” How quaint those days seem. Today reputations get destroyed by “private” online chats.

Now the internet is helping retailers market to us. Our banks know our real spending patterns: where and when we buy our morning Joe; where we shop for clothes; what we do for recreation. They’re discovering the joys of data mining. When they get together with merchants, it makes a powerful combination.

There’s an “opt-in” program where consumers can choose to receive targeted text coupons on their cell phones. Here’s how it works: the bank knows you buy a cup of coffee at 8 or so every morning. So around 7:45 you get a text message offering you a free pastry at the Starbucks just across the street. The banks don’t tell Starbucks your purchase patterns; they just sell your name as a good prospect for a promotional ad, kind of like Groupon.

There’s a creep-out factor to all this. It used to be only celebrities had paparazzi record their every move. Now I have to worry that if I get impatient today at the DMV a video will be posted tonight on YouTube. And tomorrow I’ll get discount coupons for anger management classes.

Makes you long for the good-old-days of Netscape and Friendster.

Douglas R. Tengdin, CFA
Chief Investment Officer
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The Pit and the Pendulum (Part 3)

Poe wrote the original Pit and Pendulum. And it has lessons for investors today.

Poe set his story during the Spanish Inquisition. The narrator doesn’t explain why he’s there. He is sentenced to death and undergoes elaborate tortures. At the moment he falls into the dreaded pit he is pulled to safety by French invaders who have just taken the city.

It is a study of the effect of fear. The narrator communicates his fear quite well, for all the fact that we already know that he survives—after all, he’s telling the story. Poe’s writing is effective because he’s so realistic. And fear is a great motivator. It pushes the narrator beyond his limits—and beyond ours, as we read.

Investors deal with their pits and pendulums all the time. There are aspects of investing that seem like slow torture. We’re now seeing the steady erosion of purchasing power by moderate inflation, forced on investors by the Fed’s easy money policy. Others evoke the horror of 2008: references to a possible Greek default always seem to mention Lehman. Finally, everyone seems to be looking for a redeemer: a German bail-out of Greece, a Chinese bail-out of Europe, or some other rescue.

But one of the enduring lessons of investing is that there often is no white knight. While a rescuer is welcome, the pits we encounter are often of our own making. When we face our fears, we often find that they are less terrible than we imagined.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Lessons in Sang Froid

Tim Geithner spoke at Dartmouth over the weekend. What did we learn?

For one thing, we learned that he is pretty sanguine about the debt-ceiling negotiations. “You’re going to see political theater,” he noted. “There will be six episodes of failure before people do the right thing.” Considering that a default on the debt would be a disaster, that’s good to here. He noted that no responsible person believes that the US can default its way back to fiscal stability, and that Congressional leaders are responsible.

In fact, several observers noted how calm he seemed. Compared to 2008, the debt-ceiling issues, combined with fears of a European debt rescheduling, seem like small potatoes. Yes, we need to rebuild the banking system, probably with more capital. And yes, we have 14 million unemployed, many of whom have the wrong skills for the jobs that are available. And yes, we’re facing a lot of uncertainty.

But Tim was at Ground Zero during the financial crisis. According to one reporter, there was a daily conference call with him, Ben Bernanke, and two Fed Governors. Seeing Bear Stearns fail, FNMA fail, AIG fail, Lehman fail, and The Reserve Fund fail didn’t help his blood pressure. We really did look into the abyss during those dark days.

So walkouts, speeches, grandstanding—they’re part of the act. We’re three acts into a predictable five-act play. In the end, responsible people act responsibly, he’s saying. Here’s hoping he’s right.

Douglas R. Tengdin, CFA
Chief Investment Officer
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The Pit and the Pendulum (Part 2)

You can’t make this stuff up.

Yesterday I discussed how institutional investors are being forced to take risks they’d rather not take because of the ultra-low interest rate environment we’re in. It’s no news that pension funds are under a lot of pressure to achieve significant returns over the next 10 years. The financial meltdown did a lot of damage.

Now those funds need to make up their losses. The problem is, global growth has downshifted. Instead of 3% real GDP growth in the developed world, we’re looking at 2-2.5% growth. The combination of deleveraging, default risk, and re-regulation has many talking about a “new normal” of reduced expectations.

But those pension funds still need returns. And you can’t get 8% returns out of 3% 10-year Treasury yields. It’s like trying to spin straw into gold. So these institutions are allocating assets into ever-more risky classes in ever-more exotic vehicles.

Enter the Ohio Highway Patrol Pension Fund. This $732 million fund is shifting assets around, taking $75 million out of domestic equities and putting it into foreign equities, foreign bonds, and commodities. Hey, I think there are opportunities out there. But wow, that’s a big move.

And it illustrates my point. The trustees are taking on risk and reaching for return. Ohio taxpayers sure hope they’re right.

Douglas R. Tengdin, CFA
Chief Investment Officer
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The Pit and the Pendulum (Part 1)

What’s the key to investment success?

Many people have pointed to many different things. Some say it’s diversification, which reduces risk. Some say it’s having a long-term perspective, which enables you to be patient through the ups and downs of the market. Still others point to flexibility, or organization, or having appropriate expectations. These are all part of the total picture.

But the one factor that really stands out—if I can summarize it in one word—is “cheapness.” Buying a security at a low price relative to its fundamental value makes that purchase safe. You’re far less likely to lose money when you spend less for something than it‘s worth. Ben Graham used to call this the “margin of safety.”

What’s frustrating about cheapness in investing is that it depends on other investors. In the midst of the financial crisis we could buy Johnson & Johnson bonds as if they had a 50% chance of defaulting. We didn’t create that opportunity—others did. The market was paralyzed by the fear of a global financial meltdown. So, prudent investors could be aggressive. All you needed to make money was cash and nerve.

Now the situation is different. Ultra-low interest rates have pushed investors out on the risk curve. Pension funds, endowments, and others need 8% returns to reach their goals, and they think they can’t get this with traditional investments. So they’ve moved into high yield bonds, private equity, and hedge funds. Not because they want to, but because they think they have to.

At times like this it pays to be prudent. The market doesn’t provide high returns just because we need them. And as others get greedy, there’s nothing wrong with being a little fearful.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Economy of Dreams

If you cut it, they will come.

That seems to be the mantra of both parties in Washington these days. Like the mystical voice that whispered to Kevin Costner in the movie “Field of Dreams,” they seem to think that if they cut the budget deficit by trillions, the resulting savings will sprinkle confidence pixie dust on the economy. Corporations will start spending, and a thousand flowers will bloom.

It’s a nice story, but it runs into a few problems. Corporations are already spending. Business investment has already grown faster for longer than during at almost any other time. Businesses are spending money, they’re just not hiring lots of new workers. The capital/labor equation still favors labor. Also, there is no pixie dust. Business confidence rises and falls with the economy itself. And the unmistakable indication that the economy is doing better is the jobs picture.

But both sides of the political debate are mystified on how to create jobs. That’s because they often claim credit for something they had little to do with. Hiring someone is a serious decision. Managers know this. If they think an upturn is temporary, they’ll just muddle through shorthanded rather than risk volatility in their workforce.

To start the jobs ball rolling we need stability and financing. The lack of financing coming out of the financial crisis and the policy uncertainty associated with reform in health care, taxes, and regulation do more to keep businesses from forming than the Federal deficit.

In the long run we do need to address the deficit and pay our bills. But to get the deficit down we really need jobs. And to get them we need stable policies.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Five Cities

In the history of Western Civilization, five cities stand out: Jerusalem, Athens, Rome, London, and Philadelphia. Those five cities are proxies for the ideals of law, democracy, stability, commerce, and constitutional democracy. These ideals have become dominant around the world, and form the foundation of our current economic structure.

Today, five cities are still critical to global growth. They are: Beijing, Jerusalem, Athens, Frankfurt, and Washington. Beijing stands for the hopes of more than a 1/6th of the world’s population; Jerusalem is the key to the aspirations of hundreds of millions of Arabs and Jews; Athens and Frankfurt are at heart of a fiscal crisis and European order; and Washington has replaced Philadelphia as America’s capital which sets policy for the world’s largest representative democracy.

It’s interesting how everything old has become new again. Jerusalem and Athens are still at the heart of global progress, although not in their former manner. Instead of being a cultural center, Athens epitomizes our modern fiscal crises, where a country’s citizens think they can receive benefits that they don’t have to pay for. Jerusalem is at the nub of a Middle Eastern conflict that plagues a world in need of Middle Eastern oil.

The greatest difference is the addition of Beijing—which oversees the development of over a billion people. A generation ago the Chinese were starving; now they’re adding their labor and creativity to the global economy.

It pays to keep these cities in focus. They’re our cultural legacy, and policies affecting them will affect us all.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Efficient? You Call That Efficient

That’s what some people think. Because the housing market boomed and then busted, they claim that market efficiency has been disproven. “Economists believe that the market perfectly discounts future cash flows. How was the housing market perfect?” But efficient markets aren’t perfect; they’re just hard to beat.

Careful practitioners know this. They know that the market can get it wrong. But they don’t think that the alternative to “the market got it wrong” is “the government can put it right.” If investors are occasionally idiots, then so are bureaucrats and regulators. Lionizing Robert Shiller or Nouriel Roubini because they got it right the last time is no different than the crowd that worshipped Alan “Maestro” Greenspan before and now wants to throw him under the bus.

No, market efficiency is like democracy: it may be the worst way to price assets, except for every other way. Government fiat doesn’t work—communism showed that. But neither does regulation—Reg Q set the maximum interest rate banks could pay depositors during the ‘60s and ‘70s, and it inspired a host of ways to get around it.

Instability is part every living system. People walk by slowly falling forward and catching themselves. If the markets weren’t long-run efficient, investors couldn’t make money; if the markets weren’t short-run inefficient, advisors couldn’t help them.

Stability and equilibrium may make logical sense, but they don’t characterize living systems. Only dead ones.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Trust The Numbers?

Investments are based on numbers. But can we trust the numbers?

Ten years ago the investment world was rocked by the Enron scandal, when one of the largest companies in America turned out to be based on an elaborate accounting fraud. A few months later the failure of Worldcom and Adelphia raised serious questions as to whether any accounting could be trusted.

Congress’s response was the Sarbanes-Oxley Act of 2002. The Act did many things, but one thing it did not do was mandate auditor rotation. That is, it allowed companies who’ve used the same auditing firm for decades to continue on with that firm. Originally, that was the plan. At Enron, their accountants at Arthur Anderson had gotten so cozy with management that they were unwilling to blow the whistle on the energy giant. The Justice Department goofed by filing criminal charges against the auditing firm. Clients around the country quite naturally got nervous and cancelled their contracts, thereby destroying the firm.

Now we’re left with an oligopoly where three auditing firms control over 95% percent of the market for large corporations. So some folks are suggesting that firms be forced to change auditors every seven years. Fresh eyes every few years, they claim, would strengthen auditor independence, improve the content and scope of the audit, and improve the accounting standards used.

But it’s a mistake to think that regulation can accomplish what competition can’t. It’s likely that enforced turnover will only strengthen the hands of the managers running a company. There’s already plenty of leeway for unscrupulous bosses to dip into the till. Having a newbie every few years just makes it less likely anyone will find where the bodies are buried.

Douglas R. Tengdin, CFA
Chief Investment Officer
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A Little Bit Softer, Now

Is the current economic slowdown temporary?

Recently the data has been mixed. Only 54 thousand payroll jobs were added in May, auto sales slowed, manufacturing growth slowed, housing prices are declining again, and retail sales declined for the first time in 10 months. One economist raised the probability of a “double dip” recession to 20%.

To be sure, much of the recent weakness is related to the tragic events in Japan that started with the earthquake and tsunami on March 11th. Manufacturing supply chains were disrupted, especially in auto parts. Toyota, Honda, and Nissan slowed production by as much as 30%, and that’s rippled through much of our economy. In addition, rising gas prices, although moderating now, had a chilling effect on consumer spending, even as temperatures across the country rose. And severe weather in the heartland—floods, tornadoes, fires—has impacted much of the farm economy, where incomes had been rising due to higher crop prices.

Some factors aren’t temporary: Federal stimulus spending is slowing; state and local governments are cutting back; and the fiscal crisis in Europe continues to fester. But these issues have been in the works for a while—there’s nothing new. In the meantime, much of the supply disruption seems to be behind us. And gas prices seem to have peaked.

Our expectation has been that the economic recovery that began in June of 2009 would be sluggish and choppy. This latest news has been some of the chop.

Douglas R. Tengdin, CFA
Chief Investment Officer
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