The Blessings of Failure

Many people talk about the successes of the market. But what it really allows is failure.

Centuries ago, if you couldn’t pay your debts, you were put in debtor’s prison where you wrote letters imploring family and friends to bail you out. In ancient Rome, if you pledged yourself as collateral and didn’t pay the loan you would become your creditor’s slave. Colonial Virginia was settled by many indentured (i.e. indebted) servants working off their debts via labor.

In the US we abolished debtor’s prisons by the mid-1800s. Some notable people had been imprisoned, including Light-Horse Harry Lee, a Colonel in the Revolutionary War and Governor of Virginia. We replaced prison with bankruptcy, a way of starting over.

This came to mind as I reflected on Steve Jobs and his remarkable career. In many ways, he was the most successful failure in modern history. The list of his failures is lengthy. Jobs helped invent the Apple I and the Apple II—early computers that sold by the hundreds. The product didn’t take off until they added a floppy disk. Then came the Lisa, another flop. Jobs got so distracted he missed deadlines and got tossed, so he took a half dozen Apple employees and founded NeXT, which produced a computer which sold tens of thousands. It had some interesting software, though, prompting Apple to buy it, bringing Jobs back. He brought his lessons with him.

When Jobs introduced the iPod, iTunes, iPhone, and iPad he had an inexpensive alternative approach to a large-scale consumer need with a seamless software ecosystem. His early failures prompted his later successes. In these days of too-big-to-fail banks, auto companies, and (soon) hospital systems, it’s important to remember: we can either learn from our failures, like Jobs, or send them to prison. The choice is ours.

Douglas R. Tengdin, CFA
Chief Investment Officer
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A Perfect Storm?

What are the economic effects of Hurricane Irene?

The storm caused major flooding and disrupted businesses all along the East Coast. It tested flood-level records in New York City and much of the eastern seaboard. Also, the storm itself disrupted plans all along its path, as people prepared for the storm and cleaned up their yards and Continue reading A Perfect Storm?

Polishing the Apple

Is Steve Jobs irreplaceable?

There’s no doubt that Steve Jobs made Apple what it is today. 15 years ago the company was ailing financially and received a bail-out from—Microsoft. It had been a niche supplier of computers for schools, never penetrating the business market. Investors had written it off. The stock went nowhere for a long time

Then came the iPod, iTunes, the iPhone, and the iPad. Apple redefined the music business, which had been in flux due to Napster and file-sharing. Apple dominated the smart-phone market, turning “app” into a word, and making everyone’s phone unique. And it created a whole new class of computer, the tablet, via the iPad.

Unquestionably, Steve Jobs was critical to all of these innovations. Undoubtedly, he was intimately involved in planning of each of these creations. But just as clearly, Apple is now a cash machine. It has no debt, $30 billion in cash, annual sales of $100 billion, and a 30% profit margin. It’s sales growth may slow—indeed, the law of large numbers says it has to slow—but slower isn’t stopped.

Steve Jobs has been a transformational figure—someone who re-made an entire industry. He has been compared to Walt Disney, whose vision fundamentally changed the leisure industry. After Walt Disney passed on, his company never had the same magic. But it has still been highly profitable over the years.

Charles DeGaulle famously quipped that the graveyards are full of indispensible men. Steve Jobs may be one-of-a-kind, but Apple will continue.

Douglas R. Tengdin, CFA
Chief Investment Officer
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All That Glitters (Part 3)

What’s wrong with the gold standard?

Lots of people are talking about it. Most of the world was on a gold standard from the 19th century until the 1970s. For millennia, gold has been a store of value. Now, gold prices are soaring and people are concerned about potential inflation.

A gold-backed dollar would limit the power of the central bank so it appeals to a lot of conservatives. But government must still set the price of gold in dollars, unless we want to pay for a tank of gas in gold shavings. Gold isn’t practical for transactions. Setting the right ratio of gold to currency is a critical, constitutionally-mandated task.

Still, assuming that Congress could get this right at the outset and avoid either massive inflation or depression, what would the gold standard do? As the economy grows, prices would have to fall. The same amount of currency would have to support a growing volume of transactions, unless the supply of gold expands at the same rate as the economy. Prices go down, and real interest rates rise. Investment becomes more expensive, and job creation is more difficult.

This is what happened in the late 19th century. It makes it almost impossible for the central bank to act as a lender of last resort. This is partly why, under the gold standard, our economy faced a series of financial panics and depressions. Far from serving as guarantee of financial stability, the gold standard assures the opposite.

The money is always greener on the other standard, though, and gold advocates will ever be with us. But a modern economy demands a modern currency. Gold just isn’t.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Home Alone?

Lots of people are worried about immigration. Is this realistic?

The assumption is that immigrants take jobs and push down wages in the receiving country. In fact, because of the law of comparative advantage, total income in the receiving area often rises rather than falls, even if wages in some fields, like construction, do come under pressure.

This is little-known fact is consistent with economic theory: specialization leads to increased productivity. Immigrants who aren’t fluent in the receiving country’s language might focus on manual or technical labor, and allow other workers to focus on communication or management. The entire economy is better off, because increased labor allows the entire economic pie to grow, and improved productivity allows it to grow faster. Several empirical studies by the San Francisco Fed have given evidence of this.

But what about the donor countries? Do they suffer a “brain-drain?” Again, the answer might surprise you. Because of cell phones and Skype, people stay in touch with their families far more regularly than they used to. Also, remittances back to the sending country are significant. When you’re sending a chunk of your paycheck back to Mom and Dad, you tend to stay in touch.

So what countries are the principal beneficiaries of remittances? Again, it’s not what you’d think. The country whose economy is most dependent on these flows is—Tajikistan–then Tonga, Lesotho, Moldova, and Nepal. Latin American countries don’t show up until number 8. The US is important in discussions about global immigration–just not that important.

There’s a lot of “common sense” about immigration that is just wrong. In general, when people work where they want to, it helps the economy grow.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Mr. Buffett, Taxes, and Investment

A couple weeks ago Warren Buffett wrote an op-ed piece advocating higher taxes. Predictably, the headline was inflammatory. Predictably, both Democrats and Republicans latched onto the article as an excuse to bash each other, as did the New York Times and the Wall Street Journal.

The heart of the matter is fairness. Mr. Buffett does not think it fair that his marginal tax rate should be 15%, while his secretary’s is 35%. (I noticed that his secretary must be very well paid, since only taxable income above $380,000 is taxed at this rate.) Mr. Buffett’s income is primarily comprised of dividends and capital gains, which are taxed at 15%–although those companies presumably paid corporate taxes on their income, first.

Buffett didn’t demagogue his piece; he gave a fair analysis of the issues. Long-term capital gains have enjoyed favorable tax treatment in the US, off-and-on, since 1921. It’s an active debate among economists whether reduced taxes on capital have encouraged investment over the years, but as a rule of thumb the more you tax something, the less you get.

Our economy is comprised of 70% consumer spending, 20% government spending, and 10% investment. It’s struggling to grow at a real rate greater than 2% right now. Increasing investment spending could expand the economy, improve productivity and put people to work. This is the idea behind the Administration’s proposed “infrastructure bank.”

It doesn’t make sense to increase taxes on something we want more of. Forget about coddling the rich; we need to get the economy moving. Rational tax policy can help.

Douglas R. Tengdin, CFA
Chief Investment Officer
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Your Parent’s Market?

Some folks are saying this is not your parent’s (or grandparent’s) market. Are they right?

Strictly speaking, this is true: volume has never been higher, and volatility is intense. There have been fewer than 300 four percent moves in the Dow since 1900 – less than 1% of all the trading sessions. But more than 10% of these big moves have come since October 2007.

On a deeper level, though, claiming that things are different this time wrong. The market is driven by financial fundamentals and investor psychology, and always has been. We face the same psychological challenges our parents and grandparents faced. These give us some clues as to how to face this and the next set of market challenges.

First, don’t just do something, sit there. Investors who act on the spur of the moment behave like almost everyone else, and trading on the same side as the crowd is rarely profitable. Once the masses “know” something to be true, this expectation gets priced in. This is why buying a year after a recession starts is usually quite profitable. The market “knows” that a recession will continue for “years” and assets go on sale.

Second, remember to look forward, not backward. The cost-basis is important for taxes, but not much else. The current panic is not a rerun of prior crises: it’s based on concerns about global growth, weakening profits, and European banks. Chart overlays of prior crises can’t predict the outcome of this one.

Finally, focus on quality. While big profits can be had buying and selling no-name flyers, the foundation of a profitable portfolio should be well-managed companies in growing industries with a global strategy. Fabulous fortunes have been made over the years in steady, boring pillars of financial and economic strength. Turnaround stories may be fun, but if you sleep with the dogs, often you’ll wake up with fleas.

Douglas R. Tengdin, CFA
Chief Investment Officer
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A Russian Future?

Are we facing a Russia-moment?

On August 17, 1998 the Russian government devalued the ruble, defaulted on domestic debt, and declared a moratorium on payment to foreign creditors. By October the stock market had fallen over 20% from its high and the 10-year US Treasury market had rallied about 1 ½ percent. Market volatility rivaled that of October 1987. Economists couldn’t see a way out for Russia—and they were right. Its economy didn’t begin to recover until 2000, and didn’t get to its prior peak until 2003.

How soon we forget. A financial crisis in Europe led to a market decline here, in spite of solid domestic economic fundamentals. The US equity market recovered by year-end and we enjoyed another three years of growth. The stock market ultimately rose 30% above its previous high.

Fast forward 13 years: a significant debt restructuring is in the offing in Europe, equities have fallen off their peak, the Treasury market has rallied, and volatility is extreme. But US companies continue to exceed earnings expectations. So far this earnings season, over 90% of companies in the S&P 500 have exceeded expectations. The economy is still growing: we have 1.2 million more jobs that a year ago, consumer credit is growing, and industrial production is improving.

Yes, global growth is slowing. Yes, the markets have been volatile. But oil prices are down, inflation pressures are easing, and consumers are spending. We’re seeing evidence of financial stress, but it’s more like 1998 than 2008. The situation may not yet be in hand, but this is no time to panic.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

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