Tuesday, January 31, 2006

Fed Hikes rates 1/4 point, to 4 1/2%.

The Fed statement has been released indicating another quarter point rate hike to 4.5%. There was one change in the statement from the December statement worth noting. "Further policy firming is likely to be needed…" was changed to "Further policy firming may be needed…" That implies it may be needed, or may not. The Fed may be done. They're passing Bernanke the perfect situation of being able to go either way. Smooth move.

posted at 2:30 PM 0 comments   

Picking the right slot machine

Give New Stocks Chance To Prove Themselves
Investors who missed out on Google's much-hyped August 2004 debut are likely peeved that they didn't jump in. After all, shares have only surged higher since.

But keep in mind that Google is the rare exception for newly public firms. Plenty of IPOs enjoy a big pop on their first day of trading. But many then pull back sharply after their debut. Shareholders often flip their shares for a quick gain, sending the stock back down to earth.

Editor's Notes: This topic is one that deserves a statistical analysis. It says that you should wait to buy IPOs after they go through the initial volatility that is associated with their entrance into the secondary market. But this is readily testable and it should have been tested instead of assumed.

Trading on the volatility of IPOs is an obvious choice and if memory serves me correctly my own past research showed that IPOs behave quite randomly. So many traders are trying to game them that they push prices all over the place. But I don't know what happens if you wait certain periods of time, then buy those with upward momentum and hold them for certain periods of time.

A proper test would optimize for the best amount of time to wait, the best amount of momentum / price increase to filter on, and the best amount of time to hold the stock. Then one must compare those results to holding a basket of stocks, ETF, passive fund, etc… such as one that tracks against the S&P 500. For all the effort the statistics may show results insignificantly better than the index, or worse.

I do think some of the best places to find statistically significant worthwhile strategies is in testing longer-term strategies, because the statistical traders are so typically interested in the quick buck they can make on short-term trades of less than a day to within a week. They are seldom patient enough to care how stocks react to events a month, six months, or a year or two out.

A good analogy is the way skiers react to fresh snow. Being a local to the ski areas, (shhhhhhhhh) I have observed that the majority of people will instinctively head straight into back areas where they think the least people will go, not realizing that every other powder hound is thinking the exact same thing at the exact same time as they are. Thus the powder in the farthest reaches gets thrashed within a matter of an hour or two. Ironically, great powder can be had for half a day in the all too obvious places that timid tourists struggling in the fresh snow on the green runs won't dive into.

I do agree with the author that kicking yourself over a missed opportunity is probably not the best reaction. This is similar to losing money in a slot machine, having someone sit down at the one next to you and score big, then kicking yourself for not having picked that machine, as if you could have possibly known it was about to produce a win.

While everyone else is flocking to the latest, greatest, most exciting stocks there are excellent more demure opportunities just outside of the limelight that can provide excellent returns without the stress and poor risk reward ratios.

posted at 12:33 PM 0 comments   

Nothing simple about market systems

The fellow Coloradoan (aka T) says in the comments to Foiling Oil Fiction in reference to the price of oil that "The simplest explanation is normally the right one." suggesting that there must be a simple fundamental answer that explains oil prices. He is referring to Occam's Razor, a theory which basically says that the simplest answer, the one requiring the least number of assumptions, is the most likely answer. Occam's Razor sounds great in theory, but is itself anything but simple in practice, especially applied to the markets for which there are several difficulties.

One problem is identifying the simplest answer. This can be deceiving. That the price of oil would reflect some fundamental explanation is seemingly the simplest answer. But to make that work you have to concoct / assume fundamental explanations that don't exist. There's nothing simple about that. The simpler explanation is the single assumption that people are doing the same thing they have always done, which is moving from one financial euphoria to another.

Another problem is that Occam's Razor only implies that the simplest answer is right more often than more complicated answers. It doesn't mean that the simplest answer is always the right answer. Using Occam's Razor to eliminate seemingly more complex explanations is also paradoxically not simple because you making the assumption that complex answers are not relevant or likely.

Finally, there's nothing simple about the markets. Markets are highly complex systems reacting to many factors simultaneously. Sometimes one factor is overwhelmingly the most predominant. Other times markets react to many little factors. Chaos theory, the butterfly effect, and weather systems nearly describe market systems.

Meteorologists have gotten increasingly good at predicting weather patterns. It might not seem like it at times, but it's true. They've continuously improved they're ability to identify the predominant factors driving a weather system. Arguably, economists haven't made as much headway with predicting the economic factors that impact markets.

As if the unreliability of economic forecasting weren't bad enough, there is yet another additional dimension of complexity within market systems not found in weather systems and the underlying economic factors that feed into markets. A meteorologist can observe the weather without impacting it. Similarly, I can observe the markets independently without effecting change on them. But as soon I make a trade based on the observation, or tell other people about my observation affecting them to take action, which effects change in the markets, then I am simultaneously an observer and a participant in the system. I am observing the markets reaction to my own actions, however small the reaction may be, but I also my observations are impacting my actions and future observations. This is the property of reflexivity that George Soros first wrote about.

As a trader perhaps the market reaction I cause is little more than a market maker changing the bid ask say an eighth point for a few seconds. But what if lots of other people are making the same observation as I am? Then we may collectively produce a significantly noticeable reaction. Or a single trader with control of a lot of money might also impact the markets noticeably. Market systems are so difficult to predict because prices feedback off of physical data, peoples reaction to the data, and peoples reactions to other peoples reactions.

posted at 11:49 AM 3 comments   

Monday, January 30, 2006

Foiling Oil Fiction; once and for all

Even George Soros says of the oil markets, "I'm very worried about the supply-demand balance, which is very tight". How many times have we heard that before? More importantly what does it mean?

It's very tight the bears say. I've tried many times to figure out what this means and really I can't make sense of it. It we were consuming more oil than we were producing, then this would make sense. But we aren't. If consumption were rising at a faster pace than in the past, then I could buy it. But it isn't.

It's so easy to believe it when people say these things that we don't question it. The people saying it never have to show data or prove their point in any way. I put up data and charts over and over again and it doesn't matter how indisputable the truth is people still don't believe it.

The truth is that lots of things have changed in the oil markets, but none of them are the things the stock bears / commodity bulls want you to believe. The most obvious thing that has changed is the price of oil. In the last ten years the average annual price of oil has increased 156%. Also changed are the oil companies' profits and profit margins. ExxonMobil's net income has risen 245% and its profit margin has doubled. That's a competitive market?

Why should I believe anything George Soros says? Just because he's the great George Soros? He's deserves my respect? He says oil markets are tight, so I'm supposed to take that at face value and not question it because it's Soros saying it and he's more than a man. It's such a subjective and meaningless thing to say. The truth is that over the past four years, the period that oil has been skyrocketing, world oil production has increased 9.4%, while oil consumption has increased just 5.9%. World oil production growth has exceeded demand growth by 60%. If that keeps up we'll be awash in oil in a matter of a few years. See for yourself on the World Oil Balance chart below. The data is straight from the EIA.

The largest oil company in the world, ExxonMobil, believes production growth will be able to keep pace demand growth through 2030. The company has a huge incentive to see prices stay high as the charts below show how beneficial high prices have been to its profits. ExxonMobil just announced fourth quarter profits of more than $10 billion, which reportedly are the highest profits any company has ever obtained.

Neither is there an inkling of truth to the story that growth in China is pushing up demand global demand for oil in any significant way. The World Oil Balance chart shows that oil consumption hasn't wavered more substantially from the quite steady upward path it's been on for more than twenty years. Another truth is that China is actually growing slower now than it was in the mid 90s when no one was even talking about the country.

The most recent excuse for high oil prices has been that geopolitical tensions have increased. There is absolutely no truth to this argument. If anything, the geopolitics are relatively calm now compared to that of past periods of low prices. In the 1997 through 1998 period, when prices were ranging between roughly $25 and the all time low of $10 a barrel, we were dropping bombs on Afghanistan, running sorties into Iraq, though neither were called a war, the Russian economy was collapsing and everyone was worried about the Russians selling nuclear weapons and nuclear technology to terrorist ridden nations, Clinton was in hot water over advanced weapons technology being exported to China, North Korea was testing medium range rockets, Asian currencies were crashing, Japan was in an economic funk, Iran was being accused of harboring and supporting terrorists. Here are a few of the kinds of things that were being said in the media at that time:

"…yesterday's Wall Street Journal article, titled "Fission for Cash," the reports are that at least two Russian nuclear agencies are in the shadow of Bushehr on the side, are quietly negotiating to sell Iran a 40 mega-watt heavy water research reactor and a uranium conversion facility that would allow fissionable materials to be produced by the Iranians."

Editors note: What's new about this recent Iran news? Nothing.

"US aim is to have official dialogue about issues of concern, including support for terrorism. US has not received hoped-for responses, on terrorism cooperation or on visas for Iranians to come to the US. A group of Iranian clerics, who came to the US, complained of their treatment at the airport, and left."

" Iran continues to provide financial and other assistance to several terrorist organizations, including Hizballah, Hamas, and the Palestinian Islamic Jihad. Yet at the same time that it has supported or organized terrorist attacks on others, Iran itself has been a target of terrorism."

"The policies and actions of the Government of Libya continue to pose an unusual and extraordinary threat to the national security and foreign policy of the United States," President Clinton said July 6."

"Russian President Boris Yeltsin has pledged to mount a campaign against what many see as an alarming rise in extremism accompanying the current economic crisis."

"a Russian-born consultant to the U-S Treasury Department, Igor Birman, Friday told a Washington forum that Russian's economic situation is grim and getting steadily worse."

"President Clinton says he hopes the agreement on arms inspections signed February 23 in Baghdad by Iraq's Saddam Hussein and United Nations Secretary General Kofi Annan 'will prove to be the step forward we have been looking for, but the proof is in the testing.'"

"China has welcomed a deal brokered by U-N Secretary-General Kofi Annan with Iraq, saying it hopes the agreement will disperse the war clouds gathering over the Persian Gulf."

"For the second time in three days, coalition air forces came under attack Dec. 30 and returned fire against a missile site in Iraq. The latest incident, this one over southern Iraq, occurred at about 1:30 a.m. EST, 9:30 a.m. local time, near the town of Talil. The strikes were in response to Iraqi surface-to-air missiles launched at coalition aircraft patrolling the southern no-fly zone."

" The military will play an important role in the People's Republic of China reaching its goals of being a great world power and the pre-eminent one in Asia. This is the conclusion of a DoD report submitted to Congress by Defense Secretary William S. Cohen. The report covers the future military capabilities and strategy of the People's Republic of China."

" There was a report in a Washington newspaper this morning about China developing a missile with the capability of delivering a nuclear warhead to the West Coast of this country. The test described in the press report would not involve the missile in question going anywhere. It would land within a few feet of the launcher."

"Beginning in April, the New York Times ran a series of articles that investigated the complex relationship between the U.S. aerospace industry, the Clinton White House, and the People’s Republic of China. The reporting detailed how the Clinton administration re-prioritized technology transfer policies to the benefit of U.S. aerospace companies—and possibly the benefit of Communist China’s nuclear missile and space program. Since then, many in Congress, the media, and the foreign policy community have leveled serious questions about the role the Clinton administration played in the transfer of sensitive technology to China and whether these transfers affected national security. The questions about national security and missile proliferation are so sensitive, so far ranging, and so important that at least six congressional committees have held hearings on the subject."

" After the last revelations concerning the Clinton administration’s involvement in transferring sensitive missile technology to Communist China, even members of his own party seem exasperated."

"South Korea is expected to hasten the development of a missile system in the aftermath of North Korea's successful test launch of a medium range missile."

" The financial crisis that erupted in Asia in mid-1997 led to sharp declines in the currencies, stock markets, and other asset prices of a number of Asian countries; threatened these countries' financial systems; and disrupted their real economies, with large contractions in activity that created a human crisis alongside the financial one. In addition to its severe effects in Asia, the crisis has put pressure on emerging markets outside the region; contributed to virulent contagion and volatility in international financial markets; and is expected to halve the rate of world growth in both 1998 and 1999, from the rates of some 4 percent that were projected pre-crisis for both years, to an estimated outcome of about 2 percent."

posted at 5:36 PM 2 comments   

Selling the bear story

When I started this blog I had no idea precisely what I'd be writing about day to day. I sure didn't think that I'd be writing about oil and the energy markets, as much as I have. What I did know that I wanted to focus on was being levelheaded and rationally balanced, a counter balance to the hype and reactionary exaggerated thinking about the markets.

About a century ago J.P. Morgan said "Any man who is a bear on the future of this country will go broke." Has there ever been anything more true written about the markets? To think that that has changed now when the country is at its best and brightest is nothing less than insane. The utterly pathetic reality of John Pierpont Morgan's statement is, however, that there are very many people who make their living convincing other people of the opposite. Are they really bears themselves? Doubtful, but they hype all sorts of doom and gloom scenarios in newsletters, books, and websites.

Here's a dose of reality for you. While a sizable portion of the debate on the markets is bearish in nature, as it seems for whatever reason people love to discuss all the negative possibilities, assets managed in bear funds make up an insignificantly small fraction of the markets. When it comes down to it, people love to talk the bear to talk, but almost no one wants to actually walk the bear walk.

A lot of my readers talk the bear talk. I'm sure just about all of them have or have had money in long only funds. How many have put money in a short only fund? None? It's all talk. The perma-bears almost never run money in short-only funds. They just sell information or alternative investments. No one would actually give them money to short the U.S. markets and if they did the fund would go belly up in short order. There's no end to the money managers that are bearish on the U.S., but if you pay attention you will see that what they have in common is that they sell alternative investments to U.S. stocks (i.e. international equities, bonds, commodities, etc…).

They just want your money and they'll tell you whatever you want to hear to get it. What better way is there to get people to invest in commodities and other countries than to convince them that the U.S. sucks? If it sucks so bad go ahead and short it and see what happens. If you think that U.S. stocks are a great place to invest, then you will have little incentive to buy alternative investment services.

Consider also that a very large portion of the information about the markets available to the public comes from people trying to sell you something, both bearish and bullish. Of those people that are telling the bear story that aren't selling you something, it's probably because they've been convinced and brainwashed by someone else who is.

If you believe oil is going higher that's bad for most stocks and good for most alternative investments, so the bear story is synonymous with higher oil prices. Most people selling alternative investment services want you to believe oil prices will go higher. The bull funds aren't going to argue because their stocks in oil services, natural resources, and commodities are doing great.

posted at 3:32 PM 0 comments   

Friday, January 27, 2006

Straight for the straightjacket

Ready for $262/barrel oil?
Two of the world's most successful investors say oil will be in short supply in the coming months.
…billionaire investor George Soros, wouldn't make any specific predictions about prices. But as a legendary commodities player, it's worth paying heed to the words of the man who once took on the Bank of England -- and won. "I'm very worried about the supply-demand balance, which is very tight," Soros says.

Editors Note: This is also the same guy that called for the collapse of capitalism in his 1998 book then promptly proceeded to lose $2 billion in the collapse of Russia. I can imagine him saying something like this: Oh crap, communism, I meant to say communism not capitalism, It's the publishers fault, the title was supposed to read The Crisis in Global Communism, but they thought Capitalism would be more controversial and sell more books.

Of course, for all we know the man who broke the Bank of England took both sides and netted a $1 billion overall gain. It makes my head spin to think too much about this reflexivity stuff. I know you know that I know that you know what we both know, but you don't know something else I don't know, and I only wanted you to think I knew to see what you'd do, and none that you've made your move I know exactly what you know, unless... you really knew all along that I was waiting for you to make your move and are playing me like a pawn. No, no, no, no, I'm not crazy. I know you are, but what am I.

Here's a novel idea. Buy stock in a few good companies making good products that are more than a fad, leverage up with margin and options, and you've got yourself a hedge fund sized return sans the insanity. Thanks to justanotherblogger for sending the link.

posted at 5:39 PM 3 comments   

Refreshing

CNBC Commentator: Tell us about this bill that would allow fund companies to provide 401k advice. Is there a whiff of potential conflict of interest there?

Christine Benz, Morningstar Mutual Funds Editor: I think there is. And first off I do want to say that Morningstar does have a business unit dedicated to providing investment advice to 401k participants. So arguably, it's in our interest to keep the fund companies out of the mix. But I do think the potential for conflict of interest is huge on the part of the fund companies, and think that there could be a strong incentive to keep 401k plan participants say in the house brand mutual fund rather than letting tem go out of house. So I think that there is a conflict. I don't think that this is a great idea.

That was so refreshing the way she made the honest disclaimer. It elevated my respect for her and her company's brand. As you know, I am often critical of various market personas here on this blog. And that's not always popular with readers. They don't like to have their icons criticized. The usual counter argument is to accuse me of being audacious and that an itty bitty little lowly blogger has no right to criticize far more successful people. Of course these people are hypocrites because they would not hesitate to criticize our political leaders, Fed members, etc… But don't criticize investing legends. Typically, my criticism is that they do not say what Ms. Benz said. Some people might think it's stating the obvious, but it's not. Many people, probably the majority, take to heart what investment gurus say and do not consider the games they play and the conflicts of interest they often have.

Consider why experts even speak to the public. They are either marketing themselves, which is perfectly fine by me so long as they do it honestly and transparently, or they mean to manipulate. They're not performing public services. Now when I hear Morningstar give an opinion I feel better and more trusting about it, than I am of anything Jim Rogers, Boone T. Pickens, George Soros, or Warren Buffett has to say. Whenever those guys speak, tell me what they are doing, or what I should do I am very skeptical of their motives.

Also, Ms. Benz is right to raise concerns about potential conflicts of interest. Up until the regulatory spotlight was turned on the mutual fund industry a few years ago, similar conflicts of interest were the norm. Mutual fund companies regularly paid distributors for preferential status so that the distributor would recommend their funds first over other funds. It was a similar relationship to the one that AIG and MMC had that got those two companies in hot water and uncovered the many problems at AIG.

posted at 2:33 PM 0 comments   

Never Ending Hype

Commentator: "The EIA says they export 2.7 million barrels per day from Iran. It will be pretty hard to make up that big of a supply."

And we're going to have to make it up why? They're going to stop selling oil? Yeah right. Just this morning the same media source said that oil exports account for 90% of the countries revenues. But the bigger problem I have with the above quote is that the commentator offered no perspective on what 2.7 million bpd means for the worlds oil supply.

I was just doing some back of the envelope calculating the other day on how Nigeria stacks up in terms of the world's production, but had set the information aside and forgotten about it until I heard this out of context fear mongering statement. Nigeria produces 2.5 million bpd also according to the EIA. And Iraq is still pumping about 2M bpd. The World produces 83.8M bpd and the U.S. produces 8.0M bpd. That puts Iran and Nigeria at about 3% each, compared to 10% for the U.S. So I estimate that when 10% of U.S. oil production went offline that was roughly 1% of the world's supply. And guess what, it didn't make a diddly bit of difference. Inventories rose. If Iran cuts production a bit, it's going to amount to an insignificantly small amount of the world's oil supply. It would be unnoticeable fundamentally, but of course not technically via the panicky gyrations movements of futures, spot, and refined products prices.

Iran's not going to exit the world oil markets. That's as paranoid as worrying about China and Japan letting the price of their products inflate outrageously. Though I do think our relationship with the Asian Tiger is a bit like Siegfried & Roy's relationship with tigers. We never really know when they might bight the hand that feeds them.

It there really anything new about the geopolitics of oil now compared to previous years? Are there more world problems now? Is the middle east more of a mess now than any other time? I don’t think so. I think that the high price oil has us hypersensitive, the mainstream media in hype mode, and all the various parties who have an incentive to see prices go even higher are standing in line to get airtime. Even amidst war Iraq is still managing to pump roughly 2 million barrels per day, basically the same much as Iran and Nigeria.

This is a quote from an EIA timeline on Iraq in March of 2003, "Furthermore, heavy Iraqi resistance in some parts of Iraq gives rise to market speculation that the war could last longer than initially thought. The NYMEX near-month crude oil price rises 6.5%, to settle at $28.66 per barrel, as the war in Iraq as well as the situation in Nigeria have traders concerned." So three years ago geopolitics were just is bad, I say worse, with just as many unknowns and uncertainty, but with the risk premium oil was worth less than $30 a barrel. Today virtually the same risk and uncertainty prices oil at more than double that amount. It's not rational. It makes no sense whatsoever. It's a speculative bubble. There's no other reasonable explanation.

posted at 12:57 PM 7 comments   

Thursday, January 26, 2006

Dark Matter

In the past I've written that I believe there's a disconnect in trade deficit accounting, that things don't add up. That was an independent thought on the issue, but yesterday I was Googling around the web a bit to see what people were, and weren't, saying about this blog and I happened on a discussion that takes the issue to the next level of detail.

My own analysis on the deficit admittedly has been open-ended acknowledging that there's probably a lot going on we don't know or understand that could be skewing the accounting. More specifically I've pointed to globalization and what our multinational corporations are doing overseas. Simply put out of sight is out of mind. I believe that permutations of what AIG was caught doing in Bermuda—using affiliated reinsurance companies with insufficient reserves to lower reserve requirements and therefore capital available for investment—is commonplace in all industries, as a way to manipulate accounting favorably among other dirty little tricks of the trade.

I used to work in the corporate finance department that was a hub of accounting data for the U.S. interests of a foreign company that is one of the largest financial companies, one of the largest companies period, in the world. I'm not an accountant. One of my jobs was to reconcile the data feeds, make sure all the computer jobs that processed the data ran smoothly, and no data slipped through the cracks. That might not sound like much, but data came in varying formats from a multitude of affiliates, different product lines, departments, etc… and was pushed through several hundred computer programs into the accounting ledgers, or the books as they are oft referred. I worked with reports that had to be split into multiple parts be viewed because there were more lines of data than the spreadsheet software and the PCs RAM could handle. In a sense all the financials for the country came through me. You know in Office Space the program they wrote to siphon off fractions of a penny into a secret account, but they got the zeros wrong and sent a lot of money all at once? My job was to find those errors.

I didn't know anything about the accounts, of which there were many hundreds, but I would know if the data coming in—dollars that become nothing more than a blur of big numbers—didn't add up to what was in the ledgers, both grand totals and across various sub accounts.

What I know from that experience is how things like Enron, WorldCom and HealthSouth can happen right before the eyes of most employees without them having the slightest clue. The accountants are as attached to the accounts, as a meat packer to cows in slaughterhouse. There's a new account #1234567890987654321, add it to your reports, I'm told. Sometimes I knew what the accounts were, if say there was a new product line and I worked on the data feeds, but accounts were being added and deleted all the time and I had no idea what they were for.

In the corporate scandal cases the typical defense put forth by the CEO was that they new nothing about what their CFOs were up to. In my experience this is possible, though not likely. It is easy enough for senior management to shuffle money around without the accounting department knowing the wheres and whys. The accountants, for the most part, just make sure all the accounts balance out. In major companies there's such a web of data its hard for anyone to know a whole lot about what all that data means. That's the job of the executives who are concerned with bottom line numbers. Everyone else is buried in minutia. But there can be a disconnect in that the CFO and various finance executives look at middle line numbers, whereas the CEO is mostly aware of numbers at the bottom. By that I mean that a CEO might only be looking at the bottom numbers for each of a number of sub companies, whereas further down the line executives look at specific product data within the sub companies. I know this because I've created and managed reports that went to C level. Different C level people got different reports. The higher up, the less detail. They never wanted pretty reports. They wanted reports that directed there eyes straight to their particular bottom line numbers, which would sometimes be at the top to make it even easier and quicker to skim over. There were other numbers there just in case the executives wanted more detail, but generally speaking I think they viewed the reports no differently than any regular person might open their investment account statement and head straight for the balance.

But, the problem with CEOs not knowing is one of incentive. There are a lot of cracks. No doubt. But in every case in which the accounting fraud took place to benefit the company, as opposed to embezzlement or indirectly enriching a particular executive in some way, then I'm inclined to believe the CEO is in command, as he is the person with the most to gain and the most power.

I'm off on a bit of a tangent, but the reason for it is that I'm trying to help the average person understand just how complex the accounting of a multinational company is. Most insiders don't have a macro view. They each have their niche roles and are quite in the dark about the details of everyone else's roles. How then can outsiders such as auditors or analysts really know anything?

Now take all that complexity and role it up and try to account for it on a national scale. How does the current account, account for a foreign multinational company buying a U.S. company that itself is multinational and owns companies overseas? It was a U.S., now it's a foreign company, but it's still doing the same thing it was doing and employing the same people. That's the simple scenario. In real life multiple companies are purchased, merged, shuttered, layoffs, hiring, transfers, account changes, new products, product consolidation, money stays in the U.S., money goes out of the U.S., there's currency hedging, interest rate hedging, if its an insurance company there are reserves, state laws, federal laws, state taxes, federal taxes, international taxes, domestic executives get paid, foreign executives get paid, foreign executives are transferred to the U.S., they float in and out of the country without any real sense of country. It goes on and on like this. For the multinational company, money is money, country boundaries mean little more to them than tax nightmares, or for some a way to game the system, or systems rather.

We've really come to the point where there is no such thing as a country where the company is concerned. For better, or worse, multinational companies have taken on a life of their own supersedes the boundary. If they don't like what one country is doing they file some papers and officially change their domain. It's like how a volcano doesn't care what country it's in. A large eruption sends ashes all over the world. I don't think anyone really knows whether that's a bad thing or a good thing. I think there's good and bad. It's easy to look at the bad of it. Simple-minded and closed-minded aptly describe only look at the bad, or good, of it. On the bad side there's the obvious loss of jobs and upsetting of peoples lives. On the plus side globalization is probably what has kept high energy prices from causing a recession across the entire economy. So the trade-off is some lost jobs, volatility, and uncertainty at the individual level for stability through diversification at the macro level.

From the perspective of the current account I think we've lost control. I don't see how the government can account correctly for such things. I don't think there is a correct way account for the kind of multinational scenario I laid out for you. Actually, it's not a hypothetical scenario, but what's really going on. I worked for a company in which all those things were happening and this was happening within other companies and other industries. Foreign companies are doing these things in the U.S., but we're doing them even more overseas. The global macro picture, thus far seems to be that all boats are being lifted.

I've said previously about the medium- and long-term future of oil that I don't think anyone really knows and you should skeptical of anyone that believes they do know what's in store. Chances are they're trying to sell you something. I think it's the same for understanding international trade. That doesn't mean we shouldn't try to understand it better. But we'll learn a lot more, as soon as we stop thinking we already know everything there is to know and assuming that we're accounting for trade correctly.

I really liked the way that Brad Setser open-mindedly looked at both sides of the puzzle in Directing the perennial dollar horror story. What's interesting to me about his analysis is his background, as having previously been a director in the U.S. Treasury. I'm approaching this topic with logic, deductive reasoning, and my own personal experience having worked in finance for a multinational company, but I don't have the kind of intimate knowledge and understanding of how the deficits are calculated that Brad obviously has. It was nice at least to see that someone with his knowledge is not entirely disagreeing.

I do, however, disagree with Brad on one point. He, not surprisingly, says that trade isn't mismeasured. I don't think that he can know this. He's making an assumption to come to that conclusion, which is that the data is accurate and I think this is probably a faulty assumption.

Consider the number of serious accounting issues we've uncovered just in the U.S. alone. Then consider how many companies didn't get caught. For every company that got caught there are probably many more that didn't get caught. We can't even give our compliance systems or whistle blowers all the credit for the companies that did get caught. The market brought the problems to the surface. If the stock market hadn't crashed suddenly the way it did the companies accounting shenanigans might still not have been exposed. Now extend that out to a global scale. Is it really any secret why so many financial companies are doing business in Bermuda? It's not because of the sun and great beaches, and it's not what Bermuda does for companies, it's what Bermuda doesn't do. It minds it's own business and leaves the companies to their own devices. And that's true of many places around the world. Now you have to consider moral and legal relativity. What's corruption anyway? One reader tells us how incredibly corrupt the U.S. is implying that other comparable countries are less corrupt. I don't believe that. I believe we define corruption differently. In many countries bribing officials is business as usual, but it's a scandal in the U.S. So these multinational companies operate by different rules and different standards in different countries.

The fact is that an increasingly large portion of trade flows through these multinational companies. It's simple to account for an entirely domestic company placing an order for widgets with a Chinese company. It's not so simple when the transaction involves a service provided by a British affiliate of an American company in China. There are just so many ways for the data to become corrupted.

Brad makes this all the more clear how limited and antiquated our governments measuring tools when he says, "Which brings me to the second issue - is the US trade deficit mismeasured? No. The data here is pretty bleep convincing. Look at the gap between inward and outward container traffic in the West Coast ports. 2 out of the 3 inbound containers coming into the US at Long Beach (a huge port) leave the US empty ..."

I'm not criticizing brads analysis. I really appreciate having the perspective of someone inside. It says that, as I have suspected they are justifying the old way of thinking about and calculating trade. It doesn't completely confirm my suspicions, but it sure doesn't do anything to nullify them.

Believe me that I really wouldn't mind being proven wrong. I just want to understand the truth, as much as I can. I want to be right on the markets. If our trade deficit is out of control and we are headed for a recession because of it, then I want to be on the right side of that. As a speculator my pride is derived from being right, and to be right I can't cling stubbornly to false beliefs. I have to be willing to change my mind and admit when I am wrong.

Brad says look at the containers. And my point is that the containers don't tell us what they used to. Look at ExxonMobil. The company is headquartered in Texas, but it pumps oil out of the ground all over the world and has numerous complicated business partnerships with foreign companies and governments, it's the largest refiner in the world, and then it sells it's refined products through 37,000 service stations in 100 countries and six continents. The company reported sales last year of $43 billion. What was the total value of cargo it shipped out of Long Beach to be sold to foreign buyers? Probably zero, or at least an insignificantly small amount of money. What do we really know about the money ExxonMobil makes when it pumps oil in another country, refines it in another country, and sells the refined products in another country? I'll tell you what we know. We know whatever ExxonMobil wants us to know. Scroll through the components of the S&P 500 from this perspective and you'll realize that most of them engage in similarly complex multinational transactions. Just glancing through the first fifty companies I very crudely estimated that only perhaps ten of them would be likely to place actual physical products in containers for shipment out of the U.S. The rest employee large numbers of people in the U.S., but produce and sell their products—both physically tangible and digitally transacted—and services all over the world. These included financial companies that sell insurance and numerous investment products for which the transactions occur almost entirely within computer systems, natural resource companies like Exxon, computer related companies that manufacture overseas and sell overseas, software companies that code in the U.S. then package and sell their products worldwide. Amazon.com for example, generates revenue on books that are printed overseas in international editions, and the author receives royalties on international rights.

When viewed from this perspective it's abundantly clear how little containers and shipping ports can tell us about trade.

But, again appreciate Brad's perspective and the way he assembled links to both sides of the debate. He references Hausmann and Sturzenegger a couple of Harvard Economists who I'm sure completely independently and coincidently recently researched the idea that our trade calculations might be awry and came to the extreme conclusion that we don't have a deficit at all, and actually have a surplus. They call the complexity and digital streams of money I write about dark matter and compare it to dark matter in physics, which cannot be seen, but can be detected by its gravitational pull, etc… The Economist summarized their work and linked to Brad's blog post. So at least this lowly blogger with a meager BA in economics got some third-hand credit for the concept.

posted at 2:11 PM 9 comments   

Wednesday, January 25, 2006

The Matching Game

Match the name with the face:
1) Ben Bernanke, aka Helicopter Ben
2) Nassim Nicholas Taleb, aka The Black Swan
3) Rob Reiner, aka Meathead
4) Ulysses S. Grant, aka Unconditional Surrender
5) Paul Giamatti, aka Miles
6) James Cramer, aka The Weathervane

a)


b)


c)


d)


e)


f)

posted at 5:17 PM 0 comments   

The Dawn of Truth in Trading

I stumbled on this definition of the phrase lick into shape in the Encyclopedia of Word and Phrase Origins.

For at least 10 centuries people believed that bear cubs were born just formless masses of grotesque flesh and that both Mama and Poppa Bear took turns literally licking them into shape. No one debunked this legend for so long because bears usually keep their cubs hidden for a month or so after their birth, and any debunker who ventured into a bear den in search of evidence probably didn't come out to do his debunking. So the story was widely believed—by Pliny, Montaigne, Shakespeare—up until and even after the discovery of America. By the time the marvelous tale was disproved the expression lick into shape, "make ready, make presentable," had gained a permanent place in the language.

It's only been in very recent years that the debunker has been able to debunk market myths.

Before the Internet really took off in the late 90s no were no forums for the skeptical that were freely available to the public. There were just the precursor CompuServe and AOL forums and academic papers beyond the publics reach hidden in the expensive journals. The mainstream media has seldom played the role of skeptic where the markets are concerned. And the mainstream media has confined ideas and thought to within relatively small closed community of persons often without any background in the markets or passion for them.

When the World Wide Web really began to take off the doors flew open. Raging Bull, Silicon Investor, The Motley Fool's and Yahoo's forums were the next step in open forums. But completely free flowing forums tend to be unfocused and contain dubious research.

I credit Victor Niederhoffer and Laurel Kenner for their columns first in Worldly Investor and then on MoneyCentral, as being pioneering skeptics. They were the first to really question Wall Street's many assertions and back up their skepticism with hard data. The data too used to be only available to professionals. Now all sorts of data is freely available.

Remember Worldly Investor? The publisher of this blog, Eric, was a part of that organization. I wrote one article for them before they went offline after the market tanked and suddenly no one had any interest in stocks. So BlogginWallStreet is in a way Worldly reincarnated and my efforts are a modest extension and derivative of Niederhoffer and Kenner's work, which you can find on DailySpeculations.com.

It's interesting to consider how the increase in available data, open debate, and free flowing information might be impacting the markets given that it is still so relatively new. One outcome might be that trends get cut shorter. Traders might be quicker to take the other side. Though thus far that certainly hasn't been the case with commodities and particularly oil. But I think that could be one eventual result. It could also mean less volatility. Though I am uncertain precisely what the ramifications are, I am certain the way we approach the markets are being impacted.

posted at 4:36 PM 0 comments   

I Predict

I predict that if new SEC rules take effect requiring companies to total executive pay and perks, then in time we will begin to see a significant increase in dividends and stock buyback programs. This is because to the executive with large holdings of his own companies stock dividends and buybacks are the same as bonuses, but it wouldn't show up SEC filings as part of their total compensation. See Buybacks and Insider Sales where I discovered a strong correlation between the two, likely as a way for executives to compensate themselves under the table and increase their effective bonuses.

posted at 3:51 PM 4 comments   

Tuesday, January 24, 2006

I'm thankful for...

Yesterday, I took my six-year old son to play hockey. When it was time to leave all he could do was complain about having to go. He didn't appreciate that I took him there. He didn't appreciate what he had until I threatened not to take him back again.

The perma-bears have the mentality of six-year olds. They can't appreciate what they have. Most countries don't have social security systems to lose. Most countries don't have stock markets, commodity markets, and 401k plans to invest in. Most countries don't have home equity to cash out. Most countries don't have trade deficits because their citizens don't have any money to spend on much of anything more than the bare necessities. Some countries have better school test scores because only their most privileged citizens are tested. The U.S. has lower college scores because just about anyone can go to college. The U.S. has one of the highest college participation rates in the world. I'm thankful for having so many opportunities to screw things up and get screwed over.

posted at 8:25 PM 3 comments   

The Whole World's a Bitch Fest

Yes, I'm off my rocker. I'm off my rocker with frustration. These are things I hear day in and day out. Seems like no one has a word good to say. Is it any wonder so many people obsess over so many of these things when it's thrown at them the way it is.

The U.S. is in decline. It's going the way of Greece and Rome.
Capitalism is a failed experiment.
Our trade deficit is too large.
Our budget deficit is too large.
Our debt is too large.
We'll all be sharecroppers to the rest of the world because we owe too much to foreigners.
We don't save enough.
We spend too much and buy too many frivolous things.
We're cashing out too much equity from our homes.
The dollar is doomed as soon as China and Japan stop buying our bonds.
From one year to the next uncontrollable deflation then rampant inflation are inevitable.
There's too much crime.
There's too much corporate corruption.
Our corporate leaders make too much money.
We're too fat.
We're stupid. Our kids get stupider with every generation.
We can't invent anything anymore.
No one wants to buy our stuff.
The rest of the world has passed us up and is leaving us behind.
China and India are the best places to invest your money.
We've seen the end of cheap energy.
Commodities are the greatest investment in the world.
Stocks stink.
Put 25% of your money overseas and half that in emerging markets.
Buy gold. It's the only thing that will be of value when our economy collapses.
Healthcare costs too much.
Education inflation is out of control.
Social Security is unsalvageable.
Too many men are dying in Iraq and Afghanistan.
The government is spying too much.
The government isn't doing enough to stop terrorism.
Companies don't pay out enough of their profits.
Corporate boards are corrupt.
Companies aren't transparent enough.
The Fed isn't transparent enough.
Bernanke is too focused on inflation targeting.
Bernanke is too focused on deflation.
The money supply's too big.
Foreigners are buying up all our land, which I don't know why they'd want it anyway since our corporations are polluting it to death.

What do any of these things matter anyway when we're all about to die from bird flu, WWIII with China, Global Warming, or an asteroid, whichever comes first. And if the first one that happens doesn't get you, then one of the others will finish you off. We might as well go ahead and blow ourselves up and get it over with since we're all a bunch of heathen atheists anyway. Just launch the missiles straight up in the air and watch 'em come back down. It will be quite a show. The expatriate perma-bears can watch our self inflicted Armageddon on Al Jazeera while they gloat and cheer over our self-destruction. It's too bad though that they won't be able to cash in on their shorts since the exchanges will be gone.

My biggest complaint is that we complain too much. We just bitch and moan about everything. We bitch about the destruction of our planet. We bitch about our country. I was just working in the local Borders café and the mayor of the town next door was sitting nearby bitching to some kind of planner person about whatever there is to bitch about in a small town. People all across the country are bitching about their towns and schools. There's no end to the bitching.

How can I complain when I made it to Arapahoe Basin last Friday on the first day they opened up the famous East Wall for an afternoon of untracked bottomless powder skiing above the treeline? About the only other thing I have to bitch about is that neither the Colts nor the Broncos made it to the SuperBowl.

posted at 7:34 PM 3 comments   

The Oxy Moron

A reader asks me what I think of a Marc Faber piece Our Less Than Brave New World! posted in the comments.

He's an oxy moron, which is the most moronic kind of moron. What is a doomed developed society? It implies that it will soon return to the previous undeveloped state whence it came. I use 'whence' so as not to seem too uncouth in going up against Faber's use of 'from on high', 'genteel', and elitist name-dropping. Where does a developed society have to fall, but down to the other less developed societies. Betting against an entire society, especially the most powerful one in the history of the world, is extreme contrarianism. By every single measure the U.S. is on the rise, not decline. Everyone else in the world can see it. That's why they want to invest here. This is the demesne of the doomsayer that prefers a more opaque society so that they may acquire their wealth and power, at others expense, by historically customary means.

Story: A few years ago I was invited to attend an event of intellectual thinkers in Aspen known as The Eris Society, which mainly revolves around an annual event with several days of speakers and dinners. I'm just a nobody who grew up in rural Indiana, mind you, so at the time I was a bit awed by this sort of experience. Bill Bonner, who owns Agora publishing, which puts out The Daily, was one of the speakers. The attendees were predominantly libertarians, Randians, and expatriate wannabes. I liked a line in a documentary about punk rock in which Henry Rollins, originally of the punk band Black Flag, said that the punk movement was supposed to be about open-mindedness and doing whatever you want, but in actuality the punk culture was extremely closed-minded and closed to anything new and experimental. Once the culture was well established it became very confining. Well looking back on it the group in Aspen wasn't nearly as open minded, as they preferred to think of themselves either.

I don't know how many times I heard people complain that no one was doing anything to seriously support their cause, though I'm not sure they even knew what that was. The funniest thing, in hindsight, was when I was seated next to an older fellow at dinner one night who complained the entire time. He was genuinely angry at the hosts. It seems he had sold everything and expatriated to a small country in South America. He was ticked off because none of the people there who had long been preaching about doing the same thing had actually made the jump. He was the only one to actually do it. Everyone else was living in big houses in places like Aspen. Actually, Bonner was a part-time expatriate having a villa in France. And this guy was a hypocrite because from what I could gather he was spending as much time in the U.S. as he could get away with, but not being a citizen wasn't paying anything other than sales taxes in the U.S. Basically, he was dodging taxes. But he couldn't understand why none of these other people there had made the leap. After all there were several people in attendance who had written books on the subject.

Imagine that. Someone would write a book about something they don't really believe in? The Daily Reckoning writers are a who's who list of doomsayers and fear mongers. The Daily Reckoning doesn't hide it. On one page of the site they proudly display this quote by the New York Times, "The Daily Reckoning is a freewheeling Web site for libertarians, gold bugs and doom enthusiasts of every stripe." Faber lives in Hong Kong. Of course he wants you to invest overseas. He has no interest in the success of the U.S. There's a lot of money to be made from scaring people. They cater to the gullible. I sometimes read it for a laugh, or inspiration of the opposite kind, but I don't take much of anything the authors say seriously.

But I'm not pitting myself against that crowd per se. I could tell more stories about the way some pros pit themselves against each other to drum up publicity. It's commonplace. It's all a game. Seriously. It's marketing personas and brands. Nothing more. Everyone in the game has a persona that they create in order to capture a following of people. For me, I just decided what better persona to appeal to average people in a blog than my real one, a country kid grows up to battle wits with the big boys, pull back the curtains, and bring some truth to traders, a persona I know I can feel good about for years to come because I am just an average guy.

posted at 2:13 PM 4 comments   

Putting Executive Pay in Perspective

I'm often asked what I think about executive pay. The consensus is that executive pay is too high. What good would it do you to have me tow the line? I'm not an activist. And I'm not going to do someone else's activism for them. What is too high anyway? That's a subjective statement. Don't take me wrong; you'll never hear me defend excessive corporate greed. But, even 'excessive' is a subjective term.

If you want my opinion I'll give it, for what it's worth. I think that complaining about high executive pay without backing up complaints with evidence to support a specific problem related to it is a socialist mantra and I don't like it. I don't want anyone telling me that I can't make more than a specific amount of money. Unlimited income potential is probably the single greatest motivator that this country has.

And the term public company does not mean that a company is owned by the public and reports to the public, as has been implied. Rather it means that anyone can buy shares in the company so long as someone else is willing to sell their shares in the open market. We say all the time that companies answer to their shareholders. Well not really. There are certain things that a company has to go to the board for permission, which consists partly of shareholder representatives, but generally speaking a companies executives are perfectly free to screw the company up. Shareholders may then, after the fact, let it be known that they are dissatisfied either through their representatives or by selling their shares in the open market and disassociating themselves with the company.

To put some more perspective on this somewhat thorny issue, which I think is much less of an issue than it has been made out to be, consider however unlikely you are given the opportunity to make corporate CEO sized pay. And there may very well be some readers making just that. First off, many people, most people would not be willing to step into the typical CEOs shoes. Let's face facts, most CEOs can't be what they are and be good family men, yet they are expected to have pictures of their perfect families on their desks demonstrating that they understand the plights of their employees, work/life balance, and all that mumbo jumbo. It's a façade. There kids are privileged to have just about anything they want, except a dad. They put on an air of normalcy, but under the surface you'd find among very many of them drinking problems, problems with the opposite sex, and the coke habit that keeps them going 18 of 24.

The truth is that it's easy for everyone else to say that they would trade lives, but the reality is that they aside from the money, most of their lives, in my opinion, suck. And most people would drop out of the running long before they get to that level because for many of them getting there meant that the company came before everything else every step of the way up even when they weren't making enough money to justify the obsession. Consequently, there really aren't as many people capable and willing to do that job, as we would like to think.

But let's just say hypothetically you could get there without making any tradeoffs. Who wouldn't take the money under those circumstances? And once you got it, would it then be too much? Even the anti capitalist activists would take the money so they could play socialist dictator and reallocate it to their favorite causes. Most of us would do the same things as any other CEO, buy big homes, buy a couple of vacation homes, etc… Don't say you wouldn't. We'll all know you're a liar if you do. All of a sudden CEOs don't make too much money.

Another truth is that most CEOs don't just suddenly make many millions. They got there incrementally, except in a rare extreme cases. Consider that a person who starts a business of their own, a private business with several hundred employees, gets to keep all of the profits and do whatever they want with the money. They have no shareholders yapping at them. They can make a lot of money without any of the hassle. That's reality and it's not uncommon. A person in that position might make quite a bit more money than the average CEO of a small to medium sized public company. That's the baseline. CEOs of public companies need to make as much as they can make running private companies, otherwise there'd be little reason to take a company public in the first place. Consider why people start companies in the first place. To, hopefully, make a lot of money. When they go public it's not just to grow the company, it's to grow the company so they can make more money.

I also think that most high-level corporate executives are greedy slime balls who'd cheat and screw just about anyone over that got in their way. Many are egomaniacs and habitual liars with psychopathic tendencies who are all too often willing to justify doing bad things, whatever those things may be. The upper ranks of corporate America are filled with a lot of bad people. But you don't have to look too hard to find sick, twisted, and demented parents with alcohol and drug problems at any rank of society.

But that's all just my opinion. Now for some facts. There are mechanisms in place to measure excessive corporate greed. The success of a company is related to how well it manages its revenues and reinvests profits. Salaries come out of sales. They take away from profits, which leaves less money to reinvest or return to shareholders. Although it might not seem to be the case, there's an force gravitating towards equilibrium that constrains truly excessive executive pay. It's called competition. If a company gives too much of its profits to executives it won't compete well with companies that are reinvesting their profits. Chances are some company that's managing its money better will buy up the inefficient company and fire the overly greedy executives. Obviously, these things happen after the fact, happen slowly, and sometimes never happen. So we are exposed to a lot of injustice along the way.

It's also important have some rational perspective on the issue. To say that executive pay is too much is a subjective statement. Transparency and data collection on executive pay is relatively new. Time series data is not readily available going back very far. Outside the U.S. data is virtually nonexistent, just as foreign executives would like to keep it. Consequently, it's difficult to put executive pay in the proper perspective. Important questions remain unanswered. Is executive pay rising? No doubt! But a better question is whether or not it's rising as a percentage of revenues. How would that compare to previous periods going all the way back to say the 1920s? It may actually be the case that CEOs were paid more before transparency became standard.

How efficiently do American companies operate compared to their foreign counterparts? You know I'm about to wave the flag. Darn right I am, and with good reason. U.S. companies flat out kick their foreign competitors buts when it comes to operating efficiently. U.S companies have better margins at every point on the balance sheet despite the fact that we supposedly pay our executives outrageous sums of money. Ironically, Microsoft, ran by the most widely targeted CEOs, maintains one of the best margins of any major company, foreign or domestic.

Of the 100 largest companies by market capitalization that trade shares on U.S. exchanges roughly half (55) are U.S. based companies and half (45) foreign companies trading as ADRs trading on either the NYSE or the Nasdaq stock markets. The U.S. companies have a gross margin 11% greater than comparably sized foreign companies, pre-tax margin 15% greater, and a 21% larger overall net profit margin. In other words, U.S. companies pay out substantially less to produce their goods and services overall and therefore they have more left over to reinvest.

My belief is executives of comparably sized foreign companies are actually paid more than U.S. executives, because they can without anyone knowing what they make. There's no transparency. The U.S. is by far the most transparent country in the world. No other country even comes close. Yet as soon as we have the information what do we do with it? We use it to lie with statistics. We say that U.S. executives are overpaid and Americans are all greedy capitalists. The French in particular like to point this out. But they don't know what their own greedy executives are making and they are not free enough to find out, so they express their frustrations through revolution by blowing up thousands of cars.

Just because we know how much our executives make, doesn't mean they make more than other executives around the world. The opposite is probably true if the relative inefficiency suggested in the balance sheets is any indication.

In the end profits are all that really matter. Individually, some companies operate on slim margins, as the nature of their business dictates. Wal-Mart has narrower margins than Target, but clearly Wal-Mart is the more successful organization. But the fact that average profit margins are much higher in the U.S. than elsewhere suggests that we're doing something right.

But how should this impact your trading? I heard an analyst come on TV this morning saying what a great company AIG is. It's cool to be contrarian these days. The way I look at is simple. There are thousands of stocks to choose from. Maybe AIG is oversold, maybe not. I'm not going to cry over a lost opportunity if it goes up say 50% in the next six months. I'd rather not go there. The fact that AMD has performed better than Intel probably has nothing to do with what Intel pays its executives and everything to do with the fact that everyone knows AMD chips are cheaper and the company is stealing away market share from Intel.

But company executives do often tarnish the reputations of the organizations they represent. Oracle came off looking pretty bad in the PeopleSoft deal thanks to Ellison, who does nothing to hide his hubris and egomania, which I think that rubs investors the wrong way. If the companies CEO is in the spotlight, that's usually not a good thing. Overstock.com's Patrick Byrne isn't doing his companies stock any favors with his lunatic fringe rants. Neither has Buffett's down with the dollar drivel done Berkshire Hathaway much good. By comparison you hardly here a peep out of Adobe's executives and the stock has done much better than Oracle. I just stay away from those noisy stocks. They are volatile, which equates to unknown risk that I don't need to take. I can find better risk reward ratios elsewhere.

posted at 12:03 PM 8 comments   

Monday, January 23, 2006

Financial Sector False Summits

A reader asks what I see ahead for the financial companies. This person says that the major financials have "arguably gone as far as they can, in many cases" referring to innovation, niche products, deregulation, and efficiency. I'll take the other side of that argument. I think we've only seen a false summit. Not that the industry will deregulate more, but that deregulation continues to be a catalyst for the other growth factors.

I believe that financial services will continue to grow as a major export for the U.S. Japan's recent stock market problems illustrate the doors that are open around the world for companies that can do it right. Consider that few other countries have even gotten to the point that such problems can show themselves. Many other countries have serious barriers to building out stable financial systems. The doors aren't flying open, but the trend is for foreign financial institutions to work with or compete directly with U.S. financial companies. I expect that trend to grow, a lot.

For those of you inclined to invest overseas, remember that there are many companies here in the U.S. that derive significant revenues from overseas. These companies are often globally diverse, and therefore investing in them automatically diversifies your portfolio without some of the risk and unknowns that come with investing in foreign companies. And you can feel good about supporting and promoting your own country and your currency.

The thing about financial companies is that they can innovate and adapt quickly because they don't have the kinds of mechanical barriers to change or labor issues that Ford and GM are up against.

Having worked on financial / insurance systems in my previous career I can say in the past the old guard financial companies struggled with innovation because there systems were too rigid and mechanical. Flexibility and efficiency in data management is key. A typical situation is that upstart financial company (A) comes out with a hot new innovative niche product. Behemoth financial company (B) is late to the game because they can't figure out how to process the data from this new product with their old systems. There choice is to build an entirely separate system to handle the new products data or trash their old systems.

People outside of the industry probably don't realize that the biggest thing holding back financial companies from offering new products and services is there ability to handle the data related to those products. When I was working on financial systems I routinely ran up against code in processing streams written in antiquated programming and report writing languages. They amounted to bottlenecks in the system. When the company wanted to add a new product it would always come back to, "Ok, but then we've got to update all this other code over here too and Sally retired last year and she was the only one left that knew that language and what those systems do." Many other people were close on Sally's heals. They were more concerned with making it through to their retirement date and saw new more efficient systems as a threat to their jobs. So no one ever seriously considered the possibility of scrapping the clogged pipe and laying new pipe using more modern programming techniques and tools. And they wouldn't have known how if they did. So what happens is that these companies fall behind. The newer companies build out systems designed to accommodate innovation, at least for the time being. When they make a lot of money selling innovative products they use some of the profits to acquire the assets of antiquated companies. When they do that they pump the data out of the old systems and into their own. Then they just shut off the old systems. And, of course, lay off all the people that were protecting those old systems.

It's difficult for car companies to do this because instead of leaving behind a bunch of lines of code and an old mainframe their leaving behind large factories and production capacity worth billions. Consequently, companies driven by modern electronic transactions can innovate faster than those driven by mechanical systems.

The U.S. and a few European countries lead the world in the ability to safely manage financial transactions. Data theft is a serious problem, but that's not relevant to the argument because realistically no one else's systems are any better, everyone else's systems are modeled after ours, and we're not turning back. Financial services are a growing export. Whether you agree with it or not our stocks are an export. Stocks represent fractional ownership in a company and its assets. Essentially when a foreigner buys stock in a U.S. company he's buying part of a company.

Other countries aren't going to wait say five years for their own companies to step up and offer products and services when a U.S. company can offer the same thing right now. Guess what they're telling foreigners. That instead of opening a savings account paying a paltry 4% interest they can lend their money to an American company and get double that or they can own a piece of an American company and get a profit of perhaps 10%. It's very likely that as American financial companies spread throughout interest in U.S. stocks and bonds will also grow.

As far as new products go, I don't have a crystal ball, but I think it's like climbing a large hill. Maybe some of you have experienced this feeling. You've been climbing for a while and you think that you must be near the top, you see a leveling off above you and think that must be the summit, but when you get there you see that you still aren't looking over the other side, and this happens several times before you reach the true peak. These are called false summits, as is mentioned numerous times in this description of a climb near my home. I believe that when we think there can't possibly be another way to innovate or another product we could possibly want, we will still be far from the end of innovation.

The growth that we've seen among the global financial companies over the past 20 years I believe will continue indefinitely and now I think that our major exchanges (CME, CBOT, NYSE, etc…) are just now on the same threshold. The stocks aren't cheap, but I think that twenty years from now we'll see that the same trend, as we've seen in financial stocks, false summit after false summit.

posted at 1:20 PM 4 comments   

Friday, January 20, 2006

Shameless Self Promotion

I guess there was some popup ad on the site that annoyed at least one reader and my publisher took it down. I didn't see it myself. Readers please realize that I don't do this for charity. This is my job and I rely on a paycheck just as most of you do. I really don't know much of anything about the finances and marketing of running this site. I just write and Eric sends me a check every month. It's that simple. What I do know is that I love doing this blog and want to keep on doing it indefinitely. For that to happen Eric has to find ways to make this site profitable enough to keep paying me. I don't even know if he's break even or not, but I doubt it. I know that when we started this it was an investment on his part.

I've invested in it too. I written an invest letter (The Market Spectator) every week for the past eight months where I take many of the ideas I've generated writing this blog and turn them into more specific ways to trade the markets. So far that has worked very well, if I do say so myself, and I do. It goes out to a modest number of subscribers and to the best of my knowledge that thus far has served to offset what I get paid for writing every day. I know Eric's in the middle of working on improving the site, it's distribution system, and the subscription process. So I'm not sure if you would run into any troubles signing up for it. But if you want to try it you can email me at mark@blogginwallstreet.com or Eric at elevitt@blogginwallstreet.com and we'll get you set up. It's basically more of the same as you get here, only for a modest fee you get specific trading ideas, which I track in model portfolios. Actually, I take the realism a step further and track all the ideas in model accounts so there can be no doubt as to the results.

In order for this site to be profitable Eric is going to bring in revenue from all the usual ways that web sites can. Obviously, pop ups aren't to popular with the readers. In the NPR tradition, if you like the blog, then I call on you to help me keep it going. Otherwise, I'll have to go be a ski lift operator, or something, and rent out rooms in my house. You can help by referring it to your friends (click on the email icon at the bottom of any post), taking a few seconds to click on the ads, and registering your email address in the box at the top right so we can send you stuff you probably don't really want, but that only takes you a second to delete.

Also, I do love getting questions and comments from readers. They often help me to think about the markets in ways I wouldn't have otherwise regardless of whether I agree or not. I try and respond directly, in the comments, or in new posts if I think the information is beneficial to all.

Thank you

posted at 1:24 PM 2 comments   

Observation

If it's true that Scrushy paid for favorable press, then I think it's likely that's not all he paid for. According to the article I linked to yesterday they account for payments of around $40k and supposedly he was committed to pay another $150k. Why am I not surprised that so many supposedly good people readily took such small sums of money to help him get off the hook? And it was peanuts to Scrushy, especially when he was about to lose everything.

The only reason this information is coming to light is because someone is saying he didn't pay them everything they were owed. If not for that we would never know. Again assuming it's true, and I believe it is, then it's likely there were other transactions that have not came to light.

Put yourself in Scrushy's shoes for a moment. The CEOs of other corrupt companies were heading off to prison, losing everything. Your direct reports have already been found guilty. You're a goner. Do you admit the crime and do the time? If you’re a dishonest crook you don't. Do you run? Or do you buy your way out of trouble? If you run, chances are you'll get caught and for sure you'll be found guilty. Money is no object. You're about to lose it all anyway. Buying an acquittal, stacking the deck, I'm thinking of the movie Runaway Jury now, these are the obvious things to do. You'd do whatever you can get away with that would help you stay out of jail.

posted at 12:56 PM 0 comments   

Tricks of the Trade

I'm asking my smart wife last night how is it that every single caller to the Mad Money show absolutely loves Cramer and always cooperatively starts their call with a near infinite number of twists on the worn out booyah? I say that on most call in shows the callers aren't so conveniently cooperative. From time to time I expect to hear someone sneak in a criticism. But that never happens on Mad Money. She says the calls are prerecorded. She used to work with someone whose now ex husband was a morning radio show host. Her coworker told her that she'd be amazed at how much stuff seems live that isn't.

Then it clicked. They take the calls, prompt the caller on what to say so that all the calls are all in the exact same format (ie booyah, then a question). The question is always so generic, such as "What do you think about Intel?" so that the question could be used on any day. Jim's on the line responding live. They record the caller and Jim on separate tracks. Next they pick the most agreeable calls and weed out the idiots. They script and teleprompt, refining the commentary. Then they play back the recorded booyahs and questions and Jim responds, I'd guess reading teleprompters as needed and suspect all those monitors facing away from the camera are actually prompters so that he can wander around and pretend to be looking at stock charts and information, as if he actually has time to do that. The result is that it appear as if he were talking to the caller for the first time. When they get to the lightning round he tells us, "Just to be clear I do not know the callers, or there questions ahead of time.", which would be only a stretch of the truth since he didn't know them the first time he took the calls.

Notice how they never get criticized, they never have any jumps in the tape, and they never have to hang up or bleep out anyone? The final taping always goes perfectly smooth and polished. How else would that be possible?

posted at 12:33 PM 7 comments   

The Financial Sector Myth

Many of the market's common clichés are meaningless gibberish. There's also no end to trading thumb rules. As I've said investing is trading, the trades are just longer is all. Don't believe that? Then why are 'investors' constantly told what sectors, geography, and market caps they should and shouldn't be in? That's market timing. That's trading. One thumb rule we hear all the time is not to buy financials in a rising interest rate environment. And that rule seems to be true, but it's applied incorrectly. Financial stocks are no longer (if they ever were) sensitive to minor gyrations in interest rates.

In the chart below I've taken the average price of a dozen major financial companies and compared that to the 2-year Treasury note. What is readily apparent is that in the past 25 years there hasn't hardly been a bad time to buy financial stocks. Even if you bought them at the peak of the stock bubble you've made back your losses plus a return that's nothing to write home about, but better than a money market.

In the second chart I focus in on the ten-year period after the mid 70s. There you can see that at the extreme interest rates of the day financial stocks did not do well until interest rates started to fall. I suspect this is the source of the interest rate / financial stock myth / legend. Rules of thumb are supposed to be rough and generalizations.

In this case there's some truth to the rule if you take it much more generally than it normally is. The bigger truth is that we've been in a falling interest rate environment for about the past 25 years and that's been great for financial companies, which seems backwards. But there's an equilibrium point (not sure exactly where it is) in which profits are maximized. From the perspective of revenues, profit margins, and net profits financial companies are like any widget maker. People and companies want to borrow more money when the cost of borrowing is low. Financial companies sell more loans. Revenues, which for financial companies are the stream of repayments plus interest, go up. It's not true that higher margins are always better. The higher margins are, the fewer willing buyers (in this case borrowers), there are.

In theory their net profit comes from the difference between their borrowing costs and the interest rates they charge, which is why the inverted yield curve has some investors worried, and it's great fodder for the pessimists. But in practice as borrowing has increased the major financial companies have increasingly diversified their revenue sources both in terms of products offered and geographically. Consequently, the financial companies have become relatively insensitive to interest fluctuations and the only noteworthy relationship is that as the average interest rate, the cost of borrowing, has gradually fallen, the financial companies have responded by innovating, delivering niche products, and tearing down barriers to entry, and removing unnecessary inefficiencies. And this has brought multiplicative growth to the financial companies and their stocks.

The tickers for the stocks I used to take an average of the adjusted prices are; C, BAC, DB, JPM, MER, GS, MS, LEH, WFC, WB, AXP, and NCC.

posted at 12:24 PM 1 comments   

POPUP HAS BEEN REMOVED

posted at 9:19 AM 1 comments   

Thursday, January 19, 2006

Scrushy Caught With Hand in Cookie Jar

I love this stuff. I don't love that it goes on, but I love that a bit of the truth is coming out. Does this really surprise anyone?

Writer: Scrushy Bought Sympathetic Stories
Throughout the six-month trial that led to Richard Scrushy's acquittal in the $2.7 billion fraud at HealthSouth Corp., a small, influential newspaper consistently printed articles sympathetic to the defense of the fired CEO.

Audry Lewis, the author of those stories in The Birmingham Times, the city's oldest black-owned paper, now says she was secretly working on behalf of Scrushy, who she says paid her $11,000 through a public relations firm and typically read her articles before publication.

posted at 3:55 PM 2 comments   

Oil Services

If basic economics says that high oil prices will induce oil companies to produce more oil then it stands to reason, as a reader astutely points out, that oil service companies should have more business and do well. It seems perfectly logical to me. However, investors aren't always logical and in this case the greater truth is that the oil services sector goes wherever oil prices go. The average correlation between five top oil service companies and oil prices is +0.68. The only notable exception in the past 20 years occurred between 1997 and 1998, and I'd say that probably had more to do with excessive demand for the S&P 500 and all stocks causing the oil services companies to move opposite the price of oil temporarily. If you remove those years the correlation jumps to +0.80.

What does this mean? It means in order to predict the future price of oil services stocks you have to be able to predict the price of oil, which becomes increasingly dicey the further you go out. All things being equal, assuming some rationality returns to the markets and nothing truly terrible happens, prices should fall. But the risk reward ratio for oil and oil service stocks in my opinion is ugly, because it's impossible to know all the risks and the risks can change quickly and dramatically. If you understand those risks then go for it. Otherwise, you're better off somewhere else. To me it's like trying to figure out what the avalanche risk is skiing out in the backcountry. If the risk is high, then you shouldn't be out there. If you don't know what the risk is, then that's another reason not to be out there. The same is true with the markets.

posted at 3:33 PM 0 comments   

Wednesday, January 18, 2006

Wal-Mart vs. that other mart

I sure don't care for some of Wal-Mart's more aggressive business tactics, and I prefer to shop at Target when I have to shop, but it's no wonder at all why Wal-Mart has an annual revenue six times greater, when I go into my local Target the other day and the first thing I see is bikinis and lots of them. Don't take me wrong. I like bikinis, but it's the middle of January and, if you don't already know, I live just a few miles from the top of the continental divide. The ice doesn't come off nearby Lake Dillon until late April / early May. I could be wrong. Perhaps shoppers are getting a head start on preparing for Copper Mountain's Eenie Weenie Bikini Contest.

Target's bikinis—prominently displayed in the section you come to—as I see it, amount to nothing more than wasted floor space and lost revenue. If Target had any common sense at all the first thing I'd see when I walked in was cold weather clothes like ski coats and pants. No doubt they'd sell a heck-of-a lot more of those than bikinis up here, especially to vacationers from warmer climes that show up under dressed.

It doesn't take a rocket scientist to figure out that if you sell the stuff people want to buy and adjust your inventory to the demographics, then you can have a lot more stores and sell a lot more stuff in per store. Wal-Mart has more than 5,400 stores worldwide, compared to Target's 1,400.

posted at 7:21 PM 3 comments   

One for the Gipper

Tokyo's exchange flunks another test
In ditching brokers for computers, the Tokyo Stock Exchange has faced a string of embarrassing glitches and shutdowns

The latest misstep came Wednesday, as software programs in the world's second-biggest stock market were unable to handle increase volumes or recognize trades that were impossible to execute.

These are problems we haven't seen, for the most part, on U.S. exchanges since 1987, almost 20 years ago. If Japan hasn't got it right yet with its supposedly well-established markets and the numerous world-leading companies and behemoth brands trading on its exchanges, how then do you think exchanges in China and India stack up? These are the things that the stock brokers don't bother tell us when they come on TV saying everyone in America should have as much as 25% of their retirement savings invested internationally.

In the past few years a heck of a lot of money has been funneled into international equity funds, much more than has gone into domestic funds. Honestly, I like seeing these problems emerge sooner rather than later. For one it means they'll have to fix the problems and the world's markets will improve. But most all, we compete for assets and I wouldn't at all mind seeing some of the money we've sent overseas come back, and more foreigners sending their money here if people get a little nervous about their money over there. And they should be. That would be good for the dollar, growth, productivity, and stocks.

It seems that rooting for the home team has recently become dirty and politically incorrect. It's been associated with ignorant protectionism. A couple of years ago our business leaders took a public relations beating on the issues of globalization, outsourcing, and sending jobs over seas when our own job growth was stagnate and everyone was crying stagflation. Somehow they've managed to turn that around on us to where we're starting to think it's not ok to say hooray for our side. It's a bunch hooey I tell you. There's a big difference between aggressively competing and protectionism. Having the best financial markets in the world and attracting foreign capital is good for our country, contrary to what Warren Buffett would have us believe.

posted at 2:25 PM 1 comments   

Observations

It just seemed funny to me that the mission to send some space thingy to Pluto was scrapped due to wind. We can send something all the way to freakin' Pluto, which will take 10 years traveling at an incredible 27,000 MPH, or a few billion miles away, but we have t