Saturday, May 29, 2010

The BP Oil Spill

The Memorial Day weekend is the traditional start of the summer season in America. People's thoughts turn to summer travel and vacations, many of them involving travel by car.

I hope that while people are taking that trip with their car, they pause to think of the BP oil well blowout and the environmental disaster that may be occuring now in the Gulf of Mexico. And don't forget the 11 lives that were lost when the oil rig exploded.

This is just a small part of the cost that is being paid for America's continuing addiction to oil, because of the lifestyle it chooses (suburban living where a vehicle is a necessity).

Here in the United States, we like to "outsource" the extraction of oil supply to anyone but ourselves. Americans don't particularly want to see the results of our own demand for liquid fuels, the pull from our 300 million vehicles and our four million miles of highway.

In fact, we get pissed off when some other nation even dares to begin to emulate our lifestyle. "How dare China and those other emerging countries begin to buy cars and use oil...the oil is all ours..."

Americans especially prefer that someone else - some no-name foreign country far away - despoil their own landscape and environment, so that they can send us oil. "And it better be cheap oil too!"

The United States has done quite a good job over the past several decades to make sure that's happened. Just look at the amount of oil we've imported from the Mideast, Africa, Canada and Mexico - it has skyrocketed.

This background is helpful in framing the BP well blowout at a depth of 5000 feet in the Gulf of Mexico. The reality of oil demand has now touched home. In fact, it is washing up on our shoreline.

And don't look for a solution to America's oil problem coming out of Washington DC any time soon. The politicians have been trying only token solutions - which sound good, but do nothing - for the last 40 years.

Just look at the so-called stimulus package which set aside $8 billion for high-speed rail systems. What a joke! We'd need at least $800 billion to fully restore the rail system in this country. If you want to see a country building a nationwide high-speed rail system, look no further than what China is doing.

America and its politicians need to confront the oil issue on a time and money scale that will be meaningful, not a token response - "Let's ban offshore drilling." I wouldn't hold my breath, however.

Saturday, May 22, 2010

Wall Street Fix WishList

Forget all the spin being put forth by the media that this week's stock market selloff was due to the "tough" Wall Street reform measures soon to be enacted into law by Congress.

Hogwash! Wall Street has invested their money wisely into Congress and the so-called reforms amount to nothing. I won't bore you with the details, but if I had to rate the "reform" legislation coming out of Congress, where a 10 is tough and a 1 is soft, I would it a 0.5.

Put simply, it will be business as usual for "da boyz" and they will be able to continue doing as they please, including the raiding of the US taxpayers' piggy bank.

Here are few items on my "wish list" for Wall Street reform:

First, eliminate bank/investment firm lobbying in Washington. As it stands now, this Congress (both parties) is the "best" Congress Wall Street money can and does buy.

Second, turn the investment houses like Goldman Sachs from "banks" back into partnerships. These firms used to be partnerships where the partners all have unlimited personal liability for the losses. This would remove the "casino metality" from Wall Street, which is currently gambling with other people's (including taxpayers money).

Third, return to the specialist system. This would elimate much of the ultra-fast trading which occurs on Wall Street. This would bring back the human element and would help us avoid a meltdown caused by computer trading programs run amok.

Fourth, elimate the stock exchanges being for-profit. The exchanges have forgotten about the individual investor. Instead, they are chasing fees from high frequency traders and hedge funds.

Fifth and my favorite, FIX the financial media. Every day on Bubblevision (CNBC), one can see the same terrible, and dangerous to one's wealth, advice given out by the same old faces who have been wrong about the financial markets for years.

Yet, there is NEVER any mention of the pundit's terrible track record. All financial media should be required to disclose to the public the pundit's previous market forecasts, recommendations,and commentary.

Just once, I would like to see a Bubblevision host say to some pundit "Excuse me, Mr. Smith, but why should anyone listen to your recommendations when, if they followed your advice over the past 5 years, they would lost 25% of their money?"

I know - it will never happen - but this is a wishlist!

By the way, for those of you keeping score something remarkable happened in the first quarter of 2010. Four big banks - Bank of America, Citigroup, JPMorgan Chase and Goldman Sachs - were perfect.

Each firm made money trading the market on EACH of the 61 trading days during the quarter and Goldman Sachs made at least $100 million on 35 days during the quarter. No wonder Wall Street lobbied Congress so hard not change the "rules" of this very profitable game!

Saturday, May 15, 2010

A Lesson in Stock Market Prudence

Prudence can sometimes seem rather imprudent in a runaway stock bull market. At times, prudence feels like it's downright stupid. But it's not!

The career of famed value investor and fund manager Jean-Marie Eveillard provides insight into this. He exercised prudence when share prices were soaring and exercised prudence long enough to see his investments bear fruit.

During Mr. Eveillard's first decade at the helm of the First Eagle Global Fund (formerly known as the Sogen International Fund), it easily outdistanced every applicable benchmark. From the fund's inception in November 1986 through March 31, 1997, First Eagle Global Fund delivered a total return of 236%, compared to only 133% for the MSCI World Index.

At that point, Mr. Eveillard became nervous about the stock market. He was concerned that so many flimsy tech stocks were soaring for no good reason, and that compelling values were becoming almost impossible to find.

Eveillard responded to these conditions by raising the cash level in his fund and also raising his exposure to gold. As a result of his caution, his fund lagged far behind every relevant benchmark during the next three years as the stock market (led by tech stocks) moved into bubble territory.

Between March 1997 and March 2000, First Eagle Global posted a return of only 28%. This was barely one-third the 75% return of the MSCI World Index. This number looked even more pathetic alongside a Tripling of the NASDAQ index during that same time frame!

Eveillard was unflappable. He refused to embrace the tech stock mania being spouted by CNBC. He maintained the value-based investment process that he had always pursued. He stated at that time, "I would rather lose half of our shareholders than half of our shareholders' money."

Mr. Eveillard proved to be prescient because that it exactly what happened. Investors, mesmerized by tech stocks, left his fund in droves. He lost nearly half of the shareholders and the fund nearly closed.

But he did NOT lose half of his shareholders' money. It turned out that Mr. Eveillard's prudence was, in fact, prudent. Shareholders who stuck by him have been rewarded handsomely.

In the 10 years from March 31, 2000 to March 31, 2010, the S&P 500 index and the MSCI EAFE Index both produced a negative total return. Over the same timeframe, the First Eagle Global Fund has more than Tripled!

The bottom line for investors is that prudence sometimes seems imprudent. But it never is.

Saturday, May 8, 2010

Bad Week for Wall Street

This past Thursday the Dow Jones Industrial Average experienced its largest intra-day decline since the stock market crash of 1987. The index fell nearly 1,000 points, nearly 10 percent, as about $1 trillion in market value briefly got wiped out.

By the end of the day, the loss was just under 347 points or 3.2 percent. What happened? According to media reports, it was all triggered by a trader entering a wrong number on a trade (billion instead of million).

This is what I was trying to warn investors about in last week's article!

Wall Street has become a casino with its entire focus on the very short-term. Each and every day, most of the stock trading volume (which has been dangerously very light for months) done on Wall Street comes from program trading and fast trading.

These are computerized programs designed to make many trades every day, making a little profit each time. The stock market has become susceptible to runaway feedback loops that swing prices and trigger buy and sell decisions automatically, with no human input.

These automated trading systems have nearly strangled the providers of liquidity in the past – the market makers and the specialists. When the stock market tanked in the past, these people would provide liquidity – that is, they would take the other side of the trade and buy stocks to support the market.

This is no longer happening, thanks to the robots and greedy Wall Street firms.

Stock Market Warning

However, US equity investors should not dismiss the mayhem in the markets as merely technical. It is also financially rational for the stock market to be jittery.

The Federal Reserve continues to hold interest rates at near zero. When interest rates are extremely low, the sensitivity of asset prices (including bonds) to a rise in interest rates is greatly amplified.

And interest rates have no where to go but up from zero. And sometimes they rise very quickly – just ask the banks which invested into Greek bonds.

There is also an overvaluation problem in US stocks. Stocks have skyrocketed in price on very little improvement in corporate earnings and in the US economy as a whole.

Long-term cyclically adjusted earnings multiples, adjusting for accounting changes, are off the charts in the United States. Stocks are not cheap. Caveat Emptor!

Saturday, May 1, 2010

Wall Street's Culture

The Securities and Exchange Commission (SEC) case against Goldman Sachs is an interesting one. And there should be other cases to follow...Morgan Stanley, JP Morgan and Merrill Lynch did things similar to Goldman, involving even more money.

What did Goldman do? In layman's terms, Goldman did what any good snake-oil salesman would do. It sold worthless, well-packaged “fakes”.

The “fakes” were securities which were doomed to fail. Goldman knew that since they were deeply involved in putting the securities packages together, bet heavily the securities would fail, and made a bundle of money when they did fail.

I'm sure Goldman's CEO Lloyd Blankfein probably said in executive meetings that they “were doing God's work”. That “work” being defined as separating the “suckers” from their money. The only problem is that the “suckers” in this case were quite often the pension plans and retirement funds of tens of millions of people from all over the world.

And like the snake-oil salesmen of old, Wall Street had “shills” in the crowd who would say how great the snake-oil was. The “shills” in this case were the rating agencies such as Standard & Poor's and Moody's. In exchange for many millions of dollars, these ratings agencies gave the highest ratings – AAA – to any piece of garbage Goldman or others were selling.

The situation with the ratings agencies is one reason the so-called financial reform package, that Congress is currently debating, falls far short of what needs to be done. It does nothing about the obvious conflict of interest for the ratings agencies which are being paid by Wall Street to give their securities the highest possible rating.

A Change in Culture

This latest scandal is just an example of how the culture in the financial sector of our economy has changed over the past 30 years.

Years ago, the financial sector and its professionals believed in long-term relationships. That meant nurturing the economy and the companies and people in it.

Now the financial sector does very little of that. Instead, the sector puts its efforts into creating economic waste – products, like derivatives, whose sole function seems to be transferring wealth from a large group of citizens to a small group of already rich individuals.

Today the financial sector is no longer concerned with the long-term. It is controlled by traders. With a trader, the focus is solely on the very short-term. The focus for traders for every minute of every day is to make money.

So if running the economy off a cliff makes you money, traders will do it every day of every week. Traders are in the business to get rich and care little about the long-term hazards they may create.

Goldman Sachs is an example of the change on Wall Street. In 1998, just 28% of its revenue came from 2009, it was 76% and climbing rapidly.

The solution? It's actually quite simple. It is an idea that originated in the UK and is called the Tobin Tax.

It is a tax on every financial transaction in the banking and investment industry. It would probably cause a short-term drop in the stock market as the traders sold out, but so what?

If the tax is high enough (1%), the traders would be gone and maybe we would have a semblance of a financial industry that is once again concerned about the long-term and the economy, and the people it affects, at large.