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End of July Linkfest

Sunday, July 31, 2005 | 05:22 PM

This was quite the busy week, at least in terms of interesting stories and links. Here is my own (biased) list of favorites:

In Barron's, Alan Abelson explains why GDP data ain't all that. (If no Barron's subcription, than click here).

It turns out that the Dow Theory Still Works. (Who knew?)

I mix it up again with the prediction market folk here in Prediction Markets Redux; Recall last year, my column on Political Futures Markets caused a bit of a stir amongst the futures cognesceti.

Slate's Dan Gross looks into vice investing versus socially responsible funds in (the amusingly titled): God vs. Satan: Who's the better investor?

This week's Apprenticed Investor takes a look at how our emotions wreak havoc on investing returns. Curb Your Enthusiasm. Turns out the solution to this is just a little brain damage.

Don't overlook the (surprisingly) good two part series in the Washington Times on China:

1) Thefts of U.S. technology boost China's weaponry
2) Chinese dragon awakens

This week's music and film discussion covers a lot of ground:

Content Consolidation & the Long Tail looks into how consolidated media of all sorts (radio, movies, and even journalism) lowers the variety and quality. Problem for these companies are that there are free and easily accessible replacement available on line.

A recent UK Study found that Downloaders Buy More Music; This led an music industry insider suggest that labels should Give It Away.

And for those hardcores who are interested, Why Payola Matters.

I mentioned (via the NYT) the shameful behavior by Altera management not allowing analysts with a sell rating on the stock to ask questions in their conference call; Well, now that Altera apologized to the analyst it snubbed, we can all thank Gretchen Morgenson of the NYT.

One of my favorite stock blogs is Jeff Matthews Is Not Making This Up; Its got just the right mix of snark and info.

And just for laughs, Hacking Halo so Warriors do Ballet

Ray Dalio

Sunday, July 31, 2005 | 02:30 PM

in Economy

Bipolar Disorder

Interview with Ray Dalio, Chief Investment Officer, Bridgewater Associates

By SANDRA WARD

WHEN YOU MANAGE NEARLY $120 billion in institutional assets and your hedge fund provides consistent returns of about 15%, after fees, on average, every year for nearly 16 years running, who wouldn't want to hear your views on the economy? Dalio, founder of Westport, Conn.-based Bridgewater Associates, has built an organization renowned for its penetrating analysis of world markets and its ability to seize investment opportunities among different asset classes, particularly the credit and currency markets. Clients gain access to Bridgewater's latest thinking on global markets through the firm's Daily Observations newsletter. We thought you might like to get the scoop straight from the horse's mouth.

Barron's: What's your outlook for inflation?

Dalio: I think inflation is gradually trending higher. It won't emerge as a threat probably until late 2006. World economies are late in the economic cycle, and there are not the same excesses there used to be. The dollar will go down a lot and commodity prices will go up a lot. There is a structural surplus of labor and there's disinflation from labor and manufactured goods and productivity, but commodity inflation will offset that. The rate at which this will occur will be gradual at first, and as we get later into 2006 we'll have run out of slack and there will be more of a depreciation in the value of the dollar and more appreciation in commodity prices and the Fed will lag that move. Real rates will be relatively low.

You're not concerned the Fed tightens too much?

No, I don't believe they will tighten too much. Rates will continue to rise and the Fed will continue to tighten, but their moves will lag the forces of positive economic growth, a declining dollar and rising commodity prices. The Fed is looking at general inflation, and that will rise slowly. The economy is growing at a moderate pace, and so any tightening will be comparatively slow and modest. The balance- of-payments issue is a major issue, but it is not going to be a major problem this year. This year will be the first attempt to remedy the problem, but what is going to happen is our balance-of-payments position is going to worsen a lot. In 2005, 2006 and 2007 we are going to see our current-account deficit go from 5½% to 6½% to 7½% of gross domestic product. Our need for foreign capital is going to continue to grow at the same time that China's desire to buy our bonds -- and Japan's to some extent, as well -- will diminish. China's desire to have an independent monetary policy will be a driving factor. But there is a bipolarity in the world: The mature industrialized countries are in relative stagnation, and the big reason the U.S. is growing faster than most of other countries is because we are being lent capital. We are substantially dependent on foreign lending.

To put that in perspective, we import about 65% more than we export. Then there are the emerging countries. These countries, with their economic booms, are running current-account surpluses and are net lenders to the developed world. This is a very, very healthy set of circumstances. Emerging countries are using their capital to pay down their debts, and they are buying the U.S. Treasury bonds to hold their own currencies back. There is a very favorable structural shift in wealth to developing nations. We are very, very bullish on emerging countries, particularly Asian emerging countries and their currencies. Fundamentally, though, you have to ask yourself whether the ties between us and the emerging countries that are buying our bonds will last. It doesn't make sense. The balance-of-payment situation reminds me very much of the Bretton Woods breakup in 1971.

Continue reading "Ray Dalio"

Human Behaviour as a Barrier To Trading Success

Sunday, July 31, 2005 | 07:27 AM

in Investing | Psychology/Sentiment

We've discussed the impact of emotions as recently as Friday. Its fairly apparent that "Human beings are simply not rational creatures. If they were, then no one would have ever made money out of selling pet rocks. Yet someone did, which only emphasises the long held belief that a fool and his money are easily parted."

That's a quote from Whitney Tilson in a recent article in the AustralAsian Investment Review. He obserrves that one of the biggest problems facing human investors is that they tend to be overconfident in their view of things. Not just "robustly", but "wildly" overconfident. He provides the following statistical examples:

- 82% of people say they are in the top 30% of safe drivers;

- 86% of Harvard Business School students say they are better-looking than their classmates;

- 68% of lawyers in civil cases believe their side will prevail;

- 81% of new business owners think their business has at least a 70% chance of success, but only 39% think any business like theirs would be likely to succeed;

- Mutual fund managers, analysts, and business executives at a conference were asked to write down how much money they would have at retirement, and how much the average person in the room would have. The average figures were $5 million and $2.6 million respectively.
In regards to the last example, apparently it doesn't matter who the audience is, the ratio is always about 2:1.

Tilson has put together an excellent guide for the "Rational Investor." It is, as he notes, "hewn from years of good and bad experiences."

Here's his rulebook:

- Don't anchor on historical information, perceptions, or stock price;

- Keep an open mind;

- Update your initial estimate of intrinsic value;

- Erase historical prices from your mind; don't fall into the "I missed it" trap;

- Think in terms of enterprise value, not stock price;

- Admit and learn from mistakes, but learn the right lessons and don't obsess;

- Put your original investment thesis in writing so you can refer back to it;

- Sell your mistakes and move on; you don't have to make it back the same way you lost it;

- Be careful of panicking and selling at the bottom;

- Don't get fooled by randomness

The entire article is worth a read.

Incidentally, I have been reading Tilson's sober analysis for years, and was pleased when I found out he was opening his own mutual fund. Whiole I do not knpow his long term performance record, he has always impressed me as the sort of fund manager that Wall Street needs more of: Contemplative, ethical, and investor-focused.

Source:
Human Behaviour: The Greatest Barrier To Trading Success
Australasian Investment Review (AIR), May 30 2005
http://www.aireview.com/index.php?act=view&catid=6&id=1968

Income Lag? Blame China

Saturday, July 30, 2005 | 12:30 PM

in Economy

Interesting article in The Economist about China and its growing economic (and therefore political) influence. I was particularly struck by these comments on the global wage arbitrage:

In America, Europe and Japan, the pace of growth in real wages has been unusually weak in recent years. Indeed, measured by the growth in income from employment, this is America's weakest recovery for decades. According to Stephen Roach, an economist at Morgan Stanley, American private-sector workers' total compensation (wages plus benefits) has risen by only 11% in real terms since November 2001, the trough of the recession, compared with an average gain of 17% over the equivalent period of the five previous recoveries (see chart 3). In most developed countries, average real wages have lagged well behind productivity gains.

The entry of China's vast army of cheap workers into the international system of production and trade has reduced the bargaining power of workers in developed economies. Although the absolute number of jobs outsourced from developed countries to China remains small, the threat that firms could produce offshore helps to keep a lid on wages. In most developed countries, wages as a proportion of total national income are currently close to their lowest level for decades.

The flip side is that profits are grabbing a bigger slice of the cake (see chart 4). Last year, America's after-tax profits rose to their highest as a proportion of GDP for 75 years; the shares of profit in the euro area and Japan are also close to their highest for at least 25 years. This is exactly what economic theory would predict. China's emergence into the world economy has made labour relatively abundant and capital relatively scarce, and so the relative return to capital has risen. It is ironic that western capitalists can thank the world's biggest communist country for their good fortune.

Hat tip: New Economist

Source:
China and the world economy: From T-shirts to T-bonds
The Economist, July 28th 2005
http://www.economist.com/displaystory.cfm?story_id=4221685

GDP Yet Another Misleading Indicator

Saturday, July 30, 2005 | 09:04 AM

in Economy

I was out of pocket all day yesterday, and didn't get a chance to address the GDP data. At 3.4%, it came in slightly below the consensus of 3.5%.

There were two significant factors: A slight increase in wages, and big decrease in inventory. We'll see the July NFP report this Friday (more on this below) -- but lets address inventories, via Barron's Alan Abelson:

"The gleeful assumption by the sunshine crew that the inventory drop in the GDP report augurs big growth in output in the second half is more than slightly misplaced. The reason simply is that a huge chunk of the inventory reduction was the result of auto companies staging fire sales to clear their dealers' lots, an action certain to take a sizable bite out of future sales."

No big surprise there. Giving away cars at cost is hardly indicia of a red hot economy. But what about Industrial output? Isn't that a significant factor?

In a word, no. More than half of the uptick in output was Utilities cranking out more juice thanks to the heat wave. And a sizable chunk of the rest was (you guessed it) these same auto makers producing more cars to be given away at cost. GM's July numbers showed a 46% sequential monthly increase.

Where I disagree with much of the bear camp is where they go anti-Candide -- where every data point is the wosrt of all possible worlds. Instead of focusing on the underlying weakness below the headline numbers, investors of the Ursine variety are calling the data proof that the Fed has to keep raising rates. To me, that's an after the fact rationalization -- they were gonna keep raising anyway.

As to the Jobs situation, the slack in the Labor market, as Sir Alan likes to call it, continues to get even slacker:

"Moreover, something's definitely askew when the stock market starts to go bananas while the job market remains depressingly limp. As Challenger, Gray & Christmas, the placement outfit, observe, layoffs typically ease in the summer months -- but not this summer. Instead, it has produced a bitter harvest of job cuts. In May and June alone, layoffs totaled nearly 200,000. And more recent weeks have brought no respite."
-Barron's

And that's just layoffs.

As to NFP, we have yet to see a single good number that was not been the result of some hedonic adjustment or another (Prime suspecty: The Birth/Death adjustment, added in 2001). Between the inherent upside bias built into the BLS models, and the other assorted massages, its astonishing the data is this bad. And that's before we back the least significant aspect of NFP -- governement hiring.

Bottom line: Torture the data long enough, and it will confess to whatever you want it to.

Source:
Poor Darth Vadar
UP AND DOWN WALL STREET
By ALAN ABELSON
Barron's, Monday, August 1, 2005
http://online.barrons.com/article/SB112268001231000448.html

Apprenticed Investor: Curb Your Enthusiasm

Friday, July 29, 2005 | 05:06 PM

in Investing | Psychology/Sentiment

The latest "Apprenticed Investor" column is up, and its titled Curb Your Enthusiasm. (Here's where I Should insert an inside reference to the show, but they are all R rated).

The ongoing issue of emotional trading is this week's subject. Its timely, especially in light of the WSJ article about brain damaged investors (no, really) discussed earlier here.

Here's an excerpt:

Want to become a better investor?

Get brain damage.

That's the finding of a rather unusual study by researchers from Carnegie Mellon University, the Stanford Graduate School of Business and the University of Iowa. It was published in Psychological Science in June, and its conclusions were reported in The Wall Street Journal last week.

But don't start playing football without a helmet just yet: It's not any type of brain damage that helped investors in the study, but rather, a very specific form: a site-specific lesion (a kind of tissue damage) in the region of the brain in charge of controlling emotions.

The investors who have these lesions are unable to experience fear or anxiety. It turns out that lacking the emotionality ordinary investors exhibit leads to better investment decisions. It is not at all surprising that the emotionally limited investors outperformed their peers. We know from experience that when investors allow their emotions to unduly influence them, they tend to make foolish -- and expensive -- decisions.>

Emotions disrupt the process in s suprising number of ways. Its more than mere fear and greed -- surprisingly, it also impacts us analytically.

Prior Apprenticed Investor columns can be found here.

Content Consolidation & the Long Tail

Thursday, July 28, 2005 | 04:35 PM

in Books | Film | Media | Music | Television

There's an interesting discussion over at the Chris Anderson's blog on the ascendant forces that are creating a new era of Long Tails.

There's yet another source that is helping to give rise to the Long Tail: The continual consolidation and commensurate decline in quality of mainstream media content output. This is especially true for music and radio, true of some journalism, and (partially) true for film.

Let's look at few examples: The quality of music found and promoted by big labels has, over the past few decades, dropped precipitously (think insipid boy bands); Making matters worse, the major radio companies use shorter playlists to play less and less (payola funded) music.

Its no surprise both industries are in decline -- while Indie labels --the LT alternative -- are actually thriving.

Then there are films -- as they become ever more expensive to produce, producers aim for the lowest common denominator. While the LCD may help an individual film, collectively, it lowers the quality of the entire film industry's output. Is it really such a surprise that movie theatre attendance is down?

The good side of this is that it creates an opportunity for well written, inexpensive, indie films to gain exposure.

Even the mass media itself has succumbed to increasing consolidation and quality slippage: We've seen time and again investigative journalism falter as owners attempt to increase profits by reducing expenses. Good investigative journalism is expensive and difficult; But the net result is that people trust corporate journalism less and less. That's created the opening for another source of content: The Long Tail of blogs, podcasts and video logs.

Newspaper and magazine subscriptions are in decline, as is TV viewership. Why? Its Hamburger Helper all over again. None of these events occur in a vaccuum; Media consolidates, quality declines, what's left over all start to look alike.

But the internet allows for an viable alternative to come into use: Blogs. Poof! There go your readers. For Radio, its the rise of iPods and Satellites. Poof! There go your listeners. Print media is deep into the effect. Hollywood is only starting to feel it, as is TV. (Haven't figured out about books, as we produce so many unique titles each year).

Bottom line: Any content industry that finds itself dramtically reducing variety or quality or both, is an industry heading for long term trouble -- especially if the internet can be used to easily and cheaply find an adequate or superior substitute.

UPDATE: July 31, 2005 11:12 pm

Judge Richard Posner wastes nearly 5,000 words of primarily obtuse filler to observe that MSMedia is liberal, and that blogs threaten them.

He could have written a much more interesting essay if he understood the 1) Long Tail, 2) the impact of consolidation on content producers, and 3) the consumer's exercise of choice.

And all he had to do was read either this or this . . .

Bad News
By RICHARD A. POSNER
NYTimes, July 31, 2005
http://www.nytimes.com/2005/07/31/books/review/31POSNER.html

How China Will Change Your Business

Thursday, July 28, 2005 | 07:02 AM

in Economy

Fascinating story I somehow overlooked from INC, excerpting a book (China, Inc.) I am halfway thru:

How China Will Change Your Business :

1. China's economy is much larger than the official numbers show.
2. The growth of China's economy has no equal in modern history.
3. China is winning the global competition for investment capital.
4. China can be a bully.
5. China's economy is an entrepreneurial economy.
6. The most daunting thing about China is not its ability to make cheap consumer goods.
7. China is closing the research and development gap -- fast.
8. China now sets the global benchmark for prices.
9. China's growth is making raw materials more expensive.
10. No company has embraced China's potential more vigorously than Wal-Mart.
11. There are hidden costs associated with doing business in China.
12. Piracy is a problem.
13. China's heavy buying of U.S. debt has lowered the cost of money in the U.S.
14. Americans and Chinese have become reliant on each other's most controversial habits.

The article is worth reading (as is the book if you have the time).

Sources:
How China Will Change Your Business
Ted C. Fishman
(Illustrations by: Tommy McCall)
Inc. Magazine, March 2005
http://www.inc.com/magazine/20050301/china.html

Cycle of Co-Dependency
http://images.inc.com/tools/china/china.pdf

Unacceptable Corporate and Market (NASDAQ) Behavior

Wednesday, July 27, 2005 | 04:35 PM

in Investing | Markets

My jaw dropped on the way into work this morning as I was reading an article by Gretchen Morgenson in the NYT:

For the 25 years that Tad LaFountain has been a technology stock analyst on Wall Street, he has often written negatively about the strategies or prospects of the companies he followed. Not once did a company retaliate, he said.

Until now.

Mr. LaFountain, who follows 21 semiconductor companies at Wells Fargo Securities in New York, said yesterday that he was dropping coverage of the Altera Corporation, an industry giant, because its executives had told him they would not take his phone calls, would not let him ask questions on analyst conference calls and would no longer give him the information he needed to analyze its business.

Why the cold shoulder? According to Mr. LaFountain, the company objected to his negative opinion on Altera stock. Before he withdrew his coverage, Mr. LaFountain had a sell rating on Altera shares.

Writing his final report on the company yesterday, Mr. LaFountain said he expected to replace Altera in his list of companies with one "that takes a more appropriate view of the role of independent investment research."

I find that astonishing. If there's a problem with this analyst's work, than use the appropriate channels to complain about his work. But banning the guy from asking questions?

There are two major problems with this issue: First, it reflect poorly on management. Quite frankly, it smacks of the time ~~Ken Lay~~ Jeff Skilling called an analayst who had the temerity to question his numbers "an asshole." I don't know about you, but I sure as hell don't want to own any company whose management in any way shape or form reminds me of Kenny-Boy Lay. If ever there's a reason to simply dump a stock, this is it.

Second, it makes me wonder what the hell the exchanges are doing; Isn't there some minimal requirements -- besides capitalization --- that companies should have to meet in order to maintain their listing status?

Hey Nasdaq and NYSE! You wanna get on the ball with this please?

UPDATE July 27 7:57pm

Michael correctly notes in the comments that it was Skilling and not Lay who said that:

April 17, 2001: Raised eyebrows during an conference call with stock analysts and reporters. Richard Grubman, managing director of Highfields Capital Management in Boston, asked to see Enron's balance sheet and was told it would not be available until later. "You're the only financial institution that can't come up with balance sheet or cash flow statement after earnings," Grubman grumbled. "Well, thank you very much, we appreciate that. Asshole," Skilling replied. This incident would later be cited over and over as evidence of Skilling's unsuitability as a CEO. Skilling's explanation: "The specific fellow that I was not real happy with is a short-seller in the market. I don't think it is fair to our shareholders to give someone a platform like that they are using for some personal vested interest related to their stock position."

I stand corrected.

Source:
An Analyst Receives a Time Out From Altera
By GRETCHEN MORGENSON
Published: July 27, 2005
http://www.nytimes.com/2005/07/27/business/27place.html

Bloomberg TV (1:10 PM, 7/27/05)

Wednesday, July 27, 2005 | 12:32 PM

in Media

>
A quick heads up: If you are in front of a set over lunch, I'll be on Bloomberg TV (US) today at 1:15 pm for a quick Earnings / Econ / Oil / Markets discussion . . .

UPDATE: July 27 2005 1:56pm

The new Bloomberg studio is pretty cool hi-tech space. Here are a few camera phone snaps from today:

click for larger (but poor resolution) photos

Studio