Sep 30

Mid-Year Review: 2014

So I’m a little late in writing down my “mid”-year review for 2014.  You can see my review from last year, here.  I honestly do not have much to add, but I’ll say a couple of things in particular, in response to it:

  1. I think I veered a little too far into the “macro” last year.  To some extent we always must, but that is not really what I’m about as an investor.  I’m not Hugh Hendry.  
  2. What I was really responding to, though I did not articulate it well, is that it is hard to find values in the market in companies that I want to own forever.  This has gotten harder still in the past year.  My really “big idea” value stock pick, which I have been pounding the table on for awhile, was Microsoft.  That is up 40% in the last year.  I didn’t add money last year because of uncertainty and because it was already one of the three largest positions in my portfolio, but it’s hard to scream anymore even about that company being undervalued.

For this year, uncertainty is up, and it is even harder to make a discrete value case, for particular companies that I analyze.  (And of course the market is up by about another 16%.)  I continue to pay down student loan debt.  I am learning electric guitar, as I have posted about on Twitter.  I am sure there are opportunities in the market.  I am sure I am missing them — though keep in mind I haven’t sold anything, I’m just not adding new money (outside of my kid’s 529 plans and some to my 401k).  

But I just don’t care.  2009-2010 is seared into my memory as a time when it was very, very hard to make mistakes.  I think I am still finding my way in this new kind of market.  Berkshire’s cash balance just hit an all-time-high, so clearly I’m not the only guy having a hard time figuring out how to meaningfully deploy cash in this environment.  (And Buffett doesn’t have student loans to pay off.)  I’m in wait-and-see mode.

As an aside: somebody asked me on Twitter why I don’t think this is a bubble market, just like 1999 was.  The answer is because Coke doesn’t trade at a P/E ratio of nearly 50.  I remember that era quite well, too, you see.  There is froth today, and the CAPE is high.  And the Fed is easing out of QE, which it will probably do, and seems to be doing, too early, given inflation rates, and this will likely hurt the market.  But we are hardly partying like it’s 1999.  I do not regret scaling back on new purchases after 2012, yet.  I continue to monitor the market to see if there is evidence that profits are growing sufficiently to alleviate the overvaluation (or at least the lack of undervaluation) that I see in my stock screens.

Sep 23

Why Now May Not Be The Right Time to Buy Berkshire Hathaway

As you likely know, I’m a big fan of Warren Buffett.  Who isn’t? of course.  But I do try to model my investing style on him (sadly, without the advantage of being able to buy an insurance company to get free float).  I have owned shares of $BRK.B for years.  I also added a bunch more in 2011 in the high $60s and low $70s.  I have no intention of selling.  However, I think it is possible that the window has passed to buy, for now.

This is not a post about the valuation of the company.  Still, it’s probably about fairly valued in the market, maybe a little over-valued.  Buffett won’t let it get hugely undervalued, because of his promise to buy back shares when they are below about 1.1 times book.  At 1.4 times book, as of this writing, the shares are outside of Buffett’s own margin of safety.

That said, the company will grow.  The economy in the U.S. does not show a high risk of recession anytime soon.  Yada-yada.

Buffett is 84 though.  Now this is also not one of those posts about how you should not buy Berkshire shares because the company will go into the toilet when Buffett dies.  I think the structure he has put in place, along with Charlie Munger, will live on.

On the other hand, I think one can make two assumptions, relatively safely.  First, according to actuarial tables, Buffett has about 6.6 years of life left in him.  Let’s say he steps down a little before he dies, that is 6 years.  Second, I believe that on the day Buffett dies (or more likely, over the subsequent month), shares of Berkshire Hathaway will likely drop at least 20%, because so many people will freak out.  Either that, or his increasing age will continue to constrict the valuation.

Thus, to make a new long term investment now, you have to believe, because there are no dividends, either: 1) that the price will appreciate more within the next six years than it will drop following Buffett’s death; or 2) that people will not depress the stock price in anticipation of his death.  Six years is a lot of time for the company to grow, but I think it’s a close call.  I’m not saying don’t invest.  I do however think, that at these levels, as opposed to in 2011 when I made my last large purchases (I did add a little more in 2013 at $112/share as well), there are probably better opportunities out there.  As always, this position is subject to change if and as my views evolve.

Aug 10

Why The Education Debate in This Country is Nonsense

There are two camps in the great education debate in this country.  In the one corner is a coalition of liberals, Democrats, teachers, and unions, who typically argue that the problem is a lack of sufficient funding.  In the other corner is a coalition of serious education reformers, ideological opponents of the concept of public education, anti-union activists, and Republicans, who argue that the problem is the “quality of schools,” the teachers, the unions, etc.  

Both sides are wrong.  The entire education debate in this country is proceeding upon totally false premises.  Nobody is looking at what is really going on, and until people do, there can be no solution.

Let us start with certain facts:

  1. Studies have repeatedly shown that the highest determinant of school success is things like the social class of the parents.  One international study found that the single factor that correlates most highly with school success is simply the number of books the parents own and keep in the home.
  2. Both “good” and “bad” public school districts are all unionized.  I live in Southern California.  Pasadena Unified School District, which is considered to be a “bad” school district, is unionized.  San Marino, which is considered to be an “excellent” school district and is next door, is also unionized.  La Cañada Unified School District, also next door to Pasadena, and also considered to be an “excellent” school district, is also unionized.
  3. In 1970, the Pasadena District was hit with a busing ruling by a Federal District Court, which was the first one outside of the South.  After this decision, PUSD became heavily minority and poor, and areas with highly educated white parents that are still part of the district have repeatedly tried to secede and join affluent nearby districts.  In fact, the above mentioned LCUSD itself seceded from PUSD in 1960 — it was 90% white.
  4. Since the 1970s, the number of children whose families live in Pasadena (which is unusual in that it BOTH has some of the wealthiest people in the region, and also the poorest — i.e., it is hugely stratified) and who attend private school.  In fact, in 2014, Pasadena was named the snobbiest mid-sized city in America largely because it now has the highest per-capita concentration of private schools in the country.

This is an example area.  But the pattern has repeated itself all over the country.  So what is actually going on here?

Liberals need to acknowledge that while Civil Rights decisions had laudable goals, they had huge negative consequences.  One can make the case that Civil Rights busing decisions — by focusing ONLY on particular cities, rather than on regions or states, and by the nature of the fact that they cannot include private schools — essentially destroyed a lot of public education in this country, and certainly destroyed broad public support for it.  

Highly educated whites (and later Asians) did not all abandon public schools, or public schools in certain cities, because they were racists, though some were.  Many others simply did not want their kids to have to spend an hour or two on a bus every day.  Over time, too, whether a district was “good” or “bad” simply became a sort of received wisdom.  Chicken-and-egg cycles took hold.  In Southern California, all the educated and wealthy people either move to places like San Marino, or they send their kids to private school.

Liberals don’t want to acknowledge this for two reasons:  1) they do not want to view the Civil Rights Era as anything other than an unadulterated good; and 2) saying what I’m saying sounds like one is saying that minorities are stupid.  That is not what I’m saying, but the optics are bad.  Minorities are not dumber, but in the aggregate, when parents have fewer resources, when they are working three jobs, or when they have no job, or when kids are in foster care, etc., educational outcomes will tend to be worse.  Liberals also do not want to acknowledge that throwing more money at the problem will not fix it.

Conservatives have different issues.  In their coalition, those who hate unions in general have a great tool for dumping on them.  They fail to acknowledge that all of the great destinations public school districts, where property values are high and virtually everyone is highly educated, and either white or Asian, are also unionized.  Education reformers have typically bought into what I believe is a canard that the quality of the teachers is the primary determinant of school success.  They fail, in my opinion, to acknowledge things like the fact that excessive needs of a student population actually impact negatively the quality of teachers.  

I believe that if you took all of the private school teachers in Pasadena, and switched them with all of the teachers at PUSD, the quality of education at PUSD and in the private schools would only change by no more than about 10%.

Many Democrats have also bought into the false idea of what makes schools “good” or “bad.”  That is what led them to support No Child Left Behind, which was a law totally based on these false premises of the education debate in this country.

In short, nobody is talking about the fact that the education problems in this country are largely racial and class problems.  Nobody wants to talk about it because it’s a hugely upsetting topic.  Instead, people talk in terms of abstractions.  Liberals talk about money.  Conservatives talk about “reform” and vouchers.  Vouchers may actually help because they may create a form of stealth desegregation (by class, not just by race) and do so on a basis that is, at least on its surface, non racial.

But we are not going to solve this problem until we begin talking about what the problem actually is.

Aug 05

Why You *Maybe* Should Buy A House

This is based on some comments I recently made on an article by the esteemed Morgan Housel, who I have been saying for years is the heir to Jason Zweig.  Somebody asked me why I think now might be a decent time to consider buying a house.  First of all, take anything I’m saying with a major grain of salt and do your own diligence, I’m just some dude with no formal financial training. That said, here’s why you should have considered buying a house starting in 2009, and why it may not be too late.

1) The investment arguments against home-ownership, I think, assume you pay all cash.  This relates to the oft-repeated statement that the US housing market over time basically matches inflation and is not as good as the stock market.  But nobody pays all cash, outside of investors who are planning to flip short-term, or Chinese guys looking to park money in a place where they will not be thrown in jail when the political tides turn. If you put 20% down, that is a leveraged investment in the property on which the house sits, coupled with ownership of a depreciating asset (the house itself). Because it is leveraged, the housing market as a whole does not have to significantly beat the market in order for one to come out ahead. Let’s say you buy a $100K house and you put $20K down. Let’s say the value of it only goes up 2% per year, matching inflation. In thirty years, your house is worth $181,136.16. But the return on your original $20K (ROIC) is not 2% per year. The return on that is closer to 5% annualized.  Not bad, huh?

Moreover, because 30-year fixed loans (which I’m assuming, because I am assuming my readers are not morons) are so heavily amortized, for years and years you are paying mostly interest. Congratulations, you get a massive portion of that back in a tax deduction!  Think of it as a massive rent subsidy from the government that only goes to those who don’t need it.

Yes, you pay down your loan over the thirty years, and you get a lower ROIC on these later dollars, but the vast majority of it you pay down in dollars that have been drastically devalued by between 15 and 30 years of 2-3% inflation, assuming inflation does not jump (in which case they are devalued more).

You also have to deduct maintenance and repair costs, but a lot of that can be done oneself. In the past three years since I bought my home in mid-2010, I have repainted two rooms, put on gutter covers, fixed rails on my porch that were dry-rotted, etc.  These costs are also much lower if you buy a newly built home.

Whether this is a good idea is heavily dependent upon where you live. The famous average home value appreciation figures look at the whole country. That means they are averaging in Detroit over the last 40 years, along with Los Angeles and Dallas over the last 40 years. That seems nuts to me. Real estate is local — sometimes cliches are true. The “investment” portion of your home purchase is really the land, as stated above. It is the land, by-and-large, that appreciates in value, and it does so when macroeconomic and regulatory pressures in a particular region or city cause it to do so. Buying a house in rural Kentucky is probably not as good an idea, generally, as buying one in Raleigh, in other words. There is little demand in rural Kentucky, and little economic growth, and there is tons of space, and there are no NIMBY neighbors putting up all kinds of zoning ordinances that restrict building and prop up their property values (whether intentionally or not) because everybody in rural Kentucky hates the gub’ment, even though they are largely supported by the government.  It’s a wonderful world we live in.

2) Interest rates are low.  Currently, fixed rate 30-year loans are a terrible deal for the lenders unless we get outright deflation. (I refinanced mine in 2012 at 3.75% — that is INSANE my friend — a 30-year fixed loan, you have to be kidding me.) We have a new Fed Chairman who is just as strong as Bernanke was in resisting the calls of creditors to allow deflation (whether they know they are advocating that or not, and some do not, they are actually deluded).  It is very possible, or at least a good bet, that the Fed’s actions have provided the “bridge over troubled waters” that they were designed to provide.

3) Hatred of home-ownership.  Home-ownership rates are at a 19-year low. Articles appear constantly about what a terrible investment they are. The rental economy is the fad du jour.  Pay attention to this.

4) I live in California. So in addition to the above, I get Proposition 13, which means my property taxes can never go up more than 2% per year no matter how much my property appreciates. That removes a lot of uncertainty. The equation is different in states like New York where do-gooder policy-makers are constantly allowed to raise taxes willynilly on property owners whenever they want to fund a new pet project.

5) Antideficiency legislation.  Also, like many, many states, California is a non-recourse state, which means if I ever default, my lender can’t go after my personal property or savings to recover any deficiency. So in addition to getting a great rate on my loan, I have a built in default option that can never, ever cost me more than what I paid in. (Which, incidentally, is why the people who “bought” homes in California and similar states with interest-only loans or low-payment ARM loans in 2006 and then got foreclosed on a couple of years later — after basically paying just a low rental rate — and then screamed bloody murder about it, are either ignorant, or are moochers.)

6) Pay attention to thy psychology.  While an investment in a property/home may not beat the market, MOST INVESTORS DON’T BEAT THE MARKET and virtually nobody just owns the market as a single basket anyway. Statistically, investors are likely to trade in at horrible times, and sell at horrible times. It’s so easy to trade. It makes you feel so smart. With a house, you can’t just freak out and sell because of a “flash crash” or because the Eurozone looks like it is falling to pieces. The very idea of that is insane. So pay attention to the psychological aspect. Ask yourself how many people who invest in the market actually beat the market over 30 years anyway. Ask yourself if you have the psychological fortitude and skill to do so. As Munger says, life is all about incentives. Having a brokerage account with sub-$10 commissions creates an incentive to trade too much. Have a home that would be a massive PITA to sell and where you would have to move your whole family creates a massive disincentive to “trade” too much.

Buying a house is not right for everyone, and I may be wrong. And it depends upon where one is buying. One has to make a sanity-check effort to compare it to the cost of renting (when monthly loan/tax costs in an area are historically high compared to rents in that area, that is a problem). But it is not always the investment sinkhole it is now portrayed to be. Literally tens of millions of people in this country have major assets only because they bought a home in an area where there was economic growth and immigration decades ago, and held onto it.

My ultimate point is, you can’t rely on blunt instruments like the relative appreciating value of all property in all of America versus the stock market when considering a home purchase, any more than you can merely rely on PE or CAPE or Tobin Q or what you like to buy in stores, or a broker, when investing in the stock market. All of life must be addressed holistically.  

Any investment decision must begin with: 1) a diligent and objective effort to seek out all of the factors that might impact it, whether financial, regulatory, macroeconomic, psychological, or whatever; and 2) a diligent and objective effort to evaluate as best as one can the likely impact of each of those factors as applied to one’s own particular situation, in one’s own spot in life (and, in real estate, in one’s own city, in one’s own state, in one’s own country, according to one’s own finances, prospects and proclivities). There are no shortcuts. There are no easy answers. There is no golden ticket. There is no unifying theory. There is no Platonic ideal. The is only the relentless seeking out of all possible relevant facts, including trying to determine, as a starting point, who one is as a person, as to which one must apply the coldest, most objective eye of all.

Jul 23

My Reaction to William Deresiewicz On the Ivy League

A man I have known in the past just published an op-ed about the horrors of the Ivy League.  Here it is.  As a product of the Ivy League (though not of the elitist private school/destination-public-school complex that so often leads there), I have this to say about it.

Deresiewicz makes some valid points, but mostly the piece is an eye-roller.

I think part of the problem is that he is actually talking about four distinct things.  However, in the time-honored manner of a person who trained in literature, but not in logic and math, he is weaving them all together in a “narrative,” instead of discussing them each distinctly and logically. 

His actual points, when you unpack the needless rhetorical weaving, are: 

  1. you become timid and anxious and lost from going to these schools;
  2. they “educate” “leaders” only for the purpose of climbing corporate ladders, not to be out-of-the box thinkers;
  3. they are elitist and they privilege kids from upper-middle-class families and are not meritocratic and exacerbate inequality; and
  4. the entire educational system is at fault. 

I think there is some validity to some of these, but tagging Ivy League schools with these problems, except for number 3, is unfair and just about catching eyeballs for the op-ed. 

Point one has some validity, but I also know people who become timid and lost because the do NOT get into these schools, and go to Ohio State instead, or have chips on their shoulder and who treat education as even more of a commodity than Ivy Leaguers do. 

Point two has some validity, but I think is wildly overstated, based on my own college experience and the experiences of my friends, he is talking about maybe 20% of the students.  It would be more accurate to say that the Ivy League ATTRACTS these types of students.  It is not the cause.  He is confusing correlation with causation here.  Or, alternatively, since the text of the article acknowledges the broader role of the education/industrial complex, he just had a dishonest headline writer who was interested in generating clicks.

Point three is definitely true.  However, it has been ameliorated in recent years by all of the scholarship money the Ivys give out.

Point four has some truth, but again, has nothing to do with the Ivy League, per se.  It relates more broadly to insecurity about America’s place in the world, and parents’ reactions to that.  The Ivy League is a symptom of a far broader issue, not a cause.

In short, I felt he made some valid points.  But they are cloaked in a great deal of nonsense.  He confuses correlation with causation, possibly deliberately as to point two, possibly it just seems that way because he had a cheap, dishonest headline writer.  Broadly, he is failing to grapple with far broader societal issues, and unfairly focusing on the Ivy League.  One cannot help but sense the bitterness of a very smart, high-achieving man who was denied tenure at Yale, and who before that had “never experienced anything but success.”

Oct 19

99% of Long Term Investing is Doing Nothing

It’s a bold headline to be sure, and perhaps exaggerated, though not by much.  This is also not an original view, but it helps to be reminded of it from time to time.  The recent government shutdown and debt ceiling farce (er, I mean, crisis) have reminded me of it.  During the last month or so of our National Lampoon’s Rationality Vacation, I have bought and sold zero stocks, aside from my automated monthly DRIP purchases, 401k contributions, and 529 plan contributions to index ETFs for my two children.  I am happy about that.

So what is the work actually involved in long term investing?  For my own purposes I break it down into the following four categories.

  1. Either purchasing index funds or selecting a relatively small portfolio of stocks (no more than 25), focusing on stocks that you both: a) believe are presently undervalued; and b) have a reasonable likelihood of growing earnings and cash flow faster and more consistently in the long-term than the universe of stocks as a whole; which c) preferably but not necessarily pay a dividend that has been historically increased with boring regularity.
  2. Generally reviewing those stocks (assuming you buy stocks, not index funds) about once per year (or even less often) to make sure your buying thesis is not totally blown.  (I.e., you want to make sure you have bought Coke in 2009, not Blackberry in 2012.)
  3. Rebalancing your index fund investments once per year at a set time each year, which can be automated.
  4. Being generally aware of market conditions, but only insofar as the aggregate value of stocks is either far below or far above historical averages.  With the understanding that you may do absolutely nothing based on this awareness.

A few words on each category:

The most important is Category One.  If you succeed in purchasing companies that meet those two criteria (and the third preferable criteria), you basically never need to sell them.  Go to the beach, play with your kids, do your job, be affectionate to your spouse, and take care of your health.  When people talk about “evaluating free cash flow,” that is valuing the company now.  When people talk about “moats” or “competitive advantage” or “return on equity” or “return on capital” or “brand,” or “patent protection,” those are all ways of evaluating whether the company is reasonably likely to grow faster than the universe of stocks over the long term, or at least whether it is likely to be sufficiently successful that you will not lose your money.  This means don’t buy “turnaround” stocks like J.C. Penney or Blackberry these days.  Too much risk that you will have to do lots of Category Two work, even if you are correct that they aren’t toast.  I have owned a bunch of Phillip Morris stock since 1998, before the SAB Miller partial sale, before the Kraft split, before it split into two companies, Altria and Phillips Morris International.  I have had wild gains in this stock, always reinvesting dividends, during one of the great secular bear markets.  I sold the Kraft when that split off and reinvested it in Phillip Morris.  I eventually sold the Altria after that split, and reinvested it in Phillip Morris International.  I very well may never sell this stock.  I only seriously even think about it about once every two years or when something happens in regard to it that is significant enough that it appears in the business section of a generalist newspaper.  I seriously think about this stock about an hour per year.  That, to me, is investing success.

Category Two could also be titled, “Don’t Be An Ostrich.”  Technical traders look stupid when the change their minds by not sticking to a previous stop.  If they violate their preset short-term buying and selling rules, they will eventually blow up.  They are psychologically disassembling and turning into gut-motivated day-traders. Long term investors look stupid when they don’t change their minds or ever consider selling.  If they never sell anything or even look at it, they will eventually blow up, too, at least in one or more positions.  They have turned into ostriches.  There is no such thing as “buy-and-forget.”  If you really want to be a “buy-and-forget” investor, start buying index funds when you get your first job, and other than yearly rebalancing, set a timer to start thinking about them again when you are about 60.  But if you must buy stocks, you do have to think about them occasionally, even if you think they are great companies.  I aim for once per year.  When I bought Phillip Morris in 1998, I also bought a much smaller amount of Eastman Kodak stock, literally only about $200 worth.  (I was in college.)  I totally ignored it and rode that $200 to zero.  I didn’t need to gather news on Eastman Kodak daily to avoid that loss.  I just needed to analyze it at least once within the first five years or so after I bought it.  Unfortunately by that time I was out of college, making lots of money, busy with my wife and friends, and it was only $200 and I just did not care.  Still, lesson learned.

Category Three only applies if you are buying index funds.  Studies as far as I know show that rebalancing your index funds to their original percentages is beneficial to long term returns.  This is because reversion-to-mean is a fact of life.  It’s the investing equivalent of taxes and death.

Category Four is optional, and probably should be excluded by the vast, vast majority of people.  But it’s important to talk about it, if only so you know why you should ignore it.  You can get into trouble here.  It’s also extra work.  I hate extra work.  If you are a fearful sort, there is always a reason to be all cash.  If you an aggressive sort, there is always a reason be all in stocks.  Know thyself.  Here you have your biggest risk of massive psychological error, because decisions made in this category can impact your entire portfolio, not just one stock purchase or sale.  Here is where you buy tons of Janus mutual funds in 1999, and where you panic-sell everything in March 2009.  But here you can also have our highest possible impact.  Here is where you either stop buying stocks in 2000, or you go all-in in 2009.

Notice I didn’t say “sell” stocks in 2000.  If you have satisfied Categories One and Two, and particularly if you have been holding them for awhile (thus building psychological capital), you don’t really ever need to sell stocks, even at market peaks.  You’ll survive the inevitable drop, you’ll have the fortitude not to panic-sell at the low, and you’ll benefit from the eventual rebound.  Timing is hard.  I think at a market high it’s generally best to simply chill out, maybe sell stocks if any that you bought on a flier or based solely on temporary undervaluation without much faith in the long term business (already a mistaken purchase), and build cash for the drop.  If you sell, you are likely to sell way too early, then freak out when stocks rise, then buy way more at the top and consequently lose more, and then panic-sell after the drop because you hate yourself for buying back in so strongly at the true top.  Then you are well and truly screwed, my friend.  And even if you correctly sell at the top, you’re quite likely to buy back in way too late, after a sharp rise off the bottom.  Satisfying Categories One and Two and riding the thing out is, in my view, the best way to preserve psychological capital.  Satisfy your market-timing urges by reducing new purchases as you begin to perceive a market-related topping.  Build cash.  Pay down debts.  Go to Disneyland.

If that all sounds like a lot work still, that’s because it is.  It’s work, even if you only look at your stocks once per year.  It’s work picking them in the first place.  The true zen master probably just buys index funds and rebalances them for forty years.  

My continuing fascination with common stocks as a non-professional with a full-time job probably is indicative of my egotism, and some cognitive bias.  But I have done well enough, beating the S&P though only marginally across all of my accounts, not making huge mistakes, that I continue.  Still it’s quite possible I’ll write a post one of these days throwing up my hands and saying I’m all in index funds.

Anything you do beyond these four categories is not investing, it is indulging in a hobby.  Reading financial blogs all of the time, following finance people on Twitter, writing this blog: a lot of the things I do I do mainly for fun.  Whether you are an long term investor or a trader, this is  all perfectly fine, as long as you recognize it is totally separate from your actual investing/trading process, and as long as it doesn’t lead you to violate your rules.

Stay frosty out there.

Aug 23

A Few Thoughts on Microsoft’s Past and Future

The Ballmer departure (which I approve of) led me to run a quick-and-dirty on its free cash flow, and to some general thoughts on Ballmer’s departure.

First, as you can see here, even after today’s bump (to $34.75/share) Microsoft is priced never to grow free cash flow again, and in fact for it to gently decline.  An alternative explanation of the pricing is that free cash flow may fluctuate somewhat, up and down, but ultimately decline.  Note that the model simply deletes 35% of the value of Microsoft’s $77.022 billion in cash on hand.  This is to account for taxation on eventual repatriation of foreign earnings, and/or inflation for holding the cash too long, and/or money wasted on things like Surface or Skype.  Note that the model also assumes a constant future figure for diluted shares outstanding, even though that figure has been declining steadily, which is cash-flow-per-share accretive.  (The figures are all from the June 2013 report.)

So the question really is whether you believe that is Microsoft’s future or not.  In valuing a company, the numbers only are useful to help frame your qualitative and strategic thinking.  The English Major side of investing is much more important than the mathematical side, unless you are writing trading algorithms.  I continue to think Microsoft can manage some modest growth, and thus the stock is by definition undervalued.  I may be wrong, and I’ll say it when I determine that I am.  If it happens, it will be a judgmental error, not a math one.  In any event my money is where my mouth is; it’s one of my top two stock positions, and is about 8% of my portfolio (much of which is admittedly invested in S&P, Emerging Markets, and European ETFs at the moment).  But my desire to be in Emerging Markets and European ETF’s right now is a post for another day.

Now to Ballmer.  Contrary to what some are saying, the initially euphoric market reaction to his departure has no relationship to a belief that someone else will be able to staunch the bleeding in Windows, for example.  No one can.  That is structural.  Rather, this reaction is about Microsoft’s inability to innovate in new areas under Ballmer’s tenure. This is about his mockery of iPhones when they came out, his blundering with tablets, his statement that he wouldn’t even let his kids touch the products of “those” other companies. This is about the fact that a Surface tablet glitched up at its debut presentation, and that it was wildly overpriced from the get-go — and everyone knew it (except Microsoft, apparently).

The future of Microsoft, if there is one, is in new product and software categories.  The company has to think of something new, like Xbox was new, and it has to make money (unlike with Surface).  Microsoft has to take risks.  The market simply thinks that such a future is more likely to exist without Ballmer: nothing more. There is good reason for such a conclusion, given Ballmer’s generally abysmal record of innovation, even if there are no guarantees as to the future CEO.  A solid, diligent ‘caretaker’ CEO like Ballmer is never a recipe for strong growth, but it is a recipe for disaster in the tech industry.  The world simply moves too quickly.  IBM was selling its laptop business to Lenovo in 2004.  Zuckerberg was creating Facebook.  Apple expanded the iTunes music store internationally.  Google had its IPO that year.  Ballmer was working on Windows Vista.  Enough said.

Aug 02

Mid-2013 Market Outlook

I’m a little late this year, but I try to review my market outlook at least two times per year in writing.  In my head, I am revising it constantly, but it helps to set fingers to keyboard in order to hold oneself accountable.

As I’ll explain further below, I view the market as being in a period of lukewarm but solid optimism.  We are nowhere near the euphoria of 1999.  We are nowhere near doldrums of August/September 2011, let alone March 2009.  For me, this is the hardest kind of market to navigate, what we have now.  

I have made many mistakes along the way, but I was buying pretty consistently in 2009 and 2010, and when the market swooned in late 2011 I picked up sizeable chunks of BRK.B, UNP, LMT, and BDX, among others.  2010 in my mind was the perfect time to buy.  It was clear we weren’t going down the toilet.  But it was clear many people still thought we were, and that bargains were to be had.  Gold bugs ran wild on civilized streets and Johnson & Johnson traded 50% below today’s price.  The risk-reward seemed perfect to me.

Today we are up around 150% from the 2009 lows, the market is reasonably though not by any means cheaply priced, and profit margins remain at or near all-time highs (more on that in a later post).  This makes the rewards seem less attractive, relative to the risk one is taking.  Margin debt has also made a massive comeback, which I always view as a strong negative both substantively and procedurally.

Economically and monetarily speaking, there are positives and negatives:

Everyone can have different responses, and to some extent that is fair.  A lot of retail investors sadly just started to get back into the stock market in 2013.  I recall mocking BoA-Merrill Lynch in January when it issued a call that “now is the time to invest!  It was so sad on so many levels.  2009 or 2010 or even 2011 was the time to invest.  

For me, because I bought so much in 2009-2011, and have held it, I have felt comfortable scaling back on new purchases.  I severely curtailed new contributions to my 401k, starting in June.  I am not investing any new money outside of my 401k and IRA.  This is, note, colored by the fact that I still have approximately $50,000 in student loan debt from law school.  In 2010 it seemed fairly clear to me that I could beat my low interest rates (none are higher than 3.5%) by investing in the market.  And I have, by a mile.  That has become less clear with every year that has passed.  It is possible I still could and I’m now wrong, but life is all about judgment calls.  I am hedging my “bet” in that I’m not selling anything.  We are not at 1999 or 2007 levels.  I am fundamentally a long-only long-term investor, my average holding period is at least three years, and my ideal investment is one that is undervalued when I buy it and that I can hold forever.  

What does the future hold?  Oh seriously, do you think I or anyone knows?  I think we have about a 60% probability that the U.S. recovery continues and strengthens for at least the next two-three years and the next recession and major (greater than 15 or 20%) stock market drop is at least three to four years out.  But I think we have a 40% probability that we really stall out, particularly if there are additional policy errors like allowing the sequester to take effect this year.  There is a non-negligible chance that the Republicans take control of the Senate next year, which given that party’s current attitudes I think would be a market- and economic-negative.  Just as Romney’s election would have been.  Note that I am not a partisan liberal.  I think that Democrats are generally correct on short-term economic policy given the current situation, whereas Republicans have been living in Hoover-land (Bush, circa-Fall-2008 excepted, bless him).  I think that Republicans have it right on Medicare, which (given what I know today) I think needs to be cut significantly in the longer-term.

So for these reasons, and to expand on my intro, my market outlook is this: today is not the time for an investor to be wildly investing new money.  That time is past.  If you missed it, suck it up, because you cannot overcome that error by wildly investing today.  You will simply compound it, even if you are a “long term” investor.  That is because if you invest today you will have less psychological capital (than I will) to help you refrain from selling during the next major downturn.  This is all particularly true if you have any debt.  While it is always hard to restrain one’s greed in regard to the stock market when it is going up, now is probably the time to: 1) review and relish one’s gains in lifetime holdings with satisfaction, 2) prune any overvalued stocks you bought without thinking you would hold them forever (for me, AT&T); 3) pay down debts so you can continue to increase your net worth; and 4) be very selective about new investment opportunities in stocks that seem particularly undervalued compared with the market as a whole, relative to their growth prospects.

If 1999 was a sell moment, and 2009 was a buy moment, today is a moment for prudent reflection, always keeping in mind there is never a bad time to buy a quality, growing company that for whatever reason is appraised by the market at less than your best estimate of its true worth.

Jul 12

The 21st Century Glass-Steagall Act Misses The Point

Recently, Senator Warren announced plans with Senator McCain to reintroduce a 21st Century version of the Glass-Steagall Act, which in simple terms banned banks from combining with investment banks, and which was repealed by the Gramm-Leach-Blilely Act of 1999.  The news of potential bipartisan support for this idea puts me in mind of an old saying (at least in my head):  the worst ideas in Washington are usually the ones everybody agrees on.

Here is why it won’t solve anything, and basically signifies the disfunction of our political system.  (Nobody seems to be saying it, so I will.)  In short, the repeal of Glass-Steagall was not remotely as big a deal as the repeal of the much less famous Bank Holding Company Act.  Ever heard of that one?  Read on, dear friend.

First, the combining of traditional banking and investment banking does not seem to be what caused our problems.  After all, Bear Stearns was a pure investment bank.  Lehman was a pure investment bank.  They failed and (particularly Lehman) were systemic risks even though they were not combined with any regular bank.  By contrast, WaMu, IndyMac, Countrywide and countless others were pure banks, not combined with investment banks, which all failed.  In fact, hundreds of pure banks/thrifts, without regard to size, have failed since the financial crisis.  Meanwhile JPMorgan Chase, a combined bank and i-bank, rode through the storm far better than just about anybody else.

So pure banks fail.  Pure investment banks fail.  So why now focus on separating them? 

Now let me tell you about the Bank Holding Company Act of 1956.  This Act prohibited bank holding companies headquartered in one state from acquiring a bank in another state.  In short, it prohibited Mega Banks like Bank of America and Chase that operated in all fifty states.  This Act was repealed in the first Clinton Administration, in 1994, by the Riegle-Neal Interest Banking and Branching Efficiency Act of 1994.  Here is a good rule of thumb about Congressional Acts: when their titles contain qualitative judgments of what they do, the actual Act probably does the opposite.  It was in the wake of this 1994 repeal that banks such as Wells Fargo wildly expanded and truly became “too big to fail.”  Wells Fargo, incidentally, is arguably not really “Wells Fargo.”  Actually, it is Norwest, the Minnesota bank that was the apparent survivor of their 1998 post-Riegle-Neal merger, but which wisely adopted Wells Fargo’s name and ye oldey stage-coachey, stolid Old West image.

Many other things also contributed to our Crisis, as others have noted.  By the by, Chairman Greespan kept rates wildly low after the 9/11 attacks, and early on the Bush Administration promulgated a regulation that preempted many state predatory lending laws (yay! won’t interest-only and negative-amortization loans be fun!?).  In 2004 the Net Capital Rule was relaxed.  From these actions, and many others, including individual greed and this horrible 2000 book, a hit which was in no small part about buying real estate, horror was born.  (Incidentally, the genius who wrote Rich Dad Poor Dad was all over the place in 2011 as a prepper talking about impending economic collapse.  That guy is a national emergency.)

What are the arguable lessons here?  1) it basically means squat whether banks and i-banks are combined; 2) it means a lot when one bank or investment bank gets so huge even independently that it can theoretically cause a systemic risk; 3) it means a lot when governments abdicate any responsibility to regulate the types of financial products consumers may be sold; 4) leverage is key — leverage, not the size the bank, is what kills a bank, and leverage combined with size may be what makes a bank “Too Big to Fail.”  The general theme is that too little regulation especially in regard to lending standards and leverage is horrible in the long run (including for bank managers and shareholders who think for awhile that they are Ayn Randian geniuses, until the bottom falls out).

Many of the above issues have been fixed. 12 CFR 560.2 was basically repealed by Dodd-Frank from its effective date.  We are implementing Basel III in large part (though it’s probably not stringent enough).  Renting is chic.  Etc.

But what hasn’t been fixed?  Allowing huge banks, even pure banks, to form via merger, banks that have trillions of dollars in assets, operate all over the globe, and that do form a systemic risk even if they never, ever even utter the word “investment bank.”

The problem of course is that it is very hard to split Bank of America into twenty or thirty banks (which is what it basically is an amalgam of, via merger).  It is very hard to split Chase into dozens of banks.  It is messy.  It looks like and is the heavy hand of government.  It’s “anti-market.”  It’s — you name it.  Not only that, but there is a sense it makes it harder for “our” banks to compete internationally (an idea that assumes it’s a good idea for any bank in the whole world to be that large).  The monkey is out of the bag and as a matter of political will we cannot put it back in again. 

So we won’t.  Instead Senators Warren and McCain have proposed a new Glass-Steagall, not a new Bank Holding Company Act.  In this way they can cater to her supporters, who basically adhere to the cliche of “Too Big to Fail” without knowing what it really means, and to his supporters, who hate them-thar Wall Street Fat Cats who got a bailout, which they no doubt wrongly think Obama gave.  But I digress. The long and short of it is, since almost everybody loves having fifty-state- and international-availability of ATMs, all from one bank (!!), we won’t solve the last best problem that got us into this fine mess.  Instead we will focus now for a time on a piece of window dressing that is easy to implement, sounds nice, and like most such things, does virtually nothing.

Jun 12

A Summary and Categorization of my Equity Holdings

It is important for me to try to practice what I preach about understanding why one owns certain holdings.  To that end I’m going to set down in pixels what is in my head about my stock holdings, in my self-directed accounts.  Like much of what I write, it is as much designed to clarify my own thinking and keep me honest as it is to be of any use to any of you.  What follows below is a full basic summary of my self-directed stock accounts — which includes my IRA and my online brokerage accounts.  In total, I am managing about $95,000 to $100,000 of my own money in this manner, constituting about 1/5 of my nuclear family’s net worth, of which $71,000 and change is in my IRA.  (Hey, we’re all about openness here, except for the pseudonym.)

A brief preliminary note:  I recently transferred two old 401ks totaling a bit over $50,000 to my IRA.  That money was fully invested, albeit some in bond funds, in those old 401ks.  The IRA to which that money was transferred is still about $25,000 in cash, meaning that my exposure to the market has actually gone down in the last two months.  I have been slowly phasing back into investment in the market.  This is for two reasons: 1) moving so much money to self-directed investment in ETFs and stocks and bonds reduced my psychological capital, so I am slowly phasing in to reduce the risk I will do something stupid (or do something stupid far down the road); and 2) as Tweeted repeatedly, I am very concerned about this market.  More than at any time in the last four years, I think the probabilities favor things other than investing in bonds and stocks.  Accordingly, I have reduced 401k contributions to my present-employer 401k as well, and am instead using that money to pay down student loan debt.  My returns over the past few years have far exceeded my student loan interest rates, and the long and short of it is that I am far from convinced that will be true in the next three years or so.  At the same time, I take a long view and am not really a market timer.  I don’t do black and white.  So I’m not selling out.  I’m comfortable with my equity holdings (and keep in mind we also have 401ks in addition to my self-directed money) taking a 30% temporary dive.  I would describe what I and doing as “recalibrating my emphasis.”

So here is a rough sketch of my holdings:

Hold Forever:  The first category of stocks are companies I reasonably think at this time that I can hold forever.  Some of them I have owned for a long, long time.  I have no expectation that these are going to light the world on fire, but they are incredibly solid businesses that give nice dividends or other benefits, and they form a sort of anchor for my portfolios.

These are, alphabetically, which years of purchase:  Berkshire Hathaway (2009, 2011 — $67/share yo!, 2013), Coke (2009), ExxonMobil (1998, 2010-Present), Johnson & Johnson (2009, 2011),  McDonalds (2009, 2011), Philip Morris (1998, 2012) and Proctor & Gamble (2008).  Of these, I have owned XOM and PM the longest — with original holdings dating to 1998 or so.  I also purchased a lot of new XOM stock in 2010 at great prices, and that stock is the only one of these that is in a “DRIP” account with Computershare. On all but BRK-B, which pays no dividends, I also reinvest dividends.  In Lynchian terms, these are Stalwarts.  (Though some would argue P&G has become a “Slow Grower,” and I’m attuned to that, though I do think its problems have resulted from a disastrously-“integrated” Gillette acquisition, which I am hoping recent activism will help fix.)


DRIP “Forever” Holdings:  XOM is a DRIP holding and could be put in this list.  But to me it is true forever stock.  I would sell the following stocks before I sold the above, though by the very nature of them being in DRIPS, they are long-term.  All of these DRIPS were initiated in November 2011, with $50 monthly investments since that time.

These stocks are Becton Dickinson, Lockheed Martin, and Union Pacific.  New monthly investments and dividend reinvestments in these stocks are essentially free, which is compelling.  I also like the businesses of each a great deal:  railroads have tremendous economies of scale and barriers to entry, Becton is a tremendously well run medical supply maker and dividend king (or whatever the present term is), and Lockheed, despite present concerns, is essentially a necessary phantom arm of the U.S. government, which optionality for when (not if) we get into our next likely-ill-advised war.  None are going anywhere.  In Lynchian terms, these are also Stalwarts, but excluding XOM, on a lower level than the above, because the in my view are on average more cyclical.  (Note as to my UNP holding that I also owned Burlington Northern before Berkshire announced it was buying it, and I think UNP is the second-best option and best publicly-traded option in railroads.  Some of my Berkshire shares are converted Burlington shares.)

Growth Investments in Which I have Tremendous Long Term Faith:  Value does not mean a low P/E.  Value means the stock is appraised for less in the auction stock market than the company is actually worth.  

In this category I have:  Google (Mid 2010, Mid 2011), Intuitive Surgical (Late Summer 2010), and Sodastream (Fall-2011).  Google may be the best-run tech company (and as prior posts have urged, tech remains one of the few remaining values in the U.S. market), Intuitive Surgical is a disruptive surgical robot maker with tremendous growth (and concerns about lawsuits are overblown in my present view), and Sodastream is a disruptive DIY soda maker.  I bought all at prices significantly lower than they trade at now.  SODA in particular was interesting, because in addition to fad/growth-through-new-doors concerns, it reported in Euros during the Eurozone crisis, and so traded like a Euro stock even as the American business was plainly exploding if you just took ten minutes to look at each quarterly report.

While I have a great deal of long term faith in these companies, I look more closely at them, because their business models are less ironclad.  I would not sell on temporary valuation concerns, but I would sell if I think my growth thesis is blown.  So far, it has not been.

Index Investments:  Approximately 30% of my self-directed funds are in Vanguard’s S&P index ETF, about 2.5% is in the Vanguard emerging markets ETF, and about 2% are in the Vanguard health ETF, VHT.  The 30% represents part of my concern about my psychological capital and understanding of individual stocks.  Accordingly, when I transferred 401ks to my IRA, instead of putting money into individual stocks right away, I put more than $20,000 into the Vanguard S%P ETF.  This may be a permanent holding, or I may shift some to individual stocks as I perceive value and feel comfortable doing so.  The emerging markets ETF and healthcare ETF are relics of when I was only managing a self-directed $30,000 on my own, when they constituted a higher percentage of my self-directed allocation.  I can see myself upping the emerging market’s ETF, particularly if emerging markets continue to tank.  The healthcare ETF is owned based on the continuing (though slowing) rise of healthcare costs in excess of inflation.

Value Investments:  I continue to think the most undervalue investable sector of the U.S. stock market is Tech.  (For example, I do not consider airlines to be anything other than “trading sardines,” as Doug Kass would put it, and since I’m not a short-timer, I have no interest in them.)  My thesis here for at least three years has been as follows:  1) people are still not over the psychological damage of the tech bubble, and these companies have been growing into their valuations for more than ten years and are now valued beyond their price, but people still hate them because they are “dead money” and 2) the failure of Palm and Blackberry has scared the crap out of people and they consequently hate the tech industry and since they don’t know who is going to win, the treat every company and every tiny misstep as a prelude to doom.  Not all are tech companies, however

Companies in this category, with years of purchases:  Apple (2011, 2012), Cisco (2010), Intel (2009, 2011, 2013), Microsoft (2009-2013), United Health (2010, 2013).  Microsoft has obviously (finally!) had a nice run lately, as has Intel and Cisco.  United Health has been a 100%+ beast for me, because ideologues (of which the finance industry has many) were so down on Obamacare.  (I love ideologues — they are like ATMs for people who can use their brains.)

Other/Dividend:  This is a catchall category.  In fact, doing this post has actually helped me see that the these may represent stocks I should consider selling.  However, I’ll add some nuance below.

These are:  Abbot Labs/AbbVie (2010, Early 2011), AT&T (Early 2010, July 2011), Walmart (2010, 2011), Parker Hannifin (2013).

AT&T has been nice for me, returning 72% or so with dividends and soundly beating the market, but its performance has deteriorated and I’m not convinced of it as a long-term holding.  I think the drastic undervaluation from probably gone.  I have been considering selling it for at least six months, but the dividend is still great, my cost-basis is spectacular, and in some sense I just haven’t been willing to upgrade it to forever status.  

Abbott Labs was a value play.  Remember back in 2010 when everybody had reversed their 2000-era euphoria about drug stocks?  Yeah, that.  I also also owned Pfizer, which I sold at a profit.  AbbVie alone now trades at close to the $47 I paid for a lot of my Abbott Labs shares.  I’m still letting this one play out in the wake of the split-up, but I’m not married to it.

Walmart, oh Walmart.  Two years ago I would have categorized it as a Stalwart.  Now, not so much.  The stock price had a nice run over the last year, and I am way up given when I bought it (I hold shares purchased in the 40s, and many more in the 50s), but two things have me worried.  First, the size of a company only matters insofar as it has filled its addressable market.  Contrary to what people often say, size alone does not mean returns will be low: like most unwise things, it contains a kernel of truth, but has been taken out of context and oversimplified.  The problem with Walmart is it has long-since picked all of the low-hanging fruit.  I see any growth here as basically being population growth + inflation, with some undetermined bonus for international growth in countries most of which are even more hostile to Walmart than the U.S. is.  Second, Amazon.  Amazon is the kamikaze bomber of retail.  It is the world’s greatest wealth-redistribution mechanism: from wealthy investors to middle-class consumers.  But nobody seems to care as long as revenue keeps growing.  It is killing many retailers, and it is and will continue to eat at least a portion of Walmart’s lunch.  I have my eye on this situation.

Parker Hannifin is a wonderful motion and control company.  This is a “starter position.”  I think sometimes you take a small position in a company you love just to incentivize yourself to pay attention to it and learn more about it, while waiting for a time when you can truly hit that thing.  PH makes all kinds of specialized stuff (pumps, valves, gears, fuel separatorts, etc.) you never see, but that goes inside larger systems that you or the government or defense contractors buy.  It is very well-regarded.  I only own a tiny position here, because the price is near an all-time high, but if the market tanks, you can expect me to back the truck up on this company, which I would describe as a small/mid-cap cyclical stalwart.