Tag: davidson

Should We Apply Wicksell Rate to Monetary Policy?

Post author By ToddSullivan
Post date March 2, 2009

“Davidson” took a stab at having an influence with the Dallas Fed using their own published data and their statement that Wicksell is the “Father of Modern Monetary Policy”. The following letter was sent..

To whom this may concern:

Below you will find a comparison of what I call the Wicksell Rate based on Knut Wicksell’s observation that the cost of capital is arbitraged on the Return of GDP vs. comparable fixed alternatives, namely the 10yr Treasury Note. I took the Dallas Fed trimmed mean12mo PCE values and added these to the long term trend line of the Real US GDP(2nd Chart) to produce the Wicksell Rate(1st Chart). The reason for using longer term trends is that business investors typically make capital commitments with 10yr time horizons and ignore year to year fluctuations.

I think this comparison helps to differentiate the enormous short term effect of market psychology which can be observed in the multiple deviations reflecting both periods of enthusiasm and gloom. Net/net the proper relative return relationship holds over long periods. Perhaps, one will find a better fit with changes in tax treatment of capital gains, but I am a lone practitioner and have neither the resources nor the time for extensive analysis.

I note that a better alternative for making the same point which would strip out the economic swings of earnings (because the market does look ahead on the expected returns on assets) is to use a 5yr MovAvg ROE for the SP500 and its P/BV multiple thus producing a ROE/(P/BV) = hypothetical Asset Based Return Yield.

Not all returns come from earnings. For instance, oil companies and real estate companies have asset gains due to inflation which are eventually converted to earnings at some point in the future in the form of higher rents or asset sales. This is less true of companies like GE and PG which have finished products with rising cost inputs but do not have the ability to convert the rising cost of production (rising value of factory equipment) into higher margins during inflation periods as do oil and real estate based businesses. The problem with this approach is that SP500 has to my knowledge stopped issuing BV information as it is deemed unreliable as a financial indicator. However, I think that as a gross measure of the asset base of the economy, I have seen from Ned Davis Research an avg 14% ROE and ~6.1% BV growth rate which is much smoother than the ~6.1% earnings trend you see below for the SP500(3rd Chart).

The point to be made is that Knut Wicksell had the correct observation in 1898 even though the tools for proving it were not available till much later. By using his observation a less volatile monetary policy should produce a less volatile economy, less volatile inflation, fewer economic headaches and Federal Reserve decisions with substantial genius.

It is clear to me that the activities of the Federal Reserve have proven to have been since the US Real GDP trend from 1930 very beneficial as a shock absorber. However, under the Greenspan years the availability of cheap money followed by comparable contractions has resulted in higher corporate earnings volatility(see 3rd Chart Earnings Trend Line)

I ask that you consider using the Wicksell Rate. I ask that you publish this for all to see so that corporate and investment decisions can be made with greater long term clarity. My suggestion is that in the current environment an immediate implementation would be disruptive, BUT, if you were to announce that you were going to work towards implementing Wicksell Rate as a policy over the next 5yrs-10yrs, I believe you would bring great clarity to many financial decisions as well as give all a period in which to make adjustments that would not be unduly disruptive. Importantly this would result in far less speculation as returns would have to breach the Wicksell Rate and all would realize that the cost to doing this would be considerably higher than with funds much lower. Perhaps it would also be helpful to dampen rampant speculation that the Federal Reserve promote the concept of “matching maturities” when investment commitments occur and recourse as opposed to non-recourse financing.

I think some of these suggestions would result in higher levels of individual discipline and common sense.

Humbly submitted,

“Davidson”

Disclosure (“none” means no position):

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"Davidson": Traders Rule the Moment

Post author By ToddSullivan
Post date February 24, 2009

He has a very valid point, there is no talk of valuation out there currently. That both creates tremendous markets swings and for the patient of us, tremendous opportunity.,

I thought that these charts (below) told the story of the credit freeze. I think the Traders rule at the moment. Valuation for the moment does not carry much weight. The forecasted earnings yield of ~8.6% 12mo forward for SP500 seems to stimulate some to forecast worse earnings than this in order to get their 20 secs on CNBC. I interpret these charts to indicate that it appears that earnings are forecasted to be well below the long term trend. I do have a chart that takes the earnings trend back to the late ‘40’s with what appears to be the same variance within the same channel at ~6% compounded for the entire period. Today forecasts are well out side the historical range.

To get a similar collapse of valuations in the past required a high rate of inflation, 1974 and 1982 both had 7 P/E’s and 12%-14% earnings yield range. This was required. I have observed that since 1978 when we have reasonably good data that the market requires a return that provides just over 3% Real Rate of Return. In 1982 with core inflation (see Dallas Fed trimmed mean PCE data 1982 inflation at ~9%-11% + ~3% Real Rate of Return = 12%-14%) in the 11%-12% range the SP500 earnings yield was in the 12%-14% range.

Over the past few months 12mos forward earnings yields have ranged over 11% to the current ~8.6%. The market appears to be pricing inflation in the next few years at the 5.5%-8% range or a period of earnings well below that which has been in place since the 1940’s.

I cannot forecast the future any better than the many professionals who are paid handsomely to do this. But, I do not think our national productivity, our willingness to work our desire put our kids through school and our general improvement of our condition has not changed from last year to this. My view is that the SP500 which represents some 90%+ of US public companies mirrors the results of these efforts. We can measure this with some certainty since the ‘40’s. We have certainly had many issues along the way. We have always recovered.

Disclosure (“none” means no position):

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"Davidson": Thoughts on "Fair" vs "Free" Markets

Post author By ToddSullivan
Post date February 22, 2009

Davidson has a very thoughtful pieces on markets, the government’s roles, investors and traders vs value investors.

Under the Bush Administration it would appear that “Fair Markets” which was the theme of Securities Act of 1934 and other responses to the events that produced the Great Depression became “Free Markets”. Free Markets which have little restraint become dominated by the avarice of the marginal investors who are bright enough to skirt all the laws then enforced to take undo advantage of all other investors who being responsible and in the view of these few operate within the doctrine of “Fairness”. The “Free Market” syndrome simply missed the fact that there are always individuals who will “game” the system and because they have greater resources manipulate markets for their own advantage knowing that most will follow a sense of “Fairness”. These few are not stupid people. They are very bright. Bright enough to understand the system, see its flaws and acquire the means by which to enrich themselves at the expense of others who believe in the concept of “Fairness” as originally conceived.

It would appear the April 28, 2004 SEC regulatory meeting much discussed today at which investment banks were freed to lever up to 40-50X was simply part of a general belief that “Free Markets” self-correct and self-monitor. Unfortunately what was missed is that this is only possible in a medium of complete and utter transparency. In fact, while we gradually forced Warren Buffett to expose his holdings thus taking away some of his freedom to move about the market place, we gave HF’s invisibility. We also gave these folks invisibility as to the new securities contracts they created with the incredibly wrong belief that they would self-monitor. Many including Alan Greenspan supported this construct.

“Free Markets” will never be completely transparent as individuals will always find a means to game the system dishonestly. This is why rules are necessary to make markets “Fair Markets” to all with the individual investors who are the fundamental base of all investing through their daily effort, their labor and creativity, to produce GDP. We lose sight that our economy and the stock and bond markets rest on the efforts of people earning a living. We lose sight of the fact that the investment markets are not a world unto themselves that can be mathematically analyzed and thrown in to formulas by which to create wealth. The investment markets are simply a representation of the productivity of our society. I like to think of the markets as a console full of dials. It simply measures the results of all the inputs to society as it pertains to our productivity. The markets reflect our hopes, our generosity, our legal system and our political system. The markets reflect our entire value system and how we organize our efforts to self improve.

Markets need to be “Fair” not “Free”. Transparency of every contract, every levered position, every trade and every association of one contract holder with another should be paramount. If there is an ability of one investor to gain advantage over another with secrecy, then there should be rules that forces this into the light of day so that we can determine if it is “Fair to Individual Investors”.

There should also be a “Recourse Rule”. If you buy a house today it is non-recourse to the buyer. It is up to the bank to have performed the underwriting to the level that assures safety of principle and interest. This lets single buyers own multiple homes to speculate without personal risk. We are all suffering today from the fallout of housing speculators who have walked away from recent transactions leaving our financial institutions with the losses. All obligations should carry some form of recourse to the parties involved. It would add personal risk to speculation and reduce the risk to us all. How this can be done regarding investment contracts and investment firms can be left up to them to develop a fair solution. The concept is that there should be some recourse to the individual who created the contract till the contract has terminated.

“Fairness” should be the rule-personal responsibility of behavior should be the goal. “Free Markets” leads to avoidance of responsibility. I liked Pres. Bush, but he simply got it wrong. This mess will be his legacy.

We have Traders and Value Investors. The former believes that price accounts for all information, Efficient Mkt Hypothesis. The latter believe in understanding a business and buy with cash flow, Owner’s Earnings and etc.

First, the Traders support Mark-to-Market while the Value Investors scream that it is a bogus benchmark. The Traders sell stock and if it goes down they say, “See!! If it goes down, it was meant to go down to find its real “value”!!” It is an amazing set of mental gymnastics that Traders use to convince themselves that “emotional pricing” of securities represents a valid method of “fair value accounting” for which Mark-to-Market was designed to effect.

Second, there are many, many more Traders with their simplistic approach and strong self belief/confidence than there are true Value Investors. It is easy to see that Value Investors do not by their selling create tops nor by their buying create bottoms. It appears to be more a factor that Traders simply exhausted their fire power. Where this level is I do not know. Unfortunately, “Mark-to-Market” is a destructive feed-back device. It supports erroneous contention reinforcing it’s own effect. It goes in the wrong direction till you reach such a silly level that eventually some percentage of Traders see the folly and an apparent “Value” becomes obvious. The snap back becomes very sharp.

I don’t know where that level is. Obviously this past week was not that level.

Disclosure (“none” means no position):

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Do We Get A "V"??

There is a growing chorus that feels the current situation will be resolved with a “V” recovery in which upside is a violent as the downside has been. To wit:

Here is the theory:

“Davidson” submits:

Wesbury has had this stance for some time. One way I would explain this is that this was not a consumer lead economic slow down. Consumers were actually still in good shape re: credit scores and could have continued to buy cars and houses if the lending institutions were lending. BUT, the lending institutions stopped lending and consumer sales hit a wall. Consumers do not stop dead this way, especially after nearly 3yrs of slow down that began at the beginning of 2006 in housing and autos. This whole slow down is an institutional/governmental heart attack on top of a normal slow down that began with the effect of Mark-to-Market on Lehman, AIG, Bear Stearns and then was kicked over the cliff with SEC Cox’ ban on short selling.

This has been such a misunderstood economic panic that was caused by first cheap money, then encouraged by political avarice, fostered by poor regulation and the incredibly stupid belief in the “Free Markets Self Correct” syndrome and then topped off by incredibly inane elimination of the “Up-Tick Rule”, the passive approach to naked short selling, the political decision to let Lehman fail so that Republicans could display some “Character?” during the Presidential election and the rest is history. The consumer was in fact OK till the credit markets and importantly the Money Markets seized with now bankrupt Lehman commercial paper.

Politicians and regulators just do not see that it is they who are the problem, it is they who have failed to act in accordance with the regulations that they passed. Politicians and regulators are looking for some one else to blame because they are so thick in the middle of causing this mess that I really don’t think they even have a clue as to what they have done. And they think that they are the solution to the problem??

The market is healing on its own. That this is occurring you can see from the rise in Treasury rates as funds flow into various market channels looking for opportunity. I watch with fascination the activities of Warren Buffett and numerous savvy investors buying up discounted assets especially real estate. The signs are there for all to see.

I am all in and have been since January ’09.

Could it be? Consider the following chart from Howard Lindzon

It shows, far from being an abnormality, “V” recoveries in equity markets are the norm. Now, the question we need to answer is “Are we at the bottom of the “V” or are we going down to a point between where we are now and the bottom of the 1931 “V”?”

The optimists will say we are at the bottom while the pessimist will say we will pass 1931. I lay not in either camp. My take is that we fall further then shoot up. How much further, who knows, and anyone who tells you they do is lying, they are guessing. My take is that based on the news flow and economics trends, which are still negative in the aggregate, more downside is in store. I know recent numbers have been encouraging but a month does not a trend make (nor does two).

In that vein, Henry Blodget writes:

Prof Shiller’s work (above chart) shows clearly that stock values are mean-reverting. The only trouble is the time they take to mean-revert. If things go badly over the next few years, stocks could bounce along the bottom for another decade or more.

For example, Jeremy Grantham, whose shop (GMO) produced the forecasts above, reminds us what happened in the 1970s:

“Today all equities are moderately – one might say, boringly – cheap. The forecast for the S&P has been jumping around +6% to +7% real, with other global equities slightly higher.

To put that in perspective, a 1-year forecast done on the same basis we use today that started in December 1974 would have predicted a 14% return (which, by the way, it did not deliver since the market stayed so cheap). For August 1982, the forecast would have been shockingly high – over 20% real! So do not think for a second that this is as low as markets can get. “

(It’s worth noting, though, that 1982 was the start of the great bull market. Jeremy also warns of the possibility of another sucker’s rally, so don’t get too comfortable waiting for the bottom:

“Now, I admit that Greenspan and 9/11 tax cuts caused the “greatest sucker rally in history” from 2002-07. We therefore cannot rule out another aberrant phase in which extreme stimulus causes the market to rally once again to an overpriced level for a few more years, thus postponing the opportunity to make excellent long-term investments yet again. But I think it’s unlikely. “

One thing seems certain: Stocks are cheaper now than they have been at any time in the past two decades. That’s encouraging for those with another couple of decades to invest and–increasingly rare these days–cash to put to work.

We’ll see….I think we have a bit deeper on the “V” to go..

Disclosure (“none” means no position):

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The Mark-To-Market Debate Continued

Post author By ToddSullivan
Post date February 15, 2009
2 Comments on The Mark-To-Market Debate Continued

A follow-up to last weeks conversation…

“Davidson” chimes in about the following piece:
“Wesbury had a follow-up to his prediction that last Monday would see some Mark-to-Market modification. He stated that Sen. Dodd had told him that this would happen and my guess that Wesbury was so miffed at being used as a trial balloon that he decided to reveal his source in this video. Keep up the pressure on this issue as the tide is turning I think.”

Disclosure (“none” means no position):

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"Davidson" Says: PG Is A Buy!!

Post author By ToddSullivan
Post date February 12, 2009

“Davidson” is back with a breakdown of Proctor & Gamble (PG)

He writes:
I calculated the ROE/Multiple of BV for PG from 2000 till the lastest Morningstar report. Gillette was bought in 2006 and it was a transition year which did not have simple year end values.

For the time period the Current Market Rate of Return has been between 5-6%. Currently the value is 5.4% and for a return that makes a LgCap equity attractive the average is 150% x CMRR = 8.1%

With PG about $52shr this makes it buyable for the 1st time in the last 10yrs. I have looked at the margins and have been very impressed with the debt pay down from 80% Debt/Equity in 2005 to 32% today, this company has very a conservative financial position and appear to have seen our current environment coming. Their business has been steady even during the last slow down 2001-2003. Business is international with a manageable commodity input cost.

He provides the following information:

Disclosure (“none” means no position):None

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Berkshire Now Just Might Be A Buy??

Post author By ToddSullivan
Post date February 12, 2009
8 Comments on Berkshire Now Just Might Be A Buy??

After a a year of saying Berkshire Hathaway (BRK.A) was no value, I’m thinking it just may be getting there.

In July 2008 I said:

Wholly-owned subs such as Shaw Industries, Clayton Homes, Jordan’s Furniture (the are 4 furniture companies), Benjamin Moore, Home Services and Acme Brick and directly tied to housing and will suffer in the downturn.

For all its holdings, Berkshire is essentially an insurance company. It has operated under “perfect” conditions for the last two years according to Buffett and eventually to run must end. Premiums are already falling and as houses are re-poed and fewer new cars are purchase, insurance premiums derived from those products will fall accordingly. I know people who are looking at homeowners and auto policies for way to decrease coverage and save money. Whether or not this is a good idea is irrelevant (I do not think it is), it is happening. Throw in a hurricane or two (we are due) and insurance could suffer quite a poor year.

For more on Berkshire’s insurance read this former post:

Back in March when shares sat at $133,000 I argued they were not a “value”. Today they sit at $111,000. Are they a value now? Perhaps but one also has to expect that the near term, if Tilson is correct is fraught with potholes for Berkshire and earnings ought to take a hit.

Based on that, share price ought to suffer also meaning you will probably be able to pick them up cheaper down the road. If I owned shares would I sell? If I needed the money in the next year, yes. If I had a multi-year time frame would I sell? No. If that was the case I would be watching down the road for a cheaper entry price, I think you’ll get it.

What has happened since then?

From Barrons:

Berkshire agreed to purchase $150 million of 10 1/8% notes due in 2015 and $250 million of 10 3/8% notes due in 2018 from Birmingham, Ala.-based Vulcan. The note sale was reported in late January, but Vulcan didn’t identify the buyer of the notes until Tuesday’s earnings conference call.

Other recent Berkshire bond purchases include $300 million of Harley Davidson Inc. (HOG) 15% notes due in 2014 and $150 million of Sealed Air 12% notes due in 2014.

These purchases follow big transactions in the fourth quarter, when Berkshire purchased $5 billion of 10% preferred stock from Goldman Sachs (GS) and $3 billion of 10% preferred from General Electric (GE). Both those deals came with a sizable amount of equity warrants. During October, Berkshire also bought $4.4 billion of 11.45% subordinated notes and $2.1 billion of 5% preferred stock issued by Wrigley, which was purchased by Mars in a leveraged buyout.

One deal that Buffett probably regrets is his agreement to purchase $3 billion of convertible preferred stock in Dow Chemical Co. (DOW) if it goes forward with its deal to buy chemical maker Rohm & Haas Co. (ROH) for $15 billion. Berkshire’s purchase is contingent on the consummation of the deal.

Buffett may be hoping that the deal dies, or that Dow comes back to Berkshire with more generous terms to get a larger investment from Berkshire if Dow goes forward with the deal. Dow is resisting completion of the transaction, arguing that the debt that it would have to take on would be ruinous financially. As it stands, the Dow convertible preferred that Berkshire agreed to purchase will carry an 8.5% interest rate and a conversion price around $40, way above Dow’s current share price of $10.

If we do some simple math, Bekshire has put roughly $17.9 billion to work at 10%. That will provide Berkshire $1.7 billion a year for the next three years (some of it may convert to equity at that point). When one considers Berkshire has earned $7.8 billion of the last 12 months (Q4 2008 numbers not released yet), Buffett’s recent moved will add 21% to those earnings.

Now, insurance. Yes as stated above, the party is over but, rates are scheduled for increases. As insurance companies look to cover losses in investment portfolio’s, the aggressive pricing that has taken place in the past few years will abate, causing industry rates to rise. Also, one should expect those insurance companies feeling the pinch to take fewer larger risks. Since this is an area Berkshire loves to play in, fewer players will mean stronger pricing power on the part of Berkshire.

We will not a resurgence to the “glory years” in insurance, but conditions for the first time in a few years will improve. Remember, Berkshire is essentially an insurance company, since that business seems to have stabilized, being the best of that lot, we must assume Berkhsire has.

Berkshire’s investment portfolio has been hurt this year by the weak showing of some of its major equity investments, Wells Fargo (WFC), U.S. Bancorp (USB), Kraft (KFT), Coca-Cola (K) and Procter & Gamble (PG). While prices here are depressed, there is no permanent impairment to earnings and that is a point being missed by folks. To believe these companies will be at depressed prices 3 years from now means the global economy will not recover. If you believe that, buying any equity is a waste of time.

Berkshire is big holder of those three companies’ shares and it also is short $37 billion of long-dated put options on the S&P 500 and other equity indexes. As the market has dropped, Berkshire has taken a charge to earnings (no cash) in the write-down of the value of these options. When the market rises, the opposite will happen (write-up). Again, to assume no improvement here implies US business is stagnant for the next decade.

Now, Berkshire is down roughly 33% since my fist post on it. The difference now is that several of its businesses are showing signs of life and Buffett has put billions to work at 10% vs the pittance is was getting previously in Treasuries.

The next piece of the puzzle is the Berkshire manufacturing businesses listed above. They will turn when the economy does. If you believe that is the 2nd half of this year, the time to buy is now. If you believe that is 2010, you have time to wait.

Will Berkshire go lower? I do not know but I do know that there isn’t a good reason for it to go much lower barring further dramatic worldwide economic collapse.

Time will tell but I think Berkhsire at its current levels do not have much more downside….

Disclosure (“none” means no position):Long WFC, none

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"Davidson" on Blankfein vs Westbury

Post author By ToddSullivan
Post date February 10, 2009
2 Comments on "Davidson" on Blankfein vs Westbury

Seeing the Blankfein piece in the FT against Mark-to-Market vs. Wesbury is the dichotomy of the market place. Those who believe in Efficient Market Hypothesis believe that price trend represent all the information available for a particular security. Mark-to-Market is valid in all environments for traders, technical and momentum investors. Efficient Market players have investment horizons from minutes to months. If they hold longer than a year, it is only due to a series of short term technical signals that reinforced holding.

The “Value Investors” on the other hand look for mispricing vs. fundamentals, i.e. discount to Book Value, Cash Flow or some other value parameter that is measurable and quantifiable. Warren Buffett is the prime example of Value Investing, the best known, but there are numerous others. However, the number of true “Value Investors” is far less than all other investors. Value investors investigate, analyze and parse a target company’s business till they are comfortable with the decision to commit funds at a level at which they feel an anticipated rate of return is likely to be had over a multi year period. It is not unknown for Value investors to hire investigators and analysts to look at each business site of a company’s operation, individual tax filings, competitors and vendor information in an effort to sleuth the locations of all values within a company. Value investors have an investment horizon that is typically greater than 5yrs.

Mark-to-Market accounting during down markets provides opportunities for Value investors. Their records are well known. There are no traders famous for their investment judgment over the same period of any well known value player.

Importantly, mixing Value investors and Efficient Market players (calling them investors is an abomination of the word) in the same room is like watching two vastly different cultures trying to communicate. They can’t. They are so culturally different that the terms, “value”, “return”, “analysis” which stand for defining action and criteria for one have no equal meaning in the other. What is even more bazaar is that in most instances they do not understand why they don’t understand each other as they each believe they are perfectly correct in their views of assessing investment opportunities.

I am a Value investor. There are truly very few of us vs. other investors. My guess is less than 2%.

Mark-to-Market accounting is an abomination of reasoning during periods of market disruption such as we just experienced when the SEC banned short selling. Unfortunately, there are more of them than us, but fortunately the market will and is currently righting itself even with the mistakes we have made and continue to make. Philosophically we need the majority of investors to not get it right so that us few can take advantage of the deep discounts not produced in any other way.

All will be well even if the current stimulus package is passed. It may just take longer.

Disclosure (“none” means no position):

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"Buffett Metric" Does NOT Say It Is Time To Buy $$

Post author By ToddSullivan
Post date February 9, 2009
6 Comments on "Buffett Metric" Does NOT Say It Is Time To Buy $$

So, there is a chart and a story going around regarding Berkshire’s (BRK.A) Warren Buffett that just does not jive to me. Hat Tip to “Davidson” for pointing bringing it to my attention..

First, here is the chart:

Here is the story that follows:

Fortune Magazine) — Is it time to buy U.S. stocks?

According to both this 85-year chart and famed investor Warren Buffett, it just might be. The point of the chart is that there should be a rational relationship between the total market value of U.S. stocks and the output of the U.S. economy – its GNP.

Fortune first ran a version of this chart in late 2001 (see “Warren Buffett on the stock market“). Stocks had by that time retreated sharply from the manic levels of the Internet bubble. But they were still very high, with stock values at 133% of GNP. That level certainly did not suggest to Buffett that it was time to buy stocks.

But he visualized a moment when purchases might make sense, saying, “If the percentage relationship falls to the 70% to 80% area, buying stocks is likely to work very well for you.”

Well, that’s where stocks were in late January, when the ratio was 75%. Nothing about that reversion to sanity surprises Buffett, who told Fortune that the shift in the ratio reminds him of investor Ben Graham’s statement about the stock market: “In the short run it’s a voting machine, but in the long run it’s a weighing machine.”

Not just liking the chart’s message in theory, Buffett also put himself on record in an Oct. 17 New York Times op-ed piece, saying that he was personally buying U.S. stocks after a long period of owning nothing (outside of Berkshire Hathaway (BRKB) stock) but U.S. government bonds.

He said that if prices kept falling, he expected to soon have 100% of his net worth in U.S. equities. Prices did keep falling – the Dow Jones industrials have dropped by about 10% since Oct. 17 – so presumably Buffett kept buying. Alas for all curious investors, he isn’t saying what he bought.

To examine this we need to go back the beginning.

One must remember that in the late 1960 Buffett closed the “Buffett Partnership” because at that time he felt “there were no values” in the general stock market. Yet, according to both the chart above and the story, Buffett would have been buying at this time.

If we fast forward to the mid 1970’s, a time when Buffett said he felt like “a guy in a whorehouse with a suitcase of cash” because stocks we so cheap, we see the above charts value level was actually below 50%. In fact, most of the largest positions in Berkshire’s portfolio, American Express (AXP), Coke (K), Gillette now PG (PG) and The Washington Post (WPO) were accumulted during this time. In fact, Buffett’s buying continued through the 1980’s and until the mid 1990’s when he then found equity values were overpriced, refrained from buying during the tech bubble and was called “out of touch” (he was later proven very right).

Again, looking at the chart we see during that at this time frame the chart values had crept back to the 75% level of the mid 1960’s when Buffett was a seller.

What is inmportant to note and what has been lost in the “Buffett is buying rhetoric” is that Warren’s three largest recent investments, totaling roughly $10 billion, Dow Chemical (DOW), GE (GE) and Goldman Sachs (GS) were NOT stocks purchases, they were preferred investments.

Essentially Buffett is betting their share prices will all rise, in the next 3 to 5 years, when the convertibles convert to common stock. Until then, he has a bond paying 10%. With Treasuries paying essentially nothing, Buffett has found a vehicle that pays 10% to park his cash.

Did Buffett pen the link article above? Yes. To be sure Warren is buying an interest in US companies as witnessed above, just not their common stocks (except Burlington Northern (BNI)).

Buffett’s preferred purchases are not an endorsement of cheap US equities, if anything it says he would rather be a bondholder than an equity one……for now.

Disclosure (“none” means no position):Long Dow, GE, none

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"Davidson": Panic at The White House

Post author By ToddSullivan
Post date February 8, 2009
1 Comment on "Davidson": Panic at The White House

My readers, named “Davidson” by me has submitted the following piece…

He writes:

The panic in Obama’s recent speeches as he attempts to railroad the Democratic spending bill is without thoughtful analysis. Unfortunately, this reflects the misunderstandings of his advisors who believe that throwing spending at the lack of liquidity is the solution.

How wrong can so many people be!!!

The issue is that Mark-to-Market is providing a false view of the value of assets. Brian Wesbury and others have suggested a “Cash Flow” methodology, i.e. if the debt security is paying its interest and principal streams then it should be valued according to the risk of non-payment along bonds that are paying. This is a simple model and one that can be trusted as it is based on the realities of commerce.

This does not require another $800bil of spending. This requires 20min of discussion and a flip of the accounting switch. We may need a few guarantees as well.

Just where do we get people who cannot see the simplicity of this! It is Mark-to-Market that has caused many $billions of write offs. These need to be reversed and then let the market pricing mechanism get to work.

It is frustrating to watch so much intelligence go to waste and even do great damage because they are panicked.

For more on mark-to-market, here is a post I wrote in March 2008.

Here is a bit of a rant I wrote on it in May of 2008

Disclosure (“none” means no position):

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Davidson Writes: "Was 2008….. 1987?"

Post author By ToddSullivan
Post date February 6, 2009

This did get me to thinking…….

There were many similarities, 1987 vs. 2008. To understand the dynamics will lead to understanding how a quick recovery is possible this time around.

Both 1987 and 2008 had a period of debt accumulation to enhance investment returns with leverage. Then it was a series of LBO’s. This time the debt was elsewhere but the main point is that part of the market was over-levered.

In 1987 the trigger for the crash was one Dan Rostenkowski, Dem-IL, Chairman of the House Ways and Means Committee, who angered that LBO’s were causing labor reductions to produce gains for the financially privileged introduced a retroactive tax law which would be in effect as of Jan 1 of 1987. This law if enacted would make all the year’s LBO’s uneconomical. It was changing the tax laws after much had occurred. He did the same in 1986 to completely rewrite the tax law as it pertained to tax shelters thus making them no longer as attractive and thus helped kick the S&L’s into a swan dive that resulted in a major bail out because the S&L’s had already closed on deals which now resulted in immediate losses.

The 1987 proposed legislation came out of committee late on Oct 13th, the market began to slide. The slide continued the 14th&15th (Thurs&Fri) but many were as yet unawares of the proposed law. They found out over the weekend as the news spread and a 10 sigma event began in Europe and hit us on Oct 19th with the help of “Portfolio Insurance” which was run by computers, never designed or tested for a massive sell off and in fact multiplied the sell off in the subsequent crash. Only one keen observer, Robert Bartley of the WSJ wrote about this at the time. The rest of the word did not understand what truly happened. A single individual had attempted to change the investment rules over night. Rostenkowski let the legislation die quietly.

The crash of 2008, i.e. what happened in Oct.&Nov., was also the work of one individual changing the playing field in a market already fragile. This was one SEC Chairperson Chris Cox who had eliminated the short sale rule saying he did not have the capacity to monitor the market in June 2007, then decided to ban the only defensive tool HF’s had to limit portfolio volatility w/levered positions of 20:1. He banned short selling. Now the HF’s were forced to sell levered positions outright, banks called margin for fear of losses and the market hit a vacuum. Cox changed the playing field and the participants had to adjust as quickly as possible. Just as in 1987.

Most will not see it this way. Most will point to the build up of debt in HF’s, sub-prime lending, the extraordinary period of Greenspan’s cheap money, the mistakes by certain regulators, the avarice of certain politicians and the mortgage agencies, but this was not an economic collapse. This was an economic slowdown and had begun at the end of 2005 when auto and home sales had peaked.

We were in an economic slow down with financial institutions at risk and we were in an orderly correction when Cox changed the rules and the wild collapse shattered investor confidence.

What we have today is shattered trust. No one knows what the rules are at the moment. It is not that liquidity is not available. It is that liquidity is not moving about the system. People with reasonable credit scores cannot buy cars or houses at the moment because of the fear of the unknown that was inspired by Cox’s single thoughtless decision.

Yes, jobs are being lost not because individuals are over levered, but more because of the fear of lending the copious funds that are available. Ah yes. There is also the issue of the Mark-to-Market rule that was never expected to see an overnight change in value as we have seen. Cox should have suspended this but did not. Mark-to-Market was meant to be a helpful investor tool in an orderly declining market place, something to keep the financial institutions honest. When Mark-to-Market valuations are registering default levels for perfectly healthy securities then you know the rule should be modified.

Much of the value destruction today is the result of accounting rules designed for a functioning market pricing mechanism meeting a frozen market pricing mechanism because one person changed the playing field.

This is not a Depression and does not even have to be a Recession. It is solvable. The rules have to be modified to produce fair valuations and to get pricing mechanisms working again. The head of the SEC can do this. It is quite simple.

Trust is what is missing. We need to revive it.

“Davidson” is the pseudonym for a reader who must remain anonymous…..

Disclosure (“none” means no position):None

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Davidson Writes About Treasuries & What They Tell Us

Post author By ToddSullivan
Post date February 5, 2009

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I have named my optimistic and very intelligent new writer “Mr. Davidson”. It is a brilliant pseudonym and maybe someday I will be able to explain it.

Davidson Writes:

If you learn the effect of psychology on markets you will come to know that you cannot predict bottoms or tops. These are unpredictable turns in market psychology and is directly tied to the use of margin in how fast greed can turn to fear. No one has a handle on this although many claim to have modeled some market behavior or other only to have a 10 sigma event prove the model wrong. Long Term Capital is the most well known, but lately the market is strewn with disproved models. AIG hung its hat on a model by a Wharton/Yale professor and “poof”

You cannot model human behavior. You can observe, you can place a historical deviation to it, but you better not hang 20xleverage as so many have done and lost.

There is no better indicator of market psychology than the Treasury yield chart. All maturities are rising. This reflects substantial flow of funds into other opportunities. If fear still ruled, you might see the longer term maturities rates rise while the T-Bill rates remained low or even turn negative once again. Not so. All maturities show fund outflows. THIS IS THE TURN!

Buffett recognizes this among others.

He also provides the following chart:

Of it he says:

We have already witnessed a return to par of the LQD ETF(Invest Grade Corp) and a substantial rise in the HYG ETF(HiYield Corp) as well as rises in all the indices since November. House sales appear to be finding a bottom, The insider buying is extraordinarily high, investor and consumer pessimism at record 30yr+ levels, savvy investors announce new commitments(Buffett, Ackman, Berkowitz, Cumming and many not as well known) weekly.

Changes are there for all to see if only they would give up listening to the endless stream of negative headlines. Markets turn without fan fair in the gloom of pessimism. I think the best time is to invest is now.

Treasury rates are rising across all maturities as this chart from Don Hay’s recent note indicates. The best interpretation in my opinion which has been offered by only few observers thus far is that capital is flowing from Treasuries to other parts of the economy and securities markets. The desperate hoarding of cash that has been a hallmark of the current economic slump is diminishing in my view.

I remain positive that the current financial issues will be resolved and that this chart provides strong evidence for this.

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Tags ackman, buffett, davidson

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Warren Buffett Likes Bacon

Post author By ToddSullivan
Post date February 3, 2009

Berkshire Hathaway (BRK.A) has purchased $300m of Harley Davidson’s (HOG) debt. The real news is he is getting 15%, so much for credit “loosening up”.

Disclosure (“none” means no position):Long HOG

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What To Buy? What Doesn’t Need Credit?

Post author By ToddSullivan
Post date January 23, 2009
4 Comments on What To Buy? What Doesn’t Need Credit?

As I look at the universe of stock I watch, one thing keeps coming to mind, who’s business does not rely on consumer or corporate credit?

Today GE (GE) reported:

Fourth-quarter 2008 earnings from continuing operations of $3.9 billion, or $.37 per share before preferred dividend, or $.36 per share attributable to common shareowners. Results included $1.5 billion of after-tax restructuring and other charges, including increased reserves in current environment, which are above the Company’s original plan and the restructuring will lower costs for 2009 and beyond.

For the year, revenue was $183 billion, up 6%, and earnings were $18.1 billion, down 19%. This was the third highest earnings year in GE history.

“In a very tough environment, we delivered fourth quarter business results in line with expectations we provided in December,” Chairman and CEO Jeff Immelt said. “We grew Infrastructure and Media by 3% in the quarter and 10% for the year. Energy Infrastructure led the way in the quarter with 11% segment profit growth driven by continued global demand. Technology Infrastructure grew earnings by 1%, led by 21% growth in Aviation. NBC Universal segment profits declined 6% in fourth quarter as strong cable earnings were offset by declines in the local stations.

“Capital Finance earned $1 billion in the quarter and $8.6 billion for the year,” Immelt said. “We had several negative impacts to earnings in the quarter including increased loss reserves, negative marks and impairments. These charges, along with global benefits, generated a tax credit that more than offset our pre-tax loss. We also originated $48 billion of new assets in the quarter at solid margins.

“We run the company to have a Triple-A credit rating, and we have significantly strengthened our liquidity position,” Immelt said. “We generated $16.7 billion of industrial cash flow from operations, up 5%. We ended the year with $48 billion in total cash, after paying down our commercial paper balance to $72 billion from $88 billion at the third quarter. We used $5.5 billion of our equity offering to meet our stated GE Capital debt-to-equity leverage goal of 7:1 by the end of 2008. Through today, we have been able to fund $29 billion of our $45 billion long-term debt needs for 2009.

Also, Harley Davidson (HOG) reported:

Decreased revenue, net income and earnings per share for the fourth quarter of 2008 compared to the year-ago quarter. The Company said it plans lower motorcycle shipments in 2009 and made public its overall strategy to deal with the current economic environment.

“We have a strong core business anchored by a uniquely powerful brand, but we are certainly not immune to the current economic conditions,” said Jim Ziemer, Chief Executive Officer, Harley-Davidson Inc. “We have a clear strategy to not only deal with the economic conditions, but also strengthen our long-term operations and financial results. We are executing that strategy with confidence and conviction.”

Fourth-Quarter and Full-Year Results

Revenue for the quarter was $1.29 billion compared to $1.39 billion in the year-ago quarter, a 6.8 percent decrease. Net income for the quarter was $77.8 million compared to $186.1 million in the fourth quarter 2007, a decrease of 58.2 percent. Fourth quarter diluted earnings per share were $0.34, a 56.4 percent decrease compared to last year’s $0.78.

Revenue for the full year 2008 was $5.59 billion compared to $5.73 billion in 2007, a 2.3 percent decline. Full-year net income was $654.7 million, compared to $933.8 million in 2007. Diluted earnings per share were $2.79, a decrease of 25.4 percent compared to $3.74 in 2007. The full-year results are below the previously provided company guidance.

For the full year, wholesale shipments of Harley-Davidson® motorcycles were 303,479 units, an 8.2 percent decrease compared to 330,619 units in 2007.

2009 Shipment Plan, Gross Margins

In the first quarter of 2009, the Company plans to ship between 74,000 and 78,000 new Harley-Davidson motorcycles, a 3.0 percent to 8.5 percent increase versus the first quarter of 2008. However, for the full year 2009, the Company plans to ship between 264,000 and 273,000 new Harley-Davidson motorcycles, a 10 percent to 13 percent reduction from 2008.

“We reduced our production levels prudently in 2008, helping our dealers achieve lower inventory levels,” said Ziemer, “and we’re going to show similar discipline in 2009. That’s not only critical for the health of our business, but for our dealers’ businesses, as well.”

For the full year 2009, the Company expects gross margins to be between 30.5 percent and 31.5 percent, which compares to 34.5 percent for the full year 2008. The decrease is primarily due to an expected unfavorable shipment mix versus 2008, the allocation of fixed costs over fewer units, and expected unfavorable foreign currency exchange rates versus 2008. Given the volatility of the current economic environment, the Company also indicated it would not provide EPS guidance for 2009.

Strategy for the Current Economic Environment

The Company is executing a three-part strategy that includes a number of measures to deal with the impact of the recession and worldwide slowdown in consumer demand, with the intent of strengthening its operations and financial results going forward.

“Our strategy is focused on three critical areas: to invest in the Harley-Davidson brand, get our cost-structure right, and obtain funding for HDFS to help our dealers sell motorcycles and our retail customers to buy them,” said Ziemer.

They both run the gamut of customers, GE more corporate and HOG pure consumer. Both are great companies and both are struggling while still profitable. Long term both will be just fine. BUT, this year, I think significant downside is possible. Now, that only means a fantastic buying opportunity later, not the end of the world.

One of the best traders I follow sees GE hitting $7 or $8 in Q2. Here is UpsideTraders site. Should GE be forced to cut the dividend or lose its AAA rating, this is all but assured (that and Immelt is out of a job). As much as GE says it will not, they also said full year earnings were “in the bag” when they were not. Until they fix the credibility problem, anyone saying anything from Fairfield will be look at very skeptically.

That being said, even if they cut is 50% to $.62 annual, at $8 a share that is a nice 7% yield, still a screaming buy. I just cannot commit new money there now until I get some evidence to the contrary.

HOG is the consumer, simple. The consumer is not going to be bailed out this year. So, because of that, we should not expect HOG to be. BUT, should it continue to drift into single digits, not buying it for an IRA to tuck away would be very difficult. They still are the best at making a one of a kind item and have brand loyalty like to other (until I see the Apple (AAPL) logo tattooed on folks, HOG has them beat). That being said, once credit issues are resolved, one can expect good results to follow immediately.

So then, what? Stuff in the ground, oil (USO), (DBO), (DXO), gold (GLD), (UGL) and silver (SLV). We need all three, they do not need credit for their value (one could argue tighter credit is a positive here, miners cutting back due to lack of credit decreases supply, bullish for prices), and are necessary.

Yes, as the economic recession has slowed demand for all, BUT, supply is also being taken off the market almost as fast AND demand will resume well before the current production being taken off the market can catch up. That means a spike in prices.

For all three there is also the specter of corporate and government debt and possible worldwide defaults. Mish says that there is a crisis looming and that currencies will take the fall. Gregor McDonald says that when that happens, money will flow to currencies without borders or governments, gold, silver and (maybe) oil.

Cash is not such a bad thing to have right now. Think of it this way, if deflation is running 2%, and you can get 2% on a CD, that is a real return of 4% in purchasing power. That and locking it up for 6 months might stop us from doing something dumb with it…

Either way, I think one has to think that something dramatic is coming….one way or another..

Disclosure (“none” means no position):Long GE, DXO, none
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Articles

Harley Davidson Seeks Loan Guarantee’s from FDIC

Post author By ToddSullivan
Post date January 20, 2009

This is just too much…

Sen. Bob Casey Jr. (D- Penn) has asked a federal agency to find Harley-Davidson (HOG) eligible for funds handed out under a federal bailout for financial institutions. In a Jan. 16 letter to Federal Deposit Insurance Corp. chairman Sheila Blair, saying Harley-Davidson recently inquired whether its financing company and subsidiaries — Harley-Davidson Credit Corp. and Eaglemark Savings Bank — are eligible for the Temporary Liquidity Guarantee Program, or TLGP.

“Without access to TLGP, Harley-Davidson may be forced to make tough decisions that will impact workers in Pennsylvania, jeopardize the local economy … and negatively impact the state economy,” Casey wrote in the letter. Casey said he wants to do everything possible to make sure Harley’s financial arm has access to help if it’s eligible.

He said the problem with the economy is related to credit, and Harley’s participation in the program would allow more people to get Harley loans to buy motorcycles. “Without the determination (of eligibility) made, it puts their financing company in a much more precarious situation,” he said.

In October, in an attempt to improve confidence in the banking sector and to improve liquidity for banks, the FDIC started the program to guarantee newly issued unsecured debt of qualifying institutions and guarantee certain noninterest-bearing accounts.

Guarantee debt: Harley spokesman Bob Klein said the program would guarantee unsecured corporate debt against default; Harley would only get federal funds if a customer defaulted on his or her motorcycle loan.

Klein said the TLGP is one of several options that Harley-Davidson’s financial arm is pursuing “to ensure continued funding of its lending activities” in a challenging economic environment. Lower consumer confidence has affected the motorcycle industry, he said.

The Wisconsin-based company told elected officials in Pennsylvania and Wisconsin about its plans to seek inclusion in the program, Klein said. The company appreciates Casey’s support, he said.

A recent dealer survey shows that year-over-year retail sales appear to have softened from the third quarter, when Harley-Davidson reported a 15.5 percent drop in U.S. retail sales. The company is expected to report fourth-quarter results Friday.

Now, this is government programs run amok. It is one thing to backstop the debt of the compnay to lower borrowing costs, but to backstop its customers? Insane…

Do we really expect corporations to increase lending standards in an effort to avoid another fiasco like we are going through when taxpayers are backing the loans they are making now? Do we really?

What’s next, guaranteeing the debt we use for dishwashers at Home Depot (HD) or Sears (SHLD)?

Disclosure (“none” means no position):
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