Category Archives: Lens grinding

Buy and hold no more?

Baruch has long held that the academic finance industry has produced nothing of lasting worth. Or at least nothing that has helped anyone make money consistently, which is, after all most of the point of the exercise, isn’t it? In fact the impact of the academics on markets has probably been on balance pernicious, contributing to overconfidence, instability and perdiodic crisis as much as it has shed light on the inner workings of anything. I’m thinking of course of Black and Scholes, portfolio insurance, hard Efficient Market theories and the large number of ” new paradigms” we have had in the past 30 years, which invariably ended in disastrous crashes, with yet looser money in their wake and another round of inevitable “new paradigms”. All of them, I guarantee you, had the solid imprimatur of some finance professor somewhere or other.

It is not all hopeless, however, because the academic study of finance has also produced Andrew Lo, whose “adaptive market hypothesis” seems to Baruch to sum up better than most how things actually work. Insofar as Baruch understands it, the general idea borrows from biology and behavioural economics. It is that markets are crucibles for evolution and adaptation, like an ecosystem, and while they can be efficient they are so only periodically and then only in bits. Strategies that work well will only do so for a time; only punters able to identify changes in the environment rapidly enough and (more difficult perhaps given the current animus against “style drift”) able to adapt their style of investment to profit, or at least not blow up, will survive. That, by the way, survival, appears to be the name of the game in the adaptive market; sticking around long enough to make it to retirement. It’s not an easy place to hang out in. As Spinoza was fond of saying, we also know this from experience to be true.

The point is, I always watch out for something from Lo and read it avidly. I was therefore very surprised to find myself disagreeing with something he was saying in an interview with CNN Money (HT I am sure either Josh or Tadas, like everything else), which was that the increased use and democratisation of technology in financial markets has led to higher levels of volatility and instability that make “buy and hold” no longer viable:

Buy-and-hold doesn’t work anymore. The volatility is too significant. Almost any asset can suddenly become much more risky. Buying into a mutual fund and holding it for 10 years is no longer going to deliver the same kind of expected return that we saw over the course of the last seven decades, simply because of the nature of financial markets and how complex it’s gotten.

Baruch worries that Lo, while likely spectacularly right in general with his highly convincing theory, may be wrong in the particular here.  Continue reading

You don’t WANT to be making iPhones, really

Last week’s hairshirt NYT piece got a lot of attention — it was AR’s lead link on Sunday and pointed at by Josh, Reformed Broker,  — bemoaning “America’s inability” to manufacture or assemble iPhones and other electronic gizmos. However, it entirely missed the point, thinks Baruch. It is always en vogue to bemoan one’s own nation’s manufacturing competitiveness, in the case of Southern Europe, possibly fairly. But most of the time it ignores the great dynamic of economic development, that as economies increase in wealth, intellectual property and sophistication, pure manufacturing becomes less and less attractive an activity. America has the most sophisticated economy on the planet; the idea that it is bad that people who participate in it no longer fit bits of plastic together is a wrong one.

The other point that the article makes rings truer, that making iPhones isn’t much fun:

. . . Apple had redesigned the iPhone’s screen at the last minute, forcing an assembly line overhaul. New screens began arriving at the plant near midnight.

A foreman immediately roused 8,000 workers inside the company’s dormitories, according to the executive. Each employee was given a biscuit and a cup of tea, guided to a workstation and within half an hour started a 12-hour shift fitting glass screens into beveled frames. Within 96 hours, the plant was producing over 10,000 iPhones a day.

Assembling iPhones is a repetitive and gruelling manual job. It is hard on the eyes, on the stamina and probably on the spirit. The majority of the workers at the Foxconn (also known as Hon Hai) plant are young, resilient recent immigrants to the city, for whom the alternative to doing this is working on the family smallholding or some other menial job in the Chinese boondocks. They don’t need engineering degrees, though do need skills and motivations I and probably a lot of Americans don’t have, e.g. being able to put small parts together in exactly the same way, again and again for hours and hours all the while standing up, Don Rumsfeld like. Being in a position where you can be woken up at 12.30 am to do a 12 hour shift fortified only with a biscuit and a cup of tea is not something I would wish on my fellow countrymen — at least not all of them.

I don’t think the NYT seriously wants their fellow Americans to work like this either (and by the way, since when was a foreman’s job on an assembly line “middle class”?). It’s the sort of thing workers in developed countries stopped doing since the 1970s and 1980s, and trades unions have been fighting against for decades before. We shouldn’t go back.

Don’t get me wrong — I don’t disparage the necessity of mind-numbing manual work, I certainly don’t look down on those who do it, nor hate the bosses who oversee them. It is a fact of life. However, it has to be for something worthwhile, however, and in large part I think it is in the case of Foxconn and Apple. For the Turkish and Greek Gastarbeiter in Europe in the 1950s and 1960s factory manual labour was a stepping stone to better things, and similarly, one hopes the Chinese building iPhones will be able to save some money to take back home or stay in the city to start a business, get married and educate some (well, typically only one) kids, or, at worst, buy an xBox. You have to look at the alternatives open to the people doing the work; for a Chinese late teen or 20-something the more realistic alternative to the Foxconn plant is a life of rural toil, tedium and poverty. For the average US teen it would be college (and some debt) and/or relatively bearable job in a service industry, possibly cutting hair. The American shouldn’t have to compete with his Chinese counterpart — the menu of his or her life choices is so much richer.

The other idea implicit in the article I have a problem with is that iPhones and the physical location of the plants that supply them have disproportionally favoured the Chinese economy over the US. Well, when it comes to assembly, the amount that stays in China is an infinitesimal fraction of the total added value of an iPhone. Foxconn earns something like a 5% gross margin and a 2-3% EBIT margin on its assembly business and for business from Apple it might even be less. Indeed, some analysts think Foxconn only earns a positive margin because it can throw in a few components of its own into the deal. Its notable that no-one else has ever been able to take any of Apple’s assembly business from Foxconn. Many have tried and lost money, such are the competitive razor thin margin this business operates at.

Compare that to the 30% to 50% gross margins (and 20-30% EBIT) a semiconductor supplier earns selling a chip into the iPhone — almost all the semi content in the iPhone is from US companies, and by no means not all the chips are fabbed in China, although I agree with the article that many are. I’m not even talking about the great margins that a software company selling code into the iPhone foodchain makes, nor the insanely great margins Apple operates at, just the hardware foodchain. Which part of that foodchain does the NYT really want American companies to be at?

My final comment is that the article ignores the flipside of the equation, the dual nature of employees like Eric Saragoza, the mid-level Apple engineer who  got laid off in 2002. Scant comfort for him of course, but he is also a consumer. The huge benefit of the constant price down in technology is that consumers get to be able to buy amazing, life changing products at increasingly affordable prices, while incentivising the companies who make them with great margins. iPhones and iPads have changed my life moderately, but have transformed the lives of millions of people in a more profound way. This is what technology does, and I don’t know another way of ensuring that it happens. Very often the ability to make something new and useful for significantly less is just as impactful as the ability to make that new and useful thing in the first place — it opens the door to new business models, to new uses, to things the inventors may not have dreamed of. Look at Tim Berners-Lee and the internet*. Benefits like these are immeasurable and general to all, and you only notice what happened later on, while Eric Saragoza’s job loss was immediate, specific, and personal. It makes a good, heart rending story. “Everything is slowly getting better for most everyone” should make a good story too, but in practice will be less affecting, and get fewer links.

Baruch is not an American and the decline of the middle class there is not his uppermost concern; in fact he cares as much about the Chinese factory workers toiling away at Foxconn. He thinks the dynamics of what the NYT is writing about is actually fantastic for almost everyone, and actually strengthens the global middle class by adding more people to it, in China. This is wholly a Good Thing, for all the problems we actually should be concerned about, like war, poverty, the environment, healthcare, education and the personal outcomes of ourselves and our fellow humans, all these things are mitigated by expanding the middle class, because only people with some disposable wealth of time and income are able to think about them.

* You think he ever thought he would end up using his invention for finding Angry Birds cheats like the rest of us? Of course not.

 

 

Do let’s be optimistic . . . even if we don’t feel like it

 

Tis (or, by the time I finish this post, ’twas) the season for pundits to give specific predictions for 2012 and a more pointless exercise has yet to be devised. Baruch isn’t going to waste your time doing this, for various reasons. The main one is that Baruch has long been convinced he is almost always wrong about almost everything. His only solace (and it is a big one*) is that everyone else is always wrong as well, and unlike him they don’t know it.

This year prediction seems a lot more difficult anyway. If Baruch is at all representative of bien pensant investor opinion the overriding emotion among practitioners today is a lack of confidence in anything, especially themselves. This is because almost without exception everyone traded like an idiot in 2011, both on the hedge fund side, where “slightly down” is the new “up”, and on the side of benchmarked long only funds. As you may know, Baruch is a professional investor and helps run one of these latter things. Looking at his peer group he is amazed, despite a mild underperformance, to find himself firmly in the top quartile in YTD relative returns. Despite this, he feels like a schmuck. How much worse must the average PM have fared, he asks himself. Just why has everyone done so badly this year?

Baruch has some ideas about why this is; a lot of it can be put down to the narrative of the year and investor positioning.  Overall, the majority of the active management community were extremely badly positioned for the key moves in the market in the back half of 2011. They were mostly long for the big August swoon associated with the US credit rating cut, and many compounded this by adding exposure into the decline too early — catching falling knives, in the parlance. Having finally understood the appalling ramifications of the European debt crisis, investors were nice and short, or in cash, for the quick but steep October rally that brought the major indices almost back up to the point at which they had broken down back again in August. Shellshocked, with what seemed had seemed a decent year now in tatters, all they were able to do in November and December was curl up in a foetal position, to derisk, and hope the kicking stopped.

A time of derisking, by the way, is a terrible time for those who are not derisking to make money. It means PMs selling positions that they like, and buying the ones that they hate. If everyone is doing this it makes for the market of Bizzarro World, where down is up and up is down. Good stocks, at best, make no traction, while bad stocks are likely to squeeze. November and December were marked by this worst of enviroments, what Baruch calls “high amplitude chop”. This had the effect on putting the kibosh on the few players left who still had any profits, and who had thus been less inclined (the fools) to join the mass huddle.

By the end of 2011, then, the performance-led derisking must have been largely complete, and at least some investors, if not the majority of them, are probably looking at trying their luck in a new year, with slates wiped clean, and having another go at earning those management fees again. Indeed the last datapoint in 2011 from ISI, who tracks these things, had the gross at hedge funds (a measure of how much of their capital they have deployed in short and long positions) at the same level as June 2008 — ie very low, crisis levels. Not at all what you would expect at the end of a year in which the S&P was only flat.

Just off that then, it would seem that maybe we don’t have to worry too much, and we could have a return to something approaching a normal environment where active management works again. In fact it is necessary to be mostly optimistic in this business, as a general rule. But then again I suspect I am merely trying to reassure myself because while people may be underinvested, there is also a very high degree of nervousness out there. It won’t take much to bring us back to derisk mode again, and if 2012 is another chop-filled  year like 2011 for active managers, well the only people who are going to be happy are the indexers. And they’re the enemy.

I would like to end the blogpost right there, and not talk about the things which are actively making me worried, such as $200bn in dodgy European sovereign paper to roll over, the apparent Chinese slowdown, nasty commodity trends and record high corporate margins etc etc, because thinking about these things makes me stressed out.

Happily, others have done that better than me**. So I sign off and wish my reader(s) a very happy and prosperous new year.

* knowing that whatever thesis you have in your head is likely to be wrong makes it much easier to discard it when it gets falsified, or when you think of something better. Knowing also that you are really quite thick makes it harder to worry about looking stupid (why live a lie?), and more money is lost trying not to look stupid than in any thing else you are likely to do in the stockmarket.

** Baruch is not sure whether The Interloper makes him want to retire from blogging or want to blog a lot more. Either way, it is grand he is around to be read. If he wants a hand on Euro Telcos he can drop me a line.

The Beginning of the End of the Euro Crisis?

Baruch has been a student of the wondrously dysfunctional Greek
political system long before it became fashionable, and is surprised at the
sudden relevance of what he had always thought to be rather interesting, but
not particularly useful. No longer – Greek politics is currently at the centre
of the world. What is upsetting, however, is that most everyone inside and outside Greece seems to disagree with him about what happened last week. Far from being a calamity exposing the weaknesses of the latest bailout package, Baruch thinks the ramifications of the call by Papandreou for a referendum are deeply positive. Merkel and Sarkozy, and the rest of us, should actually be grateful to him for heading off in Greece what is frankly the
biggest risk Europe and the global economy faces – political risk; specifically
“austerity ennui” on the part of the population, and pandering politicians
eager to exploit it.

Baruch is also unamused by the people who are watching what appears
a train wreck with barely disguised glee, rubbing their hands in anticipation
of the Euro’s supposedly imminent demise, starting of course with the ejection
of Greece. Your celebrated correspondent has no particular love for the common
currency, not least the silly name (“Euro-“ is a prefix, he has always thought),
but once in, the likely costs of leaving are so awful as to make it imperative
to stay in. In the case of Greece, were it to drop out of the Euro, we would be
talking about the instant impoverishment of a modern democracy, whose citizens’  life savings would be wiped out (apart from the  very rich who are able to have accounts abroad, take that, Gini co-efficient!) and the bankruptcy of every exporting enterprise. There would be mass unemployment. Imports such as energy and medicines would skyrocket in price, creating shortages; basic services would likely break down. People would die. It would be less like Argentina, more like post WW1 Germany, or maybe Eastern Europe after the collapse of communism.

Within the living memory of politically active people Greece has fought a bloody civil war, and flirted with fascism. European leaders should probably pause before inflicting this sort of stress on one of the most politically dysfunctional and divided states in Europe, a relatively big fish in the Balkan backwater, itself no stranger to conflict.

Seriously, I wouldn’t want this Pandora’s box opened even
if I was short the Euro, which I am not and which I happen to think may be a
quite bad idea if you want to make money in the near future. Yet never mind the
Eurosceptics who are actually looking forward to it, everyone else seems to be
fairly resigned to it as well. Even clever people. Felix, for instance, sees a “chaotic collapse” of Greece as “inevitable”. Josh Brown cheers him on.

I think the very awfulness of what will happen if Greece is ejected from the Euro in a messy way (and until the treaty is changed there isn’t really another way it can happen) actually makes it more likely that it doesn’t happen. No matter how nasty a generation of austerity may be, it is a walk in the park in comparison with the likely alternative.

And that realisation may just have dawned in Greece last week. Continue reading

Homicidal zombie markets reconsidered

Baruch received old media brickbats for his bloggy frettings last year about the impact and meaning of QE2. At the time, while understanding why people thought it was necessary, he worried that we were opening a can of worms which were going to wriggle off in all sorts of undesirable directions. He wrote:

in his darker moments that Baruch thinks a very good analogy for where we are right now is Pet Sematary. The people who buried their cat (and later their son) in the Indian burial ground to bring it back to life got something which looked ostensibly like a cat, but was so only on the outside. On the inside their little puddy tat  was really an undead homicidal zombie cat, as became clear through its increasingly odd behaviour. Unintended consequences followed (mayhem, murder, horror, the Wendigo — all that Stephen King stuff).

The Bernank is like the guy who buried his cat, but in this case instead of a resuscitated cat he wanted his rally back, a healthy stock market and the wealth effect that would bring. I worry we have got something else.

Pointing to potentially horrible unknown unknowns tends to capture the imagination much less than pointing to the definitely unpleasant known knowns of an imminent economic slowdown. The QE2ers’ argument at its core was the eternal and seductive call that Something Must Be Done. No less than James Suroweicki at the New Yorker picked up Baruch’s idea of the “undead homicidal zombie market”, tautology and all, and lumping me in with the Tea Partiers, House Republicans and the other dead-end no-brained foes of QE, labelled us  “hysterical”. Baruch loves the New Yorker, but knowing their editorial stance and lack of track record when it comes to advising macro funds and governments, Baruch concluded their love of QE was less a well-thought-out economic analysis, and more a gleeful response to finding their political foes against an idea that felt “right”, Colbert-like, in their gut. In his response, (Felix also had a good one) Baruch bemoaned the politicisation of monetary policy by anyone. This hasn’t got any better – having an (admittedly Texan) presidential candidate threatening the Chairman of the Federal Reserve with a tarrin’ and a featherin’ if he buys any more bonds doesn’t seem conducive to a mature conversation on the subject.

So, was Baruch right? Or were the Suroweickians? An interesting thought experiment would be to think of where we would be without that second round of easing. With the benefit of hindsight I’m inclined to think we would have been better off right now had we not done QE2. Why? Continue reading

No Second Chances

Baruch has been reading Asymco, a fascinating techie site he was put onto by Jean-Louis Gassé at Monday Note, and those interested in tech investing should really have a look at it. You can now see the site popping up on more generalist econo-investing sites like AR. Anyway, introductions over; there was something Asymco’s proprietor Horace Dedieu wrote earlier this month that made Baruch sit up and think.  “The post-PC era,” he wrote, ” will be a multi-platform era,

The thesis that one dominant platform wins the mobile “war” is naive.  . . Developers already understand this. Platform vendors know this. It’s time to unlearn the lessons of the PC era.

Evidence for this? Microsoft Windows Mobile platform apps are growing at a percentage growth rate that is faster than WM users grow, who collectively make up so little of the pie of smartphone users that the slice representing them would be mostly invisible. It’s not getting any better. WM activation rates are 1/28 of that of Android smartphones. The platform is continuing to lose share with subscribers yet, strangely, still seems to be gaining relative share in apps.

What appears responsible for this is the previously unheard-of ease of transferring apps from one platform to another, software tools such as Microsoft’s that allow the rapid creation of new apps and their adaptation for different operating systems, and an economic system that is set up to make writing software for mobile applications a “cottage industry” with a thousand points of light, rather than an industrial enterprise with 2 or 3 dominant players. The marginal cost of creating apps and sharing them between platforms seems to be very low indeed.  So why not make or adapt apps for Windows Mobile? You never know, it might come back. Mango, the new version which will be Nokia v.2′s adopted OS, might be the Apple or Android killer Microsoft hopes it will be.

If the ability to run the largest number of apps determines success then, far from being a returns to scale market like the one for PCs, the implication is that the market for smartphone platforms will be fluid, with nothing written in stone. There will be room for their relative shares to ebb and flow, variously dominating, fading and coming back repurposed for the new new thing in mobile computing: on this reading, it will be something like the game console market today, where 3 viable platforms survive.

What this means in its most practical sense is that there is hope for the platforms falling behind now, such as HP’s WebOS, RIM, and for OEMs like Nokia, for whom Mango is the only game in town. The implications for stocks are major. The option value in RIMM and Nokia would be much much higher than current share prices imply. This would make a lot of people who are short these stocks very unhappy.*

Comfortingly for them, however, there are equally compelling arguments that mobile computing will end up more like the PC industry than anything else. Firstly I suspect that, contra Horace, the profusion of WM apps has more to do with the sponsorship of Microsoft and its deep pockets than a sudden developer interest in championing losing platforms.  Secondly, its not just developers who decide who wins; operators remain in the mix. Their atavistc promotions and subsidy policies can also determine which platform sells. Don’t forget, moreover, that O/Ses are free! Android makes it so you can’t underprice zero to gain market share for your new platform. That helps to freeze things in place and mitigate against fluidity.

But most of all, the apps game remains secondary to the real goal of platform competition. The aim of the game, the whole schlemiel, remains to sell hardware, not software. Apple’s app store revenue is negligible in comparison to their hardware revenues, and will be for some time to come, at least until Apple finds a way to persuade people to buy higher ASP apps. Frequent purchase of 90c apps won’t move the needle against a $600-$900 hardware sale, even if everyone buys Angry Birds (and they probably already have). Until the dynamics of the mobile computing market stop being hardware heavy,  platforms are still vulnerable to hardware death spirals of the sort we’re seeing in RIMM and Nokia right now, where scale returns and operational leverage go into reverse

Don’t think either that just because is easier to write apps for a platform it is going to make it break out. The fact is that if all apps were available on all platforms rather than freeing up competition it would be likely to freeze the status quo in hardware into place. What killer app can Microsoft’s Mango offer me that I can’t get on my iPhone? What could possibly make me change my Android phone? A more functional OS? Better hardware at a cheaper price? Possibly. More likely that in the absence of anything significantly better than what I have currently I won’t change at all. Ecosystems are grabbing territory now that it will be hard to dislodge them from.

The dream of a fluid ecosystem for mobile computing is nice, especially for software developers tired of being the bitches of the hardware dudes. But it looks far off still. Mobile looks subject to the same laws that have governed tech markets throughout  history. That law is: no second chances. Value investing in consumer or enterprise tech very very rarely works. This is the key message for those who read Baruch’s last post and have fired their retail brokers and dumped their index funds, and who may be tempted to go off any buy RIMM at a 5x PE (don’t let me stop you, but do let me help you think before you do it)**. The graveyard of history is littered with those names that didn’t come back. For those that did, such as IBM, and indeed Apple, we forget just how low the low point was, and how wrenching it was to do the right thing so as to eventually re-emerge.

* you may think that this group of people includes Baruch. You may think that if you wish. But I couldn’t possibly comment.

** as I have said before, if you take anything you read on a blog written by an anonymous author as actionable investment advice, you may not be too bright. I can do nothing for you.

The stockmarket is still where it’s at

Baruch is more pleased than he can say to see his pal Felix get a spot on the NYT’s op ed page. But I wish he had written about bonds, or art or something else. He knows I don’t like it when he is rude about stocks.

Felix uses the occasion of the takeover of the NYSE by Deutsche Börse to claim the US stockmarket has become somehow “irrelevant”. Far from being the “bedrock” of American capitalism, he writes, instead

the stock market is becoming little more than a place for speculators and algorithms to compete over who can trade his way to the most money. . . a noisy sideshow that churns out increasingly meager returns.

Well.

Excuse me, but when any stockmarket not been full of speculators trying to outdo each other? Algobots are new, to be sure, but they don’t change the market’s essential nature, other than giving bad or unlucky traders another mealy mouthed excuse as to why they lost money. I think the great traders of stockmarket history, Jesse Livermore, Bernard Baruch and our own George Soros would be amused to be thought of as something other than speculators.

Yes, sometimes stocks can go up when economic growth is only so-so; the link between the two is indirect. Eventually they correlate, but the period when they don’t mesh can be pretty long. Increasingly though, as companies globalise, they reflect global economic growth. And you all have to get used to the fact that the US economy isn’t as relevant as it once was.

Sure, it might be that the number of listed companies has fallen. Baruch hasn’t counted. But so what if there are fewer? Is that bad? I would imagine that after a period of prolonged weakness, such as we have come through, when IPOs were hard and bankruptcies and mergers common, the number of listed entities would fall. It’s a bit like speciation in biology; every now and then we get Cambrian-like explosions, and periods of higher extinction levels. Let’s not draw conclusions from low samples. And anecdotally it is simply not true that there are no IPOs out there, and no small IPOs. Baruch has been positively plagued with them in the past 12 months, from second rate brokers pushing illiquid crap I wouldn’t go near with my worst enemy’s money, to once in a lifetime opportunities the Goldmans and Morgans have to beat the investors off with sticks. There was a great one the other day, and Baruch would love to tell you about it. But he won’t.

Where Felix is right is when he says that there are lots of interesting companies out there who don’t want to go public; its a complete pain, having to explain yourself to people like me. There are certain things about how investors think, their collective expectations, the behaviours they force companies into, that make Baruch’s toes curl. But there is one very important reason for going public which still proves, ultimately, irresistible to entrepreneurs, and it is this: it’s the only way to pay yourself and your people stock options. It is still the easiest way of making a lot of people very rich, and keeping them rich.

And ultimately whether Facebook goes public or not won’t change the central importance of stockmarkets. They are still the cockpit where it all happens, where the key society-shaping corporate entities of our time, such as Apple and Google, keep score against each other and their competitors. The power of a massive market cap doesn’t necessarily get used in all-stock M&A or when it raises money; it is a latent power, it is potential financial energy, which you don’t want to waste. You typically don’t want to use your equity to raise money as it dilutes you. But your stockmarket valuation sure as hell counts when and if someone wants to buy you.

Does the stockmarket allocate capital as efficiently as it used to? I have no idea, but frankly if you think you know better than the stockmarket how to allocate capital in a complex economy, I suggest you get back in your time machine and return to the 1970s to see how well that worked out last time.

I think far from being irrelevant, stocks are the asset class of the future; we had the years where bonds ruled in the noughties, and it ended badly. The Asian countries which are leading global growth now are debt averse, and their main focus is on their own equity markets which are getting almost as important, and just as liquid and vibrant, as the NYSE, with world leading companies like TSMC, Samsung, and Infosys trading billions of dollars on their local exchanges every day. Meantime, this is Baruch’s advice: stop worrying, and go buy an actively-managed mutual fund or go research a selection of stocks in spaces you know about, with the aim of holding them for a few years. Make sure that at least some of them are listed in a different country (but you can still buy the ADRs). Try not to listen to brokers. Keep reading Felix’s blog, though.

The market as an analysis-free zone

Baruch has noted a curious thing about this results season, dear readers. Sell side analysts seem to have stopped doing as much research as they used to. I think it’s because, in the light of the SEC’s insider-trading investigation and a lack of certainty between what constitutes legitimate insight and illegal information, they are keeping a low profile. If it continues it could give great power to some of the market’s worst actors, and create a lot more single-stock volatility. Already this earnings season there seemed to be a lot more violent moves in stocks than usual. Hopefully Baruch is imagining it, and if he isn’t, let’s hope it is temporary.

It was most obvious when F5 blew up in late January. The print was merely in line, and the guidance, sin of sins, was weak. FFIV opened down 20% and stayed down. This sort of move off a quarter can happen in tech, and is not at all uncommon. What was vaguely unusual, however, was  the extent of the surprise: there was no warning. The company had made no hints it had seen any weakness, and none of the analysts covering it had done the usual checks with their sources. Worse, no-one really knew what everyone else was expecting. There were no “whisper” numbers out there. Frightened of being accused of insider trading , no one had done the work. Continue reading

Baruch the political football

James Suroweicki is using Baruch’s (rather good) line, the “undead homicidal zombie market”  as grist to his anti-anti QE2 mill.

What’s most striking about the attacks on QE2 is how hysterical they are. People aren’t just suggesting that the Fed’s policy—which is quite modest relative to the size of the U.S. economy—might be ineffective or mildly inflationary. Instead, they’re accusing the Fed of “injecting high-grade monetary heroin” into the system, pursuing a policy that “eviscerates” the middle class, and potentially giving birth to an “undead homicidal zombie market.”

The main problem with this of course, is that this last bit never happened. No-one ever accused the Fed of potentially creating an undead homicidal zombie market.

What Baruch actually wrote (my emphasis) was:

“I’m not saying we’re in an undead homicidal zombie market,”

And there we could let it lie.

Although to be fair, I did add “though we may be” as quite frankly I was not very sure of anything at that particular moment. Communicating this lack of certainty was the point of the post, which was about feeling confused and worried. But nevertheless, in the offending line above, Baruch was trying to stop going too far down the path of a metaphorical flight of fancy about undead cats. To avoid, if you like, hysteria.

So James S. has it completely arsy-versy. Clearly he hadn’t actually read Baruch’s post, and by the way James, in the unlikely event you ever read this one, if you do choose to misquote me disapprovingly the least you could do would be to drop us a link, no? Probably you have an outdated editorial policy that prevents you from doing so, but still, this is the 21st century.

Calling one’s opponents “hysterical” is, moreover, quite a cheap rhetorical shot, a debating tactic much used by Straussian neo cons and WSJ op ed writers to close off a reasoned argument they are on the wrong side of. Different words that do the same job are “partisan”, and (Baruch’s favourite) “shrill”. If someone is hysterical it is much easier to ignore the points they make. Rather, the word implies, they just need a hard slap and a good shake. The word has the stench of politics about it.

That’s the wider context here, which I think we need to put James’ article into. QE2 has become politicised, and this is a mark of just how demented US political discourse has become. Domestic bond purchase programs elsewhere don’t generally create similar levels of controversy between parties; most politicians realise their central bankers are just following through with their mandates, as the Fed clearly is, without any regard for political advantage. Baruch thinks the blame for the politicisation lays squarely at the feet of congressional republicans. He also finds it highly amusing to find himself somehow lumped in with this lot, however indirectly, as he has yet to contemplate a more priceless, ill-intentioned, irresponsible and ignorant set of economic baboons.

But the worry is that if the republican baboons don’t like QE2, then it follows that those on the other side of the aisle will start to like it, not on the basis of a reasoned weighing up of pros and cons, rather because it gives them good talking points. The result will be the vaguely uncritical lumpen thinking we see in the New Yorker article, and at its worst, an item of pragmatic economic policy which should be debated on its merits will join the pantheon of topics of almost theological controversy in the US such as abortion, gun control, flag burning and gay marriage. Pretending that QE2 is a well established economic policy without risk of externalities is frankly as absurd as saying it is an unmitigated evil.

Felix, whose own position is not far from Baruch’s, does a much better job of tackling the article in this post. As he puts it, “the weird thing is that Surowiecki and I actually agree on most of the issues here.”

Indeed. As things stand right now, Baruch is very rapidly coming to terms with QE2: not particularly astonishingly, the thing might actually be working! There are green shoots everywhere he looks , from an apparent increase in volume at transaction processing companies, to semi makers guiding for much lower seasonality in the next quarter, to positive 2011 GDP revisions by the economists, to strategists telling me to buy cyclicals, etc etc. The price of gold even dropped a bit on thursday. He is pretty optimistic, certainly much more than he was last month, when his problem was that he could see the sufficient reasons for stocks to rise (QE2), but not the efficient ones (forward EPS estimates going up). That’s been solved, confusion lifted. Things are great!

Then again, that’s exactly what I’m supposed to feel, isn’t it? There’s nothing like turning up to a party with a hangover (swearing you’ll only stay for a bit), having that first drink and realising how much fun you’re going to have if you stick around. Thoughts of a potentially much worse hangover yet to come are far away.

Quantitative Queasing

So we have been having Quantitative Easing already, and Baruch doesn’t  like it.  The stockmarket is up (or was), the data seems to be improving; QE has done its work and for all we know it will continue. But there is a special unhealthy quality to it all. It feels like a “wrong” rally, like the cat from Pet Sematary was clearly a wrong kind of cat.

The problem as I see it is this: QE lowers overall interest rates and makes all the stocks go up when they wouldn’t have normally. It raises their valuations, which you can also express by saying it makes for higher PEs. This makes people feel richer. They will go and buy more stuff like LCD TVs, making the companies who make the stuff they buy richer too. They will invest more, and buy more stuff from companies who make stuff not for people, but for other companies. Eventually all the companies grow into their higher stock valuations, and we are all fine.

The key word here however, is “eventually”. What happens in the bit between the 2 points:  after all the stocks have gone up, and before the fundamentals improve to justify their new valuations? Because I think that’s where we are if stocks have stopped going up, or where we will soon be.

Now, my tech stocks aren’t exactly expensive. Lots of them are to be had for PE multiples in the low teens, which really isn’t bad. But there has been no fundamental improvement in their businesses since the summer, as far as Baruch can tell, and yet their stocks have absolutely zoomed to levels I frankly have difficulties buying them at, at least on the charts. Baruch was astonished last week to see that the NASDAQ 100 was basically back to its pre-crisis high!! You get that? That index is telling you that things are as good as they were before the Great Unwind.

I can’t short them either, at least not on past form. That’s been a mug’s game; the subtext of QE is “kill all the shorts” — another way of making sure stocks go up. Returns on short books have been pretty brutal, and most long short guys in the past couple of months have learned to be mostly long, or if they have to stay balanced, then long stocks, short indices.

So, now what? If stocks are now disassociated from their fundamental realities, however short a time that disassociation is supposed to last, non-fundamental realities are going to rule, and I have no idea what that means. Will we get stasis, a crunch in volatility and volumes? Will we have vast nauseating unexplainable swings in stocks, huge moves in the VIX? Will we crash? Will we carry on straight up? Will we pause and rally? Who can say? We’re in a period where anything is possible, as I’ve said before, a world of unintended consequences coming down the pipe. Some may be good, and some may be bad.

This is why in his darker moments that Baruch thinks a very good analogy for where we are right now is Pet Sematary. The people who buried their cat (and later their son) in the Indian burial ground to bring it back to life got something which looked ostensibly like a cat, but was so only on the outside. On the inside their little puddy tat  was really an undead homicidal zombie cat, as became clear through its increasingly odd behaviour. Unintended consequences followed (mayhem, murder, horror, the Wendigo — all that Stephen King stuff).

The Bernank is like the guy who buried his cat, but in this case instead of a resuscitated cat he wanted his rally back, a healthy stock market and the wealth effect that would bring. I worry we have got something else.

I’m not saying we’re in an undead homicidal zombie market, though we may be. But here’s an example of what the Pet Sematary market is capable of in terms of unintended consequences: QE inflates all asset prices, including commodities. This pressures the Chinese consumer, who we are relying on to pull us all out of this mess, who can suddenly not afford his new LCD TV because his Moo Shu pork is costing 20% more than it used to. Changes in commodity prices have a much greater impact on his consumption than Joe Schmoe in Idaho, with his low cost high fructose corn syrup and processed trans fat diet. The BoC has to raise rates to offset the inflation this is causing, hurting Chinese growth even more, and global GDP growth drops 50bp. Bravo the Bernank. With your Quantitative Easing you just killed off the only good thing in this market which was working naturally without outside interference.

OK, Baruch may be exaggerating, but a big part of today’s selloff is driven by fears of commodity prices in China and a collapsing Shanghai stockmarket. It’ll probably turn out to be nothing, a damp squib. But if it doesn’t, you heard it here first. I feel sure there is a wider point here to make about the bad things that happen when you mess with the signalling mechanism of the stockmarket. After all, the stockmarket does not exist solely to make us richer, does it? But that’s probably for another post.