Lead by Example: Seth Klarman

Seth Klarman is the founder and president of The Baupost Group, a Boston-based private investment partnership. He is a topic of discussion on kaChing's Investing IQ App's "The Intelligent Investor" group (now with 1,270 members).

In the video, Klarman discusses his investment philosophy. He prefers to look for securities that fly below the radar, that are involved in complicated situations (and are therefore ignored by the investment community), stocks that are out of favor (kicked out of a major index or not belonging to one). He also prefers significant and illiquid securities over significant and liquid securities.


Klarman is worth listening to: Baupost manages $1.7 Billion for 40 families encompassing 700, and his book, "Margin of Safety," is $1,100 on Amazon.com (although the price of a book does not indicate the value of its content, but its lack of availability). Most importantly, his investment approach is to start cautiously by identifying all the risks and by avoiding them by hedging.

Klarman is rarely heard or followed by the media, unlike, for example, Warren Buffet. Yet, both investors have similarities in their approach to the selection of securities. For this reason,the Harvard Business Review interview (link below) is a worthwhile watch.

On Writing Margin of Safety:


Here is a link to the full interview provided by Harvard Business School.

These are some of the hi-lights from the video on leadership:

• On leadership, lead by example
• Be there and be available to staff (Klarman has an open trading desk as opposed to an office, even though he isn't a "trader")
• Empower others: let others shine if you know they can do so
• Set an example to colleagues on a having a balanced work-life

Bubble in China

Andy Xie is a former analyst from Morgan Stanley. He graduated from Massachusetts Institute of Technology with a M.S. in Civil Engineering, and obtained a PhD in Economics from Massachusetts Institute of Technology.

Xie is worth listening to. He was one of the few economists who accurately predicted economic bubbles including the 1997 Asian Financial Crisis, dot-com bubble (1999) and Subprime mortgage crisis (2008).

In his most recent post, Xie analyzes the impact of money flow to Chinese real estate, not to productive assets. With government policy promoting speculation, this action inter-connected with the zero interest rate policy found in the U.S. (my emphasis in bold): 

Each belief depends on the key assumption that the Chinese government will let neither exchange rates nor land prices fall. The market psychology that the Chinese government is capping the downside for speculators has emboldened them to speculate in any asset class with a China angle.

Yet the assumption has not been tested because the U.S. Federal Reserve’s low interest rate policy continues to drive money out of dollars and into China-related assets. When inflation forces the Fed to raise interest rates quickly, probably in 2012, this assumption will be tested. In the current speculative game around China, the force is the Fed’s zero interest rate. When that changes, I suspect few of today’s speculators will be around.

Xie  comments on inflation in China:

Money supply cannot grow faster than GDP forever. A prolonged gap between the two usually suggests an asset bubble, i.e. excess money supply is piling up in an asset market. But sustained asset inflation inevitably leads to consumer price inflation, either through the wealth effect on consumption or a cost push on the production side.

Investors in China need to have a plan longer out:

China’s monetary overhang in a more inflation prone environment augurs poorly for the inflation dynamic this year and beyond. The growth outlook, on the other hand, is dimmer. On the demand side, developed economies will continue to suffer high unemployment and property deflation. Despite a strong export showing in December, China’s exports are unlikely to grow as they did in the previous five years. I expect China’s exports will average single digit growth for the next five years, compared to 27 percent between 2003 and ‘08.

His 2012 outlook:

Indeed, 2012 is building up to be another crisis year. Governments and central banks did not handle the last crisis well. They did not reform a global financial system plagued by incentive misalignment and wild speculation. All the money governments and central banks released is turning into global inflation. And they resorted to bailing out speculators, laying the foundation for another crisis.

This is a worthwhile read for investors who want to diversify geographically to other countries thought to have greater growth opportunities than that found in the U.S. A link to the full article is below.


Source: http://english.caing.com/2010-01-27/100111543.html 
Chinese version: http://magazine.caing.com/2010-01-24/100110562.html
H/T to: The Big Picture

Get Me A Meaningful Job

There are three fundamental mainstream sources for news.

The first is mainstream media such as Wall Street Journal, New York Times, Business Week, and The Economist. The second are blogs, such as Market Folly or Zero Hedge. Note that the former source would be more likely to report the optimistic viewpoint of the market. The latter tends to report on the negative side of the market.

The third source for news comes from the ordinary citizens who take the time to write comments on the previously mentioned sources for news.

It is a potential source for getting unique insight.

Below is a response on The Economist by a user, tp1024, in response to an article about unemployment. The article is entitled The Trap | The Curse of Long Term Unemployment will bedevil the economy.

My emphasis is in bold.

There are several fallacies in the public presentation and perception of the current economic crisis.
One is that people spent beyond their means. This is - at best - a half truth. The other half is that corporations necessarily also earned beyond their means. When demand overshoots (people spend beyond their means), prices will necessarily rise. Thus, at least part of the spending will directly go to the corporations, increasing their profits through the credits and mortgages of Jane and Joe Consumer.

The naive economic models, that unfortunately underly [sic] the very models that real-world economists use all the time when advising policy makers, would have you think that what now happens is that labor becomes scarce. A scarcity of labor implies a rise in real wages. Statistics show that those models aren't worth the paper they are written on - real wages were stuck for a decade or so. Only part of the "extra spending" had plasma TV's to show for it, a lot turned out to be corporate profits, fees and interest rates for credits.

All of the latter would be turned into investments, if the economic models were true. In fact, however, they went into bubbles. While the internet-bubble was mostly benign (the over-investment in glass fiber ruined the market for communication satellites, but the positive results by far exceeded the negative ones) as they actually did something positive for the population as a whole, they created a new industry for that matter.

The pure price bubbles that followed (housing, oil, steel, grain and what have you) were more like a malign cancer. The difference between those and the internet bubble, was that there was (almost) no internet to begin with before the bubble. Housing, oil, steel or grain were at or near their maximum physical capacity to begin with. If you go into such a market and pour a 100 billion dollars into it, well guess what happens. If the market sells 100 million widgets in the same time, prices will have risen by 1000 dollar per widget at the end of the period, which what "investors" call their "profits". But those "profits" have nothing real to back them up. Except for the eventual consumers who can't help but buy grain or oil and have to pay the higher prices. And this is exactly where those "investors" got their "profits" from.

The *real* problem, however, in all this is something else. It's money. Because the money is in the hands of investors who (as I hope I've shown here) didn't invest. The money was in the hands of people who didn't know what to do with it in terms of producing stuff, delivering services or engaging in any other profitable business, other than toying around with numbers and making bigger numbers out of them.

--

As for unemployment, it reflects the lack of past investment. That is because the making of bigger numbers is perfectly tangential to what we call economic activity. As soon an the bigger numbers stop coming, there is nothing to stop this house of cards from collapsing.

Bad as the situation is, there is a silver lining. A lack of investment in the past means that there is *potentially* a lot of investment to be done in the future - lots of work for long term unemployed. This, however, has be organized. And it won't be the corporations who will do the investment, because they will use any profits they can get to pay back *their* excessive debt.

Contrary to what others here suggest, the government can do a lot. China has shown you what to do. Instead of throwing good bail-out money after the bad debt of the corporations, the USA should put it into places where it will pay off.

Will it pay off to put money into the levees of New Orleans? Will it pay off to put money into crumbling pipes that keep breaking, creating car-swallowing craters? Will it pay off to repair pot-holed roads that force drivers to slow down and sustain damages to their cars? Will it pay off to build high-speed railroads that can move passengers from state to state without waiting in line at the airport, waiting on the tarmac for the plane to take off, waiting in the air for the airport to give landing clearance, taking off shoes, suffering undignified body-scans and tap-downs, wasting incredible amounts of fuel? Will it pay off to put money into a public schooling system that has to failed the nation to the point that most Americans are unable to *pronounce* the names of the researchers on the average "American" scientific paper (if they can read them in the first place, that is)?

I'm not talking about building bridges to nowhere. I'm talking about building a nation that is worth being called that name.

Outlook for 2010

Many financial media sources are providing outlooks that argue either a bullish case or a bearish case for the stock markets in 2010.

My view is that investors need to macroeconomic factors and then react accordingly, since making predictions is an act that is very difficult to do so accurately and consistently.

While searching for the factors that will matter in providing a financial outlook for 2010, two excellent arguments were found.

The first is from Zero Hedge. The site's argument is based on the dynamics of fixed income.

The full article is here, and is entitled "Brace For Impact: In 2010, Demand For US Fixed Income Has To Increase Elevenfold... Or Else."

The site concludes with the following:

Everyone has major problems at home, and is more focused on the supply than the demand side of the equation.

What options does this leave for the administration? Very few, and all of them are ugly. As we stated earlier on, the options for the Fed are threefold:

1. Announce a new iteration of Quantitative Easing. This will be met with major disapproval across all voting classes (at least those whose residential zip codes do not start with 10xxx or 068xx), creating major headaches for Obama and the democrats which are already struggling with collapsing polls.
2. Prepare for a major increase in interest rates. While on the surface this would be very welcome for a Fed that keeps hinting that deflation is the biggest concern for the economy, Bernanke's complete lack of preparation from a monetary standpoint (we are surprised the Fed's $200 million reverse repos have not made the late night comedy circuit yet) to a forced interest rate increase, would likely result in runaway inflation almost overnight. The result would be a huge blow to a still deteriorating economy.
3. Engineer a stock market collapse. Recently investors have, rightfully, realized there is no more risk in equities, not because the assets backing the stockholder equity are actually creating greater cash flow (as we demonstrated recently, that is not the case), but simply because taxpayers have involuntarily become safekeepers for the entire stock market, due to Bernanke's forced intervention in bond and equity markets. Yet the President's Working Group is fully aware that when the time comes to hitting the "reverse" button, it will do so. Will the resultant rush into safe assets be sufficient to generate the needed endogenous demand for Treasuries is unknown. It will likely be correlated to the size of the equity market drop.

If the Fed decides on option three, we fully believe a 30% drop (or greater) in equities is very probable as the new supply/demand regime in fixed income becomes apparent. We hope mainstream media takes the ideas presented here and processes them for broader consumption as indeed the Fed is caught in a very fragile dilemma, and the sooner its hand is pushed, the less disastrous the final outcome for investors.

My second source below is more optimistic.

Jon Fisher combines the observation of the inverse relationship between housing starts and unemployment with a model in entrepreneurship: the planning the actions while having the end in mind.

In this video, Fisher asks what would happen if everyone was wrong with the forecast that unemployment will continue to rise. What if unemployment peaks at 10.4% in the United States, and then falls...rapidly? If that is the case, then the place to invest in will be in technology and real estate.

Entrepreneurism, Begin With The End In Mind: Jon Fisher

Commonwealth Club

I Can't Remember If the Car Left First, or If the Girl Left First

Carl Icahn is an American billionaire financier. He appears in headline news as a "corporate raider." This means that his company will do what it has to do to unseat existing management of poorly run companies. The purpose for doing so is to change the way it does business. Most recently, Icahn wants to break-up Motorola. He believes its wireless division is worth more than the 0 value that the market is assigning it.

I am reviewing Motorola. Its wireless division is undervalued. Indications for strong sales are favorable:  Motorola's Droid and Cliq are very well-designed and well-received.

In the video below, Yale University's Professor of Economics Robert Shiller introduces Icahn as guest lecturer. Icahn speaks extensively about the lack of accountability in many (but not all) corporations. He explains that these CEO's are morons. They are selected to run the company, because they move up the corporate ladder by being:

1) likeable
2) politically astute.

A CEO's assistant is "dumber" than the CEO for the reason that the job security of the CEO will not be threatened by the assistant. When the CEO retires, the assistant gets promoted.

h/t marketfolly.com for originally posting this video.

"I Can't Remember If the Car Left First or the Girl Left First" - Icahn, on winning ~$10,000 in poker, losing it all in 1962, and then deciding to earn money through his own skill and intellect.

Watch it on Academic Earth

During Q&A, Icahn talks about how to handle when things are going well or going poorly:

If you are do great, don't think you are a genius. If you are doing poorly, don't think the world is coming to an end.

- @27:42 min

So what? Work hard. Believe in your abilities. Stay on course (Embrace luck, which comes and goes). Below is Kipling's poem, If, Icahn mentioned to illustrate this frame of mind. My markings are in bold.

If

By Rudyard Kipling 

If you can keep your head when all about you

Are losing theirs and blaming it on you,

If you can trust yourself when all men doubt you,

But make allowance for their doubting too;

If you can wait and not be tired by waiting,

Or being lied about, don't deal in lies,

Or being hated, don't give way to hating,

And yet don't look too good, nor talk too wise:

If you can dream - and not make dreams your master;

If you can think - and not make thoughts your aim;

If you can meet with Triumph and Disaster

And treat those two impostors just the same;

If you can bear to hear the truth you've spoken

Twisted by knaves to make a trap for fools,

Or watch the things you gave your life to, broken,

And stoop and build 'em up with worn-out tools:

If you can make one heap of all your winnings

And risk it on one turn of pitch-and-toss,

And lose, and start again at your beginnings

And never breathe a word about your loss;

If you can force your heart and nerve and sinew

To serve your turn long after they are gone,

And so hold on when there is nothing in you

Except the Will which says to them: 'Hold on!'

If you can talk with crowds and keep your virtue,

Or walk with Kings - nor lose the common touch,

If neither foes nor loving friends can hurt you,

If all men count with you, but none too much;

If you can fill the unforgiving minute

With sixty seconds' worth of distance run,

Yours is the Earth and everything that's in it,

And - which is more - you'll be a Man, my son!

Primer on Balance Sheet Recessions

The value of Fortune runs far deeper than money and financial returns. On kaChing.Com, I was, and continue to be, fortunate to have acquired a large network of influential contacts. This includes hedge fund managers.

Most recently, Bluecut Capital brought to my attention, economist Richard Koo. Bluecut Capital was also interviewed on BTS. The fund management team currently manages assets via the kaChing product offering (total assets under management is collectively $4 million).

Many investors would not spend an extra moment reading on unrealistic economic models that are consistently proven to be more theoretical than practical.

This viewpoint is short-sighted.

Koo implemented various economic models during both the Latin American crisis in the 1980's and the problems of Japan between 1990 - 2005. Koo is currently the Chief Economist, Nomura Research Institute.

The current economic problems, and its current "solutions," have many similarities to that which occurred in Japan. The presentation below will give an idea of what end-game of "de-leveraging" will be like and the consequences for the U.S. if it continues to follow its economic policies.

A Primer (and a slide presentation) was provided here on Zero Hedge:
http://www.zerohedge.com/article/primer-balance-sheet-recessions

Here is an audio presentation from Koo (November 2008):
http://csis.org/multimedia/audio​-great-recessions-lessons-learne​d-japan

Notes on a 0.01% Returns

Bill Gross of PIMCO wrote about the malaise of holding cash that earns next to nothing. In his December newsletter 'Anything but 0.01%,' Gross stated the desire to earn more than 0.01% also meant the potential return for investors in accepting higher risks:

That 0% yield is not a joke. Almost all money market accounts – totaling over $4 trillion dollars (...) – yield close to nothing, so close to nothing that I mistakenly did a double take when reviewing my monthly portfolio statement. “Yield on cash,” read the buried line on page 15 of the report, “.01%.”

Remember: one component for arriving at the market value of company will depend on whether to assign an optimistic or pessimistic P/E multiple. When there is an appetite for risk, this multiple expands and therefore stock prices rise (if justified by the accompanying earnings growth rates). The stock market's return is a function of these three variables: earnings growth/decline plus change in P/E + dividend yield.

My point is to recognize, and to hope that you recognize, that an effective zero percent interest rate, as a price for hiding in a foxhole, is prohibitive. Like the American doughboys near France’s future Maginot line in WWI – slumping day after day in a muddy, rat-infested pit – when the battalion commander finally blew his whistle to charge the enemy lines, it probably was accompanied by some sense of relief; anything, anything but this! Anything but .01%!

Gross makes a very important point here:

The Fed is trying to reflate the U.S. economy. The process of reflation involves lowering short-term rates to such a painful level that investors are forced or enticed to term out their short-term cash into higher-risk bonds or stocks. Once your cash has recapitalized and revitalized corporate America and homeowners, well, then the Fed will start to be concerned about inflation – not until.

h/t marketfolly. Full original newsletter may be downloaded here.

SNL Video: China Cold Open - China Would Like Their Money Back

If It Looks like a Bear, Smells like a Bear, and Acts like a Bear

...It is not a bear.

Before reading on, know that any pattern may exist if you look long enough to find one.


In the chart of the S&P 500 from mid-June 2009 to present, above (click for full image), I labeled the uptrend days (D,E,F) against the sell-off days (A,B,C).

Uptrend Days (%, rounded)
D - +8.0%
E +8.7%
F + 3.4%

Downtrend Days (%, rounded)
A – -2.0%
B - -3.8%
C - -6.4%

The pattern that emerges is that on the downtrend days, volume is higher than average, and on the uptrend days, volume is on the decline. With exception, only the rally in D had rising volume, and was followed by the market still rising in E's rally.

With the trading activity this month, volume decline continues to be even more pronounced with each passing day.

The PPO (percentage price oscillator) compares two different moving averages. Its 3 peaks against the absolute price changes were also on the decline, a negative short-term sign.

About Me
I was interviewed by Behindthespread.com this past week. Here is the link:
http://www.behindthespread.com/chris-lau

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