Notes on George Soros, Rosenberg on CNBC

The Mighty U.S. Dollar No Longer?
In the U.S., the S&P 500 is now trading over 60% higher from the bottom reached in March. For we Canadians, this return looks more impressive than it really is: the U.S. dollar fell 20% against the Canadian dollar in that time. Similarly, the U.S. currency is weak against the Yen- and the Euro. A massive U.S. dollar "carry trade" may be in the works, or maybe not.

It remains to be seen.

Rosenberg vs. CNBC

What's Next for Stocks

Michael Pettis is a professor at Peking University’s Guanghua School of Management, where he specializes in Chinese financial markets, and a Senior Associate at the Carnegie Endowment for International Peace.

So, what business does this blog or any individual have, in taking advice or developing/validating a theme for an investment portfolio?

China is a driving force in influencing currency levels and commodity prices. The important point made by Pettis is marked with a bold font.

I spend a lot of time talking to large hedge funds and institutional investors – with at least three or four one-on-one meetings a week – on China and market conditions. It worries me that recently I have heard investors say many times, generally very sophisticated investors, that we are clearly in a bubble and the best strategy is to ride it out as long as we can. This has almost become one of the mantras of sophisticated investors – the less sophisticated, I guess, assuming that the crisis is safely behind us.

It worries me because of course we can’t all collectively ride the bubble and bail out before everyone else does. I wonder if this means that an awful lot of the big funds can be expected to rush to the doors at the same time when things turn bleak. If so, of course, that means we are likely to see both the upside and the downside market risks increase. Several of my fund management friends have insisted the problem has to do with the nature of hedge fund compensation. Most of the hedge funds were hurt pretty badly in the financial crisis, but a very large number of them were very pleasantly surprised by how quickly they’ve been able to make back a substantial share of their losses.

This means that recovering the high-water mark, which many thought would take years, has suddenly become a lot easier, and many expect that if the markets go on as they have been doing for another year or so they’ll be back in business (that is, able to charge performance fees once again). This may create a natural, albeit dangerous, incentive to take big risks on the likelihood of a rapid recovery.

Source: http://mpettis.com/2009/10/chinese-railways-and-speculating-pig-farmers/

Arts and Science: Ying and Yang

Below is an interview Schmidt in regards to its decision to purchase You Tube. Schmidt is, of course, the CEO of Google.

Finance is as much a science as it is an art. Assigning a dollar value to a privately owned company is an art, in that this value is subjective and relies heavily on the optimism or pessimism at the time, a value to a forecast of worth, and a value of what the company is worth in terms of what it can do for and with its buyer.

In this case You Tube's buyer was Google:

Baskin: What methodology did you use to come up with that number?

John P. Mancini, an attorney working for Google, objects.

Schmidt: My judgment.

Baskin: Was it based on cash flow analysis? Comparable companies? What were you using as the basis for your judgment?

Mancini objects.

Schmidt: It's just my judgment. I've been doing this a long time.

Baskin: So you orally communicated to your board during the course of the board meeting that you thought a more correct valuation for YouTube was $600 million to $700 million; is that what you said, sir?

Mancini objects to characterization of the testimony.

Schmidt: Again, to help you along, I believe that they were worth $600 million to $700 million.

Baskin: And am I correct that you were asking your board to approve an acquisition price of $1.65 billion; correct?

Schmidt: I did.

Mancini objects.

Baskin: I'm not very good at math, but I think that would be $1 billion or so more than you thought the company was, in fact, worth.

Mancini objects.

Schmidt: That is correct.

Later...

Baskin: Can you tell us what reasoning you explained?

Schmidt: Sure, this is a company with very little revenue, growing quickly with user adoption, growing much faster than Google Video, which was the product that Google had. And they had indicated to us that they would be sold, and we believed that there would be a competing offer--because of who Google was--paying much more than they were worth. In the deal dynamics, the price, remember, is not set by my judgment or by financial model or discounted cash flow. It's set by what people are willing to pay. And we ultimately concluded that $1.65 billion included a premium for moving quickly and making sure that we could participate in the user success in YouTube.

Source: http://news.cnet.com/8301-31001_​3-10360384-261.html

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Crossing...the...Finish Line (Memo to Followers)

Dear Followers:

KaChing is scheduled to launch trade mirroring in under two weeks. However, this portfolio is likely to be delayed in qualifying for mirroring on launch day. Crossing...the...Finish Line of the race will need to wait.

These are the following reasons:

1. Under-performance against the s&p (largest loss was in commercial real estate) over an 8 month period.

2. Lack of sticking to a stated strategy.

3. Maintaining an above-average cash level provided superior safety but sacrificed on potential gains.

My portfolio IQ score is 126. To qualify, a score of 140 is required. It is close to the finish line, but it not close enough.

Investing is not a race. Investing is about (1) not losing assets and (2) beating the market over a very long period of time.

To Beginners:
There are a number of followers who are new to investing. These beginners are smartly learning about the stock market instead of being a sucker (a sucker is born every minute, but clearly "kaChingers" are not one of them).

My advice to Beginner followers:
* Open an IB (Interactive brokers) account and have a balance of at least $5,000-$10,000.

To Interested Investors:
Mirror more than one qualified kaChing "signature investors." This will give you the portfolio diversification.

Tip: Be sure to review the "analytics" first for investors you intend to "mirror." After all, the IQ number will only tell you risk-adjusted return, investment management focus, and ability to write stock research. Since the cost of transactions on Interactive Brokers is low, buy your own stocks too.

As for investors interested in mirroring my portfolio, the game plan stays the same. When the IQ score reaches 140 some time after the official launch day, mirroring my portfolio will be possible.

Below is the game plan. The approach that will be taken in managing the portfolio will be as follows:

1. Risk for holdings will continue to be assessed well before its potential gains (margin of safety).

2. Continue to build portfolio based on identified macro themes playing out.

3. Maintain Hedge strategy to reduce losses.

4. Be a rabbit. Let favorite stocks reach entry price. Don't chase wins. After all, gains are only as good as price paid.

5. Stick to stated a strategy and become an expert that field. It is the only way hard work may be translated to attaining superior knowledge in that field.

6. Invest in companies for which superior insight and knowledge in them may be attained.

...
If you have a twitter account, subscribe to these blog posts @ http://twitter.com/chrispycrunch.

The Sure Thing

Speculating vs Investing

"When I was a kid, my dad used to joke about the habitual gambler who finally heard about a race with only one horse in it. He bet the rent money on it, but he lost when the horse jumped over the fence and ran away. There is no sure thing, only better and worse bets."

- Howard Marks

Is characterizing the current state of the economy an act of speculation?

One mainstream media-driven phrase that is cropping up with unusual regularity is "the new normal." How normal is it for the U.S. stock markets to be up 60% this year since March, whilst the U.S. shed 2.5 million jobs? In Rosenberg's newsletter, Rosenberg describes this phenomenon as jobless prosperity. He goes further to ask who is actually doing all the buying:

FT quotes data from TrimTabs showing that only $2.5 billion in net inflows has gone into U.S. equity funds and ETF’s since the March lows. Inflows into bond funds have been ten times as strong. We know that corporate insiders have been net sellers of size. And the buying power from short-covering subsided months ago.

The answer, and this validated by the FT on page 16 of yesterday’s edition, are the hedge funds. And once they begin to see signs that a V-shaped recovery is about as real as Santa or the tooth fairy, watch out.

If hedge funds are characterizing what is going to happen next in the market, then hedge funds are speculating. Any act that attempts to forecast or predict what will happen is both dangerious and risky. After all, we now know how a "can't fail" one-horse race may still lead to losses.

If the markets continue adjust on the downside this month to account for actual unemployment figures, look for the tide to wash out companies with weak balance sheets. "Simply" invest in companies that are able to produce steady or rising profit margins not achieved through one-time cost cuts.

How? Bring your two warriors.

As Leo Tolstoy said, "The two most powerful warriors are patience and time."

On a personal note, 660 kaChing users following my online virtual portfolio are probably wondering what steps will be taken next. The portfolio activity reflects an IQ score that is 30/200 points from qualifying (140 points) to be mirrored by interested investors.

The strategy continues to be:

• Don't lose money
• Exploit significant spreads between the intrinsic value and current market value of companies

If you have a twitter account, blog posts are broadcast to http://twitter.com/chrispycrunch.

Let's Talk "Zebras"

The only thing more comforting for an individual investor "missing" the March 2009 -Present rally is not having a professional career dependent on justifying why one "missed" the great returns in the market this year (my high-lights in bold). How difficult it is now for investors to pick great investments: when stock prices go up, risks goes up, not down.

Zebras!?
“Zebras have the same problem as institutional portfolio managers. First, both seek profits. For portfolio managers, above average performance; for zebras, fresh grass. Secondly, both dislike risk. Portfolio managers can get fired; zebras can get eaten by lions. Third, both move in herds. They look alike, think alike and stick close together.

If you are a zebra, and live in a herd, the key decision you have to make is where to stand in relation to the rest of the herd. When you think that conditions are safe, the outside of the herd is the best, for there the grass is fresh, while the middle see only grass which is half-eaten or trampled down. The aggressive zebras, on the outside of the herd, eat much better. On the other hand – or other hoof – there comes a time when lions approach. The outside zebras end up as lion lunch, and the skinny zebras in the middle of the pack may eat less well but they are
still alive.”

. . . Acorn Fund’s founder, and portfolio manager, Ralph Wanger

H/T Marketfolly. The full article by Jeffrey Saut is here.

Continuing on the topic of investment psychology, Ken Norquay describes risk management in a different way in his most recent entry. Here is an excerpt:

The investment industry’s pat answer does not address the basic truth that there is risk in investing in the stock market and we need to know how to handle that risk.

...


When I first entered the investment business in 1975, mutual funds guru John Templeton got it right. He used to say: “We shop the world for undervalued stocks. We hold them for three or four years and sell them when that value is recognized.” He wanted us to buy and hold Templeton Growth Fund in full knowledge that he would buy and sell stocks for us within the fund. Modern mutual funds do not talk about selling at all. They want us to buy and hold their mutual funds, and they want to buy and hold stocks within that fund. And they really do hold: how many mutual funds off loaded their stocks before the 2008 melt down? Mutual funds management has changed dramatically since 1975.

3 Things You Ought to Know

Michael Lewis is an author and financial journalist. In one of his bestselling books "Moneyball: The Art of Winning an Unfair Game," Lewis writes about how an underfunded team, the Oakland Athletics, was able to wins by 2002.

This book was published in 2003 and anyone - not just an ordinary investor - ought to read about how Billy Bean used statistics, challenged "conventional wisdom," and went against the MLB formula for running a baseball team.

I - Here are the highlights:

1. Know the end result you want

Before anything else, you should know exactly what you want. This requires thought. In Oakland A’s case, their goal was to win as many games as possible, not to retain their stars. This was because they found that the fans would come to games when the team was winning, regardless of whether or not they had their stars with them. They then aligned their strategies with this goal. They often couldn’t afford to retain their stars, but they could find ways to win more games.

2. Ask yourself: What is the Conventional Wisdom?

Now you should ask yourself what the conventional wisdom says about how to achieve your goal. List them. This is what most people think you should do to achieve your goal, and this is what the majority of people are doing.

3. Question the Conventional Wisdom

This is not easy, but this is how you can find opportunities. Your best weapon is why. By asking why you may find that:

• The conventional wisdom is unreasonable
  There is simply no evidence that it works. Most likely it became conventional wisdom because some people said so. In baseball for example, the way people count things can be traced back to a different game: cricket. Because the man who improved the box score in 1859 was familiar with cricket, he brought the ideas to baseball without thinking about whether or not that was the best way to count things in baseball.
• The conventional wisdom is not the best way to achieve the goal
  The conventional wisdom might contribute something to achieve the goal, but there could be other more significant factors that are overlooked by other people.

4. Find the real contributing Factors to Achieving Your Goal

The goal of questioning the conventional wisdom is to find the real contributing factors to achieving your goal. The more different they are from the conventional wisdom, the bigger the opportunities you have. To avoid guessing, it will be better if you can find data to support your ideas. If that’s not possible, at least make sure that you use clear logic.

5. Determine the kind of Stats you Need

After you find some ideas in step 4, think about the kind of stats you need to test your assumptions and help you do things correctly. For now, don’t think about how to get the stats; you will worry about that later. Just think about the ideal stats you need.

6. Find the measurement Tools

The next step is to find the tools you need to give the stats in step 5. Sometimes the tools are available, and sometimes they aren’t. If you can’t find the tools that exactly meet your needs, just find the best possible ones.

7. Measure what you Do

The next obvious step is to measure what you do when you apply your ideas. As I said in step 5, measurement is important to make sure that your assumptions are correct and you do things correctly.

8. Adjust Yyourself Accordingly

The measurement gives you the feedback you need to adjust your actions. This way you can do the right things better over time.

Comments and Application to Investing:

Money can only be made from the stock market using the"2x2" matrix. This idea was discussed on kaChing's blog. To recap, on one axis you are either right or wrong. On the other access you are either consensus (following the herd) or non-consensus (contrarian). As Andy Rachleff describes it:

What most people don’t realize is that you don’t make money if you are right and consensus because all the returns get arbitraged away. The only way to make money in the long term is to be in the right and non-consensus quadrant.

The 2x2 matrix is the model for investors to use for financial success. The reason is that time will be better spent ignoring the direction of the market and focusing the energy challenging consensus and being right (about a company).

II - More Philosophy

While I detest hearing the philosophy from others (it is meaningless without context), I detest even more in regurgitating it. With that in mind, here are other ideas that are worth repeating from Moneyball:

1. Every form of strength covers one weakness and creates another, and therefore every form of strength is also a form of weakness and every weakness a strength.

2. The balance of strategies always favors the team which is behind

3. Psychology tends to pull the winners down and push the losers upwards

III - The Kool-Aid Market

David Rosenberg summed up the advance in the U.S. markets by suggesting various pundits are drinking Kool-Aid:

Marc Faber is the latest pundit to drink the Kool-Aid and recommend stocks over bonds, citing the Fed’s printing press — the problem here of course, is that the U.S. stock market has only recovered in devalued U.S. dollar terms. Look at the Dow or S&P 500 in gold terms, Canadian dollar terms or euro terms, and this wonderful rally basically disintegrates. It’s otherwise known as a rally based on “money illusion.”

Reflections from 1934 - 1 Year Anniversary

With 870 members now registered in the "Intelligent Investing" group on I created on kaChing, it is appropriate to compare a 1934 publication to events that have taken place currently.

In Security Analysis, written by Benjamin Graham, Graham wrote about the real estate mortgage-bond business between 1923 and 1929.

For owners of the first edition publication, this is on page 116. In regards to a bond offering, there was a statement of "appraised value" of the property:

"A typical building which cost $1,000,000, including liberal financing charges, would immediately be given and "appraised value" of $1,500,000. Hence a bond issue could be floated for almost the entire cost of the venture so that the builders or promoters retained the equity (i.e., the ownership) of the building, without a cent's investment, and in many cases with a goodly cash profit to boot. This whole scheme of real-estate financing was honeycombed with the most glaring weaknesses, and it is a sad commentary on the lack of principle, penetration, and ordinary common sense on the part of all parties concerned that it was permitted to reach such gigantic proportions before the inevitable collapse."

1 Year Anniversary
One year after Lehman Brother's collapsed, Financial Post published a great story about it, entitled "After the Fall." Link: http://www.financialpost.com/story.html?id=1987721

Caution
Rosenberg is the former Chief Economist of Merrill Lynch. Now back in Toronto with Gluskin Sheff & Associates Inc., Rosenberg stated the following in his recent (September 11) newsletter:

One thing we do see is that the private client is taking the prudent approach towards risk. There have been $50 billion in net new cash flowing into equity mutual funds over the past four months. It is hard to believe that these flows can really push a $10 trillion market higher by 50%. But we do see that $130 billion of retail fund flows have gone into hybrids and bond funds — income is the key in a deflationary backdrop.

The market sentiment is obvious: investors are hungry for any asset class that generates returns greater than 0% (the approximate rate of government treasury bills e.g. yield on 1 month - 1 year t-bill is 0.13%-0.36%). This hunger is often accompanied by an appetite for greater risk as seen by rising stock prices.