Valuable advice on investment advisers - By Tim Harford

Don’t try this at home: seek professional advice. A sound maxim, one might think. Unless you know something about electrical wiring, get an electrician in; go to a doctor rather than diagnosing yourself. And, since you are a fallible investor, choose your financial portfolio with the help of an investment adviser.

But do typical investment advisers give good investment advice? Three economists recently published research exploring this question in an intriguing fashion – they mixed the experimental methods of a double-blind controlled trial with the latest behavioural economics, all seasoned with a dash of tabloid sting.

The researchers recruited professional mystery shoppers and asked them to seek advice from a variety of financial advisers in Massachusetts. Each mystery shopper was equipped with one of four imaginary portfolios.

Lehman...

From Barry Ritholtz’s blog:

How awesome is this treasure trove of emails, documents, files et. al placed online by the NY Fed?

Some of the emails between Lehman execs are laughable — naive, silly, hubristic, childish.

But my favorite piece simply has to be the Morgan Stanley research report from June 30 2008 “Overweight Rating” on Lehman Brothers — “Bruised, Not Broken, Poised for Profitability“. 60 days later, Lehman Brothers filed what was then the largest bankruptcy in the United States.  This is (literally) what the category “Really Really Bad Call”  was invented for.

Who was the author of this steaming piece of [s**t], and where is he today? Why, he is Patrick Pinschmidt, and he is a Senior Policy Advisor at U.S. Treasury Department! (You could not make up stuff this un-f***ing-believable even if you tried).

Hugh Hendry quotes

From his April 2012 Commentary:

“It is my contention that value does not mix so well with debt.” 

“I do not think it is logical to try and outsmart the smartest people. Instead, my weapons are irony and paradox. The joy of life is partly in the strange and unexpected. It is in the constant exclamation ‘Who would have thought it?’” 

“I attempt to cultivate my own insights and to recognise the precarious uncertainty of global macro trends. I attempt to observe such things first hand through my extensive travel (I promise no more YouTube videos), and seek to understand their significance by investigating how previous societies coped under similar circumstances. But first and foremost, I am always preoccupied with the notion that I just do not have the answer. I am not blessed with the notion of certainty. Someone once said we should think of the world as a sentence with no grammar. If we do I see my job as putting in the punctuation. But above all, my job is to make money. 

In keeping with this theme, I want define the three ingredients that I believe make for an outstanding macro hedge fund manager. These are, in no stringent order:

1. Successful but contentious macro risk posturing. 

2. The need to choose the asset class offering the highest probability of payout should the conviction hold true whilst offering an asymmetric loss profile should the original premise prove unfounded. 

3. A best in class risk technique that stop losses the narrative and responds early with loss mitigation procedures (i.e. a method of staying solvent, rational and disciplined under pressure). 

I have always figured that the first is the real key. That success was simply a matter of contentious macro posturing. In other words, going long very rich risk premium or buying cheap stuff. It is my assertion that what makes a great fund manager first and foremost is the ability to establish a contentious premise outside the existing belief system and have it go on to become adopted by the broader financial community. Bruce Kovner expressed the idea more eloquently when he said, “I have the ability to imagine configurations of the world different from today and really believe it can happen. I can imagine...that the dollar can fall to 100 yen”. I am sure you are nodding in agreement, except Bruce was saying this when the USDJPY was well over 200, not today's rate of 80! 

That is the kind of guy I want to be when I grow up.” 

… 

“Remember, Jesse’s [Livermore] demise was down to [i.e. because of] his shorting of the stock market. Without a doubt, as our transition starting in 2007 testifies to, bearish macro calls are better expressed through the use of fixed income strategies. There is a higher probability that such bets will pay out should the narrative be vindicated. One is long, not short, risk premium and the lower volatility enhances the persistency of the trade.”

John Mauldin: A Gold Standard?

There are times, my friends Michael Lewitt and Dr. Lacy Hunt agreed today at lunch, when the study of economics is best informed by a sound knowledge of history. Indeed, Michael's son wants to follow his father into the finance world, and Michael is starting him off in history. I have spent hours listening to Lacy stroll through economic history, detailing the path of economic thought from Fisher to Kindleberger to Minsky. The last few days have been one of those times when I realized how much I don't know and how much more there is to learn. Not only Lacy and Michael are here in Florida, but a long list of bright minds to learn from. James Rickards, who has recently written the tour de force book Currency Wars, Harry Dent, Doug Casey, Porter Stansberry, Greg Weldon, and John Williams of Shadow Stats, with whom I look forward to meeting (do I have questions for him!). And so many more.

And it is because I simply have to stop, listen and learn (and visit with friends) that this week I will kind of take the weekend off and instead send you one of the more remarkable essays I have read in a long time. It is a speech by Jim Grant to the New York Federal Reserve. The always erudite Grant takes us back in time to the very beginnings of the Federal Reserve, to show us how far we have strayed from the original intent. I really think you should read this. I have perused it several times and intend to read it yet again – and then some more.

Warren Stephens: How Big Banks Threaten Our Economy

As of this past January, any bank operating in the United States with more than $50 billion in assets must have the business equivalent of a living will—plans for what to do in the event of catastrophe. Every well-managed business should have contingencies and ways to assess its health and viability. But the fact that the Dodd-Frank financial regulations require the largest banks to submit detailed plans for worst-case scenarios suggests something is seriously amiss.

We all know what happened when the "too big to fail" banks teetered on the verge of collapse in 2008. The government stepped in with $700 billion of taxpayer money, justified by the notion that failed banks would destroy our economy. (Of the eight biggest U.S. banks, only J.P. Morgan Chase didn't receive a bailout.) Three years later, we have Dodd-Frank's complex regulations and banks that are bigger than ever.

The solution isn't to demand that the big banks plan for disaster—it's to take steps to prevent disaster. We need bank reform that addresses the root of the problem: Some banks are simply too big—for their own good, as well as that of investors, the economy and their customers.

Hussman Weekly Market Comment: Release the Kraken

Over the past 13 years, and including the recent market advance, the S&P 500 has underperformed even the minuscule return on risk-free Treasury bills, while experiencing two market plunges in excess of 50%. I am concerned that we are about to continue this journey. At present, we estimate that the S&P 500 will likely underperform Treasury bills (essentially achieving zero total returns) over the coming 5 year period, with a probable intervening loss in the range of 30-40% peak-to-trough.

Why? First, with respect to 5-year prospective returns, it's important to recognize that returns at that horizon are primarily driven by valuations - not the "Fed Model" kind, but the normalized earnings and discounted cash flow kind. Stocks remain strenuously overvalued here, and only appear "fairly priced" relative to recent and near-term earnings estimates because corporate profit margins are more than 50% above their long-term norm. Meanwhile, corporate profits as a share of GDP are about 70% above the long-term average. As I detailed in Too Little To Lock In, these abnormally high margins are tightly related (via accounting identity) to massive fiscal deficits and depressed household savings rates, neither which are sustainable.

Our projection for 10-year S&P 500 total returns - nominal - is about 4.4% annually, which is far better than the 2000 peak, far inferior to the 2009 trough, and save for the period before the 1929 crash, worse than any prospective return observed prior to the late-1990's bubble - even in periods having similarly depressed interest rates.

Of course, rich valuations can persist for some time - predictably resulting in poor long-term returns, but often doing little to prevent short-run speculation and temporary gains. The issue is then to identify the point at which overvalued conditions are joined by sufficiently overextended conditions, and a sufficient loss of speculative drivers, to make rich valuations "bite" even in the shorter-term. This is where additional criteria come in, such as overbought technical conditions and extreme optimism in the form of low bearish sentiment, depressed mutual fund cash levels, and heavy insider selling. Presently, it doesn't help that T-bill yields and long-term bond yields remain higher than 6 months ago, and we have signs of oncoming recession. This is particularly evidenced by collapsing economic measures in Europe, softening economic performance in developing economies including China and India, and jointly weak year-over-year growth in key U.S. economic measures such as real personal income, real personal consumption, real final sales, and reliable leading indicators from the OECD and ECRI, as well as our own measures.

Hugh Hendry: The Eclectica Fund: Manager Commentary, April 2012

I’ve seen this in a few places, though none that has allowed printing of the document yet. If I come across one, I’ll try and update the link below.

Link to: The Eclectica Fund: Manager Commentary, April 2012

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April 2012 TEF Commentary

Notes from student meeting with Warren Buffett

Thanks to Santangel's Review and David for passing this along.

Link to: Notes from the Meeting Dr. George Athanassakos and Ivey MBA and HBA students had with Mr. Warren Buffett

How Earth Made Us (BBC)

Link to Part 1


Link to Part 2


Link to Part 3


Link to Part 4


Link to Part 5

Tim Ferriss: A Day In The Life

Link

The Economist: A fishy tale

Interesting historical fact.

This engraving, of a flying fish, almost changed the course of history. It is one of a set from John Ray’s and Francis Willughby’s book“Historia Piscium”, published in 1686 by the Royal Society and recently put online by them for the edification of scholars everywhere. The society, which today proudly describes itself as the world’s oldest scientific academy (it was founded in 1660), was almost bankrupted by the expense of the high-quality illustrations in what was regarded at the time as a leading natural-history text, but which unfortunately failed to sell as well as its publishers had hoped. As a result, no money was left over for another publication, “Principia Mathematica”, by Isaac Newton. That the most important volume in the history of physics, which described the laws of motion and of gravity, saw the light of day the next year was, in the end, due to the deep pockets of Edmund Halley, of comet fame. Halley was the son of a wealthy soapmaker and he stumped up much of the cost himself.

Wired: How to Spot the Future – By Thomas Goetz

So how do we spot the future—and how might you? The seven rules that follow are not a bad place to start. They are the principles that underlie many of our contemporary innovations. Odds are that any story in our pages, any idea we deem potentially transformative, any trend we think has legs, draws on one or more of these core principles. They have played a major part in creating the world we see today. And they’ll be the forces behind the world we’ll be living in tomorrow.

1. Look for cross-pollinators.

It’s no secret that the best ideas—the ones with the most impact and longevity—are transferable; an innovation in one industry can be exported to transform another. But even more resonant are those ideas that are cross-disciplinary not just in their application but in their origin.

This notion goes way back. When the mathematician John von Neumann applied mathematics to human strategy, he created game theory—and when he crossed physics and engineering, he helped hatch both the Manhattan Project and computer science. His contemporary Buckminster Fuller drew freely from engineering, economics, and biology to tackle problems in transportation, architecture, and urban design.

Sometimes the cross-pollination is potent enough to create entirely new disciplines. This is what happened when Daniel Kahneman and Amos Tversky started to fuse psychology and economics in the 1970s. They were trying to understand why people didn’t behave rationally, despite the assumption by economists that they would do so. It was a question that economists had failed to answer for decades, but by cross-breeding economics with their own training as psychologists, Kahneman and Tversky were able to shed light on what motivates people. The field they created—behavioral economics—is still growing today, informing everything from US economic policy to the produce displays at Whole Foods.

The Man Who Makes the Future: Wired Icon Marc Andreessen

Found via The Big Picture.

He’s not a household name like Gates, Jobs, or Zuckerberg. His face isn’t known to millions. But during his remarkable 20-year career, no one has done more than Marc Andreessen to change the way we communicate. At 22, he invented Mosaic, the first graphical web browser—an innovation that is perhaps more responsible than any other for popularizing the Internet and bringing it into hundreds of millions of homes. He cofounded Netscape and took it public in a massive (for that time) stock offering that helped catalyze the dotcom boom. He started Loudcloud, a visionary service to bring cloud computing to business clients. And more recently, as a venture capitalist, he has backed an astonishing array of web 2.0 companies, from Twitter to Skype to Groupon to Instagram to Airbnb.

As Wired prepares for its 20th anniversary issue in January 2013, we are launching a series called Wired Icons: in-depth interviews with our biggest heroes, the tenacious pioneers who built digital culture and evangelized it to the world over the past two decades. There’s not a more fitting choice for our first icon than Andreessen—a man whose career, which almost exactly spans the history of our magazine, is a lesson in how to spot the future. In an interview at Andreessen’s office in Palo Alto, California, Wired editor in chief Chris Anderson talked with him about technological transformation, and about the five big ideas that Andreessen had before everyone else.

Jim Grant on Capital Account

Link

How Keynes was the Warren Buffett of His Day (video)

April 27 (Bloomberg) -- David Chambers, lecturer at the University of Cambridge, discusses investment tips from a past master - John Maynard Keynes.

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Link to paper: Keynes the Stock Market Investor

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Related previous post: Keynes: One Mean Money Manager - By Jason Zweig

Bruce Berkowitz's Big Asset Sales (video)

April 27 (Bloomberg) -- In today's "Movers & Shakers" Bloomberg's Dominic Chu reports that Bruce Berkowitz, manager of the $8.4 billion Fairholme Fund, sold stakes in Citigroup Inc. and China Pacific Insurance (Group) Co. during the quarter ended Feb. 29, according to a regulatory filing. He speaks on Bloomberg Television's "In The Loop."

Rob Arnott on CNBC

Link

Aswath Damodaran on Selling Apple Stock (video)

Found via ValueWalk.

April 17 (Bloomberg) -- Aswath Damodaran, a professor of finance at New York University, and Lawrence Haverty, a portfolio manager at Gamco Investors Inc., talk about the performance of Apple Inc.'s stock. They speak with Betty Liu on Bloomberg Television's "In the Loop."

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Related previous post: Value Investing: Investing for Grown Ups? - By Aswath Damodaran

Can You Make Yourself Smarter? - By Dan Hurley

Thanks to Barry for passing this along.

Early on a drab afternoon in January, a dozen third graders from the working-class suburb of Chicago Heights, Ill., burst into the Mac Lab on the ground floor of Washington-McKinley School in a blur of blue pants, blue vests and white shirts. Minutes later, they were hunkered down in front of the Apple computers lining the room’s perimeter, hoping to do what was, until recently, considered impossible: increase their intelligence through training.

“Can somebody raise their hand,” asked Kate Wulfson, the instructor, “and explain to me how you get points?”

On each of the children’s monitors, there was a cartoon image of a haunted house, with bats and a crescent moon in a midnight blue sky. Every few seconds, a black cat appeared in one of the house’s five windows, then vanished. The exercise was divided into levels. On Level 1, the children earned a point by remembering which window the cat was just in. Easy. But the game is progressive: the cats keep coming, and the kids have to keep watching and remembering.

“And here’s where it gets confusing,” Wulfson continued. “If you get to Level 2, you have to remember where the cat was two windows ago. The time before last. For Level 3, you have to remember where it was three times ago. Level 4 is four times ago. That’s hard. You have to keep track. O.K., ready? Once we start, anyone who talks loses a star.”

So began 10 minutes of a remarkably demanding concentration game. At Level 2, even adults find the task somewhat taxing. Almost no one gets past Level 3 without training. But most people who stick with the game do get better with practice. This isn’t surprising: practice improves performance on almost every task humans engage in, whether it’s learning to read or playing horseshoes.

What is surprising is what else it improved. In a 2008 study, Susanne Jaeggi and Martin Buschkuehl, now of the University of Maryland, found that young adults who practiced a stripped-down, less cartoonish version of the game also showed improvement in a fundamental cognitive ability known as “fluid” intelligence: the capacity to solve novel problems, to learn, to reason, to see connections and to get to the bottom of things. The implication was that playing the game literally makes people smarter.

Psychologists have long regarded intelligence as coming in two flavors: crystallized intelligence, the treasure trove of stored-up information and how-to knowledge (the sort of thing tested on “Jeopardy!” or put to use when you ride a bicycle); and fluid intelligence. Crystallized intelligence grows as you age; fluid intelligence has long been known to peak in early adulthood, around college age, and then to decline gradually. And unlike physical conditioning, which can transform 98-pound weaklings into hunks, fluid intelligence has always been considered impervious to training.

That, after all, is the premise of I.Q. tests, or at least the portion that measures fluid intelligence: we can test you now and predict all sorts of things in the future, because fluid intelligence supposedly sets in early and is fairly immutable. While parents, teachers and others play an essential role in establishing an environment in which a child’s intellect can grow, even Tiger Mothers generally expect only higher grades will come from their children’s diligence — not better brains.

How, then, could watching black cats in a haunted house possibly increase something as profound as fluid intelligence? Because the deceptively simple game, it turns out, targets the most elemental of cognitive skills: “working” memory. What long-term memory is to crystallized intelligence, working memory is to fluid intelligence. Working memory is more than just the ability to remember a telephone number long enough to dial it; it’s the capacity to manipulate the information you’re holding in your head — to add or subtract those numbers, place them in reverse order or sort them from high to low. Understanding a metaphor or an analogy is equally dependent on working memory; you can’t follow even a simple statement like “See Jane run” if you can’t put together how “see” and “Jane” connect with “run.” Without it, you can’t make sense of anything.

East Coast Asset Management's Q1 Letter

Found via Market Folly.

We believe there are two general kinds of mispricings - structural and psychological.

Structural mispricings exist when an event occurs that forces a large population of owners to sell without any change in the investment’s intrinsic value. Examples of structurally induced selling would include: when an investment is deselected from an index, when a company is spun off from a larger parent company, or perhaps when a company’s credit rating is reduced. These scenarios are just a few examples that produce a good flow of ideas into our workout category which we can then use to apply an appropriate lens.

Psychological mispricings are driven from collective investor psychology which induces broad selling or a lack of buying in an investment, asset class or group of securities. Psychological mispricings have produced some of our most compelling compounding opportunities. The study of how human beings perceive the world is a helpful tool to understand the psychological biases that produce mispricings.

More than half of our brain is used for processing sensory information with the majority of that processing being vision. Evolutionary psychologists have said that animals from fiddler crabs to humans use eyesight for collision avoidance, suggesting that vision is for directing action not providing knowledge. We want to focus and apply a lens in the direction where there is a gap between the directed action of the marketplace and that of knowledge (truth).

Two universal visual impairments are myopia and hyperopia. Individuals, who suffer from myopia, or myopes, have difficulty seeing distant objects; hyperopes have difficulty focusing on near objects. These impairments can be used to describe the optical challenges that affect investors.

Excerpt from The Most Important Thing Illuminated - by Howard Marks

Combating Negative Influences
By Howard Marks,

Author of The Most Important Thing Illuminated: Uncommon Sense for the Thoughtful Investor

People who might be perfectly happy with their lot in isolation become miserable when they see others do better. In the world of investing, most people find it terribly hard to sit by and watch while others make more money than they do.

Howard Marks: Emotion and ego: A lot of the drive in investing is competitive. High returns can be unsatisfying if others do better, while low returns are often enough if others do worse. The tendency to compare results is one of the most invidious. The emphasis on relative returns over absolute returns shows how psychology can distort the process.

I know of a nonprofit institution whose endowment earned 16 percent a year from June 1994 to June 1999, but since its peers averaged 23 percent, the people involved with the endowment were dejected.

Seth Klarman: Even the best investors judge themselves on the basis of return. It would be hard to evaluate yourself on risk, since risk cannot be measured. Apparently, the risk-averse managers of this endowment were disappointed with their relative returns even though their risk-adjusted performance was likely excellent, as borne out by their performance over the following three years. This highlights just how hard it is to maintain conviction over the long run when short-term performance is considered poor.

Without growth stocks, technology stocks, buyouts and venture capital, the endowment was entirely out of step for half a decade. But then the tech stocks collapsed, and from June 2000 to June 2003 the institution earned 3 percent a year while most endowments suffered losses. The stakeholders were thrilled.

There's something wrong with this picture. How can people be unhappy making 16 percent a year and happy making 3 percent? The answer lies in the tendency to compare ourselves to others and the deleterious impact this can have on what should be a constructive, analytical process.

Joel Greenblatt: This is incredibly important. Most institutional and individual investors benchmark their returns, and therefore most end up chasing the crowd: accent on the wrong sylLABle.

Excerpted from, The Most Important Thing Illuminated by Howard Marks. Copyright (c) 2012 Howard Marks. Used by arrangement with Columbia University Press.

Author Bio
Howard Marks, author of The Most Important Thing Illuminated: Uncommon Sense for the Thoughtful Investor, is chairman and cofounder of Oaktree Capital Management, a Los Angeles-based investment firm with $80 billion under management. He holds a Bachelor's Degree in finance from the Wharton School and an MBA in accounting and marketing from the University of Chicago. He is the author of The Most Important Thing: Uncommon Sense for the Thoughtful Investor, published by Columbia Business School Publishing.

For more information, please visit Amazon

Hubris and other signs of trouble ‘down under’

Australia is rich in iron ore, coal and copper … and its stock of hubris seems to be growing.

After a recent trip to the “quarry in China’s backyard” SocGen’s Dylan Grice is even more worried about its economy than he was beforehand. It seems a book describing Australia’s economic success as “a miracle” was the catalyst (more on that below). In a note to clients Grice is recommending shorting the aussie dollar. And, if you’re lucky enough to be Australian, stockpiling gold.

But let’s rewind. His point is that the commodity boom has masked the full extent of the credit expansion and has fooled some into thinking the country’s economy is stronger than it really is.

Gundlach - Two Dangers for Equity Markets

Don’t buy stocks – for real, this time. That was the message Jeffrey Gundlach delivered to investors last Tuesday.

Among riskier asset classes, only equities have performed well since February 14, the date of Gundlach’s previous remarks to investors, during which he advised investors in his Doubleline funds to avoid those assets – Including equities.  In his most recent conference call with investors last Tuesday, he reiterated that forecast, this time singling out equities in particular.

“I really think we are not going to be making money on stocks bought at this level,” he said.

Gundlach identified two “triggers” that could set off a decline in stock prices – a worsening of the fiscal crisis in Europe and the ongoing inability to confront debt problems here at home, regardless of who is elected president this fall.

Gundlach, who is the founder and chief investment officer of DoubleLine funds, titled his remarks to investors “To QE3 or not QE3 – That is the Question.”

Bruce Greenwald on Structural Imbalances in the Economy

Bruce Greenwald likes to say that he is constituted todisagree with everybody about everything, and he was true to his word at therecent Hyman P. Minksy Conference in New York. Taking immediate exception withthe virtually unanimous characterization of the economic crisis as abalance-sheet recession, Greenwald, a professor of finance at ColumbiaUniversity, argued that, far from being unusual, balance-sheet recessions canin fact be found at the heart of almost all business cycles.

The upshot of Greenwald’s talk was that, although we aretechnically out of recession, troubling structural imbalances remain andcontinue to drag down growth and employment.

John Mauldin's Outside the Box: The Pain in Spain

It really does seem to be All Spain All the Time, but there is a reason. Unlike Greece, Spain makes a difference to the eurozone. It may be both too big to allow to fail and too big to save. Last week I came across a very informative 50-page PowerPoint on the situation in Spain from Carmel Asset Management. It is too big to send, but I asked Jonathan Carmel to draft a smaller document with some of the key points. I find it compelling. You can access the entire PowerPoint on my website. If you are not registered with me, you will need to enter your email address and, if you would, your zip code or country. There is a lot if information and data in the report. It will certainly make you think.

I want to emphasize that I do not think Spain is hopeless. Rather, it has a narrow set of limited options that will require a great deal of austerity and economic pain on the part of Spain and significant help from the rest of Europe, combined with the forbearance and patience of the bond market or massive buying of Spanish bonds by the ECB for an extended period of time. I think it will need to be the latter, as the bond market is on the brink of breaking down on Spanish debt, failing a realistic path to economic balance and growth. The way ahead is most difficult and treacherous. It appears to me that at the end of the day only ECB participation can buy Spain the time it needs. If they give Spain the time, it can get through. But the pain will then be spread to the valuation of the euro and thus the entire eurozone.

Is a new fiscal compact a possibility? One with nations giving up control of their budgets and a euro-wide bond issue by which all the nations guarantee the others' debt? Or is there some middle option? Anything is possible and everything will be discussed, as the cost of a eurozone breakup would be massive.

Thomas W. Phelps on the kinds of people/managers to look for

“Bet on men and organizations fired by zeal to meet human wants and needs, imbued with enthusiasm over solving mankind’s problems. Good intentions are not enough, but when combined with energy and intelligence the results make it unnecessary to seek profits. They come as a serendipity dividend on a well-managed quest for a better world.” 

-Thomas William Phelps, 100 to 1 inthe stock market

Value Investing: Investing for Grown Ups? - By Aswath Damodaran

Found via the Corner of Berkshire & Fairfax.

Abstract:

Value investors generally characterize themselves as the grown ups in the investment world, unswayed by perceptions or momentum, and driven by fundamentals. While this may be true, at least in the abstract, there are at least three distinct strands of value investing. The first, passive value investing, is built around screening for stocks that meet specific characteristics – low multiples of earnings or book value, high returns on projects and low risk – and can be traced back to Ben Graham’s books on security analysis. The second, contrarian investing, requires investing in companies that are down on their luck and in the market. The third, activist value investing, involves taking large positions in poorly managed and low valued companies and making money from turning them around. While value investing looks impressive on paper, the performance of value investors, as a whole, is no better than that of less “sensible” investors who chose other investment philosophies and strategies. We examine explanations for why "active" value investing may not provide the promised payoffs.

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Related link: Professor Aswath Damodaran’s (free) Course on Valuation

TED Talk - Brian Greene: Why is our universe fine-tuned for life?

Link

Near Record High Gold/XAU Ratio Prompts Buying in Gold Equities

While the yellow metal has declined considerably in recent months, gold equities have continued to fare even worse. With today’s sell-off in precious metals, the ratio of the price of gold to the Philadelphia Gold & Silver Index (XAU) reached another new multi-year high.

In late Monday morning trading, COMEX gold futures were lower by $9.80 at $1,633.00 per ounce while the XAU – a leading composite of the world’s largest precious metals companies - fell 2.5% to 160.08.

At its current level of 10.2, the gold/XAU ratio reached its highest point since the depths of the 2008 financial crisis; the ratio’s all-time high occurred on October 24, 2008, at 10.72.

Hussman Weekly Market Comment: Run, Don't Walk

Wall Street continues to focus on the idea that stocks are "cheap" on the basis of forward price/earnings multiples. I can't emphasize enough how badly standard P/E metrics are being distorted by record (but reliably cyclical) profit margins, which remain about 50-70% above historical norms. Our attention to profit margins and the use of normalized valuation measures is nothing new, nor is our view that record profit margins have corrupted many widely-followed valuation measures. As I noted in our September 8, 2008 comment Deja Vu (Again), which happened to be a week before Lehman failed and the market collapsed, "Currently, the S&P 500 is trading at about 15 times prior peak earnings, but that multiple is somewhat misleading because those prior peak earnings reflected extremely elevated profit margins on a historical basis. On normalized profit margins, the market's current valuation remains well above the level established at any prior bear market low, including 2002 (in fact, it is closer to levels established at most historical bull market peaks). Based on our standard methodology, the S&P 500 Index is priced to achieve expected total returns over the coming decade in the range of 4-6% annually." Present valuations are of course more elevated today than they were before that plunge.

Suffice it to say that every P/E multiple is simply a shorthand for proper discounted cash-flow methods, because there are countless assumptions about growth, margins, return on invested capital and other factors quietly baked inside. Like price-to-forward operating earnings multiples, even our old price-to-peak earnings metric has been rendered misleading due to historically high profit margins. Of course, we knew that was happening even before the credit crisis began, and believe that numerous widely-followed valuation measures remain distorted by record profit margins here.

Benjamin Roth quote on investing

From The Great Depression: A Diary, and written in September of 1931:

“The wise investor will disregard the day-by-day fluctuations of the stock market or real estate market and base his buying and selling on these long periods of rise and fall. Above all, and I repeat it again and again—he must have liquid capital in time of depression to buy the bargains and then he must sell before the next crash. It is difficult if not impossible to do this but the conservative longtime investor who follows the general rule of buying stocks when they are selling far below their intrinsic value and nobody wants them, and of selling his stocks when people are bidding frantically for them at prices far above their intrinsic value—such an investor will pretty nearly hit the bull’s-eye.”

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Related previous post: WSJ: The View From Inside a Depression

60 Minutes: The case against Lehman Brothers

 Link

Danny Meyer on Charlie Rose

Link to: Danny Meyer on Charlie Rose

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Related previous post: Business Insider Interview With Danny Meyer: The Truth About The Restaurant Industry

ECRI Insight: The Yo-Yo Years

The convergence of two cyclical patterns virtually dictates an era of more frequent recessions in developed economies. As a result, and because of the Bullwhip Effect, growth in developing economies is going to be jerked around more than people think, making for a good deal of cyclical economic contagion. In other words, we are now in the yo-yo years.

Jeff Bezos' 2011 Letter to Shareholders

Kindle Direct Publishing has quickly taken on astonishing scale – more than a thousand KDP authors now each sell more than a thousand copies a month, some have already reached hundreds of thousands of sales, and two have already joined the Kindle Million Club. KDP is a big win for authors. Authors who use KDP get to keep their copyrights, keep their derivative rights, get to publish on their schedule – a typical delay in traditional publishing can be a year or more from the time the book is finished – and … saving the best for last … KDP authors can get paid royalties of 70%. The largest traditional publishers pay royalties of only 17.5% on ebooks (they pay 25% of 70% of the selling price which works out to be 17.5% of the selling price). The KDP royalty structure is completely transformative for authors. A typical selling price for a KDP book is a reader-friendly $2.99 – authors get approximately $2 of that! With the legacy royalty of 17.5%, the selling price would have to be $11.43 to yield the same $2 per unit royalty. I assure you that authors sell many, many more copies at $2.99 than they would at $11.43.

Kindle Direct Publishing is good for readers because they get lower prices, but perhaps just as important, readers also get access to more diversity since authors that might have been rejected by establishment publishing channels now get their chance in the marketplace. You can get a pretty good window into this. Take a look at the Kindle best-seller list, and compare it to the New York Times best-seller list – which is more diverse? The Kindle list is chock-full of books from small presses and self-published authors, while the New York Times list is dominated by successful and established authors.

Amazonians are leaning into the future, with radical and transformational innovations that create value for thousands of authors, entrepreneurs, and developers. Invention has become second nature at Amazon, and in my view the team’s pace of innovation is even accelerating – I can assure you it’s very energizing. I’m extremely proud of the whole team, and feel lucky to have a front row seat.

How the Fed Favors The 1% - By Mark Spitznagel

A major issue in this year's presidential campaign is the growing disparity between rich and poor, the 1% versus the 99%. While the president's solutions differ from those of his likely Republican opponent, they both ignore a principal source of this growing disparity.

The source is not runaway entrepreneurial capitalism, which rewards those who best serve the consumer in product and price. (Would we really want it any other way?) There is another force that has turned a natural divide into a chasm: the Federal Reserve. The relentless expansion of credit by the Fed creates artificial disparities based on political privilege and economic power.

David Hume, the 18th-century Scottish philosopher, pointed out that when money is inserted into the economy (from a government printing press or, as in Hume's time, the importation of gold and silver), it is not distributed evenly but "confined to the coffers of a few persons, who immediately seek to employ it to advantage."

In the 20th century, the economists of the Austrian school built upon this fact as their central monetary tenet. Ludwig von Mises and his students demonstrated how an increase in money supply is beneficial to those who get it first and is detrimental to those who get it last. Monetary inflation is a process, not a static effect. To think of it only in terms of aggregate price levels (which is all Fed Chairman Ben Bernanke seems capable of) is to ignore this pernicious process and the imbalance and economic dislocation that it creates.

Pensions Find Riskier Funds Fail to Pay Off

Thanks to Phil for passing this along.

Searching for higher returns to bridge looming shortfalls,public workers’ pension funds across the country are increasingly turning toriskier investments in private equity, real estate and hedge funds.

But while their fees have soared, their returns have not. Infact, a number of retirement systems that have stuck with more traditionalinvestments in stocks and bonds have performed better in recent years, for afraction of the fees.

Consider the contrast between the state retirement fund forPennsylvania and the one for Georgia.

The $26.3 billion Pennsylvania State Employees’ RetirementSystem has more than 46 percent of its assets in riskier alternatives,including nearly 400 private equity, venture capital and real estate funds.

The system paid about $1.35 billion in management fees inthe last five years and reported a five-year annualized return of 3.6 percent.That is below the 8 percent target needed to meet its financing requirements,and it also lags behind a 4.9 percent median return among public pensionsystems.

In Georgia, the $14.4 billion municipal retirement system,which is prohibited by state law from investing in alternative investments, hasearned 5.3 percent annually over the same time frame and paid about $54 milliontotal in fees.

The Last Great Ape (NOVA)

Broadcast (2007) With their intelligent gaze, human-like posture, and peaceful nature, it's no wonder bonobos—one of five great apes, along with gorillas, chimpanzees, orangutans, and humans—remind us of ourselves. But while we share a common hominoid ancestor with bonobos as well as 98 percent of our DNA, this unique primate has been largely overlooked by all but a few scientists.

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Lawrence Krauss - A Universe from Nothing: Why There Is Something Rather Than Nothing

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Related previous post: Something From Nothing: Lawrence Krauss and Richard Dawkins

Richard Feynman - The Pleasure Of Finding Things Out

I posted this before, but since it is so good and I saw Tim Ferriss put up a post on it, I thought I'd post it again.

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Related link: Bill Gates posts 7 Feynman Lectures

Sequoia Fund Campaigns Against Goldman Board Member, Former Fannie CEO Jim Johnson

Found via Naked Capitalism.

As your investment manager our goal is to own shares in outstanding public companies that boast both excellent long-term performance records and ethical corporate governance standards. In the normal course of business we shouldn’t need to vote against management’s recommendations on proxy issues, because we trust management to act in our best interest.

Unfortunately, this year we are voting against James A. Johnson as he stands for re-election to the board of directors of Goldman Sachs, which we own for Sequoia Fund and separately-managed accounts. Mr. Johnson also serves on the board of Target Corp., which we own, and which should issue its proxy soon. If Mr. Johnson stands for re-election at Target, we intend to vote against him. If you vote your own shares in accounts we manage for you, we recommend you vote against James Johnson.

Warren Buffett quote

“The most common cause of low prices is pessimism - some times pervasive, some times specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It's optimism that is the enemy of the rational buyer.

None of this means, however, that a business or stock is an intelligent purchase simply because it is unpopular; a contrarian approach is just as foolish as a follow-the-crowd strategy. What's required is thinking rather than polling. Unfortunately, Bertrand Russell's observation about life in general applies with unusual force in the financial world: ‘Most men would rather die than think. Many do.’”

–Warren Buffett, 1990 Letter to Shareholders (found via A Few Lessons for Investors and Managers)

Jonah Lehrer on Charlie Rose

Link to: Jonah Lehrer on Charlie Rose

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Related book: Imagine

Jeremy Grantham's 1Q Letter: My Sister's Pension Assets and Agency Problems (The Tension between Protecting Your Job or Your Clients' Money)

The central truth of the investment business is that investment behavior is driven by career risk. In the professional investment business we are all agents, managing other peoples’ money. The prime directive, as Keynes knew so well, is first and last to keep your job. To do this, he explained that you must never, ever be wrong on your own. To prevent this calamity, professional investors pay ruthless attention to what other investors in general are doing. The great majority “go with the flow,” either completely or partially. This creates herding, or momentum, which drives prices far above or far below fair price. There are many other inefficiencies in market pricing, but this is by far the largest. It explains the discrepancy between a remarkably volatile stock market and a remarkably stable GDP growth, together with an equally stable growth in “fair value” for the stock market. This difference is massive – two-thirds of the time annual GDP growth and annual change in the fair value of the market is within plus or minus a tiny 1% of its long-term trend as shown in Exhibit 1. The market’s actual price – brought to us by the workings of wild and wooly individuals – is within plus or minus 19% two-thirds of the time. Thus, the market moves 19 times more than is justified by the underlying engines!

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You apparently can survive betting against bull market irrationality if you meet three conditions. First, you must allow a generous Ben Graham-like “margin of safety” and wait for a real outlier before you make a big bet. Second, you must try to stay reasonably diversified. Third, you must never use leverage. In my personal opinion (and with the benefit of hindsight, you might add), although we in asset allocation felt exceptionally and painfully patient at the time, we did not in the past always hold our fire long enough or be patient enough. It is the classic failing of value managers (and poker players for that matter) to get impatient and bet too hard too soon. In addition, GMO was not always optimally diversified. We are generally more cautious (or, if you prefer, “more experienced”) now than in 1998 with respect to, for example, both patience and diversification, and at least we in asset allocation always stayed away from leverage. The U.S. growth and technology bubble of 2000 was by far the biggest market outlier event in U.S. market history; we had previously survived the 65 P/E market in Japan, which was perhaps the greatest outlier in all important equity markets anywhere and at any time. These were the most stringent tests for managers, and we were 2 to 3 years early in our calls in both cases. Yet we survived, although not without some battle scars, with the great help that we did, in the end, win these bets and by a lot. Hypothetically, resisting the temptation to invest too soon in 1931 may have been a tougher test of survival in bucking the market. Luckily we, and all value managers, were not around to be tempted by that one. (Although Roy Neuberger – who died in December 2010, unfortunately – was, and he could talk about it as lucidly as any investor ever.)

This exemplifies perfectly Warren Buffett’s adage that investing is simple but not easy. It is simple to see what is necessary, but not easy to be willing or able to do it. To repeat an old story: in 1998 and 1999 I got about 1100 fulltime equity professionals to vote on two questions. Each and every one agreed that if the P/E on the S&P were to go back to 17 times earnings from its level then of 28 to 35 times, it would guarantee a major bear market. Much more remarkably, only 7 voted that it would not go back! Thus, more than 99% of the analysts and portfolio managers of the great, and the not so great, investment houses believed that there would indeed be “a major bear market” even as their spokespeople, with a handful of honorable exceptions, reassured clients that there was no need to worry.

Career and business risk is not at all evenly spread across all investment levels. Career risk is very modest, for example, when you are picking insurance stocks; it is therefore hard to lose your job. It will usually take 4 or 5 years before it becomes reasonably clear that your selections are far from stellar and by then, with any luck, the research director will have changed once or twice and your deficiencies will have been lost in history. Picking oil, say, versus insurance is much more visible and therefore more dangerous. Picking cash or “conservatism” against a roaring bull market probably lies beyond the pain threshold of any publicly traded enterprise. It simply cannot take the risk of being seen to be “wrong” about the big picture for 2 or 3 years, along with the associated loss of business. Remember, expensive markets can continue on to become obscenely expensive 2 or 3 years later, as Japan and the tech bubble proved. Thus, because asset class selection packs a more deadly punch in the career and business risk game, the great investment opportunities are much more likely to be at the asset class level than at the stock or industry level. But even if you know this, dear professional reader, you will probably not be able to do too much about it if you value your job as did the nearly 1100 analysts in my survey. Except, perhaps, with your own assets or, say, your sister’s pension assets.

The Lost Steve Jobs Tapes

Found via The Corner of Berkshire & Fairfax.

A treasure trove of unearthed interviews, conducted by the writer who knew him best, reveals how Jobs's ultimate success at Apple can be traced directly to his so-called wilderness years.

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Related book: Steve Jobs

Reuters Special Report on Aubrey McClendon’s Undisclosed Loans

Aubrey K. McClendon is one of the most successful energy entrepreneurs of recent decades. But he hasn’t always proved popular with shareholders of the company he co-founded, Chesapeake Energy Corp., the second-largest natural gas producer in the United States.

McClendon, 52, helped cause Chesapeake shares to plummet amid the financial crisis when he sold hundreds of millions of dollars in stock to raise cash for himself. Later, to settle a lawsuit by shareholders, he agreed to buy back a $12 million map collection that he’d sold to Chesapeake.

His approach to running his company also is renowned: Among other employee perks, on-site Botox treatments are available at its headquarters in Oklahoma City, Oklahoma. Now, a series of previously undisclosed loans to McClendon could once again put Chesapeake’s CEO and shareholders at odds.

McClendon has borrowed as much as $1.1 billion in the last three years by pledging his stake in the company’s oil and natural gas wells as collateral, documents reviewed by Reuters show.

One Economist's Mission to Redeem the Field of Finance

Found via The Big Picture.

Among the members of the rogues' gallery blamed for the crash of the economy in 2008, none have worn the black hat of villainy quite as convincingly as greedy financiers.

Robert J. Shiller, however, sees them and their field in shades of gray.

"It's kind of a mythology that's developed around finance," says Mr. Shiller, a behavioral economist, professor at Yale University, and teacher of many future financiers. Rapacious Wall Street types, he says, may make handy bad guys in the movies. "The problem is, we can't live in a mythic world. We have to live in the real world."

And in the real world, Mr. Shiller argues in his new book, Finance and the Good Society (Princeton University Press), finance is a powerful and necessary tool to keep society running.

It is the architecture that allows people to reach their goals, such as paying for college or starting a business, and to protect their assets throughout their lives.

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Related book: Finance and the Good Society

Simoleon Sense Episode #2: Professors Dan Ariely & Mike Norton on Wealth Inequality in America and Last Place Aversion

Link to: Simoleon Sense Episode #2

Warren Buffett quotes (defining what you don't know)

This is a great example of Peter Bevelin pulling complementary quotes together from different Warren Buffett letters to shareholders in his new book, A Few Lessons for Investors and Managers. The book also includes thoughts from Peter that add to the discussion.

“Though the mathematical calculations required to evaluate equities are not difficult, an analyst - even one who is experienced and intelligent - can easily go wrong in estimating future "coupons." At Berkshire, we attempt to deal with this problem in two ways. (1992)

First, we try to stick to businesses we believe we understand. That means they must be relatively simple and stable in character. If a business is complex or subject to constant change, we're not smart enough to predict future cash flows. Incidentally, that shortcoming doesn't bother us. What counts for most people in investing is not how much they know, but rather how realistically they define what they don't know. (1992)

If we have a strength, it is in recognizing when we are operating well within our circle of competence and when we are approaching the perimeter. (1999)

Intelligent investing is not complex, though that is far from saying that it is easy. What an investor needs is the ability to correctly evaluate selected businesses. Note that word "selected": You don't have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital. (1996)”

Warren Buffett diagnosed with diagnosed with (non life-threatening) stage I prostate cancer

To the Shareholders of Berkshire Hathaway:

This is to let you know that I have been diagnosed with stage I prostate cancer. The good news is that I’ve been told by my doctors that my condition is not remotely life-threatening or even debilitating in any meaningful way. I received my diagnosis last Wednesday. I then had a CAT scan and a bone scan on Thursday, followed by an MRI today. These tests showed no incidence of cancer elsewhere in my body.

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Related article (Carol Loomis): How Berkshire Hathaway CEO Warren Buffett spent the week he found out he has prostate cancer: Business as usual.

Related video (CNBC, Whitney Tilson): Buffett Diagnosed with Prostate Cancer

INEQUALITY 101: THE PICKET FENCE AND THE STAIRCASE - by John Cassidy

Found via The Big Picture.

When a group of millionaires appear onstage with a Democratic President to call for higher taxes on people like them, you know one of two things: either the President is in Hollywood, or something interesting is happening in the country at large. In this case, it’s the latter. After three decades in which rising inequality was largely ignored, it has finally emerged as a serious political issue—or, at least, President Obama is trying to turn it into one.

I’ll have more to say later about the “Buffett Rule” that Obama has proposed, which would force people who make upwards of a million dollars a year to pay at least thirty per cent of their income to the federal government. But before getting into a policy discussion, I thought it might be useful to provide a reminder, with the aid of some charts, about the basic facts underlying the debate.

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Related previous posts:

FiveBooks Interview: Daron Acemoglu on Inequality

Fault Lines: The Top 1%

TED Talk - Richard Wilkinson: How economic inequality harms societies

Capital versus Talent: Discussion between Malcolm Gladwell and Roger Martin

How Inequality Fueled the Crisis - By Raghuram Rajan

Amy Chua: World on Fire

Hoisington Q1 2012 Letter

The standard of living of the average American continues to fall. Real median household income today is near the same level as it was fifteen years ago, a remarkable statistic since the debt to GDP ratio is 100 points higher (Chart 1). The cause of this deterioration in living standards can be traced to the excessive accumulation of debt, as well as the debt proportion that has turned increasingly unproductive, or even counterproductive. When debt is utilized to finance nonproductive assets, an economic process is initiated that undermines prosperity. Productivity gains must be generated in order to boost income, and thereby the standard of living. If debt enhances productivity, incomes will expand and the economic pie will be enlarged. Otherwise, the debt increase exercise is debilitating to economic growth.

Why Investors Should Pay Attention to the JOBS Act of 2012

From the Distressed Debt Investing blog:

On April 5th, 2012, President Obama signed the Jumpstart Our Business Startups (JOBS) Act into law. In my opinion, this may be one of the most important pieces of legislation enacted in the past 20 years. And investors of all sorts: angels, value, distressed, etc., should be paying attention.

It has surprised me that discussion of the JOBS Act has not perpetuated the "investing blog" universe given the ramification of this new legislation. I am hoping this post will be a springboard for institutional investors and writers to begin discussion of the bill and its implications for those in the professional money management business. I'd encourage you to forward this post to those who may be interested.

Gerd Gigerenzer: What Can Economists Know?

Mentioned by both Steve Keen and Yves Smith.

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TED Talk - Atul Gawande: How do we heal medicine?

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Related books:

The Checklist Manifesto

Better: A Surgeon's Notes on Performance

Complications: A Surgeon's Notes on an Imperfect Science

The Secrets of the Super Creative

The myth of the "creative type" is just that--a myth, argues Jonah Lehrer. In an interview with WSJ's Gary Rosen he explains the evidence suggesting everyone has the potential to be the next Milton Glaser or Yo-Yo Ma.

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Related book: Imagine

Related previous post: What it takes to be great