Thursday, September 30, 2010

"Despite Frenetic Advances in Technology, Relationships Matter at Monness"

Sydney M. Williams

Thought of the Day
“Despite Frenetic Advances in Technology, Relationships Matter at Monness”
September 30, 2010

We live in a fast-paced world, in which the speed of everything seems to be accelerating. E-mail and telephones follow us everywhere, into restaurants and the theater, on vacation, and at home on weekends. Invasive and insidious IMs track one down wherever one is. All night long muffled bleeps signal the arrival of more e-mails – most of which are candidates for deletion. Our omnipresent cell phones, constant companions, synch automatically as soon as we start the car. (Incredibly, if I choose – and I do not – my cell phone can synch with my ski helmet.)

What is gained is timely information and, if one has the ability and inclination, an opportunity to make a quick trade – possibly (but not assuredly) a profitable one. To those for whom staying in touch is imperative, one is never out of the loop. In our business, speed is important and provides a competitive edge, especially when customers exist all over the world. (Once asked to describe high frequency trading to someone outside of our business, I used an analogy from the animal kingdom. Imagine two frogs sitting on adjoining lily pads, each waiting for a dragonfly to drift within range. Frog ‘A’ has the ability to uncoil his tongue a fraction of a second faster than frog ‘B’. The unsuspecting dragonfly flits by; frog ‘A’ is sated; frog ‘B’ goes hungry.) The duration of orders on electronic exchanges, for example, can be measured in one thousandth of a second. To those who make use of high frequency trading computers, speed, efficiency and technology are more important than relationships.

Human interaction, in such instances, becomes unimportant, irrelevant, or non-existent. This process toward efficiency, with machines replacing man, has been evolving for two hundred years, but the last half dozen years have seen a sharp acceleration in the rate of change. The speed of computers and the ubiquity of the internet have hastened the trend away from personal interaction.

What is lost in this, almost paranoid, urgent dash for data points, where rumor and fact become indistinguishable, are the benefits of reflection – opportunities to weigh the evidence, to determine the source. People of like mind send out comments designed to reinforce their predetermined opinions, spreading stories in rapid-fire fashion. They are aided, of course, by a media to whom every story, no matter how trite, is a “news flash”, entertaining rather than informative. Laszlo Birinyi, writing in the October issue of Reminiscences, compares today’s market to a trek through the Amazon, requiring a guide.

In our firm we have always believed that no amount of technology can substitute for personal relationships. Technology in today’s world is critically important, but the ancient characteristics of mankind – honor, integrity, respect, loyalty – are indispensible to our building an enduring business.

Wednesday, September 29, 2010

"Self Confidence, the Missing Ingredient"

Sydney M. Williams

Thought of the Day
“Self Confidence, the Missing Ingredient”
September 29, 2010

The dictionary defines confidence as “full trust; belief in the full powers, trustworthiness, or reliability of a person or thing.” Self confidence: “a belief in oneself and one’s powers or abilities.” While slower than historic growth is likely a given (i.e. “new-normal” as characterized by Bill Gross of PIMCO) after the debt-driven growth of the past several years, it is the absence of confidence that restrains future growth. Confidence is certainly missing from people’s belief in their government, but it is the absence of self confidence that, in the longer term, is most damaging. Restored, we will thrive; without it we wither.

Much has been written about confidence or more aptly the lack thereof, in our economy. It is the single most important factor in driving Independents away from the Democratic Party and, at least in part, responsible for the Tea Party. At the peak of the financial crisis, two years ago exactly, confidence in the banking system hit record lows. A measurement of confidence in the credit system, the TED spread, had widened from 50 basis points in July 2007 to 465 basis points by early October 2008. (The TED ratio is the spread between three month LIBOR and the Three-Month Treasury Bill.) Acting decisively, Treasury Secretary Henry Paulson, Fed Chairman Ben Bernanke and then New York Fed Timothy Geithner convinced Congress to guarantee money market funds and to pass a TARP Bill (Troubled Asset Relief Program), a program through which banks could sell to the government “troubled” loans. The program was later amended allowing the government to take equity stakes in troubled banks. Despite Monday morning quarterbacking, the plan worked, in that confidence in the banking system returned as manifested by a TED spread that declined 300 basis points by the end of December 2008. While it was still high, the immediate crisis had passed.

Unfortunately what has not returned is confidence in the economy. Confidence is a tricky matter. It is an intangible; it must be sensed and encouraged. It is elusive, so difficult to restore. While the President exudes self-confidence, he has been unable to instill in the people a belief in their future. His mistake, in my opinion, has been emphasizing a confidence in government, rather than a belief in the individual. He blames former President Bush and Wall Street for the morass in which we find ourselves, and claims that the answer is government. In contrast, when Ronald Reagan was President, and faced with rapidly increasing inflation and prohibitively high interest rates, he emphasized his faith in the individual, that government was the problem, not the solution. The Obama administration’s emphasis on government, as opposed to the individual, reminds one of the old Chinese proverb – give a man a fish and he eats for a day; teach him to fish and he eats for a lifetime. For employers to rehire, they must feel comfortable about the future. For individuals to buy homes, they must feel confident about their job.

In yesterday’s New York Times, David Brooks – “Tom Joad Gave Up” – wrote: “Sometimes it’s hard to remember what good government looks like:..government that inspires trust.” Mr. Brooks blames the crisis (he is writing of California, but the analogy is applicable) on both Parties: the Democrats for granting too much power to the public employee unions and to environmentalists who supplanted reason with ideology. Republican, he says, were simply blind to the public sector’s role in creating prosperity within the state. George Melloan, in the August 24, 2010 issue of the Wall Street Journal wrote: “The Fed can flood the banks with liquidity in an effort to stimulate economic growth (if it is willing to run the very real risk of inflation). But that will not necessarily stimulate a demand for this money.” Later he quoted George Fisher, President of the Dallas Fed, who stated that “no amount of further monetary accommodation can offset the retarding effect of heightened uncertainty.”

The increasingly bitter partisanship that has marked Washington (admittedly heightened by the fall campaign) adds to this lack of confidence. Attempts to find a middle ground are immediately demonized as a sign of weakness. A recent case in point was John Boehner’s response to a question a couple of weeks ago. Barack Obama, on the stump, had said that the “Party of No” would let all taxes rise, if those earning over $250,000 were not included in a bill to extend the Bush tax cuts. Mr. Boehner said that, while his preference was clearly to extend the cuts to all people, if the only bill feasible excluded the top earners then he would support it. Conservatives, goaded by the Press, immediately jumped down Boehner’s throat, claiming that he had fallen into the President’s trap. It was as though he were a traitor. Have we traveled so far down the road toward incivility that compromise is no longer possible? This incessant bickering adds to uncertainty and decreases confidence.

More than anything, people need a strong dose of self confidence – to be told that they can achieve whatever their aspirations, as long as they are willing to put in the time and the effort. It was Reagan’s genius that he recognized that fact. The future is always unknowable, but it is in the belief each one of us must muster in ourselves that overcomes doubt and leads to success. As Sir Edmund Hillary once said: “It is not the mountain we conquer, but ourselves.”

Tuesday, September 28, 2010

"Equities - Is it Time to Consider Behavior?"

Sydney M. Williams

Thought of the Day
“Equities – Is it Time to Consider Behavior?”
September 28, 2010

Fundamental investors determine stock values to be the present value of its future earnings. To do so one uses a discounted cash flow model, into which one enters estimated earnings growth over a specific period of years. The model provides for a “leveled-off” annual growth rate. The discount rate, an estimated (and theoretically appropriate) benchmark return, is then used to calculate the present value. Since the model incorporates numerous estimates, the system works best when confidence is high. At times like the present when confidence ebbs, investors often turn to technical analysis to calculate resistance and support for individual stocks. The language of technicians can be arcane, tossing out words like oscillators, flags, double tops and candlestick charts – words that are off-putting to many individuals.

However, a good friend, and successful investor, suggests that in times like the present studying investor behavior may trump both fundamentals and technicals. The concept assumes that, while the future is unknowable, people act in ways that may be anticipated. Patterns emerge. For example, as my friend pointed out, during the early years of the Depression many out-of-work men would don their suits and head downtown, only to sit all day in the Automat sipping coffee and reading the papers. It was an attempt at “normalization”. Similarly, he suspects, people early on in the current downturn continued to spend on consumer products, in spite of their altered financial situation. They were stuck in denial, fervently hoping that what was happening was not. Reflecting that mood, he points out, retail stocks did well in the first part of this year.

The past ten years have been tough for equity buyers. In 2000-2002 investors were “slaughtered”. In 2003-2007, stocks recovered and home prices levitated. In 2008, investors were “killed” as both stocks and home prices plummeted. And now, in 2010, the markets seem unable to make up its mind. The 2003-2007 is now seen by many as a “fake” recovery. Rising stock prices lifted 401Ks and soaring home prices provided a false sense of security, akin to England in the glorious summer preceding World War I. Debt proliferated. Home equity loans became ubiquitous; the proceeds were used to continue the “good life” that commonsense said had ended in March 2000.

While stocks and home prices collapsed, debt initially continued to rise, lifting to 130% of disposable income. (It has since declined modestly to 126%.) Today people, if they have not lost their job, they worry that it is in jeopardy. They realize their savings is inadequate. (Savings has now risen to 6% from 1% at its low.) What savings they do have – Treasury Bills, Money Market Funds and savings account – provides little return. A million dollars in T-Bills pays $1300 annually. (Three years ago that million dollars paid $50,000 annually. To generate the same level of income today, one would need $38 million in T-Bills.) Remarkably, a retired person today on Social Security, with two million dollars in Treasuries would have an income placing them substantially below the poverty line.

So people, understandably, are nervous and cautious. They are focused on their jobs (if they have one) and on saving. De minimis returns have meant that retirees have had to buy riskier securities and/or extend maturities. As witness to this trend, money market funds have declined from $3.8 trillion in December 2008 to $2.8 trillion today. Yields on High Yield securities, over the same time, have declined from 17.4% to 8.3% today. Since the start of the current year, the Treasury yield curve has flattened from 373 basis points to 241 basis points today.

My friend draws the obvious conclusion that investors, especially the elderly, are scared. They worry where they will live and how they will survive. Even if their assets survived the double onslaught of house and stock price declines, their income is only a fraction of what it was. They want safety, but they need income. He cites a recent survey, which suggests that 90% of people’s concern today is about money. Additionally he assumes that the CEOs of companies sitting on cash hoards are just as worried, and those concerns prevent them from investing that money in new jobs.

Compounding the problem is that many individuals see Wall Street as a “rigged” game. They note that no blame has been assigned for the “flash crash” in May, despite the obvious “usual suspects”. They read of Wall Street getting bailouts; yet they hear the same politicians who voted for those bailouts demonizing “greedy” bankers and speculators. They distrust the “system”. Blaming others and instigating class warfare does little to restore confidence and serenity.

My friend concludes that while momentum is in bonds, opportunities lie in stocks, and suggests that the recent rally is the dawning of that knowledge. In terms of stocks, the characteristics he looks for include:

• Dividend payers that have a history of annually increasing payouts.
• Businesses that are global, as future growth will assuredly come from Asia and the developing world.
• Companies that are dominant in their industry and are gaining market share.
• Companies that are cash rich, providing the flexibility to make acquisitions, increase dividends, or buy back stock.

There are no seers on Wall Street (a lot of pretenders, perhaps, but none that have the ability to foretell the future), but one could do worse than be an observer of people, especially in times of distress. Interestingly, much of what people are instinctively doing – increasing savings, reducing consumption, paying down debt – sows the seeds of ultimate recovery. What is needed more than anything are leaders in Washington who will work to restore people’s faith and confidence in themselves. That we have not yet seen.

Monday, September 27, 2010

"Sanctions on Goods from China - Not a Good Idea"

Sydney M. Williams

Thought of the Day
“Sanctions on Goods from China – Not a Good Idea”
September 27, 2010

Mark Twain once famously said: “Suppose you were an idiot. And suppose you were a member of Congress. But I repeat myself.” In an illuminating manifestation of Twain’s principle, two events were reported in Saturday’s press. On Friday the House Ways and Means Committee, headed by Democrat Sander Levin of Michigan, with bipartisan support approved a bill that would give the Commerce Department the power to “impose economic sanctions on China and other countries found to be manipulating their currencies to gain trade advantages.” Also on Saturday, Apple’s new iPhone went on sale in China. Yahoo! News reported: “Some customers waited as long as two days to get their hands on one of the phones.”

The irony is blatant. While it may be true that Apple manufactures phones in China, the technology is American. Despite all that we read about how China’s growth is based on trade, it is worth remembering that our trade numbers are 25% larger than China’s – $4 trillion versus $2.9 trillion. The United States has a long history of hardworking, entrepreneurial innovators and it has a long history, especially in times of economic distress, of encouraging government intervention. In a fascinating and timely article in Saturday’s Wall Street Journal, “Reassessing John Kenneth Galbraith”, James Grant quotes Galbraith as writing, in the mid 1960s: “The day of Adam Smith’s ‘invisible hand’ was over or ending”, pushed aside by corporate and government bureaucrats, collectively the “technostructure”. Grant then added: “The cosseted, self-perpetuating corporate bureaucracy that Galbraith described in The New Industrial State (1967) was in for a rude awakening. Deregulation became a Washington watchword under President Carter, capitalism got back its good name under President Reagan and trade barriers fell under President Clinton…Wal-Mart delivered everyday low, and lower, prices, and MCI knocked ATT off its monopolistic pedestal. The technostructure must have been astounded.”

The action taken by the House Ways and Means Committee suggests that the old technostructure was not killed, but only put to sleep. Have lessons from the past been truly learned? In spite of the financial crisis and a concern that some banks “were too big to fail”, big banks are getting bigger. Government intrusion has become pervasive. The government today is 90% of the new mortgage market. They are making autos in Michigan and deeply involved with banks in New York. They are writing insurance, through AIG, around the world and will be determining pricing for healthcare and health insurance. And now they want the Commerce Department to be able to easily and quickly impose sanctions on China and others. In the interests of protecting outmoded manufacturing and union pensions, they are willing to raise the costs of imported clothing, electronics and other consumer and manufactured goods.

The reason for the protectionist bill is the Yuan and the perception that it is grossly undervalued. Many of the most vociferous critics of the Yuan, and who want free market forces to determine its level, are the same ones who favor keeping interest rates and the dollar low. It is OK for us to intervene, but not for our foreign competitors!

China has, at least, two large advantages over the United States in the race for competitive advantage. First, it has an abundance of labor; and second it has no legacy manufacturing facilities, or technologies. For all intents and purposes China has entered the Twenty-first Century with a clean slate; whereas the United States must transform from the past to the present. Such change has disrupted millions of people and to a large extent accounts for the income disparities that have plagued our nation over the past thirty years. Aside from the practical benefits of community colleges, education and training have failed to keep pace; so, as technological efficiencies in manufacturing reduced the need for manual labor, displaced workers found they did not have the skills needed for the computer age in which we live. A great and unfortunate irony of this recent downturn is that while unemployment and under-employment remain high, thousands of jobs go unfilled because of lack of skills. The Milwaukee Journal Sentinel on September 11 had a column on the subject: “According to Manpower Inc., the global job-placement company, the nation has a gaping disconnect between openings and qualified candidates – a gap contributing to around 3 million unfilled U.S. jobs – which in turn hampers growth.” Training is the answer.

The point I am trying to make is that attempts to defend the past and the old way of doing things condemns the worker who is being “protected” to a life of less. Jobs get shipped offshore for the very valid reason that the functions can be performed less expensively somewhere else, and consumers around the world benefit. The answer is not to raise barriers, for that never works. Affected countries will simply counter by implementing their own tariffs. Neither is the answer to raise taxes on income American companies generate from foreign subsidiaries. The U.S. already has one of the highest corporate tax rates in the world. The answer is to re-train workers for today’s environment; it is to be innovative, developing products and services that are competitive in today’s world. Encouraging investment and unleashing entrepreneurs will do more for domestic employment than erecting barriers.

Around the world an estimated 500 million people, or more, are entering the middle classes. There is much that they will need and more that they can use. They are potential customers for America’s products and services. Trade and the global shifting of jobs is not a one way street. Keep in mind, half the cars built in this country are built by foreign manufacturers who have elected to ship their jobs to this country, and Apple’s Steve Jobs has demonstrated the impact of America’s technology with the iPhone.

One hundred years ago, New England, where I grew up, was the center for mills, converting cotton to cloth. As wages and costs rose, factories moved south and New Englanders were forced to find other occupations. For years those mills remained vacant, reminders of a past that was no more. Today they are filled with small shops, businesses and condos. It is, in a sense, a manifestation of Joseph Schumpeter’s theory of creative destruction. Government may choose to intercede, but its purposes, in this instance, should be to educate and train, not to hold back the tide of progress by defending the indefensible.

Trade wars often start as small skirmishes and the intentions of those who ignite them may be honorable – to protect their constituents, but they and all of us are better served if we prepare for a constantly evolving world. A consequence of America’s proposed sanctions is seen in the threat this morning by China to raise tariffs on imported U.S. chickens – a $752 million business. Sanctions can lead to tariffs and tariffs may lead to trade wars, and trade wars impoverish nations.

Thursday, September 23, 2010

"Public Education - Flickers of Light?"

Sydney M. Williams

Thought of the Day
“Public Education – Flickers of Light?”
September 23, 2010

Not everybody is equal, nor will they ever be. Native intelligence varies greatly, as does physical ability. Some people are born with beautiful features, others with physical handicaps. Focus and diligence may be taught, but are inherent in a lucky few. Each one of us is unique. In any family, two parents are better than one, as are parents who have the leisure to spend time with their children. But such luxuries are available only to a fortunate minority. Responsibility for educational success lies with parents and with schools and their teachers. However, none of this means that every child should not be offered an equal opportunity to succeed.

Unfortunately that has not been the case. Similar to many on Wall Street, a large number of Washington politicians send their children to private schools. President Obama’s decision to send his two daughters, Malia and Sasha, to Sidwell Friends School only followed the precedent set by President Clinton whose daughter, Chelsea graduated from Sidwell. Of course, some politicians do take advantage of public schools. George Bush’s daughters graduated from Austin High School, but that was in 2000 before he assumed the Presidency. Jimmy Carter’s daughter Amy attended public schools in Washington while her father was President. In general, though, Washington, in return for campaign contributions, has chosen to put the demands of teacher’s unions above the needs of children and their parents.

The importance of teachers, especially those in elementary and middle school cannot be over-stated. All one has to do is look back on one’s own life to know how critical to one’s life are the first twelve or fifteen years. In terms of adult impact, teachers are second only to parents and, for many less fortunate children, the most important influence on their young lives. The biggest hurdle to successful schools has been the teachers unions – a problem now being addressed with the rise of charter schools and increased competition from private and parochial schools. While good teachers remain underpaid, public school systems have become very expensive. The Center for Education Reform notes that the average district public schools’ per pupil expenditure, at $12,018, is 33% above that for charter schools and 30% above the average private school tuition. Despite that, the results have been mediocre at best. In today’s Wall Street Journal, it is pointed out that the Newark, New Jersey school system spends $22,000 annually per pupil, “but only about half of its students graduate.”

Public schools have particularly failed for Blacks and the poor in both urban and rural America. The Schott Foundation recently reported that only 47% of black males graduate from high school, versus 78% of white males. In New York the spread is wider – 25% versus 68%. Ironically and mystifying the pressure to maintain the status quo has come from within. Anthony Bradley in the August 25, 2010 issue of Acton Commentary writes: “Sadly the NAACP and the NEA (National Education Association, the largest labor union in the United States) have long undermined the push for low-income black parents to exercise freedom to choose the best schools as a national norm.” Los Angeles, a city in severe financial straits, has just unveiled a $578 million school, the costliest in the nation, and 50% more expensive than any other school. Nevertheless, “Yahoo! News” points out that it will be run by the same people who have provided a 50% dropout rate. A show-case is nice if you can afford it, but should not the priority be to get the best teachers possible, pay them well and treat them as professionals? The interests of administrators, along with that of union leaders and politicians, have taken precedent over the needs of the students.

However, into this dreary (and I would add corrupt) landscape there are flickering signs of positive change. First, President Obama and his Education Secretary Arne Duncan with their “Race for the Top” have shown a willingness to take on the teachers unions. Second, Wendy Kopp’s “Teach for America” has proven enormously successful in attracting some of the best and the brightest from the nation’s most elite colleges into the profession of teaching. Lastly, on Friday, Davis Guggenheim’s documentary, “Waiting for Superman” will hit the theaters.

I have been critical of President Obama and his administration on many issues – a stimulus, which did not stimulate; healthcare reform, which will only add to cost and limit care; financial reform, which does not touch the government GSE’s, and trade, where the President has not signed agreements that have already been negotiated. But on the issue of education he has shown foresightedness and courage.

The President and Education Secretary Arne Duncan with their “Race for the Top” stated that to win the dollars offered schools must do three things: ease restrictions on charter schools, adopt common national standards and link teacher pay to student achievement. The first and the third go against the wishes of unions. Nevertheless, there have been some significant successes, including Harlem Village Academy Charter School, and the New Orleans school system, which has benefitted from competition from charter schools, which provide increased opportunities to those in that poor city. Michelle Rhee, chancellor of the Washington, D.C. public school system, has been a spark for reform in the nation’s capital; she has raised the standards of this long suffering school system. However, she has run up against the unions, and the defeat of Mayor Adrian Fenty (her mentor and supporter) in the 2010 Democratic primary, puts her survivorship in doubt. It will be interesting to see if the President intercedes on her behalf.

Wendy Kopp started Teach for America based upon her senior thesis at Princeton in 1989. The organization is privately supported and last year placed 4100 teachers from a pool of 35,000 applicants. In 2010, applications increased to 46,000 (17% of the graduating class from Yale applied!), with 20% being placed. Each one agrees to teach for two years. The applicant pool, in its quality and size, is reminiscent of the early days of the Peace Corps.

Davis Guggenheim won an Oscar in 2007 for “An Inconvenient Truth”. In his new movie, Waiting for Superman”, he takes on the teachers unions, as he follows five students and their families, in an attempt to understand why so many public schools are failing. The hero of the movie is Geoffrey Canada, president of Harlem Children’s Zone. (In the interest of full disclosure, Monness, Crespi, Hardt & Co. provides support to the Harlem Children’s Zone.) The NY Daily News, in a report yesterday, stated (about the movie): “Canada stands out as the singular voice of hope in a film that paints the nation’s public school system as nothing short of a full-scale disaster.”

It is not yet clear that the unions will be beaten. They have enormous financial resources and are generous in their giving to those politicians who support their inflated contracts, unrealistic pensions and their guarantee of employment based upon years of service rather than achievement. The President must stand resolute. There have been others, such as Governor Chris Christie in New Jersey, who have shown a willingness to confront the unions. It is an uphill fight, but in this foreboding landscape the forces for change are now battling the status quo, providing flickers of light and hope.

Wednesday, September 22, 2010

"The Tea Party - Is It Only a Fad?"

Sydney M. Williams

Thought of the Day
“The Tea Party – Is It Only a Fad?”
September 22, 2010

First, let me state unequivocally I am not now, nor have I ever been a member of any “Tea Party”. I do not say that from a sense of remorse or of pride. It is simply a statement of fact. I also would never be a Rotarian or an Elk. My problem with the Tea Party – if it is a problem – is of two parts. It stems, first, from my sense that Tea Party members invoke “God” too often; second, I am generally uncomfortable in crowds and, in fact, dislike joining most any organization. That social reluctance probably stems from my being raised by parents who were artists and who preferred individualism to collectivism. In terms of the use of “God”, it is my belief that religion is a personal matter and should be celebrated individually. I have nothing against temples, churches or even mosques, all of which I am sure satisfy multiple needs. However, I do not like others to impose their beliefs on me and I have no interest in imposing mine on them. While morality, I believe, is universal, formal religions tend to be parochial – important to individual congregations, but not necessarily to those on the outside.

Nevertheless and having written the above, there are certain tenets for which the Tea Party stands with which I have sympathy. Robert Merry, writing in Stratfor, cites three general principles of the Tea Party: fiscal responsibility, constitutionally limited government and free markets. These are what I would term “directional” as opposed to “precise” terms and depend upon one’s definition or interpretation. Most people would agree that to be “fiscally responsible” is an admirable trait. A “constitutionally limited government”, to invoke former President Clinton, depends upon one’s definition of “limited”. Certainly, a non-intrusive government is preferable to a meddling one. I am a believer in “free markets”, but I also believe in reasonable regulation. In my opinion, government should set the rules and private enterprise should provide the players. Historically, though perhaps not histrionically, the difference between the two main parties has been a question of emphasis or degree, more than definition. The rise of the Tea Party reflects concerns that Mr. Obama may be leading the country down the path toward European Socialism, not simply tilting left.

Despite the inclusion of the word “Party” in its name, the Tea Party has not become, at least not at this point, a third party. The history of the United States is replete with third parties. While some of those Parties were distinctly out of the mainstream, others have been in the vanguard of change and influenced future elections. Two examples cited by Mr. Merry in Stratfor, are the 1968 and the 1992 elections. In 1968 George Wallace took 14% of the popular vote and won an Electoral College plurality in five Southern states. Richard Nixon won the election with only 43% of the popular vote, but, by incorporating the angry Wallace voters, Nixon won a landslide victory in 1972 – winning the popular vote with a 23.2% margin, the fourth largest in U.S. history. The second example Mr. Merry writes of was Ross Perot in 1992. Mr. Perot ran on the platform of the Reform Party. Bill Clinton won the election, ironically with the same percentage of the popular vote (43%) as did Nixon 24 years earlier. While Mr. Clinton did not address the concerns of the disaffected Perot voters in his first two years, after Democrats lost the House in 1994 he moved to the center and then won re-election with their support in 1996, with an 8.5% margin. (Mr. Perot ran again in 1996 and, even though excluded from the Debates, still garnered eight million votes.)

In a front page article, “Bloomberg Pushes Moderates in National Races”, Michael Barbaro in the New York Times on last Sunday wrote: “Mr. Bloomberg described the Tea Party movement as a fad, comparing it to the short-lived burst of support for Ross Perot in 1992.” Perhaps, but an Eastern elitist trivializing a few million voters (most from the heartland of the South and Midwest) does not make a lot sense for someone who appears to have higher political aspirations. Appearing to rise above Party frays, Mr. Bloomberg “is trying to pull politics back to the middle, injecting himself into marquee contests and helping candidates fend off the Tea Party.” However, his support for Senator Harry Reid, hardly a centrist, suggests to me a politician who is less interested in the “middle” than one concerned with the right, as represented by the “dreaded” Tea Party.

On Monday, President Obama referred to the Tea Party movement as part of a “noble” American tradition. He is right. Two sitting U.S. Senators were elected as third party candidates – Joe Lieberman, by the Connecticut for Lieberman Party and Bernie Sanders as an Independent in Vermont. Wikipedia lists 25 active micro parties, 22 regional parties, 22 inactive micro parties and 64 historical parties. Some of these parties, such as the Socialist Workers Party and the Progressive Labor Party, have been around for fifty or more years. The Liberal Party of New York was formed in 1944. Others are (or were) ephemeral.

For the last 150 years two Parties have dominated American politics: Democrats, since Thomas Jefferson in 1800 and the Republicans since 1860. In the early years of the Republic, the Federalist Party of John Adams morphed in 1834 into the Whig Party and then, with the election of Abraham Lincoln in 1860, into Republicans. Today the two main Parties, not surprisingly, look upon third parties as spoilers, but the real role they play has been to serve as an outlet for the frustrations of voters who feel disenfranchised. Polls representing both Democrats and Republicans indicate disenchantment with Washington politicians of both Parties. While the President’s numbers have declined, they are far above those for elected members of Congress. Many, though not all, of elected officials have been in office so long they feel a sense of entitlement – that the seat they occupy is theirs, not the people’s.

The Tea Party is a manifestation of the estrangement people feel today. Politicians who choose to marginalize and trivialize the movement do so at their own peril. The Party has become a collection of a diverse group of people, some of whom, like Christine O’Donnell of Delaware, just seem nutty, while other like Marco Rubio of Florida and Joe Miller of Alaska seem more reasonable. The history of Third Parties suggests that it will eventually peter out, not because it is a “fad”, but because many of its ideas will be incorporated into the Platforms of the two main Parties. It is the way in which both the Democratic and Republican Parties, in an ever changing world, survive.

Tuesday, September 21, 2010

"All That Glitters May Not Be Gold"

Sydney M. Williams

Thought of the Day
“All That Glitters May Not Be Gold”
September 21, 2010

On Friday, on the day gold hit an all-time high of 1279.60, I watched Fox News’ Special Report with Brett Baier. I noted that there were four ads urging me to buy gold, one reason being “because it has never been worth zero” – not to my mind the most compelling and comforting argument for a commodity that has risen from $269.50 ten years ago to $1282.00 today – a compounded return of 16.9%. Another gold ad, this one from Rosland Capital, with G. Gordon Liddy as chief spokesman, was equally off-putting. In my mind – perhaps unfairly – Mr. Liddy is indelibly linked to President “Tricky Dick” Nixon, breaking-and-entering, and Watergate; so it is hard for me to imagine that anything Mr. Liddy wants to sell is something anybody would be willing to buy.

Gold has certainly performed well over the past ten years, but if one looked at the price of gold ten years before that – September 21, 1990 to September 21, 2000 – one would see a more dispiriting picture, as the price declined 30.8%. Thirty-nine years ago, on August 15, 1971, President Nixon removed the guarantee that the United States would honor foreign central banks’ redemption of their U.S. paper Dollars for gold at $35 per ounce. Within a month, gold was trading at $42.73 and within a year at $67.03. The price proceeded to rise sharply, driven by stagflation (a combination of low economic growth and high price inflation), until it reached $850, providing a staggering compounded annual return of 41.7%.

Bulls today, as part of their argument, cite the final surge, which carried the price up almost four fold from $230.55 on Friday, January 19, 1979 to its peak of $850.00 on Monday, January 21, 1980. They note that today’s gold price should witness a similar blow-off. They also point out that the previous peak of $850.00, on an inflation adjusted basis, would equate to $2184.00, seventy percent above today’s price. Additionally, gold bulls cite gold’s ability to protect against the dollar’s debasement, a possibility, given our enormous deficits, that has morphed into a probability. However, history shows that gold acts as a hedge some of the time, but not all the time.

Over the forty years since it began trading freely, gold has proven a valuable hedge during two of those four decades – the first and the last. The middle two decades went to stocks. Timing, as is true in so many situations, is especially critical in investing. If one had bought gold on January 19, 1979 (a year before the final blow-off) and held it through yesterday the compounded return would have been 5.7%. Of course if one had bought gold a year later on January 2, 1980 and held it through today, the price would have compounded at 2.8%, approximately off-setting the compounded annual decline of 2.6% for the U.S. Dollar.

Following forty years of a fixed price at $35.00, the untethered price of gold surged during the inflationary, unstable 1970s. It has done so again over the decade of the ‘00s – not a period of high inflation, but a time when monetary policy was easy and deficits began to build. The question for investors: will the price of gold continue to rise?

Over the years, stocks have reflected almost precisely the mirror-image return to gold. During the 1970s, while gold was levitating, stocks were sinking. As gold went into a twenty year bear market slump beginning in early 1980, and the dollar’s value shrank by about 40%, stocks gained 1170%, providing a far superior hedge. Now, after a ten year period during which stocks have lost 22% of their value, gold has appreciated 440%.

For years, an old wives tale once made the rounds, suggesting that an ounce of gold bought a decent suit. Suits have gone out of fashion and prices have sympathetically declined; so the comparison may no longer apply. (Other than weddings or funerals, for example, I rarely wear a suit.) Nevertheless, an average suit at Brooks Brothers cost about $600.00, a considerable discount to an ounce of gold.

I claim no ability to read the future. But investors should avoid the temptation to extrapolate their most recent experiences when forecasting the future trend of any commodity, be it gold or stocks. However, when a price of anything has risen as steeply as have gold prices over the past decade, coupled with Mr. G. Gordon Liddy barking abuses urging me to buy gold at today’s prices, I find comfort in procrastination.

Monday, September 20, 2010

"Xenophobia - No Matter the Economy, Never an Answer"

Sydney M. Williams

Thought of the Day
“Xenophobia – No Matter the Economy, Never an Answer”
September 20, 2010

In the late 1940s/early 1950s, on our way to swim in Willard Pond in Hancock, NH, we used to drive past what my father always claimed was a Gypsy encampment. Whether my father was romanticizing what was a small group of people living in desperate, rural squalor, or whether they really were Romas or Romanis, I never learned. While my sister Betsy also remembers our father’s claim, the owners of the Hancock Inn where my wife and I spent this past weekend were unable to confirm that Gypsies ever lived in the area.

What got me thinking of that incident so many years ago was a disquieting report in Friday’s New York Times (and echoed in the same day’s Wall Street Journal) that President Sarkozy has been deporting Romas from France since mid August. The decision to do so is a reminder that prejudice and injustice remain present in developed societies; economic hard times bring forward feelings of xenophobia, not unlike the way a summer’s rain on a garden brings forth earth worms.

The September 16 issue of The Economist includes an article entitled, “A Long Road: Europe’s Romanis have mostly a horrible time. But they are thriving in America.” The author writes: “They fare better in some countries than others. Spain and Macedonia count as ‘relative’ success stories; the worst black spots of disadvantage are in Bulgaria, the Czech Republic, Hungary, Romania and Slovakia.” Since France has chosen two of those countries – Romania and Bulgaria – as the recipients of their Roma deportees she must rank among the worst. Thus far, since mid August, France has banished 8000 Romas and “cleared hundreds of illegal camps.” Both Bulgaria and Romania joined the European Union in 2007, so in a sense the peripatetic Romanis are testing the concept of the Union’s “open borders”.

As a child, and unaware of the awful poverty of their very existence and the gross persecution of their members, the term “Gypsy” conjured a romantic vision of a rootless people who happily wandered the world. So, when my father talked of the Gypsies camped along the dirt road leading to Willard Pond, I pictured campfires, music and dancing. What I saw instead were dirty faces with despondent expressions, dressed in rags – a people discriminated against simply because they looked different. (Of course, in rural New Hampshire at that time, if one weren’t white and of western European heritage, one did look different.)

The history of the Romas is not well documented. Most authorities trace their heritage to fifth century India, to a time when an economic calamity forced large numbers to take to the road to fend for themselves. They appear generally to have wandered west. The word “Gypsy”, apparently, derives from a corruption of the word “Egyptian”. What is known is that they are nomadic (perhaps more from need than inclination), that they are patriarchal, that they stick close to one another and that the language they speak is Romani. What is also well known is that they have long been persecuted. As early as 1544, Britain deported Gypsies to Norway. And, of course, they suffered grievously under the boot of Nazism seventy years ago. No one knows how many Romas were exterminated by the Nazis, but estimates range from 500,000 to 4,000,000.

While Gypsies are popularly associated with crystal balls, palm readings and tarot cards, many have risen to prominence, including at least one Nobel winner – Dr. Augustus Krogh of Denmark for physiology in 1920. More commonly famous entertainers of Roma heritage include Charlie Chaplin, Yul Brynner, Elvis Presley and Michael Caine.

The current issue of The Economist has a damning piece on President Sarkozy, entitled “The incredible shrinking presidency.” They write that when first elected President in May 2007: “He balanced firmness on immigration from abroad with fairness towards ethnic minorities at home.” In contrast, today “Mr. Sarkozy seems to be a shadow of the reformer he once was on economic affairs and a caricature of the tough-cop leader on social matters. He bashes capitalism with one hand and now Roma (gypsies) with the other. His popularity has collapsed…” No one denies the problems Mr. Sarkozy faces, but the deportation of thousands of Roma to countries that will not treat them well seems unnecessarily harsh and reminds one of earlier expulsions.

The world is in constant motion – for good and for bad. But fanning the fans of Xenophobia risks tilting the world toward nationalism, the tightening of borders and restrictions to trade; it risks halting a global economic recovery that is fragile at best. The answer, in the end, involves education and assimilation. A risk during times of economic hardship and high unemployment is to turn inward. Xenophobia is never a solution. America’s concerns about illegal immigration from Mexico get overblown and fail to recognize that the jobs these people often perform are ones that others, already here, do not want. Fear of the Chinese and the competition they bring to our manufacturers, so threatening tariffs, harms consumers and will hinder, not help, our exports. Similarly, sending Romas packing to Bulgaria and Romania raises the specter of past atrocities and will not enrich the French economically.

Thursday, September 16, 2010

"Washington, Are You Listening?"

Sydney M. Williams

Thought of the Day
“Washington, Are You Listening?”
September 16, 2010

Candidate Obama, two years ago, wanted change. As the primaries on Tuesday showed, so do the people. The problem for the President is that the change the people want is not what he desires. The problem for traditional, ensconced Republicans is that the change people want is not on their agenda either. “It is a year,” as Gerald Seib writes in today’s Wall Street Journal, “of deep alienation.”

The President has, through the passage of healthcare reform and financial reform, moved the country toward statism, a direction that goes against the grain of an individualistically-inclined people. At the same time, Washington Republicans, like their Democratic brethren, have grown too comfortable with a Party that has served elected officials well, but not the people they represent.

The “anti-Washington” mood is not new and is not solely aimed at Democrats, as voters in Delaware and New York learned on Tuesday. Eighteen years ago Ross Perot garnered 19% of the popular vote for his Independent Party. An increase in spending and deficits in Washington disturbs a lot of people, and the “Tea Party” is its most obvious manifestation. People instinctively know that the financial crisis, which precipitated the deep recession we are now exiting, was not solely the fault of large, greedy banks and unscrupulous mortgage brokers. They know that a culture that encouraged consumption over savings and materialism over moral values certainly helped. They also know, that the federal government – through legislation such as the 1977 Urban Development Action Grants, the 1995 Empowerment Zone and Enterprise Community Program Enactment and the untethered increase in the balance sheets of the GSE’s – abetted reckless borrowing. Additionally, promises by government to public unions have been fiscally unrealistic for decades.

There were no mea culpas on the part of those in Congress for the role they played in the collapse of the housing market. In fact, the GSE’s were not included in the finance reform bill. And the installation of a new (temporary) Czarina, Elizabeth Warren, to lead a new consumer protection watchdog agency, looks to protect members of Congress from consumers, while attacking banks.

While the President rails against the “rich” and corporate interests, he should remember that those are the very people who funded his campaigns and helped elect him. In 2008, Goldman Sachs gave twice as much money to Mr. Obama as it did to Mr. McCain. In the 2004 Presidential election, the richest counties in the country voted for John Kerry, and in 2008 they voted for Mr. Obama. If one looks at a map of the country, for decades the two coasts, home to the wealthy and the educated elite, have been dominated by Democrats. Their claim that they solely represent the indigent and the helpless has not been true for decades.

Lost in the morass of political gibberish has been the backbone of America, small business people and the aspirational young. Warren Buffett and George Soros, pontificating from their bastions of billions, have theirs. The young want an opportunity to get theirs.

Election time is always a period when tempers flare and differences become accentuated. It is important to keep that in mind as we listen to the harsh rhetoric from both sides of the aisle. There was a time when politicians ran for office from the fringes – inciting their bases to get out the vote – but then governed from the center. That time seems to have passed and the rise of the “Tea Party” suggests that people are mad as hell. It becomes easy to demonize the members as “extremists”, but from what I have read, they seem to be an uncoordinated collection of people of diverse opinions and backgrounds with only one thing in common: they are frustrated by a federal government which is concerned with expanding its reach, perpetuating its life and lining its own pocket. When, for example, was the last time you saw a member of Congress in a Sears & Roebuck suit? Congress, with an approval rating of 23%, has a “no confidence” vote from the people.

Tuesday’s primaries may make the fall elections more difficult for Republicans. But the fact that 31 Democrats in the House signed a letter yesterday asking him to, at least temporarily, extend the Bush tax cuts for all income levels indicates a disenchantment with their party leaders.

The time has come, as I have advocated in the past, to impose term limits on those in Congress. Forty years in Washington enriches the members, makes them too comfortable and serves to insulate them from their constituents. Voters are frustrated and angry. Washington, are you listening?

Wednesday, September 15, 2010

"Don't Dismiss Dividends"

Sydney M. Williams

Thought of the Day
“Don’t Dismiss Dividends”
September 15, 2010

Since the end of August, the S&P 500 has rallied 7.1%, while the yield on the Ten-Year has risen 10.5% from 2.48% to 2.75%, indicating a quick, sharp decline in Treasury prices. Have investors just tired of negligible returns on cash and only modest returns on bonds? It’s too early to say if this is anything more than reflexive action, but it’s possible. Of course the three-week rally has been dramatic, so it may back off some, or at least go into neutral for a time.

A measure often used to determine the value of stocks relative to bonds is the spread between the earnings yield on the S&P 500 and the yield on the Ten-Year Treasury. Using that metric, stocks appear attractive. The spread today is 480 basis points, only slightly lower than it was in mid August when it reached 514 basis points; however, at the end of last year, when the market was trading where it is today, the spread was 160 basis points. The cause for the widening spread was a combination of a rally in Treasuries and an increase in earnings. (For comparison purposes, at the market lows in March 9, 2009 the spread reached 620 basis points.)

Low interest rates have driven corporations to the bond market – sensibly, in my opinion. Yesterday morning Bloomberg had a story that Microsoft may try to sell as much as $6 billion in bonds, allegedly to buy back stock or pay dividends. While they have a lot of cash, much of it is off-shore; so the company would incur a tax liability in repatriating the money to pay dividends or buy back stock. In May 2009, Microsoft raised $3.8 billion, in five, ten and thirty year notes and bonds. Given the current yield on those bonds, one could expect the company today to be able to raise money cheaper by at least 100 basis points – or an annual savings of $60 million, on $6 billion.

It’s understandable why corporations are raising funds in the bond market. What makes less sense is why individuals are buying those bonds so enthusiastically.

While Cisco, yesterday, declared their intention to pay a dividend – a good sign and, hopefully, a precursor of change – the general attitude toward dividends seems one of indifference. Equity is, of course, inherently riskier than debt and dividends can be reduced or eliminated with greater ease than interest payments. And, of course, there is uncertainty as to what the tax rate on dividend income will be in 2011. The Bush tax cuts are scheduled to expire at the end of this year, meaning that the 15% tax rate on dividends will go higher. Thus far no bill has been proposed to address the tax situation by either the President or the Democratic leadership. If nothing happens, taxes on dividends will increase, for those in the highest brackets, to 39%. The uncertainty as to the tax rate, I assume, has led to caution on the part of companies to use some of their large cash hoards to initiate or increase dividends. On the other hand, it is possible we may see some special dividends paid in 2010 to take advantage of the current tax rate. Should Microsoft proceed with their rumored bond offering, a special dividend may be in the offing.

The big advantage of dividends on common stock is that, unlike interest payments or dividends on Preferreds, they can be increased and often are. Dividends and stock performance are related. Standard & Poor estimates that about one third of their Index’s total performance over the past fifty years is due to dividends.

Additionally the Company (S&P) has what they term the S&P “Dividend Aristocrats”. These are companies within the S&P 500 Index that have increased their dividends annually for at least 25 years. These companies should not be confused with the S&P High Yield Dividend Index, which selects the 50 highest dividend yielding stocks from the S&P Composite 1500 that have also followed a policy of annual increases for at least 25 years. The latter includes some smaller companies. Of the former, there are currently 43 names, 8 fewer than a year ago. According to S&P’s data, the “Aristocrats” have outperformed the S&P 500 over the past three, five, ten and fifteen year periods, “while exhibiting a lower standard deviation across all those time periods”, meaning they did better with less volatility. Through Monday, the year-to-date price performance of those 43 stocks is +5.99% versus the Index which is up +0.61%.

Simply being on this list does not assure positive performance. The companies are on the list for only two reasons: 1) they are included in the S&P 500 and 2) they have raised their dividends every year for 25 years. And the list does change. Ten companies were removed in 2009 and two were added. In 2008, 60 companies were on the list, so there are 28% fewer companies listed today than two years ago, a testament to the financial crisis that precipitated the recession.

Investing for dividends is, obviously, not without risk. In 2009, eight hundred public U.S. companies reduced their dividends. The financial crisis, coupled with recession, created cash squeezes (or, at least, the fear of a squeeze) for a number of businesses, especially those in the financial sector. In the past two years, twenty companies have been removed from the list of “Dividend Aristocrats”, thirteen of which were financials, or financial related. (One, Legg Mason, was added and then removed after one year.)

Nevertheless, some factors are aligned that should favor dividend paying stocks going forward. The FINRA-Bloomberg Investment Grade Corporate Bond Index now yields 4.42%, about 140 basis points above the “Dividend Aristocrats”, a modest premium versus a group of stocks that has a long history of rising dividends; inflation, while positive, is modest, at least for now; the earnings yield on stocks is attractive relative to the yield on the Ten-Year Treasury; historically, dividends have contributed substantially to long term gains; corporations have record levels of cash on their balance sheets; and, perhaps most important, we appear to be in the early stages of exiting – not entering – recession.

As we have oft repeated, it is impossible to see into the future. But, in investing, trend following is not usually a rewarding path. Bloomberg recently reported that in the first seven months of this year $185 billion flowed into bond mutual funds, while $33 billion came out of U.S. equity funds. Savvy corporations are taking advantage of those capital inflows by issuing bonds with historically low coupons. In contrast, stocks have been sold down to pay for redemptions. It is a trend unlikely to persist, though there is no knowing when the turn will come. In the meantime, don’t dismiss dividends.

Tuesday, September 14, 2010

"Slow Down; There May be Value in Stocks"

Sydney M. Williams

Thought of the Day
“Slow Down; There May be Value in Stocks”
September 14, 2010

“Today, the old attitude of buying solid stocks as a cornerstone for one’s life savings and retirement has simply disappeared.” Those words, so apt today, appeared in the August 13, 1979 issue of Business Week and were part of a cover story, entitled “The Death of Equities”. More than seven million people had abandoned the stock market, following the 1974 bear market – at the time, the worse market decline since the Great Depression.

There is temptation, during times like these, to invoke the classic French phrase, “Plus ca change, plus c’est la meme chose.” Looking backward, in order to peer ahead, has validity and certainly a knowledge of the past is important. George Santayana, the Harvard philosopher, famously said: “Those who cannot remember the past are condemned to repeat it.” But things do change. In investing, change is the one constant we must live with. Each economic and stock market problem is unique, yet policy responses too often mimic those that were used in the past.

On August 30 of this year, the Wall Street Journal headlined an article, “The Decline of the P/E Ratio”. The piece by Ben Levisohn began: “As investors fixate on the global forces whipsawing the markets, one fundamental measure of stock market value, the price/earnings ratio, is shrinking in size and importance.” The very fact that the article was written at a time when multiples have been contracting, in my opinion, says more about the author than it does about the market.

A P/E ratio is a function of price and earnings, either reported or estimated. Mr. Levisohn writes: “Based on profit expectations over the next twelve months, the P/E ratio has fallen to 12.2 from 14.5 in May.” As to what explains the decline in multiples, Mr. Levisohn adds, “In short, economic uncertainty. A steady procession of bad news, from the European financial crisis to fears of deflation in the U.S., has prompted analysts to cut profit forecasts for 2011.” The statement, as written, just doesn’t read right. Stocks, at the end of August, were down just over 10% from their highs in May, yet Mr. Levisohn has the multiple down 16%, indicating that estimates for 2011 are higher than they had been four months ago?

Despite the lemming-like nature of analysts and their earnings estimates, the anticipatory nature of markets may well mean lower 2011 earnings. I don’t know. However, as a man of simple beliefs, I prefer lower multiples to higher ones, especially in terms of estimated earnings. The future is unknowable, but writing the obituary for the P/E ratio as a measure of value seems a tad presumptuous.

Similar to the 1970s, investors have been defecting from stocks. Terry Kennan, in Sunday’s New York Post, wrote: “Recent figures from the Investment Company Institute note that investors have taken out more than $33 billion from U.S. mutual funds in the first seven months of the year. If the trend continues, 2010 would be the biggest year for withdrawals since the 1980s.”

It is not my intent to imply that we are on the cusp of a new bull market, similar to the one begun in 1982. My guess is that we have not yet paid the full price for the exuberance of the late 1990s or for excesses in leverage endemic to the mid 2000s. But there is little question that stocks today are more attractive than they were eleven years ago, when investors were pouring money into them. On December 31, 1999 the S&P 500 closed at 1469.25 and earned $48.00. Today the Index is 24% lower, with consensus earnings estimates for 2010 70% higher than they had been in 1999.

Adding to traditional investor’s difficulties, a proliferation of indices, a growing number of ETFs and an expanding population of quantitative, algorithmic traders have caused markets to become increasingly correlated. Last Friday, Strategas issued a White Paper, “Beta as the new Alpha”. They point out that retail investors have been leaving a market that “has been dominated by professional investors whose time horizons have become increasingly short.” Thus, “returns to the stock picker appear to us to be increasingly dependent upon the returns of the average investor…” There is little wonder, then, why individual investors have been vacating the premises.

Uncertainty in Washington and the economy, along with more tightly correlated markets are pressuring multiples. Academics would argue that low interest rates should cause multiples to expand. Perhaps stocks, with contracting multiples, are suggesting we are nearing the end of the twenty-eight year bull market in bonds? Again, I don’t know, but it seems possible.

Augmenting the problem – what is an investor to do? – is the rapid-fire, ubiquitous proliferation of information. Hundreds of insistent e-mails and IMs are received daily; cable television has channels numbering in the thousands; there are more bloggers in the world than there are people in the United States, and there are still half a dozen newspapers that demand to be read. One feels one is on a treadmill, on which an invisible hand is constantly increasing the speed and raising the incline. We are out of breath and unable to push the hold button. The ability to stop and reflect is only a distant memory. We are experiencing what Douglas Coupland, in Sunday’s New York Times, termed “frankentime” – what time feels like when you realize that most of your life is spent working with and around a computer and the Internet.

An op-ed in this weekend’s Financial Times wrote of Jonathon Franzen and his new, highly acclaimed novel, Freedom. The article states that Mr. Franzen has “a reputation for near-monastic isolation” and wrote using “an old laptop that has had its Ethernet socket filled with glue.” According to the op-ed, Mr. Franzen retreats from the real world by bird watching.

As investors, we can learn something from Jonathon Franzen – not that we need to become ornithologists or muck up our computers, but reflection is an important ingredient in determining investments. It helps clear the brain. It behooves us all to slow down, turn off the talking heads on cable television, and look for values.

Monday, September 13, 2010

"The Rise of Anti-Islamism in the U.S."

Sydney M. Williams

Thought of the Day
“The Rise of Anti-Islamism in the U.S.”
September 13, 2010

Anti-Muslim sentiment in the United States, according to a recent poll, has risen from 39% in the immediate aftermath of 9/11 nine years ago to 49% today. Why?

People recognized, at the time of the attack, that it took an unusual level of fanaticism to seize control of a plane in mid flight, kill the pilots and, fly it into a building. Common sense told people that these actions did not reflect the interests or the beliefs of a billion Muslims. It was obviously the manifestation of a small group of terrorists who happened to be Muslims. President Bush quickly made that point. Two days after the horrific act, the President spoke: “Our nation must be mindful that there are thousands of Arab-Americans who live in New York City, who love their flag just as much as we do. And we must be mindful that as we seek to win the war, that we treat Arab-Americans and Muslims with the respect they deserve…We will hold those who are responsible for terrorists’ acts accountable and those who harbor them.”

Unfortunately, and surely unintentionally, President Obama has not demonstrated similar restraint and wisdom in his remarks regarding the building of the Cordoba Center, housing a Mosque, two blocks from Ground Zero. With the exception of a few Christian fanatics, no one denies the right of Muslims to build a Mosque wherever local zoning laws permit. However, the right to do so does not make it the right thing to do. It beggars the imagination to presume that Imam Feisal Abdul Rauf, an educated and sophisticated man who has worked to bridge cultural differences on behalf of both Republicans and Democrats, did not anticipate the backlash it has endangered. The decision was either insensitive or deliberately provocative.

If the desire had been truly to bring people together, in the manner of Edward Hicks’ Peaceable Kingdom paintings, the Imam would have made the decision in a collegiate manner, involving people of all faiths, including families of those who died on that tragic date nine years ago. Similarly the President and Mayor Bloomberg could have quietly urged a different location. The Center would still have risen in downtown Manhattan, but not in the shadow of Ground Zero; it could have worked to heal wounds that still fester.

The President, in emphasizing the right of Muslims to build where they choose – a fact with which there is little disagreement – served to put on the defensive those who opposed the location of the proposed center. In his hubris, he impugned, in his didactic comments, that anyone opposed was bigoted – an unfair and inflammatory observation, which has served to further divide an already polarized people. The consequence of this division has been a rise in anti-Muslim feelings, an elevation in rhetoric and the fifteen seconds of fame for a nut case in Florida who had intentions to burn the Koran.

President Obama may be a very smart man, but he does not convey the Wisdom of Solomon.

Friday, September 10, 2010

"Three Bites - Interest Rates, Exports and Hillary Clinton"

Sydney M. Williams

Thought of the Day
“Three Bites - Interest Rates, Exports and Hillary Clinton”
September 10, 2010

Very low interest rates have provided a unique opportunity for borrowers, or, as Thursday’s New York Times put it in a front page headline, “Debtors Feast at the Expense of the Frugal”. Jim Grant writes of the phenomena in his recent Grant’s Interest Rate Observer when he speaks of IBM “bookending” the great bull market in bonds, begun in 1981 and still underway, though appearing to me to be getting long in the tooth. The bonds that IBM issued in 1981 paid 850 basis points more than the three year, one percent notes IBM issued a couple of weeks ago. One could also point out the thirteen hundred basis point decline in Ten-Year Treasuries during the same thirty years.

Yields on Investment Grade Corporate Bonds have declined from 6.35% at the end of 2008 to 4.48% today, while yields on their High Yield cousins have fallen from 17.43% to 8.58% in the same time. The Wall Street Journal pointed out yesterday that $51 billion in corporate bonds and leveraged loans came to the market in the past two days. Earlier this week, for example, the health care company Allergan raised $650 million in ten year bonds for a cost of 3.375%! At the same time, according to Bloomberg, 68 of the S&P 500 companies have dividend yields that exceed that of their debt.

Low rates, while good news for borrowers, serve to mask excess leverage, as interest costs are kept exceptionally low. However, when things seem too good to be true they often are. And the enormous deficits and obligations being rung up by the federal and state governments will almost certainly extend into a period of rising rates, putting added pressure on already bloated budgets. Of course, if deflation is to be our future, today’s interest costs may turn out to be expensive, but, in my opinion, that is a low probability bet.


On Thursday morning, in a somewhat rare piece of good economic news, the trade deficit narrowed from $50 billion in June to $42.8 billion in July, thanks to a 1.8% increase in exports and a 2.1% drop in imports. Exports represent only 12% of our economy (and, of course, imports are subtracted from GDP), but if consumers continue to retrench (which they should for the sake of their balance sheets) we will have to rely increasingly on exports to generate the kind of growth the economy needs to shrug off the malaise of the present. For that to happen, however, our leaders in Washington must focus on permitting American businesses to be more globally competitive - to worry less about perceived acts of unfairness on the part of trading partners and competitors and more on lowering barriers and reducing taxes. Unfortunately a recent survey by the World Economic Forum of the world’s most competitive economies indicated that the United States, in terms of competitive advantage, slipped to fourth place from second, behind Switzerland, Singapore and Sweden. Two or three years ago, the U.S. had been number one.

Any success in meaningfully expanding world trade is going to have to overcome the objections of our shrinking industrial-based unions, not an easy task for a President who relies heavily on financial support from them. It will also require the quick adoption of free trade agreements from Colombia, Panama and South Korea now awaiting the President’s signature. Nevertheless, Thursday’s news was welcome.

In a remarkable response to a questioner on the federal deficit following a major speech at the Council on Foreign Relations early this week, Secretary of State Hillary Clinton answered: “It poses a national security threat in two ways: it undermines our capacity to act in our own interest and it does constrain us when constraint may be undesirable.” Later she added that the deficit projects a “message of weakness.” Interestingly, Reuters reported the comment as did a number of TV news shows, but neither the New York Times nor the Wall Street Journal mentioned it in their articles on her speech.

Perhaps I am reading too much into her comments, but, at a time when the deficit is at record highs, the President’s poll numbers are low and when his economic proposals show no let up in government spending, her answers raise questions as to her future plans. A legacy of President Clinton, and one for which he should feel justifiably proud, is that he left the White House with a fiscal surplus. The federal deficit is now roughly three times the level it was when President Bush, no paragon when it came to deficits, left office. And, of course, should interest rates begin to rise the costs of the debt will mount. In an op-ed in this morning’s Wall Street Journal, Jason DeSena Trennert of Strategas Research Partners, that 60% of America’s sovereign debt is set to mature within three years and that the weighted average cost of the U.S.’s debt is 1.21%. A 200 basis point increase on the $8.3 trillion in debt would add $160 billion to the annual budget.

Secretary of State Clinton is not known for her casual, off-the-cuff comments. She is a deliberate, controlled person, who had to have understood the consequences of her answers. One cannot help wonder if she has plans for mounting a challenge to Mr. Obama in 2012.

Wednesday, September 8, 2010

"The Economy and the Market - A Perspective"

Sydney M. Williams

Thought of the Day
“The Economy and the Market - A Perspective”
September 8, 2010

A long plane ride provides an opportunity to read the papers more closely, and to think about and consider the myriad questions that envelope us every day. A flight on Tuesday morning gave me that chance.

The financial world is always confusing. Just as we think we understand what is happening, and therefore feel confident in our assessment as to the future, our preconceptions are interrupted, sometimes rudely and other times pleasantly.

There was a wonderful article in Tuesday’s New York Times on a recently cut down willow tree in Turtle Bay garden, memorialized in E.B. White’s paean, Here is New York. The Times story by Victoria Shannon is a reminder that the Press, so often accused by me and others as purveyors of partisan political polemics, can rise above the furor and provide the reader observations on the basic goodness and humanity of the world beyond the immediacy of our financial and political travails.

Gideon Rachman, in the same date’s Financial Times, writes of the risks of adamant economists who with “physics envy” reach precise predictive conclusions as to the direction of future trends based upon their formulaic responses to today’s events. In contrast, Mr. Rachman writes, “Historians know their work cannot be used to predict the future. History can suggest lessons and parallels and provide wisdom - but what it cannot do is provide a sociological equivalent of the laws of physics.”

The risk in economists presuming to “know” the consequences of the action they recommend is that they lose their flexibility and their ability to adapt. They become stubborn. Curiously (and instructionally), action taken by policy makers in the aftermath of the Lehman collapse was never hindered with that sense of certitude. Those of us in the investment world who have seen over decades the many sizes, shapes and directions of markets realize that “certainty” is not part of the lexicon. Investment expectations should be tempered, especially in an environment as uncertain as today’s appears.

Of course historians have the luxury of studying the past, not forecasting the future. They ask “what if” questions, such as had Germany proved victorious in World War I would World War II inevitably have followed? While such questions make for stimulating debates, we must live with the world as it is, not as it might have been. On the other hand, policy decisions taken today will impact our lives tomorrow.

In that regard, I found Peter Orzag’s (former director of the White House OMB from 2009-2010) op-ed in Tuesday’s New York Times disappointing. He wrote of the troubling economy and his suggestion that the Bush tax cuts be extended for two years - a good suggestion in my opinion. But he went on to argue that, “Additional revenue - in the range of 0.5 to 1.5% percent of the economy - will be necessary to reduce the deficit to sustainable levels.” He asks, rhetorically, “How would we do this?” His answer is to impose new and higher taxes. At a time when the federal budget, as a percent of GDP, is the highest since World War II, his answer is that salvation lies in making government even bigger.

Higher rates may be part of the solution. I don’t know, but I strongly suspect that successful initiatives for private industry will propel investment, so they would be the principal contributors to economic growth and, thereby, federal revenues. Government’s share of GDP has been reasonably constant in the post-World War II period at about 20%. It is now three or four percentage points above that. I agree with former British Prime Minister Tony Blair when he wrote in the weekend edition of the Wall Street Journal, “The role of government [in a financial crisis] is to stabilize and then get out of the way as quickly as is economically sensible. Ultimately the recovery will be led by industry, business and the creativity, ingenuity and enterprise of people.”

Taking a longer view is always difficult and especially in these times when politicians, reporters, economists, portfolio managers and pundits are seemingly afflicted with a bad case of Attention Deficit Disorder. It explains why tough decisions, despite exhortations to the contrary, like Social Security and Medicare get kicked down the road. In Washington, frugal congressmen are never as popular as big spenders.

James Grant, in the current issue of Grant’s Interest Rate Observer, writes of the current period of low interest rates and their cyclical nature. He quotes Sidney Homer, author of the classic History of Interest Rates, “The cost of borrowing has tended to rise and fall at generation-length intervals.” No matter the logic behind the reasoning, economics and markets can never be forecast with mathematical precision. They are, as Mr. Grant puts it, cyclical in nature and subject to “the fallibility of human judgment.” So, no bell will be rung marking the end of the bull market in bonds, even as the twenty-eight year old current bull market approaches generational levels.

Life is akin to E.B. White’s willow. To Mr. White, the tree came to symbolize the city of New York, but it is also a metaphor for our lives: “Life under difficulties, growth against odds, sap-rise in the midst of concrete, and the steady reaching for the sun.” That willow, as all things alive must, died. But, as Ms. Shannon points out, the tree, in giving hope, served its purpose. And, in death there is life. Bill Logan, who lives in Brooklyn and who cut down the willow, saved some cuttings. Ms. Shannon quotes Mr. Logan about one of the cuttings, “It’s doing fine! It’s now fully eight feet tall...we better decide what to do with it before it gets too big to move.”

Life does go on. And so will we, perhaps in directions different from what we imagine, but, with an understanding of the past, while living in the present, and remaining flexible as to the future, we will survive and, with care and diligence, thrive - comforting thoughts as my plane descended into San Francisco.

Thursday, September 2, 2010

"The Economy Finally Takes Center Stage as Election Nears"

Sydney M. Williams

Thought of the Day
“The Economy Finally Takes Center Stage as Election Nears”
September 2, 2010

Tuesday night, speaking from the Oval Office, President Obama marked the end of “Operation Iraqi Freedom” and said, as reported in the New York Times, that “he sees his primary job as addressing the weak economy…” A focus on the economy will, of necessity, include a debate over taxes, a subject of increasing tensions with adamancy on both sides subsuming reasonable debate. It will also bring the plight of small business, the employer of most U.S. workers, to the forefront. The way out of recession and toward long term prosperity depends on private employers.

The Obama-Biden plan for small businesses incorporates some sensible recommendations, including eliminating all capital gains on small and start-up businesses, doubling federal funding for basic research, making the research and development tax credit permanent, and promoting broadband to every community in America.

But the plan also displays the administration’s predilection for extending their tentacles into the reaches of business and promotes the concept of a wise, paternal and bigger government. For example, the administration, with shades of the 1996 Affordable Housing Act hovering overhead, would expand the Small Business Administration’s loan and micro-loan programs which provide start-up and long-term financing for small firms that are unable to receive through normal channels. They would implement the Women Owned Business program, a plan that helps women set up enterprises that would like to do business with the federal government; additionally, they want to increase the access to venture capital by minority owned firms.

The goals may be noble, but should the purpose of government, in times of economic distress, be to stimulate growth or to promote equality of outcomes? Keep in mind that about 50% of the approximately 600,000 new businesses that start each year fail after five years and about 70% fail after ten years. It is nature’s equivalence of the survival of the fittest. An overreliance on Uncle Sam may breed bad habits and risks a descent down a slippery slope toward an agency modeled on other GSEs, like Fannie Mae, Freddie Mac or Sallie Mae. More than anything else entrepreneurs must be self-starters. The most important thing government can provide entrepreneurs are clearly defined rules, a sense of stability and a tax base that allows them to compete in a global environment. Nevertheless, access to credit has been a problem. While according to the New York Times, the Federal Deposit Insurance Corporation’s quarterly report showed that the banking sector is beginning to recover, the number of “problem banks” reached 829 in the second quarter, an increase of 54 from the first quarter. Tighter lending standards, coupled with their experiences during the 2008-2009 recession, have naturally made banks more cautious.

More than anything else, as we and others have repeatedly argued, the administration needs to restore confidence. An article in Monday’s Washington Times reported that “a recent Labor Department survey found that businesses with fewer than 50 employees – which normally create as much as 75% of all jobs – accounted for 62% of all job cuts and only 54% of new jobs at the end of last year.” A complex healthcare bill, a fragile recovery and uncertainty about taxes have made business people nervous and wary.

The question of extending the Bush Tax cuts of 2001 for those earning more than $250,000 will be first on the agenda. There appears to be a general agreement about extending the cuts for those earning less. What complicates the issue is that about 30 million tax returns report small business income: sole proprietorships, and pass-through entities in the form of partnerships and S-corporations. Many of those would be negatively affected by an increase in taxes.

The question as to the impact of tax increases has been debated endlessly. David Leonhardt, in the New York Times, quotes Moody’s Analytics as estimating that “a new rebate would have about three times as large an effect on growth next year as would making all the 2001 tax cuts permanent.” He also praises last year’s cash-for-clunkers program, though he acknowledges that “of course, no temporary tax cut will solve the economy’s long-run problems.” I am left perplexed.

On the other hand, the Joint Economic Committee of the Congress of the United States in an April 1996 white paper, “The Reagan Tax Cuts: Lessons for Tax Reform”, notes: “the reduction of high marginal tax rates actually increased payments by the rich”. That has always been the case. The Committee’s report goes on to state: “High marginal tax rates discourage work effort, saving and investment, and promote tax avoidance and tax evasion.” The economic benefits of the Economic Recovery Tax Act (ERTA) of 1981 were summarized by President Clinton’s Council of Economic Advisers in 1994: “It is undeniable that the sharp reduction in taxes in the early 1980s was a strong impetus to economic growth.”

The economy needs focus and the President’s words were welcome. Confidence remains low. Corporations, alone, remain in good shape. Their cash levels remain high; M&A has been active, yet investment in green-field expansion, which would encourage hiring, is low. The costs of the enormous federal deficits are being masked by very low interest rates and relatively short maturities. A back up in rates will raise the costs of borrowing and aggravate the deficits. (In fact any business depending upon short term financing is at risk to the potential to rising rates, which will happen.)

It is the economy, and specifically jobs, that has been the principal concern for the majority of people for the past year and a half – not healthcare, not the bankers, and not Iraq or Afghanistan. Remarkably, there has been no bill proposed by the president or Congress as to what to do when the Bush tax cuts expire in four months. Equally disturbing, the administration has chosen to wait until after the mid-term elections to hear the recommendations of the deficit commission. Common sense suggests the focus must be on growing the economy and addressing the deficit. We are pleased that this has become the President’s focus; however, the risk is that ideology interferes with needed changes.
I will be out the next few days, back in the office on Friday, September 10. My best wishes for a labor-free Labor Day.

Wednesday, September 1, 2010

"Somber August Days"

Sydney M. Williams

Thought of the Day
“Somber August Days”
September 1, 2010

A deep, dark gloom is bad enough, but when it is also silent it lends eeriness to an otherwise dismal month. August, which started so promising with a 208 point gain in the DJIA, saw the S&P 500 decline 52.27 points (- 4.7%), with volume on the consolidated tape running 31% below a year earlier. Volume has been ebbing since May and on Monday was the lowest of the year for the consolidated tape. Global equity markets have lost more than $2 trillion in value since Treasury Secretary Timothy Geithner termed this long, hot, dry period, the “summer of recovery.” “August Horribilis”, is the term Queen Elizabeth might use to describe the month should she be long U.S. equities. Of course, as the four-greats granddaughter of George III (and perhaps still bearing a grudge), she may consider the month “August mirabilis”, saying it serves us right and that money is simply quitting its wrongful owners.

Light volume may be principally a function of dispirited investors escaping the heat and despondency so familiar to those of us who have stuck it out in the City, but, as I wrote in an earlier piece, it may also reflect a retrenchment in high frequency trading programs. Providing some credence to the latter postulation, volume on the NYSE, while down, did not on Monday set a record for the year or the month of August. Two other Monday’s in August, the 9th and the 16th had lower volumes than that day.

Bearishness may not be rampant, but it is becoming more the norm. Over the weekend, Bob Farrell noted that the AAII Individual investor poll fell below .50 for the first time since early July, a number below which generally portends at least an interim low.

Economic news has been equally somber: unemployment continues to be weak, home sales are at multi-year lows, as are auto sales and banks remain cautious as to lending. However, curiously, while the S&P 500 is down 5.5% year-to-date, prices of high-yield bonds, using the FINRA-Bloomberg Index, are up, with interest rates declining from 9.57% to 8.50%, suggesting speculation is around, just not in stocks.

Into this dour world has arrived on my desk a report from Empirical Research Partners, a fascinating report on the state of the money management business. Words and phrases like bundling, commoditization, low-priced beta, liability-driven investing, absolute-returns, uncorrelated, volatility and complexity fill the pages – words that have become increasingly commonplace in investing and are attempts to describe what was once an art and which is now perceived a science. Responsibility for this change that has been underway for two or three decades comes from the confluence of a number of factors: the rise of consultants who have worked actively to narrow the benchmarks against which managers are measured (consultants earn their bread moving money from one manager to another), the advent of computer trading programs and the concomitant hiring of quantitative analysts, and more recently the rise in volatility and the abysmal performance of stocks over the past dozen years. I would add another qualitative factor and that is the unrealistic return assumptions of businesses and unions, who are responsible for defined benefit retirement plans. By using exorbitant return assumptions, a promise to employees could be made while the company could avoid making contributions which could hurt the profitability of the company. Similarly, unions have been able to promise guarantees without subtracting funds from the current earnings of their workers. The effect has been to kick the proverbial pail down the road, leaving the dirty work of cleaning up the mess to some future employer or union leader. In the meantime investment managers, as the authors of the report put it, “are slouching toward liability-driven investing”, a euphemism for watching one’s back.

I have been in this business long enough to be somewhat cynical as to anyone who can plan with precision the future course of events, especially when it comes to investing, a field which is notorious for attracting not only the bright, but the unconventional. The one thing we can say with certainty is that, as long as companies need markets to fund their operations, there will be stock and bond markets. The advent of indexing and ETFs – at 15% of assets, still a relative small slice of the equity world – does not eliminate the need for the underlying securities, in fact they require them. One could argue, that in an investment world increasingly populated by index funds, ETFs, HFT portfolios, etc. the analyst who can differentiate between an attractive investment and a poor one will become the “content provider” – the value link in the chain.

What is more important, as we enter a new month, is how and when do we exit this slough of despond. Like most questions of this sort, I have no answer, other than to quote Abraham Lincoln who when speaking in Milwaukee in 1859 quoted an “Eastern monarch”: “’And this, too, shall pass away’. How much it expresses. How chastening in the hour of pride – how consoling in the depths of affliction.” August ends; September begins.