Wednesday, October 7, 2015

Good management makes for great investing

Investors with the time will want to imitate Warren Buffet and invest in a few good companies rather than put up with a host of losers in an index fund, but analyzing individual companies in the way that Ben Graham taught is time consuming. Several experts have developed algorithms that examine financial data that helps weed out the worst.

But if an investor is going to marry a business he must become familiar with the quality of its management. Good management can turn a bad company around and value investors often want to buy shares in a company when it has hit rock bottom and has the potential to turn around.

Thursday, October 1, 2015

Currency wars round three

I finally got around to reading James Rickards’ 2011 book Currency Wars: The Making of the Next Global Crisis and really enjoyed most of it.

The best parts are the history of the currency wars, Currency War I (1921-1936), Currency War II (1967-1987) and the launch of Currency War III in 2010 that still rages. War III will likely finish in the same way that the previous ones did but Rickards suggests far more disastrous results.

As Rickards explains, currency wars are a continuation of the ancient mercantilist economics that Adam Smith tried to drive a silver stake into the heart of but failed. Like vampires, mercantilism will live forever by hibernating in the dark places of economic thought and springing to life in tragedies, and that vampire has bitten most mainstream economists.

Thursday, September 24, 2015

Myths of discounted cash flow

Discounted cash flow (DCF) is the adjustable wrench of modern financial mechanics. Essentially, the analyst forecasts the revenue and costs for several years out and applies an appropriate discount, or interest rate, to calculate what those future dollars are worth today. The process is supposed to provide a hard number for the current worth of the company.

But as many of us recognized in college, there is a lot of room for wiggle in the process. Forecasting revenues and costs is tricky and always based on assumptions. An optimistic analyst might generate a rosy forecast while a pessimist may predict gloom and doom. Usually, analysts just assume the future will look like the past, which is always a dangerous assumption. How many oil analysts saw the recent collapse in oil prices as a result of projecting the past into the future?

Thursday, September 17, 2015

New York manufacturing stumbles

In the Ricardo Effect, Hayek’s chief contribution to the Austrian business-cycle theory (ABCT), the turning point in the cycle from expansion to recession happens when the makers of consumer goods and services employee more workers and buy less equipment. Equipment makers face plummeting sales and rising costs for materials and labor, and therefore a profits squeeze. So they cut back on production.

Signs of that may have appeared in New York. The New York Federal Reserve released its August 2015 Empire State Manufacturing Survey reporting that the index fell to -14.9, its lowest level since 2009 in the depths of the latest recession. Naturally, economists had expected the number to be +3.86. A positive number suggests growth ahead and you can guess what negative numbers mean.

Thursday, September 3, 2015

Don’t drink the Schwab Kool-Aid

The Schwab Center for Financial Research recently published an article intended to tranquilize investor nerves after the latest volatility and keep them shoveling funds into the stock market. “Schwab’s Perspective on Recent Market Volatility” begins with “Global markets may have swung wildly in recent days, but we think the recent selloff in stocks and commodities is not a sign of imminent global recession.”

I’m picking on Schwab because they are big and can take it, but they have said nothing that almost all mainstream financial service firms aren’t saying. Also, Schwab put their piece in nice bullet points that are easy to address. I’ll take them on one at a time:

1. The basics of investing have not changed.

They should change because the received wisdom is to always buy, never sell and just swallow the bitter pill of a major market decline. Instead, investors should try to time the market by getting out of stocks before a recession hits.

Friday, August 28, 2015

Stock market forecasts better economists

After the stock market stumbling through the past two weeks, you will hear top mainstream economists repeat the old joke that the market has predicted ten of the last eight recessions. The point of the joke is to belittle the idea that the market can predict recessions and to convince investors to remain fully invested. Austan Goolsbee echoed the joke on National Public Radio recently then insisted the economy was fine and he saw no recession in the near future. When asked if now was a good time to panic, he said it’s never a good time to panic and people should just ignore what the market does.

It is true that the market has predicted more recessions than actually happened, but if anyone will examine the data they will find that growth slowed dramatically after major declines in the market even though the fall wasn’t deep enough for the National Bureau of Economic Research to declare an official recession. But even with its false positives, the market has done a better job of predicting recessions than have any mainstream economists.

Thursday, August 20, 2015

Training the Chinese dragon in economics

The story of China’s great leap forward to slightly freer markets is well known. Around 30 million people starved to death in the 1960s and the West fed the Chinese in the 1970s. Deng Xiaoping took over after Mao died and began looking for some way to make Communism work well enough to at least feed the people.

About the same time, a small group of farmers in a remote village rebelled against socialist farming by dividing up the land among them and selling their excess produce on the black market. They signed a contract binding each farmer to take care of the families of any farmers whom the state discovered and executed. After a couple of years, they couldn’t keep their success a secret any longer and Deng found out. But instead of executing the farmers, Deng made them national heroes and encouraged other farmers to do the same.